Banking, The Bailout, and Money

[darinhouston]

Darin,

Thanks for the video reference. I just finished watching it earlier this evening. The producers of the video certainly hold a similar view of the Fed to the one I expressed above.

I would like to share the following website of the Ludwig Von Mises Institute which I only discovered about one or two weeks ago. I've gotten a very good initial impression of the material available here.

Peter

I enjoy the von mises site -- when I find them, I'll post a couple of excellent articles on the subject from that site. One makes a compelling case that inflation is only the friend of those with political power or the artificial elite (hedge fund types) instead of providing labor or a service of real value. The case is made that deflation is actually good for everyone if extreme government measures aren't provided to keep bailing out those in power. The Australian economists from Hayek on seem right on target. If you're at all interested in economics of government, read FA Hayek's "The Road to Serfdom." I read it years ago when I was more engaged in these things, and it's a great view of our government from the eyes of an outsider. He takes the position that all attempts at central control end up enslaving a people.

[darinhouston]

I enjoy the von mises site -- when I find them, I'll post a couple of excellent articles on the subject from that site. One makes a compelling case that inflation is only the friend of those with political power or the artificial elite (hedge fund types) instead of providing labor or a service of real value. The case is made that deflation is actually good for everyone if extreme government measures aren't provided to keep bailing out those in power. The Australian economists from Hayek on seem right on target. If you're at all interested in economics of government, read FA Hayek's "The Road to Serfdom." I read it years ago when I was more engaged in these things, and it's a great view of our government from the eyes of an outsider. He takes the position that all attempts at central control end up enslaving a people.

Here it is:
http://mises.org/story/1254

There's a good one somewhere that makes the case that a key component of The Great Depression was the minimum wage laws (and if I recall correctly led in some ways to Hitler's rise in Germany). So many things intended to "protect" people end up being their ruin. Wage deflation doesn't hurt if there's a general deflation, also, since the price of goods and other services falls, too. With wage protection, though, the only choice employers have in a down market is to lay people off.

Deflation: The Biggest Myths
Daily Article by Jörg Guido Hülsmann | Posted on 6/11/2003

The prospect of deflation haunts the political and economic establishment in our western democracies. Their fears are understandable, at any rate from an economic point of view. Consider the following three basic propositions of monetary economics:

According to the first proposition, both the quantity of money and the price level are irrelevant for the wealth of a nation. Firms and households can successfully produce any quantities of consumers’ goods at any price level and with any nominal quantity of money. The ultimate springs of human wellbeing are savings, technology, and entrepreneurship – not money supplies and price levels.

According to the second proposition, while changes in the money supply do not affect the wealth of a nation in the aggregate, they change the distribution of resources among the members of society. In the case of an increasing money supply, for example, the first owners of the additional quantities of money benefit at the expense of all other money owners. Notice that these redistribution effects result not only from changes in the quantity of money, but from any changes in the supply of any good. There is a significant difference between money and all other goods only in a fiat money regime. This brings us to our third proposition:

A fiat money regime considerably facilitates the re-distribution of resources within society. It allows the owners of the printing press and their political and economic allies to enrich themselves far quicker and at much lower cost than any other producer in any other field. This explains why governments have for centuries sought to establish a paper currency. And it explains why, after they had achieved this goal in the 20th century, governments and their business allies set off on an exponential growth path. The welfare state has exploded in the 20th century, and Wall Street and the banking sector grew quicker than almost any other sector of the economy.

This would not have been possible on a free currency market, because nobody would accept banknotes the purchasing power of which depends on the whim of its producer. And indeed paper money has never existed in a truly free currency market.[1] It is essentially fiat money – money that the government imposes on its citizens. Paper money is protected through “legal tender” laws, which means that you and I can be forced to accept it as payment, even if we have contractually stipulated payment in other commodities. Moreover, in many countries paper money is shielded against its main competitors such as coins made out of precious metals through the tax code – sales taxes and capital gains taxes apply to these metals, but not to paper money. In short, paper money is monopoly money; it enriches the happy few at the expense of all others.

The deflation-phobia of our elites is therefore the rational reaction of those who profit from the privileges that our present inflationist regime bestows on them, and who stand to lose more than any other group if this regime is ever reversed in a deflationary coup. Perennial inflation is based on monopoly. Deflation brings in the fresh winds of the free market. True elites would welcome deflation for precisely this reason, because they owe their leadership positions exclusively to the voluntary support of other members of society. They have nothing to fear from deflation – a shrinking money supply – because their leadership is grounded on the useful entrepreneurial services they provide to their fellow citizens – services that would subsist through any changes in the money supply or in the price level.

