We are developing the social individualist meta-context for the future. From the very serious to the extremely frivolous... lets see what is on the mind of the Samizdata people.

Samizdata, derived from Samizdat /n. - a system of clandestine publication of banned literature in the USSR [Russ.,= self-publishing house]

The ‘money’ quote

John Hawkins: Now, in recent years we started to hear more people calling to get rid of the Federal Reserve. Good idea, bad idea? What are your thoughts?

Thomas Sowell: Good idea.

John Hawkins: Good idea? What do you think we should replace it with? What do you think we should do?

Thomas Sowell: Well it’s like when you remove a cancer what do you replace it with?

63 comments to The ‘money’ quote

  • A couple of days ago I was trying to explain to my sister what modern money is, and after a while I realised that all I could explain was what it isn’t. I found this personally very distressing.

  • Actually on the subject of central banks, perhaps somebody can answer a question that has been puzzling me. That is- why do governments borrow money instead of just printing it themselves?

    I’m not advocating money supply expansion. We all agree that is bad. But if you are a government and you want to expand the money supply; if you want extra cash to buy votes with, why would you borrow it? You have absolute power. You can just tell your mint to print a billion notes, then spend them into the economy. So why borrow it and lumber yourself with a national debt and interest payments?

    What is the rationale behind government borrowing, from the statist point of view?

  • jamess

    Does borrowing money keep the scam running by making people (the politicians included) think that money has intrinsict value?

    There’s more economic sense in Obelix and Co. (and in Duck Tales) than in most economic “experts.”

  • PeterT

    “why would you borrow it?”

    To give the impression that you will pay it back perhaps?

    Also, the amount of value you can raise from printing money is an inverse function of the expected future inflation rate. So at the limit it won’t work. Imagine all your employees and suppliers include a clause in their contracts saying that their wages and payments must increase with realised inflation. If we for the moment assume that printing money causes inflation (not denying it, but there are lags, matters of incidence and so on) then doing so will cause the problem you are trying to solve (not enough revenue). This means that there is a limit to the extent to which you can solve your financing problems by printing money.

    There is an analogy to the roll over of debt. There is nothing in theory that would stop you rolling over your debt infinitely without every paying it back. It would be a huge Ponzi game. However, at some point people won’t be willing to lend any money to you, for fear of not having it returned. And at that point everything collapses.

    While I haven’t followed this reasoning to the end I suspect that ultimately you are correct that the two are economically equivalent. Probably the dominant factor is that debt is socially acceptable whereas printing money isn’t really. I am aware that the central bank prints money all the time – but people don’t realise this (it was a bit more obvious with QE).

    By the way, it is a recognised phenomenon in developing countries that inflation surges around election time, as the ruling party bankrolls its campaign.

  • Roue le Jour

    My completely ignorant assumption is that they do print it, they print it all the time, that’s why we have inflation in the first place and beer isn’t a couple of bob a pint like when I was a lad. If they printed any more, inflation would run away, and that’s a problem now. Borrowing, on the other hand, boosts GDP and is a problem later, i.e. someone else’s.

  • …is having an inflation target above zero part of the problem here? Or from the state’s perspective, part of the solution?

    Even at 2% rates (assumong they’re correct and not understated) the transfer of value from my saved money to the producer of money is substantial.

    In effect inflation targets above zero are simply a tax.

  • Midwesterner

    Actually on the subject of central banks, perhaps somebody can answer a question that has been puzzling me. That is- why do governments borrow money instead of just printing it themselves?

    To remove it from circulation. If there is $100 in circulation and they print and spend $50, there are $150 dollars circulating and market prices adjust upwards. If, on the other hand, they borrow spend the $50 dollars, there is still only $100 dollars in circulation and prices remain steady.

    This is the principle reason why ‘monitizing’, printing money, is considered the beginning of the end.

    The big question with ending the Fed is how to continue levying income taxes. There is a reason that the Fed and the 16th amendment arrived at the ball hand in hand.

  • Ben

    Modern money is effectively a share certificate to a pool of assets, but in a convenient denomination. You can only get Gilts in denominations a little too large to buy a coffee. (Convenient to buy the coffee company though).

    What matters is the value of those assets on the world market. Because if everyone suddenly decides to switch from pounds to dollars, that is only a problem if the underlying assets cannot be sold for dollars.

    Those assets include gold, money issued by other banks, bonds issued by governments, FOREX and interest rate futures of various kinds, and other financial instruments.

    The value to you is that you can exchange your pound for something you actually want. What ensures that value is the expectation that the bank will at some point be able to exchange the backing assets for something of value too.

    Your £1000 is worth something to Johnny (including Johnny Foreigner) because your Bank holds assets that Johnny’s bank considers valuable. As long as Johnny’s bank likes the look of 10-year gilts, the Bank of England can swap 10-year gilts for gold or something else with Jonny’s bank, and it won’t matter that gilts “just” are a promise by the government to pay. And that will be true as long as the Government looks like it will be able to repay in ten years.

    (How do they repay? By either taxing Pounds, or more likely buying pounds using Gilts as currency, then giving the pounds to the bondholder, in this case the Bank of England. This is basically equivalent to a share buy-back: It reduces the value of the assets pool as the Gilts are no longer held, but the issued share capital, i.e. currency in circulation, is reduced, so the value of each share is more-or-less unnaffected).

    Johnny’s bank will get the yield on the gilts, to pay out as interest to depositors. So Johnny’s bank is happy to accept your £1000 as it is a claim on a package of gold, gilts etc.

    (I’m assuming we aren’t just going to have Johnny Foreigner buy British goods with the money as that makes the story too simple).

