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How Central Banks Create Inflation (Intellectual Capitalism Part 4)

This article continues from where my article Money and Banking ended.

Central Banks like the Federal Reserve in the United States are different than commercial fractional reserve banks.   As explained in the article A Brief History of Central Banks on the Federal Reserve Bank of Cleveland’s website,

A central bank is the term used to describe the authority responsible for policies that affect a country’s supply of money and credit. More specifically, a central bank uses its tools of monetary policy—open market operations, discount window lending, changes in reserve requirements—to affect short-term interest rates and the monetary base (currency held by the public plus bank reserves) and to achieve important policy goals.[1]

Unfortunately, this definition misses that fact that central banks are monopolies and therefore not part of capitalism (free market).

A central bank, or monetary authority, is a monopolized and often nationalized institution given privileged control over the production and distribution of money and credit. In modern economies, the central bank is responsible for the formulation of monetary policy and the regulation of member banks.[2]

According to this definition a central bank has control over “printing” the national currency, which in the modern world can be done by just a computer entry.  If you look into the Federal Reserve of the United States you will find that they have control over printing paper money, while the Treasury has control over minting coins.  However most currency today is just a computer entry and here the answers get even more obscure.  The best answer is that direct money creation is a dance between Congress, the Treasury, and the Federal Reserve.  Everything becomes convoluted when a central bank is added into the equation and so far we have only discussed direct creation of currency not open market operations, discount window lending, and changes in reserve requirements.  I think politicians and central banks, not to mention the largest banks and brokerages, like this obscurity.

In order to make this less obscure I will analyze each “tool” of a central bank separately.  In addition, we are going to analyze the direct money creation issue through the lens of Modern Monetary Theory (MMT).  One reason to look at MMT it is how most central bankers see the world, which is illuminating.  It also points out some uncomfortable truths and exposes some of the Keynesian nonsense.  Wikipedia explains MMT as:

Modern Monetary Theory (MMT or Modern Money Theory, also known as Neo-Chartalism) is a macroeconomic theory which describes and analyses modern economies in which the national currency is fiat money, established and created by the government. The key insight of MMT is that “monetarily sovereign government is the monopoly supplier of its currency and can issue currency of any denomination in physical or non-physical forms. As such the government has an unlimited capacity to pay for the things it wishes to purchase and to fulfill promised future payments, and has an unlimited ability to provide funds to the other sectors. Thus, insolvency and bankruptcy of this government is not possible. It can always pay”.[3]

This quote is very revealing, especially the idea that “the government has an unlimited capacity to pay for the things it wishes to purchase and to fulfill promised future payments, and has an unlimited ability to provide funds to the other sectors.”  At the beginning of this series I pointed out that when money enters the equation in economics, people think magic happens and logic disappears.  The MMT people think they can create wealth by manipulating money.  The MMT advocates believe money and banking allow for good magic and Austrian Economics argues that money and banking are bad magic (meaning it destroys wealth). econgrowth.small

This is why I wrote my book on The Source of Economic Growth, which shows that increases in real per capita wealth are created by applying our reason to the objective problems of life – in other words by inventing and increasing our level of technology.  Money is not wealth, as I showed earlier in this series.  Money and banking are mainly a lubricant for the economy.  Of course real inventions in money and banking do increase our per capita wealth, such as cryptocurrencies might do if the governments (central banks) of the world would get out the way.  Cryptocurrencies hold the promise of significantly reducing the cost of transferring money around the world.

Modern Monetary Theory is correct that the government cannot run out of money if has legal tender laws, but that does not mean that “the government has an unlimited capacity to pay for the things it wishes.”  The Gross Domestic Product (GDP) of the United States in 2016 was around $17 trillion.[4]  If the government decides to spend $20 trillion of wealth and continues to spend more than the total output of wealth of the United States, then the Unites States will go bankrupt.  The ability to print (create) more money will not matter.  Venezuela has a central bank, but it has not saved Venezuela or allowed its government “to pay for the things it wishes.”  The expected inflation rate in 2017 for Venezuela is 1,660% according to the IMF (International Monetary Fund) and its GDP fell 15% in 2016.  It also did not save the Weimar Republic which had a central bank, and it did not provide the government an unlimited capacity to pay for the things it wishes.  The MMT’s answer to the Weimar Republic is that they were forced to repay their war debts in gold.  According to MMT governments with a central bank and legal tender can be infinitely wealthy, which is clearly absurd.

The problem with MMT is it confuses money with wealth.  This is similar to how Keynesians reverse cause and effect, by arguing wealth is created by spending (consumption).  The ideas underlying MMT were proposed by John Law, who created the Mississippi Company in France in the early 1700s and almost bankrupt the whole country.[5]  It is a fascinating story, but beyond the scope of this article.

According to MMT the government creates money by spending.  As this article, Why a Central Bank Can Never Run Out of Money, explains:

The U.S. government spends it currency into existence. This is important, too. The government spends first and then collects taxes. (Logically, this is how it began, or else how would people get the money to pay taxes?) Taxes are what give the dollar value. As Alfred Mitchell-Innes, a diplomat and credit theorist, once put it: “A dollar of money is a dollar, not because of the material of which it is made, but because of the dollar of tax which is imposed to redeem it.”

According to this statement then increasing spending causes inflation, while increases in taxes cause deflation.  In the United States the Democrats (socialists) always want to increase spending and taxes, which cancel each other out according to MMT.  Republicans (conservatives) want to reduce spending and taxes which would also cancel each other out by this theory.  This analysis again confuses money with wealth and it ignores debt financing.

Another amazing thing about this statement is that if you or I “spent money into existence” it would be called counterfeiting and would be considered theft.  Somehow when the government does this, it is okay and according to MMT stimulates the economy (creates wealth).

The parenthetical comment “else how would people get the money to pay taxes?” is easily refuted by history.  People in the United States paid taxes, before the United States government had any legal tender.  As a result, there was no way for the government to spend before it collected taxes.  Even a cursory review of history provides numerous other examples, including early man in which there was no formal government.  In addition, my earlier article on Banking shows that banks create money when they create loans, which any MMT advocate should know.

I cannot make any sense of the final statement that the value of a dollar is created because of the tax necessary to redeem it.  This statement could only make sense to a totalitarian.  Totalitarians believe that when the government spends money it gives up some of its power and when it taxes and redeems the money it redeems this power.

This article explains the mechanism by which money is created as:

The Treasury spends dollars into existence through the central bank. The central bank credits the accounts of banks, and banks credit whoever is getting paid. Taxes reverse the process. Banks then debit accounts, and the central bank debits the banks. The government cannot run out of credits.

Note that no liability is created by the government in this direct money creation and no one is paying interest on this money, just like no one pays interest when money is printed.  There is a myth that all money in the United States (most modern countries) is created by a loan and that we have to pay the banks interest on all money created.  This is incorrect, the money created by this direct money creation process is not a loan and no one pays interest to have this money.

This process of money creation is only possible because the government has legal tender laws.  In my earlier article on Banking, I pointed out that legal tender laws were necessary for the government counterfeit money.  Since a central bank is tasked with controlling the money supply they require legal tender laws.  One of the fastest ways to undermine (eliminate) the Federal Reserve is to eliminate legal tender laws.

In theory Congress has to first authorize spending first.  However, in the United States we are not allowed to audit the Federal Reserve.  Thus it is possible even likely that the Federal Reserve creates money (direct money creation as opposed to a loan) and no one knows about it.  For instance, the Federal Reserve admitted that it could not account for $9 trillion of off-balance sheet transactions.[6]  While these may have been loans (we don’t know because we cannot audit the Federal Reserve), it shows how easy it would be for the Federal Reserve (or Treasury) to just credit someone’s bank account without anyone knowing.  Of course, I have no evidence of this, because we cannot audit the Fed, but human history would be on my side.

 

“Simple Inflation” under a Central Bank

In my earlier article on Banking and Inflation I defined simple inflation as that which occurs because of printing money or debasing the currency.  This direct creation of money function the same as these processes.  The amount of direct money created is equal to the total amount of money spent by the government, less the amount of taxes received, and less the amount of money borrowed by the government.  When a government resorts to direct money creation to pay for a large part of their operations, it results in rapidly increasing inflation rates.  Venezuela is the most blatant example today.

 

What we have learned:

  *Central banks do not arise in a free market (capitalism) they are a distortion of the free market.

            *Central banks require legal tender laws in order to fulfill their mission of controlling the money supply.

            *The amount the government spends less the amount it taxes and borrows is the amount of money created by the government (government counterfeiting), which results in simple inflation.

            *Modern Monetary Theory confuses money with wealth.

            *The fastest way to undermine (eliminate) the Federal Reserve is to eliminate legal tender laws.

