Why Do We Need Monetary Reform?
The monetary reform proposals of the Libertarian Party consist of three central planks. However, and before we can talk about what we'd like to change, we need to take a brief look at how the current banking system works, and expose the flaws that our policies seek to address.
Where Does Money Come From?
Most people think that the government creates all of our money by printing banknotes, and minting coins. But that is not the case. Let's start by looking at where the government gets its income from.
Government Income
Banknotes are printed by the Bank of England (BoE) on behalf of the government. The BoE then sell those notes at face value to commercial banks, who use them to fill their cash machines and to hand over to us when we withdraw money from our bank accounts. The profits from the sale of these notes by the BoE (known technically as seigniorage) is passed straight back to the government, and netted the Treasury the sum of £2.3 billion in the tax year 2007/081.
The second source of government income is well known and hated by us all—taxes.
Finally, the government gains income through borrowing. If insufficient funds have been brought in through seigniorage and taxation to meet the government's spending commitments, it sells bonds. Bonds are the equivalent of a government IOU, and promise the holder that the government will buy them back at a future date for the value of the bond plus some predetermined interest.
Raising money through selling bonds has a huge downside, though. It means that the government incurs debt. And, like the rest of us with debts (on a credit card, for example), the government ends up paying a sum of money each year simply to service those debts. Government estimates for 2007/08 put the figure that it will have spent on servicing its own debts last year at a staggering £30 billion2—over 20% of the total amount of income tax that we all paid!3
Money From Thin Air
Currently, around 97% of the 'money' in our economy isn't in the form of notes that you can fold, or change that weighs down your pockets—it's in the form of credit (or debt, depending upon which side of the transaction you are standing). So the real question to be asking if we want to understand where our money comes from is how all of this debt appears?
Our commercial banks create money as debt, effectively from 'thin air'.
Imagine a person paying, to keep the example straightforward, £100 in notes or coins into their bank account. Now, bankers know that most of the time, most people leave their money in their bank accounts; we tend to pay for goods with our debit cards, or by writing cheques to one another. Consequently, if a bank has just received £100 in cash it knows that there is little chance that the depositor is going to come along and ask for it back at any moment.
Knowing this, banks only keep on hand a certain proportion of deposited funds; the amount that they reasonably expect they will need to cover any requests for withdrawals. The amount is termed the reserve ratio, and for any funds deposited, a bank will solely keep the amount of the reserve ratio on hand, and lend out the remainder. The whole process is known as fractional reserve banking (FRB).
So, to carry on our example, if the bank that person paid his £100 into maintained a reserve ratio of 10%, the bank would accept the £100 deposit, keep £10 on hand, and lend out the remaining £90.
But what happens to that £90 loan? The individual or business who takes it from the bank will probably not just spend it straight away, but deposit it into their bank account. If they do so in cash, the whole process can start again. Assuming that their bank also maintains a 10% reserve ratio, the bank will accept the £90 deposit, keep £9 on hand, and lend out the remaining £81.
And so the process continues. In fact, if fully worked through the system, that original £100 deposit will end up having 'created' a total of £1,000 that can be spent in the real economy.
In accounting terms, no money is actually created. If each borrower were to pay back their loan in sequence, the debts would unwind until we were left with our original £100 deposit at the first bank. This is why those who defend the existing system will tell you that no new money is really created.
What these folks conveniently overlook, however, is that in real terms, as opposed to accounting niceties, new money has appeared—it's in your hands, and you can spend it. And as long as new bank deposits are being made, the process above can continue.
Keeping The Merry-go-round Turning
And what allows the entire process to continue is our central bank—the Bank of England. Remember the bonds that the government sells to raise additional funds, the Treasury IOUs? Well the BoE will, from time to time, buy bonds in the market. To pay for its purchases, the BoE genuinely does create money from thin air, and credits the seller's account with money that it has just decreed should exist.
This process injects new money into the economy, which spreads about and ensures that the fractional reserve system described above never grinds to a halt.
If it wishes to, the BoE can use the same process in reverse; selling Treasury securities and destroying the money the purchaser pays. In this manner, the BoE has a crude control mechanism available for determining how much money exists in our economy at any one time.
The BoE also sells money to the commercial banks. These banks buy money at one rate, then loan it out to their customers at a higher rate, pocketing the difference.
The above is, of necessity, a simplified explanation of how FRB operates, and the role played by the central bank. The Bank of England do not appear to have ever produced a layman's guide to these processes, but the US Federal Reserve has. Although several years old now, this document is still a good guide to the operation of a fractional reserve system, and largely applicable to the regime in the UK as well as the US. If you wish to look at the technical detail for the UK system, the Bank of England's Handbooks In Central Banking series of publications, and in particular Handbook #24 (Monetary Operations), is a good place to start.
And whilst the above is a simplistic version of the processes at work, remember that much of the complex language and obscure practice of the banking industry is designed to mask its operations from public scrutiny. At its heart, it is a simple fraud: central banks genuinely creating money from thin air, and commercial banks lending money that's not rightfully theirs to loan. As the famous economist JK Galbraith once noted: "The process by which banks create money is so simple that the mind is repelled."
Why Have We Got This System?
The short answer is because bankers profit from it!
Remember the seigniorage that the government receives from the printing of banknotes by the Bank of England? That brought £2.3 billion into the Treasury last year. Estimates by Huber and Robertson back in 2000 suggested that the loss in seigniorage to the government by allowing commercial banks to create money was in the order of £49 billion per annum4. And, of course, the more money there exists within the economy, the greater this loss is to the government.
The big driver for commercial banks is the interest that they charge on loans. Obviously, the more loans that they have on their books, the greater the potential amount of interest that they can earn. Simply by being able to loan (effectively) the same money over and over again, they are able to develop multiple interest income streams from a single deposit. Banks also profit from the business of actually arranging loans. Most will charge a small percentage of a loan's value simply for allowing you to enter into the loan contract with them.
We've enjoyed this system—largely unchanged—since the Bank of England was first established in 1694. Seeing the obvious benefits to themselves, bankers around the world have, over the centuries, embraced a model first imposed upon the people of our nation.
But it's a flawed model. It's one built to serve the interests of the few, not the many. It's one that results in the scourge of inflation. It's one whose time has long passed.
Libertarian Monetary Reform: Three Necessary Planks
To build a strong bridge from our unfair and failed banking system to an honest and prosperous future one requires some sturdy materials. The Libertarian Party's monetary reform proposals consist of three central planks.
Plank One: Sterling — A National Currency That Belongs To The Nation
Our first key proposal is to wrest the privilege of creating money from the private banking industry, and to return it to where it rightfully belongs: the Crown.
Where an increase in the money supply is required to maintain monetary value—because of a growth in the underlying economy—government will spend the newly created debt-free money into the economy in the form of financing capital works, paying the salaries of public sector workers and so on.
This money will be the money that we are all familiar with: pounds Sterling. Our national currency, it will once again become the property of the nation. Out of control inflation caused by feckless bank lending will become a thing of the past, as we will demand that all Sterling be 100% reserved. All income from seigniorage will end up in the public purse, to provide funds for necessary government activities.
Should a particular government abuse its position and create more money than the economy requires, all of us—as the electorate—will have the opportunity to do something about the situation at the ballot box. This is in stark contrast to the current position, where inflationary pressures are created by unelected private bankers; people who actually have a vested interest in causing such pressures in the first place—the more money that they create, the greater their profits.
Nobel Prize winning economist Milton Friedman once said: "Money is too important to be left to central bankers". This is a position that we wholeheartedly endorse. The private banking industry needs to be removed from involvement in the creation of our national currency and, as US President Thomas Jefferson remarked over 200 years ago: "The issuing power should be taken from the banks and restored to the people to whom it properly belongs"; to the government of the nation, on behalf of the entire nation.
How To Prevent The Fractional Reserving Of Sterling?
A key point of these proposals is to prevent the fractional reserving of pounds Sterling in the future. As banks must be allowed to continue taking deposits and making loans in Sterling, this raises a potential problem.
To illustrate the problem, cast your mind back to the person depositing £100 in cash into his bank in our example above. Currently, the bank taking that deposit has no way of knowing if the money is government produced (debt-free) money, or if the person depositing it has acquired it via a loan. Without being able to distinguish between debt-free and debt-laden money, the bank cannot determine whether it should be allowed to re-lend that money.
In the days before computerisation of the banking system, this issue would have been easily dealt with. When there was a direct one-to-one relationship between money and the physical representation of it (the banknote), everybody knew where they were. However, it would be totally absurd in this day and age to return to the historic system of having fleets of security vans ferrying physical banknotes around the country between branches and different banks.
