I recently spoke to a professor of mine who is in favor of fractional-reserve central banking. Below is a quote from an email he sent to me. If it is possible to receive some insight to the comments and questions posed below, I would be grateful.
There is a good case to be made that banking, like many social needs, is a federal not a local issue, and so should have a federal bank. Interstate commerce is regulated by the federal government, not state governments. This is constitutional. You make many claims that I do not agree with about how this is an unconstitutional invention (I know you base these on quotes, but you need to also consider the other interpretation with quotes), but I think it is rooted in interstate commerce, which is regulated by the federal government.
Marriage, citizenship, national security, are all regulated by the federal government, are these monopolies? Is the army a monopoly, or the police force, or firemen? Or is it necessary for some services to be supplies by the government to guarantee they work (they are necessary for our continues existence) and to guarantee they are given fairly to all.
Fractional reserve banking, allows for greater capital and therefore greater research and development of products humans need. Minimizing lending also minimizes research and development.
Any insight in giving a well-reasoned response would be appreciated. I don’t know how to respond to the assertion that a gold standard or abolishing fractional-reserve banking would limit research and development which is greatly beneficial to human flourishing.
Is this guy a professor? He has not given a single real argument. Are they monopolies? Umm, yes, all the services he mentioned are coercively funded governmental monopolies. He will no doubt make recourse to a public goods argument to justify them. Right or wrong (it’s the latter), it will not change the fact that these services are provided in a monopolistic fashion. He is sneaking in normative arguments.
The other argument only works if he equates increases in the money supply without relevant increases in productivity to be increases in capital. But it isn’t. It is merely an increase in the amount of claims in the economy chasing after scarce goods. He needs to do more than just assert these things.
It was a conversation I had with a professor presenting (not necessarily arguing) the benefits of the other side. What I was thinking of saying was that money is a medium of exchange and therefore is not in the same category as national security, police force, etc. It takes the medium of exchange to establish these other so-called monopolies for the public good. I don’t know if that is a sound response or if there are valid rebuttals.
In terms of capital, how would a 100% reserve or the gold standard hinder or not hinder further research and development in the private sector to help humanity? The health industry seems to be expanding significantly as baby boomers enter retirement and old age. If we went to an international gold standard, it seems that there would be less capital for research and development.
Fractional reserve banking allows for inflationary pressure on money. Whoever gets the new money first gets the most value for the money, but the overall result is to devalue all money, and therefore reduce its power to fund greater research or buy more of anything at all. Inflated money is not increased capital.
The only way to increase capital is to increase productivity, and a gold standard provides no limits on increased productivity. In fact, a gold standard might help because it would provide a stable monetary supply, and simplify monetary calculation.
In short, money is not wealth; it merely represents wealth. Wealth is goods and services.
I’m assuming you’re some kind of Paulite trying to justify everything through the Constitution. Just admit and get over the fact that the Constitution is a very old contract written by wealthy landowners for the wealthy landowners and their own misconceptions.
Uhhh… Yes, they are obviously government enforced monopolies.
The institutions of marriage and citizenship shouldn’t even exist, but that’s an entirely different issue.
Fractional reserve banking is a remnant of failed Keynesian economics. It leads towards greater inflation, devaluating the savings of the average Joe. It also creates “boom-bust” cycles which we have seen historically in the panic of 1819 and the stock market crash of 1929 (those are the two more extreme examples). Also, inflation and unemployment are not inversely proportional, as we have seen recently with stagflation.
I find this last remark baffling. What about greater capital? If you inflate, there’s more capital that’s worth the less per unit than when there’s less capital.
If you inflate the money supply, the value of the dollar will go down (supply and demand, duh). So having greater capital means nothing but having higher prices, devaluating the savings of people who have dollars, and reducing your nation’s purchasing power. After the temporary boom of overproduction is up, you have to face a recession.
On the other hand, if we had a free market currency like the gold standard, we wouldn’t have to worry about any of this. You’d have your currencies backed up by commodities, the way it was originally done with success.
Haha yeah. What does he think if it is a task carried out by the state it cannot be a monopoly? Any task carried out by the state is a monopoly because there is no way to legally compete with it. The state has set up institutions where they are the sole firm producing the certain task/service and there is blocked entry. That is the exact definition of a monopoly. Not sure what this guy was thinking. I feel sorry for you if you have to listen to this crap every class session.
If it is true wealth consists of goods and services that enhance and prolong the lives of humans, then good product ideas need capital to get them off the ground. According to proponents of fractional-reserve banking, the case for increasing capital brings to society the true wealth of goods and services with health and prolonged lives despite some inflationary results. Fractional-reserve banking has enhanced productivity for our own good. It almost seems like a necessary evil in some respects.
I’m still a bit confused since it appears that there could be some benefits of fractional-reserve banking.