  • Laird

    Also, Ian, you do realize that for the most part the Treasury doesn’t actually “print” money (just the relatively small amount of bills in circulation), but rather creates it in electronic form via computer entries, right?

  • John

    Midwesterner:

    The big question with ending the Fed is how to continue levying income taxes. There is a reason that the Fed and the 16th amendment arrived at the ball hand in hand.

    Interesting. Can you elaborate on that? Why is the Fed necessary to income taxes? (Not that I’d mind them not continuing. From my perspective that’s a feature, not a bug.)

    I’ve often wondered what manner of bad things would happen if we just explicitly allowed the government to inflate the currency through printing money up to a certain cap (with a constitutional moratorium on borrowing or taxing in any other way). I’m sure it would be bad, I just wonder what kind of bad, and, since perfect is not one of the choices, how it would compare to the mess we have now.

    I can see one upside to it: No more IRS.

    N.B. I’m not advocating this, it is a thought experiment.

  • Ben

    “That is- why do governments borrow money instead of just printing it themselves?”

    “[My] assumption is that they do print it, they print it all the time, that’s why we have inflation in the first place and beer isn’t a couple of bob a pint like when I was a lad.”

    If the government literally just printed money, that would be the same as if the money was backed by bonds which everyone knew would never be repaid.

    The result is that nobody would want the money and you would be unable to spend it. People would use dollars or euros instead – or barter.

    Which is exactly what happens in those countries whose issuing banks don’t back the currency with assets which command the confidence of world market participants.

    -

    “…is having an inflation target above zero part of the problem here? Or from the state’s perspective, part of the solution? ”

    Inflation is there on purpose. Generally it is a way of making exports cheaper so as to maintain employment. This helps struggling export industries. Industries which are not struggling are at liberty to give correspondingly higher wage increases.

    Why do struggling industries not simply cut wages? That would have the same effect surely? Yes, yes it would.

    However it is generally (but not universally) agreed that it is easier and less disruptive to give a below-inflation wage rise, than negotiate a wage cut. That’s particularly the case in places like England which are not “at-will” jurisdictions.

    As such, in a nutshell, the purpose of the inflation target is to make it easier for struggling industries to cut wages, thereby becoming more competitive and preserving employment.

    “Even at 2% rates (assumong they’re correct and not understated) the transfer of value from my saved money to the producer of money is substantial.”

    Inflation generally makes it cheaper to pay off debt, by reducing the real value of the debt. That’s true.

    But the beneficiary is current borrowers, on fixed rates, who don’t intend to roll over the loan. New borrowers, and rolled-over loans to existing borrowers, do not benefit because the interest they pay will account for expected future inflation. If inflation persists, savings rates will usually rise to account for this, because the savings rate is basically the borrowing rate, minus default insurance, minus fees, and minus commission. (Unless there is something else going on).

    If you are the government, you are going to roll over the loan by auctioning more gilts, and the presence of inflation means you won’t get as much for the new Gilts.

    This means that the government is generally NOT one of the parties which benefits from high inflation, unless they take advantage of inflation to buy back Gilts, which they rarely do since periods of high inflation usually co-incide with government budget squeezes.

  • llamas

    Gold-based currency / Land Value Tax in

    Five . . .

    Four . . .

    Three . . .

    Two . . .

    One . . .

    Which reminds me –

    How great is Amazon?

    So great that I was just offered – and bought – the complete 12-disc set of Thunderbirds – for less than $40.

    50 years later, in a country a half-a-world away, I can be transported back to the days of my childhood, overnight and with free shipping. Even 20 years ago, such a thing would have seemed like the stuff of dreams. Truly, we live in remarkable times.

    llater,

    llamas

  • Ben

    @llamas:

    A wise and succinct essay on the meaning of inflation.

    Thank you.

  • Johnathan Pearce

    Great line from Sowell.

  • Midwesterner

    John,

    In order for income taxes to be calculated, measurement of income needed to be standardized. To standardize measurement of income, legal tender laws were required and further, they had to stipulate a single medium of exchange. This paragraph will give you some idea of how many different ways mediums of exchange can be valued unless everybody is forced to accept only uniform one.

    Without a monopoly on legal tender, the gaming of income taxes would be utterly beyond anybody’s calculation, much less control. By shifting from gold to silver or even to other commodities, worth and profit cannot be calculated unless everything is valued in the same exchange unit at all times. Just for a mental exercise, imagine trying to calculate profit when raw materials are purchased using gold, finished products exchanged for silver, and employees paid with merchandise but on the next day rearrange the chairs according to the day by day, hour by hour markets prices. The IRS would be utterly helpless. The Constitution was set up to accommodate asset (ie property) and transaction (ie sales) taxes and tariffs. For these kinds of taxes, no economic calculations are required. The taxing authority just sets either a fixed tax rate or a percentage of the transfer. Income taxes require heinously complicated and gameable calculations. It is a license for corporatist favoritism.

    As to your second question, the problem is two fold. The size of the base currency pool has to be multiplied by the velocity that it moves around at. So, if you put a bundle of Hamiltons under your mattress, its velocity is once. You received it, you concealed it, it changed hands once. But if you put that same bundle of Hamiltons in a bank, the bank lends it out and somebody else spends it, the recipient puts it in the bank and the bank lends it out to somebody who spends it and the next recipient puts in it the bank who then lends it out, etc. Since banks in the US are required to hold back ten percent of demand deposits just in case ten percent of their depositors want to withdraw cash, this process can continue until the original bundle of Hamiltons behaves like ten times that many.

