Reality Bits and Bytes 2

2 comments

1. Bill

   January 31, 2009 at 8:53 am

   Fantasy? Fantasy is thinking the stimulus bill crafted by the House democrats is a real stimulus package instead of just more pork. Both parties need to stop kowtowing to their respective constituents and do what is right for the country. A pox on both their houses.

    
2. swingarm

   February 25, 2009 at 11:17 am

   (This is a very long and thoughtful comment. I edited it slightly for readability and added the “more” tag because it is so long. I did not change any words, just clarified the paragraphing. William Jennings Bryan and I disagree with it wholeheartedly, but it is so thoughtfully presented it deservers viewing.–Frank)

   As a Canadian I watch this last election with interest. Ron Paul is the only man who spoke the truth. Unfortunatly, truth is not good for buisness. So the media ignore him. He was calling for a return to sound money.

   It’s a pretty popular fallacy nowadays, that a 100% gold standard monetary system could never work in a modern economy. This fallacy has been embedded into the public mind through well over a century’s worth of pro-inflationist propaganda; and admittedly much of this propaganda seems to make perfect sense on the surface. And that’s the great advantage that the pro-inflation interests hold: that the vast majority of the general public — here in the U.S. as well as throughout the world — have no real understanding of basic monetary economics, and many have little understanding of economics in general. This is evidenced by the continued widespread public support for government policies that when put into practice are actually contrary to the public interest, and often times are even detrimental to the very people whom they are allegedly intended to benefit. Government initiatives such as protectionist tariffs, minimum wage laws, price controls, “public works” projects, and countless other grand interventionist schemes put forth by the political class and their interested hangers-on in the nominally private sector, have a superficial populist appeal to the economically-oblivious; but in practice these policies benefit only a select few at the direct or indirect expense of everyone else. But in this article, I intend to expose only one section of the vast web of economic sophistry spun by the political class and their gaggle of special interest rent-seekers: their fallacious objections to the gold standard, and their bogus claims about the necessity of a central bank.

   “Fiat money” — in other words; money backed only by the government’s threat of violence against anyone who refuses to accept the notes in trade or in settlement of debts — under a regime of central banking, is beneficial only to the government, their partners in the central banking cartel, and to the privileged private interests who receive the newly-printed paper money and newly-expanded bank credit first. This is the partnership of interests who perpetrate the scam. The gains made by these three groups by way of the scam come at the expense of everyone else. But they have devised and perfected a scheme of propaganda by which they have convinced most of us to not only sit still and be plundered by them, but also to fervently defend the scam itself, ridiculing those who dare to suggest a return to sound, honest money and free market banking. The most successful aspect of their propaganda campaign has been in inducing mass confusion among the public as to the nature of money. This has been the essential part of their promulgation of the widespread fallacy that “there is not enough gold available to satisfy the needs of commerce in a modern economy.” This belief comes from people confusing money itself with capital or wealth. But money, in and of itself, is not real capital, it is not wealth; it merely represents and measures capital and wealth. If it were, then the policies of the pro-inflationists would make sense; inflation would be good thing. The government and its banks would be able to enrich us all simply by running the printing presses. But real capital is not green pieces of paper with portraits of dead presidents and neat little designs on them, nor is it entries in a bank ledger or digits in an electronic account. The wealth of nations is not measured in the aggregate supply of money. The wealth of nations is measured in the abundance of goods and services available for the sustenance and enjoyment of everyone; it is in the alleviation of natural scarcity through the application of labor and savings. As the great 19th Century French economist and statesman Frederic Bastiat articulated:

   “For riches, don’t you see, are not a little more or a little less money. They are bread for the hungry, clothes for the naked, fuel to warm you, oil to lengthen the day, a career open to your son, a certain portion for your daughter, a day of rest after fatigue, a cordial for the faint, a little assistance slipped into the hand of a poor man, a shelter from the storm, a diversion for a brain worn by thought, the incomparable pleasure of making those happy who are dear to us. Riches are education, independence, dignity, confidence, charity; they are progress and civilization. Riches are the admirable civilizing result of two admirable agents, more civilizing even than riches themselves-
   labor and exchange.”

   Money is simply a medium of exchange, nothing more and nothing less. But to say this is so is not to underestimate the importance of the role a generally-accepted medium of exchange plays in the economic and social life of society. On the contrary; to think of money as anything other than a generally-accepted medium of exchange is the root of our modern economic crisis, so to stress the fact is to recognize the importance of it. The creation of wealth; the increase in the standard of living of society, comes only from an increase in the production of capital. But you cannot increase real capital simply by printing more money, or by artificially expanding bank credit. This only undermines the effectiveness of money to perform its vital functions.

