Mike Sproul,
Apparently, in a Real Bills economy, banks would issue into circulation the dollar amount of each loan, but where would the dollars come from to pay the interest?
Inflation being the increase of the money supply, the question is to anticipate what kind of money would produce a free banking system. I am not sure that the gold standard would be competitive. With the gold standard, there is certainty that the excess of money will be washed out at some point, i.e there is a mecanism to burn created money, but whatever the reason there has been in history behind bubbles of credit under the gold standard, the burst was always very severe. Austrians say, I believe, that the bubble is the cause of the burst. Thus I anticipate that a free banking system would practise some sort of Central Banking where they would seek to increase or decrease the money supply at a pace that fits the economic needs of their customers so that credit would remain abundant and controlled. Exuberant bubbles as well severe burts must be avoided and for that the financial revolution as well prudent central banking has greatly generated a lower volatility.Which Central Bank has generated the best sustainable pace of economic growth ? seems to me Australia.
Are you sure that is what the Austrians say? As for free banking, it is very possible that banks in such a system would submit to some sort of voluntary regulation, or follow the lead of the most successful firm, but I am not a free banker, so one of them will have to answer that question.
Mike Sproul,
Let’s say the bank(s) loan a total of exactly $1 million every day into circulation with one-year (365-day) loans at 10% simple annual interest.
Am I correct in the following analysis?
On the day at the end of the first year, there would be $365 million minus 1 million capital
(paid back to the bank) minus $100,000 (i.e., 10% interest on the first $1 million loan made 365 days previously) which would equal $363.9 million in circulation.
$100,000 would be deducted from the dollars in circulation every day in order to pay the interest for the loan made 365 days previously.
The $1 million capital of the first loan would be returned at the end of the year, but that would not diminish the dollars in circulation because another $1 million loan would be made on the same day. The next day $1 million of capital would be repaid and another $1 million loaned thus not affecting the amount of dollars in circulation caused by this movement of loan capital.
The $363.9 million in circulation on the day at the end of the first year would diminish by $100,000 each day for (363.9 divided by 0.1 which would equal) 3,639 days or 10 years until the dollars in circulation became completely depleted.
OOPS, THIS IS A REWRITE:
Mike Sproul,
Let’s say the bank(s) loan a total of exactly $1 million every day into circulation with one-year (365-day) loans at 10% simple annual interest.
Am I correct in the following analysis?
On the day at the end of the first year, there would be $365 million minus $1 million capital paid back to the bank plus $1 million capital loaned by the bank minus $100,000 interest paid to the bank which would equal $364.9 million in circulation.
$100,000 would be deducted from the dollars in circulation every day in order to pay the interest for the loan made 365 days previously.
The $1 million capital of the first loan would be returned at the end of the year, but that would not diminish the dollars in circulation because another $1 million loan would be made on the same day. The next day $1 million of capital would be repaid and another $1 million loaned thereby not affecting the amount of dollars in circulation caused by this movement of loan capital.
The $364.9 million in circulation on the day at the end of the first year would diminish by $100,000 each day for 364.9 divided by 0.1 which would equal 3,649 days or 10 years when the dollars in circulation would become completely depleted.
Gethky:
If the dollars in circulation do actually become depleted, then interest can be paid in some other form: silver, foreign money, etc. But as long as new dollars are continually issued, the depletion doesn’t happen.
If the only way that dollars get into circulation is through bank loans, then (as I have described in the hypothetical model, above) each interest payment on those loans would deplete the dollars in circulation. As this deflation of the money supply advances, it follows that most prices will become lower and lower. This continued lowering of prices would impose more and more hardship on borrowers trying to scape up enough lower-priced goods to pay off their yearly loans until, finally, people would not be foolhardy enought to take out loans and the dollar economy would then collapse.
Another correction:
Mike Sproul,
Let’s say the bank(s) loan a total of exactly $1 million every day into circulation with one-year (365-day) loans at 10% simple annual interest.
Am I correct in the following analysis?
On the day at the end of the first year, there would be $365 million minus $1 million capital principal paid back to the bank plus $1 million capital principal loaned by the bank minus $100,000 interest paid to the bank which would equal $364.9 million in circulation.
$100,000 would be deducted from the dollars in circulation every day in order to pay the interest for the loan made 365 days previously.
The $1 million capital principal of the first loan would be returned at the end of the year, but that would not diminish the dollars in circulation because another $1 million loan would be made on the same day. Each following day another $1 million loan principal would be repaid and yet another $1 million loaned thereby not affecting the amount of dollars in circulation.
The $364.9 million in circulation on the day at the end of the first year would diminish by $100,000 each day for 364.9 divided by 0.1 which would equal 3,649 days or 10 years when the dollars in circulation would become completely depleted.
We cannot bid up the price for everything at once. Sure, heavy demand for crude drives the price of gasoline higher. Higher costs could be passed on to the consumer to an extent. But that’s just the point: if we are paying more for our gas then we have less money for everything else, we have less money to bid up the prices of other things,unless you increase the stock of money in circulation. And that’s where the central bank and fractional-reserve banking comes in. I actually read this from an article by Frank Shostak and that article alone explained inflation to me in a way I could easily understand.
