Patterico's Pontifications

5/10/2014

A Response to a Reader’s Question About Government Control of Money

Filed under: General — Patterico @ 11:01 am

In response to my question: ‘why in the world would you want the government involved in money?” a reader asks:

Why do you think the founders did?

“But, ultimately, the thing that pushed Coke off its 5-cent price was abandoning the gold standard, and the resulting inflation. It took a few years, but the prices of the inputs eventually rose to such a degree that Coke had to raise its price.”

How much have computing prices changed since we left the gold standard?

But lastly, how is setting a gold standard not the government having control?

My response was rather long, and since I spent some time on it, I thought I would turn it into a post, which expands on some points I have already made, reinforces others, and hopefully answers a few related questions some of you have had.

It is good to remember that there was quite a bit of disagreement on various topics among “the Founders.” I think they tend to be treated as a lumpy whole these days, probably because the disagreements that they had amongst themselves seem to pale in comparison to the difference between the ideals they shared, on one hand, and the support for an oppressive central government that so many accept these days, on the other.

The gold standard acted to brake some of the excesses back then. As Walter Williams has observed: “Our founders feared fiat money.” They had good reason to; during the Revolutionary era, states issued paper currency not backed by gold, and the Continental Congress issued Continentals, which were later famously worthless for various reasons, including British counterfeiting, and the colonies’ decision to continue to issue fiat money backed by nothing. (Governments like to inflate during times of war.)

Government control of coinage in a gold standard system is quite different from wanting the government to control the money supply in an era (today) completely untethered from any mechanism that can serve to brake government’s natural and historic tendency to debase (inflate) the currency. Government-caused inflation expands governmental power and reduces (or, as today, merely delays) the consequences of irresponsible borrowing.

The primary money controversy in the days of the founding, I believe, was the argument over whether to have a central bank. Hamilton favored it. Jefferson and Madison opposed it — but Madison eventually gave in once the precedent was established.

Soon, Jefferson was warning: “We are to be ruined by paper, as we were formerly by the old Continental paper.” He warned of a “bank bubble.” Soon enough, we got the Panic of 1819, and a call for hard money. But it never happened — at least not in a pure sense — and the 1800s had bank panics (largely resulting from state laws preventing banks from having more than one branch!) and other government interference with the free market.

As for the question: how is setting a gold standard not government control? read my last few posts. All refer to one I did on the history of money, and how the gold standard arose. But I’ll explain it again, briefly.

The idea is that the gold standard arose, as money must, organically — within the context of a free market demand for a medium of exchange to facilitate what are essentially barter transactions between people who have created wealth by supplying goods or services others want. Government simply providing a currency that is based on a certain weight of gold creates no immediate concern. The worry is over the potential for abuse — because government has incentives to debase the currency in ways that the market cannot correct.

The problem arises when government interferes with the unhampered market economy. Specifically, when government monopolizes the right to coin money; passes laws that allow banks to suspend payments in gold (as it did repeatedly in the 1800s); grabs the gold (as it did in 1933); inflates the currency; and the like.

As for computing prices, that is a situation where rapid technological development, together with the laws of supply and demand, create a “deflation” in the price of a particular good so rapid that it outstrips any government effort to control it. I’m glad you brought up the example, because it illustrates the basic fallacy of those who fear deflation, claiming that people will always delay a purchase when prices are falling. Yes, people sometimes wait out a purchase of a smartphone or a computer because they hope prices will fall and quality will increase — but ultimately, just about everybody buys one.

Deflation is not a phenomenon to be feared, I submit, in an unhampered market economy. It is a problem only when government has already interfered in other critical aspects of the economy, such as setting minimum wages, or passing laws that allow unions to force themselves on workers who don’t want them. When wages cannot fall below a certain level by law, deflation poses a problem for businessmen — but when the unhampered market economy can respond to such adjustments, the dreaded prospect that we might have to spend less for a higher quality good, as we do with computers, seems less frightening.

Blaming the free market economy for its inability to deal with deflation, when government has taken away the very tools that entrepreneurs use to address that phenomenon, is obviously unfair. A natural and smooth business cycle should take place when government stays out of economic affairs. Unfortunately, government is seemingly always “here to help” — and so the smooth transitions we should see, never seem to actually occur.

P.S. Another reader writes with a rare expression of support:

Since we’re almost to the point of “Godwinning” this argument, I thought I’d let you know that you’re doing an excellent job so far in defense of the gold standard. I appreciate the fact that you understand the argument for it well and you’re hitting the correct sources. (Nice point about the contradictions inherent in the 1873 “Long Depression”, btw.)

. . . .

Don’t get too frustrated with the fiat monetists. I know that it’s like arguing with a religionist or a progressive but, as Rand put, you can’t force a mind. Just put up your info on the gold standard and let the seeds sprout in receptive minds. Good luck.

I appreciate that very much. As I have consistently said, I don’t claim to be an expert on all this, but I think the ideas make sense, and are (in broad strokes) consistent with my basic political/economic philosophy: that freedom and prosperity are maximized when the government steps out of the way and lets people make their own decisions. While I have always believed in those principles, until recently I took it for granted that they do not apply to government control of interest rates, the money supply, and the like. The Austrian economists have caused me to rethink all that, which is why I consider this series of posts important to me personally.

Comments (103)

103 Responses to “A Response to a Reader’s Question About Government Control of Money”

Ding!
Patterico (9c670f) — 5/10/2014 @ 11:01 am
The commenter in question has posted a couple of comments addressing this. I asked him to bring the discussion here, and I will address them here in turn.
Patterico (9c670f) — 5/10/2014 @ 11:04 am
“It is good to remember that there was quite a bit of disagreement on various topics among “the Founders.”

True, but we can all agree on what made it into the text of Article I, Section 8:

“To coin money, regulate the value thereof, and of foreign coin, and fix the standard of weights and measures;”

Yes: the Constitution says what it says, and should be interpreted in the way that it was understood by the ratifiers. What is your point there? The Founders did it, so it was right? Or something else?

“As for the question: how is setting a gold standard not government control? read my last few posts. All refer to one I did on the history of money, and how the gold standard arose. But I’ll explain it again, briefly.”

Let’s say it’s 1893, and we have the gold standard. What’s the argument against Free Silver?

I have no problem with free silver. You have some for me?

To be serious: Please understand that in arguing for the “gold standard” I hold no brief for gold. I fixate on gold only because that is the commodity that the free market has historically settled on as the best medium of exchange. If people want to use silver instead, or in parallel, I am fine with that. What I don’t approve of is government setting a fixed exchange rate, because that distorts the market and ultimately favors one metal over another as the free market price diverges from the government-set exchange rate. Keep govermnent out of money to the maximum extent possible will always be my argument.

“Yes, people sometimes wait out a purchase of a smartphone or a computer because they hope prices will fall and quality will increase — but ultimately, just about everybody buys one.”

And then they lose money when the thing they own is now dropping in price. But anyway, the point with pointing to computing is that you’re mismeasuring inflation or deflation if you just fixate on one product. Inflation/deflation are about changes to general price levels, not about what technological or other factors are changing the costs of one thing relative to others.

Right. And I believe that in an unhampered market economy, you don’t get a general inflation or deflation. You get a reallocation of resources to the production of higher-order or lower-order goods as demand and supply cycles go through a natural expansion and contraction with respect to one type of good or another. The phenomenon of changes in general price levels overall, in my view, is always a consequence of government interference in the unhampered market economy. Austrian theory explains this well.
Patterico (9c670f) — 5/10/2014 @ 11:20 am
“FDR established cartels, gave his blessing to price-fixing, destroyed livestock and crops, and doled out public works projects in return for Democratic votes. Do you support all this too, because of a crude correlation to an increase in GDP from the very trough of the worst Depression in the country’s history?”

Do you think those things helped growth? The quote you posted said the confiscation and other factors were an attempt to stoke growth. Did they?

My answer: absolutely not. These policies were destructive, harmful to the public, and extended what would have otherwise been no worse than the recession at the beginning of the 1920s. The fault did not all lie with FDR. Hoover signed Smoot-Hawley, jawboned businessmen to keep wages high, and signed other legislation interfering with the market’s efforts to recover. But FDR really went off the reservation and, together with the Fed, helped keep us in Depression for years.
Patterico (9c670f) — 5/10/2014 @ 11:22 am
Hoover signed Smoot-Hawley, jawboned businessmen to keep wages high, and signed other legislation interfering with the market’s efforts to recover

You’re leaving out how he affected income and other taxes, per below. IOW, he was a liberal’s wet dream come true.

