Debitism

[fatdogs12]

This has got to be the most rationalistic threads I've ever read. But the rationalism and evasion exhibted by others is breathtaking. Now I'm starting to understand the epistemological problems behind the Rothbardians and other various doomsday cults who go on about the financial system without even understanding what a bank does, or what money is. After a certain point, one can't continue to assume that there's an honest effort to understand reality in process.

Yup... I seriously doubt this topic will resolve itself.

[IAmMetaphysical]

I have to agree with that.

[Trudy Cool]

... who go on about the financial system without even understanding what a bank does, or what money is.

Here in detail, is the mechanism by which Federal Reserve dollars are created "out of thin air".

Start with . . .

GOVERNMENT DEBT

The federal government adds ink to a piece of paper, creates impressive designs around the edges, and calls it a bond or Treasury note. It is merely a promise to pay a specified sum at a specified interest on a specified date. As we shall see in the following steps, this debt eventually becomes the foundation for almost the entire nation's money supply. In reality, the government has created cash, but it doesn't yet look like cash. To convert these IOUs into paper bills and checkbook money is the function of the Federal Reserve System. To bring about that transformation, the bond is given to the Fed where it is then classified as a . . .

SECURITIES ASSET

An instrument of government debt is considered an asset because it is assumed the government will keep its promise to pay. This is based upon its ability to obtain whatever money it needs through taxation. Thus, the strength of this asset is the power to take back that which it gives. So the Federal Reserve now has an "asset" which can be used to offset a liability. It then creates this liability by adding ink to yet another piece of paper and exchanging that with the government in return for the asset. That second piece of paper is a . . .

FEDERAL RESERVE CHECK

There is no money in any account to cover this check. Anyone else doing that would be sent to prison. It is legal for the Fed, however, because Congress wants the money, and this is the easiest way to get it. (To raise taxes would be political suicide; to depend on the public to buy all the bonds would not be realistic, especially if interest rates are set artificially low; and to print very large quantities of currency would be obvious and controversial.) This way, the process is mysteriously wrapped up in the banking system. The end result, however, is the same as turning on government printing presses and simply manufacturing fiat money (money created by the order of government with nothing of tangible value backing it) to pay government expenses. Yet, in accounting terms, the books are said to be "balanced" because the liability of the money is offset by the "asset" of the IOU. The Federal Reserve check received by the government then is endorsed and sent back to one of the Federal Reserve banks where it now becomes a . . .

GOVERNMENT DEPOSIT

Once the Federal Reserve check has been deposited into the government's account, it is used to pay government expenses and, thus, is transformed into many . . .

GOVERNMENT CHECKS

These checks become the means by which the first wave of fiat money floods into the economy. Recipients now deposit them into their own bank accounts where they become . . .

COMMERCIAL BANK DEPOSITS

Commercial bank deposits immediately take on a split personality.

On the one hand, they are liabilities to the bank because they are owed back to the depositors. But, as long as they remain in the bank, they also are considered as assets because they are on hand. Once again, the books are balanced: the assets offset the liabilities. But the process does not stop there. Through the magic of fractional-reserve banking, the deposits are made to serve an additional and more lucrative purpose. To accomplish this, the on-hand deposits now become reclassified in the books and called . . .

BANK RESERVES

Reserves for what? Are these for paying off depositors should they want to close out of their accounts? No. That's the lowly function they served when they were classified as mere assets. Now that they have been given the name of "reserves," they become the magic wand to materialize even larger amounts of fiat money. This is where the real action is: at the level of the commercial banks. Here's how it works. The banks are permitted by the Fed to hold as little as 10% of their deposits in "reserve." That means, if they receive deposits of $1 million from the first wave of fiat money created by the Fed, they have $900,000 more than they are required to keep on hand ($1 million less 10% reserve). In bankers' language, that $900,000 is called . . .

