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Is it a currency board or a central bank? (guest post by Mike Sproul)

by Kurt Schuler April 21st, 2014 9:21 pm

(Mike Sproul responds to this post, part of a back and forth we have been having. Readers will pardon my inexpert formatting.)

A currency board gives a convenient way to explain the backing theory of money. In line (1) of Table 1, a currency board receives $100 of Federal Reserve Notes (FRN’s) on deposit, and it issues 100 of its own newly-printed paper pesos in exchange. By its nature, a currency board stands ready to redeem the pesos it has issued for the dollars it has on deposit, just as it stands ready to create and issue more paper pesos (line (2)) to anyone who deposits more dollars. It is clear from the table that whether there are 100 pesos backed by $100, or 300 pesos backed by $300, 1 peso will always be worth $1. This is an essential point of the backing theory: As we triple the quantity of pesos, we also triple the assets backing those pesos, so the peso holds its value as the quantity of pesos rises and falls. The quantity theory of money would imply that an increase in the quantity of pesos would reduce the value of the peso, because there are more pesos chasing the same amount of goods. But the quantity theory does not apply to this case, since the currency board is always able to maintain convertibility at the rate of 1 peso=$1. This idealized currency board thus gives the backing theory a foot in the door. Even someone who thinks that the quantity theory is correct for modern government-issued paper money must admit that the backing theory is correct in the case of a currency board.

Table 1

            ASSETS…………………………………..LIABILITIES

1)   $100 FRN’s………………………………..100 paper pesos

2) +$200 FRN’s……………………………...+200 paper pesos

The obvious problem of the currency board in Table 1 is that it earns no interest, and thus cannot pay its operating costs. This problem is solved in line (3) of Table 2, where the currency board prints 300 new pesos and uses them to buy a $300, 1-year US government bond. (Table 2 duplicates Table 1, except for line (3).)

Table 2

            ASSETS…………………………………..LIABILITIES

1)   $100 FRN’s………………………………..100 paper pesos

2) +$200 FRN’s……………………………...+200 paper pesos

3) +$300 bond……………………………….+300 paper pesos

With the purchase of such a bond, many of us would no longer call this institution a currency board. Currency boards are not supposed to make loans, but the purchase of a US government bond is a loan to the US government. Also, currency boards are supposed to offer immediate convertibility of pesos into US dollars. But if customers wanted to redeem all 600 of the pesos held by the public, they would have to wait for the bond either to mature, or to be sold for paper dollars. But perhaps this definition of a currency board is too literal. Currency boards often hold bonds, and they suspend convertibility every night and every weekend, and we still call them currency boards. So someone might still call our institution a currency board, even though it now looks more like a bank.

The purchase of the $300 bond doubled the quantity of paper pesos from 300 to 600, but it also doubled the currency board’s assets from $300 to $600, so the currency board is still able to maintain convertibility at 1 peso=$1. The backing theory still applies, and the quantity theory does not.

Table 3

             ASSETS…………………………………..LIABILITIES

1)   $100 FRN’s………………………………..100 paper pesos

2) +$200 FRN’s……………………………...+200 paper pesos

3) +$300 bond……………………………….+300 paper pesos

4) +600 peso loan……………………………+600 paper pesos

In Table 3, our bank/currency board lends 600 newly-issued paper pesos to a local miller, who intends to buy wheat that he will grind into flour and sell within 30 days, at which point he will repay his loan with interest. If he fails to repay, then 600 pesos worth of his property (plus interest) will be taken from him in court.

With the loan in line 4, nearly everyone would stop calling this institution a currency board and start calling it a bank. It is backing its pesos with a loan, and the loan itself is payable in pesos, rather than dollars. But the backing theory is still just as true of this bank, and the quantity theory just as false, as ever. Even though some of the bank’s assets are now denominated in pesos instead of dollars, and even though the bank has once again doubled the quantity of pesos, the bank still has enough assets to maintain convertibility at $1=1 peso. Even if all 1200 of the pesos issued by this bank were returned to the bank at once by customers demanding payment in dollars, the banker could satisfy his customers with the following steps:

1. Delay redemption of 600 pesos for 30 days until the 600 peso loan is repaid in pesos, then retire those pesos as they are received from the borrower. This reduces the number of returning pesos from 1200 to 600, and the interest on the loan can be used to compensate customers for the 30-day delay.

2. Sell the bond for $300, and use the $300 to buy back another 300 returning pesos.

3. Use the remaining $300 of FRN’s to buy back the last 300 returning pesos.

Let’s take stock of where we are. We all agree that the backing theory is true of a currency board. We have found that the backing theory remains true if that currency board buys bonds and makes loans, even peso-denominated loans. In short, the backing theory remains true as the currency board is transformed into a bank.

Now consider one last change to our bank/currency board: Let it suspend dollar-convertibility. With the peso now floating against the dollar, it might seem that the backing theory has finally been made irrelevant. But suspension of dollar-convertibility is nothing new to this bank. We have already seen that convertibility can be suspended for a weekend or for thirty days, and as long as the bank’s assets remain untouched inside the bank, the peso holds its value at $1=1 peso. Also, we must remember that the peso was initially redeemable at the bank for either dollars, bonds, or loan repayments. The bank has suspended only dollar convertibility, but bond convertibility and loan convertibility remain in force. If the public wanted to return 900 pesos to the bank, the bank could buy back all 900 pesos in exchange for its bond ($300) and its loan (600 pesos), without ever touching its dollar reserves. Dollar convertibility would only matter after the bank had paid out all its non-dollar assets.

With the suspension of dollar convertibility, our currency board now operates like a modern central bank. It never trades its pesos directly for dollars, but it nevertheless uses its bonds and loans to either issue new pesos when the public needs more pesos, or to soak them up when pesos are excessive. The central bank’s assets are crucial to the process, since a bank without assets would have nothing with which to buy back its pesos on the occasions when pesos return to the central bank. Moreover, the central bank’s balance sheet still looks exactly as it looked in Table 3: 1200 pesos are still fully backed by $600 worth of FRN’s and bonds, plus 600 pesos worth of loans. The backing theory is still fully applicable, and the quantity theory is not.

We all agree that when it comes to currency boards, the quantity theory is wrong and the backing theory is right. It’s too obvious to deny. A modern central bank is nothing but a currency board that holds bonds, makes loans, and suspends one kind of convertibility. None of these things affects the validity or relevance of the backing theory, so the backing theory is just as relevant to a central bank as it is to a currency board.

138 Responses to “Is it a currency board or a central bank? (guest post by Mike Sproul)”

  1. avatar Paul Marks says:

    "Backing" is a confusing concept - either a commodity (or another fiat currency) is the money or it is not the money.

    For example if silver is the money then silver is the money - why talk of it being "backing" for something else that is the money? And if the U.S. Dollar (fiat) is declared the currency of some other country the U.S. Dollar (fiat) is the currency of this other country - why talk of it being "backing" for something else that is the money? A "Currency Board" or a "Central Bank" is quite unnecessary.

    As for the banking system.....

    I repeat a question I have asked so many times - and never got a straight answer. If the bankers (the banking system) do not increase lending so that is higher than real savings of cash-money (if the system just "puts people's savings to work") then what form of money supply crashed between 1929 and 1933 (and so many other busts)?

    No one was going into bank vaults and destroying cash - yet some form of money supply massively declined between 1929 and 1933 (and so many other busts) so what form of money supply was it? Was it not bank credit? The credit bubble? So much for the idea that the banking system does not increase lending beyond real savings (the sacrifice of consumption) of cash-money.

    The increase in lending (beyond real savings of cash-money) is the artificial "boom" and the bust (the bust of the banking credit bubble) is the inevitable result. Government Central Banking makes everything worse (vastly worse) by encouraging (standing behind) commercial banks (and other such) leading to the credit bubble (the "expansion of Broad Money") being vastly greater than it otherwise would be - thus meaning that the bust (the bust of the banking credit bubble) will be bigger also.

    • avatar vikingvista says:

      "For example if silver is the money then silver is the money - why talk of it being "backing" for something else that is the money?"

      To answer the questions "Why do people value the money?" and "What determines how much people value the money?" Backing theory isn't the right answer, but the answer is essential to understanding money and explaining monetary events.

      • avatar Paul Marks says:

        vikingvista - all economic value is (as you know) subjective, however people have valued silver (and various other commodities) for thousands of years and they have various reasons for doing so.

        As for a purely fiat (command - the word "fiat" means command-order as in "by fiat") currency such as the U.S. Dollar - it is valued because of legal tender laws and tax demands, Paul Krugman's "men with guns". There is also the hangover (the memory or tradition) of the time when the U.S. Dollar was not a fiat currency - when it represented a commodity gold (a claim that was made, at least to other governments, till 1971).

        I believe that a commodity money system (as long as people voluntarily choose the commodity) is better than an fiat (command - force-and-fear) currency system, some other people disagree.

        As for the banks - they do not even have much fiat cash (not in comparison to the amount of "money" they claim to have). The gap between the cash the banks have and the credit bubble (the "broad money") may be smaller than it was in 2008 (due to the bailouts, hidden as well as open, by the Federal Reserve), but it is still very large.

        • avatar vikingvista says:

          Like I said, backing theory answers the question. It just isn't the right answer.

          But neither is yours the right answer, since your answer is incomplete--possibly necessary, but definitely not sufficient. To say people use USD because of protecting laws is like saying Soviet East Germans drove the Trabant because laws inhibiting the use of other cars. In the latter case, it ignores the fact that people value an individual form of transportation, and in the former you ignore the fact that people value the *function* of money.

          And while your answer is not a sufficient reason, it is not even clear that it is necessary one, particularly given the increased discipline the central bank would face as the likelihood of competing currencies increased. A great deal of the advantage USD have over other potential monies, is that USD are *already* a money. The fact that it is fiat merely (for the individual users) abstracts away other uses from its already tremendously valuable money use (i.e. commodity money is dual use money--valued as a commodity and valued as a money).

          A similar mistake would be to say that people trade widely in commercial bank IOUs because of the long established reputation of the issuing banks. That is a necessary reason, but it also matters what the IOUs are denominated in. A reputable commercial bank that reliably issued IOUs redeemable for a nominal molar amount of air, would not see its IOUs widely used. Likely, in contrast with the backing theory, IOUs redeemable for title to an unknown arbitrary asset nominally marked to market would also not see wide use.

          Finally, to beat a dead horse, commercial banks don't have nearly as much basic money as they do liabilities, for the reason that they are in the business of loaning out basic money. They keep no more than they observe as necessary to maintain an acceptably low risk of an illiquidity crisis. Even post-2008, with the record high bank reserves, the banks still loan out almost all the basic money they get their hands on. The difference today is that they loan their basic money disproportionately to the US Treasury and to the Federal Reserve, and regulators treat IOUs from both institutions as equivalent to cash reserves. The Treasury and FedRes not being significant relenders, the broad money supply is accordingly low even in the face of an enormous growth in the basic money supply.

    • avatar Mike Sproul says:

      Paul:

      My attempt at a straight answer: People originally use silver as money. The backing is contained within the silver coin itself, so no additional backing is needed or offered.

      Next, people deposit 100 oz of silver into a 100% reserve bank and trade instead with paper claims to that silver ('dollars'). Now, the paper dollars are backed by the silver.

      Next, people who want to borrow $200 come into the bank and, rather than offering 200 oz for that $200, they offer an amount of land that is worth at least 200 oz. The bank can earn interest on this, so he accepts. Altogether, the bank has issued $300 in paper, backed by 100 oz of silver plus land worth 200 oz.

      If the bank goes broke (Its assets fall in value to 299 oz.), then there will be a bank run. The first $100 in paper to reach the bank will be redeemed for 100 oz of silver, so no money supply crash there. But the last $200 paper to reach the bank will have to be redeemed for the land, so $200 of paper money actually disappears, that is, it is retired by the bank in exchange for the same land for which it was created. There's your money crash.

      I wouldn't say that the boom was artificial, but the bust was real.

      • avatar McKinney says:

        So why would the silver lose its value? You often mention that money loses its value when the assets backing it lose value, but that doesn't answer the question. It only moves it back another step. If the assets backing money can lose value, you have to have some kind of explanation for why that might happen.

        • avatar Mike Sproul says:

          It was the assets that fell in value to 299 oz. In this case it was the land that fell in value from 200 oz to 199 oz.

          The silver might fall in value too, and if the dollar is pegged to silver, the dollar would fall in step with the silver.

          • avatar McKinney says:

            But why does the land and silver fall in value. You haven't explained; only repeated the assertion that their values fell.

          • avatar Mike Sproul says:

            Mckinney:

            I don't understand your question. Prices rise and prices fall. Why is that an issue?

          • avatar McKinney says:

            It's an issue because they don't rise/fall randomly. They rise and fall according to the economic principles of value, one of the most important of which is the change in the volume offered in exchange. Your backing theory has not disproven the quantity theory, which is just the theory of value applied to money. You have merely moved the change in value from the actual currency to the assets backing it, a slight of hand that fools people into ignoring the cause of the change in value of the asset. The quantity theory applies to the asset backing the currency as much as it does to the currency itself.

            To put it another way, if you offer an asset as backing for currency you have monetized the asset. In essence, the asset is being traded in the market for goods/services with the currency merely acting as a proxy. So the bank can fix the exchange rate between the asset and currency at a set ratio, but the value of the asset will rise/fall relative to goods/services in proportion to the change in quantity monetized. You put it differently by saying prices rise/fall because the value of the backing assets rose/fell. By saying that, you confirm the working of the quantity theory.

      • avatar Paul Marks says:

        Mike many thanks for your attempt at a "straight answer".

        If silver is the money people choose then silver is the money people choose. If a money lender (called a "bank") has silver it can lend it out, if it does not have silver it can not lend it out. Once the silver is lent out the lender (the bank) no longer has the silver - to when (and if) it is repaid.

        If there is only (say) one million ounces of silver, total lending can not be (if things are straight) more than one million ounces of silver lent out - certainly not one hundred million ounces of silver (with the banking system lending out one hundred ounces of silver for every one ounce of silver they actually have - a "fraction" of one thousands tenths).

        I ask you again - if the banking system does not expand lending beyond real savings of cash money, what form of money supply fell between 1929 and 1933? Why did prices fall?

        No one was going around destroying cash in bank vaults - it was "broad money" (the banking credit bubble)that collapsed (as banking credit bubbles inevitably collapse), I am astonished that you do not see this.

        The late 1920s "boom" (like all such "booms") is indeed artificial as it is based on the idea that there can be lending that is not from real savings (the sacrifice of consumption) thus artificially inflating asset prices (such as real estate and stocks and shares) and preventing the gradual fall of general prices which is natural as people find better ways to do things.

        To believe that a banking credit bubble is not artificial (that it is sustainable) is no more sensible than believing in a perpetual motion machine. Sooner or later the banking credit bubble (the "broad money") must collapse back down towards the monetary base of cash-money.

        If this is not the case then the antics of such people as Benjamin Strong in the late 1920s (so admired by the late Milton Friedman) were quite sensible - in fact they were anything but sensible.

        • avatar Mike Sproul says:

          Paul:

          The trouble is that a bank's lending is not limited to the cash it has received on deposit. Say a bank has $100 FRN's on deposit, against which it issues a $100 checking account. Then someone asks to borrow $200 from the bank, not in the form of FRN's, but in the form of $200 credited to the borrower's checking account. As long as the borrower "deposits" an IOU worth at least $200, the bank can make that loan. Someone might object that such a bank would be unable to cash the $200 check, but that's just the nature of fractional reserve banking. Banks operate on 30% cash reserves all the time, and this bank is just as capable of it as any other.

          The key error lies in looking at the 30% cash reserve, while forgetting that the bank's liabilities ($300 in deposits) are fully backed by $300 worth of assets.

          • avatar Paul Marks says:

            Mike.

            "The trouble is that a bank's lending is not limited to the cash it has received".

            There we agree - but, unfortunately, you go on.

            An honest money lender (as opposed to a bubble blower) only lends out money (cash) that they actually have - and admits that once the cash is lent out they (the money lender) do not have the cash any more, till when (and if) it is repaid.

            As for telling people they have money "on deposit" when the cash has actually been lent out.....

          • avatar Mike Sproul says:

            Paul:
            Going back to that $200 of checking account dollars "dishonestly" lent to the borrower: If each of those checking account dollars says "This checking account dollar is instantly redeemable for $1 in FRN's during business hours", then that's fraud. But if it says NORMALLY redeemable for $1 in FRN's, except during bank panics or some such, in which case the bank has the option of delaying payment by 30 days, or the bank can buy back the checking account dollar with a dollar's worth of its bonds or various assets, then it's just a case of two consenting adults making a deal.