   What’s actually happening in a market economy is that goods and services are being produced and traded for other goods and services on the market. Money is a unique commodity in that it is not demanded for it’s own sake, but only because it can be traded for all other commodities. It makes all market commodities universally able to exchange for all others; and in doing so makes calculating relative exchange valuations of all goods and services easy and accurate. In real terms, a carton of cigarettes exchanges for 9.5 loaves of bread, or 12 gallons of gas; or a candy bar exchanges for 1/1000 of a Gibson Les Paul guitar. But by using a money-commodity as a medium of exchange, we can know that a carton of cigarettes is $38, a loaf of bread $4, a gallon of gas $3.17, a candy bar $1.50, and a Les Paul $1,500.

   But in order for money to perform this function, it is essential that it’s aggregate supply remain relatively static. Increases or decreases in the supply of money must necessarily result in the respective decrease or increase in the relative purchasing power of each individual unit of money. Since money is only kept and used at all as a storehouse of purchasing power, then fluctuations of it’s real value are essentially corresponding fluctuations in the wealth of the people who keep and use money. When the money-commodity used by a given society is nothing but a piece of paper that can be printed at will (though only by a select pre-determined group of people), then the inflation of the money supply results in a transfer of wealth from the holders of the already-existing money, to the first people to receive and use the newly-printed money. The first people to use the inflationary money benefit exactly the same way any common counterfeiter would: they receive real value in goods and services, without having contributed any value to have earned such a claim. They deduct from the wealth of society. The take from the existing pool of available capital, without having produced any capital themselves. This means there is less capital being represented by the existing supply of claims to it, thus each individual claim (monetary unit) must necessarily yield less purchasing power on the market.

   This is why the three perpetrating groups of the scam love it so much. The banks, because they have the ability to allocate real wealth to themselves by simply creating claims to capital from out of thin air (in the form of demand deposit accounts), which they then loan out at interest; the interest payments they receive then represent their own claims to wealth which they themselves created from out the ether. The government loves it because it gives them the ability to levy a hidden tax, which the public ultimately pays for in the form of higher consumer prices due to inflation (which always fall hardest on those who can afford it least; the poor and those on fixed incomes). Politicians and statist pundits can then divert the blame for the inflation tax away from the government and it’s banks, instead pointing the finger at “greedy” business owners, “irresponsible” consumers, and unduly euphoric investors. And then there are the politically-connected corporate interests — the Military-Industrial Complex and the conglomeration of interests it owns ands operates, e.g., the major media networks and publications — who love the system, because they are among the first to gain access to the inflationary money and credit, thus they receive real wealth at the value of that money, before it works its way down through the economy and depreciates the value of all money. Those of use who receive the inflationary money late, or not at all, actually subsidize those who receive it first. When inflation sucks away the real value of our wages and savings, it does not merely evaporate into the atmosphere; our purchasing power is literally redistributed to the counterfeiters themselves, and to the privileged groups who receive the counterfeit loot first.

   But the aspect of inflation that amounts to property theft — the regressive redistribution of wealth — is not the only evil that comes out of it. It also is the engine of what has become known as the “business cycle;” the endless cycle of inflationary booms and the inevitable busts that follow. It has long been the “conventional wisdom” that the boom-and-bust business cycle is an unfortunate and unavoidable byproduct of free market capitalism, and thus the proponents of central banking have claimed the mantle of Benevolent Monetary Crusaders, working tirelessly to pinpoint and counteract the cyclical failures of the market. But, as keen-eyed economists from as far back as David Ricardo in the early 1800’s, and Frederic Bastiat just a few decades later, have observed, the disastrous boom-and-bust cycles that began in the era of institutionalized fractional-reserve banking, are not a naturally-occurring market phenomenon, but are a direct consequence of the artificial expansion of bank credit and bank-note currency which result from government and central bank manipulation.