But large parts of our present-day elites are “false elites” or “political entrepreneurs.” These men and women owe a more or less great amount of their income and decision-making power to legal privileges that protect them from competition and which enrich them at the expense of all other people. The fortunes of many political entrepreneurs are directly or indirectly attributable to the money monopoly of the Federal Reserve System. It is only because of this monopoly that the Fed could create a near boundless expansion of the money supply. And it is this inflation that in turn has financed a near boundless expansion of the activities of the federal and state governments, and of those who rely essentially on their lobbying effort with the Fed, rather than on the quality of their products, to reach and maintain leadership positions.

Political entrepreneurs are thus right to fear deflation. For deflation takes away the source of their illegitimate income and puts them finally back on equal footing with all other members of society, whose incomes are based on efforts and services provided in a competitive environment.

But these privileges can only survive because of widespread ignorance about the true character of deflation.[2] A closer look reveals that the case against deflation squarely rests on a litany of inflationist myths. To these we now turn.

Myth #1: You cannot earn a living and make profits when the price level falls
Most of our analysis will deal with deflation in the sense of a shrinking money supply. This case is most interesting from a political point of view, because few economists and laymen are ready to concede any benefits to deflation in this sense. But before we turn to this case, let us briefly examine the character of deflation in a somewhat different connotation, namely, in the sense of a decrease of the general price level. This type of deflation draws much less criticism than the other type, but it might be useful to deal with it first as a warm-up for out subsequent discussion.

Thus, is it true that one cannot earn a living and make profits when the price level falls? The answer is in the negative. Successful business does not at all depend on the level of prices, but on price spreads or, more precisely, on spreads between selling receipts and cost expenditure. But such spreads can exist and do exist at any level of prices, and they can exist and do exist even when there is a secular decline of prices. The essential reason is that entrepreneurs can anticipate declining prices, just as they can anticipate increasing prices. If they anticipate a future decline of their selling proceeds, they will bid down present prices of factors of production, thus assuring profitable production and paid employment for everyone willing to work. This is exactly what happened in the few periods of modern history in which deflation was not prevented through inflationist counter-measures.

For example, both the U.S. and Germany enjoyed very solid growth rates at the end of the 19th century, when the price level fell in both countries during more than two decades. In that period, money wage rates remained by and large stable, but incomes effectively increased in real terms because the same amount of money could buy ever more consumers’ goods. So beneficial was this deflationary period for the broad masses that it came to the first great crisis of socialist theory, which had predicted the exact opposite outcome of unbridled capitalism. Eduard Bernstein and other revisionists appeared and made the case for a modified socialism. Today we are in dire need of some revisionism too – deflation revisionism that is.

Myth #2: While falling prices are good, lacking aggregate demand is bad
This is a variant of myth #1. While the advocates of this myth concede the point that lower prices are advantageous from the point of view of consumers, they claim that there are manifest disadvantages from the point of view of producers. In particular, there would be few incentives to invest into any sort of business in an environment of shrinking prices. We have already rebutted this view by pointing out that the absolute future price level is irrelevant for profitable enterprise. The relevant factor is the possibility to realise a spread between selling proceeds and cost expenditure, and this possibility exists irrespective of the movement of the price level.

Now our anti-deflationist might come up with the following objection: profitable enterprise in times of falling prices presupposes that businessmen can bid down factors of production in anticipation of the event. If they are unable to bid factor prices down, they will not invest at all. QED.

But this argument overlooks that all resources are invested into some use at any point of time. Why are our farsighted entrepreneurs unable to bid the factor prices down? Clearly this is so either because the factor owners are not ready to sell them at the lower prices, or because other entrepreneurs offered slightly higher prices. In the latter case, there is clearly no lack of investment and productive activity. The factors in question are bought and sold – albeit at lower prices than would have been offered in inflationary times. And even in the former case, the factors are invested – they are invested in the “reserve stock” of the owner of these factors, and such a reservation demand fulfils a useful social function just as any other form of demand.

Myth #3: You cannot earn a living and make profits when the money supply shrinks
Human beings are able not only to anticipate a falling price level, but also the consequences of a shrinking money supply. Such anticipations will usually accelerate the deflationary process and make it reach the "rock bottom" of a stable money supply very quickly. Two cases need to be distinguished: A) the case of a fractional-reserve banking system operating on the basis of a commodity money such as gold or silver and B) the case of a paper money.

