I just sent this letter to the editor of my local newspaper, the Olive Press. I have been writing to them each month:
A number of Olive residents have questioned my claim that limousine liberals favor the wealthy, i.e., themselves. The financial elite has often been called the military industrial complex (MIC) but is more accurately a nexus of real estate, Wall Street and commercial banking with the MIC and so I will refer to it as the banking elite.
Gabriel Kolko in his Triumph of Conservatism shows that the establishment of the Federal Reserve Bank was part of a larger movement, Progressivism, that reflected the banking elite's interests. This followed three decades of cumulative politicization of the economy by the Mugwumps and Populists of the 1880s and 1890s. One fruit of these movements, the 1890 Sherman Anti-trust Act, supported increasing concentration of industry. Martin J. Sklar provides detailed documentation in his Corporate Reconstruction of American Capitalism 1890-1916. The Federal Reserve Act in 1913 further enhanced the banking elite's domination, which was accelerated in 1932 when Franklin D. Roosevelt abolished the gold standard and confiscated all privately held gold.
The way that the Federal Reserve Bank helps the banking elite at the expense of the average American is that it increases the number of dollars in circulation, distributing them to the banking system. The banking system takes the reserves that the Fed gives it and expands the reserves further through fractional reserve banking. Briefly, when the fractional reserve banking system receives a Federal Reserve deposit (created out of thin air) of one dollar, it can expand the number of dollars by ten. Thus, the Federal Reserve Bank, which the banking system legally owns, can create deposits (reserves) out of thin air and then the banks can lend up to ten times the reserves also out of thin air. In other words, the Fed and the banking system cheapen the dollars that you own.
Economists, who are on the banking elite's payroll through consultancies, endowed chairs, and appointments to the Federal Reserve Bank staff, serve as an important propaganda source. They claim that the reserves are distributed evenly throughout the economy. Of course, this claim is absurd. Limousine liberals like William Greider (author of Secrets of the Temple) claim: (a) the Federal Reserve Bank helps the middle class but (b) the Federal Reserve Bank gives hundreds of billions of dollars to Bunker Hunt, Wall Street speculators and recipients of foreign investment. Limousine liberals never question how it might be possible to give hundreds of billions to Wall Street banks and at the same time help the average American.
Thus, at the foundation of big government is big subsidy to the banking elite. But that's the least of big government's subsidy to limousine liberals. A bigger way is the Fed's bloating of the stock market. The way the Fed's monetary expansion bloats the stock market is by reducing interest rates. Low interest rates mean higher stock prices. The present value of future dividend payments are higher at a lower interest rate. Since stocks are present value indicators of a firm's future profits, lower interest rates reduce the discount factor and raise stock prices.
The income inequality about which limousine liberals shed crocodile tears is due to the system which they put in place: by keeping interest rates low, stock prices are buoyed and wealthy limousine liberals like George Soros and Warren Buffett become richer. The way that interest rates are kept low is by the Fed's and the banking system's increasing the amount of money. The increasing amount of money leads to higher prices (inflation). Higher prices mean the average American becomes poorer. Thus, the inflation adjusted wages of workers are reduced while stock prices are increased and the wealthy become wealthier. No source has advocated this system more aggressively or for longer than the New York Times.
The period of the Fed's greatest power began in 1971 and continues today. During this 39 year history, American workers' wages began to stagnate in the early to mid 1970s. They continue to stagnate today. American workers today earn per hour what they earned in 1971. Prior to 1971, real hourly wages increased 2% per year. The post 1971 period saw massive increases in stock prices and increasing income inequality. All of this is due to the policies of limousine liberals, beginning with Franklin D. Roosevelt, who abolished the gold standard, and Richard M. Nixon, who declared "We are all Keynesians now."
Sincerely,
Mitchell Langbert
Showing posts with label fractional reserve banking. Show all posts
Showing posts with label fractional reserve banking. Show all posts
Sunday, February 28, 2010
Friday, January 23, 2009
The Banking System Has Caused Economic Slowdown
The consensus argument (which is often wrong) is that the banking system has caused the current economic malaise. In general, recessions and depressions are monetary. The Great Depression was a monetary phenomenon. This time, the Fed has ballooned money supply yet the slowdown continues. Of course, it is likely that there is a lag, and in a month, two or three there will be a turnaround. The stock market, however, continues to fall. This may have to do with continued media publicity. If the lag or media publicity arguments do not turn out to hold, the culprit is the banking system itself, which is what I keep hearing.
Not that money supply is independent of the banking system. Much of the money supply is created by the banks. But if the money supply is the reason for depressions and recessions, there is an argument to maintain the current banking system--the Fed can counter panics and so fractional reserve banking's chief problem (the threat of runs) can be countered. But not if the banking system itself is faulty. Then the argument for the current fractional reserve system is attenuated. Then, fractional reserve banking is in part responsible for misallocation and slowdowns, and money supply (itself a product of fractional reserve banking) is only partly to blame. In that case, a clear thinking public (sans the New York Times, pro-bank "liberals" and the like) ought to ask why the the banking is perpetuated given its dismal performance.