    The Fed system was created in order to exercise command and control of all banking. It didn’t happen immediately, there were state banks and S&Ls and others but for practical purposes, the Fed now controls all banking. In theory at least, it tries to use that power to maintain the multiple of the Hamiltons, the velocity, and they pay less attention to the amount they actually printed. In short, they try to manipulate the market, that is lending activity, with central control. When they say they are regulating ‘money supply’, that is misleading to say the least. There is no need to control base money supply, you either ‘print’ it or you don’t. What they are really attempting to do is regulate things they call M2, M3 etc ‘money supply’ but these are not in fact ‘supply’ but rather apparent supply because of velocity.

    But what if people don’t want to borrow money or can’t qualify for loans? Then banks stop relending and you might as well have put that bundle of Hamiltons under your mattress. This causes a massive reduction of commodity prices (food, gas, clothing, etc) because as a practical matter, when velocity of circulation drops there is less money circulating. There is still the original number of Hamiltons, but since the banks are not circulating it so rapidly, it changes hands a lot less often and we get what is called ‘deflation’.

    If you cap the number of Hamiltons that the Fed or whoever can issue, you still face the problem of bank regulation, ie can banks lend money that is supposed to be available on demand. Presently, the Fed permits 90% of money that is in demand accounts to be lent. It is this money and its volatility that causes the higher measures of money supply to expand and contract when things are economically uncertain. In other words, capping the number of Hamiltons that can exist just exchanges one set of problems for another. Currently the Fed has two roles, maintaining the money supply and dictating banking practices.

    My opinion is we eliminate the eliminate the 16th Amendment by reducing 16th Amendment revenue as a share of total Federal revenue by 10% per year until income taxes are completely abolished, then we eliminate the Fed and, dare I say it, let the market again determine the worth of various mediums of exchange.

  • Rob

    So you agree with Sowell…..

  • Midwesterner

    Me? Yes. But like getting down off of a roof, method matters.

  • Sigivald

    That’s a pretty lame response for Sowell.

    I one removes the Fed, one has to replace it with something.

    Now, what he’s implying (I assume) is that one need not replace it with a central bank issuing fiat money to banks with fractional reserve requirements.

    But it must still be replaced with something, even if it’s just a mandated return to metallic currency (or even more unlikely, free coinage).

    For all the faults a central bank and fiat money have (most of which are alleviated by not choosing inflationary policies), it bears remembering that metallic currency has its own significant issues.

  • I one removes the Fed, one has to replace it with something.

    Only to the extent that the ‘something’ is to replace it with a market.

  • PeterT

    “Without a monopoly on legal tender, the gaming of income taxes would be utterly beyond anybody’s calculation, much less control. ”

    I don’t buy this at all. There are ‘network externalities’ to having only a few currencies, and the exchange rate between them would be readily published. If you have enough currencies in an economy then this is no better than barter. You could have the ‘sheep’ currency, the ‘wheat’ currency, the ‘haircut’ currency etc.

    “For all the faults a central bank and fiat money have (most of which are alleviated by not choosing inflationary policies), it bears remembering that metallic currency has its own significant issues.”

    Doesn’t have to be metallic. Probably a gigantic pooled fund of liquid assets would do the trick. That is what the Chinese currency is ‘backed’ against, although it is a misnomer since the Chinese government does not guarantee to give you anything for your renminbi. I am guessing that for an early mover the pooled fund would mostly contain foreign currency. If all countries moved to the same model this would not be possible of course, so the pooled fund would probably contain commodities, either in direct holdings, or more likely, in certificates that said some party owed you X grams of commodity Y. A problem is that most banks do not have enough liquid assets (I define this here as excluding sterling for obvious reasons) to back all current accounts, so the exchange rate towards whatever assets would be used to back the new currency would have to adjust. In practice that would mean finding somebody willing to buy sterling for these liquid assets. This would lead to a cheapening of sterling in terms of these assets, i.e. their sterling price would go up.

    “To remove it from circulation. If there is $100 in circulation and they print and spend $50, there are $150 dollars circulating and market prices adjust upwards. If, on the other hand, they borrow spend the $50 dollars, there is still only $100 dollars in circulation and prices remain steady.

    This is the principle reason why ‘monitizing’, printing money, is considered the beginning of the end. ”

    Good reply. But really this is just saying that they choose to use debt because printing money would be inflationary.

  • MJ

    “Why is the Fed necessary to income taxes?”

    Rather the questions should be, why are income taxes necessary for the Fed? The answer is to insure a demand for whatever money the fed decides to use. The government, having the largest single demand for your money (at the point of a rifle, of course), is a simple reason to accept the use of said money. Gresham’s Law also helps once people are forced to take delivery of said government paper.

    “That’s a pretty lame response for Sowell.

    I one removes the Fed, one has to replace it with something.”

    One replaces it with what was there before the fed…the free market (which is certainly not lame), or what the constitution said the governments could allow as money (which is too complex for this point atm).

    What is the significant issue with metallic currency? That banks inflated their notes by fractional reserve banking and thus failed from time to time? That government can’t borrow money at will because there is an actual supply constraint, meaning they can’t fight perpetual wars (I use perpetual loosely).

    The URL over my name below will take you too a free reading of “What Has Government Done to Our Money?” by Murray N. Rothbard
    Read it if you have never done so, and follow up “The Case Against the Fed”

  • Midwesterner

    Interesting point on the cart/horse, MJ. It does work both ways. Without a need to track tax liabilities, most of us would probably use other mediums to varying extents.

    PeterT,

    The more I read your “I don’t buy this” paragraph, the less I understand it. Can you explain how it could work without a complicated tax code laying out rules for how to value everything, calculate income/expenses and calculate tax liabilities? And if gold went down and silver went up, what’s to stop people from valuing in whatever reduces their tax exposure?