EXCESS RESERVES

The word "excess" is a tip off that these so-called reserves have a special destiny. Now that they have been transmuted into an “excess,” they are considered as available for lending. And so in due course these excess reserves are converted into . . .

BANK LOANS

But wait a minute. How can this money be loaned out when it is owned by the original depositors who are still free to write checks and spend it any time they wish? The answer is that, when the new loans are made, they are not made with the same money at all. They are made with brand new money created out of thin air for that purpose. The nation's money supply simply increases by ninety per cent of the bank's deposits. Furthermore, this new money is far more interesting to the banks than the old. The old money, which they received from depositors, requires them to pay out interest or perform services for the privilege of using it. But, with the new money, the banks collect interest, instead, which is not too bad considering it cost them nothing to make. Nor is that the end of the process. When this second wave of fiat money moves into the economy, it comes right back into the banking system, just as the first wave did, in the form of . . .

MORE COMMERCIAL BANK DEPOSITS

The process now repeats but with slightly smaller numbers each time around. What was a "loan" on Friday comes back into the bank as a "deposit" on Monday. The deposit then is reclassified as a "reserve" and ninety per cent of that becomes an "excess" reserve which, once again, is available for a new "loan." Thus, the $1 million of first wave fiat money gives birth to $900,000 in the second wave, and that gives birth to $810,000 in the third wave ($900,000 less 10% reserve). It takes about twenty-eight times through the revolving door of deposits becoming loans becoming deposits becoming more loans until the process plays itself out to the maximum effect, which is . . .

BANK FIAT MONEY = UP TO 9 TIMES GOVERNMENT DEBT

The amount of fiat money created by the banking cartel is approximately nine times the amount of the original government debt which made the entire process possible. When the original debt itself is added to that figure, we finally have . . .

TOTAL FIAT MONEY = UP TO 10 TIMES GOVERNMENT

The total amount of fiat money created by the Federal Reserve and the commercial banks together is approximately ten times the amount of the underlying government debt. To the degree that this newly created money floods into the economy in excess of goods and services, it causes the purchasing power of all money, both old and new, to decline. Prices go up because the relative value of the money has gone down. The result is the same as if that purchasing power had been taken from us in taxes. The reality of this process, therefore, is that it is a . . .

HIDDEN TAX = UP TO 10 TIMES THE NATIONAL DEBT

Without realizing it, Americans have paid over the years, in addition to their federal income taxes and excise taxes, a completely hidden tax equal to many times the national debt! And that still is not the end of the process. Since our money supply is purely an arbitrary entity with nothing behind it except debt, its quantity can go down as well as up. When people are going deeper into debt, the nation's money supply expands and prices go up, but when they pay off their debts and refuse to renew, the money supply contracts and prices tumble. That is exactly what happens in times of economic or political uncertainty.

[IAmMetaphysical]

Also Trudy: the reason I used money interchangeably in that last post is because that's how you have been using it. (Or felix has been using it)

[softwareNerd]

I finally read some of the more recent posts in this thread. I still cannot figure out the exact topic being discussed, the thesis being put forth. (With all respect, Trudy does not help his case by remarks about 30 years of research and Chancellor Bismark.) That is not to say that there is no thesis; but that there are too many. I see a few:

• a 100% gold standard cannot work
  
• a fractional-reserve standard based on gold cannot work
  
• fiat money cannot work
  
• a crash is coming
  
• banks and financial companies engage in fraudulent activity
  

At one point in the thread, and from some discussions in Chat, I thought that the main thesis was that an economy with a fixed quantum of money would have problems (even if that fixed quantum is gold money). The devil's advocate case goes like this:

If the economy has a fixed quantum of money, profit and interest payments are not possible in the aggregate. The reason for this is that all those who want to invest with the intent of getting profit and interest require that they end up with more than they have. Since the quantum of money is fixed, ending up in this situation may be possible to some investors, but not to investors in the aggregate. Therefore, on average, aggregate investment -- for profit and for interest -- will be stifled until it no longer takes place.