Fractional reserve banking is a form of fraud and need not be legal. Bankers lend out more money than they have on reserve. For every one dollar deposit, banks lend out up to six additional dollars. These dollars are covered by incoming new deposits. The system is not far from a Ponzi scheme. New investment covers old loans. It works if borrowers come and go with regularity. The problem until the days of the New Deal was that they frequently did not. There would be "runs", banks would falter and depressions would result.
Without fractional reserve banking there would be more savings and less economic activity. The economic activity that occurred would be more rational than it is with fractional reserve banking. Over time, better projects would be built and there would be more innovation because investors would be more focused on rational investments. This would stabilize economic outcomes over time, as more good ideas were implemented as were fewer bad ones. There would be less reckless depredation of the environment as unnecessary housing and manufacturing would be cut back. Higher unemployment levels over the intermediate and perhaps long term could be subsidized through relief, just as it is now. Interest rates would be higher and more people would save. There would be less or no inflation (and perhaps deflation) so people planning for retirement would not need to rely on the stock market. Savings would generate adequate returns for retirement. Better investment would be made, so that statistical economic growth might be slower but substantive economic growth would be much faster. The difference to which I'm alluding, satistical versus substantive economic growth, is that statistical growth includes garbage investment like sub-prime housing and public schools that do not produce value. Substantive economic growth would include private schools that do produce value and housing that people really want.
Banks need not be permitted to lend more money than they have. The argument for doing so is economic growth. But the argument against it is the rape of America's retirees; and the stifling of innovation caused by the misallocation of credit and irrational turns in the economy due to banking panics--on the part of bankers themselves.
Not that money supply is independent of the banking system. Much of the money supply is created by the banks. But if the money supply is the reason for depressions and recessions, there is an argument to maintain the current banking system--the Fed can counter panics and so fractional reserve banking's chief problem (the threat of runs) can be countered. But not if the banking system itself is faulty. Then the argument for the current fractional reserve system is attenuated. Then, fractional reserve banking is in part responsible for misallocation and slowdowns, and money supply (itself a product of fractional reserve banking) is only partly to blame. In that case, a clear thinking public (sans the New York Times, pro-bank "liberals" and the like) ought to ask why the the banking is perpetuated given its dismal performance.
Fractional reserve banking is a form of fraud and need not be legal. Bankers lend out more money than they have on reserve. For every one dollar deposit, banks lend out up to six additional dollars. These dollars are covered by incoming new deposits. The system is not far from a Ponzi scheme. New investment covers old loans. It works if borrowers come and go with regularity. The problem until the days of the New Deal was that they frequently did not. There would be "runs", banks would falter and depressions would result.
Without fractional reserve banking there would be more savings and less economic activity. The economic activity that occurred would be more rational than it is with fractional reserve banking. Over time, better projects would be built and there would be more innovation because investors would be more focused on rational investments. This would stabilize economic outcomes over time, as more good ideas were implemented as were fewer bad ones. There would be less reckless depredation of the environment as unnecessary housing and manufacturing would be cut back. Higher unemployment levels over the intermediate and perhaps long term could be subsidized through relief, just as it is now. Interest rates would be higher and more people would save. There would be less or no inflation (and perhaps deflation) so people planning for retirement would not need to rely on the stock market. Savings would generate adequate returns for retirement. Better investment would be made, so that statistical economic growth might be slower but substantive economic growth would be much faster. The difference to which I'm alluding, satistical versus substantive economic growth, is that statistical growth includes garbage investment like sub-prime housing and public schools that do not produce value. Substantive economic growth would include private schools that do produce value and housing that people really want.
Banks need not be permitted to lend more money than they have. The argument for doing so is economic growth. But the argument against it is the rape of America's retirees; and the stifling of innovation caused by the misallocation of credit and irrational turns in the economy due to banking panics--on the part of bankers themselves.
Wednesday, December 3, 2008
End Fractional Reserve Banking--Send Bankers to the Hoosegow
Everyone blames the current economic volatility on credit default swaps and similar kinds of derivatives. Sub-prime loans were "stripped", securitized and sold. Rights to payment in the event of default were purchased. The buyers and sellers weren't able to value the risk. The profits from the sales were recorded as profit...
Wait a minute! Let me understand this. Banks were registering profits on derivative instruments whose risks they did not understand? If that is so, then the profits they recognized during the years when they were buying and selling the derivatives were fraudulent, and criminally so. What the banks did was the equivalent of a fire insurance company's telling investors that insurance premium money needed to cover payments for losses due to fires was profit. If that occurred, the firms and the executives were engaging in outright fraud, no different from what Ken Lay and Jeffrey Skilling did at Enron. If Andy Fastow rightly ended up in jail, the heads of the money center banks that engaged in derivatives-related fraud belong there as well.