I will admit to originally falling for the notion — based on absolutely nothing, on pure ignorance on my part — that Hoover perhaps was a libertarian Republican, a president who presumably had a laissez-faire attitude about the economy and helping the working stiff, and that’s where his unpopularity arose from. So, yea, I was an idiot about the reality of the 1930s. Mea culpa.

mises.org: [Republican] President Hoover came to the legislative session of 1932 in an atmosphere of crisis, ready for drastic measures. In his annual message to Congress, on December 8, 1931, Hoover first reviewed his own accomplishments of the past two years: Measures such as Federal and state and local public works, work-sharing, maintaining wage rates…, curtailment of immigration, and the National Credit Corporation, Hoover declared, have served these purposes and fostered recovery. Now, Hoover urged more drastic action, and he presented the following program:

– Establish a Reconstruction Finance Corporation, which would use Treasury funds to lend to banks, industries, agricultural credit agencies, and local governments;
– Broaden the eligibility requirement for discounting at the Fed;
– Create a Home Loan Bank discount system to revive construction and employment measures which had been warmly endorsed by a National Housing Conference recently convened by Hoover for that purpose;
– Expand government aid to Federal Land Banks;
Set up a Public Works Administration to coordinate and expand Federal public works;
– Legalize Hoover’s order restricting immigration;
– Do something to weaken “destructive competition” (i.e., competition) in natural resource use;
– Grant direct loans of $300 million to States for relief;
– Reform the bankruptcy laws (i.e., weaken protection for the creditor).

With a $2 billion deficit during annual year 1931, Hoover felt that he had to do something in the next year to combat it…. In his swan song as Secretary of Treasury, Andrew Mellon advocated, in December, 1931, drastic increases of taxes, including personal income taxes, estate taxes, sales taxes, and postal rates.

Obedient to the lines charted by Mellon and Hoover, Congress passed, in the Revenue Act of 1932, one of the greatest increases in taxation ever enacted in the United States in peacetime. The range of tax increases was enormous. Many wartime excise taxes were revived, sales taxes were imposed on gasoline, tires, autos, electric energy, malt, toiletries, furs, jewelry, and other articles; admission and stock transfer taxes were increased; new taxes were levied on bank checks, bond transfers, telephone, telegraph, and radio messages; and the personal income tax was raised drastically as follows: the normal rate was increased from a range of 1 percent-5 percent, to 4 percent-8 percent; personal exemptions were sharply reduced, and an earned credit of 25 percent eliminated; and surtaxes were raised enormously, from a maximum of 25 percent to 63 percent on the highest incomes. Furthermore, the corporate income tax was increased from 12 percent to l3 percent, and an exemption for small corporations eliminated; the estate tax was doubled, and the exemption floor halved; and the gift tax, which had been eliminated, was restored, and graduated up to 33 percent.

Hoover also tried his best to impose on the public a manufacturers’ sales tax, but this was successfully opposed by the manufacturers. We might mention here that for Hoover the great increase in the estate tax was moral in itself, in addition to its alleged usefulness as a fiscal measure.

The estate tax, he declared, is “one of the most economically and socially desirable—or even necessary of all taxes.” He hinted darkly of the “evils of inherited economic power,” of “cunning lawyers,” and “obnoxious” playboys: there was no hint that he realized that a tax on inherited wealth is a tax on the property of the able or the descendants of the able, who must maintain that ability in order to preserve their fortunes; there was not the slightest understanding that a pure tax on capital such as the estate tax was the worst possible tax from the point of view of getting rid of the depression.

^ Hoover was merely FDR Part One, and how ironic for me to now fully realize that if Hoover had been a laissez-faire conservative instead of a do-gooder squish — if not a flat-out leftwinger — this nation’s recession following the infamous stock market crash of 1929 wouldn’t have turned into the Great Depression.
Mark (99b8fd) — 5/10/2014 @ 11:55 am
Mark,

Precisely so.
Patterico (9c670f) — 5/10/2014 @ 12:08 pm
“What I don’t approve of is government setting a fixed exchange rate, because that distorts the market and ultimately favors one metal over another as the free market price diverges from the government-set exchange rate. ”

Now I see why I got confused. Because when people use the term “gold standard” that means that the unit of value/currency is fixed to an amount of gold.
cbuund (74098c) — 5/10/2014 @ 12:35 pm
Regarding this point, from the commenter: And then they lose money when the thing they own is now dropping in price.
Er. Only if the thing was bought purely as an investment, with the intention of reselling it.
If I buy a computer to use for the next 5 years, and it’s on sale the next week, well: I could have gotten a better deal if I’d waited, but, assuming I made a rational decision to pay what I did for what I got, I still got my money’s worth.
If the “oh no, the price dropped!” argument were valid for non-investment purchases, no one would ever buy a new car, nor a diamond. Nor a Big Mac: what’s the resale value on one of those, anyway?
There is more to life than capital gains.
Eric Wilner (3936fd) — 5/10/2014 @ 12:44 pm
“If the “oh no, the price dropped!” argument were valid for non-investment purchases, no one would ever buy a new car, nor a diamond. ”

People do concern themselves about the resale value of cars.
cbuund (74098c) — 5/10/2014 @ 12:50 pm
Some people can double the value of their used cars.
JD (9cbc9b) — 5/10/2014 @ 12:56 pm
“What I don’t approve of is government setting a fixed exchange rate, because that distorts the market and ultimately favors one metal over another as the free market price diverges from the government-set exchange rate. ”

Now I see why I got confused. Because when people use the term “gold standard” that means that the unit of value/currency is fixed to an amount of gold.

I mean a fixed exchange rate between gold and silver — “bimetallism.”
Patterico (9c670f) — 5/10/2014 @ 2:32 pm
People do concern themselves about the resale value of cars.

Usually because they want to buy a new one. If the new ones are now cheaper, resale value is less of an issue.
Patterico (9c670f) — 5/10/2014 @ 2:33 pm
Let’s remember that the depression was not caused by the stock market crash of 1929. A significant factor was the gold standard and France’s cheating on it. Countries sticking to it (like the US) had to deflate their money as gold flowed to France, and that deflation had a major negative impact on the economy.

Tying money to gold protects against some excesses by government, but it also creates other hazards. Also, it is ultimately unreliable, as economics driven political pressure can cause it to be revoked suddenly.
John Moore (1372fd) — 5/10/2014 @ 2:55 pm
My question about converting to a gold standard is simply this: is there that much gold in the world? It seems to me that for an economic system to run smoothly, there would have to be enough liquidity for people to buy and sell homes, cars, businesses, etc. without waiting for enough gold to pile up at the local bank. The real assets of the United States for instance are—according to— http://rutledgecapital.com/2009/05/24/total-assets-of-the-us-economy-188-trillion-134xgdp/ — 188 trillion. I realize that we wouldn’t have to have that much in liquid currency, but honestly, is there actually enough gold in the world to back a worldwide gold standard?
Jack (ff1ca8) — 5/10/2014 @ 3:17 pm
the 1800s had bank panics (largely resulting from state laws preventing banks from having more than one branch!) and other government interference with the free market

You don’t have to go that far back to see how that worked. I worked for Continental Illinois National Bank and Trust Company in Chicago during the late 1970’s into the mid 1980’s. At the time, it had the largest commercial and industrial loan portfolio in the nation – our nearest rival was First National Bank of Chicago. Part of the reason for the demise of the bank was the fact that Illinois law prohibited banks to branches – except a single branch within a specified few thousand feet of the bank HQ building.(!)

With a limited consumer deposit base, the bank took to funding its large loan portfolio of fixed rate long-term loans to businesses with “hot money” – short-term borrowings from other banks, the Fed, and the limited number of CD’s it could issue. This worked out as long as the yield curve was normal, but when it inverted and short-term rates (the bank’s cost of funds) exceeded the rates on the long-term loans (remember the Prime Rate reaching 21% under Carter?), the bank began losing money by the truck load since it couldn’t call the loans.

One of the reasons for the limitation on branches was the desire of politicians from downstate Illinois to protect community banks and currency exchanges from competition from the big city banks. The smaller banks soon figured out they could grow by forming “chains of independently owned” banks – but only banks smaller than a certain size were able to do that.

The currency exchanges prospered when blue collar workers had no local banks to cash their paychecks, so they went to currency exchanges which cashed the checks for a % fee, and offered payday loans as well. One year the Illinois Secretary of State (who de facto regulated financial services in the state) died. He was a bachelor and when the authorities went to his apartment following his death they found his closets filled with shoeboxes stuffed with cash. Hmmmm. I guess he was also involved in a form of currency exchange. Illinois politics – always something going on.
in_awe (7c859a) — 5/10/2014 @ 4:28 pm
is there actually enough gold in the world to back a worldwide gold standard?

Absent government interference there will always be enough. Adding to the supply merely dilutes the value of each unit of weight. You’re making the mistake (I think) of conflating the face value of a dollar with a true value. All money is, is a medium of exchange to allow people to trade goods and services of value and calculate profit and loss.
Patterico (9c670f) — 5/10/2014 @ 5:08 pm
Absent government interference there will always be enough. Adding to the supply merely dilutes the value of each unit of weight. You’re making the mistake (I think) of conflating the face value of a dollar with a true value. All money is, is a medium of exchange to allow people to trade goods and services of value and calculate profit and loss.