Various solutions to this problem have been mooted by different experts. Fortunately, the very technology that has largely rendered banknotes obsolete—computers, with vast amounts of cheap data storage—offer us the potential for tracking money through the banking system, to ensure that is only capable of being on loan to any one person at any time.
Those who run the banking computer systems have not had cause to give much thought to these issues to date, as they don't currently require this functionality. As a responsible political party, we intend to fully consult with private banking institutions to develop a future system that is both effective and transparent.
No matter that any such system would mean changes in the way that banks do business, we need to remember that what we are talking about here are solely implementation issues. Whether hard or simple for banks to adapt to, such mere procedural issues must not be seen as a barrier to prevent the much needed structural change from occurring. No government fails to attempt to apprehend criminals simply because it would be easier to allow them to roam free; and no government should shy away from monetary reform simply because the changes required might be arduous for the private banks to implement.
Plank Two: Pounds Sovereign — A 'Hard' Currency
In addition to reforming how pounds Sterling are created and handled, the Libertarian Party is proposing the introduction of an additional, parallel, currency: pounds Sovereign.
What gives our money today the value that it has is simply our trust that the government, and the banks, will honour it. There is no physical commodity backing Sterling: it is what is known as a fiat currency.
Our money was not always like this. In the past, precious metals such as gold and silver (the origin of our pounds Sterling) were kept by banks, and banknotes issued in relation to the amount of precious metals on hand. Such hard currencies proved remarkably resilient over the centuries, and really only died off during the 20th century with the explosion in fractional reserve banking.
Precious metals like gold have held their value—their real purchasing power—remarkably over the ages. Back in Roman times, an ounce of gold would have bought you a good quality toga, belt and sandals. Today, that same ounce of gold would pay for a quality suit, belt and a pair of shoes.
Metals, and particularly gold, are still of great value in the world economy. This is never more true than during times of economic trouble, such as that which we are facing right now. Whilst fiat money may be refused as a means for financing foreign trade, gold never is.
Back in 1999, Gordon Brown decided to sell off over half of the UK's gold reserves via auction—an act described by Peter Fava, then head of precious metal dealing at HSBC, as "a disastrous decision"5. Not only was the decision to sell the wrong one, but trailing it in advance guaranteed that prices would be depressed prior to the auction. As Martin Stokes, former vice-president at JPMorgan, said: "I was surprised they had chosen the auction method. It indicated they did not have a real understanding of the gold market"5.
Gold is still key to the operations of most central banks around the world. At the end of the financial year in March 2007, the United States held 8,133 tons of gold, Germany had 2,422 tons and France had 2,710 tons. Britain, currently the fifth largest economic power in the world, at least on paper, had a pitiful 315 tons5.
The Libertarian Party is proposing to reintroduce a hard currency, one backed by gold: pounds Sovereign. Although we would expect it to be initially used largely to fulfil international trade obligations, such a currency would have the added advantage of attracting foreign investors into the UK, as it would provide a secure harbour for their money in a turbulent world market. Over time, and if both the amount of gold held by the Treasury and the demand from the public was great enough, pounds Sovereign could become a commonly used currency in all our daily lives.
Plank Three: Free Banking
Another approach to banking reform that is advocated by some is the concept of free banking. Within a free banking system, there is no government control over currency or banking whatsoever—market forces determine everything. A free bank would be able to create its own currency, and make its own decisions as to how it would operate—choosing to embrace FRB if it wished.
The idea is that you—the customer—would make your own decisions as to which banking institutions and currencies to use; with pure market forces determining which survived and prospered, and which fell by the wayside.
The Libertarian Party is committed to allowing a plurality of choice in as many situations as possible for the citizens of the UK. Consequently, allowing a free banking regime to be instituted is the third plank of our portfolio of monetary reform proposals.
If the adherents of the free banking model are proved right, and such a system is embraced by the consumers of banking services, then over time free banks will become predominant in our economic system. If, on the other hand, the system isn't well received by the public, few, if any, free banks will come into existence or survive.
That's the real beauty of a truly free market: what is ultimately available to the consumer are the products and services that consumers create and sustain a demand for.
Summary
Money has to come from somewhere. Currently, money is created by the banking industry and, with the exception of the seigniorage on physical banknotes which returns to the Treasury, the profits from creating money stays within this private industry.
Our proposals for monetary reform address the issues raised above in three ways. Firstly, we will return the sovereignty of our national currency—pounds Sterling—to the Crown, with new Sterling being created, debt-free, by the government, and thence spent into the broader economy. The amount of Sterling in circulation will be prevented from being expanded through FRB, stopping bank generated inflationary spirals developing, and keeping the value of your savings safe.
Secondly, we will create a new currency, pounds Sovereign, to be 100% backed by gold. Still vital for international trade, a gold-backed currency will be immensely strong, and help protect the UK from the storms and squalls that sometimes rip through international markets. In providing a safe haven, this currency will attract investment from many overseas into the UK.
Thirdly, we will legislate to allow for the creation of free banks. If these prove popular with the market—the citizens of our nation—they will grow and prosper, with their currencies likely supplanting Sterling as the primary means of exchange on a day-to-day basis. However, and should they fail, such failure will not impact on anyone who chooses to keep their banking facilities purely denominated in pounds Sterling. In this way a genuine free market in banking will be able to be tried, without the risks being spread over the general population.
We believe that the proposals outlined above are sound and necessary. Our existing banking system has been creaking from one crisis to the next over many years, and has only remained unchallenged because of the enormous influence that those who most benefit from it—the private bankers—wield over our elected politicians.
It's a broken system. And, uniquely amongst the UK's political parties, the Libertarian Party is ready to fix it.
Policy Highlights
- Removal of all legal tender legislation except in [9] below
- Removal of all additional (VAT etc.) taxes on precious metals
- Allow free banks to operate how they like with their own currencies (enabled by [1])
- Only the Government shall be permitted to perform fiat issuance of pounds Sterling. Banks must either use foreign currencies or issue their own Bank Money
- Sterling held in on-demand deposit accounts to be 100% reserved by any bank handling it. Banks have always been free to create investment accounts to enable on-lending
- New pounds Sovereign currency to be introduced, 100% backed by gold
- Sovereign to incrementally replace Sterling as gold reserves allow
- Payments to government (taxes) and payments by Government to be in pounds Sterling or pounds Sovereign
- Only pounds Sterling and pounds Sovereign will be "legal tender" in regards to the obligation to accept as payment for debts
- Existing pounds Sterling fiat debt to be reduced systematically within the first parliament
- The various Bank Money, pounds Sterling and pounds Sovereign shall float against each other
The true value of pounds Sterling will no longer be affected by private lending operations. A "safe haven" of a 100% gold backed currency, pounds Sovereign, will be provided. Pounds Sovereign will not initially to be issued in note form. All deposits of pounds Sovereign must be recorded by the Bank of England to ensure that no fraud occurs (totals should always be as expected by the BoE). Banks will be free to continue FRB operations using their own Bank Money or foreign currencies. We expect pounds Sterling to be the main currency in day to day life.
Sources
1 Bank of England Annual Report & Accounts 2008
2 Debt servicing from table 1.15, HM Treasury Public Expenditure Statistical Analyses 2008
3 Income tax revenue from table T1.2, HM Revenue & Customs Annual Receipts
4 Huber & Robertson, Creating New Money
5 The Sunday Times, April 15 2007
RSS Syndication
33 comments:
Precious metals like gold have held their value—their real purchasing power—remarkably over the ages. Back in Roman times, an ounce of gold would have bought you a good quality toga, belt and sandals. Today, that same ounce of gold would pay for a quality suit, belt and a pair of shoes.
This sounds like an INCREDIBLY bad idea then. The price of consumer goods has fallen dramatically over the centuries and if gold was really maintaining its value well, an ounce of gold should be able to buy you (and your wife!) an entire wardrobe full of clothes and shoes.
The fact that it can't shows that it is just another commodity and not really a viable basis for a currency.
Sorry, you're wrong.
If you are looking at quality hand-made items -- as my example was -- then there is little that technological progress adds to the mix.
If we were talking about white goods (for example), then you would have seen an increase in purchasing power. But the Romans didn't have washing machines.
Description of FRB is largely accurate, conclusions aren't.
I read as far as FRB results in 'the scourge of inflation' and got bored. We've had FRB for centuries, but inflation seems to come and go. Monetary inflation is driven by gummint, not banks. If there's a price spike in oil or food, then demand for other stuff goes down.
With the exceptional case of property price inflation - because property is fixed in supply. This is not general monetary inflation, this is land price/house price bubble (to be fixed by LVT).
And bashing banks because they 'serve the interests of the few, not the many' is straight Labour nonsense. Would you say the same for supermarkets or car manufacturers?
As I have said before you CANNOT prevent banks from lending out sterling any more than you can prevent them lending in USD or JPY or EUR.