Oddly, though, both the Bush and Obama administrations view the bank presidents' fraud not as a matter of criminal enforcement, but as an activity that warrants subsidization. The pissant propagandists at Fox, CNN and the Times all agree. Henry Paulson, friend of the perpetrators, has succeeded in effecting a near trillion dollar bailout. Ben Bernanke, whose job includes stopping reckless banking practices, has tripled the monetary base in order to subsidize the fraud. Like a horde of drooling morons, the progagandists applaud.
The complaint among many of the propagandists is that there needs to be "regulation". In fact, regulation already exists. The Federal Reserve Bank is empowered to oversee commercial banking, and can tell commercial bankers anything it wishes to tell them. Chairmen Greenspan and Bernanke could have hired experts to evaluate the risks and degree of fraud involved in the derivatives trading. But they did not. Nor did Congress even hint that that they should do so in light of Warren Buffett's public statements over the past few years that the derivatives were leading to trouble. That wouldn't have anything to do with all those Goldman Sachs contributions to the Democrats last year, would it?
In 1913 the nation adopted a specific approach to banking that lacked justification. The nineteenth century was a period of increasing real wages among workers, far greater levels of innovation than in the 20th, and increasing immigration as millions around the world aimed to come to America to participate in the real wage growth. There were three groups who suffered during this period: capitalists, landowners and farmers. The reason these groups suffered was that the gold standard era was characterized by deflation because the greenbacks that had been created during the Civil War were retired in the 1870s and innovation created highly intense competition. So prices were declining and stockholders, landowners and farmers were hurting. Innovation came from the free economy, absence of income taxes and increasing real wages, which permitted many new business start ups. Thus, this was a land of opportunity but pressure was on those who speculated in stock and held wealth in land.
Family farmers combine two elements. They are property owners and workers. Richard Hofstadter, in the book Age of Reform, has argued that 19th century American farmers were in large part land speculators. They sold land in New England and pushed into the midwest and then into what we now call the west in part to make gains on land values that were increasing due to increased population. This process was stalled by deflation during the post Civil War gold standard era. Hence, William Greider's claim that the Populist movement, which argued for inflation in the 1880s and 1890s, was a working class movement is mistaken. Although farmers were often workers, in this role they were benefiting from deflation. Real wages were rising across the board. It was as capitalists and landowners who were facing declining asset values and prices that farmers were hurting. Lower food prices are good for workers, but Greider omits this consideration in his discussion of the Populist movement. Deflation is good for workers but bad for capitalists, sellers and landowners. In claiming to be workers' friend, Greider somehow makes an argument that supports real estate speculators and bankers. He does this while saying hard money helps bankers. (Funny how the left manages to say that they help the poor while they are helping the rich, and then turn around and get donations from George Soros!)
Because of the massive gains to workers during the late nineteenth century (due to increasing real wages) the Democrats' attempt to introduce an inflationary economy was voted down in 1896 by popular vote. William Jennings Bryan ran three times altogether and was voted down each time. However, when JP Morgan approached death, bankers realized that in order to maintain fractional reserve banking as a system there would need to be a replacement for Morgan, who frequently arranged loans that provided liquidity to rescue banks. This was accomplished by the establishment of the Fed in 1913, which Wilson, a gold standard advocate, introduced with little fanfare or debate.
There is no evidence that fractional reserve banking was essential to the dynamic economic growth of the nineteenth century. Other countries had fractional reserve banking but did not grow to the same degree that America did. Other countries had more frequent wars and had more inflation, though. Nor is there evidence that the key growth areas of the economy, manufacturing and innovation, received more funding from banks than would have been available without fractional reserve banking. In the case of Standard Oil, which revolutionized the oil industry, Rockefeller and his partners financed the business from their own savings and then profits. Bondholders and investors were brought in and over time a "trust" was formed. Although banks played a role, there is no evidence that fractional reserve banking was necessary to this or any other important business.
The public has accepted the need for a money supply managed and controlled by commercial banks. But is such a system essential? "Progressives" (the very name is laughable) argue staunchly for the 1913 system based on the conservative argument that it's been that way for 95 years. But since 1971 real wages have been declining, not rising. The 20th century has seen some innovation, but much less than the nineteenth. Fractional reserve banking facilitates allocation of credit to incompetent investment schemes, derivatives and crackpot investments such as Enron, the tech bubble and the sub-prime bubble. Redlining, excessive real estate development and the rape of cash savers and Americans on fixed incomes (the lower middle class) in favor of William Greider's* favored elements, millionaire construction firm owners, big banks, Wall Street investors, stockholders and major borrowers like billionaire hedge fund managers have all resulted from fractional reserve banking and from the Fed.