In case A, the supply of physical gold or silver can obviously not just vanish in thin air, and thus it remains to provide rock bottom in case of a deflation of fractional-reserve notes. Such a deflation usually starts when more and more people refuse to accepts these notes as payment, and it usually ends in a bank run, when even the present holders of the notes no longer wish to own them and rush to the issuing bank to redeem them in gold or silver. After the run, the money supply has often considerably shrunken because all fractional-reserve notes have disappeared from circulation. But the stock of metallic money remains and provides a rock bottom, below which the money supply cannot sink. There is no reason why this deflationary process should not be finished in a few hours or days. When it has ended, many banks will be bankrupt and many entrepreneurs will be bankrupt too, to the extent that they have financed their firms with debt rather than with equity. This explains of course why the present debt-financed establishment ferociously resists deflation. But it does not mean that production could not go on without them – in fact it can go on and will go on under new ownership.

In case B, there is no rock bottom to provide a stopping point to the deflationary process reducing the supply of a paper money. When people no longer wish to own a paper money and start selling it at any price, the result will be an ever declining purchasing power of this money, which in turn might convince even those who had bought that they better get rid of it, and the sooner the better. The result is a deflationary spiral: less willing owners – less purchasing power – less willing owners – less purchasing power and so on, until the paper money has completely vanished from circulation. Notice that this does not mean that the economy will necessarily be thrown back into a state of barter. What usually happens in such cases is that people start using other monies such as gold and silver coins, or foreign paper monies. The deflationary spiral therefore has the healthy effect of replacing an inferior sort of money – inferior from the point of view of the money users – with superior money. Again, there is no reason why this process should not be completed in a few days. And there is therefore no reason to expect that production will not resume very quickly under new ownership.

Myth #4: Deflation entails slower economic growth than inflation
Some champions of inflation concede that production can go on after a deflation, and possibly even in the midst of a deflation. But they claim that economic growth will be seriously curtailed by the necessary adjustments, to the point that it would have been preferable to avoid the deflation through inflation – or as they say, reflation.

It is difficult to discuss such claims in the absence of a commonly agreed-upon definition of economic growth. But the following consideration nevertheless applies: The problem of adjusting to deflation in the sense of a shrinking money supply is inherently a short-run problem. It is a problem of identifying those investment projects that are most profitable (and thus most socially beneficial) under the new conditions that deflation has brought into being. In particular, deflation in the worst of all circumstance induces businessmen and factor owners to hold back with their assets to avoid wasting them in any fancy venture. Deflation is therefore inherently sober, prudent, and financially conservative.

By contrast, inflation constantly lures capital into investment projects that do not find the spontaneous support of other members of society – capitalists, workers, and customers – but which are feasible only because they are financed, directly or indirectly, with money from the printing press. The most glaring example is the welfare state, which can be financed, not because there is any prospect of future returns, and not because it attracts a sufficient amount of voluntary donations, but solely because it is backed up with an ever-increasing amount of debts, which one day will be paid with new money from the printing press. This consideration applies quite apart from the fact, stressed by the Austrian economists, that inflation can induce inter-temporal misallocations of capital.

Given the enormous waste that goes in hand with inflation, it is not farfetched to assume that deflation will spur economic growth both in the long run and in the immediate run, by any definition of growth that emphasises the value scales of the individual members of society, rather than some arbitrary criterion of social justice.

Myth #5: Deflation is particularly burdensome for lower-income groups
The main asset of relatively poor people is their labour, and labour is a relatively non-specific asset, which means that it can be used in many branches of industry. If a worker can no longer be employed in his present position, it is therefore always possible for him to find new employment elsewhere, even though at a lower market price. By contrast, relatively rich people typically derive a larger part of their income from financial assets. Ultimately these assets relate to the ownership of capital goods, which in turn are highly specific assets – they can very often be used only in exactly the way in which they are presently used. If this use is no longer profitable, there will be a more or less dramatic drop of their market price, often to scrap value.

It follows that deflation affects lower-income groups less than higher-income groups.

Myth #6: Deflation destroys the credit of the state
It is true that deflation – especially deflation in the sense of a contraction of the money supply – will make it impossible for a government to ever pay back public debts. And it is also true that it will then for some time be impossible for the government to obtain new credits.

But it is a myth to believe that we have to wait for deflation to bring about this result. Public debts are on an exponential growth path and no official even talks about paying them back. Fact is that our western governments are already on a slippery slope that will inevitably end up either in hyperinflation or in state bankruptcy. It is just a question of time until they will have destroyed their credibility all on their own – deflation would merely speed up this process.

Let us also notice that there are potentially beneficial effects associated with state bankruptcy. In particular, governments would again be dependent on obtaining revenue mainly through taxation, and that puts a healthy break on their expansion path.