          • avatar George Machen says:

            ^ Bingo! A demand deposit is not a bailment.

          • avatar vikingvista says:

            Paul: "An honest money lender (as opposed to a bubble blower) only lends out money (cash) that they actually have - and admits that once the cash is lent out they (the money lender) do not have the cash any more, till when (and if) it is repaid."

            What a profound advance you'd make in your understanding if you could only grasp (as most do) that an institution that "only lends out money (cash) that they actually have" is the mechanism by which credit expansion (including bubbles) occurs, and that retaining reserves is how a limit is imposed on that expansion.

            What you've described as an "honest money lender" is all, of course, true of a textbook fractional reserve banker.

            "As for telling people they have money "on deposit" when the cash has actually been lent out....."

            Telling people they have money on deposit when the funds have been lent out, would be telling them the obvious and widely understood truth--as well as telling them what they already know. If 3 centuries of banking with countless textbooks and explanatory articles and open discussion of this most basic working of commercial banks isn't enough, surely a person can be expected to at least know or ask or look up in a dictionary what kind of a transaction earns *interest*.

            Such dimwits merit no sympathy, but fortunately they are exceedingly rare in the history of banking, as the existence of historical runs makes clear.

  2. avatar Rob Rawlings says:

    "It is clear from the table that whether there are 100 pesos backed by $100, or 300 pesos backed by $300, 1 peso will always be worth $1"

    Its not clear to me why this would be true.

    Suppose the peso notes are printed with designs that people find intrinsically desirable. People will pay more than $1 for them. The currency board will have to issue additionally peso's until parity is restored. At that point $300 may actually back more than 300 pesos.

    The bank/currency board will always need to adjust the qty of pesos up or down to maintain a 1/1 exchange rate and it will be the exception rather than the rule that n dollars backs n pesos (as opposed to 1 peso = 1 dollar)

    • avatar Mike Sproul says:

      Rob:
      If the relation $1=1 peso is violated there will be arbitrage opportunities. For example, if 1 peso=$1.01, then the issuer of that peso earned a free lunch of $.01, and will eagerly issue more pesos. Furthermore, rival currency boards will sprout up and compete away that profit of $.01. Even short sellers will get in on the act. They will borrow 1 peso, sell it for $1.01, and wait for the peso to fall to $1, at which point they buy 1 peso for $1 and repay their loan with a $.01 profit. The short selling itself will put additional downward pressure on the peso, until the equilibrium of $1=1 peso is restored.

      • avatar Rob Rawlings says:

        Mike,
        Here is how I am understanding the difference between the backing theory and the quantity theory as it applies to your example:

        Backing theory: The value of the peso in dollar will always be = (total dollar value of dollars held by the currency board)/total qty of pesos issued.

        This will be true irrespective of whether convertibility at a fixed exchange rate is in place or not. An increase in the qty of peso's as long as its backed by an equivalent increase in its dollar backing will not affect the value of the peso.

        Quantity theory: The value of the peso in dollar will be be determined by supply and demand to hold pesos. Other things equal an increase in the qty of peso's will decrease its value in dollar terms.

        Is that correct ?

        If so I don't think you have demonstrated that the qty theory is true in your post. To go back to my point - if people start to value peso's over dollars (say they just like the designs) then the value of the peso will increase relative to its dollar backing. If the currency board wants to maintain parity it could in theory safely start printing peso's and giving them away. At this point there will be more peso's than dollars backing them. (The currency board would probably not want to do this, because it would be left exposed if demand to hold peso's ever fell , but that is a separate issue).

        • avatar Rob Rawlings says:

          "total dollar value of dollars" = "total dollar value of assets""

        • avatar Mike Sproul says:

          Rob:
          Correct statement of the difference between the QT and the BT.

          " I don't think you have demonstrated that the qty theory is true in your post."

          That's a typo, right? I was demonstrating the truth of the BT.

          Let's be more realistic and say that people value pesos over dollars because, at least in their country, pesos are more liquid. This runs us into violations of the no-free-lunch principle. If 1 peso=$1.01, then there is a free lunch of $.01 that could be earned by the currency board, by a rival currency board, or by a short seller of pesos.

          • avatar Rob Rawlings says:

            yes, that was a typo.

            On "This runs us into violations of the no-free-lunch principle. If 1 peso=$1.01, then there is a free lunch of $.01 that could be earned by the currency board, by a rival currency board, or by a short seller of pesos."

            If people start to value pesos more than dollars then the issuers of peso's can indeed earn a free lunch. Competing currency issuers will also move to make their currency more like the peso to try and grab some of the free food. This will tend to adjust the qty of pesos supplied to qty demanded at a price close to that which would hold if the BT was true - but it does so in a way entirely consistent with the QT.

          • avatar Mike Sproul says:

            Rob:

            JP Koning takes a position similar to yours. I would summarize it by saying that the peso might have a monetary premium of 1% or so over its fundamental backing value. In that case the backing theory accounts for 99% of the peso's value, and the quantity theory for the other 1%.

  3. avatar McKinney says:

    "1 peso will always be worth $1."

    That is trivial since the bank has agreed to exchange pesos for dollars at a 1:1 rate. But few people care about that rate. They care about how many goods/services the money will buy.

    " The quantity theory of money would imply that an increase in the quantity of pesos would reduce the value of the peso,"

    No it does not imply that. If a bank agrees to always exchange pesos and dollars at a 1:1 ration, quantity theorists will accept that as a fact. But quantity theorists could not care less about the bank's promises to redeem. They care about the ratio of exchange between the peso and goods in the marketplace.

    " But the quantity theory does not apply to this case, since the currency board is always able to maintain convertibility at the rate of 1 peso=$1."

    The currency boards promise of a fixed exchange ratio has no bearing whatsoever on the rate at which the peso will exchange for goods in the market. There is no connection logically or empirically. The two have no relationship to each other.

    For Mike's theory to work, retailers would have to not care about or respond to changes in demand. If the quantity of goods available in the market doesn't change, yet the number of customers doubles because they now have twice as many pesos to spend, Mike insists that the merchants would not respond by raising prices. They would simply notice that the bank will continue to exchange pesos and dollars at a 1:1 ration, so they will sell out their stock very quickly and then shut their doors.

    In the real world, an increase in the money supply generates greater demand from consumers and business people. It's the whole reason the Fed desperately tries to pump up the money supply. It shifts the demand curve to the right. Suppliers respond by raising prices. No one cares that the banks have a fixed exchange ratio for the currency.

    This should be obvious from the history of the gold standard. Governments maintained a fixed exchange rate between their currency and gold, but prices changed dramatically and to a far greater degree than the change in the stock of gold. Why? The ratio of the stock of currency to the stock of goods changed even while the exchange ratio between the currency and its backing never changed.

    • avatar Mike Sproul says:

      McKinney:

      1:1 convertibility is only possible because the bank has 300 oz of assets backing $300. If assets fell in value to 299 oz, then any attempt to maintain 1:1 convertibility would result in a run. The first $299 would be redeemed for 1 oz worth of stuff, while the last $ in line would get nothing.

      So it's not convertibility of the dollar that maintains its value. It's the backing of the dollar that maintains its value (and that makes convertibility possible).

      • avatar McKinney says:

        You're dodging the issue. The 1:1 convertibility only applies at the bank, not in the markets for goods/services. I has no relevance or applicability to the goods/services market.

        The peso has no trouble maintaining its value relative to the dollar at the bank because the bank defines the ratio. The bank does not define the exchange ratio in other markets, such as the market for goods/services. Essentially, you're saying that the bank's ratio prevents merchants and producers from raising prices. Do you really think that producers can't raise prices because the bank has a fixed ratio of pesos to dollars?

        You're just repeating yourself instead of responding to my point.

        • avatar Mike Sproul says:

          McKinney:

          If the rate were 1 peso=$1 at the bank, and 1 peso=$.90 in the next town, then arbitragers would buy pesos for $.90 in the next town, and redeem them for $1 at the bank, until the rate was the same everywhere (or the bank went broke).

          • avatar McKinney says:

            I didn't say anything about a change in the value of the peso to the dollar, did I? The bank sets that ratio and I assumed it didn't change. What changes is the ratio of exchange of the peso for goods.

  4. avatar Paul Marks says:

    It should be pointed out that U.S. Dollar is not "backed" by anything. I do not like the concept of "backing" (for example if gold is money then gold is money - there is no need to talk of "Dollars" or "Pounds"), however the old "backing" idea had its supporters who claimed that (at least before 1914) it sort-of worked. The modern system is nothing to do with "backing" - the modern system is Paul Krugman's "men with guns".

    • avatar Mike Sproul says:

      Paul:
      The US dollar is backed by the assets of the federal reserve, (mostly gold and bonds), which are in turn backed by the assets of the US government (mainly taxes receivable). Those assets appear on the fed's own balance sheet as "collateral held against federal reserve notes". If the public wants fewer dollars, the fed uses its bonds to buy back those dollars. If the fed were ever shut down, then federal reserve notes are legally a "first and paramount lien" against the fed's assets.

      If modern paper money has no backing, why do ALL central banks hold assets?

      • avatar Lawrence Kramer says:

        For a currency to be accepted, it must be credibly scarce. Otherwise, no one will accept it with any confidence that he will not be outbid for his next purchase by someone with a wheelbarrow full of the stuff. Issuing currency in exchange for assets guarantees scarcity, if the assets are really there. Convertibility - "backing" as you call it - assures that the assets are really there by allowing anyone who wishes actually to have them. What you call "backing" reifies the combination of (i) issuance in exchange for assets, which establishes scarcity if the assets are really there and (ii) convertibility, which proves the assets are really there. Modern money is accepted without that second step because our information systems and free press are adequate to assure that if the central banks says it holds assets, it does hold them. But the issue is always and only about credible scarcity. The rest is technology.

        • avatar Mike Sproul says:

          Lawrence:

          As long as every peso is backed by a dollar's worth of assets and convertible into $1, the scarcity of the peso plays no part. The currency board can triple the amount of pesos, and as long as it also triples its assets, it remains true that $1 =1 peso, even though pesos are only 1/3 as scarce as before.

          • avatar Lawrence Kramer says:

            Mike -

            "Scarcity" is a relative term. So long as each peso is issued for a dollar, the peso is equally "scarce." Those $300 had to come from somewhere. They were, presumably, acquired for value given, i.e., they are evidence of the productive capacity in the economy. That is the kind of scarcity I believe is relevant.

            My view is that the backing theory is merely an example of the scarcity theory, which is why unbacked currency can work at a time and place where information about how money comes into being is widely disseminated and trusted. Specie was self-proving; convertible paper is testable; non-convertible gold-standard money is relatively auditable; fiat money is "backed" by the sounds of watchdogs not barking. These are technological advances, each made possible by improvements in communication and governance. But at the heart of it is credible scarcity, the confidence that the money is being created not significantly more rapidly than the things it can buy.

          • avatar Mike Sproul says:

            Lawrence:

            Scarcity is a good explanation of why apples and oranges and gold have value, but it is not a good explanation of why stocks, bonds, and paper money have value. Apples and oranges and gold are consumed and produced, and do not appear on the liability side of anyone's balance sheet. Stocks and bonds and paper money are the liability of their issuer, but they are not consumed or produced, meaning there is no consumption function, no production function, and therefore no meaningful supply and demand curves.

            The quantity of goods produced might be rising at 2%/year, and the quantity of paper money rising at 50%/year, but as long as the assets backing that money are also increasing at 50%/year, the price of goods (measured in paper money) will not change.

          • avatar McKinney says:

            Mike: " The quantity of goods produced might be rising at 2%/year, and the quantity of paper money rising at 50%/year, but as long as the assets backing that money are also increasing at 50%/year, the price of goods (measured in paper money) will not change."

            Now you have made a leap in logic the size of the Grand Canyon. It's one thing to say that the bank defines its own exchange rate and will stick with that definition. It's another to claim that the bank's limited definition applies to all exchanges that involve currency. The latter does not follow from the banks limited definition. When people exchange the currency for goods/services, the principles of subjective valuation apply and those subjective valuations are largely guided by scarcity. No one in the market, least of all merchants, cares what the bank's definition of its exchange ratio for currency is.

            When consumers spend currency in the market, no one cares that it exists on the balance sheet of a bank, but, btw, apples and oranges do exist on the balance sheets of producers and retailers as assets. The assets and liabilities of banks and producers and retailers are all different because they handle different products, but there is no reason to assume that banking products are exempt from the principles of human behavior, unless of course you assume no humans are involved in banking and I might have to agree with you there.

            The bank's fixed exchange ratio of pesos for dollars applies only in the currency of fx exchange markets, not to any other markets, least of all the market exchanging currency for goods.

          • avatar Mike Sproul says:

            McKinney:

            There's no logical leap at all. Every dollar is backed by assets worth 1 oz of silver, so every dollar is worth 1 ounce. Note that I've said nothing about the value of silver relative to other goods. That might be going all over the place. It's just the price of a dollar relative to silver that is specified by the backing theory.

          • avatar McKinney says:

            Yes, it's an enormous logical leap. You keep repeating your assertion, but nowhere have you shown logically or empirically that the fixed exchange rate of the bank forces merchants to keep their prices the same.

            " It's just the price of a dollar relative to silver that is specified by the backing theory."

            Exactly! It has nothing to do with the exchange rate of the currency for goods. When most people talk about the value of currency, they mean the value in exchange for goods, not the fixed exchange rate set by the bank. You say that if prices rise then the value of the backing asset must have fallen. But as I pointed out in my other post, you have not solved the problem, but merely removed it one step hoping that no one will notice. But if the value of the backing asset falls, it's because too many assets were monetized.

            As the great George Reisman pointed out many times, mainstream economists fail most of the time because they can't understand how an economy works with a fixed stock of money. With a fixed stock of money, prices cannot rise but will fall in proportion to the increase in production and productivity. It's logically impossible for prices in general to rise with a fixed stock of money. Individual prices will rise and fall due to changes in output, but a general price rise is impossible. The only way that a general rise in prices can happen with a growing stock of money. That is the quantity theory.

          • avatar Mike Sproul says:

            McKinney (4/26, 2:28)

            I'll just repeat what I said to Lawrence:
            "Maybe a papaya costs 3 pesos in new york and 1 peso in mexico, but if the currency board pegs $1=1 peso, then a papaya will also cost $3 in NY and $1 in mexico. Once the value of a peso is established (by backing and convertibility) at $1, the law of one price does the rest."

            If you want empirical verification, my paper entitled "There's No Such Thing as Fiat Money" cites work by Sargent, Calomiris, Smith, Bomberger & Makinen, and others.

      • avatar Paul Marks says:

        Mike.

        The U.S. Dollar is not "backed" by anything. Go to the Federal Reserve and ask for these "mostly and bonds" they will just ask you to go away, and if you do not go away they will call security have you removed.

        As for taxes - taxes are in Dollars, so saying that "the Dollar is backed by taxes" is saying "the fiat Dollar is backed by fiat Dollars".

        You remind me of the French Revolutionaries with their claim that their new fiat currency was backed "by all the wealth of France" - it was, of course, "backed" by nothing at all (as Edmund Burke pointed out in "Reflections on the Revolution in France" 1790 - where he predicted the French hyper inflation and bankruptcy).

        • avatar Mike Sproul says:

          Paul:

          If I go to one of the fed's licensed securities dealers, I can hand over $100 FRN's and they will give me a $100 bond in return. Assuming I am otherwise well-behaved, they won't call the cops.

          Alternatively, if a bank has borrowed from the Fed, then the bank can repay its loan by returning FRN's to the fed. So already we have two kinds of convertibility that the fed maintains: bond convertibility and loan convertibility.

          Taxes are normally denominated in dollars. Just change the denomination to ounces of silver or something else, and your argument goes away. Denomination is a trivial matter, and does not affect the fact that there are real resources underlying all of this.

          The assignats were backed by the land that the National Assembly had taken from the church. After the National assembly sold off all the land, and paid all its bills by printing mountains of new paper with no new assets backing it, then the assignats lost value, just as the backing theory predicts.

          • avatar Paul Marks says:

            Mike a government "bond" is just government debt - it is not "backing". When someone sells you a government bond they are selling you government debt - this has nothing to do with "backing".

            As for your reference to gold - I repeat go to the Federal Reserve and ask for the gold you think is "backing" in return for your Dollars. They will not give you any specified weight or fineness in return for your Dollar.