If people want 100% sterling backed guaranteed deposits, they can keep it in cash under the bed, or put it into National Savings & Investments. Nobody is forced to deposit with banks (apart from convenience aspect). Don't try to be clever and invent things that already exist.
If people want gold backed currency, they can just ,er, buy gold. There's another free market solution for you! There's no law against people buying and hoarding gold (AFAIAA VAT has been removed from investment gold, but either way, VAT is the worst tax and ought to go)
Description of FRB is largely accurate
I won't take offence, but that was a patronisingly superfluous comment!
Monetary inflation is driven by gummint, not banks.
Both cause inflation in the money stock.
And bashing banks because they 'serve the interests of the few, not the many' is straight Labour nonsense. Would you say the same for supermarkets or car manufacturers?
I would say that supermarkets and car manufacturers were serving the interests of their customers. In your examples, 'the few' are the paying punters. In the case of banking, 'the few' are the owners of the institutions. Quite, quite different.
As I have said before you CANNOT prevent banks from lending out sterling
And we're not seeking to. As long as it's to one person/business/whatever at any one time.
Don't try to be clever and invent things that already exist.
We're not. We're interested in dismantling something that shouldn't exist.
Patrick -- anyway of turning this into a PDF.
Would love to read it all but need to print it off and find the time.
tbrrob -- a little rough and ready, but available here.
Our commercial banks create money as debt, effectively from 'thin air'.
I ask you again: how can a bank put a person in debt, without that person signing a loan agreement? And if that person does sign a voluntary contract, by what right can you nullify it? You have explained how banks create money (ie. not debt) "out of thin air", but not why this violates anyone's rights. If people wish to use a depreciating currency they have a right to do so! If they wish to use a currency that doesn't depreciate (impossible, as value is subjective, and can always change according to the whims of other market participants), then they have the right to try and do that as well.
Why Have We Got This System?
The short answer is because bankers profit from it!
And the correct answer is that it's convenient for the vast majority of the population who aren't gold-hoarding conspiracy nutters.
Precious metals like gold have held their value—their real purchasing power—remarkably over the ages. Back in Roman times, an ounce of gold would have bought you a good quality toga, belt and sandals. Today, that same ounce of gold would pay for a quality suit, belt and a pair of shoes.
Ugh, not this again. I've seen this a thousand times, and nary a source to be seen. Also, have some Gold Does Not Have Intrinsic Value.
Hahaha, holy shit. When I wrote this:
Of course there needs to be a mechanism to prevent re-lending of the 'same' money over and over -- that's the whole damn point of the exercise!
I would love to see how you plan to enforce this. Maybe each banknote could be individually RFID-tagged?
"Money check, citizen. Won't take a moment. Hmm... your velocity seems a bit slow. Be sure to keep up your spending! You wouldn't want to be accused of speculative hoarding of cash, would you? After all, that would cause deflationary pressures that could impede the easy flow of business and violate the people's positive right to a stable currency. Remember: tampering with the value of the Crown's currency is treason."
it was supposed to be a parody, not something you would enthusiastically embrace! Now I feel like Nick Cohen asking Jack Straw whether he'd implement a curfew. You're seriously telling me you're going to have government tracking every bank transaction? This is the biggest police-state enabler I've ever seen anyone advocate, ever. Even the talking heads calling for "strong, effective financial regulation" on TV nowadays wouldn't go this far.
Also, I'll echo Mark's sentiments with what I posted on Jock Coats's blog:
"Intangible Money? Who cares?"
I've never understood why people who think bank deposits/fractional reserve banking are somehow evil can't just hold cash or gold coins instead. Well, gold coins are likely to be difficult to fob off in transactions, but then them's the breaks! Get into that, and you start arguing that people should have a positive right to a convenient life, rather than a negative right to engage in voluntary contracts (eg. borrowing from/depositing money in a bank). As for the business cycle, well, if it's so damn easy to predict the collapse of "the system" then why aren't you a millionaire from making contrarian investments?
Now don't get me wrong, anyone who owns derivatives, of which there are $900 trillion or whatever floating around, has to know that "not everyone will get to cash out at once," so to speak, just like a fractional-reserve bank. So you'd have to be an idiot to count on that money always being there for you - keep a few million in used twenties and junk gold and silver just in case. But I don't see how their play-money games violate mine, or anyone else's, rights.
On this note, I see that you're the LPUK's treasurer. Would you mind telling me in what form you keep the LPUK's assets? It goes without saying that you haven't placed them in a bank account, as that would apparently make you an accessory to fraud. So is it cash, junk gold, junk silver, or some mix. Two more questions: (1) are your home address and LPUK HQ registered with the electoral commission? And (2) are you planning on any holidays in the near future?
Seriously, though, I don't understand this hostility to the banking industry in particular next to all other industries. If you think bank deposits are corrupt then don't use them! If you're right, then you'll make a packet! That's the free market, isn't it? And if you do hold any assets in the form of bank deposits, then you're a total hypocrite and no-one should listen to your investment advice.
Britain, currently the fifth largest economic power in the world, at least on paper, had a pitiful 315 tons.
The Libertarian Party is proposing to reintroduce a hard currency, one backed by gold: pounds Sovereign.
A currency with a value of £5 billion? Wowzers.
Finally, how on earth are you trying to reconcile "free banking" with socialist money-monopoly? Can I start my own currency that just happens to trade at par with Pounds Sterling, and is backed by 10% cash reserves of Sterling? If so, all your populist wrangling about banks screwing us over is meaningless. Hell, they would just have to rename their accounts "Natwest Pounds - redeemable on demand in Sterling" to get around all your laws. And as far as the consumer is concerned, this would make no difference.
If you are looking at quality hand-made items -- as my example was -- then there is little that technological progress adds to the mix.
Apart from the better, faster sewing machines; the better, cheaper belt buckles; the better, cheaper cobbler's tools; the ... oh ... do I really need to go on?
@macx
Gold. Nothing -- no, not even gold -- has any intrinsic purchasing power. It's only worth what people think it is.
However, people have valued it highly over millennia, and there is no reason why that is about to suddenly change.
The toga example comes from Griffin's book on the history of the Federal Reserve: The Creature From Jekyll Island.
If you would prefer another source, try Roy W. Jastram's The Golden Constant. Jastram looked at the purchasing power of gold (and paper) against commodity prices in England from 1560 onwards, and the US from 1800 on. His findings? Although there are obvious short-term fluctuations in the purchasing power of gold, over time it is remarkably constant. Here's a brief overview of his work.
You can also find some of data from Jastram's work on printed pages 165-166 of a Minority Report of the US Gold Commission, written by Ron Paul and Lewis Lehrman.
Sorry that the facts don't support your ill informed position.
macx stirner: I ask you again: how can a bank put a person in debt, without that person signing a loan agreement? And if that person does sign a voluntary contract, by what right can you nullify it? You have explained how banks create money (ie. not debt) "out of thin air", but not why this violates anyone's rights. If people wish to use a depreciating currency they have a right to do so!
By bailing out northern rock using future tax receipts, for one.
Macx, nobody is saying someone cannot take out a loan and you know very well we are not proposing this. It is illegal to sell something you do not own, unless it is money. Banks sell-on depositors money and re-deposited sold-on money yet give the impression they have it on hand - on demand. Anyone trying to do that with any other commodity would be locked up.
Further, on devaluation, what GOD DAMN RIGHT has someone to devalue MY savings just because THEY want a loan? This is why we propose Bank Money - so if your view is Kosher, Banks can issue bank money for their loans and everyone will be happy. Banks won't want that, for they will be personally and directly responsible for their own devaluation and "printing", virtually or otherwise. Sure, Natwest can issue NWB Pounds, but at some stage the word might get out that they really have no assets to back up the paper and then we will get a run, or should I say, YOU will get a run on YOUR account, but I will not. For sure ANY currency that is pegged will immediately be subject to speculation and arbitraging - witness the Asian currency crisis of 1997. One currency could NOT be broken (excluding the Malaysian Ringit that was subject to exchange controls and fixed rates by the government) was the HK dollar. It was pegged to the US Dollar, but not via the flimsy way your currency woudl be, it was backed by the equivalent USD at the peg in VAULT CASH. What a laugh the authorities had.
As for your thinking Pounds Sovereign will only be 5bill...er...when you buy Pounds Sovereign from the BoE it can buy the physical gold with your paper money (as much as that paper can manage) and then you will get your Sovereigns. The BoE can expand the gold reserves to match the uptake of Pounds Sovereign.
Banks sell-on depositors money and re-deposited sold-on money yet give the impression they have it on hand - on demand.
It isn't made explicit that banks don't hold all deposits as cash (which it should be), but I don't think many people believe that they do, otherwise bank runs wouldn't occur. People know that their money is being lent out, so it is clear that it isn't sat as notes in the vault.