  • MJ

    “I don’t buy this at all. There are ‘network externalities’ to having only a few currencies, and the exchange rate between them would be readily published. If you have enough currencies in an economy then this is no better than barter. You could have the ‘sheep’ currency, the ‘wheat’ currency, the ‘haircut’ currency etc.”

    The free market automatically narrows down the selection to a currency which is the most fungible. Please see the link below in my name, it is a 10m video of Walter Block discussing this issue. Should explain your questions.

    Thanks Midwesterner.

  • PeterT

    “The more I read your “I don’t buy this” paragraph, the less I understand it. Can you explain how it could work without a complicated tax code laying out rules for how to value everything, calculate income/expenses and calculate tax liabilities? And if gold went down and silver went up, what’s to stop people from valuing in whatever reduces their tax exposure?”

    The government could just make a law saying that everybody has to declare the value of the income they had, net of all expenses and whatever, during a year, in terms of currency X at the exchange rates prevailing at year end. Currency X would just be whatever currency the government had decided to use. Presumably it would just be the currency that was the most commonly used. I don’t think it is likely that there would be that many major currencies used within an economy. Maybe a handful. Tax payers might complain that the exchange rate at the end of the year did not reflect what it was during the year; the value of any deductables may have been higher during the year. To this the government just says “tough, you should look into currency forwards”. In any event I think it is clear that governments will find a way to raise the tax that they want.

  • Mid, thanks for your extensive post, most interesting particuarly the first two paragraphs. But a few things don’t quite gel for me.

    The hypothetical money “velocity” is V in MV=PQ. It is the number of times an average Hamilton is transacted during the time period over which PQ (“GDP”) is measured. You seem to be using the term to describe the fractional reserve multiplier which is a different thing so far as I understand it. It is simply inferred by dividing GDP by M, the money supply.

    Central bank operations don’t adjust the FRB (your “velocity”). They adjust the base money supply M0, which then indirectly adjusts M3 due to the FR multiplier.

    Further thoughts:

    Only base money, M0, is actually available for transactions. You cannot transact M3 Hamiltons. An M3 Hamilton is merely an aspiration to have (temporary) access to M0 Hamiltons for transactions. If people attempt to transact more than M0 Hamiltons, the banks do not have the liquidity available, and there is a bank run.

    It’s debatable whether the Velocity of money changes much. Milton Friedman didn’t think it does. Most of the M0 in the economy “clocks” through at a regular rate, which is generally monthly these days (monthly pay cheques, monthly bill settlements etc).

  • Chuck6134

    He says it all in just a few words. The fact that men like this aren’t in our government proves we are doomed.

  • Midwesterner

    Ah, you’ve cut to the key point. I deliberately blurred the distinction between the multiplier and velocity. Here is why. The way the multiplier works is by allowing M0 to move a lot faster. You hit this exact point in your observation that:

    Only base money, M0, is actually available for transactions. You cannot transact M3 Hamiltons. An M3 Hamilton is merely an aspiration to have (temporary) access to M0 Hamiltons for transactions. If people attempt to transact more than M0 Hamiltons, the banks do not have the liquidity available, and there is a bank run.

    What helped me understand money supply is when I took that same observation and realized that the consequential effect of the money multiplier was not to increase the amount of M0, it can’t, but to allow the existing M0 to circulate a lot faster. What we have are two separate ways of increasing the number of times that M0 changes hands in a fixed amount of time. One way is that people exchange their Hamiltons between each other faster. No banks are required for this method. The other way is to take those peoples’ Hamiltons and loan them to other people who will spend them. This is where FRB comes in.

    The multiplier and the fractional reserve rate are linked. Their movements correlate to each other. What is really happening is the money that people think they have in their pocket (accounts) is being picked out of their pockets, moved around a lot, and put back in their pockets before they notice it is missing. Both methods increase velocity, but the one way people don’t realize where the ‘extra’ money is coming from.

    FRB is in many ways similar to if I were to pick your wallet, bet on a horse, return the amount I picked, I keep the winnings. You’ll never be the wiser unless I bet on a loser. The banks, backed up by the Fed, in making shaky loans and then selling them indirectly to the Fed, has bet on a loser. Since the Fed has printing presses they can put new money, M0 money, in your wallet. But that doesn’t do anything about the money that went to the punter that bet on a winner. In the shaky mortgages case, the ‘winners’ were the homeowners and contractors selling houses. The ‘real’ money supply has still increased.

    I think the reason they like to call it money supply 2, money supply 3, money multiplier, etc is to preserve the “money for nothing” image. But it isn’t money for nothing, is it? The source of the money becomes apparent when they bet on losing horses.

  • Midwesterner

    Peter T,

    The government could just make a law saying that everybody has to declare the value of the income they had, net of all expenses and whatever, during a year, in terms of currency X at the exchange rates prevailing at year end.

    How does this differ from a monopoly currency? It sounds like you are describing the way things are now. Am I missing something?

  • 'Nuke' Gray

    Look, if we eliminated Central Banks, we’d need to adjust to multilpe systems of money all the time! We’d need to think for ourselves!!!! Who wants that?

  • Midwesterner

    BTW, when I used the term ‘bundle of Hamiltons’ I originally meant large amounts of physical currency, but I didn’t follow that nomenclature with complete consistency. Also, I’ve deliberately avoided discussing the digital creation of money since everything we need to know to understand what is going on predates digital money and was only enhanced and exaggerated by the e tech. For purposes of this discussion I am using the Hamiltons as a visualization of M0, exclusive of Ms 2, 3 etc. In other words, your bundle of Hamiltons is handed off to other people in your deposit account and it is replaced with M2 which is, as Ian B says, “merely an aspiration” to have Hamiltons.