 

Discount Window Lending

When most people think about the Federal Reserve (the central bank in United States) they immediately think about interest rates.  The Federal Reserve mainly affects interest rates in the United States by it setting of the Federal Funds Rate and by the Discount Rate.  The Federal Funds Rate is set by the Federal Reserve and is the interest rate at which banks lend reserve balances to each other.  The Discount Rate is the interest rate that the Federal Reserve charges banks to borrow from the Federal Reserve.  Both of these are related to the Federal Reserve’s function as a lender of last resort and are intended to prevent a “run on a bank.”

A run on bank is when a bank does not have enough cash (species) on hand to meet its customers demand.  This can occur to a sound bank and just represents a cash flow issue or it can be the result of a legitimate lack of solvency and confidence in the bank.  One of the main justifications for creating the Federal Reserve was to reduce the frequency of this occurring.  The empirical evidence is a mixed on this issue.  The Federal Reserve was created before the Great Depression and there were huge numbers of bank failures then.  However, the number of runs on banks and the number of bank failures where depositors lost money have probably decreased in frequency since the Great Depression.

When the Federal Reserve changes the Federal Funds Rate or the Discount Rate, which they usually change at the same time, it affects the interest rates that banks charge.  If the Federal Reserve increases either or both of these interest rates it usually causes banks to increase the interest rates they charge customers.  Generally the goal of raising interest rates is to reduce the number of loans banks are making and thereby decrease the money supply or slow its growth.  The opposite is true when the Federal Reserve lowers interest rates.  Thus it is normally considered inflationary when interest rates are lowered and deflationary when interest rates are raised.  Unfortunately, the empirical evidence is a bit murky on this issue.  For instance, interest rates were very low during the Great Depression in the United States and the money supply was shrinking.[7]  Milton Friedman and Anna Jacobson Schwartz argued that the Federal Reserve failed to fulfill their responsibility of lender of last resort.[8]

Since there appears to be some contradiction between the empirical data and the theory let’s examine this issue more closely.  When the Federal Reserve increases interest rates above the free market rate the result is that some projects that would have made economic sense to fund with a loan no longer are.  As a result fewer loans will be imitated by banks than would have been the case if interest rates were at the free market rate (the free market rate is the interest rate that banks would charge if there was no central bank).  This will reduce the money supply.  However this is a transient effect.  Once the economy has adjusted to the new interest rates loans will be created at this new lower rate.  At this point it is likely the money supply will grow (shrink) roughly at the same rate as the economy, as I explained in my earlier article on Banking.  If the Federal Reserve raises interest rates too far above the free market rate it can cause a nationwide liquidity crises, which will destroy some wealth that was or would have been created.  The government can destroy wealth, but it cannot create wealth only redistribute it.

If the Federal Reserve sets the interest rate lower than the free market rate but not too low, then more projects that would have not made economic sense to fund with a loan now are.  This results in a one-time increase the money supply and after that it the money supply should grow at about the same rate as the economy.  As a result, lowering the interest rate below the free market rate, but not too low, will result in a one-time increase in the money supply.

If a central bank lowers the interest rates too low, banks will refuse to initiate loans.  How low?  Well if the interest rate that banks can charge to commercial customers is the same as they can get on Treasuries, then the banks are not compensated for the risk and expense of initiating a commercial loan.  Banks need to be able to charge interest rates to their commercial customers that compensates for the extra risk and expense involve over supposedly safe investments like Treasuries (government bonds).  As a result, when interest rates are set too low by the central bank it results in a contraction of the money supply.

This shows that low interest rates (lower than free market rates) are not the cause of long term inflation and if the interest rate is too low it can be deflationary.  This is likely what has been happening in Japan since the 1990s and happened in United States during the Great Depression.  Other government policies can also effect how the economy behaves, which makes it hard to nail down the exact effect of the central banks policies.  For instance, Friedman and Schwartz seemed to blame the Federal Reserve for everything that happened in the Great Depression, however it is clear that other anti-free market policies by Roosevelt and Hoover before him also contributed significantly to the Great Depression.

Central banks can also change the number of loans that are initiated by changing the reserve ratio requirement.

The commercial bank’s reserves normally consist of cash owned by the bank and stored physically in the bank vault (vault cash), plus the amount of the commercial bank’s balance in that bank’s account with the central bank.[9]

However, this also should have a one-time effect on the money supply.  The result is that long term inflation is not caused by a central bank’s interest rate policy.  A central bank’s failure to act as a lender of last resort may cause an extended period of deflation however.

 

Open Market Operations

Another tool of central banks is open market operations where the bank goes into the market and sells or buys securities, usually bonds.  When a central bank buys securities it increases the money supply.  This operation involves the central bank creating money (a computer entry without any associated liability) and then buying the securities, which puts money into the economy.  As those bonds (normally the central bank buys bonds) are paid off it decreases the money supply.  As a result, buying securities results in a one-time increase in inflation that is removed as the bond is paid back.  Of course the central bank can continue to buy bonds if it wants to continue to inflate.

Alternatively, the central bank can sell securities, which results in a decrease in the money supply as private parties trade cash for the security.  As the private parties receive payments from the securities (if they are bonds) the money is reintroduced into the economy.  Each purchase by the central bank is a one-time decrease in the money supply (assuming the security is a bond) that is removed over time as the bond is paid back.

Both of the scenarios above assume that the central bank is buying or selling bonds (or other securities) at their free market rate.  If the central bank over pays for a bond the amount that it overpays for the bond is a direct creation of money and is not redeemed as the bond is paid off.

When the bond is a government bond (national) and the central bank agrees to purchase the bond at a lower interest rate than the free market rate, then this results in the direct creation of money equal to the difference in the required payments in a free market verses what the government actually pays.  This is clearly inflationary and very subtle.

When a central bank starts buying a significant percentage of the government bonds when issued, the most likely reason is that private buyers are not willing to purchase the bonds at the price (interest rate) the government wants to sell them at.  This is one of the surest signs that the central bank is creating large amounts of money to finance the government.  However, it is very subtle.  It is very hard to calculate how much money has been directly created.  If the central bank buys the government bonds near their real cost and requires payments based on tax receipts, then the amount of inflation is very small or not at all.  The central bank can just quietly retire these bonds and then the inflation is huge.  Since in the United States we cannot audit the Federal Reserve we have very little idea of what is really happening.  Inflation caused by open market operations and interest rate targeting are subtle and hard to detect and I call the inflation caused by these operations “complex inflation.”  Central banks and the legal tender laws they depend are designed to obscure what the government and central bank are doing.  This allows for all sorts of mischief and inside deals.

Attempts to measure money creation, M0-M4, do not differentiate between these mechanisms and therefore are poor at predicting inflation.

How many companies did the Federal Reserve bail out in 2008?  Did these companies really pay back these loans?  We know for sure that banks were allowed to “borrow” huge sums money from the Federal Reserve at near zero interest rates and then “invest” this money in Treasuries.  This was just a complex way of hiding the fact that the Federal Reserve created (printed) money and gave it to these banks.  The procedure was obscure enough that most Americans would either not understand what was happening or would get bored when someone explained it to them.  However, the money created was paid for by (really stolen from) all those Americans (and people forced to use US dollars around the world) who hold or work for US dollars.  The bankers then paid themselves huge bonuses for their brilliant investment strategies.

 

Here is what we have learned:

          *Central banks create money directly, although in theory in the United States with the direction of Congress and the Treasury.
            *When central banks change the interest rates it causes a one-time increase in inflation (deflation).  Low interest rates do not

            *Open market operations provide numerous ways to increase inflation that are subtle and hard to detect. 

 

 

History of Central Banks in the United States

Many people label the First National Bank of the United States as a central bank.  A central bank is different from a national bank, such as the First National Bank (FNB) of the United States setup during Washington’s presidency.  The FNB was a private bank in which the federal government had a twenty percent equity interest.  It was forbidden from buying government bonds, had a mandatory rotation of directors, it could not issue notes or incur debt beyond its capitalization, and the federal government could withdraw its money from the FNB and place it with another bank.[10]  The FNB of the United States was a truly a private bank not a central bank.  It did not set the policies that “affect a county’s supply of money and credit.”  It also did not issue legal tender.

Hamilton and Washington pushed for a national bank because the national government had to be able to pay bills through-out the nation and a national bank made this easier than working with multiple different banks.  Depending on a person’s view of central banking they either vilify Hamilton or think he was a genius.  Both sides seem to confuse the national bank issue with the Hamilton’s efforts to put the newly formed United States government on sound footing.  Hamilton’ s first report on public credit did not mention a national bank, it only dealt with the state and foreign bonds left over from the revolutionary war.  The report called for:

1) Assumption of the state and foreign bonds that were trading around 20-25% of their face value.

