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I think people are confusing consumer debt and fiat money, fiat money in the US is backed on the strength of the economy and acceptance as legal tender for taxes/public debts.
"Fiat money achieves value because a government accepts it in payment of taxes and says it can be used within the country as a "tender" (offering) to pay all debts. In effect, this allows it to be used to buy goods and services and to pay tax. Where fiat money is used as currency, the term fiat currency is used. The most widely-held reserve currency, the US dollar, is a fiat currency, as are other widely held currencies like the Euro, Pound Sterling and the Yen."
The problem with using a metal based economy is that it is limited in quantity, so as population increases the value of the money would actually increase (more people chasing a fixed amount of money). Without a way for the money supply to expand in relation to increases in population, increases in productivity, and increases in markets, and interest rates the money supply would go through massive deflationary pressure without similar increases in finding, smelting, and storing more precious metals. There would be no more debts at all if deflationary pressure happened, as money would be worth more in the future then now (time value of money) and people will hoard it.
The balance of accounts to foreign countries would also have a fixed transfer of gold in order to pay them, similar to earlier experiences with Spain during the colonial period that produced a big inflation (from expected currency from the new world to fixed output) to deflation and bankruptcy as gold was spent to finance more expeditions and sent to foreign markets as the finds dwindled. Those who are net exporters will bankrupt the importers as the metals are transferred.
"Deflation is, however, the natural condition of hard currency economies when the rate of increase in the supply of money is not maintained at a rate commensurate to positive population (and general economic) growth. When this happens, the available amount of hard currency per person falls, in effect making money more scarce; and consequently, the purchasing power of each unit of currency increases. The late 19th century provides an example of sustained deflation combined with economic development under these conditions."
My understanding (I am not an economist) is that there is also a theory called endogenous money creation.
It says, more or less, that the consumer demand for loans is what creates money in our system. Banks lend to consumers FIRST, then go borrow reserves later from central banks.
I further understand this to mean that central banks do not have the level of inflationary ability that many assume, at least not as long as the consumer is shunning debt. Inflation has more to do with the American consumer's demand for debt than it does with Central Bank policy. I realize this is a controversial point of view.
I think people are confusing consumer debt and fiat money, fiat money in the US is backed on the strength of the economy and acceptance as legal tender for taxes/public debts.
"Fiat money achieves value because a government accepts it in payment of taxes and says it can be used within the country as a "tender" (offering) to pay all debts. In effect, this allows it to be used to buy goods and services and to pay tax. Where fiat money is used as currency, the term fiat currency is used. The most widely-held reserve currency, the US dollar, is a fiat currency, as are other widely held currencies like the Euro, Pound Sterling and the Yen."
The problem with using a metal based economy is that it is limited in quantity, so as population increases the value of the money would actually increase (more people chasing a fixed amount of money). Without a way for the money supply to expand in relation to increases in population, increases in productivity, and increases in markets, and interest rates the money supply would go through massive deflationary pressure without similar increases in finding, smelting, and storing more precious metals. There would be no more debts at all if deflationary pressure happened, as money would be worth more in the future then now (time value of money) and people will hoard it.
The balance of accounts to foreign countries would also have a fixed transfer of gold in order to pay them, similar to earlier experiences with Spain during the colonial period that produced a big inflation (from expected currency from the new world to fixed output) to deflation and bankruptcy as gold was spent to finance more expeditions and sent to foreign markets as the finds dwindled. Those who are net exporters will bankrupt the importers as the metals are transferred.
"Deflation is, however, the natural condition of hard currency economies when the rate of increase in the supply of money is not maintained at a rate commensurate to positive population (and general economic) growth. When this happens, the available amount of hard currency per person falls, in effect making money more scarce; and consequently, the purchasing power of each unit of currency increases. The late 19th century provides an example of sustained deflation combined with economic development under these conditions."
Your post goes a long way towards explaining why it is that virtually no country on earth continues to maintain the gold standard (and have not done so for three quarters of a century). Deflation is even more dangerous to an economy than Inflation.
It says, more or less, that the consumer demand for loans is what creates money in our system. Banks lend to consumers FIRST, then go borrow reserves later from central banks.
Okay, I have no idea where you found this. Banks are required to keep a fraction of deposits on hand and then lend out the rest, they can't borrow money from the fed to cover liquidity reserves (save if the bank fails). They can from over night markets from other banks if demand deposits force them to dip into reserves. This is the definition of the term fractional reserve banking (Fractional-reserve banking - Wikipedia, the free encyclopedia).
Okay, I have no idea where you found this.B anks are required to keep a fraction of deposits on hand and then lend out the rest, they can't borrow money from the fed to cover liquidity reserves (save if the bank fails). They can from over night markets from other banks if demand deposits force them to dip into reserves. This is the definition of the term fractional reserve banking (Fractional-reserve banking - Wikipedia, the free encyclopedia).
Google "Endogenous money stock" and you should be able to find more about it. It is a component of post-Keynesian economics.
Google "Endogenous money stock" and you should be able to find more about it. It is a component of post-Keynesian economics.