            The U.S. Dollar is a fiat currency, fiat currencies are not "backed" by anything (other than Dr Krugman's "men with guns"). Period.

          • avatar Mike Sproul says:

            Paul: (4/24, 8AM)

            You are focusing on the denomination of the assets and ignoring the real resources underlying them. It is indeed possible to "back a dollar with another dollar", as long as there is some real resource that anchors everything. For example, GM might hold some call options on GM stock. Those calls are GM's asset, and they back GM stock. The only complication is that if GM lost some assets then GM stock would fall. This would make the GM calls fall, which would make the GM stock fall more, etc.

            The same is true of dollars. The fed holds dollar-denominated bonds as backing for the dollars it has issued. This makes the dollar more volatile (because of the inflationary feedback effect described above) but as long as there are some anchoring real assets, it does not make the value of the dollar indeterminate.

      • avatar Paul Marks says:

        Of course the same is true in Britain - if someone goes to the Bank of England and asks for the "mostly gold and bonds" they will also just call security.

        The British Pound and the American Dollar are not "backed" by anything. Other than men-with-guns.

  5. avatar Luke M says:

    Good post, but I feel something needs to be added. In the case of a fixed exchange rate, it's easy to figure out the central bank's policy. It doesn't need to say a word. But in the case of a freely floating money, you can't figure out the central bank's policy so easily. Exchange rates would bounce around like crazy even if every CB was absolutely committed to a stable price level. It's hard to distinguish between random fluctuations and intentional ones. You have to trust the CB more to accept a floating exchange rate. A low-credibility CB may be inclined to manage the exchange rate, since otherwise people would react to normal fluctuations by assuming the worst and fleeing the currency.

    • avatar Paul Marks says:

      Luke - a "stable price level" is a terrible policy objective. It is the Irving Fisher fallacy and it led to the terrible policies of Benjamin Strong in the late 1920s and Alan Greenspan more recently. Prices should be allowed to fall gradually over time as people find better ways to do things (even the late Milton Friedman eventually came to the position that the "monetary base" should not be increased - although, unlike the Chicago School before him, he did not see that this means that bank credit should not expand either).

      As for rigging ("fixing") exchange rates - that is a profoundly mistaken policy, it leads to terrible harm.

      An "exchange rate" is a price - and prices must not be set by government edicts (if they are - vast harm is done), also such rigged exchange rates (like all forms of price control) inevitably break down.

      The only way to really have "stable exchange rates" is to have the same currency - for example gold (which was, basically, the international currency before 1914).

      • avatar Lawrence Kramer says:

        Paul -

        What you say about prices falling is true in real terms. Whether it should also be true in nominal terms is a completely different question, to which the answer is clearly "no." Modest, predictable inflation forces rediscovery of real prices, including the downward sticky ones such as wages, creates an incentive for putting cash to work rather than growing in value in a drawer, causes loans to self-amortize, rather than increase in real terms as their underwriting ages, etc., etc., etc. There is nothing good to be said about generally declining nominal prices. They can be tolerated in a period of hyper growth - America, circa 1870, say - but they are always a headwind, and never a tailwind.

        • avatar Paul Marks says:

          Lawrence I profoundly disagree.

          As people find better ways to do things prices fall - Benjamin Strong (or Alan Greenspan) efforts to expand the money supply in order to maintain a "stable price level" cause incredibly severe harm.

          It is the Irving Fisher fallacy - exposed in theory by Frank Fetter, and in practice by the bust of 1921 and 1929 (as well as 2008).

          • avatar Lawrence Kramer says:

            "As people find better ways to do things prices fall "

            Paul -

            REAL prices fall. Nominal prices do what they do depending on how much credit is created to demand the lower-priced things.

            If you don't address the real/nominal distinction, you aren't addressing my claims.

    • avatar Mike Sproul says:

      Luke:
      Good points, and that's why private banks always maintain strict convertibility between checking account dollars and federal reserve notes (FRN's).

      The trouble is that strict convertibility (like a private bank or a currency board) makes the institution vulnerable to bank runs, while suspension of convertibility (like a central bank) makes the bank immune to runs. That's why almost all central banks suspend convertibility, in spite ot the difficulties you mentioned.

  6. avatar Lawrence Kramer says:

    "It is clear from the table that whether there are 100 pesos backed by $100, or 300 pesos backed by $300, 1 peso will always be worth $1"

    But what's the dollar worth in our mythical country? If more pesos chase more goods, then prices rise. So, either the currency is worth less, or the goods are worth more. If we say arbitrarily that the measure of the value of the peso will be given in dollars, can we not ask how many dollars it would take to buy enough pesos to buy the newly scarce local goods? The answer, of course, is "more than before," i.e., the dollar has fallen in value, which means that any currency pegged to it has fallen as well.

    • avatar Mike Sproul says:

      Lawrence:

      In the case of a currency board in, say, Uraguay, it's safe to say that the value of the dollar is determined outside of Uraguay, and is beyond Uraguay's control. So whether uraguay has issued 100 pesos backed by $100, or 300 pesos backed by $300, 1 peso=$1 even if the quantity of pesos in uraguay has tripled, and there are 3 times as many pesos chasing the same goods. As one example of many, the new pesos might have displaced barter transactions, so it's not really right to say that there are more pesos chasing the same goods. (Good illustration of the importance of the law of reflux, by the way.)

  7. avatar Lawrence Kramer says:

    Mike -

    "Credible scarcity" is my term for a certain phenomenon. You cannot make that phenomenon go away by denying some other form of "scarcity." I made very clear what I meant by "credible scarcity" - the belief that someone attempting to spend a currency will not be outbid by wheelbarrows of the stuff printed at the whim of the issuing authority. No other usage of "scarcity" is relevant to that claim. If you can describe a good currency that is not credibly scarce, as I use the term, I would be interested. Otherwise, I don't see that you are contradicting my claim.

    • avatar Mike Sproul says:

      Lawrence (4/24 at 12:13):

      For the sake of argument, grant your definition of scarcity.

      Question:

      Suppose the bank/currency board triples the quantity of pesos it has issued, while it also triples the dollar value of its assets. Meanwhile, the quantity of goods produced in the economy grows by 1%.

      On your definition, are the pesos any more or less scarce than before?

      • avatar Lawrence Kramer says:

        Mike -

        Suppose, for sake of argument, that there is a barber in town who shaves every man in town and only those men, who do not shave themselves. Who shaves the barber?

        You don't get to posit events willy nilly any more than a CB will create money on that basis. WHY would a CB issue more pesos? Some guy with dollars must want them. Why does he want them if there isn't anything more to buy? Does he intend to invest in production so that your 1% gain is only temporary? If so, then the 1% is a transient condition that users of the currency will ignore. You have made precisely the point that I was trying to make in my last post: the very creation of the 300 pesos implies to users of the currency that there is or will be supply to meet it. Otherwise, the pesos would not have been created, or, having been created, will reflux back to dollars when the buyer discovers that there is nothing to buy with them.

        Please do not underestimate the importance of the word "credible" in my claim. My approach is behavioral. So long as the users of a currency BELIEVE that it is scarce, they will accept it. Because of how CB money is created, users of it have reason to believe that there will be supply to meet it. If they are wrong, they are wrong. But the currency is accepted, because the scarcity implied is credible.

        • avatar Paul Marks says:

          Lawrence - this is not a difficult one.

          Either the barber has a beard or is a women (or both).

          Most of these puzzles have fairly simple solutions.

          People complicate them - for reasons that are unknown to me.

          • avatar Lawrence Kramer says:

            "Either the barber has a beard or is a women (or both)."

            Suppose, for sake of argument, that there is a MALE barber who shaves every man in town and only those men, who do not shave themselves. Who shaves the barber?

            Your female solution works because I forgot to say that the barber was male. But the male barber cannot have a beard, because a man with a beard does not shave himself, and the barber shaves every man who does not shave himself.

            If the problem is properly stated, the only solution is that there can be no such barber, just as there can be no CB that issues money without there being something for it to buy (collectibles aside).

        • avatar Mike Sproul says:

          Lawrence:
          I say 'backing' and you say 'credible scarcity'. Do we mean the same thing? How can anyone tell without thought experiments, etc? So you reject my question about tripling the money supply since, as you rightly point out, they would only print more money if the money was wanted. Is there some thought experiment that you would accept? Perhaps the question of what would happen if the assets of the issuing bank fell in value? I'd call that a loss of backing and you'd call it a loss of credible scarcity, but we arrive at the same answer. Reminds me of the way quantity theorists use "velocity" to make sure that the quantity theory is always right, no matter what.

          In defense of the backing view, I point to textbook accounting theory, which has a longer and considerably more dignified history than economics. When accountants value stocks, bonds, warrants, etc, they speak only of backing, of the assets and liabilities of the issuer, and never of the 'credible scarcity' of the financial instrument in question.

          • avatar Lawrence Kramer says:

            "I say 'backing' and you say 'credible scarcity'. Do we mean the same thing?"

            Not exactly. Credible scarcity is a psychological state; "backing" is a metaphor. Credible scarcity is a goal; backing is a technique. Where those differences come into play is not always clear, but Paul is not saying fiat money lacks credible scarcity, whereas he is saying that it lacks backing. You have responded to his claim - more about that later - whereas I don't have to.

            "How can anyone tell without thought experiments, etc?"

            I love thought experiments, but you acknowledge that I rejected yours for good reason, so I'm not sure why you are defending the concept to me.

            "Perhaps the question of what would happen if the assets of the issuing bank fell in value?"

            I started to deal with that in an earlier comment, which appears below:

            "If the bonds held by the Fed go bad, then one can infer that the money issued against them was not in fact issued against paper that evidences the availability of supply, and the money may, therefore, not in fact be so credibly scarce as was previously thought."

            But I think there is a more useful way to approach the problem. For a more pristine test, assume that some percentage of the FRNs accepted by the CB are fakes. What happens to the peso? Does the answer depend on whether the information gets out? After all, if the percentage is small enough, no one need ever know. Each peso is still convertible to a dollar even if there isn't a dollar there for every dollar. So what's a peso "worth" under the backing theory if the missing backing is not disclosed? Or even if it is disclosed but the convertibility is maintained? As I tried to argue earlier, I believe that the dollar value of the peso is an arbitrary and unhelpful measure except to someone who wants to buy dollars. I think it makes more sense to ask how many papayas a peso is worth.

            Being an apparent attribute, credible scarcity can arise from any number of sources of information. As I have said, the sine qua non for any currency is spendability: the users must believe that if they accept a peso, they can immediately buy something equivalent in value to what they sold for that peso. The method by which a CB creates currency establishes prima facie that the peso is credibly scarce. The CB must receive value in order to issue pesos, and, because Uruguayan owners of FRNs probably had to sell Uruguayan goods to get the FRNs, it is sufficiently likely (not necessarily true, but sufficiently likely) that there exists enough Uruguayan supply to meet the demand that the new pesos will effect. BUT, there there is in fact not enough supply, inflation will occur, and the peso will be rendered less credibly scarce in the minds of those trying to spend them.

            Any number of things could cause such a shortfall in supply, but an excellent choice would be counterfeit FRNs. If the Uruguayan owner of the FRNs did not have to sell Uruguayan goods to get them, then the capacity of the Uruguayan economy to produce goods will be overimplied by the quantity of pesos in circulation. In that case, the value of the peso, in papayas, will fall, even as it remains convertible to $1 at the CB.

            Therein, I think, lies the difference in our accounts. The counterfeit FRNs effectively turn the CB into a fractional reserve lender. Convertibility remains unchanged. Thus, you have to deal with the subtle question of whether the peso is backed by the dollars in the CB's vault or by the CB's promise of convertibility despite its fractional reserve of dollars. I don't have that problem.

            More important, perhaps crucially true to ascertaining what is the ur-test and what is the proxy, the supply-shortage feedback mechanism that affects the domestic value of the peso does not tell the user that the peso is not 100% backed by real FRNs, but it does tell the user that the peso is not credibly scarce. Thus, whenever there is inflation, one can infer that the currency is not credibly scarce, but, contrary to your claim in another comment, I do not believe one cannot infer that it is not adequately backed.

            "Reminds me of the way quantity theorists use 'velocity' to make sure that the quantity theory is always right, no matter what."

            Actually, your pointing out the many forms "backing" can take strikes me as a far better example of molding facts to fit concepts. In my examples, the bottom line is always actual user belief in the credible scarcity of the currency, not something that I say can be counted as such.

            In this context, I think your farm collateral example is highly instructive. At the outset, though, I think you need to meet Paul on his own turf. Fractional reserve banks do create unsecured loans, so citing collateral as backing does not address his quibble. I think you have to go all the way to saying that the borrower's credit - his ability to create future wealth - "backs" the dollars created by the bank. At this point, Paul will simply say that you have defined "backing" to mean nothing more than an underwriter's opinion, and in that regard he'd be right. Whether you would call that "backing," or whether there is under such a definition such a thing as an unbacked loan so as to make "backing" a useful concept, I will leave to you.

            But back to that farm. The difference between the income potential of a farmer and the value of his farm is not conceptually great. What is the value of a farm (assuming farming is its best use) if not the income potential of the farmer farming it? What you are calling collateral is really garnishment: if the farmer cannot pay you out of the income he has left after feeding his family, then he has to pay you BEFORE he feeds his family. More important, the same drought that can kill the farmer's business can destroy the value of the collateral. So the dollars lent are "backed" by the farmer's equivalent of fair skies and a following wind. Pie in the sky...

            My point is that the "backing" metaphor gets its utility from the substantial heft of the alleged backing. Once we start talking about more ephemeral backing, like the lender's underwriting opinion, backing just seems to lose its metaphoric appeal, sort of like saying that your chin is at the foot of your face. It works, but really? In contrast, a well-underwritten loan does imply that someone credibly expects to produce outputs sufficient to repay the loan. Such a loan, whether or not collateralized, thus suggests the emergence of supply concomitant with the loan and, therefore, is consistent with the credible scarcity of the currency, even though it is created by a fractional reserves lender against nothing more than the promise of a guy with a Visa card.

          • avatar Mike Sproul says:

            Lawrence:

            1. Start with a currency board that has $100 worth of various assets and has issued 100 pesos. I say 1 peso=$1 because the board has $1 worth of assets for every peso issued. You say 1 peso=$1 because the pesos are credibly scarce. Already you run afoul of accounting theory.

            2. Next, the CB is robbed of $10. I say each peso has 10% less backing, so 1 peso=$.90. The quantity of pesos is still 100. Scarcity theory implies they should still be worth $1 each.

            3. Suppose that, before the robbery, the CB held half its assets denominated in pesos, not dollars. Define E as the exchange value of the peso ($/P). Setting Assets=Liabilities (after the robbery) yields:

            40+50E=100E, or E=$.80/peso

            That's according to the backing theory. I don't know how your scarcity theory would handle it.

            4. Back to $100 backing 100 pesos. The CB tries to support the peso the way central banks used to do, by deliberately using its dollars to buy up pesos (and retire the pesos), and presumably over-paying for the pesos bought. Let's say the CB pays $11 to buy back 10 pesos. The new value of the peso is E=89/90 or $.99/peso. In other words, the backing theory implies that the peso will fall as a result of the attempt to support the peso, but presumable the scarcity theory would say that there are 10 fewer pesos than before, so the peso is more scarce and therefore more valuable.

  8. avatar Paul Marks says:

    Mike.

    An honest money lender (as opposed to a bubble blower) lends out real savings and real savings only - either their own real savings, or the real savings that others have voluntarily entrusted to them (to be lent out).

    When money has been lent out the money lender does not have the money any more - till when, and if, it is returned. And people who entrust a money lender with their savings (to be lent out) have not "deposited" anything - because the money is not "deposited" (like grain in a grain silo) the money is lent out.

    Contrary to Lord Keynes - monetary expansion (or credit expansion) is not (not) "savings as good as any other kind", it is not savings at all.

    Calling a money lender a "bank" should not make a difference to any of the above - sadly, in practice, it does.

    I ask yet again.......

    If the banking system does not expand lending (credit) beyond real savings of cash-money what form of "money supply" fell between 1929 and 1933 (was it not "broad money" - i.e. bank credit?), why did prices collapse between 1929 and 1933? I remind you that no one was going round destroying cash in bank vaults.

    A bust is caused by the artificial (and it is artificial) "boom" - the idea that one can lend out "money" that no one has really saved (credit expansion).

    Central Banking makes things worse by encouraging the basically mistaken way the banking system operates (which violates basic logic by treating credit as real savings and pretending that different parties can have the same money at the same time) and carrying it to an extreme that bankers (left alone) dare not do.