2) Paying off these state and foreign bonds at their face value by issuing new federal bonds.

3) Tariffs and tonnage duties would back these new federal bonds.

The result of this legislation, according to Wikipedia was:

The adoption of Hamilton’s Report had the immediate effect of converting what had been virtually worthless federal and state certificates of indebtedness into $60 million of funded government securities. Fully funded, the central government regained the ability to borrow, attracting foreign investment as social unrest destabilized Europe. In addition, the newly issued bonds provided a circulating currency, stimulating business investment.[11]

Hamilton’s plan worked brilliantly and it had nothing to do with a National Bank.

            The national bank was proposed in a separate report.  Hamilton would not have been in favor of a central bank.  Hamilton believed that a bank run by the government would be tempted print too much money.[12]  The First National Bank was not a central bank, however it was a government chartered and supported enterprise sort of like Fannie Mae and not strictly a free market enterprise either.  Such enterprises are prone to inside deals.

Most people point to the Second National Bank of the United States created in the Madison administration as a central bank.  The Second National Bank was modeled after the First National Bank, except it had some regulatory authority over other banks.  This made it closer to a central bank, however it did not have the power of legal tender or a monopoly on the issuance of money.  Apparently, the Second National Bank was poorly run and became involved in politics.  Andrew Jackson refused to renew its charter so its operations ended in 1836.  The information I could find on the Second National Bank was sparse compared to the First National Bank.

The first real central bank in the United States is the Federal Reserve, which was created in 1913.  The Federal Reserve is a private entity of sorts.  It is more like Fannie Mae than a true private bank however.  It has the power to create legal tender, it is tasked with setting interest rates to achieve policy goals, and it has regulatory control over the whole banking system in the United States.

There were two main justifications for the Federal Reserve: 1) the United States needed a lender of last resort to avoid banking panics, and 2) the idea that the United States government almost went bankrupt a couple of times, but JP Morgan saved the day.[13]

The United States did suffer from a number of bank panics, but these were due to over-regulation, not the free market.  Oddly, finance (stocks and bonds) was not regulated at all in the United States until the Kansas’ Blue Sky Law in 1911, which was the blue print for the Securities Act of 1933.  Banks on the other hand were highly regulated, the most obvious of these regulations were unit banking laws.  Unit banking laws required that banks could have only one location and these laws existed in a number of states and was applied to federal banks.  These resulted in a lack of diversification in banks’ portfolios, which increased their risk of failure.[14]  Canada did not have these restrictions.  Canada had many nationwide banks and as a result did not have a single bank fail during the Great Depression.[15]

Private banks had already created clearing houses that acted as a lender of last resort, before the Federal Reserve.

Friedman understood . . . that before the Federal Reserve Act financial panics in the US were mitigated by the actions of private commercial bank clearinghouses. Friedman and Schwartz’s view of the 1930′s was that the Fed, having nationalized the roles of the clearinghouse associations [CHAs], particularly the lender-of-last-resort role, did less to mitigate the panic than the CHAs had done in earlier panics like 1907 and 1893. In that sense, the economy would have been better off if the Fed had not been created. This position is perfectly consistent with the position that, provided we take the Fed’s nationalization of the clearinghouse roles for granted, the Fed was guilty of not doing its job.[16]

The idea that the United States needed a central bank, is not justified by the banking failures before the Federal Reserve and the Federal Reserve failed in this function during the Great Depression.

The other justification for the creation of the Federal Reserve was the supposed bailouts of the United States federal government in 1893 and 1907 by JP Morgan.  The United States was on a gold standard and the governments gold reserves were being depleted rapidly in both cases.  In both cases Morgan guaranteed to buy bonds issued to purchase gold for the United States Treasury.  These bonds were sold on the strength and credit of the United States and Morgan profited by both of these so-called bailouts.  If the Treasury had been doing its job correctly it would have cultivated a market for these bonds long before this crisis.  In addition, the federal government could also have slashed spending.  Not surprisingly the bailout of 1907 happened under the bad economic policies of Teddy Roosevelt.  In addition, the United States had the power to issue legal tender, which it could have done to conserve its gold.  The history surrounding these events is confused and has not been fully explored.  This paper is not full exploration of this topic, however it raises serious doubts that the narrative of these panics was a legitimate justification for the creation of the Federal Reserve.

Another narrative pushed by the banking interests is that somehow banks are different than other businesses.  Banks always argue that if one bank (large politically connected bank) fails then the whole banking system will collapse.  This narrative is trotted out every time banks demand a bailout, the most recent being the bailouts in 2008.  When a bank fails it goes through bankruptcy, which acts as a circuit breaker from a cascading series of failures.  This is exactly what happens in other areas of the economy.  Another solution that I do not endorse, but is better than bailouts, was the Resolution Trust Corporation that was created to liquidate the savings and loan failures of the late 1980s.  The Resolution Trust Corporation was essentially a massive bankruptcy proceeding and importantly its existence was limited.  It had to liquidate all its assets by 1992 (five year life).

The justifications of for the Federal Reserve are weak at best and considering the damage the Federal Reserve has done to the economy and its potential for abuse it should be ended.  The origins of the Federal Reserve are based on government failure, specifically interference in a free market.

 

What we have learned:

        *Central banks do not arise naturally in a free market and are not part of a free market.

            *Central banks and legal tender laws are the source of inflation, not private fractional reserve banks.

            *Central banks provide an easy way to obscure that the central bank and the government are creating inflation.

            *Lowering interest rates causes a one-time increase in the money supply over the trend line.

            *The fastest way to undermine (eliminate) the Federal Reserve is to eliminate legal tender laws.

 

 

[1] Bordo, Michael D., A Brief History of Central Banks, Federal Reserve Bank of Cleveland,

http://www.clevelandfed.org/research/commentary/2007/12.cfm, A Brief History of Central Banks, December 1, 2007.

[2] Investopedia, Central Bank http://www.investopedia.com/terms/c/centralbank.asp#ixzz4V5iaLeW, accessed January 7, 2017.

[3] https://en.wikipedia.org/wiki/Modern_Monetary_Theory, accessed January 13, 2017.

[4] We can debate the accuracy of the actual number, however the point is the same.

[5] https://en.wikipedia.org/wiki/Mississippi_Company, accessed January 13, 2017.

[6]

[1] Lawrence Hunter, Forbes, OCT 29, 2012,  Is The Federal Reserve Using Money-Laundering Techniques To Cleanse Banks’ Balance Sheets?, http://www.forbes.com/sites/lawrencehunter/2012/10/29/are-federal-reserve-regulated-banks-laundering-dirty-money/#6da1ce8f27cb accessed February 7, 2017.

[7] Ivan Pongracic Jr., The Great Depression According to Milton Friedman, FEE, Saturday, September 01, 2007, . https://fee.org/articles/the-great-depression-according-to-milton-friedman/, accessed January 14, 2017.

[8] [8] Ivan Pongracic Jr., The Great Depression According to Milton Friedman, FEE, Saturday, September 01, 2007, . https://fee.org/articles/the-great-depression-according-to-milton-friedman/, accessed January 14, 2017.

[9] Wikipedia, https://en.wikipedia.org/wiki/Reserve_requirement , accessed January 14, 2017.

[10] The book, Hamilton’s Blessing, is a great reference for this but I do not have a copy anymore.

[11] https://en.wikipedia.org/wiki/First_Report_on_the_Public_Credit#Funding_the_national_debt , accessed January 15, 2017.

[12] Gordon, John Steele, Hamilton’s Blessing: The Extraordinary Life and Time of Our National Debt, Penguin Books, 1997, p. 34.

 

[13] http://www.investopedia.com/articles/economics/08/federal-reserve.asp, accessed January 15, 2017.

[15] CARPE DIEM, http://mjperry.blogspot.mx/2008/09/great-depression-not-single-canadian.html , accessed January 15, 2017.

[16] . https://fee.org/articles/the-great-depression-according-to-milton-friedman/,  The Great Depression According to Milton Friedman, Ivan Pongracic Jr., Saturday, September 01, 2007, accessed January 15, 2017.