Myth #7: Deflation creates unemployment
Unemployment of a factor of production comes about only in two cases: A) if the owner of the factor is not willing to rent it out at the price offered to him, or B) if the law prevents him from doing so. It is therefore not true that declining wage rates bring about unemployment by any sort of inner necessity. People are not just unemployed. They choose not to work for an employer under the (pecuniary and non-pecuniary) conditions offered to them. Now it is clear that no sane person will accept to work for somebody else if the wage rate does not allow him to survive anyway. But this is not the case in a deflation. Remember that here all prices fall, and thus the decline of wage rates is compensated by a parallel decline of the prices for consumers’ goods. It is true that there might not be in all cases an exact parallel between wage rates and the prices of consumers’ goods, but any deviations will be temporary only and can easily be bridged for some time with the assistance of family, friends, and charitable institutions.

Involuntary unemployment might arise in a deflation only if the latter is combined with minimum wage laws, which prevent the worker from offering his services at lower rates. But clearly this unemployment does not result from deflation, but from the minimum-wage laws, which infringe on the freedom of association.

Myth #8: Deflation entails unequal and arbitrary burdens for the citizens
It is true that deflation involves heavy burdens for many individuals. Just consider the fact that today the great majority of U.S. household have incurred considerable liabilities, usually in the form of real estate mortgages. If a contraction of the money supply sets in, household incomes will decline and it will be impossible to pay back these liabilities. It will then be necessary o renegotiate debts, and some individuals will have to file bankruptcy. It is also true that deflation has unequal consequences for the individual citizens. Some will prosper in a deflationary environment more than they would have prospered in the present inflationary regime, and others will fare worse. Finally it is true that these re-distributions are often difficult to square with one’s notions of what is just and unjust.

So where is the myth? The myth consists in the belief that only deflation entails unequal and arbitrary burdens for the citizens. The truth is that the present inflationist regime is no less re-distributive and arbitrary than any deflation could possibly be. Inflation constantly re-distributes income from people who offer genuine services to people who happen to enjoy political alliances with the masters of the printing press.

Even if inflation is used “only” to prevent an impending deflation, these arbitrary and unequal redistribution effects cannot be avoided. The very least thing we could say, therefore, is that deflation is certainly not more unjust than inflation. But as well shall see further down, there are in fact very tangible benefits to be derived from deflation that make it actually preferable to continued inflation. But before we come to discussing this point, let us briefly deal with another issue:

Myth #9: It will take decades to settle deflation-induced legal disputes
Have we not been too over-optimistic in assuming that deflation might be a matter of a few hours or days? Is it not rather likely that deflation will upset a great number of long-term contracts, from mortgage contracts over industrial bonds to real estate leases? And is it not rather likely that it will take the courts some twenty years or so to sort out all the different claims and counter-claims?

It is true that, while the adjustment of the price structure to the new deflation-created conditions might take just a few hours or days (but could take much longer if government interventions hamper the adjustment process), the settlement of legal disputes could involve much longer times periods. But based on the empirical evidence it is certainly exaggerated to assume that more than a few months would be needed.

Consider the German deflation that set in after the bankruptcy of the Darmstädter Bank on July 13, 1931, and which lasted some two years. The crisis very quickly jeopardised the liquidity, not only of the banking sector, but also of virtually all other branches of German industry. Contractual relations were upset on a large scale, and thus it not only came to bankruptcies on an unprecedented scale, but also to a great number of revisions of previous contracts, both inside and outside of the courts, and to payment moratoria. Unemployment rose to almost 7 million, production stopped in many firms, salaries and wages plummeted, as did all other prices. The radical drop of real estate prices jeopardised the mortgage business, as well as financial titles backed up with mortgage claims.

How were these problems handled? Well, the unemployment problem was not handled at all, because government had created the conditions under which unemployment was inevitable: unemployment insurance and minimum wage laws. The result was social upheaval and twelve years of National Socialism.

But the problems relating to claims resolution were handled rather quickly and efficiently, partly because the German courts had, in the wake of the hyperinflation of 1923, gained some experience in dealing with dramatic changes in the purchasing power of money. In a great number of cases, the disputes never made it into the state courts, but were settled in private arbitration. The remainder was settled in the state courts or dealt with in a series of four emergency laws, the last of which was voted in parliament on December 8, 1931. Thus, a few months after the deflation had set in, all essential legal tools and institutions were in place and operated fairly efficiently.

There is no reason to assume that things would be handled less efficiently in the present-day United States, especially if legal scholars turn their energies into analysing the problems that are here at stake.[3]

Myth #10: Deflation confers no positive net benefit
Granted that a heavy contraction of the money supply is merely on equal footing with increases of the money supply when it comes to the distribution of burdens among the citizens. But is it not the case that we have pretty well adjusted out behaviour to the present inflationary environment, where as letting deflation happen would impose on us a re-adjustment? Even if this adjustment is only a temporary affair, still it involves costs for all members of society. So what are the benefits of deflation that could prompt a responsible citizen to endorse it, apart from the uncertain prospect of being on the winners’ side in the short-run zero-sum redistribution process that deflation entails? Here the following consideration comes into play.

