Last week we got
another comment on a posting of the kind that we like to get, i.e., that writes another blog posting
for us. This gets more bang for the buck
by killing two birds with one stone, as long as we hit the nail on the
head. Which uses up our quota of
aphorisms for the day. So, let’s cut to
the chase. Our commentator said,
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| What most people think, but it's not correct. |
I feel like this banking principle/capital homesteading is
the same as a small business loan with the terms defined differently. You talk
about someone buying an orchard with the promise of paying part of the harvest
for an agreed period of time. The bank acts as an intermediary and pays the
seller in silver notes, and the buyer owes the bank the produce. He goes about
his business and pays the bank in silver notes from the sale of his apples each
year an amount which includes the principle plus interest. That by itself doesn’t
create money, but when it’s someone else’s money on deposit, e.g., the orchard seller’s money, being
loaned out, then money is created. For every bit of money deposited M1,
the money available for circulation M2 is the initial amount M1
divided by the reserve fraction. Do you
propose to make the reserve requirement 100%? Or can we just accept that all
the money in circulation is M2?
This is a good
question, if only because it demonstrates just how hard it is to get across the
idea of the Banking Principle versus the Currency Principle. Essentially, the commentator is mixing apples
and oranges.
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| Dr. Harold Glenn Moulton, President of Brookings |
The so-called “multiplier
theory” — disproved by Dr. Harold G. Moulton within months of when it was
promulgated, which disproof has been completely ignored for over eighty years —
is pure Currency Principle. That’s the
belief that banks create money out of nothing by double counting reserves. By complete coincidence, the mathematical
gymnastics involved in the Currency Principle multiplier theory work out to the
same answer as the actual Banking Principle operation of a bank bound by a
reserve requirement, letting economists who don’t know how a bank operates or
basic bookkeeping “prove” their false theory.
But
how does a bank create money, if not out of thin air by counting each reserve
dollar multiple times?
Under
the Banking Principle there are two types of money, past savings money and
future savings money. In technical terms
these are mortgages (contracts on existing assets) and bills of exchange
(contracts on future assets). All money
is a contract, just as all contracts are, in a legal sense, money. Any promise consisting of offer, acceptance,
and consideration is a contract and thus money.
The
role of a commercial bank and a central bank (broadly speaking, a central bank
is a commercial bank for commercial banks) is to “accept” money in the form of
a personal contract, and issue its own general contract to “buy” it. Strictly
speaking, a bank can only “create” money by accepting something of value and
issuing a promissory note that obliges the bank to deliver value once the
original borrower has redeemed the contract he or she “sold” to the bank. A
bank’s promissory notes, whether in the form of banknotes or to back a new
demand deposit, are negotiable, and can be used as currency, a general medium
of exchange with a uniform and (presumably) stable value.
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| Jean-Baptiste Say |
All
the talk of M1 through MWHATEVER are simply ways Currency
Principle economists have tried to force their theories to fit reality. The
Banking Principle, by defining money as anything
that can be accepted in settlement of a debt, avoids this problem. If there was
a contract, it counts as money. If there was no contract, there was no money.
(That’s simplified, of course, but we’re using the economists’ “ceteris paribus”
assumption: keeping everything else the same and assuming that all exchanges of
value are commercial transactions.)
If
you keep in mind Say’s Law of Markets, founded on Adam Smith’s first principle
of economics (“Consumption is the sole end and purpose of all production”),
everything falls into place. “Money” is simply the means by which I exchange
what I produce, for what you produce, nothing more. Everything else is either
ways intended to facilitate this process, or ways that some people have figured
out to game the system for their own benefit.
For
example, Moulton believed that the reason so many countries went off the gold
standard in the 1920s and 1930s was to make it easy for governments to
manipulate the currency and impose the hidden tax of inflation, freeing
themselves from oversight by the taxpayer, a great benefit to a totalitarian
regime.
Now — why does
the fractional reserve requirement give the same answer mathematically under
both the Banking Principle and the Currency Principle?
Banking Principle: Given a 10% reserve
requirement, having reserves of $1 million means the bank can accept contracts
totaling $10 million, and issue promissory notes to that amount, thereby
expanding the money supply by $10 million.
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| A theory built on a completely false set of assumptions. |
Currency Principle: Given a 10% reserve
requirement, having reserves of $1 million means the bank can lend out
$900,000, which is deposited in another bank when the borrower issues checks. In multiplier theory, the $900,000 in checks
on deposit is counted as new reserves in addition to the reserves on deposit in
the bank on which the checks were drawn.
Multiplier theory assumes that checks are never presented for payment
(!), but are kept on deposit, 90% of which are used to back new demand deposits
in the second bank in the amount of $810,000.
These in turn are drawn on by the borrower(s) and deposited in a third bank, which creates money in the
amount of $729,000, and so on, down to the last nickel. Keep in mind that the multiplier depends on
the assumption that no checks are ever cleared at any time, but remain on
deposit as additional reserves . . . which is not only contrary to banking
theory and practice, but completely illegal.
The amount by which the money supply allegedly expands in this manner is
equal to the reciprocal of the reserve requirement, 1 divided by 10% or 0.1,
which equals $10 million.
The bottom line
here?
Modern
monetary and fiscal policy is based on a principle that is not only completely
false, it is so transparently wrong as to be completely insane.
Now, just in case
there is any doubt about this, tomorrow we will begin posting Moulton’s
refutation of the money multiplier.
#30#
