Monday, September 7, 2015

Banks and the Stock Market, II: Currency Principle v. Banking Principle

Here’s a little game for you to play the next time you’re in a situation in which someone is ranting about “the banksters.”  First ask him or her, “Say, what is a bankster, anyway?”  If the ranter manages to answer that one to your satisfaction (instead of dodging the question with some variation of “If you don’t know, I’m certainly not going to tell you”), ask, “And just what the heck is a bank?”  If the first question didn’t stump the ranter, the second definitely will.

Sir Robert Peel, Currency School Co-Founder
It’s a trick question, you see.  Pretty much all economists and politicians come from a “Currency Principle” perspective (that is, they belong to the “Currency School”), when banks are an application of the “Banking Principle” (that is, they fall within the “Banking School”).

What’s the difference between the Currency School and the Banking School?  Possibly to oversimplify,

·      Currency School economists and politicians believe that “money” is itself a thing of value (a commodity), while Banking School economists and politicians (assuming you can find any) believe that “money” is a symbol of a thing of value (a contract).

·      To an adherent of the Currency Principle, the issuer of money transfers wealth, while to an adherent of the Banking Principle, the issuer of money transfers a claim on wealth.

·      In the Currency School, money is only one medium of exchange, while in the Banking School money is the only medium of exchange: “all things transferred in commerce” — anything that can be accepted in settlement of a debt.

Colonel Robert Torrens, Currency School Co-Founder
The three mainstream schools of economics (Keynesian, Monetarist/Chicago, and Austrian) are all Currency School.  (The belief that Keynesian economics is a modified Banking Principle school of economics comes from confusing private sector bills of exchange and government bills of credit, and not understanding private property or contracts . . . sorry you asked?)  The differences among the Currency Principle schools of economics are,

·      In Keynesian economics, money is a general claim on the existing wealth of the economy issued by the State, making the State the real owner of everything in the economy.  The amount and value of the currency may be adjusted to achieve political and economic goals (“Chartalism,” or “Modern Monetary Theory”).  Ultimately (merging the concepts of private and collective property), the money supply is a non-repayable debt the nation owes itself.  The amount of government debt outstanding is irrelevant, because issuing or retiring money simply increases or decreases the number of claims on existing wealth.  Interest rates are subject to change to discourage or encourage investment.

Samuel Jones-Loyd, Lord Overstone, Currency School Co-Founder
·      In Monetarist/Chicago economics, money is a general claim on the existing wealth of the economy, which may be issued either by private sector banks or the public treasury.  In either case, the amount of money issued must equal the value of existing wealth of the economy.  If too much money is issued, there is inflation, which erodes private property.  If too little money is issued, there is deflation, which inhibits economic growth.  The amount of government debt outstanding, and the activities of private sector banks must be strictly regulated to avoid issuing money is excess of the existing wealth in the economy, thereby causing inflation.  Interest rates are the price of money and must be set by the market.

·      In Austrian economics, money is a commodity with generally recognized value and acceptability (formerly silver, now gold) that serves as a medium of exchange to facilitate commerce and that can be used as a standard to measure all other things of value.  If the needs of an economy require an increase in the money supply, either the natural increase in the supply of gold through mining or commerce, or a rise in the price of gold as it becomes scarcer relative to other things of value in the economy will bring in more gold and stabilize prices at their natural, real level.  Any increase in the money supply from other sources is thus inflationary as it interferes with the real price level established by parity with gold, whether or not the price level rises, and any decrease in the money supply by artificially controlling the price of gold is deflationary for the same reason, whether or not the price level falls.  Interest rates are the price of money and must be set by the market.

Obviously, if you use a “bank” — a financial institution based on the Banking Principle — as if it were a financial institution based on the Currency Principle, you’re misusing a very powerful tool.  Think along the lines of using an industrial grade bench or table saw with a precision 30-inch blade to cut out paper dolls.  You won’t get good paper dolls, you might ruin the saw, and you’ll probably cut off one or more of your hands, arms, or legs.



Atlantan said...

I agree that using the term bankster sounds too negative and conspiratorial so I try to avoid it. But I think I have a definition that you may agree with:

Any bank leader or stakeholder who has the ability to end or reduce the practice of fractional reserve lending for non-productive purposes such as consumer debt and speculation, but does not do so. Although most (who are currency school) don't care to think about this issue enough to realize it is wrong, that doesn't mean they are innocent.

Thanks for the best blog ever as usual.
Dave Hamill

Michael D. Greaney said...

Technically, there is no problem with fractional reserve banking per se, except for the fact that it is past savings based, and unnecessarily restricts money creation for new capital to what currently exists as money savings.

The problem is in the creation of money for non-productive purposes. Using the central bank properly to create an asset-backed and elastic reserve currency, paper issued for non-productive purposes could not be rediscounted, and thus would not increase reserves if needed.

The only way to ensure that there would be no abuse of fractional reserve banking, however, is to end it, and require that commercial banks be restricted to making loans that qualify for rediscounting at the Federal Reserve and thus either be converted immediately to reserves, or have the capacity to be converted instantly to reserves on demand, thereby instituting an automatic 100% reserve policy.

Of course, this requires absolutely that banks be separated by function (a "super Glass-Steagall), e.g., commercial banks make ONLY commercial loans (including Capital Homesteading loans, of course), and ALL consumer credit services being handled by a separate depository only institution. A pain in the you-know-what at first, but as people become used to it, they would see its advantages.