People would also like it to be a store of value. So fluctuations in value are bad.
James B. Shearer (9233b4) — 5/10/2014 @ 5:55 pm
Deflation is not a phenomenon to be feared, I submit, in an unhampered market economy …

It is an empirical fact that wages are sticky downward which means deflation causes problems.

And unexpected deflation (like unexpected inflation) is bad because it causes future payments in fixed dollars to become unfair to one side.
James B. Shearer (9233b4) — 5/10/2014 @ 5:59 pm
“People would also like it to be a store of value. So fluctuations in value are bad.”

You would think.
cbuund (74098c) — 5/10/2014 @ 6:50 pm
“If unsustainable debt and runaway inflation don’t sell you on fiat money, how about the bank bailouts?”

The above is pulled from Patterico’s prior post and creates in my mind the implication that if we switch back to the gold standard we will get rid of government deficits and runaway inflation, whatever that means.

The problem I have with that verbiage is our record with deficits under the gold standard is as bad under without the gold standard. What year hasn’t the government run a defict? The get bigger in dollar terms because the economy grows and we keep adding entitlement programs. Click on Table 1.2 below.

http://www.whitehouse.gov/omb/budget/Historicals/

With respect to inflation, the record isn’t exactly a day at the beach either.

http://inflationdata.com/Inflation/Inflation_Rate/HistoricalInflation.aspx

The response from Austrians is sort of like the response of those bemoaning the fall of communist Russia. You know, we have never properly tried a true gold standard free of government interference and that evil fractional reserve accounting.

Maybe, maybe not, but that does nothing to answer the question whether we should.

Do people believe they should earn any income on money they deposit with banks? Where does that come from?

Can the U.S. move to a gold standard all alone without being subjected to a raid on its reserve holdings by foreign trading partners who want to be paid in gold rather than dollars?

Is it silly to fixate on a faulty government definition of money when your decrying government involvement in controlling the money supply?
daleyrocks (bf33e9) — 5/10/2014 @ 7:10 pm
4. Comment by Patterico (9c670f) — 5/10/2014 @ 11:22 am

But FDR really went off the reservation and, together with the Fed, helped keep us in Depression for years.

I believe the low point of the Depression was on or about March 4, 1933, the day FDR took office (and the bank holiday)

The problem was the reduction of the money supply, and the main reason for that was the attempt to maintain the gold standard.

Every single country had to give up.

(except maybe, I don’t know, Saudi Arabia, which nobody knew or cared about then)
Sammy Finkelman (bcd7c8) — 5/10/2014 @ 7:26 pm
illustrates the basic fallacy of those who fear deflation, claiming that people will always delay a purchase when prices are falling

That actually isn’t the problem with deflation, although they keep on saying so. The effect is limited.

The problem is this means that businesses would need to sell inventory below cost, or at a reduced gross profit margin, and it doesn’t make sense for businesses to keep inventory. They can go broke, too.
Sammy Finkelman (bcd7c8) — 5/10/2014 @ 7:32 pm
Absent government interference there will always be enough. Adding to the supply merely dilutes the value of each unit of weight. You’re making the mistake (I think) of conflating the face value of a dollar with a true value. All money is, is a medium of exchange to allow people to trade goods and services of value and calculate profit and loss.

If the face value of a “dollar” is not the “true” value of the gold contained within it, then either the gold will be removed from circulation as too valuable to spend or gold will be dumped into circulation as overvalued for its content, and you will get destructive bubbles with inflation or deflation.
This has happened repeatedly in history, and been repeatedly ignored by advocates of a gold standard as inconvenient to their declarations and guarantees of economic utopia if only a gold standard were imposed.

The worry is over the potential for abuse — because government has incentives to debase the currency in ways that the market cannot correct.

And all of those incentives exist for private dealers in gold.
From coin clipping to debasing new mints to overt fraud in an issue back to different standards for issues and on around to hoarding and flooding the market and defaulting on loans, not only do the same incentives exist but the ability to perpetrate them because of the profusion of standards and inability of individuals to deal with the multitude of competing currencies that will be unleashed upon them.

What I don’t approve of is government setting a fixed exchange rate, because that distorts the market and ultimately favors one metal over another as the free market price diverges from the government-set exchange rate.

Then how exactly do you imagine that coins will be minted without a fixed exchange between two or more different metals employed in the currency?
If you want to mint a coin with a face value of $10 out of gold and another with a face value of $1 out of silver, what mechanism do you believe will be used to determine the amount of gold in the one coin and the amount of silver in the other coin, and how will that relate to the $0.01 coin made out of silver?

And to expand that for private minting in general:
How will a standard for that be establishing among minters?
How will the standard for metal content be established?
How will it be guaranteed?

As a note on Founders:
Soon, Jefferson was warning:

Jefferson had extreme difficulty managing his property and ultimately wound up so deeply in debt that his estate was auctioned away. That Library of Congress that was built using his collection? He only sold it to stave off immediate bankruptcy.
It is to be expected that a man who mortgaged himself to bankers and spent most of his retirement fending them off would have such a negative view of bankers and banking.
It is not to be expected such a man would ever provide truly objective commentary on the subject.
Sam (e8f1ad) — 5/10/2014 @ 7:37 pm
“illustrates the basic fallacy of those who fear deflation, claiming that people will always delay a purchase when prices are falling”

Deflation is also very bad for debtors, who have to repay debt with dollars that are now more expensive and with wages that may have stagnates or declined.
daleyrocks (bf33e9) — 5/10/2014 @ 7:40 pm
deflation is also very bad for balloons
happyfeet (8ce051) — 5/10/2014 @ 7:42 pm
I still adhere to what I was learned in college, that if you took all the economists in the world and stretched them end to end that they would not reach a conclusion.
daleyrocks (bf33e9) — 5/10/2014 @ 7:43 pm
~~was~~
daleyrocks (bf33e9) — 5/10/2014 @ 7:44 pm
… A natural and smooth business cycle should take place when government stays out of economic affairs. …

Unfortunately it appears to me that this isn’t true. Free markets seem to be prone to certain instabilities that can reach destructive levels. You can always make up some story about how government causes them but I don’t buy it. Especially when the story is about a failure to properly regulate which is contradictory to the government staying out of economic affairs.
James B. Shearer (9233b4) — 5/10/2014 @ 8:37 pm
Our brethren across the ocean, aren’t any smarter;

http://www.breitbart.com/Breitbart-London/2014/05/10/Cameron-let-us-into-your-bank-or-well-raise-taxes
narciso (3fec35) — 5/10/2014 @ 9:14 pm
29. This will end well:

http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2014/05/20140510_BOJ.png
gary gulrud (e2cef3) — 5/11/2014 @ 1:37 am
“Deflation is also very bad for debtors, who have to repay debt with dollars that are now more expensive and with wages that may have stagnates or declined.”

And whatever secures the debt (such as your house) is also declining in value.
cbuund (74098c) — 5/11/2014 @ 4:59 am
Oh, really, 50 lbs.? Good for you!

https://celebrity.yahoo.com/news/rosie-odonnell-explains-dramatic-weight-loss-193326668.html

Here, stand next to Candy. Why, yes, I believe I see it.
gary gulrud (e2cef3) — 5/11/2014 @ 5:49 am
Well done and informative series. Bet the gov’t defenders are coming out of the woodwork, no?
TXWhiteHouse (85f23d) — 5/11/2014 @ 6:42 am
16

Absent government interference there will always be enough. …

If the US were to go back on a gold standard, a dollar gold exchange ratio would have to be set. What ratio do you favor? Or how would you determine the ratio?
James B. Shearer (9233b4) — 5/11/2014 @ 6:51 am
3

To be serious: Please understand that in arguing for the “gold standard” I hold no brief for gold. I fixate on gold only because that is the commodity that the free market has historically settled on as the best medium of exchange. If people want to use silver instead, or in parallel, I am fine with that. What I don’t approve of is government setting a fixed exchange rate, because that distorts the market and ultimately favors one metal over another as the free market price diverges from the government-set exchange rate. …

The problem with gold is that it is too valuable for low denomination coins. Hence silver or even copper coins for small transactions. But this doesn’t work without some sort of fixed ratio (so that a dime is exactly a tenth of a dollar etc.).

… Keep govermnent out of money to the maximum extent possible will always be my argument.

A question is what is the maximum extent possible (or practical)? I think you have unrealistic expectations. If you somehow managed to established a gold standard why would expect it to be immune from government interference? Why wouldn’t we soon go off the gold standard for similar reasons to why we went off it before (at a time when government was less powerful and intrusive than it is today)?
James B. Shearer (9233b4) — 5/11/2014 @ 7:03 am
I wonder. There was a May Fool’s in England and other places; April Fool’s was during Lent this year; Patterico has mentioned his deadpan “humor” which people take seriously. Hmm. Are we being pranked?
nk (dbc370) — 5/11/2014 @ 7:33 am
Hoover was merely FDR Part One, and how ironic for me to now fully realize that if Hoover had been a laissez-faire conservative instead of a do-gooder squish — if not a flat-out leftwinger — this nation’s recession following the infamous stock market crash of 1929 wouldn’t have turned into the Great Depression.