  • Mike

    What’s all this talk of M3? We don’t need no stinking M3..

    Discontinuance of M3 (from about five years ago.)

    Oh wait… maybe that M3 concept could have been an indicator that drew attention to the ballooning of M3 via CDO-backed repos and more careful consideration of the risk. As in: “What if the velocity of the M3 backed by CDOs went to zero?”

    Or maybe it did, so that’s why it was discontinued.

    How many pounds in a pound of sterling?

  • I would pay many chickens to sit at the feet of Thomas Sowell and learn economic wisdom.

  • Darryl,

    But how much would the chickens learn, and how much would you have to pay them?

  • jamess

    I think I’m missing something here wrt multiple currencies and income tax.

    What would happen if, say, five currencies were legally recognised and income tax was based on income accrued in each currency?

    We’d obviously need a fixed rate income tax, and we could even allow the existence of a “favoured” currency – say income was only taxed on sterling after the first £10,000 per year – but no such offer was made on the other currencies.

    Towards the end of the tax year I may need to buy some euro’s with gold to lower my gold income tax whilst bringing my euro income up to zero. (Would this have a stabalising effect on currencies – or at least stabalise any possible increase in currency fluxuations brought about by multiple currencies?).

    (Shops obviously could accept payment in any currency, and banks would quickly find a way to make debit/credit cards function in various currencies – with transfers between currencies possible at the shopping till.)

    As always, enjoying learning about economics from people here!

  • Rich Rostrom

    Ian B: You have absolute power. You can just tell your mint to print a billion notes, then spend them into the economy.

    Ever see the movie Viva Villa? It’s a Hollywoodized biography of Mexican revolutionary Pancho Villa. At one point Villa takes over the government, and orders the printing of several million peso notes. Then he tries to pay the printers with the paper notes, but they insist on coin…

    IOW, if government just creates money in its account out of thin air, people will not regard it as having value. Money created within the banking system is a bit different; indirect enough that it doesn’t feel like cheating. (But the recent direct purchases of government bonds by the Fed with newly created money are tantamount to the government simply creating money to spend.)

    John: I’ve often wondered what manner of bad things would happen if we just explicitly allowed the government to inflate the currency through printing money up to a certain cap (with a constitutional moratorium on borrowing or taxing in any other way).

    See Robert A. Heinlein’s 1941 science-fiction novel Beyond This Horizon. In the future society described, the productive economy is expanding so fast that all the expenses of government are paid out out of money newly created to avert deflation. And then some: the government is looking for ways to spend all the created money, and every citizen gets a quarterly grant from the leftovers.

  • Paul Marks

    There is actually a solution to the problem Ian presents.

    Why does government just create money and spend it – rather than create money, lend it out (for example to Goldman Sachs) and then borrow it bad (for example from Goldman Sachs) at a higher rate of interest?

    It does not just create (which can include “print” even today) and spend because THAT WOULD BE OBVIOUS – the last thing the government (or the academics, or the bankers, or …..) want to be is straightforward. Otherwise they would be hanging from lamp posts (oh no “violent rhetoric” the next time a LEFTIST goes off and kills some people I will be to blame).

    Modern economics books (of the sort that those who run the universities favour) and even modern news reports do not explain things – they obscure them. Whether this is deliberate or not I leave to others.

    It goes back a long way – for example J.M. Keynes endorsed the “monetary crank” theories of Major Douglas and others, but he did NOT say the government should print out money and hand it to people (which is basically what Major D. did say).

    On the contrary Keynes fully supported this – do it via the banks (and other such) approach (at least most of the time – remember John Keynes can be quoted for and against virtually anything). He did this for two reasons.

    Firstly it gets important special interests on your side – if you just hand out money to people what special benefit is there to bankers (and others such) from this? And if there is no special benefit for them – WHY SHOULD THEY SUPPORT YOUR POLICY?

    But also it makes the whole scheme COMPLEX (even the above is a vastly simplified vision of it – the reality is wildly more complex) and complexity looks SPECIAL – “scientific” and so on.

    If you just had a printing press and handed out money the “man in the street” (even if you were handing him the money) would say “this is insane STOP THIS”, but make it very complex and obscure and the man-in-the-street says “I do not really understand all this” and walks on – leaving the government to carry on.

  • Jamess:

    What would happen if, say, five currencies were legally recognised and income tax was based on income accrued in each currency?

    What would happen if five kinds of breakfast cereal were legally recognized? Currency is a commodity, in many respects like any other. What you are proposing is a regulated currency market, as opposed to the nationalized one we have now. It never works in the long run, and often results in re-nationalization.

  • Ben

    Wow, I really wasted my time, didn’t I?

  • PeterT

    Midwesterner


    “The government could just make a law saying that everybody has to declare the value of the income they had, net of all expenses and whatever, during a year, in terms of currency X at the exchange rates prevailing at year end.”

    How does this differ from a monopoly currency? It sounds like you are describing the way things are now. Am I missing something?”

    You can still use whatever currency you want, but for the purpose of calculating your taxes the government says you have to use currency X according to such and such rules. Its no different from ASDA saying that they will only accept payment in gold. Well except that you have to pay taxes but don’t need to shop at ASDA, but that is a different issue.

    I remember reading a pro-competitive issue piece (in the FT of all places) quite some time ago (I think it was written by Samuel Brittan). It pointed out that there was no legal impediment to issuing your own currency in the UK and that one way the government could promote competitive currency issue (assuming that it wanted to do so) would be to accept tax payments in a variety of different currencies.