There is no evidence that bankers are or were better at allocating capital than a free market would be. With a trillion dollar bailout whose costs may mount to five trillion, a tripling of the money supply in order to subsidize the mistakes of the commercial banks, and large scale economic dislocation purely because of fraudulent and incompetent investment and profit-recognition practices in which the money center banks have engaged, people who claim that fractional reserve banking creates surplus for the economy have begun to look like delusional cranks.
The declining real wage of the past 36 years is evidence enough that fractional reserve banking has failed. Add the two bubbles of the past ten years to the mix, and the claim that fractional reserve banking contributes to the economy becomes laughable. Now that the banking system aims to absorb trillions of dollars from the productive economy in order to subsidize fraud, the time has come to consider scrapping it--and sending the money center bank CEOs to the hoosegow.
*See William Greider, Secrets of the Temple.
Wait a minute! Let me understand this. Banks were registering profits on derivative instruments whose risks they did not understand? If that is so, then the profits they recognized during the years when they were buying and selling the derivatives were fraudulent, and criminally so. What the banks did was the equivalent of a fire insurance company's telling investors that insurance premium money needed to cover payments for losses due to fires was profit. If that occurred, the firms and the executives were engaging in outright fraud, no different from what Ken Lay and Jeffrey Skilling did at Enron. If Andy Fastow rightly ended up in jail, the heads of the money center banks that engaged in derivatives-related fraud belong there as well.
Oddly, though, both the Bush and Obama administrations view the bank presidents' fraud not as a matter of criminal enforcement, but as an activity that warrants subsidization. The pissant propagandists at Fox, CNN and the Times all agree. Henry Paulson, friend of the perpetrators, has succeeded in effecting a near trillion dollar bailout. Ben Bernanke, whose job includes stopping reckless banking practices, has tripled the monetary base in order to subsidize the fraud. Like a horde of drooling morons, the progagandists applaud.
The complaint among many of the propagandists is that there needs to be "regulation". In fact, regulation already exists. The Federal Reserve Bank is empowered to oversee commercial banking, and can tell commercial bankers anything it wishes to tell them. Chairmen Greenspan and Bernanke could have hired experts to evaluate the risks and degree of fraud involved in the derivatives trading. But they did not. Nor did Congress even hint that that they should do so in light of Warren Buffett's public statements over the past few years that the derivatives were leading to trouble. That wouldn't have anything to do with all those Goldman Sachs contributions to the Democrats last year, would it?
In 1913 the nation adopted a specific approach to banking that lacked justification. The nineteenth century was a period of increasing real wages among workers, far greater levels of innovation than in the 20th, and increasing immigration as millions around the world aimed to come to America to participate in the real wage growth. There were three groups who suffered during this period: capitalists, landowners and farmers. The reason these groups suffered was that the gold standard era was characterized by deflation because the greenbacks that had been created during the Civil War were retired in the 1870s and innovation created highly intense competition. So prices were declining and stockholders, landowners and farmers were hurting. Innovation came from the free economy, absence of income taxes and increasing real wages, which permitted many new business start ups. Thus, this was a land of opportunity but pressure was on those who speculated in stock and held wealth in land.
Family farmers combine two elements. They are property owners and workers. Richard Hofstadter, in the book Age of Reform, has argued that 19th century American farmers were in large part land speculators. They sold land in New England and pushed into the midwest and then into what we now call the west in part to make gains on land values that were increasing due to increased population. This process was stalled by deflation during the post Civil War gold standard era. Hence, William Greider's claim that the Populist movement, which argued for inflation in the 1880s and 1890s, was a working class movement is mistaken. Although farmers were often workers, in this role they were benefiting from deflation. Real wages were rising across the board. It was as capitalists and landowners who were facing declining asset values and prices that farmers were hurting. Lower food prices are good for workers, but Greider omits this consideration in his discussion of the Populist movement. Deflation is good for workers but bad for capitalists, sellers and landowners. In claiming to be workers' friend, Greider somehow makes an argument that supports real estate speculators and bankers. He does this while saying hard money helps bankers. (Funny how the left manages to say that they help the poor while they are helping the rich, and then turn around and get donations from George Soros!)
Because of the massive gains to workers during the late nineteenth century (due to increasing real wages) the Democrats' attempt to introduce an inflationary economy was voted down in 1896 by popular vote. William Jennings Bryan ran three times altogether and was voted down each time. However, when JP Morgan approached death, bankers realized that in order to maintain fractional reserve banking as a system there would need to be a replacement for Morgan, who frequently arranged loans that provided liquidity to rescue banks. This was accomplished by the establishment of the Fed in 1913, which Wilson, a gold standard advocate, introduced with little fanfare or debate.