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January 16, 2017 Posted by | Intellectual Capitalism | , , , , | Leave a comment

More Proof ENVIRONMENTALISTS are EVIL

There is a general attitude among most people that environmentalism is about making the world a better place for humans.  The reality is that environmentalists want to kill off most of the human population, which means they are advocating mass murder on a scale that makes Stalin, Mao, Hitler, and Genghis Khan look like choir boys.  In addition, they are quite happy to lie about their agenda and the supposed science they are doing.  Here are some quotes by environmentalist that show that they are EVIL.
”My three goals would be to reduce human population to about 100 million worldwide, destroy the industrial infrastructure and see wilderness, with its full complement of species, returning throughout the world.”
David Foreman,
co-founder of Earth First!environmental-nazi

”A total population of 250-300 million people, a 95% decline from present levels, would be ideal.”
Ted Turner,
Founder of CNN and major UN donor

”The prospect of cheap fusion energy is the worst thing that could happen to the planet.”
Jeremy Rifkin,
Greenhouse Crisis Foundation

”Giving society cheap, abundant energy would be the equivalent of giving an idiot child a machine gun.”
Paul Ehrlich,
Professor of Population Studies,
Author: “Population Bomb”, “Ecoscience”

”The big threat to the planet is people: there are too many, doing too well economically and burning too much oil.”
Sir James Lovelock,
BBC Interview

”We need to get some broad based support, to capture the public’s imagination… So we have to offer up scary scenarios, make simplified, dramatic statements and make little mention of any doubts… Each of us has to decide what the right balance is between being effective and being honest.”
Stephen Schneider,
Stanford Professor of Climatology,
Lead author of many IPCC reports

”Unless we announce disasters no one will listen.”
Sir John Houghton,
First chairman of the IPCC

”It doesn’t matter what is true, it only matters what people believe is true.”
Paul Watson,
Co-founder of Greenpeace

”Childbearing should be a punishable crime against society, unless the parents hold a government license. All potential parents should be required to use contraceptive chemicals, the government issuing antidotes to citizens chosen for childbearing.”
David Brower,
First Executive Director of the Sierra Club

”We’ve got to ride this global warming issue. Even if the theory of global warming is wrong, we will be doing the right thing in terms of economic and environmental policy.”
Timothy Wirth,
President of the UN Foundation

”No matter if the science of global warming is all phony… climate change provides the greatest opportunity to bring about justice and equality in the world.”
Christine Stewart,
former Canadian Minister of the Environment

”The only way to get our society to truly change is to frighten people with the possibility of a catastrophe.”
Emeritus Professor Daniel Botkin

”Isn’t the only hope for the planet that the industrialized civilizations collapse? Isn’t it our responsibility to bring that about?”
Maurice Strong,
Founder of the UN Environmental Program

”A massive campaign must be launched to de-develop the United States. De-Development means bringing our economic system into line with the realities of ecology and the world resource situation.”
Paul Ehrlich,
Professor of Population Studies,
Author: “Population Bomb”, “Ecoscience”

”If I were reincarnated I would wish to return to earth as a killer virus to lower human population levels.”
Prince Phillip, Duke of Edinburgh,
husband of Queen Elizabeth II,
Patron of the Patron of the World Wildlife Foundation

”The only hope for the world is to make sure there is not another United States. We can’t let other countries have the same number of cars, the amount of industrialization we have in the US. We have to stop these third World countries right where they are.”
Michael Oppenheimer
Environmental Defense Fund

”Global Sustainability requires the deliberate quest of poverty, reduced resource consumption and set levels of mortality control.”
Professor Maurice King

”Current lifestyles and consumption patterns of the affluent middle class – involving high meat intake, use of fossil fuels, appliances, air-conditioning, and suburban housing – are not sustainable.”
Maurice Strong,
Rio Earth Summit

”Complex technology of any sort is an assault on the human dignity. It would be little short of disastrous for us to discover a source of clean, cheap, abundant energy, because of what we might do with it.”
Amory Lovins,
Rocky Mountain Institute

”I suspect that eradicating small pox was wrong. it played an important part in balancing ecosystems.”
John Davis,
Editor of Earth First! Journal

 

January 12, 2017 Posted by | philosophy | , , , , , , , | 6 Comments

Latest Review of Source of Economic Growth

This is an excellent book that cuts through the morass of theories about the source of wealth to make an identification that gave me a thrilling “Eureka!” moment, followed by an “Of course! Why didn’t I see that?” which comes with every brilliantly made, clearly expressed discovery. Thank you for clearing the cobwebs on the vital issue on the source of ongoing wealth — the dissemination of your well-supported identifications can make the difference in the quality of life in all nations for all lifetimes to come.
econgrowth.small

January 11, 2017 Posted by | Intellectual Capitalism | | Leave a comment

Slayer Live Webcast: There is no Radiative Greenhouse Effect (Jan 10, 10AM MST)

Climate of Sophistry

PDF of presentation: There is no Radiative Greenhouse Effect

Presentation start at 18:20.

In this live webcast I will be giving a slideshow presentation which demonstrates that the radiative greenhouse effect, upon which climate alarm and even the field of climate science itself is based, does not exist. On both scientific requirements of having theoretical & empirical support, the radiative greenhouse effect is proven to have neither: it is based in false physics and paradox, violates the laws of thermodynamics, and doesn’t produce the empirical observables it predicts and claims responsibility for.

It isn’t just that climate alarm isn’t as bad as the alarmists say it is, it is that the very foundation of the science – the radiative greenhouse effect – is in error, does not exist, and hence the alarmism and the policy surrounding it is completely, 100% in error.

Not merely slightly wrong, not mostly wrong…

View original post 69 more words

January 10, 2017 Posted by | Uncategorized | Leave a comment

Ayn Rand’s Ethics: Natural Rights and Self-Ownership

There seems to be a lot of confusion on the issues of whether Rand’s ethics is (or is consistent with) a natural right ethics and the idea of self-ownership.  These issues seem to bring up a lot of hidden assumptions and emotions.

 

Natural Rights:  Any logical analysis of whether Objectivist ethics can be classified as a natural rights ethical system has to start with some definitions.  The word “rights” here means that this term is only concerned with the ethical interaction between people.  Usually, this is even further limited to the ethical basis of governments or political systems.  Objectivist ethics covers more than just natural rights.

Natural means that the ethical system is based on nature or reality.  Logically, a “rights” system is either natural or unnatural there are no other choices.  That is basic logic and is called the law of the excluded middle.  (If you comment that there is some third choice, expect a harsh reply explaining that you do not understand basic logic.  If you double down on this irrationality, expect an even harsher reply).

The question then boils down to whether Objectivist ethics is based in nature (reality) or whether it has a non-natural basis and the only non-natural basis would have to be a supra-natural or completely arbitrary basis.

It is clear to anyone who has studied Rand’s ethics that it is based in nature, specifically the nature of man.  I have written on this extensively, see here.  It is clear that Rand’s ethics is in the broad category of Natural Rights.

If you want to argue that Rand’s formulation of rights is different than the Founding Fathers or Locke’s or other natural rights philosophies, that is fine, but that is not the question.  Do not comment that Harry Binswanger or Leonard Peikoff or someone else disagrees.  Objectivism is about reason, not about ordained leaders.  Arguing from authority, without providing a rational argument, is dishonorable to Objectism, Rand, and turns aynrandstampObjectivism into a religion.

 

Self-Ownership:  Once again we start with a definition.  Self-ownership is defined as having ethical and legal control over one’s body and mind.  If you disagree with this definition then you need to provide you own and you need to explain why you are not using the standard definition, which has been around for hundreds of years.

Based on the definition above it is clear that Rand’s ethical system is consistent with self-ownership.  If you argue it is not, then you do know what a definition is or alternatively what Rand said on the subject (expect harsh replies if you argue this irrational position).

Now you might argue that “self-ownership” is not axiomatic (or a fundamental observation) of Rand’s ethics and you would be correct.  Technically, it is not an axiom in Locke’s formulation of natural rights either.

January 6, 2017 Posted by | philosophy | , , , | 4 Comments

Money and Banking (Intellectual Capitalism Part 3)

There are a lot of misconceptions about money and banking.  Often people either think these are the root of all our problems or the solution to all our problems.  Both seem to believe that once money enters the equation in economics magic happens.  This paper will focus on how money and banking work in a free market and then examine the distortions caused by government manipulation of money and banking.

 

Money

If you examine an economics book on money it will tell you money is a medium of transaction, a store of value, and a unit of account.  Some economist say that money being a medium of exchange is the real function (definition) and the other two functions follow from money’s primary purpose.  I agree and therefore in this paper the definition of money is a medium of exchange.

All sorts of things have served as money including sea shells, tobacco leaves, grain, large immovable stones, tea leaves, cigarettes, silver, gold, paper, and computer bits (entries).  Why money is a useful invention is usually explained by way of an example.  Suppose that you raise cows for a living and you wanted to buy a loaf of bread.  If you tried to trade your cow to the butcher, you would want several hundred loaves of bread in return.  Most of the bread would spoil before you can eat it, so you only want two loaves of bread now.  On top of this, the baker wants chickens not a cow.  Under a bartering system these transaction will not occur, however with the addition of money you can sell your cow to the butcher and he will give you money.  You can then use the money to buy two loaves of bread, which the baker can use the money to buy chickens.