First of all, deflation is a very efficient mechanism to speed up adjustment to new circumstances in the wake of a major financial crisis. The reason is, as we have noticed above, that deflation affects the prices of factors more than it affects the prices of consumers’ goods. As a consequence, deflation increases the spread between selling receipts and cost expenditure – in other words, the interest rate – and thus creates powerful incentives for increased savings and investments.

Second, and equally importantly, deflation is a one-time process that however has the potential to destroy the very institutions that produce inflation on a perennial basis, in particular, fractional-reserve banks and fiat money producers (“central banks”). The destruction of these institutions eliminates the “advantage at the margin” enjoyed by liability finance as compared to auto-finance. In other words, economic and social power is taken away from the Fed and the banks, and returned into the hands of individual citizens. Firms will operate on a far higher equity basis than before, and households will, in more cases than before, first save and then buy a home. Furthermore, the destruction of the inflation machine will destroy the main financial engine of the welfare state. Governments will henceforth have to obtain their resources exclusively through taxation, which is subject to far greater social control than the unworthy stealth method of gaining resources by inflating the money supply.

Myth #11: Letting deflation happen is “passivism”
In the light of our foregoing discussion, it is clear that letting deflation happen must not be simply equated to an apathetic resignation before the power of mysterious forces and blind market mechanisms. Deflation can fulfil extremely useful social functions and those who cherish individual liberty and the sanctity of private property are on good grounds in consciously striving to let deflation run its course. If anything, it is letting inflation happen that amounts to apathetic resignation – resignation that is before the power of a money monopoly that thrives on ignorance, and which benefits political networks at the expense of capitalistic civil society.

Jörg Guido Hülsmann is senior fellow of the Mises Institute. jgh@mises.org. See his Daily Article Archive and his vita and other links. He is lecturing at the Mises Institute this summer. His latest lecture on deflation is available on Mises.org audio.

[1] One might object that the banknotes of the Bank of England that circulated from 1797 to 1821 were an exception, because they were not legal tender. But these notes were not paper money, but credit money. During the entire period of this “paper pound,” the market participants expected a resumption of specie payments of the Bank of England in the near future. For the distinction between commodity money, credit money, and fiat money (in most cases: paper money), see Mises, Theory of Money and Credit, part one, chap. 3, sect. 3.

[2] Of course we mean to defend only free-market deflation. Confiscatory deflation is in-defendable. See Rothbard in Making Economic Sense, and Salerno, “Taxonomy of Deflation.”

[3] One of the most interesting present-day problems for libertarian legal scholarship is the development of a legal theory of deflation.

[darinhouston]

An argument in the video was that a gold coin has inherent value and a gold coin in Roman Empire times has the same purchasing power as today. It seems to me that gold is as arbitrary as fiat money. It also is a means for conducting a transaction or holding value. Someone can always dig up more gold. The obvious difference is that gold is a physical thing so it is harder to come by than a virtual thing like fiat money. So maybe gold has greater potential for limiting inflation because it itself is physically limited. But it also seems like this limitation also has its own set of problems, like less credit.

I'm no economist, but I believe the argument is that gold (or other fixed standard) creates a floor for a crash at which point valued institutions rebuild (albeit under new ownership) and artifices fall. Without a floor, it can be protracted, especially with extraordinary intervention by government.

[darinhouston]

http://mises.org/story/3104

Don't Bail Them Out
Daily Article by Llewellyn H. Rockwell, Jr. | Posted on 9/10/2008

It was the singular achievement of Murray Rothbard's America's Great Depression to have demonstrated that the Great Depression was a crisis manufactured and prolonged by the attempts to stop an inevitable downturn. The policy response — creating more money, propping up prices, ginning up employment, and a host of other devices — took a stock-market price collapse and a banking liquidation and spread the mess throughout every sector of the economy. What might have lasted a year to 18 months instead lasted 16 years.

At the time, Ludwig von Mises tried to warn against intervention. See his Causes of the Economic Crisis. So did F.A. Hayek. See his Prices and Production. So did Lord Robbins. See his book The Great Depression.

And yet, that is not the conventional wisdom. The conventional wisdom is that the Depression was a natural disaster, a hurricane that swept through society that had to be fixed by the government. Another view, found in the work of the monetarists, is that it was caused by the failure of the government to create oceans of paper. This seems to be the view of Bernanke.


