(Future Bankers of America)

sincerely, A girl.

There are a few steps further in the cause –effect relationships that are important.

If money is not created as productive capacity increases, then deflation occurs. When deflation occurs, the purchasing power of money increases. When the purchasing power of money increases, the prices of goods decrease. When the prices of goods decrease, the quantity demanded increases. When the quantity demanded increases, more items are sold. When more items are sold, the economy goes forward. The end result is a productive economy with lower prices

We are not talking about rapid deflation, which is just as damaging as rapid inflation. In the normal course of events, the productivity increases at a relatively slow pace. A slow paced deflation can be taken into account in prices for final goods, but also for factors of production, so the end result can still be profits for producers during a slow, steady deflation.

An important concept that has very good theoretical support, whether monetarists choose to accept it or not, is that any quantity of money is the right quantity. The real economy will function the same. The only affect of increasing the quantity of money from out of nothing is a redistribution of wealth from the producers to the money counterfeiters.

When deflation occurs, money has more purchasing power tomorrow than it does today. So the incentive is to sit on it, and economic activity slows.

This would be great if we really are running out of oil, land, water, and breathable air. I believe this is the great debate of our time- will technology be able to obviate current natural resource limits (solar for oil, skyscrapers for land, reservoirs and desalinization for water, etc.) or is Lester Brown right about needing to cut population and ration resources?

I’m in the “let’s grow, because there are billions of people living in poverty and my empathy for poor people doesn’t stop at the border” camp- so we need more money. Look up “deflation” on wikipedia if you think I’m making the correlation between deflation and reduced economic activity up.

Thanks for losing the rhetoric about Sharia law taking over the entire western world. It is much easier to discuss without the emotional baggage.

My apologies if you felt I was being patronizing, but the quote still holds. Free is not free. Someone pays for it. The fact that depositors don’t pay the related fees absolutely means that they are borne by others. It can’t be any other way. A system where checking account fees are paid by checking account holders and loan costs are paid by borrowers is no less of a rational system than checking account costs being borne by borrowers. It is actually more fair and rational. That is, however, a very minor issue and more of a distraction from the key points.

I have to agree that fractional reserve banking is not the core cause for the crisis. That honor lies with the Federal Reserve Bank and its manipulation the money supply and interest rates. Obviously there are more contributing factors, such as ones you mention, but without the Fed’s manipulation, there would not have been the inflationary bubble. The role that the fractional reserve system plays is in greatly magnifying the effects by inflationary credit creation.

The creation of money by banks granting of credit is a very understandable and straight forward process. It multiplies by many times the creation of reserves by the Fed. Because of the leverage, a $200 billion creation of money out of nothing by the Fed can be multiplied into $2 trillion, with a T, of new money created from nothing in a relatively short period of time.

The problem is that the inflationary credit process is inevitably reversed when it becomes obvious to everyone that the economic conditions are a house of cards, a bubble market. Businesses and individuals default and go bankrupt, mortgages foreclose and loans become uncollectible. Those inherent deflationary pressures are what hurt so bad, but they are absolutely guaranteed by the fractional reserve system now in place, in conjunction with the Fed.

As I said in one of my other comments, if a depositor wrote a check on an account with no money in it and refused to cover it, he would go to jail. The other side of the coin is that if that depositor wants his money and the banker refuses to provide it, he should go to jail also.

If a bank always had depositors’ money on hand, bank runs would never, ever happen. Bank failures would be extremely few and far between. A bank run results only from the realization of the depositors that the bank embezzled their money, and does not have it to give back to depositors. In that case, the first ones there get the goods. Once the small amount of reserves on hand are gone, the rest of the depositors are cheated out of their money as the bank goes bankrupt. That is the problem we face. The only way for the fed to help is to create more counterfeit money, and even then, the system melts down.

There is something inherently wrong with that system. To me, the arguments against fractional reserve banking are overwhelming. What the system should look like in its place should be determined by the market. The banks that serve the customers with the best model would be the ones that perform the best. But it is not too much to ask that bankers be held to the same level of accountability as their depositors.

If my analysis is wrong, please tell me where. I am truly willing to learn.

“You may have heard the old saying “There is no such thing as a free lunch.” That applies very well to the situation you are discussing. Just because you don’t have monthly fees deducted from your account doesn’t mean that nobody pays the expenses related to your accounts.