    There can be (and have been) banking credit bubbles (efforts to construct perpetual motion machines - doomed to fail and crash) without Central Banks - but Central Bank activity makes them bigger than they otherwise would be.

  9. avatar Lawrence Kramer says:

    "The fed holds dollar-denominated bonds as backing for the dollars it has issued. This makes the dollar more volatile (because of the inflationary feedback effect described above) but as long as there are some anchoring real assets, it does not make the value of the dollar indeterminate."

    Pardon my stalking behavior, but let me rephrase your statement:

    The fed holds presumably well-underwritten dollar-denominated bonds equal in market value at the time of purchase to the dollars it has issued. This makes the dollar more volatile (because of the inflationary feedback effect described above) but as long as the dollars were issued for evidence of real creditworthiness, it does not reduce the credible scarcity the dollar.

    I am looking for some way to determine whether your statement or mine more accurately describes the functional underpinning of money. For example, you need to tackle Paul's claim that a dollars cannot back dollars, and you point out - rightly, I think - that it is the credit behind the bonds, not the currency in which they are denominated, that allows them to be backing. I don't have that problem. I don't say that the dollars are "backed by" the bonds. I simply say that the dollars are credibly scarce because they were issued against bonds which were issued against a scarce resource - good credit. The problem arises because you have chosen to defend a reification - "backing" - a category into which you must shoehorn all manner of logical devices in order to demonstrate that a currency is backed. In contrast, I need only explain why the mechanism whereby a currency is issued has safeguards against it being issued other than in exchange for value.

    I won't go too deeply into the distinction between "exchange for value" and "backing" except to say that the value for which money is exchanged is itself evidence of the supply available to be bought with the money created, and it is this evidentiary function, not the ongoing existence of backing, that gives the currency credibility. This not to say that the quality of credit, and therefore the implications with respect to supply, cannot be assessed with the benefit of hindsight. If the bonds held by the Fed go bad, then one can infer that the money issued against them was not in fact issued against paper that evidences the availability of supply, and the money may, therefore, nor in fact be so credibly scarce as was previously thought. It's perfectly fine to say that the money has become "unbacked," but I believe that just attests to the high quality of "backing" as a metaphor for credible scarcity in cases where the currency is created in exchange for credit whose quality can be measured. It does not, however, elevate "backing" to more than a proxy for supply, which is a sine qua non for credible scarcity.

  10. avatar Mike Sproul says:

    Paul:

    You talk as if "saving" only happens when people "save" money, but saving also happens when people save commodities, land, etc. So if a bank lends 200 newly-created checking account dollars to a guy who "deposits" a $200 IOU backed by the deed to his $200 farm, then nothing financially illegitimate has happened, even though the MONEY lent by the bank exceeded the MONEY previously deposited in that bank.

    About your question: Prices rise when there is less backing per dollar, and prices fall when there is more backing per dollar. The trouble is that the backing is not always obvious, and can be subject to the whims of government officials.

    • avatar Paul Marks says:

      Mike if someone wants to lend money (without playing the credit bubble game) either that person or someone else has to save money.

      Talking of "saving land" (and so on) is just silliness - unless you are talking about saving land from a flood or something (it is nothing to do with money lending).

      And you continue to talk about "backing" - the U.S. Dollar (like the British Pound) is a FIAT currency - it is not "backed" by anything (other than Dr Krugman's "men with guns").

  11. avatar Paul Marks says:

    Vikingvista

    If what you say is true (i.e. that the banking system does not expand lending beyond the level of real savings of cash money) then what form of "money supply" declined between 1929 and 1933?

    No one went around destroying cash in bank vaults - so was it not bank credit (the credit bubble) that declined?

    If lending is larger than real savings then there is a credit bubble - and the bubble will bust.

    As for "fractional reserve banking" - most people when they use the word "fraction" mean less than the total amount, for example one tenth or nine tenths.

    Most people do not think of a hundred tenths or a thousand tenths as a "fraction" - if banking system that lends out ten times or a hundred times the level of real savings of cash-money is better described as "credit bubble banking" rather than "fractional reserve banking".

    By the way it is not "dim witted" to ask for basic honesty in language (and in accounting) - if money is lent out, it is NOT "on deposit" (period).

    • avatar vikingvista says:

      "If what you say is true (i.e..."

      Paul, your asinine id ests would still be amusing if they weren't so repetitious. What *I* said (as opposed to what is said by the monotonous voices in your head that drown out what people say) is true. But more to the point, if you could muster the intellect to grasp the classic money multiplier of Econ 101 (or is it 102 now?), it would profoundly change what you write. Credit expansion (and possibly a bubble) occurs, of course, if institutions loan *EXCLUSIVELY* the basic money that they have.

      "As for "fractional reserve banking" - most people when they use the word "fraction" mean less than the total amount, for example one tenth or nine tenths."

      Not just most people, but every person who isn't an idiot. Fractional reserve banks reserve "less than the total amount" of deposits, and loan out the rest. All this commentary, and you've never bothered to look up the definition of "fractional reserve bank"?

      "By the way it is not "dim witted" to ask for basic honesty in language"

      You are absolutely right. The basic language of banking is honest and well understood by anyone interested who uses banks. On the other hand, those who claim that an INTEREST BEARING bank deposit is anything other than a loan to the bank are either dishonest or dim-witted, or both. But fortunately, they are an insignificant portion of people who deal or have ever dealt with banks.

      "if money is lent out, it is NOT "on deposit" (period)."

      Why the gross ignorance here? If you loan money to a bank in the form of a deposit, your loan is ON THE BOOKS as a DEPOSIT. I.e., it is ON DEPOSIT. This is a mystery to NO ONE who is interested in knowing the first thing about banking. It is only falsely *claimed* to be a mystery by an astonishingly confused few, like the rothbardians.

      • avatar Paul Marks says:

        Vikingvista

        The same money can not be "on deposit" and at-the-same-time lent out - that is having the same money in two different places at the same time. This is where the weird nature of banking accounts helps (via the complex interactions between banks) to create credit bubbles - i.e. boom-busts.

        You also keep dodging the question (which is why I keep repeating it).

        If you are correct that that banks just put the savings of people to work (that the banking system does not expand lending beyond real savings of cash-money)then what form of "money supply" declined between 1929 and 1933?

        No one was going round destroying cash in bank vaults - so some other form of "money supply" declined between 1929 and 1933. Was it not "broad money" - i.e. bank CREDIT.

        Lending that was greater (larger) than real savings of cash-money.

        That is the nature of the credit bubble - and it is based on such things as counting money that is LENT OUT as still in the possession of the savers ("on deposit").

        If the money is LENT OUT the savers (and the bank) do not have the money any more (it is not "on deposit") not till when, and if, the money is repaid.

        The basic language (and accounting methods) used in banking are just flat wrong.

        • avatar vikingvista says:

          "The same money can not be "on deposit" and at-the-same-time lent out"

          Of course it can. That is what it means in banking, as anyone born in the last 300 years can tell you. Is English not your first language? You DEPOSIT money with a bank. It is thereby ON DEPOSIT with that bank until you withdraw, regardless of what the bank does with the specific funds you loaned to it. ON DEPOSIT at a bank is used synonymously with SAVED at a bank. Absolutely everyone (who is interested) has long understood this well-known semantic fact. The difference between you and the rest of the literate world is that you claim all these people with a perfect grasp of the semantics are somehow victims of deceit because YOU choose to ascribe your own personal meaning to the terms. How preposterous is that?

          Here's an even better argument that is right up your alley: Money isn't "on deposit", because there is no money is on top of the deposit, and the money is actually on a counter or floor of a vault or server room. Therefore bankers are deceivers.

          "that is having the same money in two different places at the same time."

          Beyond silly. I think I was in elementary school when I first learned the basics about how banks turn deposits into loans. I believe I learned it from some old black & white cartoon made in the 1950's (long before I was born). It is common knowledge. Anyone espousing something different in common company would rightfully be considered an ignoramus of unusual caliber.

          "This is where the weird nature of banking accounts helps (via the complex interactions between banks)"

          Just because *you* don't grasp it doesn't mean it is either weird or complex to the rest of us. And as I keep telling you, if you would just commit a little time to the money multiplier section in your high school economics text, it wouldn't be such black box to you.

          "You also keep dodging the question (which is why I keep repeating it)."

          If you want me to resume answering your questions (a waste of time I already tried), then I have two requirements:

          1) Stop lying about what I said as a premise to your question, and
          2) Swear upon the lives of all of your descendents and your great aunt Myrtle, that you will not again ignore my answer.

          "If you are correct that that banks just put the savings of people to work..."

          The private banking system directs savings to more productive uses. I have said this to you before. In the absence of distorting signals, the amount of credit expansion generated in the banking system tends toward an optimal amount in that the forcing of any less or more expansion would result in funds finding their way to less productive uses, on a risk:benefit basis.

          "(that the banking system does not expand lending beyond real savings of cash-money)"

          There you go again. If you want me to answer your questions, you absolutely must stop the bald-faced lying. This, as you well know, is something I have NEVER said to you, though you have falsely attributed it to me numerous times. I have explained my quite contrary position to you in full honest detail, only to be utterly ignored.

          "and it is based on such things as counting money that is LENT OUT as still in the possession of the savers"

          Oh, I see. So now *semantics* are the cause of the business cycle. Brilliant.

          "The basic language (and accounting methods) used in banking are just flat wrong."

          Riiiiight. It's not that you don't understand them. Oh nooo. It's not that.

          • avatar Paul Marks says:

            Vikingvista - if I deposit something and it is removed it is NOT "deposited" there any more.

            That is not banker language - but it is English.

            It is not my fault if banker language is hopelessly dishonest and designed to cover up what any normal person would consider fraud (or insanity - such as the idea that the same money can be in two different places at the same time).

            If lending is larger (and it is larger - vastly larger) than real savings of cash-money then a credit bubble has been created, and that is not "semantics", that is a basic fact (one I suspect you understand perfectly well - but have commercial reasons for pretending not to understand).

            As for your claim that you answer my questions......

            Very well I will ask the question again.

            If the complex interactions of the bankers do not expand lending so that it is larger than real savings of cash-money what form of money supply shrank between 1929 and 1933 (and so many other busts)?

            Did evil "deflation" elves go around destroying cash in bank vaults? Or was it really "broad money" (i.e. banker credit bubble - lending that was not from real savings) that collapsed?

            Will you answer the question this time?

            What form of "money supply" collapsed between 1929 and 1933?

            If it was not banker credit (i.e. loans that were not from real savings) what was it?

            How did the evil deflation elves get into the bank vaults to destroy the real savings of cash-money?

            You know perfectly well that there are no deflation elves (they do not exist) - no one went around destroying cash in bank vaults.

            What collapsed is what always collapses - the banker credit bubble (which had been encouraged, every step of the way, by Benjamin Strong of the New York Federal Reserve).

            That bankers (with or without a Central Bank) create the credit bubble (the boom-bust) is something you know perfectly well Vikingvista.

            The banking system lends out vastly greater amounts of "money" than actually exist as real savings of cash-money (thus creating the credit bubble - the boom-bust), and you know it.

          • avatar vikingvista says:

            “if I deposit something and it is removed it is NOT "deposited" there any more.”

            If you *deposit* something in a bank, then you *deposited* it there. As long as the bank maintains the liability, it is *ON DEPOSIT* because it is *ON THE BOOKS* as a bank liability. This is 9th grade verbal comprehension at best. The language is clear and literal. But that doesn’t matter. It doesn’t matter if instead of “on deposit” the entire English-speaking world called it “chasing the dragon” or “axing your aunt”, because everyone who is interested understands it. It is no secret, never has been, and therefore is impossible to be deceptive.

            Next time you say these things in front of others in person, look at their faces. That look they give you is the same look you would give someone who proclaimed in all earnestness, “You know when that guy says he’s a ‘headhunter’ he’s lying, because he’s not really cutting off anyone’s head, he’s only recruiting.”

            “It is not my fault if banker language is hopelessly dishonest and designed to cover up what any normal person would consider fraud”

            It is your fault that you persist in uttering these absurdities, when the truth is so readily available. Deliberately maligning innocent people is a sign of very poor character, but since your calumny is so ridiculous, I doubt anyone’s response is as much offense as it is pity.

            “(one I suspect you understand perfectly well - but have commercial reasons for pretending not to understand).”

            I see. It is not that you are an imbecile. It is that I am a liar. Got it. If only I could achieve your level of honesty, like when you deliberately falsely attribute positions to me.

            “If the complex interactions of the bankers do not expand lending so that it is larger than real savings of cash-money”

            Why do you believe such nonsense? You (and only you) keep repeating it, so as far as I can tell only you believe it. Since (as I’ve made clear to you in ignored replies in the past) I disagree with this premise, there is no point in going further with the question, is there?

            “You know perfectly well that there are no deflation elves (they do not exist)”

            There really is something wrong with you.

            Again, you could do yourself a tremendous favor by simply--SIMPLY--looking up the explanation of the money multiplier. This is a very simple concept that you don’t, but I believe could, understand. Credit expansion requires only that institutions physically loan out some portion of the total basic money deposits that they receive. Basic money in, basic money out, and credit expands. That’s it. It isn’t so hard to grasp if you would only try.

      • avatar Paul Marks says:

        vikingvista.

        If I put something in a bag ("deposit it" in the bag) and someone else takes it out of the bag - it is not in the bag any more. It is no longer deposited in the bag (it has been taken out of the bag).

        Credit bubble banking (the process by which, via the complex interactions of commercial banks and with the encouragement and support of government backed Central Banks, banks lend out many times more "money" than was ever really saved) rests on the assumption that money taken out of the bag is still in the bag (that it is still deposited there).

        That is why credit bubble banking (as opposed to honest lending of cash-money) is so destructive.

        "But the money is still on the books".

        What is the (fantasy) ledgers (electronic or leather bound) does not matter - what matters is what is actually in the vaults.

        If the banking system lends out vastly more money than actually exists (and they do - "broad money" is vastly larger than the monetary base) then a credit bubble has been created.

        If you deny this - I (yet again) refer you to 1929 - 1933.

        What form of "money supply" collapsed between 1929 and 1933?

        It was not cash - no went around bank vaults destroying cash.

        What collapsed is what always collapses (in bust after bust) - bank credit, the credit BUBBLE (loans that are from "on the books" money, not REAL money).

        The old fallacy that one can (without terrible consequences) lend more than has really been saved(i.e. the sacrifice of consumption to really save cash-money).

        I repeat the truth....

        If I deposit something in a bag (or a bank) and someone else takes it out (or I take it out myself), it is not deposited there any more.

        Dishonest banker language to the contrary.

        • avatar vikingvista says:

          Would it kill you to respond to just one or two of my points? At least to break the monotony of your repetitions?

          “If I put something in a bag ("deposit it" in the bag) and someone else takes it out of the bag - it is not in the bag any more.”

          Correct.

          “It is no longer deposited in the bag”

          I’m going to go out on a limb here and hazard to guess that you are not an English teacher. I mean, I might say that “You are no longer delivered by your mother’s obstetrician”, but besides being tortured grammar, it is, in its most sensible disambiguation, false. You were delivered by your mother’s obstetrician, and nothing that can ever happen to you can change that fact.

          Likewise, if you deposited something into a bag, then the fact is eternal (unless someone invents a time machine) that you deposited something into a bag. It is impossible to change that fact.

          What you MIGHT have said, is: “It is no longer in the bag.” But in addition to being true, that would make it too obvious that you don’t know how to use the word “deposit” (and you obviously don’t).

          Or, continuing in your own unique grasp of English, if someone else did NOT take it out of the bag, I suppose *you* would say that the thing is “on deposit in the bag”. When you went to school, you probably told people that your books were “on deposit” in your backpack. Perhaps your creamer is “on deposit” in your coffee. Your wallet is "on deposit" in your back pocket.

          The reason you don’t say that your dentures are “on deposit” in your mouth, is because “on deposit” makes literal sense in only one possible way--as “on loan”.

          To summarize today’s 3rd grade English lesson:
          1. You deposit x into y.
          2. It becomes a permanent irrevocable historical fact that you have deposited x into y.
          3. In the well-known case of depositing x into y for the purpose of loaning x to y, you say that x is on deposit in y. You say that for precisely as long as x is on loan to y. And as is the nature of a loan, any number of things can happen to x while it is on loan to y.

          “rests on the assumption that money taken out of the bag is still in the bag”

          Of course it doesn’t. Completely absurd. Totally false. Reveals a very poor grasp of the obvious.

          “(that it is still deposited there).”