America is now imprisoned by these fallacious views of cause and effect. For this reason, we see virtual unanimity that the bailout (call it want you want: conservatorship, nationalization, socialization, whatever) of Freddie and Fannie must take place.

On the day following the nationalization, a day that will live in infamy, the Wall Street Journal editorialized against the Democrats and their reform efforts, but didn't actually oppose the bailout; instead it observed that we are all somehow "on the hook." The paper also published a piece by McCain/Palin which said that the bailout is "sadly necessary."

The New York Times called it "a reasonable and reassuring move." The Los Angeles Times wrote that the bailout was "inevitable," and complained that Freddie and Fannie should only help 20% and not half of borrowers. Steve Forbes in his magazine wrote that "drastic action" had to be taken because a default would "have triggered the worst financial meltdown since the Great Depression."


It's interesting, isn't it, that all these people believe that waving the magic money wand can make reality just go away. That incredible superstition seems to be the official position of the entire US establishment. And we like to flatter ourselves into believing that we live in an age without illusions!

As for those who should know better, Greg Mankiw, author of the leading economics textbook, writes that because "it was likely to happen eventually" it is "better to get on with it." The supposedly free-market economics blog Marginal Revolution warns that without the bailout, "most of the U.S. banking system would be insolvent," failing to point out that a system that needs a bailout with fiat money is already insolvent.

The Cato Institute agrees that the Treasury had to bail out the mortgage industry because it "was forced to do so," and since Fannie and Freddie are indeed "too big to fail." The Heritage Foundation agrees that it was a "necessary step" and a "vital move toward reform."


Sure, these people have plenty of recommendations about what should have been done in the past, and lots of ideas about what should be done in the future. As for the present, they are ready to propagandize for the largest socialist operation in American history. In all of these latter cases, we are looking not at a problem of economic education, but rather the lack of courage to stand up to the state when it is needed most.

Pretty much alone in both predicting the calamity and actually opposing the bailout are those who have learned from the Misesian tradition, people such as Nouriel Roubini of the RGE Monitor, investor Jim Rogers, and of course our own scholars such as Mark Thornton, George Reisman, Robert Blumen, and pretty much all of our adjunct scholars, who have said plainly and clearly that this is a dreadful error, one that will worsen the present meltdown. Of course Ron Paul was right all along, as the evidence proves.


Let us address this claim that not bailing out the system and not nationalizing the mortgage market would lead to a financial meltdown on the level of the Great Depression. It makes no sense to warn that we will repeat the past if we fail to do the things that actually made the past as bad as it was. The truth is exactly the opposite: to avoid another Depression-length downturn, we need to avoid the mistakes of the past, among which were the policies that attempted to keep failing firms and industries afloat in difficult economic times.

What should have happened in 1929 is precisely what should happen now. Let the price system prevail! The government should completely remove itself from the course of action and let the market reevaluate resource values. That means bankruptcies, yes. That means bank closures, yes. But these are part of the capitalistic system. They are part of the free-market economy. What is regrettable is not the readjustment process, but that the process was ever made necessary by the preceding interventions.

Let me state this very plainly: I do not believe for one second that if the government fails to nationalize Freddie and Fannie, the world as we know it will come to an end. Those who are saying so are trying to scare the population, the same as with every other major demand by the regime. It was the same with NAFTA, the WTO, the war on terror, the war on bird flu, the nationalization of airport security, and everything else.

If the government did nothing but sell off the assets of the mortgage giants, we do not know for sure what would happen, but the market has a way of finding value and readjusting. I would expect about 18 months of difficulties. Banks would fail just as many businesses in the free market fail every day. Housing prices would fall more, just as all market prices are subject to change. But the process of readjustment would be smooth and rational. Most importantly, we would all stop living a lie and believing an illusion.

Contrary to what the blogging heads say, there is nothing that makes this nationalization inevitable. We need to let the market handle the entire process, come what may. I guarantee that this solution is a better one than creating another trillion or so to bail out failing enterprises.

[thrombomodulin]

Theophilus,

The ability to loan money from depositors or the Fed that is not held on reserve is still a contractual obligation of the bank and represents a business interest or endeavor of the bank. No stealing here.

I don't think I have successfully conveyed the reason I believe that the banks are involved in a form of theft. I agree with you that there is nothing at all wrong with either borrowing money, or with honoring the contractual obligations between two consenting parties.

Instead, the problem is related in particular to the special privileges granted for the creation of money. Suppose, for example, that the government arbitrarily granted to some, but not to others, a license to create paper money (i.e. a license to create Federal Reserve Notes). It would of course be the case that those who have this license would be able to purchases goods and services, in exchange for merely printing costs. The long run consequence of such a system would be that eventually all wealth would be transferred from those who lack such a license, to those who have it.