That thesis can be answered. Problem is that I do not know if that is the thesis, or if it is something else completely. Just at the point in the thread where I thought this was the thesis, the focus seemed to change to fiat-currency.

In summary, I don't think this thread will go anywhere unless an attempt is made to argue a very narrow thesis.

[hunterrose]

Right now, money is created by government fiat.

Sure, but what I'm asking Trudy Cool is whether she is arguing against fractional reserve within a fiat system (as ours is) or against fractional reserve in any system (as her response to aequalsa implied to me.)

Like you said way back at post #37, this has become tangled, and I just want to see if anything can be resolved, optimist that I am.

If Trudy Cool means that any fractional reserve system is intrinsically harmful, I would think that would be pretty easy to refute. On the other hand, if she means that fractional reserve can be beneficial, but not under our fiat system, then we could look at the systems we agree fractional reserve is beneficial in, and decide whether the differences between those systems and our system are significant enough to change something beneficial into a detriment.

Or not

Edit:

That is not to say that there is no thesis; but that there are too many.

In summary, I don't think this thread will go anywhere unless an attempt is made to argue a very narrow thesis.

Indeed Edited April 21, 2006 by hunterrose

[softwareNerd]

I'm not sure if "Fractional Reserves" are the main subject of this thread. However, there's a pretty long existing thread (link) that discusses the issue. So, I moved the last post, which was specifically on that issue, to the existing thread.

Edited April 21, 2006 by softwareNerd

[Trudy Cool]

Statism has its roots in collectivism, altruism, power-lust--in one word, irrationality. If all the people who make the government's policy were committed to respecting the rights of individuals, you could have a gold-based fractional-reserve economy and no statism would ever grow out of it.

I think you are wrong about this. It is one of the issues I have been hoping to discuss. My Borrowed Gold scenario has to be accepted as valid before I can proceed, otherwise this discussion will continue without focus.

If your Borrowed Gold scenario is meant to be an illustration of how the gold standard works, you got it completely wrong. And this is not a jeer but a statement of fact. In reality, gold is not introduced into the economy by bankers but by miners. There is not a fixed supply of gold, just like there is no fixed supply of oil. And rational people do not borrow gold unless they have a business plan that will allow them to create enough wealth to pay the interest, and keep some. Nor would a rational bank lend any gold to a person without such a business plan.In the terms of your scenario, the gold would be mined by one or more of the participants; Midas would obtain the gold by selling them something he has produced; and no gold would be lent to anyone until Midas was convinced that the borrower could make enough drinks to sell him.

Money isn't created by borrowing. Money is created by producing. Specifically, gold is produced by mining, and the gearing of fractional reserves results out of the ability of businesses to produce goods in excess of their debt service. The only kind of money that doesn't result from productive activity is inflationary money in a fiat system--but that kind of money isn't created ; it is stolen.

Look -- if you set out to demonstrate that F = ma, it is essential that you create a model that is free of all other factors: friction, drag, etc. If the people you are trying to convince insist that it is a false trumped up model because you have deliberately removed "real world factors", what can you do?

My whole effort with the Borrowed Gold scenario has been to show the behaviour of a medium of exchange that is borrowed into existence. You declare that my "illustration of how the gold standard works" (I made no such claim) is "completely wrong". But your reasons for saying so deal exclusively with extraneous factors I removed intentionally in order to bring the discussion down to exactly one issue.

We agree that a fiat system is not a free market. But you are contending that a gold-based fractional reserve system is not free either, aren't you? But it is; freedom means absence of force, and there is no force involved in a gold-based fractional reserve system.

Nor is there in the other two models I present.

My contention is that a gold-based fractional reserve system has a peculiar characteristic. The peculiarity is that, while no productive sector individual is forced to borrow, if the productive sector as a whole refuses to borrow the medium of exchange it dries up and disappears from availability (a "Bust"). The essential mechanism by which that occurs is encapsulated in my Borrowed Gold scenario.