There is no evidence that fractional reserve banking was essential to the dynamic economic growth of the nineteenth century. Other countries had fractional reserve banking but did not grow to the same degree that America did. Other countries had more frequent wars and had more inflation, though. Nor is there evidence that the key growth areas of the economy, manufacturing and innovation, received more funding from banks than would have been available without fractional reserve banking. In the case of Standard Oil, which revolutionized the oil industry, Rockefeller and his partners financed the business from their own savings and then profits. Bondholders and investors were brought in and over time a "trust" was formed. Although banks played a role, there is no evidence that fractional reserve banking was necessary to this or any other important business.
The public has accepted the need for a money supply managed and controlled by commercial banks. But is such a system essential? "Progressives" (the very name is laughable) argue staunchly for the 1913 system based on the conservative argument that it's been that way for 95 years. But since 1971 real wages have been declining, not rising. The 20th century has seen some innovation, but much less than the nineteenth. Fractional reserve banking facilitates allocation of credit to incompetent investment schemes, derivatives and crackpot investments such as Enron, the tech bubble and the sub-prime bubble. Redlining, excessive real estate development and the rape of cash savers and Americans on fixed incomes (the lower middle class) in favor of William Greider's* favored elements, millionaire construction firm owners, big banks, Wall Street investors, stockholders and major borrowers like billionaire hedge fund managers have all resulted from fractional reserve banking and from the Fed.
There is no evidence that bankers are or were better at allocating capital than a free market would be. With a trillion dollar bailout whose costs may mount to five trillion, a tripling of the money supply in order to subsidize the mistakes of the commercial banks, and large scale economic dislocation purely because of fraudulent and incompetent investment and profit-recognition practices in which the money center banks have engaged, people who claim that fractional reserve banking creates surplus for the economy have begun to look like delusional cranks.
The declining real wage of the past 36 years is evidence enough that fractional reserve banking has failed. Add the two bubbles of the past ten years to the mix, and the claim that fractional reserve banking contributes to the economy becomes laughable. Now that the banking system aims to absorb trillions of dollars from the productive economy in order to subsidize fraud, the time has come to consider scrapping it--and sending the money center bank CEOs to the hoosegow.
*See William Greider, Secrets of the Temple.
Wednesday, November 12, 2008
Banking Is Not Necessary
Today's banking system is based on a principle that did not exist until the 17th century. The notion of fractional reserve banking is that bankers lend out more money than they actually have on deposit because they can predict with some accuracy how much money depositors will reclaim each day. Currently, the supply of money is about double the cash and reserves on deposit in banks, so half the money supply is due to bankers' lending money that does not really exist anywhere.
Academics vigorously argue in favor of fractional reserve banking. They claim to be in favor of the poor and of economic development, but a little common sense tells you that enabling bankers to double the money supply chiefly benefits bankers. Moreover, bankers do not lend to the poor, they lend to the rich and to the middle class, and to government's favored recipients. Hence, the traditional tendency is that fractional reserve banking is most beneficial to the wealthy.
Bankers refuse to lend to entrepreneurs. This is a well known phenomenon to anyone interested in starting a business. Bankers view lending to innovative start ups as too "risky". On the other hand, they are eager to lend to sub-prime mortgage borrowers, Bunker Hunt when he was eager to corner the silver market, Long Term Capital Management when it claimed to have "hedged" all bets based on crackpot theories of modern finance professors, and to sellers of credit default swaps that the bankers did not understand, but what the hell, they're less risky than investing in A/C electricity or a cure for cancer.
The main problems of capitalism have related to the fraud in which bankers engage in lending money. Economically illiterate historians and historically illiterate economists both make the argument that without fractional reserve banking there would have been no progress. But they cannot point to examples of progress that depended on fractional reserve banking. Nikola Tesla depended not on banking but on venture capital from JP Morgan to work on energy transmission and earlier inventions. Milton Hershey depended not on banking but on friends and family to build his candy empire. Do most entrepreneurs today depend on bank loans to finance new business concepts, or on private investment capital that they save themselves, from friends and family or from private "angels" who do not benefit from the fractional reserve system?
Where do bank loans go? They go to the least risky investments: real estate and to finance lumbering, incompetently managed large firms.
Now, let us think for a moment who pays for fractional reserve banking. When a bank lends a dollar it does not have, it collects interest on that dollar. But it has increased the money supply. By increasing the money supply, it reduces the value of everyone else's dollars. So anyone who holds dollars, workers and savers, subsidize the bank. As the value of everyone's dollars is reduced, the borrower repays the loan in cheaper dollars. So the banker is subsidized and the borrower is subsidized, but the thrifty and poor who do not borrow pay.
Now who are the chief borrowers? Large corporations are the most indebted. Hedge funds, investment banks and large real estate investors are the chief borrowers. It is true that the middle class has also borrowed. The group that borrows least is the poor.