Under our current system, the banking system has been granted the exclusive legal authority to create money. Of course, in our system the banks our more restricted than the above example because banks are limited by law to only loan out the created money, rather than spending it directly. Nevertheless, the banks have the unparalleled privileged of receiving interest income upon those loans. Namely, the banks are able to receive interest income for merely the cost of printing and bookkeeping - which costs essentially nothing. As such, the banks are receiving wealth without contributing due effort to its creation (work). Therefore, It can only be the case that the gains attained by the banks, are equal to the loss experienced by others.

I would like to add that one business ought not be granted legal rights that not extended to all business because inequality under law is unjust. In this case, the banking system has been given the right to create legal tender, and thus I believe it should follow that all individuals ought to be granted the same right. Namely, if it is legal for the Fed to print paper money, loan it out, and receive interest - then why should it be illegal for me or anyone else to likewise manufacture a printing press, create money, loan it out, and thereby to start receiving some interest income? On the other hand, it would also be quite fair if no individual or business were granted this right and the Fed's right were revoked.

The Fed issues bills, notes and bonds whenever it needs to raise capital. I don't think this is theft either. It is assumed that the Fed, through taxpayer money, will meet those obligations.

If this is true, then I do agree. I would agree because the theft which I am pointing out is the case when money is created of thin air. Doing such devalues the currency, and comes at someone else's expense for the benefit of the one who printed it. If the Fed is loaning out only that money which has been given to it already by its depositors, then nothing wrong has been done. As far as I know, however, bills, notes and bonds are a function of the US Treasury which is part of the federal government. They are not a function of the Federal reserve which is a private business. Notice at "http://www.federalreserve.gov/generalinfo/faq/faqts.htm" the Fed directs those who seek such to the US Treasury.

I'm not aware of the Fed just printing money to meet its obligations. That would lead to excess capital and inflation. If this did happen, this might be considered theft because the value of the current money in the system would be devalued relatively. Finance professionals may have projections about what is the optimal levels of money in the system (M1..Mn). The Fed does print money to replace worn-out money.

This is exactly what the Fed has been doing (link). The links shows figures for monetary base. The monetary base figures show an exponential increase of the volume of paper money over the last 100 years. Meanwhile, the value of the dollar, as expected, is now less than 5% of what it was what it was 80-100 years ago. If it is true the Fed is not just printing money, then where did all the money referenced in the figure come from?

Of course, if what I have been saying is true, then we should expect to see that in the real world the banks have attained great wealth. I would like to suggest that this may be demonstrated in the following way: First, consider for example the transaction when a person buys a home using a mortgage. Suppose someone buys a home for $200k, and takes out a loan from the bank for $100k to cover half the cost of the purchase. Immediately after the transaction, the house belongs legally to the owner and the owner also owes the bank $100k. I think it is a fair assessment to say that the bank owns 50% of the home and the owner owns 50% of the home. I think it is fair because (1) the home is collateral for the loan - the bank has the right of foreclosure (2) the owner has to "pay off" the bank to have all complete ownership of the property. My understanding is that as the owner pays off the mortgage, the money used to repay principle is destroyed, but the bank keeps the interest as profit. Now, by the same principle, what percentage of all home throughout the US homes are owned by bank? I would venture to guess the number it is more than 50%. If the banking system is able to receive interest income on such a great amount of assets, then I would argue that they are receiving and have attained a great deal of wealth. Furthermore, of course the banks by the same principle own a significant share of small and large businesses alike. Please critique if you feel this example is illegitimate.

I think the current system is based upon trust and confidence that counterparties will fulfill their contractual obligations as required by law.

I'm guessing when greed rules, the normal risk processes that the average person would expect go out the window. For example, predatory lending either through credit cards or mortgages is unethical. Who loans to someone who can not repay easily? This appears criminal.

One loans to one who cannot repay when he or she has nothing to loose, and everything to gain. Such is the case with paper money printed out of thin air.

Who better than Christians can be entrusted to conduct their affairs righteously? We are the salt and light and are meant to impede the rot and decay. If God calls someone to work in banking or finance, then that is a blessing to all of us.

I'm not sure this is right. For example, I would not recommend that a Christian join the mafia or work as a prostitute in order to clean up the industry.

I don't consider banking or finance to be an inherently immoral business.

Agree, but I do think the printing and loaning of paper money, printed on demand, without any banking to be immoral.

I don't think the act of borrowing money from an institution is wrong. What could be considered wrong is to borrow more than you can reasonably expect to repay.

Agree.

Just some thoughts. I hope I do not offend.