    Maybe we have a UK/US confusion between us?

    On a wider note, I really don’t see why people (not here) insist that central banks are necessary. It really isn’t that complicated.

    There is an argument that for developing countries it is more effective to raise revenue by printing money than through tax, since the latter requires a tax bureaucracy, accurate record keeping and so on. Actually, this has attractions from a civil liberties perspective. Greater evil and so on.

  • Well Ben, I appreciated your informative comments, at least.

  • John

    Ben:

    Wow, I really wasted my time, didn’t I?

    I too appreciated your comments and thank you for making them, but unfortunately didn’t really understand them. I’m trying right now to improve my understanding of finance and the macro economics that goes along with it, but apparently I’m not quite there yet. Your remark above may indicate that I’m not the only one who didn’t follow.

    Question:

    In an inflationary environment more money is entering the economy and diluting the value of the existing money. No new value is created, just new money. If the government is not the beneficiary of this new money, who is? (I don’t mean holders of fixed rate non-roll over debt, that’s second order, a result of the inflation. Who gets to spend that extra money in the first place?)

    Is there a meaningful distinction between it benefiting the gov directly or being granted to favored constituencies?

    snip
    OK, the smitebot didn’t like that remark, I’ll just leave it out… It would be cool if the bot worked on the preview but maybe that wouldn’t be effective enough…

  • In an inflationary environment more money is entering the economy and diluting the value of the existing money. No new value is created, just new money. If the government is not the beneficiary of this new money, who is?

    The Austrian take on this AIUI is that the beneficiaries are those who directly receive the money from government and are able to spend it at its “old value” before inflation has reduced that value. As the money then filters through the economy it inflates to a lower value, so it is worth less when us proles get it. Von Mises concluded therefore that this acts as a continual ratchet of wealth towards government connected plutocrats, at the expense of the middle and lower classes.

    I think one crude illustration might be; you get 100 Hamiltons as a government toady. You buy gold or some other asset with it. Inflation sets in, as the rest of the economy gets the 100 Hamiltons, pushing up the price of your gold to say 110 Hamiltons, while “everybody else” has only got 100 to spend on the now higher priced gold. This process repeats over and over, “wiping out” the lower classes’ wealth.

  • Philip Scott Thomas

    This has been quite an educational thread. Thanks to those who have provided answers to questions asked.

    I’d like to add another question to the mix, though. I’m fairly new to economic theory. What I know I’ve learned from Tim Worstall. Is there a book/website that explains velocity, M0, M3 and so on to non-economists?

  • Philip, I don’t know about a book, but I seem to recall that the Wikipedia entries on the subject are surprisingly not bad (I’m sure others will correct me if I’m wrong).

  • Midwesterner

    jamess,

    We would need a tax lawyer to address you question but my speculation is that without stipulating that everything has to be valued in one uniform currency at the time of the transaction, it would be possible to conduct your business so that you were losing value when in fact, your were profiting.

    PeterT,

    IIUC, we can presently use whatever currency we want. But we have to value it at all times in US dollars and calculate capital gains for taxes. When I was looking to get out of dollars and into gold, I looked at several different routes including funds, physical gold, futures and e-gold, etc. The only one that could accommodate the small and volatile amount of money I could invest was e-gold. I described e-gold to my tax accountant and asked if I could keep my money in it and use it for transactions, she had me explain what it was, then, as the light (darkness?) slowly dawned (settled?) on her, she did everything short of holding up a wooden cross and spraying me with holy water. In no uncertain terms, she told me that if I use e-gold, I can find another accountant. Why? because the problem with all of the other currencies and commodities is that they have to be converted into something standard so that uniform taxes (or not so uniform if you bribe the right congress critters) can be calculated. It is easier, accounting wise, to calculate gold futures gains than to actually conduct business in gold (and pay all of your taxes). Otherwise, I could just time all of my purchases to happen at advantageous times in the gold/$ exchange rate. As long as you are selling 20,000 bushels of corn once a year or whatever, it is easy. But once you start to do daily ‘nickel and dime’ retail transactions in it, it becomes a mandate for a new accounting industry.

    My point is that every single transaction in every single medium of exchange would need to be valued and calculated in dollars at the time of each transaction. It is possible that I explained it to her wrong or she misunderstood what I was saying, but she was quite clear that I needed to track the value of the gold relative to dollars at the time of each transaction. I imagine this is because by timing transactions to the variance in the gold price, I could evade income in dollars while at the same time profiting in gold. If I feared dollar inflation, I could convert all of my dollars into gold, and buy my supplies throughout the year in gold, have no gold left, have a lot of supplies, and have avoided a ton of taxes that I would have paid if I had adjusted the price of gold in each transaction to the current price in dollars and declared the gains on that gold.

    Like most people here, I believe the war on drugs and money laundering, etc, is really a war on tax avoidance. With that thought and our countrys’ present financial straits, I doubt any form of non Fed reported, approved and supervised transactions will be tolerated.

    If e-gold or something similar were to automate the capital gains calculations, provide quarterly statements and report everybody’s transaction detail to the IRS and BATF and FBI and ICE and Treasury and Fed etc, it might be tolerated and it might catch on. Actually, as I think about it, not even then because it would facilitate people not holding dollars. They would find some other way to make it untenable. Somebody has to hold onto those shrinking dollars or the ‘print more’ scheme collapses.