   When a central bank chooses to expand bank credit, they do so by way of fixing the rate of interest for demand deposit loans. This gives the illusion of an increase in available capital; as the interest rate is simply the price of advanced capital, which on the free market is determined by the supply of and demand for capital. When savings available for capital investment accrue faster than the demand for loans, the natural result is a decrease in the rate of interest. Conversely, when savings available for capital investment are more scarce, and then demand for loans increases, the natural result is an increase in the rate of interest. The price of capital, just like any other price on the market, is a signal that reflects the real-life conditions on the market. And just like any other form of government price-fixing, the artificial lowering of the rate of interest results in a distorting of the vital market signals that investors and entrepreneurs rely on when making decisions. The artificially-lowered interest rate gives a false signal that tells them there is a greater amount of real savings available for investment in consumer and capital goods than there actually is in reality, which in turn results in bouts of malinvestment that must eventually be liquidated. This simply means that there was not sufficient savings available to cover all of the investments made during the period of artificially-lowered interest rates; there wasn’t enough genuine wealth to underwrite the illusory “boom” generated during the inflationary period. This fact must, of course, eventually become evident to everyone. This is where the phony “boom” ends and the inevitable “bust” begins. The market will begin to liquidate the bad investments, and a recessionary period will ensue wherein prices and market values of assets will begin adjusting to reality. This process is, of course, a painful one, but it is better for everyone if it is allowed to run its course naturally, so that society can begin to rebuild on a sound foundation based on reality. But of course, politicians are loathe to allow this, and modern-day central bankers, like their Keynesian predecessors, have convinced a lot of people that they have some secret formula for vanquishing Say’s Law; that they are somehow able to defeat the natural law of scarcity, and create real wealth from out of nothing.
   So, one might ask, what is the alternative? How would a 100% gold standard, and decentralized free market banking be any better? For starters, it helps to train oneself to stop thinking of money as wealth, and to remember that money is just the medium of exchange. With a commodity-money system, such as a gold or silver standard, the supply of money will remain relatively static; people would not allocate resources of capital and labor to the mining of gold and the minting of coins, if the value of the gold coins to be produced would yield them much less profit than if they allocated their capital and labor to producing other goods and services. Why would someone spend hundreds of thousands of dollars producing gold that would yield them only tens of thousands or just thousands of dollars in coinage or bullion? The production of gold for monetary uses would be profitable only if the demand for the gold to be produced was sufficiently high to yield them more purchasing power than they were expending on the project.
   With a relatively static money supply, prices of goods and services would reflect real-life conditions on the market. The notion of “stable prices” is yet another sophism promulgated by the proponents of fiat money and fractional-reserve banking. They claim they need the ability to manipulate the aggregate supply of money — what amounts to macroeconomic central planning — in order to maintain “stable prices.”

   But therein lies the fallacy; there is nothing inherently desirable about “stable prices.” As the great Professor Ludwig von Mises noted, the only time we should expect stable prices is if the market economy were in it’s “final state of rest.” Remember, prices of commodities are determined by their relative exchange value with all other market commodities; their money price is simply a convenience afforded to us by the use of a generally-accepted medium of exchange. When the supply of or demand for any given market commodity changes, it’s money price must necessarily change to reflect that condition. What we should aim for — indeed, what is as essential aspect of a healthy economy — is not “stable prices,” but accurate prices. And this is what a sound commodity-money would give us: a relatively static supply of money, with money prices accurately reflecting the real-world conditions on the market.
   Thus, when we would have economic growth, and the supply of available goods and services increased, they would do so relative to the supply of money. This means that the relative value of the money-commodity would increase, and each individual monetary unit would increase in value. This in turn means that all holders of money — all wage-earners and money-savers — would enjoy an increase in purchasing power. And this is what is supposed to happen when production increases, and natural scarcity is alleviated. Society is supposed to be wealthier when there is economic growth, and this increase in wealth would be reflected in lower money prices. This is what economists mean when they refer to “real wages,” as something different than “nominal wages;” real wages are determined not by the numerical amount one receives in exchange for labor, but rather by the purchasing power afforded to a wage-earner by whatever that numerical amount happens to be.

   I’ll use myself as an example. Over the last ten years, my numerical wage rate has gone from approx. $20 an hour, to $25 an hour (give or take a few cents). At a superficial glance, one would say I have received about a 20% increase in wages. But this perceived increase is only in nominal wages. If we take into consideration the general increase in the cost of living over the same time period, including primarily the cost of gas, energy, food, and housing, we see that the real value of the money that my wages are paid in has decreased by roughly 40% (and that’s a very conservative estimate; consider that just the price of gas has increased nearly threefold, and the price of most food items has doubled, since 1998). We can see that while my nominal wages have increased by 20%, my income in real wages has decreased by the same amount. In actuality, I have taken a 20% paycut over the last ten years. Anyone whose nominal wages have not increased by more than 40% since 1998, has taken a paycut in real wages since that time, at an amount equal to the difference.