As I outlined in a post on my blog yesterday, FRB isn't something unique to banks; individuals can do it too and trying to prevent it would require incredibly invasive action.
The major problem with FRB is that the government guarantees, to a certain level, the deposits which go into the banking system and both of the major parties are promising to continue to do this as strongly as possible. That creates a situation where the saver enjoys the returns that come from risk taking, but expects the taxpayer to ensure they get their investment back if things go wrong.
If the guarantees of safety on interest paying accounts were removed, FRB would shrink in size and its risks would be kept within the system.
@paul
It isn't made explicit that banks don't hold all deposits as cash (which it should be), but I don't think many people believe that they do
I think that you'd be surprised, Paul... :-(
If the guarantees of safety on interest paying accounts were removed, FRB would shrink in size and its risks would be kept within the system.
Disregarding all of the other arguments given previously, please consider this: if a government were to do that, it would be so, so easy for any future administration to reverse out of that policy position.
They would simply tell everyone that the sky is falling, will affect everyone, something simply must be done etc. Kind of like now...
Any change needs to not only make sense, but be as non-reversible as possible. This is one of the reasons that we're supportive of abolishing income tax. Once gone, it would be politically very difficult to reintroduce. Some say that a low flat tax would be OK; but a low flat tax would rapidly become not so low and so flat under a future non-Libertarian administration.
When you're dealing with a class of folks -- politicians -- who live to lie and serve their own, and other, vested interests, then major and visible structural change (which is necessary anyway) is the only sort of change that has chance of gaining visibility and traction with the public; locking the change in. It's all too important to make it easy for folks to back out of later.
it would be so, so easy for any future administration to reverse out of that policy position.
It would be very easy, but the crucial point is that, when the deposit is made, the depositor will have no guarantee of safety. They would be taking on a risk, with potential that they might get a government guarantee in future. That is quite a gamble.
As an aside, it also be easy for a future administration to reverse the prohibition of FRB and in the system proposed, most of the issues arising from FRB would remain anyway.
As an aside, it also be easy for a future administration to reverse the prohibition of FRB and in the system proposed
Beg to differ. Introducing our proposals would create such media interest that 'education' of the public would be inevitable. The current system prospers largely because few understand that it actually exists.
Beg to differ. Introducing our proposals would create such media interest that 'education' of the public would be inevitable.
I accept the point about income tax, because removing the infrastructure would make it very difficult to re-introduce, but if the only thing preventing the re-introduction of FRB were public opinion, then the same could probably be said for the suggestion for a removal of depositor guarantees.
One of the problems of relying on public opinion is that by introducing the policies set out in the policy highlights, particularly policy 4, it would allow FRB to continue, but in a much more convoluted fashion, which would leave the public even less aware of the mechanics.
By bailing out northern rock using future tax receipts, for one.
Yes, indeed. But that is the public debt, not "bank-created debt". Mr Vessey is arguing primarily against the latter.
Further, on devaluation, what GOD DAMN RIGHT has someone to devalue MY savings just because THEY want a loan?
Someone building a house will devalue yours. Are you going to make that illegal as well?
Sure, Natwest can issue NWB Pounds, but at some stage the word might get out that they really have no assets to back up the paper and then we will get a run, or should I say, YOU will get a run on YOUR account, but I will not.
If you'd prefer the "security" of cash holdings that don't earn interest, that's fine, but what stops you holding cash/gold now?
And Patrick, you genuinely have no answer to any of the other points I raised, do you?
And Patrick, you genuinely have no answer to any of the other points I raised, do you?
Ask politely, and I will endeavour to answer -- ranting at someone doesn't encourage them to take you, or your questions, seriously.
Interesting but completely impracticable.
A few random thoughts:
1) It could never be introduced because you are not starting with a blank canvass you are starting with what we have. There is in existence a mass of "thin air" money that the banks have already "created". What are you going to do about that?
2) I don't agree it was easy to prevent FRB pre-computerisation. Mr A deposits ten £10 notes in Bank X. Bank X lends £90 to Mr B who walks out with nine of the ten notes physically deposited by Mr A. Mr B goes to Bank Y with nine £10 notes. How does Bank Y know the notes came from Mr A via Bank X? Answer: it can't unless the notes are physically marked and even then, Bank Y would not know whether Mr B got the notes from Bank X.
3) Trying to track money so that it is only loaned once is completely impossible. Lend me £1,000, I'll take it out in cash, my brother will pay it into his account and then it can be lent to someone else. And what if I pay in £1,000, is it the same £1,000 I withdrew or did I spend that, earn another £1,000 and pay that in? Can the bank lend it to another?
4) In any event, how do you enforce the embargo against lending from borrowed money? Make it a criminal offence? Make the "further" lending unenforceable in law? It's a loan shark's delight.
5) Once you add-in "free banking" you guarantee the continuation of FRB. All the banks have to do is agree among themselves to carry on as before and recognise each others currencies. That currency (let's call it the Quid, in which one Barclays Quid is worth the same as an HSBC Quid) then becomes the norm and both your Sterling and Sovereign currencies drop into the background. The vice you detect in the present system will remain but the banks will be in even greater control of it than they are now.
6) If you really could abolish FRB in this country, that would have effect overseas. So Johnny Foreigner has ready access to funds to finance his business expansion and John Bull doesn't. What happens? John Bull borrows from overseas and the profit on the loan exits the country.
7) FRB is not inflationary in itself, so the main vice you identify is not a vice at all.
8) There is a simple way to achieve your stated aim of placing the creation of money in the hands of the Crown - abolish all private banks and have a single state bank. Not particularly libertarian, I would guess, but it would fit the pattern you seem to think important.
Just a few preliminary thoughts.
My point 6) should, of course, say "would have no effect overseas". Woops.
macx,
I was talking about your argument re: a debt without a signature or consent, which you implied, incorrectly, that Patrick was talking about. Your odd point about banks somehow giving us debt without agreement is peculiar and appears to be a smokescreen, an obfuscation.
Someone building a house will devalue yours. Are you going to make that illegal as well?
Strawman. My pounds are supposed to be money, remember. A house is not a store of value or money. It is, surprisingly, a house. Someone building a new house does not reduce the size or usefulness of your house. Someone devaluing the currency most certainly reduces the size of my store of wealth and the usefulness of each pound.
Well, I hope you now see the issue with NWB Pounds. As for what stops me holding cash and gold, well, we can just go back and look at why banks existed in the first place. Therein lies your answer.
If you took time to see the original proposal, the existing "deposit" accounts will be relabeled to what they really are, investment accounts, not on demand, and interest will be available depending on market forces. I am certain Banks will find a way to make as a very thick crust and good luck to them. I am most certainly not anti-bank, just against some third party watering my beer!
TFB:
1) One option is to prohibit further fiat lending and let the existing loans be paid off and cancelled as per normal (as you probably know, the principle of fiat loans are destroyed just as they are created). Another is to steadily increase reserve ratios.
2) ALL NOTES ARE PHYSICALLY MARKED. They have, surprisingly, a serial number. Banknote tracking occurs now, if I am not mistaken. Anyhow, on lending as part of an investment account does not perpetuate the problem.
3) If you have a deposit account - on call - then money is not on-lent. If you have an investment account, it can be. If it is on-lent from an investment account, it is not "on call", i.e. there is no pretense of it sitting there for you to get instantly.
4) There is nothing wrong with on-lending lent money as long as all links in the chain are aware it is not on demand, i.e. they know that they can only be repaid if someone else or someone in the chain has repaid a loan. We are saying that true on-demand cannot be on-lent and your scenario is only a problem if on demand is on-lent.
5) We have absolutely NO PROBLEM WITH FRB. We only have an issue when it is of Pounds Sterling, i.e. a currency we cannot avoid in practical terms. Banks can FRB their own Bank Money to their hearts content. If they will not do so or complain, then there is your proof that it is not a zero sum game. If it is ok, then fine, Banks will make their profit from their Bank Money or even come to an agreement about a shared Bank Money. We welcome either or both outcomes.
6) See above. There is also no limit on FRB using a foreign currency here in the UK. When I was in Singapore, being a foreigner, I was not permitted to take out a Singapore Dollar loan . Only citizens could. Any lending to me was to be done in a foreign currency. It is all quite possible. Remember also that the foreign currency is slowly devaluing. Pounds Sterling will not be devaluing in the same way. Therefore the loan will get steadily "cheaper" as the Sterling buys ever more of the foreign currency.
7) If the money supply can grow because of FRB, then it is inflationary - it devalues the currency.