I have been wishing for some time that someone would do a good biography of Harding. He was vilified because of the antics of several of his appointees but he was behind the actions that ended the 1920-1921 depression. Within a year of his swearing in, the depression that followed the end of the war was over and the “Roaring Twenties” was underway.

The fact that leftist historians later asserted that the 20s were a period of immorality (mostly from the Progressive idea of Prohibition) carried over to saying the prosperity was immoral. The left also attacked the “greed” of the Reagan era. Leftism is the modern version of Puritan thinking, without God of course.
Mike K (cd7278) — 5/11/2014 @ 8:05 am
23. If you want to mint a coin with a face value of $10 out of gold and another with a face value of $1 out of silver, what mechanism do you believe will be used to determine the amount of gold in the one coin and the amount of silver in the other coin, and how will that relate to the $0.01 coin made out of silver?

One of them is going to be the “real money”

There was a time when gold or silver was money, but that’s not now.

the multitude of competing currencies that will be unleashed upon them.

In olden times, before coinage, it did get standarized.

http://www.mechon-mamre.org/p/pt/pt0123.htm

Genesis 23:16

And Abraham hearkened unto Ephron; and Abraham weighed to Ephron the silver, which he had named in the hearing of the children of Heth, four hundred shekels of silver, current money with the merchant.

That means there was something standard, which people used. Somebody was producing them. This would have been checked by weighing, and volume.
Sammy Finkelman (bcd7c8) — 5/11/2014 @ 9:08 am
Mike K #37 – now, *that* raises an interesting idea …

Perhaps what is needed is a campaign to remind young people of the link between Progressives and Prohibition … and also remind people how proud the Dems are to be Progressives … and how they keep banning things (except things that the Dems like) …

“Tobacco Now: Is Marijuana Next To Be Banned ?”

“Plastic Bags for Groceries Now; Are Plastic Baggies Next To Be Banned ?”
Alastor (2e7f9f) — 5/11/2014 @ 9:11 am
From the account of Tom Woods regarding the creation of money by banks out of thin air:

Suppose the Fed engages in one of its “open-market operations” and purchases government securities from one of its primary dealers. The Fed pays for this purchase by writing a check on itself, out of thin air, and handing it to the primary dealer. That primary dealer, in turn, deposits the check into its bank account – at Bank A, let us say.

Bank A doesn’t just sit on this money. The current system practically compels it to use that money as the basis for credit expansion. So if $10,000 was deposited in the bank, some $9,000 or so will be lent out – to Borrower C. So Borrower C now has $9,000 in purchasing power conjured out of thin air, while Person B can still write checks on his $10,000.
This is why the Greenbackers speak of “money as debt.” The $9,000 that Bank A created in our example entered the economy in the form of a loan to Person B.

I still have no idea who he is referring to as Greenbackers but further along in his piece he seems to agree with me that there is a limit to the amount of money banks can create and that they can’t just create it willy nilly without a demand for credit as implied by the “thin air” theory.

Taking the above example, suppose the bank is maxed out on its cash reserves to deposits ratio and risk adjusted assets to capital ratios. Can it make more loans out of thin air? No.

What enables Bank A to make the loan to Customer C in this scenario? It is the deposit of $1,000 liquid funds from the primary dealer to its balance sheet, which pull its leverage ratios back below the maximums, giving it the the freedom and funds on hand to make the loan to Company C. It is not the creation of a deposit account on behalf Company C that creates the ability to do anything.

Person B seems completely irrelevant in this example. Why do they still have unspent money from a loan. They should have taken out a line of credit and withdrawn funds as they needed money.
daleyrocks (bf33e9) — 5/11/2014 @ 9:58 am
My example above does not help the maxed out risk to capital ratio, but it is neutral to the deposit leverage.
daleyrocks (bf33e9) — 5/11/2014 @ 10:11 am
A friend recently loaned me a book titled The Worst Hard Time by Timothy Egan which I found to be very interesting albeit uncomfortable reading. It focuses on the years known as the “dirty thirties”- the dust storm and black blizzard and drought years–and the people there who both unknowingly contributed to it, and then endured it or died from it. While the worst of the devastation and human and animal misery was centered in the great plains areas where millions of contiguous acres of primeval prairie grass were torn up and denuded for planting wheat, (parts of Texas, Oklahoma, Kansas, Colorado) it had broader and costly national implications during the heart of the great depression. Many of the depression era new deal government programs were hatched to “fix” previous ill-considered government programs (Indian resettlement, homesteader laws and free land) that had gone awry. Sound familiar?

Some people who have been contributing to these threads and also enjoy historical non-fiction may find this book on a closely related subject to be a worthwhile read.
elissa (a1c062) — 5/11/2014 @ 10:56 am
Alastor and MIke K.–speaking of linkages, Marilyn Vos Savant had an interesting short piece in this week’s Parade magazine titled, “Do wind farms affect weather, at least locally?” I wonder how many of our Progressive climate change sustainable energy friends will pick up on this quote about unintended consequences:

Yes, and the more widespread they become, the more these changes will go beyond the immediate area. Some effects, such as ground warming and drying for miles around, are already known, but cumulative effects on the weather—especially if wind farming grows significantly—are unpredictable.

One point to note is that while wind farms are a source of renewable energy, this doesn’t mean they—and other forms of renewable energy, for that matter—don’t cause change. Even improved engineering of the turbines (to reduce turbulence, etc.) cannot eliminate the fact that the machines remove energy from the wind, and this will have an impact on the weather and ultimately the climate.

http://parade.condenast.com/291812/marilynvossavant/291812/
elissa (a1c062) — 5/11/2014 @ 11:11 am
I still have no idea who he is referring to as Greenbackers but further along in his piece he seems to agree with me that there is a limit to the amount of money banks can create and that they can’t just create it willy nilly without a demand for credit as implied by the “thin air” theory.

daleyrocks,

You really have not been reading what I have been saying, have you?

I have said all along that “there is a limit to the amount of money banks can create and that they can’t just create it willy nilly without a demand for credit.” For example:

Commenters in the other thread note that banks cannot simply create this money “willy-nilly.” Well, of course. Banks are constrained by the need to have the loan repaid, and that means they need a supply of creditworthy borrowers. The bank’s ability to make a profit is affected by the interest rates set by the central bank.

And another example:

I agree that they cannot create money “willy-nilly.” They are constrained by the need to profit by finding creditworthy borrowers, and their ability to profit from lending is dependent in part on interest rate levels set by the central bank.

So, your version of the “thin air theory” appears to be a bit of a strawman. You’ve now proven that Tom Woods does not agree with your strawman. Congratulations. I don’t either.
Patterico (9c670f) — 5/11/2014 @ 11:52 am
I still have no idea who he is referring to as Greenbackers

Fiat money proponents who hold up the Civil War era Greenbacks as an ideal, because fiat money does not start life as debt. I think the very same piece you’re quoting makes it pretty clear if you read the whole thing.
Patterico (9c670f) — 5/11/2014 @ 11:53 am
People would also like it to be a store of value. So fluctuations in value are bad.

Well, the gold standard is the best way to prevent fluctuations in value. The system we have is a lovely way to experience them. As we are about to find out, likely in most of our lifetimes.

Unfortunately it appears to me that this isn’t true. Free markets seem to be prone to certain instabilities that can reach destructive levels. You can always make up some story about how government causes them but I don’t buy it. Especially when the story is about a failure to properly regulate which is contradictory to the government staying out of economic affairs.

That’s the lefty story and for some the righty story. It’s not my story. Free markets always seem to be prone to certain instabilities caused by government.

A question is what is the maximum extent possible (or practical)? I think you have unrealistic expectations. If you somehow managed to established a gold standard why would expect it to be immune from government interference? Why wouldn’t we soon go off the gold standard for similar reasons to why we went off it before (at a time when government was less powerful and intrusive than it is today)?

I admit that I do have unrealistic expectations, and this dovetails with your question: why bother arguing for this when we don’t expect government to keep its hands off the economy?

To which I reply: why object to anything government does? Corruption, bloat, oppression . . . these are all common characteristics of every government in history. Why argue against them? The answer is: to improve our world, we try to educate people about what’s right and what’s wrong with our poltiical and economic systems. That’s what I am trying to do: education. And I face, even on a conservative blog, quite a bit of opposition, which tells me that there is a lot of education to be done about the benefits of the free market.

I think we’ve improved society in a lot of ways. Societies have almost always had slavery, and slavery still exists in our modern world. Yet we fight slavery and appear to have made substantial progress in the developed world.

I think the same goes for the free market economy. The more people wake up to the deficiencies of government intervention, the more people will see the benefits of freedom and the unhampered market economy, and the closer we can get to that ideal.

