Yesterday we looked at one or two
things that should be done to return the Federal Reserve system (or any central
bank, for that matter) to its original purpose of providing adequate liquidity
for private sector development for qualified agricultural, commercial, and
industrial projects. Note that financing
government was not one of the
original purposes for which central banks were invented. It just turned out that way due to an
accident of history . . . if by “accident” you mean “expedient for those
wielding political power and who could withhold a charter unless their terms
were met.”
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| Happy bankers, when most money was in contract, not coin form. |
Today we look at three additional
reforms that would make the reserve currency and the entire system even more
sound than merely conforming to the system’s original purpose: 1) A 100%
reserve requirement, 2) Phasing out monetization of government deficits, and 3)
Financing expanded capital ownership.
Let’s take these in the order given.
100% Reserve Requirement. Under today’s “fractional reserve” banking system,
commercial banks are limited in the amount of loans they can make, based on the
reserve requirement and the amount of reserves. For example, if there is a 10%
reserve requirement, and the bank has $1 million in reserves, it can make loans
— that is, issue promissory notes to “accept,” that is, discount or rediscount,
bills of exchange (create money) — totaling $10 million.
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| J.M. Keynes: the State creates money by fiat out of nothing. |
Keynesian money multiplier theory
(disproved by Moulton — “How the Commercial Banking System Manufactures
Credit,” Harold G. Moulton, The Formation
of Capital. Washington, DC: The
Brookings Institution, 1935, 77-84.) asserts that
banks increase the money supply by lending reserves, using the reserves to back
new demand deposits. The theory is that when checks are drawn on the demand
deposits, the checks are deposited in another bank, and become reserves that
the second bank then lends out, and so on (and on, and on).
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| People create money by accepting valid contracts |
This neat little Keynesian multiplier theory,
however, completely ignores the fact that 1) Checks do not qualify as reserves
and 2) Checks are not retained by the accepting bank, but are presented for
payment to the bank on which the checks are drawn through the clearinghouse
system. As Moulton pointed out, there would thus be a continual transfer of
existing money, but no new money creation.
Fractional reserve banking was originally
intended to provide uniformity, stability and confidence in the bank’s
promissory notes by providing a reserve currency of unquestioned standard value
into which other forms of money could be converted. The reserves do not back other forms of money,
but are a form of money into which other forms of money can be converted on
demand.
Thus, asset-backed reserves would allow
convertibility of the bank’s notes into legal tender currency (usually gold or
silver). Limited supplies of gold and
silver thereby restricted the amount of loans that commercial banks could make.
Given the legal tender status of paper
currency and the virtually instantaneous accommodation available from a central
bank to its member commercial banks, fractional reserve banking today acts as an
unnecessary brake on development. It ties the creation of new money to existing
accumulations of savings instead of to the present value of private sector
capital projects that need financing. The fact that the U.S. dollars used as
the reserve currency are backed almost entirely by government debt (bills of
credit) instead of hard private sector assets further undermines the utility of
fractional reserve banking.
“Excess reserves” can also have the
undesirable and unintended consequence of encouraging unwise lending or
imprudent investment by the bank. Excess reserves represent such a temptation
in order to avoid having uncommitted assets lying idle. They thereby provide an
incentive to channel money into speculative capital projects and secondary
securities. This creates “bubble” markets and fuels inflation.
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| Coin and currency are only one form of money. |
A reserve currency should consist of asset-backed
coin, Federal Reserve Notes, or commercial bank demand deposits at the Federal
Reserve. Given rediscounting of all
qualified loans made by member banks and supplemented with open market
operations in private sector securities issued by non-member banks, companies,
and individuals, a 100% reserve requirement would result in an elastic and
asset-backed reserve currency tied directly to the present value of existing
and future marketable goods and services in the economy.
The money supply would increase in
direct proportion to the increase in the present value of marketable goods and
services in the economy, and decrease as the goods and services were produced,
sold, and consumed, and the bills of exchange backing the money redeemed and
cancelled. This would, everything else being equal, avoid both inflation and
deflation, and result in a stable, uniform and elastic reserve currency
sufficient to meet the needs of the economy in periods of growth and, if it
should occur, avoid inflation during periods of contraction.
Termination
of Monetization of Public Sector Deficits. A great deal of new, inflationary money enters the
economy because the Federal Reserve purchases government securities in its open
market operations.
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| When the State creates money, money rules the State. |
This sort of thing effectively “monetizes”
government deficits, rather than private sector production. In restoring the
original discount powers of the Federal Reserve, Congress may wish to consider
eliminating control of the money supply through the Federal Reserve’s Open
Market Committee. This would discourage future monetization of federal budgetary
deficits and would require that the Treasury sell securities directly in the
capital markets to finance government debt instead of emitting bills of credit.
The Treasury would thereby be forced to compete with consumers and speculators
for the pools of existing savings, and oblige borrowers to assume the true cost
of borrowing without subsidies or artificial manipulation of interest rates.
Eligible
Shares. Under Capital
Homesteading monetary reforms, to be eligible for Federal Reserve rediscounting
privileges, loans made to ESOPs and other expanded ownership financing vehicles
should only be used to acquire “full dividend payout, full voting shares,” with
dividends tax-deductible to the corporation and fully taxable as any other
source of consumption income to shareholders.
The shares should provide workers and
other new capital owners with first-class shareholder rights, including the
right to vote the shares on all matters subject to a shareholder vote. This
reform would broaden and democratize the accountability system of the corporate
sector, a goal impossible to achieve through public and private retirement
systems or traditional institutional investors. It would also overcome the “closed
system” of corporate finance by shrinking retained earnings while offering
corporations a cheaper way (i.e., new stock issuances) to combine growth
assets with new shareholders.
Finally, by adding transparency and
greater management accountability to worker-owners and other shareholders, most
ESOP abuses could be minimized. You’ll
never eliminate all abuses, of course.
Anytime someone really puts his mind to it, he can usually figure out a
way to cheat others. The question is
whether the system inhibits such behavior, or encourages it.