   I would wager that there aren’t many ordinary working-class folks like myself who have received pay raises amounting to greater than 40% of what they earned ten years ago. And yet the statistics tell us that the economy has grown since that time, even adjusted for inflation and the increase in population. But we are not reaping the benefits of this increased production. The apparent alleviation of natural scarcity has not resulted in an increased standard of living for most of us. This is because despite the apparent economic growth, general money prices for goods and services have increased, instead of gently falling, as would happen if money prices were determined by a relatively static supply of a sound commodity-money. Inflation has robbed the general public of the purchasing power that economic growth would have afforded us, and that purchasing power has been reallocated to the three groups mentioned above: the government, and it’s partners in the central banking cartel and the privileged corporate elite.

   Furthermore, it is we, the general public, who suffer the devastating results of the chronic boom-bust cycles that result from inflationary policies. The bankers, the very one’s responsible for generating the inflationary bubbles which result in the chronic recessions, do not suffer the consequences of their own fraud and mismanagement. Capitalism is supposed to be a sink-or-swim affair, but the privileged members of the Federal Reserve Banking cartel, and their elite corporate hangers-on, have been blessed by the government with the designation “too big to fail,” and as such are the happy recipients of taxpayer-funded bailouts whenever trouble rears it’s head on Wall St.

   Under a regime of free market banking, banks would be forced to stand on their own bottom. There would be no “lender of last resort” to come along and “inject liquidity” (translation: plunder the public by redistributing wealth to the floundering banks through artificial credit expansion) if banks were to suffer a run by their depositors or a “currency drain” (basically the same things as a bank run, except by competing banks demanding redemption of bank notes, instead of the banks own depositors). Banks would be forced, by sheer market forces alone, to do business honestly, or else face insolvency. Only the honest banks would survive in this environment, and this is why bankers have turned to governments to be their partners in crime since the 17th Century. And governments, all too eager for a method to increase their own revenues without having to levy new taxes or increase existing tax rates, have been happy to oblige them.

   For a bank’s operations to be honest and forthright, they would have to separate the two distinct functions of “demand deposit” banking, and investment banking. When a banks customers deposit funds into a demand deposit account (a checking account), they would do so under a contractual agreement that those funds are to be available for withdraw at any time, and thus the bank would be legally and contractually required to keep 100% of its liabilities to its customers in reserve at all times. If, one day, for whatever reason, a significant number of a particular bank’s depositors were to show up demanding to withdraw funds from their demand deposit accounts (or if, as mentioned earlier, competing banks were to one day present the particular bank with a significant amount of it’s bank notes, demanding redemption in gold or silver money) but our particular bank doesn’t have sufficient funds available because it has been printing up and loaning out phony claim checks in an attempt to turn a quick unearned profit; then this turn of events should be treated by its depositors, the public, and the state, not as an unfortunate economic occurrence, but as the uncovering of a crime. Banks should be required to honor their contractual commitments to their customers just the same as any other type of warehouse. If a grain warehouse began loaning out grain that it had already contractually agreed to keeping in safe deposit for customers, and was found out when it’s original depositors presented their receipts and were told that their property was not available for redemption, this act would rightfully be recognized as embezzlement. Why should banks be treated any differently, when they are entrusted with the safe keeping of their depositors’ property? Demand deposit accounts at banks should be treated like any other warehouse operation, with the banking charging it’s demand deposit customers a fee for the safekeeping of their property, and the vitally-important service of check-clearing. If the banks and their depositors wish to earn interest off of loans, then this should be accomplished by contractual agreements, whereby the depositor understands that the funds he deposits in his “time deposit” account will be advanced to borrowers, and agrees that the bank will require a set period of time with which to retrieve the loan; a portion of the interest to go to the depositor, who understands and agrees that he may not withdraw funds from this account until the agreed-upon date.

   Under free market banking, there is no institutionalized counterfeiting or fraud. There is no inflationary artificial expansion of credit. All capital investment comes out of genuine savings, and thus interest rates reflect the real-life conditions of supply and demand for capital on the market, which in turn reflects the real-life savings/consumption ratio of the public. There are no chronic inflationary “bubbles” and the inevitable busts to distort market signals and throw the price structure and the entire economy out of whack.

   While inflation punishes those who save money (who are, incidentally, the essential backbone of the capitalist system), a sound money policy and free market banking would encourage savings; as investment in capital and consumer goods would serve to increase production, thus increasing the value and purchasing power of the money when it returns to the investor. The benefits of economic growth would be shared by the entire society, not just by the privileged elites who operate and manipulate the fiat money/central banking system.