It is likely that money originally grew out of an IOU (I Owe yoU) system.  For instance, in the example above it is possible that once the rancher and the baker agree that the cow is worth 300 loaves of bread, then the baker would give the rancher two loaves of bread and an IOU for 298 loaves of bread.  The rancher intends to present the IOU to the baker every week for his two loaves of bread.  At which time the baker will give him two loaves of bread and an amended (new) IOU.

Unfortunately, the rancher gets sick and needs a doctor.  The doctor agrees to accept the baker’s IOU in payment for his services.  Now the baker’s IOU has acted as medium of exchange, which means it is money.

Money is just a generally accept IOU.  In other words many people will accept it as a general IOU that they can “redeem” from most people.  In the example above the doctor would have to worry that the baker might not make good on his IOU.  Now some people will argue that only paper fiat money is a generalized IOU.  However, even gold is functioning as a generalized IOU.  It is commodity money and as a result may have value in the market separate from its use as an IOU, but the person accepting it as money does not need it as a commodity.  He is planning on trading it with other people for goods and services.  On a deserted island (with no hope of rescue) you could have a ton of gold, but it would useless and you would not be better off with it than without it.  This also shows that wealth is not the same thing as having money.

One of the advantages of this point of view on money as an IOU is that it makes it clear that money is not wealth, even gold. The Spanish Kings and Queens found out this point when they brought back tons, literally, of gold and silver but still ended up going bankrupt.  The gold was not wealth and they spent their gold on things that did not create wealth.  Wealth is the things and knowledge that solve the objective problems of life (inventions).  I added the knowledge part because if you give an aboriginal person living in the Brazilian rain forest a super-computer, or an MRI machine, or even a bulldozer they are not wealthier because they do not know how to use these things (inventions) or even trade them.  Wealth is also about the objective problems of life, the most fundamental ones being air, water, and food.  These are still problems for many people in the third world.  Even in wealthy first world countries people have real objective problems, such as health problems, safety, etc.  It might not be as obvious why cruise control or smart phones solve objective problems, however if you think about it both do.

The idea that money is not wealth is important because it immediately makes the fallacy of Mercantilism apparent, which Adam Smith spent 100s of pages on.  In addition, it makes it clear that we cannot become wealthier by manipulating the money supply.  The only way to become wealthier on a per capita basis is to create new things that are more efficient at solving the objective problems of life or solve new objective problems of life, in other words create new inventions.

People often argue about the differences between money, currency, real money, commodity money, debt money, paper money, and fiat money.  Currency is generally defined as something that is specifically designed to function as money, such as coins.  Commodity money is when the money is a commodity such as silver, gold, grain, or is backed by a commodity.  Now real money can mean several different things, however I am talking about people who argue that only gold (silver) is real money.  By this they seem to mean that gold is a commodity money and all other currencies are to be measured against gold.  All commodity moneys have the advantage that they are more difficult for the government to devalue, however bitcoin also has this feature.  The other point is that gold has a long tradition as a widely recognized money.  This is true but does nothing to enlighten what money is or what its function is.

Fiat money is money that is not backed by a commodity.  Usually it is paper money although more and more it is just electronic entries in a computer and often it is legal tender, which will discuss in more detail shortly.  Paper money is self-explanatory.  Debt money can have several meanings, but usually means the money “created” when a person (entity) takes out a loan.  Many people argue that debt money is evil or somehow costs us interest just to have money.  Since all money is essentially an IOU, all money is created by a debt, i.e., a claim to future goods and services.

 

Proto Banking

Banking and money have been closely linked at least since the Agricultural Revolution about 11,000 year ago.  The Agricultural Revolution was a series of inventions that provided man with access to a huge increase in the number of calories per acre.  As a result, the human population expanded enormously and the territory of humans also expanded.  These excess calories were converted into population increases until the number of calories collected/created by the human population were roughly equivalent to the number necessary to support that population.

The grains that were the major source of these extra calories had to be stored, because the grains ripened all at once.  While the grain was stored, it needed to be protected from water and vermin.  If the grain ran out before the next harvest, people starved to death.  Efficient, effective storage of grains reduced the chances of running out grain before the next harvest.  A centralized grain storage (grain silos) was more effective than econgrowth.smallindividual storage of grains.  When a farmer deposited their grain they received a receipt (clay tablet) for the grain.  Eventually people started to use these receipts to pay for other goods (services).  For instance, if you wanted to buy a chicken instead of going to the grain silo and taking out enough grain to pay for the chicken, you just handed over some of these clay tablets to the owner of the chicken.  In other words these receipts became money.

In ancient Mesopotamia, as long ago as 5000 B.C.E., clay tablets were used to represent beer or grain.[1]  These clay tablets functioned as money.  Gold also started functioning as money about the same time, but was probably only used for large or long distance payments and therefore was not used by average people.[2]  These clay tablets were “created out of thin air” in the vernacular of today.  After a harvest there would be a lot of these clay tablets around and we would say the money supply increased.  As people withdrew grain, the grain bank would redeem these receipts.  We do not know if the “bank” destroyed these clay tablets, which would have been the logical thing to do or if they stored them for the next harvest.  Either way the money supply would shrink until the next harvest.  In fact the number of clay tablets (in circulation) would have shrunk to almost to zero just before the next harvest.  We know this is the case because of evolution.  Population expands until it takes up the available food supply, which is known as the Malthusian Trap.  This means the grain would be almost gone by the time the next harvest rolled around.

If you eliminate money (clay tablets) this does not change the economic situation.  Until the Industrial Revolution people lived on the edge of starvation and it was common for families to have to ration their food and even pick who would get food and who would not.  Because the healthy adults were the only way any of them would survive through the next year, the old, the young, and the sick were the first one’s whose food was cut off.  This is a grim reminder that economics is not just a game, but has real world consequences.

If we replaced the clay tablets with coins (e.g., silver, gold), then the money supply would not go up and down.  However, the price of food (and other goods) would go up and down.  After a harvest the price of food would be cheap and just before the harvest food would be very expensive.  The monetary system would not change the underlying economic situation one bit.

This is what we have learned about money in a free market:

1) Money is a medium of exchange

2) Money is a generalized IOU

3) The money supply can vary in a free market without fractional reserve banking.

4) Many things can function as money and only the market should “decide” what is money.

5) Money is not magic and does not allow magic in economics.

Now we are going to introduce some government (non-free market) distortions to money.  Going back to our clay tablets, someone probably realized that it did not make sense to destroy the clay tablets when people withdrew grain, since they would have to make new clay tablets after the harvest.  The “bank” probably started storing them and this of course led to the temptation of stealing the clay tablets.  Also the government probably decreed that taxes had to be paid in these clay tablets, which was the first step to making them legal tender.

We are going to skip forward to Roman times.  The Roman’s used silver coins as their currency.  The main unit of money was the denarius, which was between the size of a modern nickel and dime and equivalent to a day’s worth of wages for a skilled laborer.[3]  As late as 68 C.E. the silver in a denarius was almost 100%, but then it started to decline.  People balked at using this debased money, however the government declared the new, lower silver coins legal tender.  By 265 C.E. the silver content in coins was down to 0.5%.  Not surprising the Roman Empire suffered huge inflation.  The Roman’s minted so many coins that even today you can buy several Roman coins of standard quality for twenty dollars or so.[4]  For clarity later on I am going to call this “simple inflation”.

An important point here is that legal tender laws are always the first step towards inflation.  The only reason for a government to pass a legal tender law is so that they can “print” money.  In other words, the government is undertaking an endeavor that would get any private citizen throw in jail.  With the end of the Roman Empire legal tender laws and banking died out during the Dark Ages.  Coins were mainly used by the rich during this period.

By the 1700s legal tender laws were being seen again in Europe.  France experimented with legal tender laws, allowing The Mississippi Company in the 1710s to have control over its legal tender with disastrous results.  Supposedly, the French swore off paper money and modern banking for years after this.  Some historians have even argued that this backwardness in France’s finance system was part of why they were beaten by the English.  This is a fascinating story, but beyond the scope of this article.