They're cute, but perfectly impractical. The problem with the first one...

...is that it lacks a standard of value. They ask Midas to debit the buyer--in what currency?

• U.S. dollars? Then you have a fiat-money economy.
  
• Amounts of gold, or gold coins? Then you have a gold standard.
  
• Glasses of drinks? Then you have just another commodity standard.
  
• Units of whichever good the buyer is buying? Then we're back to barter.
  
• An invented currency without any definition other than that it's a currency? Then you have fiat money, without even a Fed to keep inflation in check.
  

Allow me to take these one by one, but first a general remark on your whole point.

One of things that a discussion of money must make absolutely clear is that "money" has numerous overlaid functions. Different manifestations of money can include or exclude some of them. I have already listed the main ones: medium of exchange, store of value, measure of value. My purpose with my scenarios is to show cases in which those functions are absent or overpowering.

Owned Gold is an example of an inseparable binding of those functions.

Clearing is an example in which exchange is facilitated without a tight binding to the other functions. In particular, clearing permits members to select the appropriate measure of value for their purposes.

• "U.S. dollars?" I deliberately mentioned that in a clearinghouse the sum of all accounts is zero. Thus, no fiat money would be introduced. Valuations would be denominated in and subject to the same fluctuations in value as experienced in the general market, but completely isolated from fluctuations in availability.
  
• "Amounts of gold, or gold coins? Then you have a gold standard." Exactly. I have no problem with that at all, but it is sub-optimal because the value of gold can be manipulated.
  
• "Glasses of drinks? Then you have just another commodity standard." If based on a single commodity, it would be viable, but sub-optimal. A broad spectrum index is ideal.
  
• "Units of whichever good the buyer is buying? Then we're back to barter." Clearing doesn't work for multiple denominations. You need one clearing registry for each denomination.
  
• "An invented currency without any definition other than that it's a currency? Then you have fiat money, without even a Fed to keep inflation in check." Correct. That's also a poor option..
  

The second one...

...is really just barter-on-credit. It might work in an economy that consisted of a couple dozen people, but less efficiently than gold. In the U.S., which has more than two hundred million grown-up citizens, you would have more than two hundred million different currencies in circulation. Scale is key indeed!

You are not addressing the scenario, you are merely dismissing it. Consider this...

In 1932 Larkin Department Stores, a chain in dozens of towns in three states around Buffalo, N.Y. was facing massive layoffs. Larkin called his staff together and faced them with a decision. He said they must accept that 1 in 2 of them be laid off, or everyone accept a 50% salary reduction.. When that had sunk in he offered a third way. He showed them dollar denominated vouchers he called "Larkin Merchandise Bonds". He'd promised to pay the second 50% of salaries with those bonds and scrupulously accept them as payment for any product in his chain of stores. After a time he also paid his suppliers, who paid their staff, who purchased in his stores. The concept was so successful that bonds and dollars were equally acceptable in the whole region. What is more, his bonds sustained commerce in that region throughout the depression, without compulsion, without public sector authority and without gold.

The critical point here is that he did not ask a banker to give him credit. He recognized that he and his chain had credit. He saw his glass as potentially full--and turned the potential into actual.

Need I say how frivolous it is of you to come to an American forum and suggest this as a viable alternative for Americans ?

I find this last remark of yours truly bizarre. You use "Need I say" as though you are making a self-evident statement. But your statement is loaded down with fallacies. Where is it declared that this is an America-only forum? The Internet has no geography. Just the same, in response to your complaint, the preceding example is an American example. There are many more American examples, both historic and current. You say I am suggesting an alternative for Americans, but I've made no such claim. The Federal Reserve dollar is the global key currency, and has global reach. A key currency nation always derives a unique benefit from that position through seignorage. For that very reason my alternatives are less appropriate for America.

But none of the above is what strikes me as bizarre. The real problem is this. Earlier, above, you state ...

If all the people who make the government's policy were committed to respecting the rights of individuals, you could have a gold-based fractional-reserve economy and no statism would ever grow out of it.