          It WAS deposited there. It is still ON DEPOSIT there. Your first language is…?

          “That is why credit bubble banking (as opposed to honest lending of cash-money) is so destructive.”

          Honest lending of cash-money is all it takes (given the necessary signals) to create a credit bubble. I see you still haven't bothered to look up the money multiplier. In other words, if you want to eliminate credit bubbles, you're going to have to eliminate honest lending of cash-money as well.

          “‘But the money is still on the books’.”

          You put this in quotes, but neither I nor anyone else on this thread said it, as a quick search will point out. I guess if you can’t argue with my points (I have many that you have yet to address), then you might as well burn your own straw men.

          “If the banking system lends out vastly more money than actually exists”

          *** ANY BORROWER WHO LENDS DOES THIS! *** (All caps here in hopes that maybe this time you won’t ignore the point). If I have a gold coin, I can lend it to Bill. Bill can then lend it to Sue. Sue can then lend it to Jack. Ad infinitum. One specific hard tangible asset has the possibility of generating ANY conceivable amount of debt.

          So, are you really saying that all borrowers should be forcefully stopped from lending?

          “"broad money" is vastly larger than the monetary base”

          So is it semantics that irks you? If humanity had instead chosen to call it, say, “maximally liquid debt”, then you’d finally stop falsely maligning innocent credit intermediaries?

          “If you deny this - I (yet again) refer you to 1929 - 1933.”

          And if you deny it, then I refer you to 285 - 274 BC. Non sequitur right back at you.

          “What form of "money supply" collapsed between 1929 and 1933? It was not cash”

          The world’s worst kept secret.

          “The old fallacy that one can ... lend more than has really been saved”

          Uhh...how about iteratively lending the same saved funds? Ever think of that? (This will be the 43rd time I’ve made this well-known point which, of course, you will continue to utterly ignore in favor of some abiogenetic straw man).

          • avatar Paul Marks says:

            Vikingvista.

            I repeat - a system that depends on (assumes) money ("deposits") still being in the bank AFTER it has been lent out, is not sensible. Indeed it violates the basic laws of logic - which are not optional (as credit bubble bankers, and credit bubble baker friends, seem to believe).

            If I (or you) put 100 Dollars in a bank and it is then lent out, the 100 Dollars is NOT in the bank any more (the deposit is no longer there - it has been lent out).

            "But the books say.....".

            The bank ledgers (electronic or leather bound) can say anything credit bubble bankers want them to say - it has no effect on objective reality (the money is gone - it is not deposited in the bank any more, it has been removed).

            Credit bubble banker books may say that 1+1=16 - it does not make it so. And credit bubble banker books may say that ten thousand Dollars may be lent out (without harmful boom-bust consequences) for every hundred Dollars of cash-money that actually exists - again this does not make this so.

            I repeat, the laws of reason (of reality) are not optional - the words of credit bubble bankers (and credit bubble banker friends) to the contrary.

            There is nothing wrong with being a money lender (the age old attacks on "usury" are mistaken) - but there is everything wrong with being a credit bubble blower.

          • avatar vikingvista says:

            "I repeat...", "I repeat..."

            Yes. That really is all you do. If you are not a bot, you may be the first human to fail the Turing test.

            Is there a reason why you never respond to any of my counterpoints? Why do you post if you so dislike dialogue?

            "'But the books say.....'"

            Is there a reason why you repeatedly invent quotes to respond to? You just can't bring yourself to read any of my responses even for the purpose of finding a legitimate quote?

  12. avatar Paul Marks says:

    Lawrence - I repeat, if (a very big "if") there is not a monetary expansion, then prices will tend to fall over time (as people find better ways to produce goods and services).

    Whether you talk of "real" or "nominal" prices does not change the point in the first paragraph.

    • avatar Lawrence Kramer says:

      You are right. If there is no monetary expansion, there will be deflation. But that will be a bad thing.

      I don't know to which "first paragraph" you are referring. But only real prices matter to the standard of living. Creating inflation as real prices fall is a way of keeping the engine humming by conducing to the optimal mix of saving and consumption. Modest, predictable inflation has no effect on people's standards of living, except insofar as their bargaining power is changing, in which case inflation induces price discovery, again, in real terms, which is a good thing.

      • avatar Paul Marks says:

        No Lawrence - prices gradually falling over time (as people find better ways to do things) is not a "bad thing".

        What is a bad thing is the policy of seeking a "stable price level" (as defined by some "price index") - this leads to the monetary expansion that creates boom-bust.

  13. avatar Paul Marks says:

    Mike government bonds are not "backing" for the Dollar - they are just government debt.

    The U.S. Dollar is not "backed" by anything. It is a fiat currency - fiat = "command", "order". The Dollar does not represent any commodity.

  14. avatar Paul Marks says:

    I see Lawrence - yes, if no man shaves himself, and every man is clean shaven, and the barber is male, then there is a problem of "who shaves the barber".

    However, on money.....

    Let us say we believe in fiat money (full disclosure - I do NOT support this system), why should there be a Central Bank?

    Why should not the Treasury not print and spend the money directly? Why the Fed create the money - and then lend it out on the understand that the banks (and other such) will lend it back to the government?

    The Central Bank method of creating fiat money appears to be just an excuse or Corporate Welfare.

    • avatar Lawrence Kramer says:

      "Let us say we believe in fiat money (full disclosure - I do NOT support this system), why should there be a Central Bank?"

      There are lots of reasons, but let's look at your specific question:

      "Why should [] the Treasury not print and spend the money directly?"

      Checks and balances. Brilliant as our three-branch system is, the courts have no jurisdiction over monetary policy, and the other two branches cannot be trusted with it. So the political branches created an entity to implement monetary policy. As an engineering matter, that entity is best structured as a central bank with the currency being issued as liabilities of that bank, even though the currency is not convertible, and the notion of it as a "liability" is a legal fiction. (Legal fictions are analytical tools, not deceptions.) We thus have a central bank so that someone can say "No" to Uncle Sam (or to anyone else) when he or they want to borrow an amount of money that, in the opinion of the central bank, will cause inflation. In a fiat system, a central bank is how the money is kept credibly scarce.

      • avatar Paul Marks says:

        Lawrence - given the record of the Federal Reserve since its foundation in 1913 (the extermination of the vast majority of the value of the Dollar - and spectacular boom-busts such as that of the late 1920s and 1930s), your support of the Central Bank is profoundly odd. Hardly a record of keeping money "credibly scarce".

        As for the Three Branch system of government - yes and none of that Constitutional government includes any mention of a Central Bank.

        It is not mentioned in the Constitution or in any of the Amendments - so it falls by the Tenth Amendment.

        Gold and silver coin is mentioned by the Constitution (no State may declare anything other than gold or silver coin legal tender - Article One, Section Ten) and the Federal Congress may only "coin" money (Article One, Section Eight) in order to prevent a repeat of the "not worth a Continental" of the old Continental Congress. Coining money is in with weights and measures - in this case of gold and silver coin.

        Although the private mints of the West proved to be honest (competition kept them so) - so there was no proper justification for the Congress to ban the private mints of gold and silver coin in the 1850s.

        Today there is no (economic) reason who electronic cards could not be used - as long as the transferred the ownership of commodities that actually existed (not the "promises" of bankers and other such).

        Let us be honest, the purpose of the Federal Reserve is not (and has never been)anything to do with "checks and balances" - it is about CORPORATE WELFARE (giving a drip feed of "cheap money" to certain big banks and other such).

        The idea of Central Banking makes no economic sense - basic economics shows the fallacy of it.

        And defending the record of the Federal Reserve disregards the historical facts.

        • avatar Lawrence Kramer says:

          "given the record of the Federal Reserve since its foundation in 1913 (the extermination of the vast majority of the value of the Dollar - "

          This destruction of the value of the dollar is one of my favorite canards. 100 years, 98% value loss. Do the math. Seems like pretty modest inflation to me. Do you know anybody who LOST 98% of their fortune as a result of this travesty? Do think there IS anyone who did? Would you have sympathy for them? I don't. The inflation rate implicit in the record you cite is about right except for those who think a mattress is an investment vehicle. A medium of exchange is not a store of value. It must HOLD its value long enough to be spent ON a store of value, or something else, but a 2% inflation rate seems to cover that need nicely.

          • avatar Paul Marks says:

            Lawrence so you really are a defender of the Corporate Welfare machine that is the Federal Reserve system - I was not certain of that till your last reply.

            I believe that no further conversation between us AT THIS TIME would be a sensible use of the time of either of us.

            However, (in the unlikely event that we are both still about in a few years - not at all likely in my case) we may discuss the collapse of the financial system after it occurs - which it will.

            As you are fair minded person I do not think that you will still be defending the Federal Reserve system (and its violation of basic economics understood since the time of Richard Cantillon in the 1700s) in a few years time.

  15. avatar Paul Marks says:

    Mike if a Dollar represents "one ounce of silver" then just give me the ounce of silver (keep the paper Dollar).

    By the way their is no problem with carrying a large weight of silver - as ownership of physical silver can be transferred electronically (so all one need carry is a card).

    You do have one ounce of silver for every Dollar?

    • avatar Mike Sproul says:

      Paul:

      The issuer of a paper dollar doesn't need to hold a physical ounce of silver. He just needs various assets that are worth 1 oz. (And he needs to tell his depositors what he has done.)

      So you're OK with a checking account dollar that can transfer ownership of the ounce electronically, but you don't like the paper dollar that transfers ownership of the dollar with a hand-to-hand payment?

      • avatar Paul Marks says:

        Mike - if you do not have the physical silver please do not say that your notes represent silver (they do not).

        It would better to be straight forward and say "I [the government] am producing fiat money, it is not "backed" by anything - other than my friends over there with the automatic rifles".

        Turning to commercial banks (away from governments).

        "Depositing" means what it says - if I "deposit" grain in a grain silo, I expect to find the grain there (otherwise it has not been "deposited").

        The use of such language in banking (where money that is "deposited" is not deposited at all - it is lent out) is profoundly unhelpful

        It is also leads to mistaken thinking - for example the assumption (by savers as well as bankers) that money that is lent out is still (at the same time) in the bank "on deposit".

        Of course the same money can not be two different places at the same time - if it is lent out it can not also be "on deposit".

        If there is more lending than REAL saving (of cash-money) then a credit bubble has been created - and this bubble will (sooner or later) burst.

  16. avatar Mike Sproul says:

    Paul:

    My notes say "IOU 1 oz of silver most of the time, but sometimes you'll have to wait for the silver or else take a bond or something worth 1 oz". You are free to take my offer or leave it.

    I will probably add that the assets I hold on deposit are protected by my friends with the automatic rifles.

    I also allow my customers to deposit the TITLE to 100 oz worth of grain in a silo, and I will issue them $100 of my notes, which each have that "...most of the time..." inscription on them. That way, nothing is in two places at one time.

    • avatar Paul Marks says:

      Mike.

      This is why notes become a bad idea.

      It always starts the same way "I have the silver"(or whatever commodity the notes claim to represent), but then the tricks start.

      Better to just carry a card that electronically transfers the ownership of physical silver (that really exists - that is not just some empty "promise").

      Short version - if you have silver you have silver, and if you do not have silver you do not have silver.

      Ditto any other commodity.

      • avatar Mike Sproul says:

        Paul:

        Fractional reserve notes can have bad things happen to them, as can 100% reserve notes, and 100% reserve cards.

        So I want to issue some cards that entitle their holders to 1 checking account dollar, and each checking account dollar says "IOU 1 oz of silver most of the time, but sometimes you'll have to wait for the silver or else take a bond or something worth 1 oz". I explicitly tell my deposit-holders that for each dollar on deposit, I hold 0.2 oz of actual silver plus 0.80 oz worth of various other assets. As long as my customers and I agree, what right do you have to interfere?

        • avatar Paul Marks says:

          Mike.

          It is not a question of such a note (a note purporting to represent a commodity that the issuer does not really have) "having bad things happen to them" - they ARE a bad thing (by definition).

          If you have silver you have silver - if you do not have silver, you do not have it.

          Ditto for any other commodity.

          I have nothing against private currencies - whether private mints for coins, or electronic transfers of ownership of commodities.

          But I have everything against people pretending (implying) they have got stuff they have not got.

          Basing a financial system on confidence tricks is not a good idea.

          As for "what right do you have to interfere".

          What right does your Currency Board have to RIG ("fix") exchange rates? None what-so-ever for forcing people to the so called "Black Market" to get the real (un "fixed") Exchange Rate.

          And what right do you have to demand that the government and its courts rush to the protection of banks who do not honour their contracts?

          Again - none, none at all.

          If a bank (or anyone else) does not honour its contract (for example to pay physical gold on demand) then it should CLOSE ITS DOORS.

          No "suspension of cash payments" (upheld by corrupt courts even before the creation of the Federal Reserve in 1913) and no PHONY "bankruptcy" (with the state, and its courts, supporting the game).

          A real bankruptcy.

          With the bank closing its doors (and not reopening them) and the Directors (and other such) out on the street.

          One does not find many former top credit bubble bankers living in cardboard boxes on the street (their relationship with government guards against that).

          If credit bubble bankers did suffer the consequences of their own credit bubbles, I suspect we would see less of this sort of scam.

          If you want to lend 100 Dollars - you should have a 100 Dollars (cash-money honestly saved - or entrusted to you by the person who saved it) - no credit bubble scams (or suffer the consequences of your own folly - not pass the consequences off to other people via the actions of government and its courts).

  17. avatar Lawrence Kramer says:

    "1. Start with a currency board that has $100 worth of various assets and has issued 100 pesos. I say 1 peso=$1 because the board has $1 worth of assets for every peso issued. You say 1 peso=$1 because the pesos are credibly scarce. Already you run afoul of accounting theory."

    No, I say they're worth as many papayas as they will buy because they are credibly scarce. They're worth a $100 because they are convertible to that amount. My arguments have been about why the currency is acceptable to the locals, not why it is worth $1. I think McKinney and I are saying the same thing.

    "2. Next, the CB is robbed of $10. I say each peso has 10% less backing, so 1 peso=$.90. The quantity of pesos is still 100. Scarcity theory implies they should still be worth $1 each."

    Yes and no. What do the thieves do with the stolen assets? I used counterfeit because the result is that some holders of pesos are not producers, which shows up as "too many pesos chasing too few goods." When you switch to theft, it depends on what the thieves do with the assets. If they can sell them for dollars, they can buy American goods with them, and, since the pesos were ISSUED for value, they would continue to buy as many papayas as before the theft. But if the thieves use those assets to get more pesos, those pesos will chase goods that are not there, and the peso will fall in value. But all of this is probabilistic and contingent on the supply curve. If there is excess capacity in the economy - if the issuance of pesos by the CB has been inadequate - if the Uruguayans have been crucified on cross of green - then the theft of the backing will have no effect on domestic prices.

    "3. Suppose that, before the robbery, the CB held half its assets denominated in pesos, not dollars. Define E as the exchange value of the peso ($/P). Setting Assets=Liabilities (after the robbery) yields:

    "40+50E=100E, or E=$.80/peso

    "That's according to the backing theory. I don't know how your scarcity theory would handle it."

    My theory would handle it through the market. Whatever happens, happens, and it depends on whether the public believes that new pesos are being created against the once-stolen assets, whether security has been tightened so that more pesos won't be created against stolen assets, whether the actual amount of pesos chasing goods causes shortages, etc. There is no arithmetic to be done. There might be some function one could derive empirically, but it would be something like the Taylor Rule or Okun's Law, a formula with empirically contingent constants. Scarcity theory - a fancy name for a notion I am fleshing out as I go along - doesn't deal in precision, first, because precision is unnecessary in macroeconomics, and second, because some of the variables - such as the output gap - are unmeasurable with precision.

    "4. Back to $100 backing 100 pesos. The CB tries to support the peso the way central banks used to do, by deliberately using its dollars to buy up pesos (and retire the pesos), and presumably over-paying for the pesos bought. Let's say the CB pays $11 to buy back 10 pesos. The new value of the peso is E=89/90 or $.99/peso. In other words, the backing theory implies that the peso will fall as a result of the attempt to support the peso, but presumable the scarcity theory would say that there are 10 fewer pesos than before, so the peso is more scarce and therefore more valuable."

    What do you mean by "overpaying"? This thought experiment suffers from the same defect as the one I rejected earlier: you cannot posit a context. Why does the peso need to be supported? It's exchangeable for a dollar, so it must be worth $1 internationally. The problem must, therefore, be domestic, too many pesos chasing too few papayas. If so, why would the CB have to overpay? Why wouldn't people just show up and cash in their pesos for $1? In other words, you are again ignoring your own favorite law: if there is a robust reflux channel (e.g., convertibility) there won't be more money than there needs to be.