The British followed suit in 1833 making banknotes issued by the Bank of England (a private bank at the time) legal tender.[5]  The United States had no legal tender laws (after the Constitution) until 1862 during the American Civil War.  The North printed $450,000,000 under this law to help finance the war.  Eventually this law was declared unconstitutional in Hepburn v. Griswold, 75 U.S. 603 (1870).  The Court reasoned that the Constitution allowed the federal government to coin money, but not the power to make paper legal tender.  The government argued that since it had the power to carry out war and the issuance of the legal tender was necessary for carrying on the war, then legal tender laws fell under the “necessary and proper’ clause of the Constitution.  The Court rejected this argument and also pointed to the fact that the Constitution prohibited the states from interfering with contracts.  The Constitution did not specifically, prohibit the federal government from interfering with private contracts, but it would be against the spirit of the Constitution to allow the federal government to do so.  In one of the stranger twists in history, Salmon P. Chase helped push the legal tender legislation through as Lincoln’s Secretary of Treasury, then he was appointed Chief Justice of the Supreme Court and lead a 5-3 decision to declare the law unconstitutional.  Unfortunately, this case was quickly overruled by the Knox v. Lee, 79 U.S. 457 (1871) Supreme Court decision.

Multiple competing bank notes were the norm at that time.  According to the Cato Institute, “the government did not entirely monopolize issuance of notes until 1935, but the laws that made the monopoly possible date from the Civil War.”[6]  Today the legal tender law in the US is 35 USC § 5103 which states:

United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues. Foreign gold or silver coins are not legal tender for debts.

Legal Tender laws are necessary for government counterfeiting[7] to be successful.  Without legal tender laws, people would quit accepting the money printed by the government.  The key point is that legal tenders are necessary to create inflation.  Any further investigation of money will require that we first examine how banks work.

 

Banking

The first banks in Europe after the Dark Ages were goldsmiths.  Because goldsmiths were working with valuable materials they needed vaults.  Wealthy patrons would often give some of their gold or other valuables to the goldsmith to secure in their vault.  The goldsmith would give the patron a receipt for their gold.  Overtime, just like the clay tablets for grain, people started to trade the receipts instead of taking out gold and paying with the gold.

Some of the customers also started asking for loans.  The goldsmiths wanted to reduce their risk if the customer defaulted on the loan, so they asked for collateral.  Originally, they probably asked for jewelry or other things made of silver and gold, since they knew they could liquidate (sell) these items fairly easily.  The goldsmiths could have given the customer gold out of their gold reserve (capital) and they probably did initially.  Most likely many customers then gave the gold back to the goldsmith and took receipts for the gold.  If the goldsmith’s receipts were trusted enough, they could skip this step and just give the customer receipts.  If the customer failed to pay the loan back, the jewelry (collateral) became the property of the goldsmith.

Or the goldsmiths could have given the borrower gold on deposit from other customers, which is the way most people think of banking working.  In that case then the gold the goldsmith had on hand (deposit) was less than the amount of the receipts outstanding for the gold, which is fractional reserve banking (assuming the goldsmith had no gold capital or the loan(s) were greater than the goldsmith’s gold capital).  Fractional reserve banking is defined as:

a banking system in which only a fraction of bank deposits are backed by actual cash on hand and are available for withdrawal.[8]

Most customers probably deposited the borrowed gold with the goldsmith and took receipts.  Again the goldsmiths probably began to skip the step of giving the borrower actual gold (silver) and just gave them receipts for the gold.  At this point it might appear that the goldsmith is “creating money out of thin air”, however the receipts in this case are backed by the collateral, jewelry in this example.  Actually, all the outstanding receipts are now backed by the gold on hand and the collateral the goldsmith has for loans.

At this point the goldsmith risks all the holders of these receipts asking for their gold and the goldsmith does not have enough gold to fulfill all these demands.  However, the goldsmith does have enough capital to fulfill the demands, because the collateral, jewelry and gold on deposit in this example.  It is likely that initially most of these loans were “callable”, meaning that the goldsmith could demand the borrower pay them back in full (gold or receipts) at any time.  If the borrower paid up, then the goldsmith had no problem paying off the receipts.  If the borrower did not pay up, then goldsmith became the owner of the collateral (jewelry) and could sell it to fully back the receipts.[9]

Eventually the goldsmiths realized it was not only jewelry (gold and silver items) that had value and could act as collateral.  For instance, arable farmland was one of the most valuable assets that people could own for most of history since the Agricultural Revolution.  The goldsmith could not put the farmland in his vault, however he could have a legal claim to the land.  That claim stated that if the borrower did not pay back the loan, then the goldsmith owned the farmland.  Of course it takes longer to liquidate farmland than jewelry and farmland might be more subject to market fluctuations.  As a result, the amount the goldsmith would lend against the farmland was lower than for gold and silver items.

At first goldsmiths probably made loans against farmland that someone owned outright.  Eventually, they figured out that they could make loans on farmland that was being purchased, as long as there was a big enough down payment (the equivalent of loaning less than the value of collateral).  What the goldsmith is doing is securitizing assets other than gold.  When the goldsmiths created receipts for gold and silver deposits they were securitizing gold (and silver).  “Securitize is a pooled group of financial assets that together create a new security”[10] or banknote in this case.  This means that goldsmiths receipts (banknotes) are backed by not only gold deposits but the other assets that they hold as collateral.

This is exactly what a company does when it sells bonds (stock).  The bond is backed by the assets (collateral) of the company.  The bonds are usually very liquid and can be sold or traded in exchange for goods and services, i.e., the bonds are money.

These goldsmiths became fractional reserve banks once they started securitizing assets other than gold.  Fractional reserve banking is an important invention and is created (exists) in a free market.  A fractional reserve bank is doing something analogous to what engineers have done with the telephone system.  The backbone that connects two people together on a phone line does not have the capacity to allow everyone to make a call at the same time.  The engineers know that only a certain fraction of people will normally be on their phones at the same time.  By designing a system to handle this level of usage plus a margin, the cost of the telephone system is reduced.  Of course occasionally, like in the time of an emergency, everyone wants to use their phone at the same time and then you receive a message like ‘all circuits are busy, please try your call again later.’  Another example is the time sharing of resources is done by computers.  Before the 1980s this was done by having a number of computer terminals all connected to one large computer that time shared its resource among these terminals.  This is still done within your computer when it runs multiple programs.  The processing power of the microcontroller is time shared among these programs.

Banks know that only a small number of people will want gold at the same time.  Most of the time people will be happy with banknotes or just accounting entries.  However, if people lose confidence in the bank, then they will all want to withdraw gold (cash) at the same time.  This is called a ‘run on the bank’ and is the same thing as everyone trying to make a telephone call at the same time.  Note that this is a cash flow issue and can happen even to a bank that is profitable.  Usually, banks that were clearly profitable could borrow gold from other banks to weather the run.

When a fractional reserve bank (hereinafter bank) initiates a loan against an asset, let’s say a farm, the bank creates a security (banknotes or an entry in a ledger) equal to the amount of the loan.  In this process it “creates money” equal to the loan.  At one time this might have been done by printing a bunch of banknotes, but now it is an electronic entry in the banks accounting system.  An article entitled “Money Creation in the Modern Economy” published by the Bank of England explains “whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.”[11]  This article also points out that “money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits.”[12]  According to the article, “Money in the Modern Economy: an Introduction”, there are three main sources of money in modern economies, currency, bank deposits (loans by commercial banks) and central bank reserves.[13]  This article also points out that most money in the economy is created by banks initiating loans.  [14]

Some people call this debt money and argue it is bad for the economy.[15]  They imply that this system of money creation requires we pay interest to have money.  First, it is important to point out that this sort of money creation happens in a free market.  Second, the only one paying interest is the person who took out the loan.  In a free market there would also be other forms of money, such as gold, silver, bitcoin etc.

When loans are paid back money is destroyed, just like the case of the clay tablets being destroyed (taken out of circulation) when people turned them in for their grain.  The bank no longer has access to the collateral (e.g., farmland, jewelry, etc.).  As a result, the banknotes (electronic entries) are destroyed.  Note that money is also destroyed if the borrower defaults on the loan.

In a free market (for this discussion most importantly means no legal tender laws and no central bank) banks’ ability to ‘create money’ is limited by the value of the assets used as collateral.[16]  The bank is not creating money, it is securitizing assets and the banks’ ability to create money is then limited to the assets that can be securitized.

If the banks create too many loans that cannot be paid back, then they will tighten their lending standards.  This will result in fewer loans and less money being created.  When the economy is growing banks will fund more loans and create more money.  However, the amount of money in the economy will be proportional to the assets that can be collateralized in the economy.