We’ll probably never get there, but defeatism helps nobody.
Patterico (9c670f) — 5/11/2014 @ 12:02 pm
“You really have not been reading what I have been saying, have you?”

Patterico – On the contrary, I have read everything you have written. So now we are in agreement that the “thin air” theory of money creation is limited by the ability of banks to find creditworthy borrowers.

Are we also in agreement that those creditworthy borrowers must be willing to pay lenders interest at a rate high enough over the lenders cost of funds to allow the lender to make money or do you consider that part of my straw man argument?

Wooods does not disagree with my agreement if you understand my comment above, which again addresses the mechanics of loan creation also addressed in the BOE paper you linked. Woods clearly agrees as does the BOE with me that loans can not be created willy nilly without consequence. You have also not demonstrated where banks can create loans without assets on hand as you claimed they do all day long.

I read the first half of the Woods piece and lost interest. That’s why I said I couldn’t tell who he was referring to.
daleyrocks (bf33e9) — 5/11/2014 @ 12:09 pm
Person B seems completely irrelevant in this example.

Person B is not irrelevant at all. As Woods notes, Person B has the ability to write checks up to $10,000 on his account. His deposits can be converted into cash money and spent any way he pleases: withdrawn, spent in the form of checks, etc. Meanwhile Person C has $9000 in loan proceeds. Those proceeds can be converted into cash money and be used in any way he pleases (unless the loan documents restrict the manner of their use). There is now up to $19,000 of cash money floating around the economy, when we started with $10,000 — because the bank has created new money.
Patterico (9c670f) — 5/11/2014 @ 12:10 pm
“Well, the gold standard is the best way to prevent fluctuations in value. The system we have is a lovely way to experience them.”

Take a look at the price of gold over the last several years. That’s how much inflation / deflation we would have had under a gold standard. For example, in the last year, gold dropped 12%. If we had the gold standard, then we would have had 12% inflation in the last year. As of March 2014 the annualized CPI change was instead 1.5%.
cbuund (74098c) — 5/11/2014 @ 12:11 pm
Patterico – On the contrary, I have read everything you have written. So now we are in agreement that the “thin air” theory of money creation is limited by the ability of banks to find creditworthy borrowers.

You imply that we were not in agreement before. That implication is false, as I have just shown.

Therefore you spent time refuting an argument I never made. That’s called a strawman.
Patterico (9c670f) — 5/11/2014 @ 12:11 pm
Are we also in agreement that those creditworthy borrowers must be willing to pay lenders interest at a rate high enough over the lenders cost of funds to allow the lender to make money or do you consider that part of my straw man argument?

If you read the quotes of mine from past posts and comments, you see me saying exactly that. Let me reproduce a quote of mine that I made just a few comments ago, but this time I will place a different portion of the comment in bold type:

I agree that they cannot create money “willy-nilly.” They are constrained by the need to profit by finding creditworthy borrowers, and their ability to profit from lending is dependent in part on interest rate levels set by the central bank.

I guess maybe you lost interest in my quote before you got to the part where I already said the exact thing that you just asked me if I ever said.

We are “now” in agreement on that point and always have been.
Patterico (9c670f) — 5/11/2014 @ 12:15 pm
Woods clearly agrees as does the BOE with me that loans can not be created willy nilly without consequence.

Woods, the BOE, and I have always been on the same page.

You have also not demonstrated where banks can create loans without assets on hand as you claimed they do all day long.

Re-read the comment I just wrote. There is $19,000 floating around where before there was $10,000.

Now, you can explain what is happening there in one of two ways.

1. You can posit the theory that banks had to have the assets on hand to make the loan. But then you have to admit that they don’t have to have the assets on hand when they simultaneously honor a check written by the depositor for amounts that have already been lent out. Thus, money is created when the checks are honored. Or:

2. You can posit the theory that the funds never left the account, and that the bank simply created money when it made the loan.

Either way you look at it, money has been created. What is dishonest is to look only at one half of each portrayal — the half of #1 where assets had to be there to make the loan, and the half of #2 where assets have to be there to honor the check — and pretend that the other halves of each portrayal (where money is created) never happened.

Either way you slice it, the bank is creating money when it gives full title to the same property to two different people.
Patterico (9c670f) — 5/11/2014 @ 12:22 pm
“Person B is not irrelevant at all. As Woods notes, Person B has the ability to write checks up to $10,000 on his account.”

Patterico – Person B had his money before the primary dealer entered the picture according to my reading of Woods’ example. Why do we care at all about him or his source of funds? I had to read the example a few times before I could figure who he was and where he came from.

He’s just a separate customer of Bank A who has nothing to do with the primary dealer who sold the treasury notes and made the deposit with Bank A or the loan to Customer C. Tom could add in Person E, F, G, H, I, J and K if he wanted.
daleyrocks (bf33e9) — 5/11/2014 @ 12:29 pm
Take a look at the price of gold over the last several years. That’s how much inflation / deflation we would have had under a gold standard.

Um, no. Just no. Not even close.

The whole point of the gold standard is that it prevents the sort of inflation — and threat of inflation — that causes people to flee into hard money assets like gold.

Your argument means that the worse inflation gets (in part because we are not on the gold standard), the higher the price of gold will be (in part because of the abandonment of the gold standard), therefore we would have had the same amount of inflation as we see inflation in the price of gold. That makes no sense whatsoever and reflects a fundamental logical failure.
Patterico (9c670f) — 5/11/2014 @ 12:32 pm
“They are constrained by the need to profit by finding creditworthy borrowers, and their ability to profit from lending is dependent in part on interest rate levels set by the central bank.”

Patterico – If the banks are creating money out of “thin air,” what difference does it make what rate levels are set by the central bank?
daleyrocks (bf33e9) — 5/11/2014 @ 12:34 pm
“The whole point of the gold standard is that it prevents the sort of inflation — and threat of inflation — that causes people to flee into hard money assets like gold.”

There’s still a world market for gold even if some country decides on pegging their currency to gold.

“Your argument means that the worse inflation gets (in part because we are not on the gold standard), the higher the price of gold will be (in part because of the abandonment of the gold standard), therefore we would have had the same amount of inflation as we see inflation in the price of gold. ”

My argument is that if you peg your currency to gold, changes in the price of gold are now changes in the value of your currency. So if the gold price drops by 12% on the world market, that means that the dollar dropped by 12%, and that prices of things denominated in dollars are now 12% higher.
cbuund (74098c) — 5/11/2014 @ 12:42 pm
OK, forget Woods’ example, which does not articulate who “Person B” is with sufficient clarity to permit me to defend his statements with total certainty (even though I think I know what he means).

Here is my example, and I will keep the terms consistent with my argument in preceding paragraphs, even though it means I am starting with Person B.

Person B opens an account with a $10,000 deposit at Bank A.

Borrower C takes a loan for $9000. Bank A credits Borrower C’s account with a deposit for $9000.

Borrower C can now go buy $9000 worth of stuff with his $9000. Person B can also go buy $10,000 worth of stuff with his $10,000. So $9000 has been created. $19,000 has been spent. We had $10,000. Now we have $19,000. (Plus $1000 held in reserve, but I’m talking about money flowing through the economy.)

One of two things is happening. Either:

1.There is still $10,000 in Person B’s account, and always was (since he can write checks on the full $10,000 at any time), meaning $9000 was created when Borrower C’s deposit was created, or at a minimum when he spent those funds, or

2. The bank actually moved $9000 from Person B’s account to Borrower C’s account, meaning no money was created, just moved — leaving only $1000 in Person B’s account. But then, the bank honored Person B’s check for $10,000, which created at that point $9000 that wasn’t there.

I think most economists accept account #1, meaning deposits for the borrower were created out of thin air — but it doesn’t really matter.

Either way, you have $19,000 when before there was only $10,000. Money has been created.

Do I need to say again, for the umpteenth time, that a) this can’t happen willy-nilly; b) it depends on the demand for credit; c) it also depends on the ability of the bank to make a profit, meaning the borrowers have to be creditworthy and the interest rates must be sufficiently high; and d) money is then destroyed when it is repaid?

OK. It’s all said, again.
Patterico (9c670f) — 5/11/2014 @ 12:42 pm
Patterico – If the banks are creating money out of “thin air,” what difference does it make what rate levels are set by the central bank?

The answer to that is set forth in my previous quotes. To repeat:

The bank has to make money. The interest rate levels are set by the central bank, and at different levels, given varying levels of creditworthy borrowers and varying levels of demand for credit, the ability of the bank to make a profit changes as the interest rate changes. And banks are not going to lend out money if they don’t think they can be repaid, because (as you have repeatedly pointed out) the loan still has to be carried on their books.
Patterico (9c670f) — 5/11/2014 @ 12:46 pm
My argument is that if you peg your currency to gold, changes in the price of gold are now changes in the value of your currency. So if the gold price drops by 12% on the world market, that means that the dollar dropped by 12%, and that prices of things denominated in dollars are now 12% higher.