This is an extraordinary flight of wishful thinking. The Fed is the axis around which the entire corrupt statist-mercantilist power block of politicians, civil "servants" and government contractors revolves. The Fed, and its archipelago of sister central banks around the world, is the last thing those people will relinquish. A frontal attack is no solution.

My effort here is to propose concrete ways of rejecting them by rejecting their fake money -- opting out! But what reaction do I get? I'm treated as an anti-American, anti-Capitalist, anti-Money troll! Why?

[Trudy Cool]

Sure, but what I'm asking Trudy Cool is whether she is arguing against fractional reserve within a fiat system (as ours is) or against fractional reserve in any system (as her response to aequalsa implied to me.)

I've created the Borrowed Gold scenario in order to discuss the essence of a medium of exchange lent into circulation. If it's flawed I'd like to know. If you think it fails as a model of borrowing the MoE into existance, please explain how.

If Trudy Cool means that any fractional reserve system is intrinsically harmful, I would think that would be pretty easy to refute.

To do that we now have to split the discussion. I had not seen the other thread.

On the other hand, if she means that fractional reserve can be beneficial, but not under our fiat system, then we could look at the systems we agree fractional reserve is beneficial in, and decide whether the differences between those systems and our system are significant enough to change something beneficial into a detriment.

I appreciate your genuinely constructive approach. Thanks!

[Trudy Cool]

Hunter, I appreciate your level-headed involvement, I really do.

There are so many side issues here, but I bet a conclusion can be reached if this is the focus:

• Is fractional reserve banking harmful to a free market?
  

We've been asked to migrate discussion of that to the fractional reserve banking thread.

My point is distinct, and in my opinion, precedes the fractional reserve discussion. The Borrowed Gold example shows that even interest-free100% reserve lending is harmful to exchange as a way of creating a medium of exchange.

• Does the Clearing Economy/Private Paper Economy avoid fractional reserve's (at the moment supposed) pitfalls?
  

Yes. Completely.

I think I begin to see what you meant about trust

It's one of the things I particularly noticed about Galt's Gulch. Galt and the others repeatedly emphasize to Dagny that all exchange is paid for scrupulously. But when you follow events, you see all sorts of instances in which person to person exchange takes place without payment. There is no clearly defined threshold above which money must be brought in to "account for" interpersonal exchange. Where each person places that threshold is largely governed by the trust they have in the other person.

If Midas is intervening in these two economies, doesn't he pose the same threat you're attributing to fractional reserve systems?

Not at all. For one thing it is fruitless to pursue a line of argument that Midas is necessarily a threat in any of the scenarios, although the lending at interest scenarios do place him in a controlling position, for good or ill. At issue are systemic tendencies and how they distribute relative advantage. My latter two scenarios both show a medium of exchange that is available in limitless supply, but adjusts organically and nearly instantly to demand for goods and services. Moreover, when their value standard is well chosen they are also freed completely from inflation and deflation. The threat Midas represents in the borrowed money examples, is that control over the proportion of supply of money to demand for goods and services, is in his hands, apportioning to him a systemic advantage..

On the other hand, why not support a system in which success requires trading with good businessmen, but doesn't require trusting auditors - doesn't require auditors in the first place? Is non-fiat fractional reserve such a system?

If you are aware of patacones issuance in Argentina following the 2001 collapse, you will know that they followed the same path as every un-governed fiat issuance in history. Governance and transparency are absolutely essential for any privatization of money to be successful.

[Capitalism Forever]

Trudy, explain to us why you think producers have to "borrow the medium of exchange" in a gold-based fractional-reserve system. In other words: Why do the participants in your Borrowed Gold scenario "wait for Midas to arrive" before they begin producing?

[Trudy Cool]

Trudy, explain to us why you think producers have to "borrow the medium of exchange" in a gold-based fractional-reserve system. In other words: Why do the participants in your Borrowed Gold scenario "wait for Midas to arrive" before they begin producing?