As a result, in a free market fractional reserve banks do cause variations in the money supply, but do not cause inflation or deflation.  Note that the United States had fractional reserve banks from before the revolution and the United States did not have any periods of inflation.  The banks were constrained in how much money they could create.  Now prices did vary widely sometimes, particularly in times of war.  However it is necessary to separate out the fluctuation in prices due to changes in supply and demand from those due to changes in the quantity of money.  During a war (crop failure) there is an increase in the demand for goods and services, particularly food.  Men are off fighting instead of planting their fields and the war itself often destroys the crops on large tracks of land.  This increase in the price of food will mean that farmland that is not threatened by the war will be more valuable.  As a result, it is likely banks will be willing to lend more money against these farms.  This will result in some increase in the money supply.  However, when the war ends the prices of the farm goods will fall and so will the value of the farmland, which will reduce the number of loans outstanding, reducing the amount of money in the economy.  Averaged out over time money grows at the same rate as the economy and prices are roughly stable.[17]

 

This is what we have learned about banking in a free market:

1) Fractional reserve banking exist in and our an invention of a free market.

2) Fractional reserve banks do create and destroy money, however the amount of money created is proportional to the assets in an economy.  

3) Fractional reserve banks do not cause inflation.

 

(I wanted to include a discussion of central banks, however this article is already too long.  So I will post on central banks and their effects in another article)

[1] Peter Dockrill, This 5,000-year-old artefact shows ancient workers were paid in beer, http://www.sciencealert.com/this-5-000-year-old-clay-tablet-shows-ancient-mesopotamians-were-paid-for-work-in-beer; and

Rachelle Samson, History of money: From clay tablets to legal tenders

History of money: From clay tablets to legal tenders, http://www.versiondaily.com/the-history-of-money-from-clay-tablets-to-legal-tenders/.

[2] Wikipedia, History of money, https://en.wikipedia.org/wiki/History_of_money, accessed 11 November 2016.

[3] Jeff Desjardins, Currency and the Collapse of the Roman Empire, http://money.visualcapitalist.com/currency-and-the-collapse-of-the-roman-empire/, accessed 11 November 2016.

[4] coins  https://www.amazon.com/Lot-10-Uncleaned-Ancient-Bronze/dp/B001BMWATA?SubscriptionId=AKIAIKBZ7IH7LXTW3ARA&&linkCode=xm2&camp=2025&creative=165953&creativeASIN=B001BMWATA&tag=wwwbookcompar-20&ascsubtag=5820b98a48308f0454a513ac

[5] A. Andreades, History of the Bank of England 1640 to 1903, http://socserv2.socsci.mcmaster.ca/econ/ugcm/3ll3/andreades/HistoryBankEngland.pdf,

[6] Schuel, Kurt, Cato Journal, Vol. 20, No. 3 (Winter 2001) p 454.

[7] Counterfeiting in an economic sense is any currency that is not backed by productive or creative effort that someone willing exchanged their creative effort for.  Gold is clearly not counterfeit money, since it requires productive effort to mine gold.  Buy paper money presents a problem.  It takes productive effort to make and print paper, but no one would trade twenty dollars of their effort for someone who printed a twenty dollar bill.  Economic counterfeiting is really a fraud where someone believes the other person has provided value that they did not provide and purposely withheld this fact from the other party.

[8] Fractional Reserve Banking Definition | Investopedia http://www.investopedia.com/terms/f/fractionalreservebanking.asp#ixzz4QUDQvzpR, accessed November 19, 2016.

[9] The collateral is usually worth more than the loan to deal with market fluctuations.  This is why people used to say that a bank would only loan you money if you were already rich.

[10] Securitize Definition | Investopedia http://www.investopedia.com/terms/s/securitize.asp#ixzz4QVLtJy4H, accessed on November 19, 2016.

[11] Michael McLeay, Amar Radia and Ryland Thomas, Money creation in the modern Economy, http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf, accessed November 19, 2016.

[12] Michael McLeay, Amar Radia and Ryland Thomas, Money creation in the modern Economy, http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf, accessed November 19, 2016.

[13] Michael McLeay, Amar Radia and Ryland Thomas, Money in the modern economy: an introduction, http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q101.pdf, accessed November 19, 2016.

[14] Michael McLeay, Amar Radia and Ryland Thomas, Money in the modern economy: an introduction, http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q101.pdf, accessed November 19, 2016.

[15] Debt-Based Money vs. Sovereign Money, http://positivemoney.org/our-proposals/debt-based-money-vs-sovereign-money-infographic/, accessed November 19, 2016.

[16] Credit cards and personal loans may seem to violate this, but a person’s willingness to work is an asset.

[17] JOSH ZUMBRUN, A Brief History of U.S. Inflation Since 1775,  http://blogs.wsj.com/economics/2015/12/14/a-brief-history-of-u-s-inflation-since-1775/, accessed 12/3/2016.

January 2, 2017 Posted by | -Economics, -History, Intellectual Capitalism | , , , | 4 Comments

FEE: Ayn Rand Predicts Its Intellectual Bankruptcy

FEE or the Foundation for Economic Education has proven to be intellectually bankrupt.  For instance, their position against patents and Intellectual property shows that they do not understand property rights or rights generally.  They also revere the work of the philosopher David Hume, who argued “cause and effect” does not exist, induction is just correlation, and that a rational ethics is not possible (the so-called is-ought problem).  This means that Hume undermined reason, science and ethics.  Despite this FEE thinks Hume is a great guy.  FEE also promotes Matt Ridley who denigrates human achievement in science and engineering, calling Nobel Laurites in science and inventors frauds, for more click here.

Interestingly Ayn Rand predicted this.  The founder of FEE, Leonard Read, sent Rand a prospectus for his plan to create FEE.  Rand told Read that his premises were flawed.

The mistake is in the very name of the organization. You call it “The Foundation for Economic Education.” You state that economic education is to be your sole purpose. You imply that the cause of the world’s troubles lies solely in people’s ignorance of economics and that the way to cure the world is to teach it the proper economic knowledge. This is not true–therefore your program will not work. You cannot hope to effect a cure by starting with a wrong diagnosis. (The whole letter is reproduced below)

 

According to FEE reason and capitalism are incompatible, which is why they promote the works of Mises, Hayek, Menger, and Rothbard.  You cannot defend capitalism successfully while attacking reason and a rational ethics.  These ideas are incompatible with Natural Rights, which is what created econgrowth.smallthe United States and capitalism.  FEE is worse than the socialists, because they undermine the very basis of freedom.

Hat tip to Christopher Budden for finding this letter.

To Leonard Read

February 28, 1946

 

Dear Leonard,

 

I have read the prospectus of your proposed organization very carefully. No, you have not given our case away. But you have not presented it completely. You have covered only one minor, secondary aspect of it. The partial presentation of a great issue, featuring a secondary aspect, will amount in practice to giving the issue away. Therefore I don’t think that your organization will serve your purpose—if this prospectus represents its program.

 

The mistake is in the very name of the organization. You call it “The Foundation for Economic Education.” You state that economic education is to be your sole purpose. You imply that the cause of the world’s troubles lies solely in people’s ignorance of economics and that the way to cure the world is to teach it the proper economic knowledge. This is not true–therefore your program will not work. You cannot hope to effect a cure by starting with a wrong diagnosis.

 

The root of the whole modern disaster is philosophical and moral. People are not embracing collectivism because they have accepted bad economics. They are accepting bad economics because they have embraced collectivism. You cannot reverse cause and effect. And you cannot destroy the cause by lighting the effect. That is as futile as trying to eliminate the symptoms of a disease without attacking its germs.

 

Marxist (collectivist) economics have been blasted, refuted and discredited quite thoroughly. Capitalist (or individualist) economics have never been refuted. Yet people go right on accepting Marxism. If you look into the matter closely, you will see that most people know in a vague, uneasy way, that Marxist economics are screwy. Yet this does not stop them from advocating the same Marxist economics. Why?

 

The reason is that economics have the same place in relation to the whole of a society’s life as economic problems have in the life of a single individual. A man does not exist merely in order to earn a living; he earns a living in order to exist. His economic activities are the means to an end; the kind of life he wants to lead, the kind of purpose he wants to achieve with the money he earns determines what work he chooses to do and whether he chooses to work at all. A man completely devoid of purpose (whether it be ambition, career, family or anything) stops functioning in the economic sense. That is when he turns into a bum in the gutter. Economic activity per se has never been anybody’s end or motive power. And don’t think that any kind of law of self-preservation would work here—that a man would want to produce merely in order to eat. He won’t. For self-preservation to assert itself, there must be some reason for the self to wish to be preserved. Whatever a man has accepted, consciously or unconsciously, through routine or through choice as the purpose of his life—that will determine his economic activity.

 

And the same holds true of society and of men’s convictions about the proper economics of society. That which society accepts as its purpose and ideal (or to be exact, that which men think society should accept as its purpose and ideal) determines the kind of economics men will advocate and attempt to practice; since economics are only the means to an end.

 

When the social goal chosen is by its very nature impossible and unworkable (such as collectivism), it is useless to point out to people that the means they’ve chosen to achieve it are unworkable. Such means go with such a goal; there are no others. You cannot make men abandon the means until you have persuaded them to abandon the goal.