8) If you think this is our pattern, then I am afraid you are mistaken. We wish to enable Banks to continue to operate FRB, but with their own currencies. I am not anti-bank and the Party is not anti-bank. We are just concerned about protecting the value of the currency and making those responsible for it to be fully accountable to the public.
Roger,
My pounds are supposed to be money, remember. A house is not a store of value or money.
Unfortunately, a lot of people do view a house that way, which is part of the reason we are experiencing this crisis. Another example you could consider is gold; if somebody mines more gold, it will devalue the gold already being held. There is no guaranteed store of value.
One option is to prohibit further fiat lending and let the existing loans be paid off.
I think the term fiat lending is confusing here. The only entity which can create fiat currency (measured as M0) is the Bank of England. The other banks create chains of debt and increase the money supply (measured as M4), but they don't create fiat currency, in the same way that banks could FRB gold coins, but they wouldn't create any new gold in the process.
There is also no limit on FRB using a foreign currency here in the UK
In functional terms, there is no difference between using sterling or foreign currency for FRB. You could very easily convert every Sterling account into a "Currency X" denominated account and then sell the depositor a hedging product allowing them to convert back to Sterling at the same fixed rate. The problems arise because the debt is on the books of UK banks and the UK government guarantees it.
Remember also that the foreign currency is slowly devaluing. Pounds Sterling will not be devaluing in the same way.
Would there be anything to guarantee that, while we are using foreign currencies for FRB, they wouldn't be doing the same with Sterling?
There is nothing wrong with on-lending lent money as long as all links in the chain are aware it is not on demand.
On-lending removes the problems of liquidity and eliminates the risk of bank runs, but it still carries credit risk, so it is a very different situation to cash held in a vault. What happens in the event of a default? If the government continues to guarantee that deposit, then we would still have one of the worst characteristics of the present system.
If the money supply can grow because of FRB, then it is inflationary - it devalues the currency.
On-lending also increases the money supply as it is currently measured, as the M4 figures don't differentiate between on-demand and term deposits. On-lending also causes price inflation and therefore devalues the currency. Anything that gets money into the hands of people who want to spend it will push up the price of goods. If you wanted to prevent price inflation, you'd have to outlaw all lending.
Paul,
1. Housing is a separate and secondary effect of this crisis. It is more about liquidity shrinking due to the perception in the relative and ongoing drop in prices, not the absolute prices themselves - demand is strong, yet people do not wish to buy or cannot due to the lack of lending. As for gold, selling a large reserve would affect the price, yes, for a while. Fiat currencies devalue constantly. We only see them "recover" because they are relative to other steadily devaluing currencies.
2. YEs, we know banks currently do not create fiat notes and coin. That is not what we are saying.
3. Try performing fiat lending of Renminbi. See how far you get. You need the issuing bank's permission and consent, for one, functioning nostro and vostro accounts in the UK. If it were not necessary, rogue states would be making hay lending USD, CHF, YEN to their mates.
4. See above.
5. The Government guarantee scheme covers these faux "deposits", which are actually invested. We would end this nonsense which is, in fact, public liability for private profit. The extension of the deposit guarantee scheme was one of the triggers for us to finally say ENOUGH! and get moving with releasing our proposals.
6. Outlaw all lending? Not so. On-lending of investment accounts does not increase the money supply. If I have 100quid and lend it to Patrick Vessey and he lends 90 to Chris Mounsey and he then lends 80 to Ian Parker-Joseph, there is still 100quid and ONLY 100 quid in the economy. My 100 quid is NOT in my account - it has GONE. The problem of FRB is deposits are on-lent but you still have the ability to spend it all on demand as if it was always there because on balance, most people do not withdraw all at once. Investment accounts would force the bank to have to call in lending to cope with any withdrawl, for it could not have a shortfall at any stage. If my loan to Patrick was "on call" and Patrick could not get hold of Chris, he would have to go down to Costcutters with his CD collection. pronto. Patrick cannot pretend he has the money, so why do we let banks?
BTW, Putting savings in the hands of those who want to spend it does NOT cause inflation, but actually prevents deflation caused by reduced liquidity of funds sunk in dead accounts. Yes, people with deposit accounts will no constitute dead money, but considering they will probably be asked to pay a fee unless most of it ends up in a companion savings/investment account, then I do not see that happening. In Asia, it is common practice to have two accounts - a savings account and a deposit account. The savings account can be pre-programmed to top up the deposit account should it fall below a certain level. You can see how a bank can then move assets from various levels of liquidity for the customer without a) keeping all the money in dead deposits or b) FRB. This was what I saw in Hong Kong - no surprise, as the HKD is a full-reserve currency, backed by vaults of USD. This is why the HKD exchange rate could not be speculated against in the 1997 Asian crisis - did not stop people trying and getting burnt. Badly.
Hope that helps.
Tim:
Fiat currencies devalue constantly
That is because more fiat currency (M0, i.e. notes, coins and central bank reserves) is being issued constantly. If the amount of M0 were fixed, it would be in the same bracket as gold.
Try performing fiat lending of Renminbi
You acknowledged earlier that banks do not create fiat currency. I'm afraid the term "fiat lending" doesn't mean anything to me. The central bank creates fiat currency (M0) and the banks then increase the money supply (M4) through fractional reserve lending. The two issues are completely separate and it is essential to discuss them as such; it is possible to have FRB with a hard currency and it is also possible to have a fiat currency without FRB.
You need the issuing bank's permission and consent.
Not if you move notes and coins and you have a free banking system. This is one of the major problems I have with these proposals; they are incredibly authoritarian. They require the state to have an iron grip on people's transactions. It's a cure which is worse than the disease.
On-lending of investment accounts does not increase the money supply.
It does as it is currently measured by M4, which is the most quoted measure, although I don't believe it shouldn't be measured that way.
Patrick cannot pretend he has the money, so why do we let banks?
You are doing exactly the same as the banks, though. If you all have an IOU from the person you've lent to, that is effectively an "on call" deposit, which you could spend if you could find someone to accept the person you have lent to as creditworthy. You have increased the money supply in the same way as the banks do. The IOU you hold is effectively a £100 instant access deposit at the Bank of Patrick Vessey. The problem isn't with FRB as such, it's that the state props the banks up with liquidity and depositor guarantees, whereas your personal arrangement is your problem to sort out; you don't have a depositor guarantee and Patrick can't turn to the Bank of England as the lender of last resort if he doesn't have the cash when you come to collect.
Putting savings in the hands of those who want to spend it does NOT cause inflation, but actually prevents deflation caused by reduced liquidity of funds sunk in dead accounts
The previous comment was regarding somebody devaluing a store of value. My point was that nothing is a constant store of value; the actions of others will always have an impact on it. An increase in lending of any type will tend to increase the upward pressure on prices.
To correct a typo in my last comment, it should have read:
It does as it is currently measured by M4, which is the most quoted measure, although I don't believe it should be measured that way.
TC: Fiat currencies devalue constantly
PL: That is because more fiat currency (M0, i.e. notes, coins and central bank reserves) is being issued constantly. If the amount of M0 were fixed, it would be in the same bracket as gold.
You take that out of context. Still, ideally Pounds Sterling would only grow when demand for it, i.e. the economy, grew. We intend for the BoE to be chartered to protect the currency in this way. We aim for Pound Sterling to itself be a safe haven.
TC: Try performing fiat lending of Renminbi
PL: You acknowledged earlier that banks do not create fiat currency. I'm afraid the term "fiat lending" doesn't mean anything to me. The central bank creates fiat currency (M0) and the banks then increase the money supply (M4) through fractional reserve lending. The two issues are completely separate and it is essential to discuss them as such; it is possible to have FRB with a hard currency and it is also possible to have a fiat currency without FRB.
Banks do not currently create M0 of course not. I used the term fiat lending to differentiate from on-lending. I thought that was pretty clear.
TC: You need the issuing bank's permission and consent.
PL: Not if you move notes and coins and you have a free banking system. This is one of the major problems I have with these proposals; they are incredibly authoritarian. They require the state to have an iron grip on people's transactions. It's a cure which is worse than the disease.
What if somebody at your bank wants to transfer balances to another bank or issue a cheque payable to another bank account? What bank is going to be able to accept it (noting that in the UK it will be illegal to accept transactions from entities illegally performing FRB on Sterling worldwide, for that is FRAUD)? As I say, try it and see how far you get. Not very. Once your customers realise your bank cannot operate fully, they will withdraw their funds IN CASH and you will have a run on your hands. As for "iron grip" you are being fanciful. We propose free banking. What "transactions" are you saying we are preventing except selling what is not yours to sell and saying you have stored for someone what you have already sold on?
TC: On-lending of investment accounts does not increase the money supply.
PL: It does as it is currently measured by M4, which is the most quoted measure, although I don't believe it shouldn't be measured that way.
If you on-lend, the original balance does not exist. It cannot increase money supply.