Same here, please let me know if anything came across as offensive. Thanks for carrying on the conversation.

Peter

[thrombomodulin]

Darin,

I haven't had a chance to read the articles yet, it will probably be Thursday before I can do so and reply. Thanks in advance for sharing the links.

Peter

[Malachy]

Two economist to read, for a layman's introduction to economics, are Thomas Sowell and Walter Williams.

[thrombomodulin]

Malachy,

Thanks for the references. Shortly after I made my last post here, my home computer stopped working - so I haven't communicated on the forum since. Hopefully I'll be able to find a replacement in the next couple weeks.

I've been working on reading Murray Rothbard's "The mystery of banking". I started it a couple weeks ago, and I've finished about half the book. This entire book, as well as about 1000 other books, are available for download from mises.org/literature. I didn't see walters or sowell's books available on this site.

Peter

[livingink]

In addition to Von Mises and Hayek, I would also recommend a reading of Milton Friedman's book Free to Choose. I think you will find that Dr. Friedman wrote it in such a way that laymen can understand the workings of the monetary system. In particular, chapter 3, The Anatomy of a Crisis, would be helpful but don't neglect the rest of the book as you young men especially are going to enter an economic America that may be much different than the Reagan Revolution that I entered at your age 30 years ago. The current thinking seems much more collectivist and a reading of Hayek will enlighten you on the dangers of collectivism.

Specifically, Peter, you have to remember that any bank that makes a loan takes the risk that the borrower will repay the loan, that the property or security retains its value in case the loan is not repaid, that it can resell the property if it must foreclose, etc. This may exclude the current unfortunate situation where every poorly run automaker, investment banker and credit card company crawls sniveling on hands and knees to Washington for a gubment handout.

Pete, let's say for a minute that we allow you to print money--Thrombo$$. Thrombo$$ are gold and blue with a picture of a fish in the center. Darin manufactures widgets. You want 20 widgets. You offer Darin 20 Thrombo$$. Darin is going to ask himself what he can do with 20 blue and gold pieces of paper that you printed off on your computer. He'll want to know if he can pay Homer for supplies to make widgets with Thrombo$$. He needs to know what you back the Thrombo$$ with--gold or faith in your word that they're worth something. Why should he believe you? What credibility do you have? If you make this transaction you'll have 20 pieces of a physical item that you can at least use for paper weights if your business fails. Darin will simply have 20 blue and gold pieces of paper with a picture of a fish on them. Green and white Federal Reserve Notes are backed by faith in the gubment of the US of A. They are a store of value and are accepted throughout this country and in foreign countries. That's your competition.

My example is not so far fetched. We pay multiple green and white pieces of paper to economists every day to tell us that a trade deficit is a bad thing. Think about that. It means that we in the US are sending green and white pieces of paper to people in other countries who are sending us back hard goods that we can use faster than we are sending hard goods to them. So, it will work if people will develop the same faith in the Thrombo$$ that they have developed in the US dollar.

Having a bit of fun.

livingink

[thrombomodulin]

In addition to Von Mises and Hayek, I would also recommend a reading of Milton Friedman's book Free to Choose.

I watched his video series "free to choose" from - i think it was - http://ideachannel.tv. I liked what he had to say. I'll keep this book in my for my reading list.

Specifically, Peter, you have to remember that any bank that makes a loan takes the risk that the borrower will repay the loan, that the property or security retains its value in case the loan is not repaid, that it can resell the property if it must foreclose, etc. This may exclude the current unfortunate situation where every poorly run automaker, investment banker and credit card company crawls sniveling on hands and knees to Washington for a gubment handout.

Indeed the banks borrowing from the Fed take on such a risk, but I would like to point out the Fed has nothing to loose in case of default excepting a little green ink and paper.

Green and white Federal Reserve Notes are backed by faith in the gubment of the US of A.

what exactly does this "backed by faith in the gubment of the US of A" mean?

There is good reason to have no faith in the green and white notes:
1. They are being created at an absolutely unprecedented rate, and it directly follows the notes will have much less purchasing power. Quite possibly hyperinflation is not far off.
(See http://research.stlouisfed.org/fred2/fr ... 2008-10-06)
2. The notes are not a store of value to a wise investor, the notes have lost ~95% over the last ~80 years.
3. The gov't has made no promise to exchange the dollar for goods at any rate in the future (as was true at one time under the gold standard)

Except for the following I'll comment on your paragraph later: My point is that one company (the Fed bank) has been granted special privileges under law, not granted to anyone else. Thus I am saying that the government is not impartial under law unless my Thrombo$$ are also (1) backed the gov't of the USA and (2) by law legal tender for all debts private and public.

Having a bit of fun.

Same here!