And my argument is that if you peg your currency to gold, and the whole world did in a credible way (which is the hypothetical I am positing), the demand for gold itself would plummet because people would have confidence that the currency is a reliable substitute for gold.

Even in an imperfect world where only the U.S. was on the gold standard, the fact that the reserve currency was pegged to gold would result in a different market with different inflation and different gold prices than we have today. You can’t simply look at the price of gold as it exists in a fiat money world and assume that the price would be the same if we were on a gold standard. That’s just ludicrous.
Patterico (9c670f) — 5/11/2014 @ 12:51 pm
Here is the second paragraph of the Woods piece that daleyrocks said he didn’t read far enough into to learn what is meant by a Greenbacker:

Unfortunately, not all Fed critics, even among Ron Paul supporters, approach the problem in this way. A subset of the end-the-Fed crowd opposes the Fed for peripheral or entirely wrongheaded reasons. For this group, the Fed is not inflating enough. (I have been told by one critic that our problem cannot be that too much money is being created, since he doesn’t know anyone who has too many Federal Reserve Notes.) Their other main complaints are (1) that the Fed is “privately owned” (the Fed’s problem evidently being that it isn’t socialistic enough), (2) that fiat money is just fine as long as it is issued by the people’s trusty representatives instead of by the Fed, and (3) that under the present system we are burdened with what they call “debt-based money”; their key monetary reform, in turn, involves moving to “debt-free money.” These critics have been called Greenbackers, a reference to fiat money used during the Civil War.

This is the first mention of the term “Greenbacker” in the piece.

The problem is not that daleyrocks did not read far enough. The problem is that he apparently skipped over the definition offered at the beginning of the piece.

daley, in your haste to denigrate Woods (his piece was so boring I couldn’t even make it to the part where he defined Greenbacker!!!1!) you are making statements that make it evident that you are not taking the time to fully digest and consider your opponents’ positions.
Patterico (9c670f) — 5/11/2014 @ 12:56 pm
“Now, you can explain what is happening there in one of two ways.

1. You can posit the theory that banks had to have the assets on hand to make the loan. But then you have to admit that they don’t have to have the assets on hand when they simultaneously honor a check written by the depositor for amounts that have already been lent out. Thus, money is created when the checks are honored. Or:

2. You can posit the theory that the funds never left the account, and that the bank simply created money when it made the loan.

Either way you look at it, money has been created. What is dishonest is to look only at one half of each portrayal — the half of #1 where assets had to be there to make the loan, and the half of #2 where assets have to be there to honor the check — and pretend that the other halves of each portrayal (where money is created) never happened.”

Patterico – I disagree with your only two ways example. Using Woods’ example I showed that what enabled the loan to Company C was the deposit by the primary dealer, which temporarily expanded the bank’s balance sheet. Without that the bank would have been precluded from making the loan.

Let’s look at the entries related to the transaction:

Dr. Loan payable from Company C
….. Cr. Deposit Account for Company C
To set up loan payable for Company C

Dr. Deposit Account for Company C
….Cr. Interbank Clearing Assets Bank A
To fund loan to Company C

Those are the entries I envision based on the BOE description and the Woods description. The deposit account disappears when a borrower accesses the loan and the bank needs to have funds on hand to settle its obligation.

Now let’s talk about Person B and the real world because economists do need to use examples which reflect real world behavior. As I asked earlier on the thread, do people take out loans and let the theoretical proceeds sit around in bank accounts unused while they are paying interest on a larger loan amount? Some people may do it, but it is not particularly intelligent. You arrange your loan facility as a line of credit instead and increase your borrowings only as you need funds and only pay interest on funds as you borrow them. That is the real world, not your 1 or 2 dishonest choices.
daleyrocks (bf33e9) — 5/11/2014 @ 12:56 pm
“Even in an imperfect world where only the U.S. was on the gold standard, the fact that the reserve currency was pegged to gold would result in a different market with different inflation and different gold prices than we have today.”

Sure. But now people cant count on the dollar being stable, because it’s pegged to the world market for gold (until it becomes too painful). So I’m not so sure the dollar would remain the reserve currency.

It seems like you’re arguing axiomatically that gold is stable but the dollar now isn’t. When in fact the opposite is the case.
cbuund (74098c) — 5/11/2014 @ 12:59 pm
These critics have been called Greenbackers, a reference to fiat money used during the Civil War.

Patterico – Decafe. That’s what they wanted during the Civil War. When Woods refers to them in modern days, what positions is he attributing to them and how does he differentiate them from other positions?
daleyrocks (bf33e9) — 5/11/2014 @ 1:00 pm
“The interest rate levels are set by the central bank, and at different levels, given varying levels of creditworthy borrowers and varying levels of demand for credit, the ability of the bank to make a profit changes as the interest rate changes.”

Patterico – I don’t care if you claim to be repeating yourself. What difference does it make if the central bank is setting interest rates at various levels? The lending banks can charge whatever interest rates they want to creditworthy borrowers for the money they create out of thin air. Why should they give a hoot what the central bank does – The banks are creating their own money to lend, baybee!
daleyrocks (bf33e9) — 5/11/2014 @ 1:07 pm
daley,

As I have said, Woods’s example is unclear to me because “Person B” comes out of nowhere. Is “Person B” the same as the “primary dealer”? I think so but I can’t tell. That’s why I prefer to stick with my example, which is quite clear about who the various people and entities are.

In my example, money was created that was not there before.
Patterico (9c670f) — 5/11/2014 @ 1:08 pm
57. ==Borrower C can now go buy $9000 worth of stuff with his $9000. Person B can also go buy $10,000 worth of stuff with his $10,000. So $9000 has been created. $19,000 has been spent. We had $10,000. Now we have $19,000….Either way, you have $19,000 when before there was only $10,000. Money has been created ==

I have no thoughts on the gold standard. But this simplistic example/argument about “creating” 9,000 for the borrower from the depositor’s 10,000 only works if there is only one checking account depositor and one borrower at the bank. Also, you are treating it as if the initial “deposit” is an on-demand checking or debit card acct. Doesn’t the capital for most loans still come from long term CD’s, etc. with higher interest to the depositor and significant penalties for withdrawal before the term of the CD (24 mos, 5 yrs, 10 yrs) is up, so that the capital is not simultaneously available to both the depositor and the borrower?
elissa (a1c062) — 5/11/2014 @ 1:11 pm
Decafe. That’s what they wanted during the Civil War. When Woods refers to them in modern days, what positions is he attributing to them and how does he differentiate them from other positions?

Answer:

Unfortunately, not all Fed critics, even among Ron Paul supporters, approach the problem in this way. A subset of the end-the-Fed crowd opposes the Fed for peripheral or entirely wrongheaded reasons. For this group, the Fed is not inflating enough. (I have been told by one critic that our problem cannot be that too much money is being created, since he doesn’t know anyone who has too many Federal Reserve Notes.) Their other main complaints are (1) that the Fed is “privately owned” (the Fed’s problem evidently being that it isn’t socialistic enough), (2) that fiat money is just fine as long as it is issued by the people’s trusty representatives instead of by the Fed, and (3) that under the present system we are burdened with what they call “debt-based money”; their key monetary reform, in turn, involves moving to “debt-free money.” These critics have been called Greenbackers, a reference to fiat money used during the Civil War.

Could have sworn I quoted this before, but there you are.
Patterico (9c670f) — 5/11/2014 @ 1:13 pm
Comment by daleyrocks (bf33e9) — 5/11/2014 @ 1:07 pm

The lending banks can charge whatever interest rates they want to creditworthy borrowers for the money they create out of thin air. Why should they give a hoot what the central bank does – The banks are creating their own money to lend, baybee!

They can’t charge below the minimum cost of funds, which is what each bank lenbds to each other “overnight” (this is actually more important than what the centrakl bank lends (the “discount rate)

Each bank can create its own money, but they can’t hang on to it, and for every loan outstanding, they have to have a deposit, so once the person lent to writes a check, they’ve got to get replacement money from some place. Sometimes that could be a loan that some other bank gave, but money tends to flow to the biggest banks, in cities.
Sammy Finkelman (3bb3ae) — 5/11/2014 @ 1:13 pm
Comment by elissa (a1c062) — 5/11/2014 @ 1:11 pm

Doesn’t the capital for most loans still come from long term CD’s, etc. with higher interest to the depositor and significant penalties for withdrawal before the term of the CD (24 mos, 5 yrs, 10 yrs) is up, so that the capital is not simultaneously available to both the depositor and the borrower

Banks, as a rule, borrow short term and lend long term. They like of course sometimes to get some semi-long term money. They need a source of (short term) funds of last resort. The books must balance every day.
Sammy Finkelman (3bb3ae) — 5/11/2014 @ 1:15 pm
I have no thoughts on the gold standard. But this simplistic example/argument about “creating” 9,000 for the borrower from the depositor’s 10,000 only works if there is only one checking account depositor and one borrower at the bank.

