Need Major Intro. Questions answered!!!!!

Economics Economics Questions
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1

Ever since the begginning of the latest school year I have really tryed to start getting into politics and what not. Economics is the hardest concept for me to understand yet. Last year I took a Civics and Economics class which didn’t really teach me a thing. I’ve been reading this book “End the Fed” by Ron Paul and I have some very very basic questions to ask.

  • What’s a false boom? (What makes it false?)
  • Is there an easy way to explain fractional reserve banking?
  • What is our economy backed by (currency)?
  • Why have the dollar backed by Gold and/or Silver?
  • What is the main reason inflation is so bad?
  • Why does the Fed want inflation?

Thanks this is all I have right now.

2

The standard definition I believe is a non market interest rate leading to improper investments that are not sustainable. So that there is a boom period and then a subsequent bust period. Perhaps someone else can explain this one better.

For every dollar of assets on the books the bank can lend out some multiple of it. So for example for every dollar saved 10 dollars could be lent out at interest. Even if the multiple was 1 I think it would still be considered fractional reserve if they are allowed to lend out savings account money since that money is available on demand to the depositor.

Faith.

Gold and silver cannot be created by politicians and bankers, it has to be mined.

Because privileged insiders get the money first.

Because the fed is controlled by the government. The government wants inflation because it is the largest debtor.

3

It is unsustainable by the standards of the people it is supposed to benefit (consumers/businessmen)

banks keep only a small fraction of their money to not lend (the reserves) the rest is lent. This reflects the fact that under FRB, more money than things-to-be-gained by money are being made.

nothing

These metals, being harder to procure than paper, make them harder to be minted into money. Because of this latter fact, under gold/silver, it is harder for more money to exist than things-to-be-gained by money.

inflation is a rise in prices caused by an overproduction of money.

The FED wants inflation in the same way that a pro-skater wants to fall -it is an inevitable consequence of an action but not the intended outcome. The FED desires inflation because it desires to create more money in order to boost business. But as the money is passed from person to person it raises prices and ultimately inflation occurs.

Oh, and all these answers are perfectly consistent with the answers of the poster above.

4

It’s a period of illusory prosperity due to rising prices artificially propping up unsound businesses. Once the inflation stops, the businesses will see that they’re not profitable, and will fail. The failure is called the bust, or the depression.

When you lend money to a bank, they don’t hold onto that money, but rather recycle it by creating credit and re-lending it. This means that, whenever you put money into a fractional reserve bank, there may be a time where you lose all of your savings. This is called a bank run, and it happens when too many people ask for their money back at one time.

Capital and production. But this question is more philosophical than that.

When people try to exchange goods without the usage of money, they necessarily run into the double coincidence of wants. Here’s an example: I make grapes, and I want oranges. This means that I must find someone who produces oranges and demands grapes. Obviously, this is problematic and inefficient. What happens, naturally through free market activity, is that people use a highly demanded commodity (demanded by society) to act as the middle man. The fact that society finds this commodity valuable and employs it as a media of exchange, further increases its value, making it the monetary unit (highest liquidity, most marketable). The monetary unit must be divisible, distinguishable, durable, and difficult to counterfeit. Traditionally, gold and silver have always been chosen as the monetary unit, but not always. Sometimes giant boulders were used (poor choice), feathers, shells, but never paper. Paper is not valuable enough to be used as a common media of exchange (who values paper that much?). The introduction of money means that the grape producer and can exchange grapes for gold (money), and then exchange his gold for oranges–he doesn’t have to find the orange producer who demands grapes.

Inflation is the term used to describe increasing over-all prices. It’s bad because it makes business seem more profitable than they are (their goods are sold at an artificially elevated price). Furthermore, increasing the supply of money does not affect all prices and all people in the same way. Those who get the money first (banks, investors) are made wealthier, while those who get it last are made absolutely poorer. This affects the purchasing behaviors of individual’s within society causing further distributions. It also necessarily depresses the interest rate (which is the key); but this may be too technical for you.

The FED inflates by buying government bonds. Whenever the government wants to spend money it doesn’t have, it sells bonds to banks and investors (issues debt). The FED artificially props up demand for the bonds by buying them on what’s called the loanable funds market. This keeps interest rates low for businesses (as demand for bonds increases, interest rates fall), and finances government spending.

My answers are simple, and I expect you to investigate these questions further.

5

Ok so what you are saying is that a non market interest rate (no clue what that really is) leads to bad investments that look good at first but don’t hold up? So as a result some how there is a boom (how???) and then a bust follows? Am I right?

So do you think we should have a gold standard or silver or both? Are you basically just saying gold prices stay the same because the Fed can’t make gold out of thin air? And this would mean no inflation?

I don’t know what exactly this means but does this mean if a bank is in trouble the Fed can print money out of thin air (later causing inflation) and pay off the debts, which is bad because this means the people loose (value of their dollars go down at expense of banks being saved).

Alright I’ve heard of that but when does a bank save a dollar and then lend out 10 dollars? As in how exactly does that work?