Read our comments again. Fractional reserve banking devalues money, meaning the same amount of money buys less goods and services. An increased money supply is NOT an increase in capital, but instead creates boom/bust cycles that cause malinvestment in the economy and leaves people with less wealth, not more wealth.
Capital can only be increased with increased productivity, not increased currency. Fractional reserve banking does nothing to help research, unless the researchers get the money first, thus screwing everyone else in the economy.
If somebody thinks research has the potential for profits, that is, if it has the potential for providing goods and services that people desire, such as enhancing and prolonging their lives, and if people are willing to pay for it, then researchers will find investors willing to provide the necessary capital, no fractional reserve banking necessary for it to happen.
There is no direct connection between fractional reserve banking and research.
While I do agree that researchers can find investors willing to provide the necessary capital, there are some wonderful products and services that are seen as useful and profitable and therefore these researchers and entrepreneurs do not receive adequate funding. That is why, in the view of the banking industry, lending institutions are necessary to pump in the needed capital because investors with the already available capital are not willing to lend. Lending, or fractional-reserve venture capital via big banks, is the next potential option if others fail.
I am trying to give the possible rebuttals from the other side. Thank you for taking time to respond.
If they are seen as ‘useful and profitable’ and they can’t find willing investors then how useful are they really?
You pretty much just described how inflation leads to malinvestment.
Banks could care less what you do with the money as long as you don’t default on the loan and pay enough interest to make them a handy profit off of money that they created out of thin air. Do you seriously think that the betterment of humanity is the sole criteria in their loan selection process?
Inquisitive - First you need to understand that money is not capital. There is a set number of resources - including natural resources, labor, and capital goods available in an economy or the world at any one time.
Increasing the money supply, which is what happens when banks lend against regular deposits, does not increase any of these things. If anyone believes it does, they believe in magic.
When you say ‘investors with the already available capital are not willing to lend’, you are making a typical mistake. You see, these investors have money, they don’t have capital. If they choose to hold onto that money, guess what happens? The price of capital goes down, since there is less demand for it.
Know what happens when banks increase the money supply? They both raise the cost of capital (more money chasing fewer goods), and create
money that didn’t exist before on their balance sheets. They literally steal (a little bit of value from everyone who holds money) through inflation.
They do not increase the supply of capital, which is fixed at any given time. They just get to determine who has access to it, by giving them money that didn’t exist before. They also create malinvestment in the economy, by giving the illusion that certain investments are cheaper to finance than they really are (you see, when they expand the money supply they lower the ‘cost of borrowing’ or ‘cost of money’, the interest rate. But it is lowered below it’s natural rate through the expansion of the money supply), encouraging entrepreneurs to jump into long term investments that would succeed if the lower long term interest rates were real but ultimately fail because interest rates will adjust to their ‘natural rate’ (which will be higher than the previous natural rate because of the waste of real resources, but that’s another issue).
What would happen if the vast majority of investors decided they didn’t want to fund any investments? There would be a lot less money chasing capital, and the price of capital would fall greatly. The actual capital available would not decrease, however.
Bankers who say they increase the supply of capital available are full of crap and believe in a certain type of magical thinking. All they are really doing is expropriating wealth and determining for themselves who has access to credit. The other option is to give the real owners of the wealth control over who it gets lent to, and only give banks control over who gets loans based on time deposits. God this is complicated.
By the way, there are two ways to increase productivity and/or the supply of capital. One is through technological or process based innovation and progress. The other, not mentioned here and the basis for all real economic growth, is saving. For by saving ‘money’, we are in actuality choosing to not consume currently available resources right now. These resources are freed to help create longer and wider productive processes, or rather to fund longer term production. Another way of putting it is that real savings increases lower the interest rate below what it would otherwise be, permanently if the savings increase is also permanent. This allows investments that wouldn’t be profitable with higher interest rates to become so in the long term.
Confused? Read Money, Bank Credit, and Economic cycles by Jesus de Soto, do a Google search for desoto.pdf and you’ll get the book from this site.
What he means is that monetary expansion, achieved through fractional reserves, increases capital. That is wrong, capital is not paper notes. Capital is the goods used to create other goods. We could double the money supply over night, there would be no increase in capital. Would spending twice the amount of money buy twice the amount of research under those conditions? Of course not, you would pay twice as much for the same amount.
Money is not capital, it is a stand in for capital. It is used to buy capital. All inflating the supply of money does is redistribute the ownership of the real capital.
But fractional-reserve banking under the current system is necessary to purchase capital for research and development. The redistribution of capital via the means of fractional lending has brought us more productivity than malinvestment, they would argue. The good of money buying capital via venture fractional capitalism outweighs the inflationary outcome. The 20th century under fractional-reserve lending has made possible newer and improved technology, products and overall better standard of living Americans in general despite inflation.