    Without the uniform calibration currency, there is no possible way to calculate income taxes. What taxes are payed in doesn’t matter all that much, it is what transactions are valued (and taxes calculated) in that matters. As the dollar (and other currencies) go steadily down the shitter, the need to stay out of the inflating currency becomes stronger and so a greater share of the users find it worth the added trouble to convert it into other stuff (anything from forex to real estate) there are less and less people willing to hold dollars, velocity starts to hyperventilate and at some point, the currency is worthless.

    I’m sorry if this comment is confusing, I haven’t had much time to spend on making it simpler. Something that can’t always be done anyway.

  • PeterT

    Midwesterner at 10:21

    As you say governments can make life very difficult for users of alternative currencies. I thought you initially argued that a single currency was required by the government to keep it simpler for it to calculate and collect taxes. My point was only that to this the government would say to you: ‘YOU work it out and by the way you must pay an admin fee to us for having to verify that you are paying the correct taxes’.

    In an inflationary environment more money is entering the economy and diluting the value of the existing money. No new value is created, just new money. If the government is not the beneficiary of this new money, who is?

    Following on from Ian B’s point, in normal circumstances the central bank creates money by lending new money (created out of nothing) out at a sub-market rate of interest. The borrowers are first in the food chain for the new money. I suspect this is one reason why bankers are paid so much, there is just loads of money slushing around; but I don’t have anything to back this suspicion up with.

  • Midwesterner

    PeterT,

    You mean like trying to comply with this while doing business in many different currencies and commodities without a requirement that everything be converted in real time to a single currency’s valuation? It wouldn’t and doesn’t matter what the IRS says you must do. When things reach a certain complexity, compliance becomes impossible. Tax accounting could make fluid dynamics look like grade school algebra.

  • Roue le Jour

    Ben,

    I didn’t reply to your comment because I didn’t get what point you were making. I said the Government creates money all the time. I wasn’t entirely sure whether you were disagreeing with ‘Government’ or ‘creates money all the time’.

    I guess it was ‘Government’, since ‘creates money all the time’ is pretty indisputable. Then fair enough, it’s actually the central bank that creates money, not the Government. That also supplies a simple answer to Ian B’s question. The reason why the Government borrows rather than prints is that it doesn’t own the printing presses, the central bank does.

    More to the point, ‘money’ as we understand it, is debt. Every pound in existence is borrowed from the central bank. In a sense, a pound is brought into being by the act of borrowing it. Thus only way you can obtain a pound is to borrow it yourself or get it from somebody who has borrowed it. This is a fundamental property of fiat currencies and is just as true for governments as anyone else, so borrow or tax are the only options. If the Government were to literally print notes, or order the central bank to give it money, it would effectively be counterfeiting it’s own currency, since those pounds were not borrowed from the central bank.

  • I like Sowell but thats a bullshit analogy. Monetary policy always exists. Something has to replace the Federal reserve. It could be free-banking with open currency competition, or I dunno lots of other stuff, but there is something that replaces it.

  • Midwesterner

    Contemplationist, you should read the question and the answer more carefully. The question wasn’t “will something replace it?” The question was “What do you think we should replace it with? What do you think we should do?

    Assuming the “we” is the same authority that created the Fed, his answer was correct. We should not replace it with anything. Your answer “free-banking with open currency competition” is not doing something, it is doing nothing. We need a little more of governments doing nothing. Simple ending the Fed and not replacing it will take us back to something much closer to the situation you suggest.

  • Paul Marks

    Ben you did not waste your time – but you did not deal with the question asked.

    The question was not “why do governments inflate the money supply” (you gave a good reply to why they do that).

    The question was “why do governments inflate the money supply by producing money lending it out and borrowing it back – rather than just print and spend it”.

    The short reply to the question is that the complex method is chosen BECAUSE it is complex (in fact far more complicated that I have presented it).

    If governments just printed money and spent it, the public would not stand for it. Not even the British public.

    Things have to be made so complex (and cant filled) that the public do not understand what is going on.

  • Paul Marks

    What should replace the current system?

    There are two replies – a strict libertarian one and a Constitutional one.

    A strict libertarian one is as follows:

    What people choose to use as money (in their voluntary contracts) is money – that is how money evolved in the first place (see Carl Menger – “Principles of Economics” 1871). For example silver was used as money for many hundreds of years BEFORE the invention of coinage.

    How was that possible? Simple, – people traded by weight (and purity), no need for a King’s head.

    Indeed as recenly as the early 20th century Chinese merchants tended to ignore the head on a coin – they weighed it and checked it for purity (they had developed a keen sense for that over thousands of years), that was all that interested them.

    In civil society gold may be currency, or silver, or copper – or WHATEVER PEOPLE VOLUNTARILY AGREE ON IN THEIR PRIVATE CONTRACTS.

    As for loans – they come from SAVINGS (sorry for using the dirty word “savings”).

    If there are no savings there can be no (honest) loans.

    If there is only X amount of savings there can only be X amount of (honest) loans – NOT MORE. And one can not just redefine the word “savings” to include money which is NOT savings.

    Oh dear how “reactionary”.

    But there is also a Constitutional reply.

    Under the Constitution of the United States Congress only has the money to “coin” money (it need not coin money – there were private mints in the early 19th century, but it can coin money if it wishes to do so).

    The word “coin” is not an acciedent – the Continental Congress had tried PRINTING money, and it had worked out very badly hence “not worth a Continental”.

    In this way (contrary to the education system) the Constitution of the United States gives LESS power to the Congress than the Articles of Confederation gave to the Continental Congress.

    “But what should the coins be made of”.

    Well the outer covering can be anything you like (perhaps transparent plastic), but the actual money itself may (according to the Constitution) be only certain things.

    In fact two – no State in the Union may have anything other than “gold or silver” coin as legal tender.