 

Now the choice of a personal purpose or of a social ideal is a matter of philosophy and moral theory. That is why, if one wishes to cure a dying world, one has to start with moral and philosophical principles. Nothing less will do.

 

The moral and social ideal preached by everybody today (and by the conservatives louder than all) is the ideal of collectivism. Men are told that man exists only in order to serve others; that the “common good” is man’s only proper aim in life and his sole justification for existence; that man is his brother’s keeper; that everybody owes everybody a living; that everybody is responsible for everybody’s welfare; and that the poor are the primary concern of society, its holy shrine, the god whom all must serve.

 

This is the moral premise accepted by most people today, of all classes, all stages of education and all political parties.

 

How are you going to sell capitalist economics to go with that? How are you going to get them to accept as moral, proper and desirable such conceptions as personal ambition, economic competition, the profit motive and private property?

 

It can`t be done. Their moral ideal has defined these conceptions as evil and immoral. So modern men are consistent about it. Our “common-gooder conservatives” are not. It’s one or the other.

 

Here is the dilemma in which the public finds itself when listening to our conservatives: the public is told, in net effect, that collectivism is a noble, desirable ideal, but collectivist economics are impractical.

 

In order to have a practical economy, that of capitalism, we must resign ourselves to an immoral society, that of individualism. This amounts to saying: you have a choice, you can be moral or you can be practical, but you can`t be both. Given such a choice, men will always choose the moral, because it is preposterous to expect them to choose that which, by the speaker`s own assertion, is evil. Men may be mistaken about what they think is good (and how mistaken they’ve been! And what lying they indulge in to deceive themselves about it!), but they will not accept evil with full, conscious intent and by definition.

 

Nor will men accept the idea that a moral ideal is impossible, that it cannot be achieved in practice. (And they are right about that, too—it’s a thoroughly *unnatural* proposition.) Therefore it is absolutely useless to tell them that Marxist economics are impractical, so long as you`re also telling them in the same breath that Marxism is noble. They will merely say: “Well, if that’s the ideal, and it cannot be achieved through the economics of capitalism, to hell with the economics of capitalism! If Marxist economics do not work, we’ll find something that works. We must find it. So we’ll go on experimenting. At least Marxism tries in the right direction, while capitalism doesn’t even try to achieve the collectivist ideal. Capitalist economics do not even try to offer us a solution.” How often have you heard this last one?

 

Now the most futile and ludicrous of all stands to take on this question is the one attempted at present by most of our conservatives. It may be called the “mixed philosophy.” It’s a parallel to the theory of a “mixed economy,” just as untenable, silly and disastrous. It’s the idea that capitalism can be morally justified on a collectivist premise and defended on the grounds of the “common good.” It goes like this: “Dear pinks, our objective, like yours, is the welfare of the poor, more general wealth, and a higher standard of living for everybody—so please let us capitalists function, because the capitalist system will achieve all these objectives for you. It is in fact the only system that can achieve them.”

 

This last statement is true and has been proved and demonstrated in history, and yet it has not and will not win converts to the capitalist system. Because the above argument is self-contradictory. It is not the purpose of the capitalist system to cater to the welfare of the poor; it is not the purpose of a capitalist enterpriser to spread social benefits; an industrialist does not operate a factory for the purpose of providing jobs for his workers. *A capitalist system could not function on such a premise.*

 

The economic benefits which the whole society, including the poor, does receive from capitalism come about strictly as secondary consequences, (which is the only way any social result can come about), not as primary goals. The primary goal which makes the system work is the personal, private, individual profit motive. When that motive is declared to be immoral, the whole system becomes immoral, and the motor of the system stops dead.

 

It’s useless to lie about the capitalist`s real and proper motive. The awful smell of hypocrisy that accompanies such a “mixed philosophy” is so obvious and so strong that it has done more to destroy capitalism than any Marxist theory ever could. It has killed all respect for capitalism. It has, without any further analysis, simply at first glance and first whiff, made capitalism appear thoroughly and totally phony.

 

The effect is precisely the same as that produced by Willkie, Dewey and all the rest of the “me-too,” “I’ll-get-it-for-you-wholesale” Republicans. Do not underestimate the common sense of the “common man” and do not blame him for ignorance. He could not, perhaps, analyze what was wrong with Willkie or Dewey—but he knew they were phonies. He cannot untangle the philosophical contradiction of defending capitalism through the “common good” —but he knows it’s a phony.

 

Is there anything more offensive and preposterous than to tell an unemployed worker that the millionaire who is throwing a champagne party on his yacht is doing so only for his, the worker’s benefit, and for the common good of society? Can you really blame the worker if he then goes out and demands that the yacht be confiscated? Is it economic ignorance that makes him do so?

 

The more propaganda our conservatives spread for capitalist economics while at the same time preaching collectivism morally and philosophically, the more nails they’ll drive into capitalism’s coffin. That is why I do not believe that an economic education alone is of any value. That is also why you will find it difficult to arouse people`s interest in the subject. I believe you are conscious of this difficulty; your prospectus shows anxiety on the scope of “creating a greater desire for economic understanding.” You will not be able to create it.

 

The great mistake here is in assuming that economics is a science which can be isolated from moral, philosophical and political principles and considered as a subject in itself, without relation to them. *It can’t be done.*

 

The best example of that is Von Mises’ “Omnipotent Government.” That is precisely what he attempted to do, in a very objective, conscientious, scholarly way. And he failed dismally, even though his economic facts and conclusions were for the most part unimpeachable. He failed to present a convincing case because at the crucial points, where his economics came to touch upon moral issues (as all economics must), he went into thin air, into contradictions, into nonsense. He did prove, all right, collectivist economics don’t work. And he failed to convert a single collectivist.

 

The organization desperately needed at present is one for EDUCATION IN INDIVIDUALISM, in every aspect of it: philosophical, moral, political, economic—in that order. (That is the actual order in which men’s thinking proceeds on these subjects.) As part of such a program, an education in sound economics would be essential and valuable. Without it, it is a wasted effort.

 

I suspect that you might have been misled by the fact that you have heard businessmen accept the most preposterous economic fallacies; and you concluded that once the fallacies are exposed, the trouble is cured. Do not be deceived by superficial symptoms; the trouble goes much deeper than that; the trouble is not in the nonsense they accept, *but in what makes them accept it*.

 

I have written all this at such great length because I consider an organization created by you as potentially of tremendous importance. I consider you the only man in my acquaintance who has the capacity to translate abstract ideas into practical action and to become a great executor of great principles. Therefore I would hate to see you fail in what could be a great undertaking, by attempting it on the wrong premise and in the wrong direction.

 

I am particularly worried by the fact that you intend to start on such a grand scale (a $3,000,000 budget). If you do not lay the proper foundation first, a three-million-dollar skyscraper will collapse on you more surely and more disastrously than a little bungalow. You will find yourself widely, publicly known and tagged as another ineffectual outfit like the N.A.M. or the Industrial Conference board; your name will become that of “another one of those conservatives,” instead of a new, powerful figure that would attract national attention by representing a real cause, and gain a following through courage, integrity and an unanswerable case, which is what I want you to become. You will find yourself caught in the ruins and forced to go on by the responsibility of so expensive an organization. The end of such a process is—Virgil Jordan.

 

It would be so much better and so much more practical to start in a smaller way and grow by a natural process rather than a forced one. You do not have at present the men and the educational material to use on a $3,000,000 scale. It would be better to gather your specialists and train them first, rather than release on the nation a flood of unprepared, “mixed philosophy” propagandists.

 

This letter is my contribution to your cause. If it helps you to analyze the situation, that is the best help I can offer you. If you agree with my analysis, I can continue to help you in this way, in the matter of philosophical direction. I know you have plenty of economists to call on for your work, but no people capable of undertaking the philosophical-moral part of it. Your main problem is to find them. And I will help you long-distance, to the extent that I can.

 

I shall be most interested in your answer to this.

 

As to your proposed radio program, I don’t think it’s a good plan. Personally, in spite of my interest in the subject, I’m afraid I would not listen to such a program. I think it would bore me. Five men talking on the same subject from the same general viewpoint would be more monotonous than just one man making a connected speech. The fact that the five men disagree on details would only add confusion, dilute and diffuse the subject and make the whole of the broadcast inconclusive and probably pointless.

 

If you decide to use Anthem in The Freeman, let me know. I’d like to have you do it, only I’d want to edit the story a little first; it’s old and there are some passages which I think are bad writing and which I’d like to straighten out.

 

Ayn Rand

January 1, 2017 Posted by | -Economics, -Philosophy, Intellectual Capitalism, Patents, philosophy | , , , , , | Leave a comment