Inventors who are trying to build a new business based on an invention cannot borrow because banks will not lend to them. So money is transferred from innovators to borrowers. From inventors to real estate developers.
Banking is not necessary for progress. Innovation has not depended on banking. It has depended on private capital. Rather, banking stalls innovation. Thus, as the Federal Reserve Bank's power to create money has increased, and Wall Street and the banking system has flourished over the past 35 years, innovation has been limited to a few industries that stock brokers favor. Real estate and stock investment has soared. And American workers' real wages have declined.
Fractional reserve banking is not necessary to American progress. It is a form of income redistribution from the innovative to the opportunistic.
Academics vigorously argue in favor of fractional reserve banking. They claim to be in favor of the poor and of economic development, but a little common sense tells you that enabling bankers to double the money supply chiefly benefits bankers. Moreover, bankers do not lend to the poor, they lend to the rich and to the middle class, and to government's favored recipients. Hence, the traditional tendency is that fractional reserve banking is most beneficial to the wealthy.
Bankers refuse to lend to entrepreneurs. This is a well known phenomenon to anyone interested in starting a business. Bankers view lending to innovative start ups as too "risky". On the other hand, they are eager to lend to sub-prime mortgage borrowers, Bunker Hunt when he was eager to corner the silver market, Long Term Capital Management when it claimed to have "hedged" all bets based on crackpot theories of modern finance professors, and to sellers of credit default swaps that the bankers did not understand, but what the hell, they're less risky than investing in A/C electricity or a cure for cancer.
The main problems of capitalism have related to the fraud in which bankers engage in lending money. Economically illiterate historians and historically illiterate economists both make the argument that without fractional reserve banking there would have been no progress. But they cannot point to examples of progress that depended on fractional reserve banking. Nikola Tesla depended not on banking but on venture capital from JP Morgan to work on energy transmission and earlier inventions. Milton Hershey depended not on banking but on friends and family to build his candy empire. Do most entrepreneurs today depend on bank loans to finance new business concepts, or on private investment capital that they save themselves, from friends and family or from private "angels" who do not benefit from the fractional reserve system?
Where do bank loans go? They go to the least risky investments: real estate and to finance lumbering, incompetently managed large firms.
Now, let us think for a moment who pays for fractional reserve banking. When a bank lends a dollar it does not have, it collects interest on that dollar. But it has increased the money supply. By increasing the money supply, it reduces the value of everyone else's dollars. So anyone who holds dollars, workers and savers, subsidize the bank. As the value of everyone's dollars is reduced, the borrower repays the loan in cheaper dollars. So the banker is subsidized and the borrower is subsidized, but the thrifty and poor who do not borrow pay.
Now who are the chief borrowers? Large corporations are the most indebted. Hedge funds, investment banks and large real estate investors are the chief borrowers. It is true that the middle class has also borrowed. The group that borrows least is the poor.
Inventors who are trying to build a new business based on an invention cannot borrow because banks will not lend to them. So money is transferred from innovators to borrowers. From inventors to real estate developers.
Banking is not necessary for progress. Innovation has not depended on banking. It has depended on private capital. Rather, banking stalls innovation. Thus, as the Federal Reserve Bank's power to create money has increased, and Wall Street and the banking system has flourished over the past 35 years, innovation has been limited to a few industries that stock brokers favor. Real estate and stock investment has soared. And American workers' real wages have declined.
Fractional reserve banking is not necessary to American progress. It is a form of income redistribution from the innovative to the opportunistic.
Saturday, September 27, 2008
The Bailout Debate: Disgraceful Failure of American Democracy
The following questions should be addressed before there is further talk of a bailout for banks and insurance companies.
1. What was the role of the Federal Reserve Bank's monetary expansion in facilitating overly aggressive lending that lead to financial loss?
2. Given that Fed policy may have caused multi-trillion dollar losses, can we continue to sustain this institution, whose sole putative purpose is to professionally manage the money supply?
3. What is the role of fractional reserve banking in causing the losses, and given the large losses, are we certain that the institution of fractional reserve banking to which we have become accustomed is economically justifiable?
4. Are we certain that federal regulation of the money supply and banking is preferable to state regulation?
5. Would re-institution of a gold standard inhibit future losses of this kind?
6. Why is Congress not discussing a gold standard, and why does the media avoid this question?
These questions have not been asked. They have not been asked by the liberal media, by the O'Reilly Spin Zone, by talk radio's right-wing Progressives like Rush Limbaugh and Sean Hannity, or by our political leaders. This failure to debate an aggressive, socialistic bailout is disgraceful. Americans have become like sheep, following the presidential shepherd leading them over a progressive cliff into the socialist pit.