6

This is one of the problems in your understanding of FRB that is misguiding you. " lend money to a bank" is inaccurate because you retain full ownership over the money. You can still use this money using the notes or checking book to make transaction. It’s a neat trick when you can “lend” something and still use it.

“recycle” is also inaccurate for the same reason as “lend” is inaccurate but worst, the money is actually multiplied. What’s wrong with the term “multiply” instead of recycle. The first actually explains what happened while the latter obfuscates.

7

How is it multiplied?

8

It’s a boom that is not backed by voluntary savings.

People allocate their money funds towards two things: present consumption (like buying food, clothes, etc.) and future consumption (that is, savings that get invested into building industries that can increase the production of consumption goods).

Suppose the economy’s total money supply is $100. People save $50 and spend the remaining $50 on present consumption. If you notice here: 50% of the economy’s purchasing power went into savings and the other 50% went into present consumption. Now the Fed increases the money supply to $200 by printing $100 worth of extra money and lends $150 ($100 of new money + $50 of voluntary savings from people) it to investments, while $50 are still spent on present consumption by people. Note here: 75% of the total purchasing power in the economy goes into savings while only 25% goes into present consumption.

People when left to themselves have a consumption-savings proportion of 50-50 with 50 percent purchasing power going into savings (investment) and 50 percent going into present consumption, but when the Fed increases money supply it alters the original consumption-savings ratio of people by increasing money supply and thereby allocating 75% of the economy’s purchasing power towards savings while only 25% goes into present consumption. In short, the Fed imposes forced saving on people.

So the industrial sector (fed by lots of phony savings) sees a boom. But it is temporary. Why? Because when the $200 completely percolates into the economy, people would again reassert their consumption-savings proportion, by saving $100 and spending the rest (one hundred dollars) on present consumption. See the difference? People have reasserted that they want only 50% of their purchasing power to go into savings and not 75% as the Fed wants things to be.

This decrease in the savings available for funding investment projects leads to higher interest rates (just like how a decrease in the supply of apples in the market, under constant demand conditions, leads to higher prices), and the marginal borrowers of loans will be unable to fund their projects any longer, or if they have already completed building their project they would be unable to pay the higher interest rates that prevail now after people have reasserted their consumption-savings proportion. For example, James sees that he can get a 4% return on a business project and when he sees that the interest rate (artificially lowered by the Fed) is just one percent, he gets all excited and plunges into the project. But when interest rate eventually hikes, lets say to 5%, he sees that his project is no longer profitable and starts defaulting on his loans.

Lastly, when interest rates hike after savers reassert their consumption-savings ratio, the Fed doesn’t usually let the bust happen. Instead it again inflates money supply to impose forced saving on people again, and keeps the interest rates artificially low. But this policy can’t continue forever, since the money will eventually get debased because of inflation.

9
10

Thinking it over, I have a different answer about real and false booms.

A boom is when the price of something goes up alot and very fast. Thus the housing boom, the dot.com boom, and so on.

Now why does the price of something go up sharply if the supply remains the same? Because the demand has gone up, meaning more people want it, and want it bad. Now usually people want something so bad that they are willing to pay much more than before is because THEY THINK THEY CAN USE IT TO MAKE MONEY.

A real boom is when they are right, the thing they are buying will indeed make them more money, because a new use has been found for it. Like if someone discovered how to turn rags into diamonds, there would be a boom in rags. Or if there is a new very solid true reason that the price of gold will go up for years and years [and people understand that], that will create a boom in gold.

A false boom is when people think the thing they are buying will make them more money, but it wont. No new use has been found for it. It’s the same old thing, but people are tricked or misled or whatever into thinking it will be more and more valuable. Sooner or later, somehow or other, the veil gets lifted from people’s eyes [Im not sure how this happens, to be honest].

11

A non market interest rate is an interest rate that is set by monopoly interest rate setter (The fed). A market interest rate would emerge if there was bank competition. The low interest rate makes investments that are non profitable look profitable. This leads to an influx of capital into unprofitable areas, the influx of capital often leads to a boom, which is similar to a panic. Remember how people thought the price of housing would always go up and you could not lose money in the real estate market? That was an example of a boom/panic.

I think we should have a “market money” standard. Not a monetary standard dictated by the government. Its called the “gold” standard because historically societies have chosen gold. I agree with them, gold is a good choice.

It means that the people that get the new money first get to benefit at everyone elses expense because prices won’t rise until they spend this new money. Think corporate welfare and government programs. They get to borrow at negative real interest rates and we all get the shaft in terms of higher prices so that they can enjoy this benefit.

Person A has 1 dollar in his savings account. Person B takes out a loan and gets loaned that dollar. There are now 2 dollars in existence. Person B will spend his loan money on something when he buys something form Person C. Person C puts the dollar in his savings account. Person C will have his dollar lent out now, etc. This is simplified, but that is how the multiplication occurs.

12

Banks create money. You did not surrender for any predetermined period of time the right to claim or use the money that they lent out. If you did, that would be a time deposit and not a demand deposit.