The money supply theory makes some sense what they are trying to get at, but it doesn't mesh with a great deal of other factors. It is not a generally accepted money theory in the community when I was in school, but an interesting idea (I have an undergrad in economics, specifically econometrics).
The assumption of the model assumes that the central bank has little influence on loan/credit market is dead wrong...with reserve limits and interest rates, you can't loan out more assets then you have. No matter what demand is.
Repayment of loans does not create reserves as well, reserves are actual hard cash the banks are legally required to have on deposit...the theory is backwards on fractional reserve banking legality.
Repayment of loans also does not "destroy" money, the base amount of money remains the same but the amount available to loans increases...it's an accrual offset account. It doesn't differentiate between base money supply and money in play, base money stays the same in banking (with increases from interest rates) that offsets reserves, loans, and deposits. Loaned amounts increase money supply in play, but if you look at the banks books they largely offset. You destroy money in play by increase reserve amounts.
On one hand, I don't have the education required to really rebut your points. I go by what I read, what seems logical.
I first read about this earlier this year, and I have been sort of stewing over it, thinking about what it really means. I've probably read the following article 10 times, and I'm just starting to understand the point.
Thus loans come first—simultaneously creating deposits—and at a later stage the reserves are found. The main mechanism behind this are the “lines of credit” that major corporations have arranged with banks that enable them to expand their loans from whatever they are now up to a specified limit.
If a firm accesses its line of credit to, for example, buy a new piece of machinery, then its debt to the bank rises by the price of the machine, and the deposit account of the machine’s manufacturer rises by the same amount. If the bank that issued the line of credit was already at its own limit in terms of its reserve requirements, then it will borrow that amount, either from the Federal Reserve or from other sources.
If the entire banking system is at its reserve requirement limit, then the Federal Reserve has three choices:
refuse to issue new reserves and cause a credit crunch;
create new reserves; or
relax the reserve ratio.
Since the main role of the Federal Reserve is to try to ensure the smooth functioning of the credit system, option one is out—so it either adds Base Money to the system, or relaxes the reserve requirements, or both.
Thus causation in money creation runs in the opposite direction to that of the money multiplier model: the credit money dog wags the fiat money tail. Both the actual level of money in the system, and the component of it that is created by the government, are controlled by the commercial system itself, and not by the Federal Reserve.
On one hand, I don't have the education required to really rebut your points. I go by what I read, what seems logical.
I first read about this earlier this year, and I have been sort of stewing over it, thinking about what it really means. I've probably read the following article 10 times, and I'm just starting to understand the point.
It does make sense to a point, it's been bounced around for about 3 decades without a good fit though.
The problem with that article there is that it's dead wrong in legal and practical sense of fractional reserve banking. When you take in a deposit you physically (or electronically) move money to a reserve account with the fed, that money the bank cannot touch save for demand deposits in excess of your operating cash. If they get demands beyond their operating cash and cannot meet the reserve requirements, they loan from the bank to bank loan market till they can (and they need to do it fast, why it's called the overnight market). If they cannot make it from their own cash or bank to bank loans, the fed can step in and very short term loan them a little bit. If they go to long, or the amounts are higher then they can justify to the central bank, the bank has just failed.
Going under the reserve limit more then a little while is a violation of federal law, they seize the bank if the management does not comply. Doesn't matter who the bank is, you cannot lend more assets then you have after your ratio has been met. Relaxing the reserve requirement is like taking a sledgehammer to the money supply. It has changed in 1968 (12.3%), 1978 (10.1%), 1988 (8.5%) and 1998 (10.3%).
I understand that the non-fed banks, such as Bank of America, need to have cash reserves, which limits the amount they can loan. But does the Federal Reserve need to have reserves when it "creates" money or loans money to the federal government to fund the bailouts? My guess is that the federal reserve does not have cash reserves simply because there doesn't seem to be a limit to the amount of new money it creates.
The problem with using a metal based economy is that it is limited in quantity, so as population increases the value of the money would actually increase (more people chasing a fixed amount of money). Without a way for the money supply to expand in relation to increases in population, increases in productivity, and increases in markets, and interest rates the money supply would go through massive deflationary pressure without similar increases in finding, smelting, and storing more precious metals. There would be no more debts at all if deflationary pressure happened, as money would be worth more in the future then now (time value of money) and people will hoard it.
This is, however, a misconception. Money measures relative worth. An expansion of the money supply isn't needed. A gold dollar would just buy more as it becomes more valuable and scare. This in turn would drive smaller coins to be minted.
Deflation, while defined as falling prices, is healthy. In fact you should see falling prices (and do even these days with infaltion) as technology advances and less labor is needed to manufacture goods. However just because prices fall doesn't mean there is deflation - if everything falls in relative value to each other has anything really changed?
In a game of monopoly, if you start with a certain amount of money, and then double it, what happens? Prices of properties begin to rise as they are bid up do to all the "new" money. Nothing really changes. Inflation is just as evil as deflation.
How did America expand so quickly in the 1800's and early 1900's without the Federal Reserve creating fiat debt? If what you say is true the lack of money would've prevented the country from ever entering the industrial stage.
Last edited by wheelsup; 09-08-2009 at 10:40 PM..
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