If banks are basically deflationary, as I show in the above model, then increasing the stock of money in circulation is not caused by banks per se, but by other factors, namely, by increasing the number of loans. E.g., if the number of loans per year in the above model were increased from 365 to 730 per year, then the stock of money in circulation would be $730 million at the end of the first year and then diminish during the next 730 divided by 0.1 = 20 years.
gethky, in your example of the bank loaning money, you act like the interest that the bank earns simply disappears from circulation. It does not. It is used to pay employees, to build new buildings, to purchase advertising, or it is loaned back out. It is still in circulation.
We cannot bid up the price for everything at once.
For the price of all goods to go up we merely need the subjective value ascribed to money to go down. If some crisis shakes our confidence in the currency then prices for all goods will rise
I attempted to keep my above model as simple as possible, but why not assume that the bank can meet all its expenses by fractional reserve banking and thereby be able to plow back all interest payments into interest-bearing loans? If that were the case, then the interest payments for those loans would, as in my above model, also have to come from the circulating principal of other borrowers.
So this bank has no debtors in default?
And it’s able to charge an inelastic interest rate? Does this bank not face competiton from other lenders?
If the bank really does deplete the money supply, by holding the majority of it in reserves, then it seems that it is not able to be very productive in comparison to its vast resources. Wouldn’t the owners liquidate the bank in favor of more productive investments?
Is it just me or is this bank scenario far removed from reality?
BTW, is there something akin to the Austrian Business Cycle theory for a money supply that’s being intentionally and continuously deflated?
OK, let’s subtract $40,000 per day for total expenditures from the previous $100,000 daily payment of interest to the bank(s). According to my above model, on day 365 there would be $365 million in circulation. On day 366 and each day thereafter the bank(s) would receive $1 million as principle and $100,000 as interest. The bank(s) would also loan $1.06 million on day 366 and each day thereafter. $60,000 would then be the net amount of diminuation of the money in circulation every day commencing with day 366. The $364.94 million in circulation would diminish for (364.94 divided by 0.06) 6,082 days or 16 years.
Goldsmiths are said to be the first bankers when people started using their receipts as circulating currency, then the goldsmiths/bankers started lending the receipts at interest. Here I’m not considering the interest the bankers pay on deposits and other factors as well so as to allow the example to be as simple as possible and yet include all the important factors of banking that relate to whether or not banking is basically inflationary or deflationary. Instead of using ‘receipts’ or ‘currency’ I use ‘$’ which is not to mean any particular country’s dollar in the above hypothetical model. Like all models it deviates from reality, but not enough to prevent it from demonstrating that banking is basically deflationary if it keeps any part of the received interest payments out of circulation. Intentionally causing the loan rate to decrease will indeed cause deflation (see Richard Timberlake’s “Federal Reserve Follies” at http://blog.mises.org/blog/archives/timberlake.pdf ). The unintentional basic deflation caused by banking is not seen where loans proliferate in expanding economies and/or populations.
Hope the link works. Here the author explains that a price cannot be realized simply because the seller asks for it. Assigning a price? In the market, the consumer decides what is the right price.
Wasn’t baxter’s (Oct 25, 2007 at 5:03 AM) comment, “For the price of all goods to go up we merely need the subjective value ascribed to money to go down. If some crisis shakes our confidence in the currency then prices for all goods will rise” enough?
Increasing the money in circulation is another way to cause most prices to rise.
“In the market, the consumer decides what is the right price.” - Calvin
I don’t believe you’ll find a counter argument to that statement here.
If 100 gold coins represent the total amount of money in circulation, then the most that can be paid for the Mona Lisa is 100 gold coins.
So if I discover that someone just paid 150 gold coins for the painting, I would simply assume that the buyer found more gold coins from somewhere. Whether the buyer discovered a gold mine or shaved off existing coins to create new coins produced the same result. Adding 50 gold coins to the stock of money allowed for the price to go up to 150 from 100 gold coins. Something that wouldn’t have happened before.
The world has never seen a “FREE MARKET”. Hypothetical and at this point in human mentality: WON’T EVER HAPPEN.
Your gold example deals with life in a vacuum. In real life you have to deal with manipulation. Manipulation on every aspect actually. Gold is undervalued and manipulated by the CB’s and Bullion Banks, with the end goal of keeping gold low. One could say that gold has been bastardized to work on a fractional reserve system. Although that won’t last long due to gold’s built in counterfeiting protection. Some people are running out and people are getting a whiff of that.
Not true.
The money supply is a limitation on the sum of all the quantities of money simultaneously held by all individuals and other entities. A transaction involving money merely transfers money from one individual or entity to another with no impact on the total quantity of money.
Any final hypothetical achievable distribution of the supply of money can be realized by a series of partial payments without any limitation on the individual net price of any transaction.
Regards, Don