    In a sense, then, we ARE saying the same thing, but not in the way you think. I am restating the law of reflux by saying that the impetus for reflux arises from the public's discovery, whether through actual inflation or through "news" about unsupported past or future issuance, that the money is not credibly scarce. But in this context, I define reflux to include non-issue, because, conceptually, a currency that is not going to be credibly scarce will "reflux" to its issuer even before it is issued. No one will want it, and none will be demanded. In a less binary case, less will be demanded, and it will buy fewer papayas.

    Backing, of course, is one way to overcome this preemptive reflux. But once the money is out there, if it has been issued for value, it will hold its value absent a supply shock, regardless of what happens to the backing, but not regardless of whether the backing turns out to have been worth less (in hindsight) than the CB thought, because defective backing overimplies supply. In the real market, however, excess capacity may cover the shortfall in the way it covers any other fractional reserve creation of money.

    In sum, backing assures that the money supply does not outstrip the supply of goods, whereas fractional reserve banking enables the money supply to keep up with the supply of goods. When a 100% reserve CB inadvertently turns out to have engaged in fractional reserve banking, because some of the assets it created money against prove to have been bad, the effect will be the same as if the money were issued on a fractional reserve basis to begin with. If there is enough stuff to buy, the currency will hold its value; if not, then not. Backing theory, mechanistically applied, does not appear to care about the output gap. I believe that's an increasingly important fact as supply burgeons around the globe.

    • avatar Mike Sproul says:

      Lawrence:
      1) “No, I say they're worth as many papayas as they will buy because they are credibly scarce. They're worth a $100 because they are convertible to that amount. My arguments have been about why the currency is acceptable to the locals, not why it is worth $1. I think McKinney and I are saying the same thing.”
      Maybe a papaya costs 3 pesos in new york and 1 peso in mexico, but if the currency board pegs $1=1 peso, then a papaya will also cost $3 in NY and $1 in mexico. Once the value of a peso is established (by backing and convertibility) at $1, the law of one price does the rest.
      "2. “the theft of the backing will have no effect on domestic prices. “
      You could just as well imagine that GM’s factory just blew up, but nobody knows it so GM stock holds its value. That can happen for a limited time, but nobody claims that it invalidates the proposition that the value of GM stock is determined by GM’s backing.
      "3) No comment
      "4. What do you mean by "overpaying"? This thought experiment suffers from the same defect as the one I rejected earlier: you cannot posit a context. Why does the peso need to be supported? “
      Central banks used to do exactly this all the time, and the result was that their currency always fell., pretty good confirmation for the backing theory.
      “In sum, backing assures that the money supply does not outstrip the supply of goods, whereas fractional reserve banking enables the money supply to keep up with the supply of goods. When a 100% reserve CB inadvertently turns out to have engaged in fractional reserve banking, because some of the assets it created money against prove to have been bad, the effect will be the same as if the money were issued on a fractional reserve basis to begin with. “
      You have misinterpreted what fractional reserve banking is. If a bank has issued 100 pesos and holds assets of $20 of currency plus $80 of bonds or whatever, then that’s a fractional reserve bank. But if the bank started with $100 backing 100 pesos, and then is robbed of $30, it is an insolvent bank.

      • avatar Lawrence Kramer says:

        1. I'm only concerned with prices in the place where the CB operates. That depends on their being scarce there, which the peg is crucial to establishing. Backing theory works fine for a backed currency. The problem, as discussed earlier, is that you have to redefine "backing" every time a new currency comes along. They are all "backed" by whatever it is that assures their scarcity. Since every useful currency must be scarce, there is ALWAYS something you can call its backing. But it's just wordplay.

        2. The GM analogy is inapt. Stock is an equity interest in an enterprise. Money is a medium of exchange. They are different things. To the extent that you think they are in any way mappable to each other, you are revealing why you are so wrong about money.

        4. If you don't provide a factual context in which the CB is "supporting" the currency, we have no way of examining other ways of looking at the behavior of the currency. CBs don't act whimsically. SOMETHING must have changed to have required it to support its currency, and you need to posit a change for which support is necessary but backing theory is the only possible explanation for the behavior of the currency.

      • avatar Lawrence Kramer says:

        "But if the bank started with $100 backing 100 pesos, and then is robbed of $30, it is an insolvent bank."

        Are you suggesting that the bank's capital consists entirely of the assets received in exchange for the currency it issues? Who would want to deposit money in a bank like that? What if some of the money got stolen? Fractional reserve banking is about liquidity, not solvency. My only point about a bank losing backing is that it no longer has sufficient liquidity to meet all of its obligations at once, but it may still have sufficient liquidity to meet all of the redemptions that in fact occur. Of course, if the bank was badly capitalized, people might worry that the bank would close, in which case there would be a run on it. But these are not realistic fears for a CB. A CB cannot be meaningfully insolvent (but it can have negative net worth) if its only obligations are redemptions, and redemptions are not driven by panic.

        Fractional reserve banking is about liquidity, not solvency. If a bank has $100 dollars "backing" 100 pesos, its reserves equal 100% of its liabilities. If it has only $70, then it is a fractional reserve bank. It may or may not be insolvent, or have negative net worth, depending on what other capital it may have, but as to its depositors, it's a fractional reserve bank because its cash available for withdrawal is less than the sum of its deposits.

        • avatar Lawrence Kramer says:

          Sorry - I am in the habit of posting to blogs with preview and edit features, so I tend to hit the Submit key prematurely. I intended to delete the entire first paragraph of the post to which this one "replies." If the moderator can simply kill the post, that would be fine with me, and this one can be killed, too.

  18. avatar Paul Marks says:

    Vikingvista this is where you are mistaken - profoundly mistaken.

    Putting something in a ledger (it being "on the books") does not mean it is really there.

    If I deposit grain in a grain silo and the grain is then removed - the grain is no longer deposited at the silo (because it has been taken out). Keeping the grain "on the books" does NOT mean the grain is still deposited in the silo.

    It is no different with money - if money is lent out (removed) it is no longer "on deposit" (whatever "the books" say).

    Bankers (such as yourself?) confuse what it says in your ledgers (what is "on the books") with what is actually there - in the vaults.

    Then when "deflation" comes along you think the money has somehow been destroyed - when, in fact, most of the "money" in your books WAS NEVER THERE.

    If you want to know how much money a bank actually has forget "the books" (computer or leather bound ledgers) they are just a fairy story. The only way of checking how much money (how much actual cash) a bank is to go into the vaults and COUNT.

    • avatar vikingvista says:

      “Putting something in a ledger (it being "on the books") does not mean it is really there.”

      The LIABILITY *is* really there. That’s why they put it on the books! Or are you suggesting that you don’t really have to pay anything to your mortgage company, credit card company, lease company, student loan company, etc., for the reason that “the money isn’t really there in your pocket”? Good luck with that.

      “If I deposit grain in a grain silo and the grain is then removed - the grain is no longer deposited at the silo (because it has been taken out).”

      1) If you *deposit* sold grain with a food/feed company that doesn’t initially pay you for it, then the company puts your deposit on the books as a liability that it owes to you as a *future payment* of money with interest. You initially receive on trade from the company an IOU ‘money plus interest’. You obviously DON’T EXPECT to see that grain again, you instead then obviously EXPECT that grain is being used by someone else and that the interest you receive is your fee from that use for your foregone use of the grain and the money.

      2) If you *deposit* unsold grain with a storage company for later extraction of THE EXACT SAME GRAIN by you, then YOU PAY the storage company. You don’t receive interest. You receive on trade a receipt from the company for IOU ‘your specific grain upon payment by you for storage services’. You obviously expect to see THAT SPECIFIC grain again, and you obviously DON’T EXPECT the storage company to pay you for the privilege of using their services.

      3) If you *deposit* unsold grain with a grain selling company for the promise of later extraction of DIFFERENT BUT EQUIVALENT grain, then the company puts your deposit on the books as a liability that it owes to you as a *future payment* of equivalent grain plus interest. You initially receive on trade from the company an IOU ‘equivalent grain plus interest’. You obviously DON’T EXPECT to see that grain again, you instead then obviously EXPECT that grain is being used by someone else and that the interest you receive is your fee from that use for your foregone use of the grain.

      In each of the 3 cases, you’ve *deposited* grain with a company (a forever fact regardless of what happens to the grain). In each case, you have grain *on deposit* for as long as the liability exists. The IOU you hold is a statement of that deposit. The IOU and deposit are promises for FUTURE payment. Each case (as well as numerous variations of each) is a perfectly legitimate business practice free of any confusion, fraud, or “grain-from-thin-air” nonsense. Each practice serves a legitimate free market purpose.

      Here’s another tip for you, after you look up “money multiplier”, look up what “interest” means. Then look up the earliest most basic explanation of banking that you can find (probably intended for elementary school kids), and explain exactly who in this world is not a coconspirator in your alleged “bank deposits are not really safety deposit boxes!” conspiracy.

      “Keeping the grain "on the books" does NOT mean the grain is still deposited in the silo.”

      Keeping the grain on the books DOES mean that the grain WAS DEPOSITED and that a liability remains. It doesn’t necessarily mean that there is any grain in any silo anywhere--for which centuries of farmers and grain traders, and no small number of school children reply, “duh.”

      “if money is lent out (removed) it is no longer "on deposit" (whatever "the books" say).”

      As long as the liability exists, the money is BY DEFINITION “on deposit” regardless of what happens to the specific money that was deposited. I didn’t invent the English language, I only use the language my forebears left me (though in this case the language makes perfect sense). I suggest you do the same.

      “Bankers (such as yourself?)”

      For all you know, I’m a high school freshman son of plumbers, since that is the only level of banking knowledge I’ve had to express so far. But I’m sure your facility with logic is such that you realize it makes no difference who I am, right?

      “confuse what it says in your ledgers (what is "on the books") with what is actually there - in the vaults.”

      Bankers of course make no such confusion. They know the difference between an liability and an asset. You should learn as much.

      “Then when "deflation" comes along you think the money has somehow been destroyed”

      Continuing with the lies, eh? Funny how you don’t actually quote me, isn’t it? At least you know the difference between me and the contradicting voices in your head, which is in itself encouraging.

      “ - when, in fact, most of the "money" in your books WAS NEVER THERE.”

      I just don’t understand how such ignorance exists, when the knowledge is so readily available, and you appear to be so interested. Perhaps I am wrong. Perhaps your interest is in something OTHER than knowledge. Whatever you here mean by “money”, it is false that it “was never there”. Each penny on the books of the banks, whether basic money assets or broad money liabilities, was, at some point, an asset of the bank. The bank need only loan out basic money assets that it owns, as a reading of their books will show (unsubstantially qualified perhaps only by variously liquid nonmonetary assets and transition periods).

      You do realize, don’t you (you don’t) that if the only transaction any banker ever did was to physically hand-to-hand move gold coins from depositors to bankers and from bankers to borrowers, that credit would be expanded, and bubbles could still occur, don’t you? Or are you suggesting there is something wrong with a borrower being simultaneously a lender (I’d think carefully before answering this one, if I were you)?

      “If you want to know how much money a bank actually has forget "the books" (computer or leather bound ledgers) they are just a fairy story.”

      Absurdly wrong. The books are almost always accurate to the T. The books clearly and in detail lay out the assets of the bank separately from its liabilities with details about each.

      “The only way of checking how much money (how much actual cash) a bank is to go into the vaults and COUNT.”

      Sure, and you will find with rare exception that it is precisely what is in the books. In addition, you will see in the books the bank’s liabilities. But why is it you don’t think a bank’s liabilities matter? Do you think that your own liabilities don’t matter?

  19. avatar Paul Marks says:

    Vikingvista I repeat that if I deposit something someplace (whether it is money, or grain, or anything else) and it then taken out of that place it is NOT deposited there any more - because it has been lent out (it is gone, it is not there any more).

    "But the liability is still there" - a liability is not cash, a liability is a debt (debt is not an asset, sane people do not lend on the basis of debt - the magic spells and that make up banking account books to the contrary).

    "Do you think that your liabilities don't matter?" - no I do not think that a liability is an asset (that it is money - that I can lend it out).

    If a banker gets in one Dollars of cash that is how much he can lend (no more) - and the real saver DOES NOT HAVE THE MONEY ANY MORE (it is NOT "on deposit" - it is not there, it is gone). The banker (and the saver) does not have the money (the cash) till when and IF it is repaid (and repaid in cash).

    When the people of Cyprus lined up outside the banks demanding "their money back" they did not seem to understand that it was not in the banks.

    This smokescreen about "deposits" works well (customers honestly seem to believe that they have "money in the bank").

    It was the same with Northern Rock here - I remember one man who retained his confidence in the business (he refused to line up with the other people).

    "I have seen the books" (he said when interviewed by the BBC) "Northern Rock has vast amounts of money - there is nothing to fear".

    The gentleman did not seem to understand that "the books" (with their treatment of debt as if it was money) had no connection to reality - had no connection to what was actually in the vaults of Northern Rock (not the cash he thought was there - but rather mostly just a pile of IOUs of various sorts).

    Just a credit bubble - a confidence trick (although credit bubble banking is the "Prince of Confidence Tricks").

    • avatar vikingvista says:

      Paul,

      “I repeat that if I deposit something someplace (whether it is money, or grain, or anything else) and it then taken out of that place it is NOT deposited there any more - because it has been lent out (it is gone, it is not there any more).”

      How does repeating a non sequitur make it any more sensical? If you loaned a pig to Joe, would you say that the pig is NOT on loan to Joe because Joe sold the pig, or rented it out, or loaned it to someone else? Of course not. The pig remains on loan to Joe until Joe settles his liability to you, because as long as Joe OWES you a pig, the pig is ON LOAN to Joe. And if Joe loaned that very same pig to Mike, then we have 1 pig and 2 IOUs for pigs.

      Well, a bank deposit is obviously a loan (only a ignoramus doesn't know what it is that pays INTEREST, and what banks do with deposited funds). It is *on deposit* in exactly the same sense and for exactly the same reason that it is *on loan*. It doesn’t matter what the borrower does with it. All that matters, is that he OWES you something at some future date. This is how debt works.

      You cannot just take the English language, and then start attributing your own bizarre meanings to it. In banking, as has been common knowledge since long before you or I were born, “deposit” and “on deposit” already had a meaning. All you are doing is screaming to the world that you don’t know the world’s meanings of those words, and furthermore, you don’t care how the world uses them. You really want to be that person?

      “"But the liability is still there" - a liability is not cash, a liability is a debt (debt is not an asset, “

      If people broadly choose to trade IOU-dollars for general goods and services at full nominal value, would you call those IOU-dollars cash? If you loan a pig to Joe and you then hold his IOU-1pig+1chicken, would you call that IOU an asset? Or would you tear up the IOU and call your pig a charitable contribution to Joe? Your liability is certainly never *your* asset, but it is an asset *to someone else* up until no more repayment by you is expected. Liabilities are asymmetric relationships.

      “sane people do not lend on the basis of debt”

      What does “lending on the basis of debt” mean? Lending *is* the basis of debt, they are inseparable. Credit expansion occurs, whenever a hard asset like gold coins is loaned out. As the asset is loaned out repeatedly by whichever borrower comes to own it, debt expansion can occur without any hard theoretical limit. But the ONLY transaction that ever needs to occur for credit expansion to happen, is the hand-to-hand loan of tangible assets from the current owner to the future owner in the form of a loan. Get it yet?

      “"Do you think that your liabilities don't matter?" - no I do not think that a liability is an asset (that it is money - that I can lend it out).”

      Nobody thinks their own liabilities are their assets, least of all any bank. Banks do, appropriately, treat OTHER PEOPLE’s liabilities to the bank as bank assets, because those liabilities do have salable value in the market as sources of real income, since those liabilities are rightly expected to pay principal and interest (if you disagree, then I assume you never lend, but only give charitably). They are NOT, however, treated as cash liquid assets outside of government imposition.

      “If a banker gets in one Dollars of cash that is how much he can lend (no more)”

      Yes! That is what I have been telling you! Furthermore, if the banker is practicing fractional reserve banking, then he only loans out LESS than that one dollar. Now…****** what do you suppose happens to the total debt-to-asset ratio in this one dollar system if the borrower of that dollar himself turns around and loans that dollar to someone else? ****** Any lightbulbs going off yet?