    So if it is “legal tender” you are interested in – it had better be gold or silver coin.

    By the way do NOT fix the exchange rate of the gold or silver coins – if you do you will either drive out of circulation the gold or the silver coins.

    This is because the value of gold and silver, in relation to each other, naturally changes over time – so even if you fix the exchange rate honestly, it will soon be a FALSE exchange rate.

    The relative value of the gold and silver coins must be allowed to change freely.

    Just as any piece of paper (such as banker’s draft) or computer entry must be 100% from real money.

  • There’s been a lot of good comments in this thread. I’m inclined to agree Paul that one strong reason for the current money system is that it’s virtually impossible to understand. Besides all else, it means that if people like us criticise it, it’s very hard for anyone listening to us to know if we’re right or wrong in what we say.

    We ought to have an annual prize for the most succinct and clear explanation of the financial system. We need an explanation that a reasonably intelligent listener can grasp before their eyes glaze over from boredom and confusion.

  • Bod

    Samizdata ‘Liberty Award’?

    In principle, I’d actually be prepared to donate every year to fund some of the prize money.

  • So here’s a thing for clarification. When the government “borrows” money, is new money created? Do we have a consensus[1] on this?

    Would it be fair to say that if the government borrows 1 Hamilton, that is taken from M3 and turned into M0, allowing up to 10 Hamiltons of new M3 to be created? Or is that wrong?

    Clearly the borrowing process creates money (doesn’t it?). How else is consistent inflation produced without, under normal circumstances, “QE”, that is overt money printing?

    [1] To coin a popular phrase.

  • no need for a King’s head

    Indeed, off with it!

  • Roue le Jour

    Ian B,

    So here’s a thing for clarification. When the government “borrows” money, is new money created? Do we have a consensus[1] on this?

    I think as Paul says, the system sets out deliberately to confuse. If the Government borrowed directly from the central bank, it would obviously be newly created money. Instead the Government borrows on the open market, meaning the money could come from anywhere, but if the Government is offering a greater rate of return than the central bank is charging, then it almost certainly comes from banks that borrowed it from the central bank, turning a profit in the process for helping the Government cover its tracks.

    In QE, by contrast, the money is overtly borrowed directly from the central bank.

    Clearly the borrowing process creates money (doesn’t it?). How else is consistent inflation produced without, under normal circumstances, “QE”, that is overt money printing?

    I believe that is the very definition of fiat money as we understand it, that it is created by borrowing from the central bank. This naturally limits its creation, promoting confidence and leading to convertibility.

  • Midwesterner

    Ian B

    Would it be fair to say that if the government borrows 1 Hamilton, that is taken from M3 and turned into M0, allowing up to 10 Hamiltons of new M3 to be created? Or is that wrong?

    I don’t like to introduce electronic money into examples because it confuses unnecessarily. So let’s imagine all M0 is paper money (the Hamiltons, who’s face is on the twenty) and M1,2,3 is ‘virtual’ money created by the money multiplier. It shows up on your account statement but the actual paper money it promises doesn’t exist, it has been lent out. In this model, virtual money can not be put in a vault, only paper money can. M1,2,3 is money that doesn’t really exist. It is just M0 money moving around really fast. Faster than you notice it is missing from your account.

    This is why I deliberately conflated the money multiplier with velocity. Any time any paper money is actually placed in the vault, regardless of apparent source, it ceases to have a multiplying effect. This is because in order to put it in the vault as paper cash, it had to come out of the M0 – paper money – pool. That means that when the government borrowed and vaulted $100 dollars of paper money, it reduced M1,2,3 by $900. That paper money is no longer somewhere else, multiplying to make other loans.

    Put a little differently, when the government borrows $100 of M1,2,3, it ceases to be M1,2,3 when they convert it to paper to put it in the vault. It becomes M0 when it is tied up in the form of paper cash in a vault. So M0 paper money is missing from other vaults.

    However, if the government spends the $100, it behaves the same as if anybody else had borrowed and spent it. That is to say that $100 can multiply back to the $1,000 that it reduced M1,2,3 by when it was borrowed as cash.

    In summary, when the government borrows money to spend, it has no effect on money supply, only on the amount of money available for free market activity. That is because even with the multiplier, the money supply is finite. For now. If the government, instead of borrowing the money, ‘bought’ it, that is permanently removed the cash from circulation, the higher measures M1,2,3 would be reduced by ~10x the amount of cash ‘purchased’. Unfortunately, the only way the government can ‘buy’ money is by taking it as taxes, fines, tariffs, etc and then, instead of spending it, shredding it.

  • Midwesterner

    Borrowing from the central bank, unless the central bank funds are first borrowed on the open market, is an entirely different beast than borrowing on the open market’.

    ‘Borrowing’ from the central bank is a bit of a fiction. No, it’s a hell of a fiction. At best it is short term monitizing of debt. At worst it is poorly disguised permanent debasement of the currency.

  • Paul Marks

    Midwesterner – who decided to put Andrew Jackson’s face on the note?

    Were they being ironic (taking the p… as we say in Britain) – or just incredibly ignorant?

    It is almost as bad (although not quite) as putting Senator Benton’s face on the 100.

  • Midwesterner

    I just caught my “the Hamiltons, who’s face is on the twenty” error. Hamilton hasn’t been on the twenty since the 19th century. Since 1928, it’s been Jackson.

    Paul, I don’t know. Did Orwell serve on the selection committee? For anybody that doesn’t understand Paul’s comment, Wikipedia even mentions it.

    I think it was deliberate. Call me a suspicious cynic.

  • You are a suspicious cynic. And I cynically suspect that you are right.