Treat is as if there are one million Person B’s and one millon Borrower C’s. How does the analysis change?

Also, you are treating it as if the initial “deposit” is an on-demand checking or debit card acct. Doesn’t the capital for most loans still come from long term CD’s, etc. with higher interest to the depositor and significant penalties for withdrawal before the term of the CD (24 mos, 5 yrs, 10 yrs) is up, so that the capital is not simultaneously available to both the depositor and the borrower?

I am not up to speed on the relative volume of time deposits vs. demand deposits. Let’s assume that there are more time deposits than demand deposits. There is still a way that loans are treated that are based on reserves held in the form of demand deposits. And we’re still talking easily over a trillion dollars, I assume. Does the fact that all deposits are not demand deposits logically have any relevance to our discussion about how demand deposits are treated?
Patterico (9c670f) — 5/11/2014 @ 1:20 pm
elissa,

Are you taking the position that money is not created in my “simplistic” (I would say simplified) example? How did we end up getting $19,000 into the economy when Person B deposited only $10,000?
Patterico (9c670f) — 5/11/2014 @ 1:22 pm
“Is “Person B” the same as the “primary dealer”?”

Patterico – Absolutely not, but I had to read it several times to be sure. Person B has a loan. The primary dealer deposited cash. That’s why I said the example was confusing and Person B came out of nowhere.
daleyrocks (bf33e9) — 5/11/2014 @ 1:23 pm
“Could have sworn I quoted this before, but there you are.”

Patterico – Exactly. I read that last night and Greenbackers include an agglomeration of viewpoints which he attempts to refute and I found myself not sure what he was attempting to attack when he used the term. That’s why I stopped reading.
daleyrocks (bf33e9) — 5/11/2014 @ 1:27 pm
Guys, I have “work work” to do, but I will leave you with this: the fact that money is created when loans are made really is not as controversial as you portray it. I suggest some further reading to confirm my assertion. For starters try this Forbes article titled Banks Don’t Lend Out Reserves.
Patterico (9c670f) — 5/11/2014 @ 1:29 pm
“They can’t charge below the minimum cost of funds, which is what each bank lenbds to each other “overnight” (this is actually more important than what the centrakl bank lends (the “discount rate)”

Sammy – What cost of funds? I mentioned cost of funds earlier. I may have missed it, but I think Patterico may have skipped over it.

If they are creating money out of thin air how do they have any cost of funds?
daleyrocks (bf33e9) — 5/11/2014 @ 1:29 pm
That’s why I said the example was confusing and Person B came out of nowhere.

Actually I thought I said that. You said Person B was “irrelevant.” My point is, once again, for at least the third time, that we should set Woods’s confusing example aside and use mine, in which Person B is clearly a person with a bank account at the bank.
Patterico (9c670f) — 5/11/2014 @ 1:31 pm
Sammy – Apart from an allowance for loan losses and operating costs they have to cover with the interest cost they charge customers.
daleyrocks (bf33e9) — 5/11/2014 @ 1:31 pm
If they are creating money out of thin air how do they have any cost of funds?

Because they can’t do it willy-nilly, and they can’t do it beyond their capacity to be repaid.

Something we “now” agree on according to you — and always agreed on according to the facts.
Patterico (9c670f) — 5/11/2014 @ 1:33 pm
Patterico – What was wrong with my example?
daleyrocks (bf33e9) — 5/11/2014 @ 1:34 pm
Well done and informative series. Bet the gov’t defenders are coming out of the woodwork, no?

Thank you. And yes, to a somewhat surprising extent.
Patterico (9c670f) — 5/11/2014 @ 1:36 pm
==Treat is as if there are one million Person B’s and one millon Borrower C’s. How does the analysis change?==

Sorry. I can’t, because that’s a strawman too far for me. There’s simply no possibility that any banking institution has a tit for tat ratio of a borrower for every deposit of any type.

At this juncture I am wisely going to withdraw from this discussion because I know I am generally out of my area of expertise. Again, I’m calling you on the logic of your specific example above– not on the overall thrust of your three thread series, Patterico.
elissa (a1c062) — 5/11/2014 @ 1:37 pm
Patterico – What was wrong with my example?

You insisted on expanding on Woods’s example which we agree is confusing. Let’s stick with the simple example I gave in #57. I posited two ways to analyze what is happening in that transaction. You described my ways as “dishonest.” Using my example and not Woods’s please describe the “honest” third way to analyze what is happening there. Bonus points for explaining how $19,000 got into the economy based on a $10,000 deposit without any money being created.
Patterico (9c670f) — 5/11/2014 @ 1:39 pm
Sorry. I can’t, because that’s a strawman too far for me. There’s simply no possibility that any banking institution has a tit for tat ratio of a borrower for every deposit of any type.

No, they have reserve ratios generally. But a good chunk of those reserves consists of demand deposits. Until you can explain how the existence of other types of reserves has any relevance to this discussion, the fact that there exist other types of reserves appears to have no bearing on the philosophical question of how banks treat demand deposits.
Patterico (9c670f) — 5/11/2014 @ 1:43 pm
57. Comment by Patterico (9c670f) — 5/11/2014 @ 12:42 pm

…Person B can also go buy $10,000 worth of stuff with his $10,000.

If the money leaves the bank after being spent , the bank has to get a different $10,000 from another bank, or sell the loan or some other asset to another bank.

But anyway this is banking. You can spend your money, and keep it too.

Do I need to say again, for the umpteenth time, that a) this can’t happen willy-nilly; b) it depends on the demand for credit; c) it also depends on the ability of the bank to make a profit, meaning the borrowers have to be creditworthy and the interest rates must be sufficiently high; and d) money is then destroyed when it is repaid? </

OK. It’s all said, again.
Sammy Finkelman (3bb3ae) — 5/11/2014 @ 1:43 pm
There are conditions that prevent money from being created willy nilly most of the time.
Sammy Finkelman (3bb3ae) — 5/11/2014 @ 1:44 pm
“Each bank can create its own money, but they can’t hang on to it, and for every loan outstanding, they have to have a deposit, so once the person lent to writes a check, they’ve got to get replacement money from some place.”

Sammy – You know this process of creating a deposit account for a borrower is something I can conceptualize, but I have never experience it myself.

Car loans – Funds directly disbursed to dealer no account opened.

Home purchase – No deposit account opened, mortgage proceeds directly disbursed to seller at closing.

Construction loan to finance tear down – No deposit account created. Commitment funded in periodic stages directly disbursed to general contractor.

Maybe this deposit account is some internal journal entry at banks until funds change hands, which triggers the legal liability on behalf of the borrower.
daleyrocks (bf33e9) — 5/11/2014 @ 1:48 pm
“You described my ways as “dishonest.””

Patterico – I merely described you saying I had to choose between your 1 or 2 which you described as dishonest, a choice I rejected.
daleyrocks (bf33e9) — 5/11/2014 @ 1:50 pm
“You insisted on expanding on Woods’s example which we agree is confusing.”

Patterico – I applied it on the “margin,” to analyze bank behavior, something economists do all the time.

Out for a while.
daleyrocks (bf33e9) — 5/11/2014 @ 1:53 pm
Re:86… Hey, daley… you forgot the haikuloan: hamburger immediately disbursed for full payment by next Tuesday.
Colonel Haiku (39259d) — 5/11/2014 @ 1:58 pm
46

… Free markets always seem to be prone to certain instabilities caused by government.

So it is your position that asset price bubbles are always the fault of government? If there is a bubble in the price of baseball cards the government was somehow to blame?

It is easy to generate bubbles in laboratory experiments. See here :

In the lab we can create artificial assets with known dividend streams and thus known fundamental values. Since Vernon Smith’s classic experiments (JSTOR), we know that even in these cases efficient markets fail and bubbles are common. Bubbles occur even as uncertainty about the fundamental value diminishes (JSTOR). We also know that once a bubble starts it’s difficult to stop. Circuit breakers and brokerage fees (transaction taxes), for example, don’t do much to stop bubbles (see King, Smith, Williams, and Van Boening 1993, not online.) Investor education doesn’t help (for example telling participants about previous bubbles doesn’t help). Even increasing interest rates doesn’t do much to stop a bubble already in progress and may increase volatility on net.

Are you contending these experiments are all somehow wrong?
James B. Shearer (9233b4) — 5/11/2014 @ 2:30 pm
46

I admit that I do have unrealistic expectations, and this dovetails with your question: why bother arguing for this when we don’t expect government to keep its hands off the economy?

To which I reply: why object to anything government does? Corruption, bloat, oppression . . . these are all common characteristics of every government in history. Why argue against them? The answer is: to improve our world, we try to educate people about what’s right and what’s wrong with our poltiical and economic systems. That’s what I am trying to do: education. And I face, even on a conservative blog, quite a bit of opposition, which tells me that there is a lot of education to be done about the benefits of the free market.