      “- and the real saver DOES NOT HAVE THE MONEY ANY MORE”

      Exactly! You can’t loan a dollar and have it too. But if you loan a dollar, what you do have is an IOU for a dollar--and you have that IOU regardless of what happens to the physical dollar that you lent. I think you are finally starting to understand what “loan” means.

      “(it is NOT "on deposit" - it is not there, it is gone).”

      Wrong and wrong. It is on deposit, since it is on loan. It is not “gone”, it is instead in the possession of the borrower (or perhaps someone that he loaned it to).

      “The banker (and the saver) does not have the money (the cash) till when and IF it is repaid (and repaid in cash).”

      Well, as both the banker and the saver are well aware, neither are likely to ever see that very same dollar ever again. The saver does not have that sum of money, because he loaned it to the banker (remember, you can’t loan your cake and have it to). The banker then had it. But once the banker loaned it to someone else, then the banker no longer had it. Is this not what it means to *loan*?

      “When the people of Cyprus lined up outside the banks demanding "their money back" they did not seem to understand that it was not in the banks.”

      Nonsense. They all understood it. In fact, the reason they *ran* to the bank to withdraw the funds owed to them, is *because* they knew it. They ran (as in “bank run”) because everyone knows there are only sufficient reserves to cover those who arrive first. Everyone knows that is how banking works. That’s why there are bank *runs*.

      “This smokescreen about "deposits" works well (customers honestly seem to believe that they have "money in the bank").”

      Nope. There truly are very few people who are so grossly ignorant or disinterested in their own money that they solicit bank services without knowing what a bank is--that once arriving at the bank they choose a checking account over a safety deposit box without knowing the difference--that they actually believe a company would pay THEM interest for using the company’s storage services.

  20. avatar Paul Marks says:

    Vikingvista "counter points" that violate basic logic are without merit (and therefore "responding to them" is pointless).

    If you claim that money is still deposited in a bank AFTER it has been taken out, you are being illogical (violating the laws of reason).

    If you were simply being silly (for example saying that 1+1=16 or that A is NOT A) I would not care, but what you (and other credit bubble banker friends) say actually does great harm.

    By your words you seek to try and justify the banking system (by its complex interactions) lending out far more "money" than actually EXISTS as real savings of cash-money.

    If you deny this I will ask you a simple question (one I have asked many times before - but which you continually dodge).

    If the banking system does not expand lending (bank credit - "broad money") vastly beyond REAL SAVINGS (i.e. the sacrifice of consumption) of CASH-MONEY, what form of "money supply" declined between 1929 and 1933 (and so many other busts)?

    If the banking system just put peoples' real savings of cash-money to work - if it does not lend out vastly MORE than real savings of cash-money, then what form of "money supply" shrank between 1929 and 1933 (and so many other busts)?

    No one was going around destroying cash in bank vaults. It was, in fact, "broad money" (i.e. the CREDIT BUBBLE of bankers - whose growth has been supported and encouraged by the Benjamin Strong of the New York Federal Reserve in the late 1920s) that collapsed between 1929 and 1933 (as in so many other busts). Indeed all banker credit bubbles (i.e. lending that is not from real savings of cash-money) must, eventually, bust (hence - "boom-bust" with the "boom" being the banker credit bubble [often made worse by the interventionism of Central Banks], and the "bust" being the revenge of reality, the logical working out of the laws of reason).

    Well Vikingvista do you deny this?

    • avatar vikingvista says:

      ""counter points" that violate basic logic are without merit (and therefore "responding to them" is pointless)"

      Not even to point out the specific violation in logic?

      "If you claim that money is still deposited in a bank"

      Being more facile with English than you, I would never claim that. Just like I would never claim that you are "still delivered" by your mother's obstetrician. I think the phrase you are looking for, is "on deposit", not "deposited".

      "what you (and other credit bubble banker friends) say actually does great harm."

      Do you think your constant lying and vicious calumny does any harm?

      "By your words you seek to try and justify the banking system"

      I'm only trying to figure out how your brain got so broken, and whether or not it is a permanent disability (actually, I figured out the latter some time ago).

      "If the banking system does not expand lending"

      As you know, I never believed that.

      "Well Vikingvista do you deny this?"

      Do I deny the pressured rantings of a madman?

      Here's a question for you: If you loan a pig to Peter, and Peter then takes that pig and loans it to Paul, how many pig-IOUs and how many pigs exist among the 3 of you?

      (If you answer, I'll mail you $35,000 in cash).

      • avatar Paul Marks says:

        Vikingvista it makes no sense to say that Peter "loans" the pig back to me (Paul) if I have lent him to in the first place. What Peter has done (if he lets me, Paul, have the pig back) is to repay me (although where is the additional payment "interest" that I was promised?).

        As for "pig IOUs" - I do not want an IOU, I want my pig back (plus what Peter promised me as payment for the loan of the pig). So to talk of "pig IOUs" is pointless.

        Even if Peter was lending the pig to Thomas (not back to Paul) what you say makes no sense. Peter would have to be a "madman" (to use one of your insults directed at me) to "lend" something that HE JUST BORROWED.

        If Peter says to himself "I have just borrowed a pig from Paul - I will lend it to Thomas" then one is dealing with "madman" (as he is risking being unable to repay me - even the principle let alone the interest).

        If Thomas wants to borrow a pig he should go to the person (in this case Paul) who OWNS the pig - not someone who has himself borrowed the pig (because if does the latter Thomas will have to pay an higher rate of interest - as he will have to pay "Peter" who in turn has to pay "Paul", this will obviously work out to be more expensive than just paying Paul directly).

        Vikingvista if what you are describing is banking - then such banking is lunacy.

        As for treating "pig IOUs" (in the case you describe "two" for one pig - so now mail me my 35 thousand Dollars) AS IF THEY WERE PIGS (as credit bubble bankers do) that is lunacy piled upon lunacy. Not just "madness" but madness "on stilts".

        A "pig IOU" is NOT a pig, an IOU for money is NOT money - and one can (or rather should not) try and use IOUs as a basis for lending (debt is NOT money - any more than a IOU is a pig).

        Now turning back to serious matters (away from "madmen").

        You ask me to show where you have violated logic - certainly I will.

        If I deposit a pair of socks in a cupboard upstairs and then TAKE THE PAIR OF SOCKS OUT OF THE CUPBOARD the pair of socks is no longer deposited in the cupboard.

        You (Vikingvista) claim that the pair of socks is still deposited in the cupboard AFTER THEY HAVE BEEN TAKEN OUT - this is where you violate basic reason.

        It is no different with money and banks.

        If I deposit 100 Dollars in a bank and then it is TAKEN OUT (either by me - or by someone else, a borrower) then the 100 Dollars is no longer deposited in the bank - if you (Vikingvista) claim that the money is still deposited in the bank AFTER it has been taken out, then you are guilty of violating basic reason.

        Now I will ask you the question you keep dodging.

        If it is true that the credit bubble banking system (by its complex interactions) does NOT lend out more "money" than the cash-money that was really saved (i.e. the sacrifice of consumption by real savers) then what form of "money supply" crashed between 1929 and 1933 (and so many other busts)?

        It is simply not true that Central Banks (bad as they are) are the cause of all banker credit bubbles (although they do make them worse - as Benjamin Strong of the New York Fed did in the late 1920s). Banker credit bubbles existed before the establishment of the Federal Reserve in 1913.

        So what form of "money" declined between 1929 and 1933?

        No one went around destroying cash in bank vaults - i.e. destroying REAL SAVINGS.

        So was it not banker "broad money" (credit bubble) that collapsed? As banker credit bubbles (the effort to lend out more money than was ever really saved) always, eventually, collapse?

        Do you deny this?

        What commercial bankers are INNOCENT of is long term inflation.

        Credit bubble bankers (no matter how bad they are) can not produce long term inflation.

        This is because banker credit bubbles (the "expansion of broad money" in your language) inevitably collapse (shrink back towards the monetary base of real savings) so the asset price bubbles (in real estate and the stock market) collapse.

        ONLY if the authorities (such as a Central Bank - government backed if not directly government owned) intervene to "save the financial system" (i.e. to save the credit bubble bankers from the consequences of their own folly) can long term inflation be created.

        • avatar vikingvista says:

          ME: Here's a question for you: If you loan a pig to Peter, and Peter then takes that pig and loans it to Paul, how many pig-IOUs and how many pigs exist among the 3 of you?

          DU: “it makes no sense to say that Peter "loans" the pig back to me (Paul)”

          You seriously don’t even know what “the 3 of you” means? Obviously I’m referring to “you” and “Paul” as different people. If you want to collect the $35,000, you are going to have to start over and answer *my* question.

          • avatar Paul Marks says:

            Vikingvista I dealt with the possibility you meant lending a pig to a third party - by using the name "Thomas" for this third party.

            Obviously it makes no sense for Peter to borrow a pig from Paul and then lend it to Thomas.

            It makes no sense as Peter risks being unable to pay the principle (the pig) as well as being unable to pay whatever additional payment he agreed to pay Paul.

            It makes no sense for Thomas either - as (again obviously) he will have to pay more to borrow the pig from Peter than he would have done to borrow the pig directly from the OWNER of the pig (Paul), this is because Thomas will (if he borrows the pig from Peter - not from Paul) have to pay both Peter and (indirectly) Paul also.

            To use your language only a "madman" would behave in this way (unless forced to by some form of corruption - cutting off the possibility of borrowing directly from the owner).

            By the way I have SEVERAL TIMES stated that in your example there are two IOUs in the example for the same pig.

            You have no intention of sending me 35 thousand Dollars - you are simply talking like a credit bubble banker (i.e. making promises you have no intention of keeping).

            As for your confusion that an "IOU" for a pig is the same thing as a pig - I would have sympathy for you if I really thought you honestly (but mistakenly) believed that.

            Of course you do NOT honestly believe that - you are simply talking like a credit bubble banker (as with the false promise of the 35 thousand Dollars) i.e. implying things you know to be false.

            By the way you still have not answered my question (now asked many times).

            If the banking system just puts the real savings of cash-money to work - then what form of money supply fell between 1929 and 1933?

            No one went around destroying cash in bank vaults (there was no reduction in cash outside bank vaults either). Yet Milton Friedman and others complain of a terrible "collapse in the money supply" between 1929 and 1933.

            Were not the people who complain of a "collapse in the money supply" between 1929 and 1933 (and so many other busts) really complaining of the (inevitable) collapse of the banker "broad money" CREDIT BUBBLE - the effort by the banks (supported and encouraged in their folly by Benjamin Strong of the New York Federal Reserve) to lend out more (vastly more) money than had ever really been saved?

            This was no small event and your throwing abuse at me "madman" and so on shows your total lack of concern for the vast suffering that the Great Depression (and so many other busts - going back long before the creation of the Federal Reserve in 1913) caused.

            Your attitude appears to be same as one sees in so many credit bubble bankers "as long as I get out of the bubble O.K., everyone else can burn".

            I must point out to you that most people regard this attitude of the "Grab it, Grab it, and RUN" credit bubble banker, rather irritating.

            I suspect that (eventually) there will be unpleasant consequences for credit bubble bankers (and credit bubble banker friends) due to your attitude that it is O.K. to cheat everyone else (as long as you personally are not harmed when the bubble INEVITABLY bursts).

            By the way I YET AGAIN point out that in your example there are two IOUs for the same pig (I have stated this several times already).

            You will NOT send me 35 thousand Dollars - as it is not in your character to keep such a promise.

            Making financial promises that you had no intention of keeping (like implying that an IOU for a pig is the same thing as a pig) shows you for what you are.

          • avatar vikingvista says:

            "Obviously it makes no sense for Peter to borrow a pig from Paul and then lend it to Thomas."

            Obviously? But Thomas wants to borrow a pig. How is he supposed to do so?

      • avatar Paul Marks says:

        Having given a long reply (including the answer to how many pig IOUs, 2 for one pig, there are - and a given a warning not to treat pig IOUs as if they were pigs) I will point out (as I did in my long reply) one of the violations of logic you are guilty of.

        If I deposit a pair of socks in a cupboard upstairs and then TAKE THEM OUT, the pair of socks is no longer deposited in the cupboard.

        It is no different with money and banks.

        If I deposit 100 Dollars in a bank, and then I or someone else (a borrower) takes the 100 Dollars out - it is no longer deposited in the bank (the deposit is gone - it is no longer there).

        To deny this is to be (in your own language) a "madman".

        • avatar Lawrence Kramer says:

          "It is no different with money and banks."

          Yes, it is, because dollars are fungible. The deal you make with a bank is this: you GIVE the bank money, and the bank GIVES you its IOU. It's an exchange of assets. Because the money is worth more than the IOU, the issuer of the IOU pays interest on it. That's the deal. Everything else is semantics.

          You are unhappy that others don't know that a bank deposit is an exchange of assets. Fine. Tell them. Insist they be told. But the deal is the deal, and it is publicly disclosed to anyone who cares to know how it works. There is no deceit, no fraud, no double-dipping, no being in two places at once. No, there is just an exchange of an asset for the promise that a similar asset will be delivered later. What the bank does with the asset is, literally, the bank's business. Most often, it will lend it, i.e., exchange it for someone else's IOU, someone who is willing to pay more interest than the bank had to pay you. But the bank could buy a lottery ticket or burn the money to heat the building (except that its regulators might get antsy). The bank owns the asset. You own an IOU. Make that deal, or rent a vault box. The choice is yours.

          • avatar Paul Marks says:

            No Lawrence. If I (or anyone else) take money out of a bank it is no longer there - just as if I deposit a pair of socks in the drawer and then take the pair of socks out of the drawer, the pair of socks is no longer deposited in the drawer.

            Treating an IOU as if it was money is no more sensible than treating an IOU for socks as if it was a pair of socks - saying it is "fungible" does not keep one's feet warm.

            The problem with bankers is not that they are stupid - the problem with bankers is that they are "too clever by half".

            They construct complex webs of words (to hide simple matters of truth) and end up believing the stuff themselves.

            But, in the end, reality (the bust) always arrives.

          • avatar vikingvista says:

            "If I (or anyone else) take money out of a bank it is no longer there"

            If you loan money, you no longer have it. This is a revelation because...?

            "The problem with bankers is not that they are stupid"

            No, but someone here sure has that problem in spades.

            "if I deposit a pair of socks in the drawer and then take the pair of socks out of the drawer"

            What if you *loan* the socks to the drawer?

            "complex webs of words"

            Like "the 3 of you"? Like "is deposited"? Like "on deposit"? Like "interest bearing account"?

            New idea for a Paul Marks doll: you pull the string and it cries "Language is hard!"

          • avatar Lawrence Kramer says:

            " If I (or anyone else) take money out of a bank it is no longer there"

            But no one can take the money "out" of the bank. It is never IN the bank. The money BELONGS TO the bank; it's the bank's money. The depositor owns an IOU. That's what he bought for his money. If he wanted to treat his FRNS like socks, he'd have rented a safe deposit box. But he didn't. He BOUGHT and IOU with it. He could have bought shares in GM or a tuna hoagie. But he bought a IOU. There is no money IN the bank for him to take out. There is only the IOU. (Why does this make me think of dead parrots?)

          • avatar vikingvista says:

            "Why does this make me think of dead parrots?"

            Funny. Beating a dead parrot would be an appropriately mixed metaphor here.

        • avatar vikingvista says:

          "If I deposit a pair of socks in a cupboard upstairs and then TAKE THEM OUT, the pair of socks is no longer deposited in the cupboard."

          So Mr. Linguistically Challenged, if you don't "TAKE THEM OUT", would you say that the pair of socks are "on deposit" in the cupboard?

          • avatar Paul Marks says:

            Vikingvista it is not a matter of WHO takes the pair of socks out of the cupboard - it is the point that the pair of socks have been lent out (regardless of who takes them out). It does not matter if I take out the deposit - or it if it lent out to someone else (either way IT IS NO LONGER THERE).

            Two people (let alone ten people, or a hundred people) can not wear the same pair of socks at the same time. Contrary to credit bubble banker "logic".

            I find it very difficult to believe that you really think that money can be lent out and still be deposited in the band AT THE SAME TIME - but then you have previously pretended that an IOU for a pig and a pig are the same thing.

          • avatar vikingvista says:

            Per usual, you replied without even reading my post. So I'll ask again...

            If you *don't* "TAKE THEM OUT", would you say that the pair of socks are *"on deposit"* in the cupboard? It is a yes or no question.

  21. avatar Paul Marks says:

    Vikingvista what I thought you were going to do is to play the "credit to their account" game - i.e. say "the money is not physically loaned out - because a bank loan is just money credited-to-the-account of the borrower" (people who say this do not understand that the practice of "crediting to the account" is actually part of the problem, not part of the solution).