The bank incurs expenses for every service they offer.
The way the system is set up now, the burden of the bank fees is borne by borrowers. The banks collect the fees in the form of interest from customers.”

end quote

Thanks for the patronizing comment in which you want to teach me how banks work. I know how they work and I disagree with the part where you say “, the burden of the bank fees is borne by borrowers” We’re all savers & borrowers at certain times and even I was more than happy to borrow for real-estate investments that made me profit from leverage in good times. I never thought my bank was charging fees “on my back” The system of full reserve banking that you want to promote simply makes no sense. Your bank merely becomes a pawn-shop of some sort.
Fractional Reserve Banking is not really responsible for today’s crisis. It’s the whole mix of re-packaging and slicing of loans to remove them from bank’s balance sheets, together with cascading derivatives on nobody who knows how many layers all coupled together with IFRS book-keeping norms (that originally meant well but backfired) that went out of control. And I didn’t even speak of rating companies being paid by the very companies they were supposed to be rating. This all was an explosive disaster waiting to happen and Warren Buffet rightly talked about ‘weapons of financial mass destruction’ way before the subprime crisis struck.

“It would however leave some flexibility in the hands of the state to increase the money supply carefully in line with production thereby retaining stable prices over time with[OUT] the need for the kind of zero sum results…”

This simple fact often gets confused with the issue of fiat money. Fiat money is not the cause of the problem. If the money supply were created by the state and spent into existence rather than lent, then there would be no more money-as-debt, and no requirement for constant inflation.

It would however leave some flexibility in the hands of the state to increase the money supply carefully in line with production thereby retaining stable prices over time with the need for the kind of zero sum results you get from a gold standard (i.e. a one good increases in value another good decreases). 100% reserve banks would be free to set their own interest rates.

The Austrian School will complain that this system is not going to work since centrally planned government will ruin it. While this may be true it is important to separate the economics from the politics, and see that this system is in itself stable, sustainable, flexible and has many advantages over gold backed money.

The only arguments that can reasonably be made against this system is that government can never be trusted, and fiat money systems always collapse. There is of course plenty of evidence to support both these statements. However on the flip side, removing all economic constraints from individuals as advocated by the austrian school is not going to produce a sustainable economy from an environmental point of view since individuals acting alone and competeing with one another will never price in environmental depletion.

Austrian thinkers justify this attribute of their system by saying that
future generations have no rights, so sustainability is not a valid goal. However this philosophy is rarely pointed out by the austrian school itself or by their detractors.

I think we do have a lot in common. I have a couple of comments and then a serious request. First the comments.

When money is injected into the economy, it is not injected to producers who borrow money to actually produce things. The injection is to banks who create money out of nothing. They get the injection with absolutely no production whatsoever. They use other people’s money and create new money from it. The banks then charge interest on money that they get for free. Once the banks make the money from credit creation based on deposits, it is immediately in circulation. Granted, the loan recipient is not hurt as bad from the new money as the poor and those on fixed incomes, but they are not the primary beneficiaries of free money. The banks are. It is a very straight forward and explainable process.

Second, as the value of a dollar increases, meaning it can buy ever more goods, there will be fewer dollars needed to buy any particular good. But rather than having to use ever smaller chunks of gold or whatever, there could be smaller denominations, such as a half cent or, say, a mil, one thousandth of a dollar, and so on. That is the rationale for quarters, dimes and nickels, and it could be expanded upon indefinitely as money became more valuable. It would be the reverse of the devaluation process in place now.

Third, people react to reality over time. It is true that severe deflation will distort markets and make it impossible for people to predict the results of the actions they take in the short term, just as severe inflation distorts markets. The price stickiness you are talking about, however, results from people being programmed to believe that inflation is inevitable. They expect higher prices and transact their business with that expectation. It is just as rational, however, to expect that the parties to transactions would easily adjust their actions and expectations to a mild and steady deflation. If prices decline, the costs would also be bid down on the inputs, because everything becomes cheaper in deflation. The result could easily still be a profit.

Now for the request. Tell me why, specifically, that money must grow in order for an economy to grow. It really is not at all apparent to me why that should be so.

We agree on more than we disagree, but I think this disagreement is central- when an economy grows, money must grow. And when money grows, it needs to be injected into the economy- and what better way than to issue it to people who promise to produce to pay it back?

If we were all reduced to trading ever smaller chunks of gold as supply grows, we’d still be a stone age economy.

That the middle eastern countries are much closer to that than we (well, except for those dealing in dollars)is as good an example as any. Our central banking mechanism that allows money to grow with supply so that the price stickiness of relatively deflating resources doesn’t plunge those into recession, constraining parts of the economy with it, is a key reason our economy (and living standards) are superior to the vast majority of the rest of the world.

The interpretation and potential physical or moral consequences of economics I consider “political economics” as so many did in Europe.

That separation of facts and philosophy is probably the hardest aspect to teach, but the most satisfying whenever a student “got it!”

The facts just need to be gathered, proven as much as possible as factual, and marshaled in his/her argument.. The philosophical application then simply becomes a personal decision by the individual.