The end result is always the same. Multiple forms of fiduciary media (claim notes, check book money, etc..) are issued for the same physical quantity of money. In a system of many banks, this takes place in the form of credit expansion as follows: Assume a 10% reserve requirement. Bank A receives a deposit of $100. It lends out a note for $90. The $90 is then spent and the receiver of the note deposits it in bank B. Bank A then transfers the physical $90 to bank B and keeps only 10%, $10. Bank B lends out $81 and the $81 after it is spent is deposited at bank C. Bank C lends out $73. The process continues and if you continue the series, a total of new $900 in total of deposits have been created as a result of the original $100. We have only $100 of cash in the system but ownership titles for $1000, $900 of which don’t physically exist. However, the entire $1000 is in circulation due to everybody using the fiduciary media instead of the cash. The banks can achieve this by clearance mechanisms. It is harder in a decentralized system but easier in a centralized one with a central orchestrating the uniformity of the expansion so that the transfers can take place by the clearance mechanisms.

The bank creates money then. They did this by issuing fiduciary media not backed by real savings.

This is a good place to start.

13

I’d recommend you check out “What Has Government Done to Our Money?” - Rothbard.

It’s on the site in pdf and audiobook. It will answer most of your questions very well.

14

In a free economy, there will be bubbles all the time, but they will be corrected very quickly.

Look at it it this way. Let’s imagine there are no regulations or taxes on income, business profits etc. Now entrepreneurs discover the preferences of consumers directly and indirectly through their actions. If they make a profit, they have successfully employed the capital they had at hand in moving the structure of production towards genuine consumer desires. If they make a loss, they have done the opposite, and will go bankrupt, leaving the capital for more efficient use.

In a free society, it is perfectly possible that lots of entrepreneurs should suddenly decide that they should make more widgets. Assuming that those with loanable funds share this view of future consumer desire for widgets, they will invest in factories that produce widgets using the savings they have borrowed. This will cause the price of widget-producing machine tools to go up and there will be a “boom” in widget production. However, these entrepreneurs, if they are wrong, will make huge losses, as this is a false boom – their production is not genuinely aligned with the structure of consumer preferences.

Remember we also have to consider the “unseen”. In this case, the “boom” in widget production will come at the cost of decreased prices in other markets. Those producers already creating other products, or entrepreneurs with a keen eye, will see that actually, it is other products that consumers really desire. These producers/entrepreneurs will make profits. This is a profit/price signal, telling producers to move out of widget-production and into the production of other goods.

If the government is involved there are different effects. I did not highlight the importance of the loanable funds before but I shall now. Savings are vitally important, because they allow what Austrian economists call the lengthening of the structure of production. Savings allow people to invest (see particularly Irwin Schiff’s brilliant introduction to economics for further elucidation of this), and thus produce more and more efficiently. If the government counterfeits savings then this gives out incorrect signals to entrepreneurs and producers, and makes booms much worse, leading to systematic boom and bust. Counterfeited savings (printed money) hide price signals.

15

Ok and so what are the main problems of this? I mean, nothings wrong with this unless a whole bunch of people take their money all out at the same time, right?

16

I’ll try and jump in here, though I’m a bit of a newbie myself with a couple of thoughts on why inflation is bad.

Others have already mentioned that it is in fact a tax on savers. It reduces the value of money that people have saved, and benefits those who have run up debts.

They’ve also mentioned that the method used in bringing about the inflation, even if the inflation itself was not intended, is inherently unfair. Extra money is pumped into the economy and the first people to receive that extra money have an inordinate benefit. The economy has not yet adjusted to the increased money supply and those first receivers take advantage of that. Prices should be higher for the goods they purchase with that new “free” money but aren’t because prices are still based on the old money supply. Those who don’t have the political of financial collections are in effect ripped off.

Another problem is the dislocation of resources because of that inflation. I remember reading a book a pretty long time ago by Fiegge (sorry I don’t remember his first name or the spelling for sure) entitled “Bankruptcy 1995”. He was on Reagan’s Grace Commission in trying to find ways the government could economize and become more efficient. He was obviously off on the timing of when the economy would/could go bankrupt, but I think he had many good insights into how things worked.

He related a number of stories of how runaway inflation caused much hardship for the people in the street and for how it ruined an economy. One of the problems he noted was what had happened in Argentina. At one time Argentina was a major world power. IIR he said it had one of the top 2 or 3 Gross National Products in the world at one time. In any event they let their debts get out of hand and then began “printing money” and inflation really took off. He recounted stories of how people would rush home on pay day and stop at the first store to spend the money before prices went up. The stores didn’t even post prices because they could change between the time when the customer picked the item up and when the item was checked out at the register.

No one would save their “money” it dropped in value too fast.

Oops. Gotta go, but hopefully that added a little to the discussion.

17

Its wrong because it creates speculative bubbles :slight_smile: Also there is a bit of fraud involved because I don’t think people understand the mechanisms behind there savings account money and might not like it if they did.