Successive generations of progressives have weakened American democracy. In the 19th century, relatively limited government and a greater role for the states limited the cognitive demands on American voters. Americans did not need to pretend to be experts on banking, military, tax and industrial safety policy. Although there were issues, they were narrower in scope. Progressivism claimed that democracy was capable of managing such diverse issues through the expertise of college-trained experts. Thus, progressivism was associated with accentuated imperialism in the Spanish-American War, the income tax, workers' compensation, the Sixteenth Amendment and the Revenue Act of 1913 establishing the federal income tax, and establishment of the Federal Reserve Bank in 1913.
The issue of banking has become salient this month and it may pay to recall that, until the National Bank Acts of 1863 and 1864 and the federal tax on currency issued by state banks passed in 1865, the states were free to regulate banking, and they did so in diverse ways. Some western states did not allow fractional reserve banking at all and others limited the establishment of banks. Note that fractional reserve banking is not the only kind of banking available. Savings and Loans have traditionally lent based on their mortgage holdings rather than on a one sixth fractional reserve.
There is a thin line between fractional reserve banking and outright fraud. Bankers lend money that the bankers do not hold. They rely on the probability that enough deposits will be made the next day to cover the loans that they make. Writing a check to someone when you don't have the money is usually considered fraud, and frequent bank runs and inflation due to bank-issued currency led to economic cycles in the nineteenth century. States were subject to public opinion, and to the extent that they violated this trust there were political upheavals, as with the Loco Focos in New York in the 1830s, who took over the Democratic Party in response to banking "monopolies" or charters.
Laissez-faire principles do not require acquiescence to fraud, and at the height of laissez-faire in America there was considerable distrust of banks even though the nation depended upon them for economic growth. Because of this distrust, Andrew Jackson stopped depositing federal monies in the central bank in 1833 and the central bank lost its federal charter in 1836.
Until 1913 there was no central bank, although the Banking Act of 1864 established national charters and state and federal banks co-existed thereafter. During the Civil War, the United States issued "greenbacks" that led to a significant inflation in the post-Civil War era. Pundits of that time, such as EL Godkin, founder of the Nation magazine, frequently noted the connection between inflation and subsidization of speculation by Wall Street buccaneers such as Jay Gould.
Although there were frequent complaints of "depressions" in the late nineteenth century it is difficult to grasp their severity or the meaning of the term. Immigration considerably accelerated in the post-Civil War era as big business began to dominate the American landscape. Why did immigration accelerate at the very time that leftists argue that depression dominated the American economy and big business oppressed workers?
The fact is that real wages increased steadily during the late nineteenth century despite the "great deflation". Prices were going down and workers were mistreated but real wages were increasing and the ones who were really in trouble were the business owners, whose profit margins were squeezed by intense competition. Thus, the term "depression" may more accurately reflect a "profit depression" than unemployment.
In the 1890s, due to global monetary conditions (a shortage of precious metals) there was a slight inflation, but the public found this troubling. The inflation that Walter Weyl mentions in his New Democracy was in the range of 1% per year. Woodrow Wilson had no intention of abolishing the gold standard, and the Fed was initially viewed as a way to more professionally manage monetary policy and foreign exchange. It was related to the Progressives' interest in globalization as a way to extend the then-closed frontier. Subsequently, the FDR administration abolished the gold standard.
The question needs to be asked whether fractional reserve banking is a good idea. The Fed was established in part to rationalize the banking system and oversee foreign transactions. However, the banking system owns the Federal Reserve Bank and there is often political pressure for the Fed to permit excessive lending from politicians. Excessive lending leads to fast economic growth, but as I have previously blogged many times, the quality of the growth deteriorates as credit expands because of a diminishing marginal returns principle.
The purpose of the Fed is to more professionally manage the money supply than existed in the nineteenth century. But the economy has been choppier since the Fed was established. The Great Depression and the terrible inflation and stagflation of the 1970s were worse in many ways than any 19th century depression.
The current troubles of American lending institutions, including some banks as well as investment and insurance companies, is evidence that the costs of these institutions exceed their benefits. Normal market institutions charge what the market will bear and their existence is justified if they make a profit. If their costs are too high they close. The fact that the accumulated profits of investment banks and insurance companies are insufficient to cover losses means that the institutions have failed to provide a social service and should be closed. There would be little loss to the public.
1. What was the role of the Federal Reserve Bank's monetary expansion in facilitating overly aggressive lending that lead to financial loss?
2. Given that Fed policy may have caused multi-trillion dollar losses, can we continue to sustain this institution, whose sole putative purpose is to professionally manage the money supply?
3. What is the role of fractional reserve banking in causing the losses, and given the large losses, are we certain that the institution of fractional reserve banking to which we have become accustomed is economically justifiable?