TC: Patrick cannot pretend he has the money, so why do we let banks?
PL: You are doing exactly the same as the banks, though. If you all have an IOU from the person you've lent to, that is effectively an "on call" deposit, which you could spend if you could find someone to accept the person you have lent to as creditworthy. You have increased the money supply in the same way as the banks do. The IOU you hold is effectively a £100 instant access deposit at the Bank of Patrick Vessey. The problem isn't with FRB as such, it's that the state props the banks up with liquidity and depositor guarantees, whereas your personal arrangement is your problem to sort out; you don't have a depositor guarantee and Patrick can't turn to the Bank of England as the lender of last resort if he doesn't have the cash when you come to collect.
WRONG: Patrick does not issue STERLING. He issues Bank of Patrick Bank Money. It can only be "on call" if, as I outline, he liquidates an asset for cash. By doing so he is first taking cash OUT of circulation by selling the CDs to someone, then he hands it over to his creditor. No more money supply. If the holder of the Patrick Bank note tries to spend it, people need to know Patrick has the CDs to sell. If Patrick issues more than his CD collection is known to be worth he risks devaluation or, if he is foolish enough to promise to redeem one-for-one, a run as people panic to secure hard cash. Fact is, Patrick's IOUs will do no more price inflation than currently occurs and probably less. If and when the game is up or a speculative attack occurs, mostly holders of Patrick's IOUs will be affected but not holders of Sterling. That is the point. Further, you need to think how Tim's Bank will treat Patrick's Bank IOUs. I will not accept them - I want Pounds Sterling and at an exchange rate I am happy with, not Patrick! Also note that the State will not accept Patrick or Tim's Bank IOUs for taxes.
TC: Putting savings in the hands of those who want to spend it does NOT cause inflation, but actually prevents deflation caused by reduced liquidity of funds sunk in dead accounts
PL: The previous comment was regarding somebody devaluing a store of value. My point was that nothing is a constant store of value; the actions of others will always have an impact on it. An increase in lending of any type will tend to increase the upward pressure on prices.
But you forget that saving will have the opposite effect. To on-lend one must first save, so on-lending savings has no effect as the actual amount of hard cash STERLING available - not IOUs - will not change.
Tim,
noting that in the UK it will be illegal to accept transactions from entities illegally performing FRB on Sterling worldwide, for that is FRAUD
If the bank makes it clear that the late comers in a bank run may have to wait for their cash, I would say that it isn't really fraud. The question is how would you enforce that? How would you monitor banking in other countries? Also, if foreign banks performing FRB is fraud, what about the FRB that would be permitted in the UK using foreign currency?
If you on-lend, the original balance does not exist. It cannot increase money supply.
I wasn't saying it did, just that if you look at the M4 money supply figures for Sterling, they include fixed term deposits, so in effect, they are massively over-stated.
Patrick does not issue STERLING. He issues Bank of Patrick Bank Money.
By the same token, a bank issues IOUs. Only the BofE can create legal tender. My on-demand account at a bank is nothing more than an IOU for cash.
It can only be "on call" if, as I outline, he liquidates an asset for cash.
Just as, with a bank. If I want to call my IOU in, they have to have cash available. The problem arises here, because the bank can get access to emergency funding, which allows it to take excessive liquidity risks.
If and when the game is up or a speculative attack occurs, mostly holders of Patrick's IOUs will be affected but not holders of Sterling.
A holder of Sterling is someone who has notes and coins and they will not be at risk from a run, irrespective of whether it is on Patrick or on a Bank.
Further, you need to think how Tim's Bank will treat Patrick's Bank IOUs. I will not accept them - I want Pounds Sterling and at an exchange rate I am happy with, not Patrick!
That's fine, but you are in exactly the same position as with a bank. The only thing you have to accept in settlement of debt is legal tender, being notes and coins.
To on-lend one must first save, so on-lending savings has no effect as the actual amount of hard cash STERLING available - not IOUs - will not change.
FRB doesn't have any effect on the amount of hard cash STERLING either. Only the central bank can change that.
As a side question, how would you treat LETS schemes? They create the same chains of debt denoted in Sterling as FRB.
Paul,
I think this is becoming more a thrash over terminology and semantics instead of actual valid points about if the system works or not, but I reply to your points below:
PL:If the bank makes it clear that the late comers in a bank run may have to wait for their cash, I would say that it isn't really fraud. The question is how would you enforce that? How would you monitor banking in other countries? Also, if foreign banks performing FRB is fraud, what about the FRB that would be permitted in the UK using foreign currency?
You might say that, but telling people you are keeping something that do have not in fact kept is misrepresentation and thus fraud. Monitoring banking in other countries is quite possible and the risks for breech are significant. FRB of foreign currencies, as we have said, is not our concern and banks are free to do so if the governments of those currencies are happy to issue licenses to them.
PL: I wasn't saying it did (increase the money supply).
Yes you did @15:45 02Oct.
PL: By the same token, a bank issues IOUs. Only the BofE can create legal tender. My on-demand account at a bank is nothing more than an IOU for cash.
An IOU from The Bank of Patrick is not the same as a deposit account balance in Sterling. Banks do currently say you have a deposit. It is treated as more a receipt, not an IOU. A personal IOU just says one promises to repay, but it is NOT legal tender, cannot be expected to be deposited or exchanged elsewhere for face value.
PL: Just as, with a bank. If I want to call my IOU in, they have to have cash available. The problem arises here, because the bank can get access to emergency funding, which allows it to take excessive liquidity risks.
And? Such funding would be from cash, so does not affect the money supply. Interbank lending will not go on for long when they know a Bank is illegally performing FRB on Sterling, BTW.
PL: A holder of Sterling is someone who has notes and coins and they will not be at risk from a run, irrespective of whether it is on Patrick or on a Bank.
What are you saying? If there is a run on Bank of Patrick, is IOUs rapidly become just autographs.
PL: That's fine, but you are in exactly the same position as with a bank. The only thing you have to accept in settlement of debt is legal tender, being notes and coins.
And? We know this. We have gone over this already. All you are saying is interbank is settled in hard currency and this has been said alreafy, but a Patrick's Bank IOU is not hard currency, just as Bank Money would not be.
PL: FRB doesn't have any effect on the amount of hard cash STERLING either. Only the central bank can change that
You know precisely what I mean, Paul. FRB increases the money supply, on-lending does not. Get over it.
PS. LETS: AFAICT LETS do not involve withdrawals in cash or transfers of credits to Bank deposits AFAICT.
TC: telling people that you are keeping something that do have not in fact kept is misrepresentation and thus fraud.
As I said, if the banks were to explicitly say that the money is being lent out and that they might not have enough cash to pay out every account holder in the event of a bank run, that issue would be resolved. People couldn't claim that they were unaware of the risk and therefore, it would not be fraud.
By your definition, even on-lending would be fraud, because the bank is lending money which it might not be able to recover if the borrower defaults, so the bank may be unable to repay all the amounts it owes when they fall due. Both FRB and on-lending involve risk, but as long as the risk is clear to all parties, I don't see either being inherently fraudulent.
PL: I wasn't saying it did (increase the money supply)
TC: Yes you did @15:45 02 Oct
What I said was that on-lending increases the money supply as it is measured by M4. That is the measure which is most commonly quoted when talking about the overall money supply. If you want to exclude fixed term deposits from the money supply figures, then the current money supply figures are massively overstated for that purpose.
TC: A personal IOU just says one promises to repay, but it is NOT legal tender, cannot be expected to be deposited or exchanged elsewhere for face value.
A bank IOU is not legal tender either. Only cash is legal tender. You might expect to be able to settle debt using bank IOUs via your debit card, but that is only the case because creditors tend to be prepared to trust the banks and the payment system. It is custom, not law. If they trusted you, they might accept your IOUs too. There really is no functional difference.
TC: What are you saying? If there is a run on Bank of Patrick, is IOUs rapidly become just autographs.
In that situation I should be able to take Patrick to court to force him to liquidate some assets to settle his debt, just I should be able to force an illiquid bank to. If neither has enough asets to pay of all their creditors, I might not get everything back, but that is the risk of being a creditor. Again there is no functional difference.
TC: You know precisely what I mean, Paul. FRB increases the money supply, on-lending does not. Get over it.
What you are saying isn't clear, because you are using terms (such as legal tender and money supply, or fiat currency and fractional reserve banking) interchangeably, when they are very different.
Consider the situation if we used gold as currency, rather than fiat currency, but continued with FRB. If I put one ounce of gold into an on-demand account, which the bank then lent out, the money supply would have increased by one ounce of gold, but the underlying amount of currency would not have changed, because a bank cannot create gold out of thin air any more than it can create fiat currency. By implying that FRB can increase the level of hard cash Sterling, you are effectively crediting FRB with powers of alchemy.
