Wednesday, April 24, 2013

Defining Money, VII: The Expanded Law of Reflux

The friend’s analysis raises a second problem.  Compared to allowing the government to emit bills of credit at all, this is a relatively minor issue.

Consider: If Say’s Law is allowed to function through the application of the real bills doctrine, and government spends no more than it collects in taxes, ceteris paribus — everything else being equal — (including democratic access to capital ownership as well as labor and thus the capacity to produce), then the value of the money supply will exactly equal the value of existing and future marketable goods and services in the economy.

Given the operation of the real bills doctrine, then, the money supply will always and in every case adjust automatically to the needs of commerce.  (The so-called “law of reflux” on which the classical banking school economists relied to try and make their case is a somewhat crude and partial recognition of this.)

If, however, the government abolishes all banks of issue and the government or some other agency tries to guess how much money the economy needs and the government emits bills of credit accordingly (as Henry Simons proposed in his “Chicago Plan”), the money supply will not be self-regulating.  Except by chance, there will always be either too much or not enough money in the economy.

There is also the problem that if an independent agency is established to attempt and determine how much money should be added to the economy periodically, the politicians will inevitably find some means to subvert the agency and take effective control of the money supply, as Congress did in the 1930s with the Federal Reserve.  The inability to come up with a way to prevent this is why Simons refused to endorse his own plan, despite the urgings of many in the financial world, Congress, and academia, including such disparate characters as Irving Fisher and the Reverend Charles Coughlin.

In conclusion, binary economics is, in part, based on the absolute necessity (a need growing more critical with each passing day) of restoring the institution of private property fully and democratically in our society, and tying all money creation directly to the present value of future marketable goods and services through direct and widespread private property in capital.



Baseball Billy said...

I'm starting to think of you as a political-economy professor extraordinaire. What was that you said about promissory notes backing demand deposits?

Michael D. Greaney said...

Basically there are two types of banks, the "bank of deposit" and the "bank of issue" (also known as the "bank of circulation").

A bank of deposit, what most people think of as a bank, is defined as a financial institution that takes deposits and makes loans. It can only make loans to the amount of its capitalization and deposits, less any reserve requirements. The most common types of bank of deposit are credit unions, savings and loans, and investment banks.

A bank of issue, which confuses most people because it seems to "create money out of thin air" (and does no such thing) is defined as a financial institution that takes deposits, makes loans, and (here I start to answer your question) issue promissory notes.

All money is a contract, just as all contracts are, in a sense, money. All contracts consist of offer, acceptance, and consideration, "consideration" being the inducement to enter into a contract, i.e., the thing or things of value being exchanged. A contract specifically intended to circulate as money in trade and commerce is called a bill of exchange.

You can offer anything you like in settlement of a debt (money being "anything that can be accepted in settlement of a debt), but it isn't money until it is accepted. This is why a bill of exchange used between individuals and institutions in the private sector other than banks of issue are called "merchants" or "trade" acceptances.

When offered to a bank of issue and accepted by that institution, the bill of exchange is called a "bankers acceptance." To be able to accept the bill, the bank issues a promissory note.

In effect, what the bank is doing is exchanging one form of money for another, having created the money in the first place by accepting the offer of the drawer, issuer, or holder in due course of the bill of exchange.

This promissory note can itself be used as money. This is very, very rare. Formerly, the promissory note could be used to back smaller denomination promissory notes called banknotes. This was very common until the British Bank Charter Act of 1844 and the U.S. National Banking Act of 1863, both of which restricted the issue of banknotes to the State or State-authorized institutions, shifting the backing from private sector hard assets, to government debt.

Neither the British nor the U.S. Act, however, recognized demand deposits as "money." (Most currency school economists now recognize them, but they do it in a very weird way that screws up the system even more.) Where formerly banks of issue had printed banknotes backed by their promissory notes, they now created demand deposits, keeping within the law against the issue of banknotes as money, but completely negating the intent of the Acts to control the money supply by using demand deposits that the Acts didn't recognize as money.