4. Are we certain that federal regulation of the money supply and banking is preferable to state regulation?
5. Would re-institution of a gold standard inhibit future losses of this kind?
6. Why is Congress not discussing a gold standard, and why does the media avoid this question?
These questions have not been asked. They have not been asked by the liberal media, by the O'Reilly Spin Zone, by talk radio's right-wing Progressives like Rush Limbaugh and Sean Hannity, or by our political leaders. This failure to debate an aggressive, socialistic bailout is disgraceful. Americans have become like sheep, following the presidential shepherd leading them over a progressive cliff into the socialist pit.
Successive generations of progressives have weakened American democracy. In the 19th century, relatively limited government and a greater role for the states limited the cognitive demands on American voters. Americans did not need to pretend to be experts on banking, military, tax and industrial safety policy. Although there were issues, they were narrower in scope. Progressivism claimed that democracy was capable of managing such diverse issues through the expertise of college-trained experts. Thus, progressivism was associated with accentuated imperialism in the Spanish-American War, the income tax, workers' compensation, the Sixteenth Amendment and the Revenue Act of 1913 establishing the federal income tax, and establishment of the Federal Reserve Bank in 1913.
The issue of banking has become salient this month and it may pay to recall that, until the National Bank Acts of 1863 and 1864 and the federal tax on currency issued by state banks passed in 1865, the states were free to regulate banking, and they did so in diverse ways. Some western states did not allow fractional reserve banking at all and others limited the establishment of banks. Note that fractional reserve banking is not the only kind of banking available. Savings and Loans have traditionally lent based on their mortgage holdings rather than on a one sixth fractional reserve.
There is a thin line between fractional reserve banking and outright fraud. Bankers lend money that the bankers do not hold. They rely on the probability that enough deposits will be made the next day to cover the loans that they make. Writing a check to someone when you don't have the money is usually considered fraud, and frequent bank runs and inflation due to bank-issued currency led to economic cycles in the nineteenth century. States were subject to public opinion, and to the extent that they violated this trust there were political upheavals, as with the Loco Focos in New York in the 1830s, who took over the Democratic Party in response to banking "monopolies" or charters.
Laissez-faire principles do not require acquiescence to fraud, and at the height of laissez-faire in America there was considerable distrust of banks even though the nation depended upon them for economic growth. Because of this distrust, Andrew Jackson stopped depositing federal monies in the central bank in 1833 and the central bank lost its federal charter in 1836.
Until 1913 there was no central bank, although the Banking Act of 1864 established national charters and state and federal banks co-existed thereafter. During the Civil War, the United States issued "greenbacks" that led to a significant inflation in the post-Civil War era. Pundits of that time, such as EL Godkin, founder of the Nation magazine, frequently noted the connection between inflation and subsidization of speculation by Wall Street buccaneers such as Jay Gould.
Although there were frequent complaints of "depressions" in the late nineteenth century it is difficult to grasp their severity or the meaning of the term. Immigration considerably accelerated in the post-Civil War era as big business began to dominate the American landscape. Why did immigration accelerate at the very time that leftists argue that depression dominated the American economy and big business oppressed workers?
The fact is that real wages increased steadily during the late nineteenth century despite the "great deflation". Prices were going down and workers were mistreated but real wages were increasing and the ones who were really in trouble were the business owners, whose profit margins were squeezed by intense competition. Thus, the term "depression" may more accurately reflect a "profit depression" than unemployment.
In the 1890s, due to global monetary conditions (a shortage of precious metals) there was a slight inflation, but the public found this troubling. The inflation that Walter Weyl mentions in his New Democracy was in the range of 1% per year. Woodrow Wilson had no intention of abolishing the gold standard, and the Fed was initially viewed as a way to more professionally manage monetary policy and foreign exchange. It was related to the Progressives' interest in globalization as a way to extend the then-closed frontier. Subsequently, the FDR administration abolished the gold standard.
The question needs to be asked whether fractional reserve banking is a good idea. The Fed was established in part to rationalize the banking system and oversee foreign transactions. However, the banking system owns the Federal Reserve Bank and there is often political pressure for the Fed to permit excessive lending from politicians. Excessive lending leads to fast economic growth, but as I have previously blogged many times, the quality of the growth deteriorates as credit expands because of a diminishing marginal returns principle.
The purpose of the Fed is to more professionally manage the money supply than existed in the nineteenth century. But the economy has been choppier since the Fed was established. The Great Depression and the terrible inflation and stagflation of the 1970s were worse in many ways than any 19th century depression.
The current troubles of American lending institutions, including some banks as well as investment and insurance companies, is evidence that the costs of these institutions exceed their benefits. Normal market institutions charge what the market will bear and their existence is justified if they make a profit. If their costs are too high they close. The fact that the accumulated profits of investment banks and insurance companies are insufficient to cover losses means that the institutions have failed to provide a social service and should be closed. There would be little loss to the public.
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