I'm sorry that you feel this is a trash over terminology and semantics, but the terminology has to be defined and used precisely, otherwise you end up with fallacious conclusions.
Paul,
PL: As I said, if the banks were to explicitly say that the money is being lent out and that they might not have enough cash to pay out every account holder in the event of a bank run, that issue would be resolved. People couldn't claim that they were unaware of the risk and therefore, it would not be fraud.
Then that would not be an on-demand deposit account, but an investment account, which we have recognised from the outset as we believe this transparency is the right way to go and not some taxpayer funded bailout guarantee scheme - the saver should pay their own insurance. In our terminology, a true on-demand deposit account will be about safe keeping, not investment and thus risk. It would separate the investment and storage operations. Banks don't pawn the contents of peoples' safe deposit boxes, right? Why do the same for their cash unless there is a formal agreement?
PL: What I said was that on-lending increases the money supply as it is measured by M4.
Then you need to restate what the point of your statement was at the beginning, as you were saying money supply will grow.
PL: A bank IOU is not legal tender either. Only cash is legal tender. You might expect to be able to settle debt using bank IOUs via your debit card, but that is only the case because creditors tend to be prepared to trust the banks and the payment system. It is custom, not law. If they trusted you, they might accept your IOUs too. There really is no functional difference.
Banks do not issue IOUs, yet. For deposits, they give you a receipt - you cannot buy things with a bank statement! If you buy something with a debit card the result will be a near instantaneous transfer of hard currency. Bidirectional flows mean that banks can net off most movements, so meaning they can operationally survive. If you want an IOU, they will hand over Sterling. Yes, it is about trust. We are saying that if banks want to FRB, then they can with BANK MONEY, with their OWN IOUs, NOT Sterling, i.e. Naitonal IOUs, as they do now for this waters down the value of National IOUs. Why should the Bank, who is issuing the IOU, be able to say it is a National IOU? That is the crux.
PL: Again there is no functional difference.
Exactly, so this is why we are saying that when a Bank is extending itself in such a manner, it does so IN ITS OWN NAME just as The BoP has done. Bank Money, NOT Sterling. You still talk as if we are against FRB in principle. We are not.
PL: What you are saying isn't clear, because you are using terms (such as legal tender and money supply, or fiat currency and fractional reserve banking) interchangeably, when they are very different.
Not so, Paul. I have clarified in each case when I was not clear, but you appear to just move on without acknowledging to the positive or negative.
Re: Gold. Paul, I ask again what is the point of your statement? Just think of our proposals as if it were illegal to issue more IOUs than you have vault gold. Do you understand what we intend for Sterling now? ISo, if you lend out you must NOT issue an IOU to the depositor, so they become and INVESTMENT account with a statement. If the depositor wants to be free from carrying gold, they can be given IOUs by the bank, but then that is a deposit account and thus off limits for on-lending, because they cannot issue the IOU for it again or remove it from the vault. Now, you bring in the Bank of Patrick IOU, but remember that this is just CP or a Bond, and will normally carry interest to cover the risk of default or be sold at a discount.
You might now say it is not possible to track IOUs. In case of a Bank, it would result in the loss of license if they commit fraud in handing out IOUs in excess of their vault gold. That is fraud.
I think it would be useful for you to summarise what issues you still have with the proposals.
Tim
Tim
TC: Banks don't pawn the contents of peoples' safe deposit boxes, right? Why do the same for their cash unless there is a formal agreement?
I agree completely; that was partly my point. So long as an FRB bank (or an on-lending bank) makes it clear that it is lending out the money and it might not be able to pay out in the event of a bank run or credit defaults, I don't see it being a problem.
TC: We are saying that if banks want to FRB, then they can with BANK MONEY, with their OWN IOUs, NOT Sterling
This seems to be confusing FRB and fiat currency issuance. The bank is saying that they owe you the money. Sterling says that the government owes the money. The bank isn't creating any obligation on the government, except for the savings guarantees the government chooses to give, which we both seem to agree should be scrapped.
TC: Why should the Bank, who is issuing the IOU, be able to say it is a National IOU? That is the crux
It isn't. It is saying that it owes you a certain amount of cash, or National IOUs, just as, if you lent them gold, they would owe you a certain amount of gold. They aren't creating National IOUs any more than they would be creating gold. If they are short of gold, they would have to go out and get it or go out of business, just as they would have to go out and get cash.
PL: Again there is no functional difference.
TC: Exactly, so this is why we are saying that when a Bank is extending itself in such a manner, it does so IN ITS OWN NAME just as The BoP has done.
It is extending itself in its own name. I'm confused by your statement. You said "exactly," to agree with me that there is no functional difference, but then set out to show a functional difference.
As another example, consider how bank overdrafts work. The terms tend to specify that any amounts must be repaid to the bank on demand, so in effect the normal customer/bank roles are reversed; the bank has a receipt from me for an amount of Sterling which I might not have when it demands it. Would you outlaw that too?
TC: You still talk as if we are against FRB in principle. We are not.
I was working off the fact that in a previous post you described it as fraud.
TC: Just think of our proposals as if it were illegal to issue more IOUs than you have vault gold.
Which is fair enough for a pure deposit account, but it doesn't justify outlawing FRB for either gold or Sterling if it is clear that the gold or cash might not be there when the person with the IOU goes to collect. On-lending falls foul of your point just as much as FRB, because the gold is not in the vault and may not be recoverable when you come to collect, even if it is a fixed term deposit.
TC: I think it would be useful for you to summarise what issues you still have with the proposals.
I broadly agree with the aims, but the proposals appear to lump fiat currency issuance and fractional reserve banking together, rather than treating them as completely separate issues and as a result, the proposals go further than I believe they need to. I actually think that FRB is less of an issue than fiat currency. When there has been a combination of a hard currency and FRB, constant inflation doesn't appear to have been much of an issue, so it appears that FRB isn't a major problem, so long as its risks aren't externalised.
The problems could be resolved by simply enforcing the principles of outlawing fraud and enforcing strict personal liability for risk taking.
To solve the FRB problem I would suggest:
1 Banks should be required to say explicitly if an account is an investment account (i.e. cash is lent out either through FRB or on-lending) or a deposit account (i.e. cash is held as cash in vaults or as reserves with the central bank).
2 Those people who put money in an investment account should be treated as ordinary creditors in the event of a bank failure. No government guarantees should be offered to them.
3 Those people who put money in a deposit account should be treated in the same way as safety deposit box holders and have immediate access to their funds.
4 The central bank should no longer act as lender of last resort.
To solve the fiat currency problem:
1 Legal tender should only be issued as debt free notes, coins and reserves at the central bank, spent into existence by the government or issued in equal shares to the electorate.
2 Issuance of legal tender should be controlled by the central bank, with the rate set in order to keep price inflation within a pre-defined target range.
I don't see the need to engineer a more complex solution than that.
Paul.
Going to your final part first.
A1. This is our proposal (ignoring the FRB part for now).
A2. This is our proposal.
A3. This is our proposal.
A4. It did not work in the past, hence the introduction of the lender of last resort. Why do you think this will work now? This is a serious question to enable you to outline your thinking.
B1. Sounds like Social Credit thinking, which I have deep reservations about due to some fundamental flaws in the underlying ideology (e.g. that somehow depreciation creates a "gap" in cash flows!). If you have a government that hands out shares to all, rapidly you will get a government in power that does that to buy votes. It is the Welfare State on PCP. BTW, if you have FRB, what is to prevent the Banking sector increasing the money supply many times over once all the new legal tender is deposited?
B2. The idea of tracking price inflation is what has got us into this mess in the first place. Prices fall as efficiencies improve, so it will hide the devaluation of the currency unit for a time. It will, in effect, mean that instead of us getting wealthier due to cheaper prices, we increase the money supply to match the lowering prices so the currency unit devalues and so pushes the prices back up. This is also part of Social Credit thinking, IIRC. Ron Paul has repeatedly lambasted the Fed for chasing price inflation and not preventing currency devaluation. Ben Bernanke has resorted to hiding behind his charter obligations.
Now on to the other stuff, which I think is more about miscommunication between us, for which I have played a part.
1.
TC: Banks don't pawn the contents of peoples' safe deposit boxes, right? Why do the same for their cash unless there is a formal agreement?
PL:I agree completely; that was partly my point. So long as an FRB bank (or an on-lending bank) makes it clear that it is lending out the money and it might not be able to pay out in the event of a bank run or credit defaults, I don't see it being a problem.
A: Good. We got that settled. We have been VERY clear about that all along.
2.