Corruption, bloat and oppression are all things that can be fought incrementally. Partial victories can still be worthwhile. But if you fight for a gold standard and lose all your effort is wasted. And people are sensibly reluctant to make drastic changes in systems that aren’t obviously broken. This requires a lot of faith which most people currently lack when it comes to the gold standard.
James B. Shearer (9233b4) — 5/11/2014 @ 2:50 pm
46

We’ll probably never get there, but defeatism helps nobody.

Defeatism helps when it averts costly defeats.
James B. Shearer (9233b4) — 5/11/2014 @ 2:59 pm
And my argument is that if you peg your currency to gold, and the whole world did in a credible way (which is the hypothetical I am positing), the demand for gold itself would plummet because people would have confidence that the currency is a reliable substitute for gold.

So no more demand for gold in jewelry?
No more demand for gold in electronics?
No more demand for gold in food (for true and literal “conspicuous consumption”)?
No more of any of these demands affecting the overall demand for gold, and thus its “price”.
Uh huh.

Even in an imperfect world where only the U.S. was on the gold standard, the fact that the reserve currency was pegged to gold would result in a different market with different inflation and different gold prices than we have today.

And would that different inflation rate be higher or lower?
Would those different gold prices be higher or lower?
How would supply be affected by people collecting coins?
Just hoarding coins?
What about seigniorage costs – would the gold never have to be minted more than once?
Will mines run out?
Will new mines be found?
Will Green Devolutionists shut down mining or refining?
And what about that persistent trade deficit – exactly how long will our gold coins last as we pay for the next generation of iGizmos and New Balance sneakers?

You can’t simply look at the price of gold as it exists in a fiat money world and assume that the price would be the same if we were on a gold standard. That’s just ludicrous.

Of course we cannot assume the price would be the same.
What is even more ludicrous is not assuming it would be better, even nonexistent.
Sam (e8f1ad) — 5/11/2014 @ 4:00 pm
I’m not a wanker or a banker
I’m not afraid to take a risk
Colonel Haiku (39259d) — 5/11/2014 @ 4:06 pm
86. Comment by daleyrocks (bf33e9) — 5/11/2014 @ 1:48 pm

Sammy – You know this process of creating a deposit account for a borrower is something I can conceptualize, but I have never experience it myself.

Well, that concept is a litle bit wrong, or oversimplified maybe these days. It might be it used to work that way.

It really doesn’t matter if it is the same bank or a different bank – the money still came from nowhere, or rather, from the loan.

When the bank makes a loan, the bank makes out
a check, or direct deposits it to some account.

They do prefer eople use their accounts, and will give about a 1/4% (0.25%) lower interest rate I think on a mortgage if someone agrees to have the mortgage paid from that account.

Car loans – Funds directly disbursed to dealer no account opened.

So it goes to the dealer’s account.

Home purchase – No deposit account opened, mortgage proceeds directly disbursed to seller at closing.

Martin Meyer in “The Bankers” (Weybright and Talley, 1974) writes like this, bottom of page 33:

Each time a bank creates a deposit by making a loan, it sets in motion a chain of money creation.. The borrower writes checks on his account, the proceeds of thos checks are deposited at other banks, tthe oter banks make loans, the borrowers at the other banks write checks on their accounts, still other banks enter new checks on the proceeds of those checks, and so on.
Sammy Finkelman (bcd7c8) — 5/11/2014 @ 6:59 pm
I was talking with a friend who is a small business banker (credit facilities $500,000-$10 million) at one of our countries largest banks tonight. He confirmed much of what I have been saying. When they issue a loan commitment, the credit department alerts the operations folks of the funding date and amount to make sure good funds are on hands. If the commitment is above $3 million, the originating banker is required to submit a Basel III calculation form with the loan approval request showing the impact of the proposed loan on the bank’s capital ratios.

He also confirmed most people taking out loans do not leave idle cash sitting around the bank in deposit accounts. The only ones who do are companies taking out cash secured loans to beef up their balance sheets, but they pay a negative spread for the privilege.

It reminds me of when we used to occasionally accumulate a few hundred million in cash in our corporate account at our local friendly middle market bank for dividends or public debt redemptions. We would do the bank a solid and let them know, even though we were not required to, that the cash was earmarked to go out the door on a certain date in the near future.
daleyrocks (bf33e9) — 5/11/2014 @ 7:08 pm
Sammy, you mentioned that money tends to flow to the bigger banks. I can imagine a couple of mechanisms that might cause that (with modern electronic clearing most of them seem to be almost irrelevant and are now merely psychological or “the way we do things.”) Granting that it seems to be true regardless of cause, is it a good thing? Would the public (not the government, not the bank’s owners, not the bank’s depositors or borrowers) be better served by a money system where banks were constrained in size by some legal mechanism?
htom (412a17) — 5/11/2014 @ 7:32 pm
“Granting that it seems to be true regardless of cause, is it a good thing?”

htom – I certainly don’t thinks so. In the late 1990s and early 2000s the company I was working for decided to invest in a couple of private equity funds devoted to purchasing smaller banks and rolling them up into larger, but not huge entities.

The consolidation in the banking industry over the past 25 years has been incredible and the decrease in choices and services in some markets very severe.
daleyrocks (bf33e9) — 5/11/2014 @ 7:43 pm
Well, sorry to see you go full Rothbard. I guess Obama’s actions on the economy will drive anyone over the edge eventually. Protein Wisdom, Ace of Spades, and now Patterico.

By 2016, Instapundit is going to be advocating armed revolution, and Patterico will be running a guerrilla cell next to his vault full of gold.

I’ll check back in a few months to see if the place has gotten back to normal.
OmegaPaladin (f4a293) — 5/12/2014 @ 1:47 am
97. Comment by htom (412a17) — 5/11/2014 @ 7:32 pm

Sammy, you mentioned that money tends to flow to the bigger banks. I can imagine a couple of mechanisms that might cause that (with modern electronic clearing most of them seem to be almost irrelevant and are now merely psychological or “the way we do things.”)

They have more deposits in the first analysis.

It is easier now to do long distance banking, but the biggest and the greatesst number of accounts are likely to be in the biggest banks.

This means money created by small banks giving loans will flow out of them. And big banks will attract more in deposits than they make in loans.

Upstate New York and other less populated areas may be in a vicious cycle, where new businesses don’t gte loans and don’t get started.

There are ways for the smaller bans to get back the money.

Many years ago, maybe still, small “country banks” established what was called “correspondent” relationships with a partiular big bank.

In the 1980s there was a whole little industry of placing deposits up to the amount of federal deposit insurance, which had been raised way high to $100,000 in 1980 (from $40,000 and earlier $20,000 and $15,000 in the 1960s) in many different banks and savings and loans.

Granting that it seems to be true regardless of cause, is it a good thing? Would the public (not the government, not the bank’s owners, not the bank’s depositors or borrowers) be better served by a money system where banks were constrained in size by some legal mechanism?

Probably yes. There’d be more different policies as to loans, and deposits. The way this might be done would be requiring banks to split in half or three parts upon reaching a certain size.
Sammy Finkelman (bcd7c8) — 5/12/2014 @ 6:17 am
Of course, ordinary people sometimes want big banks because they avoid ATM fees and have more places to make deposits or do business that requires someone to be in a branch.

But they also don’t like high fees, and smaller banks charge lower fees or have fewer requirements.

The worst bank for the consumer is Citibank and possibly the next worst is Chase, but Chase feels the heat and now, for instance, will not charge an overdraft fee is the account is under water less than $5.00

Most banks waive fees with direct deposit, in some cases with a minimum amount requirement. My guess as to what may stop some banks from putting in a minimum amount is the difficulty of writing software to do it.

Citibank requires not just a direct deposit (of any amount) but one bill pay a month.

Chase has grandfathered accounts (you can’t open such an account now) that will waive the monthly fee with 5 debit card transactions even with no direct deposit. It’s also waived with direct depoists totalling at least $500 (originally this was one at least that bog) They must come in the statement month, not the calendar month.

Other banks will have a minimum on deposit to waive a fee, some an average daily balance, some a minimum within the statement month balance. TD bank has a $100 minimum, and you can’t put the money aside in a savings account and have it count. If it goes below $100 for one day, it’s $10.

It’s agood idea maybe to open up bank accounts because maybe later you’ll run into trouble, and if the terrms change, you may get grandfathered in. So take advantage of every promotion.
Sammy Finkelman (bcd7c8) — 5/12/2014 @ 6:19 am
Thanks, Sammy.
htom (412a17) — 5/12/2014 @ 6:11 pm
A research worthy link on the failed precious commodity fixing cabal.

http://www.zerohedge.com/news/2014-05-14/rothschild-koch-industries-meet-people-who-fix-price-gold
gary gulrud (e2cef3) — 5/14/2014 @ 4:21 pm

5/10/2014

A Response to a Reader’s Question About Government Control of Money

103 Responses to “A Response to a Reader’s Question About Government Control of Money”

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