    Instead you offered no real defence of credit bubble banking at all, just repeating your absurd claim that stuff that is removed from a place where it has been deposited (for example a pair of socks from a drawer) is still deposited in the place it has just been removed from.

    Not good my dear, not good at all.

    By the way - you still (in spite of having been asked multiple times) not answered my straight forward (and perfectly civil)_ question.

    If the banking system does not expand lending over-and-above real savings of cash-money what form of "money supply" collapsed between 1929 and 1933? (and so many other busts).

    Some form of "money supply" collapsed between 1929 and 1933 (Milton Freidman and others all complain of a "collapse in the money supply").

    Yet no one was going around destroying cash in bank vaults - so if the collapsing "money supply" was NOT "broad money" (i.e. bank CREDIT - the CREDIT BUBBLE, which the bankers had created, encouraged and supported every step of the way by Benjamin Strong of the New York Federal Reserve)what was it?

    What form of "money" collapsed between 1929 and 1933 (and so many other busts - including ones long before the creation of the Federal Reserve in 1913)?

  22. avatar Paul Marks says:

    Lawrence - even if a banker lends out his (or her) own money, the money can not be (at the same time) lent out to the borrower and remain with the banker.

    So saying "the depositor does not own the money, the bank does" solves NOTHING.

    Bankers (if they are honest money lenders - not credit bubble blowers) can not lend out more than the level of REAL SAVINGS of cash-money. Either their own real savings - or those of other people.

    Treating IOUs as if they were money, and thinking that "crediting to the account" of a borrower (rather than physically lending the borrower money) is good practice - is folly.

    Terrible folly.

    • avatar Lawrence Kramer says:

      "even if a banker lends out his (or her) own money, the money can not be (at the same time) lent out to the borrower and remain with the banker."

      But bankers do not "lend out" money. They use most of the cash they receive to buy Fed IOUs. Then, the Fed has the money, which is to say, the money disappears, since the money was a Fed liability to begin with. The money is now nowhere. The depositor has a bank IOU,and the bank has a Fed IOU. Instead of being in two places at once, the money is simply gone, but everyone has something that his most sophisticated potential creditors - silly rabbits that they are - will count as "money." Go figure.

      To make a loan, the bank trades its IOU (a checking account) for the borrower's IOU (a note). If the borrower wants to trade the bank's IOU for goods or services, which may be immediately, the bank assigns some of its Fed IOUs to the borrower's vendor's bank's account at the Fed, and that bank gives the vendor its IOU. But no "money" is being lent out. Credit is being extended by the borrower (which accepts a checking account) and the bank (which accepts a note). There is nothing dishonest or illogical about it. Rather, it allows purchasing power to be deployed in the economy by anyone willing and able to take the attendant risks.

      Maybe you're familiar with the story about Hercules and the sisters who shared one eye. They pretty much represent fractional reserve banking. Whichever sister had to see would get the eye. There was always the risk of two sisters needing the eye at one time, or of some oaf like Hercules stealing the eye from one sister leaving the others blind. But with enough sisters and enough eyes, and a central eye bank to back it all up, that risk could probably be managed. All of your fears are based on small quantities in which the risks are magnified. In a fully developed banking system, the risk is small enough to tolerate EVEN IF it sometimes comes home to roost, as it did in 2008. We are still standing, and all of the things that were financed by fractional reserve banks from 1946-2006 have come and gone. And each time the system fails, better safeguards are created. There was plenty of dishonesty, but it was all at the underwriting level, not in the structure of banking itself. Those risks were known, albeit underestimated.

  23. avatar Paul Marks says:

    Lawrence - we part company when you say the bankers buy Fed IOUs.

    You express (and clearly feel) no moral horror at such an action.

    I am well aware that the late Ludwig Von Mises stated that an economist (as an economist - not as a human being) had to be "value free" (although surely an economist must see a moral value in TRUTH? otherwise does not one just end up with someone like Paul Krugman? An "economist" who will say anything, even that increasing the minimum wage above market wages will not increase unemployment, because he regards politics as more important than truth).

    However the universe is constructed in such a way (whether or not God exists) that actions that are morally repulsive (such as buying Fed IOUs) tend to also have bad long term economic consequences.

    By the way - even if the Federal Reserve did not exist, these vicious (incredibly harmful) games could still be played - although to a much lesser extent.

    The only sound form of lending (both morally and economically) is to lend out REAL SAVINGS of cash-money. Either one's own savings - or the real savings of others (people who have made a choice to allow one to lend out their real savings).

  24. avatar Paul Marks says:

    Vikingvista - if you do not take the pair of socks out of the drawer you can not (honestly) lend them. Someone can not wear a pair of socks if they are still in my drawer.

    So your "yes or no question" is based upon an absurdity. One of many absurdities in credit bubble blowing (which must be sharply distinguished from honest money lending - I say again that there is nothing wrong with "usury" as such, but a great deal wrong with credit bubble blowing).

    • avatar vikingvista says:

      Why do you think it is absurd to refer to socks in a cupboard as being "on deposit"?

      • avatar Paul Marks says:

        No vikingvista - it is absurd to pretend that one can lend out a pair of socks (or anything else) and still (at the same time) have them "on deposit".

        Two different parties (savers and borrowers) can not have the same thing (a pair of socks or whatever) in two different places at the same time. If the socks are still in the drawer the borrower can not be wearing them.

        Once bankers were (basically - banking was never totally straight, but it was a lot less crooked than it is now) middle men between real savers and borrowers, taking a cut of the profits if they found good borrowers (for example manufacturers with solid plans for better factories) who would be a good bet to lend to.

        But that was long ago - these days most lending is credit-bubble (with little if any, connection to real savings).

        The change did not happen all at once - it happened step-by-step.

        However, I think one of the things that opened the door to it was the practice of pretending that interest earning savings handed over to bankers as somehow still "on deposit".

        It is impossible for money to earn interest if it is really just "deposited" in a bank vault - i.e. if there is no lending going on.

        True (as you, Vikingvista, have pointed out in the past) changing the word "deposited" to the word "invested" would just be a language change (it would not stop the Legion of other abuses - such as "crediting to the account" of borrowers, rather than honestly handing over physical money), but saying "invested" rather than "deposited" would, at least, be a start.

        • avatar vikingvista says:

          So now you don't think it is absurd to refer to socks in a cupboard as being "on deposit"?

          • avatar Paul Marks says:

            If I deposit socks in a cupboard there are socks in the cupboard. If I deposit money in the cupboard there is money in the cupboard. If the socks are removed from the cupboard (by me or someone else) they are no longer deposited in the cupboard, if the money is removed from the cupboard (by me or someone else) the money is no longer deposited in the cupboard.

            I can not lend someone the socks if they are deposited in the cupboard (the borrower can not wear them if they are still in the cupboard). And I can not lend someone money (and AT THE SAME TIME) have the money still in the cupboard - the money is not Satan (it can not be in two different places at the same time).

            "Crediting to the account" (pretending one can lend out money, and keep the money - at the same time) is a dodge. One of many dodges that (together) make up a corrupt system.

          • avatar vikingvista says:

            "If I deposit socks in a cupboard there are socks in the cupboard."

            Are the socks "on deposit" in the cupboard? It is a simple yes-no question about semantics. It is revealing that you are afraid to answer it.

  25. avatar Paul Marks says:

    As for dead parrots - actually it is me who is in the position of the customer in the Monty Python sketch.

    And both of you are like the shop keeper - insisting that the dead parrot is really alive(i.e. that banking system can, without harmful consequences, lend out "money" that was never really saved - i.e. money that DOES NOT REALLY EXIST).

    For that is the answer to the question I keep asking Vikingvista (and which he keeps dodging) - the "collapse of the money supply" between 1929 and 1933 did not involve any real reduction of money, what was the bursting of a "broad money" (bank credit) CREDIT BUBBLE.

    When a credit bubble banker (or credit bubble banker friend) says "the deflation destroyed the money" what he (or she) is really saying (whether they know it or not) is "my scam has been exposed by the iron laws of reality".

    The parrot is dead - the "money" that the "deflation has destroyed" never really existed in the first place.

    The Benjamin Strong "boom" of the late 1920s was artificial (like all such credit-bubble booms) - it was false, phony, the parrot is dead.

    • avatar Lawrence Kramer says:

      Paul -

      You seem to think there is nothing worse in the world than a credit bubble bursting every 50-100 years or so. It happens, and life goes on. After all, it's only money, and, according to you, not even that.

      • avatar Paul Marks says:

        Lawrence, on the contrary - whilst it may not be the worst-thing-in-the-world credit expansion is a very bad thing indeed (and NO it is not just about a bust every 50-100 years). For example, it is behind the massive expansion of inequality in the Western world (which are using as an EXCUSE for their harmful demands for an increase in taxation of investment and so on). Even Richard Cantillon (back in the 1700s) understood how credit-money expansion tends to benefit the rich at the expense of the poor (after all wealthy people tend to get their hands on the new "money" first - before the asset price inflation, in housing and so on, really makes itself felt).

        Also credit-money expansion causes chaos in the capital structure - causing massive malinvestment (and this is very much present in the "boom" long before the "bust").

        If you do not have time for long books (and which of us have the time now?) I would suggest you have a look at the short economics essays in Hayek's "New Studies" in politics, philosophy and economics (1978).

        Especially his attack on the idea (that people such as Milton Friedman had) that an increase in the money supply (either by the printing press - of by banker antics) was like rushing water - going everywhere (and to everyone) quickly.

        On the contrary, argues Hayek, the new money (or "money") is more like flowing treacle (rather than flowing water) it piles up in certain places (causing malinvestments) and some people (normally wealthy and connected ones) get sticky fingers.

      • avatar Paul Marks says:

        my last comment should have read "which the left are using as an EXCUSE for their harmful polices of...."

  26. avatar Paul Marks says:

    By the way - the same thing was true (although on a smaller scale) before the creation of the Federal Reserve.

    By modern standards J.P. Morgan was a very moderate careful credit bubble banker - but he was still a credit bubble man. And his ("his" is a little unfair - as the credit bubble is actually created by the interactions between credit bubble bankers) credit bubbles (like all such credit bubbles) inevitably burst.

    Locking other bankers into a room, getting (corrupt) courts to "suspend cash payments" (and on and on), are all makeshifts - they do not solve the problem (and the bankers of the day knew it).

    That is why they created the Federal Reserve in the first place - to support their credit bubbles.

    The alternative would have been less grand and impressive.

    The alternative would have been (and still is) to just be plain honest money lenders - lending out real savings of cash-money (their own - or that of other real savers, with their agreement).

    No pretending that the same money was in different places at the same time.

  27. avatar Paul Marks says:

    If Thomas wants to borrow a pig he should go to the owner of that pig (in this case Paul) - if he gets Peter to borrow a pig from Paul to (in turn) lend to him (Thomas) this makes no sense, for then Thomas will have to pay both Peter and Paul.

    The only way that Peter can offer a better deal than Paul - is if Peter lends out pigs that do not really exist (and sooner or later this scam will collapse).

    • avatar vikingvista says:

      "If Thomas wants to borrow a pig he should go to the owner of that pig (in this case Paul) - if he gets Peter to borrow a pig from Paul to (in turn) lend to him (Thomas) this makes no sense, for then Thomas will have to pay both Peter and Paul."

      But Thomas can't get an affordable loan from Paul (maybe Thomas and Paul don't know each other exist, maybe Thomas doesn't have a good reputation with Paul, maybe there are legal restrictions for Paul lending to Thomas, etc).

      So, I ask again, how is Thomas to be able to borrow a pig if not from Peter?

      • avatar Paul Marks says:

        Thomas can borrow the pig from the OWNER of that pig - Paul.

        Paul lending the pig to Peter who (in turn) lends it to Thomas - means that Thomas ends up paying two people, Peter and (indirectly) Paul. This is obviously not a good deal for Thomas and (I suspect) it is not a good deal for Paul (the owner of the pig) as it is unlikely he will get such a good deal from Peter as he would have got from Thomas directly.

        There was a time when bankers had the reputation of picking out really good borrowers (really safe bets as it were) better than real savers could do themselves - thus earning their income as middle men between real savers and sound borrowers. But I doubt that anyone would seriously argue that this is still true today.

        Anyway banking no longer has much of a connection with real savings - bankers offer real savers a terrible deal. Bankers actually depend on the credit-money flow (thanks to the Federal Reserve and other Central Banks).

        Lawrence regards Central Banking as a good idea.

        I hope one thing we agree on, Vikingvista, is that Central Banking is actually a terrible idea - underming what links there are between real savers and bankers.

        • avatar vikingvista says:

          ME: Thomas can't get an affordable loan from Paul
          DU: Thomas can borrow the pig from the OWNER of that pig - Paul.

          So you think it is always impossible that one person cannot get a loan from another person?

          • avatar Paul Marks says:

            "Affordable" loan vikingvista.

            By they use of the word "affordable" you reveal the heart of the scam. Credit bubble bankers (and the governments that stand behind them)think that they can offer more "affordable" loans if they engage in various manipulations, rather than pay real savers (in this case the character "Paul") a proper rate of interest for their real savings.

            "So you think it is always impossible that one person cannot get a loan from another person?"

            No - I think it is corrupt that someone who has no real savings pretends he (or she) can offer loans at a more "affordable" rate of interest than people who actually have made the sacrifice of real savings (i.e. refrained from consumption).

            After all if banking was straight "Peter" (the banker) would be offering "Thomas" (the borrower) the loan at a HIGHER rate of interest - as Thomas has to pay both Peter and (indirectly) "Paul" (the real saver).

            The fact that "Peter" (vikingvista) claims that he can offer the loan at a LOWER (more "affordable") rate of interest, even though Peter is NOT offering his own real savings, proves that one is dealing with a scam.

            Such credit bubble schemes always end in disaster - and if governments support the schemes (which is the modern practice) it just makes the disaster worse in the end.

          • avatar vikingvista says:

            ME: Thomas can't get an affordable loan from Paul
            DU: Thomas can borrow the pig from the OWNER of that pig - Paul.
            ME: So you think it is always impossible that one person cannot get a loan from another person?
            DU: No - I think it is corrupt that...

            Okay, so you do think it is possible that one person cannot get a loan from another person. Well, an example of that possibility is Thomas not being able to get a loan from Paul.

            So, now that you agree that Thomas can't get a loan from Paul (we'll assume they don't know of each other's existence), we can narrow down your imagined source of corruption. Do you think it is corrupt for Thomas to borrow from Peter, for Peter to borrow from Paul, or the combination of the two?

  28. avatar Paul Marks says:

    Yes if one puts socks in a cupboard there are socks deposited in a cupboard, and one takes the socks out of the cupboard they are no longer deposited there.

    The act of putting socks in a cupboard (or grain in a grain silo) is depositing.

    And the act of removing the socks (say to lend them to someone else) means they are no longer deposited in the cupboard.

    The problem comes when people think (or are led to think)that they can lend out socks (or anything else)and still have them - AT THE SAME TIME.

    Either the cat is alive or the cat is dead - either the socks are deposited in the cupboard, or they have been lent out to someone else.

    • avatar vikingvista says:

      ME: "Are the socks "on deposit" in the cupboard?"
      DU: "Yes..."

      So you do think the socks are "on deposit" in the cupboard. Will you please clarify by using, "socks", "cupboard", and "on deposit" in a grammatically and semantically correct sentence (e.g. write something like "The socks are on deposit in the cupboard."), so that I have no confusion about how you use those terms?

  29. avatar Mike Sproul says:

    Paul:
    I can deposit 10 socks in a drawer, and then I can deposit 20 socks WORTH of shirts in the drawer. The total value of the deposits is 30 socks, but of course we know there are only 10 actual socks in the drawer. If I want to use the contents of the drawer to buy groceries, I can buy 30 socks worth of groceries. It's just that the grocer must be willing to be paid in both socks and shirts.

    Money is special that way. As Schumpeter put it: "You can't ride a claim to a horse, but you can trade with a claim to money."

  30. avatar Paul Marks says:

    Mike - NO money is not special in this regard.

    If I deposit 100 Dollars (rather an a pair of socks) in the cupboard and then take out the 100 Dollars to lend to someone else, the 100 Dollars (just like the pair of socks) is no longer deposited in the cupboard.

    This is why old fashioned money lending is superior to "modern banking" - the old money lender (whether he lends his own money, or money entrusted to him by other REAL SAVERS to be lent out) does not pretend that he can lend out money and still have the money AT THE SAME TIME.

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