TC: We are saying that if banks want to FRB, then they can with BANK MONEY, with their OWN IOUs, NOT Sterling
PL: This seems to be confusing FRB and fiat currency issuance. The bank is saying that they owe you the money. Sterling says that the government owes the money. The bank isn't creating any obligation on the government, except for the savings guarantees the government chooses to give, which we both seem to agree should be scrapped.
A: FRB of sterling permits the increase of the money supply, it is a de facto dilution of the National IOU. That is our concern here. If a bank wants to FRB, and thus dilute, its own scrip, then it is its funeral. As long as it does not misrepresent those holding that scrip, it is caveat emptor.
3.
TC: Why should the Bank, who is issuing the IOU, be able to say it is a National IOU? That is the crux
PL: It isn't. It is saying that it owes you a certain amount of cash, or National IOUs, just as, if you lent them gold, they would owe you a certain amount of gold. They aren't creating National IOUs any more than they would be creating gold. If they are short of gold, they would have to go out and get it or go out of business, just as they would have to go out and get cash.
A: If a bank takes then owes you money, it does not automatically imply the issuance of an IOU, i.e. scrip, money, but just means a non-transferable receipt, i.e. your bank statement. You cannot go to another bank with your bank statement or even a record of your gold vault holdings and deposit it. It would only be the case if the bank hands you a bank IOU that is a bearer scrip, i.e. transferable. Then dilution would occur, but it would be the bank's name that is diluted, not Sterling.
4.
PL: Again there is no functional difference.
TC: Exactly, so this is why we are saying that when a Bank is extending itself in such a manner, it does so IN ITS OWN NAME just as The BoP has done.
PL: It is extending itself in its own name. I'm confused by your statement. You said "exactly," to agree with me that there is no functional difference, but then set out to show a functional difference.
PL: As another example, consider how bank overdrafts work. The terms tend to specify that any amounts must be repaid to the bank on demand, so in effect the normal customer/bank roles are reversed; the bank has a receipt from me for an amount of Sterling which I might not have when it demands it. Would you outlaw that too?
A: “No functional difference” refers to where we wish to be with bank money, i.e. transferable IOUs issued by a bank that float independently from Sterling. I think there is much confusion by you blurring the line between a non-transferable receipt, i.e. a bank statement and a fully transferable, bearer IOU, as in CASH.
Overdrafts: An overdraft is not exchangeable interbank as Sterling, but as an IOU with risk and interest attached. A bank can on-sell the overdraft, but you and I cannot on-sell our bank statement.
5.
TC: You still talk as if we are against FRB in principle. We are not.
PL: I was working off the fact that in a previous post you described it as fraud.
A: If Sterling is to be a 100% reserve currency under the terms of a banking license, then FRB of Sterling is fraud.
6.
TC: Just think of our proposals as if it were illegal to issue more IOUs than you have vault gold.
PL: Which is fair enough for a pure deposit account, but it doesn't justify outlawing FRB for either gold or Sterling if it is clear that the gold or cash might not be there when the person with the IOU goes to collect. On-lending falls foul of your point just as much as FRB, because the gold is not in the vault and may not be recoverable when you come to collect, even if it is a fixed term deposit._
A: The issue with FRB is one of increasing the money supply. On-lending in the scenario does not do this, but FRB does, for FRB is the equivalent of handing out transferable IOUs for an investment account as well as for a deposit account – on lending would not result in the investment account holder getting a transferable IOU. FRB is basically saying we invest your money but you can still transfer balances to another bank, just as long as those in the other bank do the same so we can basically forget about the need to actually have the cash anymore.
Tim,
"It did not work in the past, hence the introduction of the lender of last resort. Why do you think this will work now? This is a serious question to enable you to outline your thinking."
I think this is a bit of a chicken and egg scenario. The reason that banks rely on emergency lending is that they know it is there, so they take bigger risks with their liquidity. If banks knew they would be entirely dependent on the market for liquidity, they'd be more prudent; they'd take on more fixed term accounts and hold fewer on demand accounts, they'd hold bigger cash reserves and they'd re-introduce genuine deposit accounts, because they'd know that failing to maintain adequate liquidity wouldn't mean going to the Bank of England for a hand out, it would mean going into administration. The real problem with the FRB system isn't in the system itself, but the way the state props it up, with depositor guarantees and this kind of emergency funding. The state acting as a lender of last resort is an interference in the market which encourages reckless behaviour. It's a serious moral hazard issue.
Also, it is worth bearing in mind that if we returned to a currency fully backed by gold, the scope for the central bank to act as lender of last resort would be severely limited anyway. With a fiat currency, it can increase the level of currency to supply emergency lending without limit. With a fully backed currency, it might not have the scope to provide the lending that is being demanded, because it would have to hold enough gold to back up the loans that the banks want, so moving to a hard currency would go a long way to achieving what I'm suggesting too.
"If you have a government that hands out shares to all, rapidly you will get a government in power that does that to buy votes."
Possibly, although the upward pressure on inflation would soon catch them out. For that reason, the central bank should be constitutionally bound to issue currency within certain guidelines. I think the way the MPC operates at the minute, although it uses interest rates rather than fiat currency issuance to manage inflation, is actually not too bad, so long as it's independence isn't compromised. The other option is to set the volume of fiat currency at a fixed amount (say £87bn, as it was in September) and keep it there, so it effectively becomes an non-expanding currency, as it would be if it was backed by a constant reserve of gold. That could create other problems though, which I'll address in a comment below.
"if you have FRB, what is to prevent the Banking sector increasing the money supply many times over once all the new legal tender is deposited?"
Nothing, but that is a completely separate issue to fiat currency issuance. If we had a currency backed by gold and more gold was mined by the government, the banking sector could increase the money supply by performing FRB on the new gold backed currency, but it couldn't create new gold in the process and it can't create new fiat currency either.
"Prices fall as efficiencies improve, so it will hide the devaluation of the currency unit for a time. It will, in effect, mean that instead of us getting wealthier due to cheaper prices, we increase the money supply to match the lowering prices so the currency unit devalues and so pushes the prices back up"
Whether or not that is a good thing depends on whether you want the currency unit to be most effective as a medium of exchange or as a long term store of value. Keeping prices stable makes it more effective as a medium of exchange, as it constrains price movements. If you want it to be effective as a store of value, then keeping the volume of currency constant is a better way of achieving that, because the value should steadily increase over time, but I'd argue that there are better ways of storing value than in currency.
"FRB of sterling permits the increase of the money supply, it is a de facto dilution of the National IOU"
I'd like to ask you a question on this one. Would you permit FRB of gold? i.e. Bank A allows you to put 10 gold coins in an "on demand" account, of which it lends 8, say, and keeps 2 in the vault, etc., with everything made clear to all parties. It would be exactly the same as at present, but with gold instead of Sterling notes and coins. The reason I ask is that such an approach increases the money supply of gold and as we would be moving to a gold backed currency with Pounds Sovereign, that would effectively be increasing the money supply of the national currency.
"If Sterling is to be a 100% reserve currency under the terms of a banking license, then FRB of Sterling is fraud."
In that situation, FRB would be a breach of a banking regulation, but not inherently fraud.
Printing your own Bank of England notes would be fraud. Telling depositors that you are holding the cash in vaults but then lending it out would be fraud. Openly telling customers that you are performing FRB with their cash and then doing so wouldn't be fraud, as far as I'm concerned.
"FRB is basically saying we invest your money but you can still transfer balances to another bank, just as long as those in the other bank do the same so we can basically forget about the need to actually have the cash anymore."
But that is just an arrangement between the banks to recognise and exchange each other's balances. As individuals, we could recognise and exchange each other's balances too, if we wanted (in effect, that is how LETS work). The need to have the cash doesn't go away, because, if we all decide we want our cash back, the banks have to get it or go into administration, or at least that's the way it should be. Again, this market force fails because of lender of last resort and depositor guarantee effects.
You say FRB of Sterling is fraud, but so long as the terms of the deal are clear to all, I view it more like insurance. If everybody with an insurance policy were to claim at once, the insurers couldn't pay out, but the system generally works, because the insurer calculates the risk reasonably accurately and if they get it wrong, they go bust. FRB is the same, but with withdrawals instead of claims.
In short, I think the real problem with our monetary system is the creation of fiat currency as interest bearing debt and the continual expansion of that fiat currency by the central bank. I would be happy to see that resolved by either returning to a currency backed by gold at the central bank at a fixed rate or moving to a debt free fiat currency with restrictions on the rate it may be issued at, although my preference is leaning towards the latter.
I don't think FRB is such a major problem, irrespective of whether it is performed with metals, metal backed notes, foreign fiat currency or the national fiat currency. Removing depositor guarantees, removing the lender of last resort guarantees from the central bank and making banks say explicitly whether an account is a pure deposit account or an interest bearing investment account would resolve the major issues with FRB.
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