Under a 100% gold standard, how would a grade school teacher, for example, without a down payment be able to purchase a home?
You don’t seem to understand something - the fact that these investments could not find voluntary funding signals the market did not desire them. Whatever some idiot central planner may think, they have distorted the market. If a 100% reserve bank believes a firm will be able to make good on its promises, it has every reason to fund it. If not, it clearly does not believe it is worth the risk. And this is as it should be, the opinions of central “planners” notwithstanding. Both you and your professor need to read Carl Menger’s Principles of Economics and Callahan’s Economics for Real People.
To make it really simple, would you trust some charlatan who said by printing money and lending it to some research institution that they had actually increased the amount of capital (i.e. higher order goods) in the economy? If not, why would you trust a central bank?
I think I understand what you’re saying. I think the confusion is in the fact that research does take place at times through newly created money. I am drawing the distinction between the assumptive necessary implication. I will surely read Menger’s and Callahan’s books. Thank you.
But what about home mortages under a gold standard or 100% reserve standard? How would that affect someone without a down payment if he or she was a school teacher, for example? How could a first-time home buyer purchase a home?
Murray Rothbard’s very short book “The case against the Fed” would be worth reading and would help you here.
As other people have indicated your professor confuses money with capital. If he is an economics professor then he should be fired! What this shows is how institionalized statist thinking is in education. Clearly, you are inquisitive and I would suggest you leave and study elsewhere, perhaps at the Mises Institute itself.
Money is a good with exchange value, not direct use value. It is not and cannot be capital in its capacity as such. WisR did a great job of communicating the argument - essentially, all one can do by inflating is privileging some investors as opposed to others in getting the cash first. But this has little to nothing to do with real increases in productivity in the economy; it misdirects it, like any other price control.
They’d probably be able to afford it because it wouldn’t be heavily inflated in the first place… at any rate, nothing precludes the possibility of loans under a sound money regime. They’ll just be given more prudentially, as the bank will be risking its own assets.
There is only one economic argument in you quotes and I will try to answer:
Fractional reserve banking, allows for greater capital and therefore greater research and development of products humans need. Minimizing lending also minimizes research and development.
In the neutral money framework, where money is a veil which only affects nominal variable (but not real variables), credit cannot increase investiment, so it has no impact on research and development. In this neutral money world we would have immediate price increases with no real, and consequently no real intertemporal, effects. Available capital is due to a real phenomenon: savings. Credit is either intermediation of available capital or capital creation. In the neutral world there can’t be capital creation by means of monetary policies and thus investments are constrained by real savings.
In the real world, money is not neutral: an increase in the money supply by means of credit creation, in a fractional reserve world, will affect savings and investments: it will reduce savings, increase consumption, and increase investments. How is it possible that investments rise and savings fall at the same time? Money creation transfer purchasing power from consumers to firms, and the latter will have greater investment opportunities because of “forced savings”: real resources which are expropriated from the late money-users in favor of the early money-users.
Here there can be a case saying that fractional reserve banking, by stealing resources from consumers and increasing investments, enhances growth (research and development is just a particular form of investment). This would be true if real consumption fell: but this doesn’t occur in credit-induced booms!!! There is no reason to believe that real investments increase in these booms, because the only sustainable increase in investments must be based on a decrease in consumption, and this is not what we observe.
If sustainable growth cannot be the effect of credit creation, the only remaining explanation is malinvestment: consumption rises, investment rises, but the structure of production, i.e., investment decisions, are ill-advised and inefficient because of intertemporal mal-coordination in capital allocation.
Forced savings may improve the growth rate only if they force less consumption and only if malinvestment costs do not impair the increased level of investments. This is inconsistent with people’s time preferences, but it is above all absolutely unlikely.
PS In my analysis I used an implicit hypothesis: there are no sovra-marginal idle resources, i.e., there are no keynesian free lunches in the production structure. In a world of free lunches it is conceivable that both investment and consumption rise at the same time, but no one has ever tried from a theoretical point of view to explain how monetary policy should help this process of free lunches’ discovery.
The rest of the mail is about politics, not economics.
Houses cost so much today because credit is so easy to get. If people were not able to get credit to buy homes, homes would not be able to sell for as much. Thus your grade school teacher would be able to afford it because it would not longer be overpriced.
(Humorous that you chose a government employee as the person who would be harmed if government intervention would cease.)
Obvious counterfitting money enables purchases, but it is not a necessary condition in order to buy goods.
Thats a utilitarian justification for theft. Its also not true that productivity is increased by monetary expansion. Any any investment that is acheived through manipulation of the markets, rather than participation in the market, is a malinvestment. It prioritizes production in a way other than consumers prefer.
That is the fallacy of concluding that correlation means causality. It is also factually in correct. American standard of living is stagnant, despite the market’s continued innovation.
The largest boom in standard of living did not occur post World War II, but during the 19th century.