For exactly the reason I explained in my last reply to you 113599.

... if you set out to demonstrate that F = ma, it is essential that you create a model that is free of all other factors: friction, drag, etc. If the people you are trying to convince insist that it is a false, trumped up model because you have deliberately removed "real world factors", what can you do?

How can I focus a discussion on the Boom/Bust properties of a borrowed medium of exchange, if it is mixed up with the Owned Gold example?

As I said earlier, the ethics of fractional reserve is a red-herring. The real problem with the borrowed medium of exchange models is the consequent, completely artificial, distortion of trade inherent in the system.

[Capitalism Forever]

How can I focus a discussion on the Boom/Bust properties of a borrowed medium of exchange, if it is mixed up with the Owned Gold example?

The reason I'm asking is that I simply don't see how your "Borrowed Gold" model has anything at all to do with how things ever happen(ed) in reality. Which would make your model a floating abstraction.

It isn't even quite clear to me what you mean by "borrowing the means of exchange." When you borrow money, you would typically spend it immediately on some equipment or other productive assets, so in effect it is not the currency you borrow but the equipment. There wouldn't be much sense in borrowing-and-holding large amounts of currency, would there? If you borrow tons of gold from a bank and then just sit on it, you've only got yourself to blame if you can't pay the interest.

[Trudy Cool]

The reason I'm asking is that I simply don't see how your "Borrowed Gold" model has anything at all to do with how things ever happen(ed) in reality. Which would make your model a floating abstraction.

My logic is simple, if paper money is borrowed into existence, it is important to understand the essential dynamics of all mediums of exchange borrowed into existence. To remove all extraneous characteristics, such as those of paper certificates with or without gold reserves, I've deliberately concentrated on the dynamics of a market in which gold coins are borrowed. At the beginning and end of the scenario there is no medium of exchange. By mutual agreement Midas lends it into being, on the condition of installment reimbursement. After the last reimbursement the medium of exchange is once again unavailable.

My point is very simple. There is a "boom" at the beginning, where everyone confidently buys and sells the different ingredients for the various contributions to the meal. As time goes by, the quantity of money falls to zero, engendering a "bust". Not everyone partakes of the meal or succeeds in repaying their debt.

This dynamic is inherent in any borrowed medium of exchange. It isn't equitable, and it isn't necessary.

It isn't even quite clear to me what you mean by "borrowing the means of exchange." When you borrow money, you would typically spend it immediately on some equipment or other productive assets, so in effect it is not the currency you borrow but the equipment.

You are looking only at the first half of the process. In the context of the scenario, where will you get the medium of exchange to reimburse what you borrowed? You bought productive assets in order to add value and sell on. In the scenario that becomes increasingly difficult and finally impossible, when everyone has made their last payment.

There wouldn't be much sense in borrowing-and-holding large amounts of currency, would there? If you borrow tons of gold from a bank and then just sit on it, you've only got yourself to blame if you can't pay the interest.

This is a strawman. I've never suggested anything like it, and it has nothing to do with the Borrowed Gold scenario.

[Trudy Cool]

It isn't even quite clear to me what you mean by "borrowing the means of exchange."

I'm not the only one who uses such terminology, by the way ... July 2004 archive commentary in Prudent Bear

[Capitalism Forever]

My logic is simple, if paper money is borrowed into existence, it is important to understand the essential dynamics of all mediums of exchange borrowed into existence.

You don't understand. I dispute your assertion that money is "borrowed into existence."

[aequalsa]

You don't understand. I dispute your assertion that money is "borrowed into existence."

By 'paper' money being borrowed into existence, do you mean in the sense that(assuming it is backed by gold) a one ounce paper bank note means that the bank "owes" you one ounce of gold? So, in other words, the bank note represents a debt owed to you by the bank?

[Trudy Cool]

You don't understand. I dispute your assertion that money is "borrowed into existence."

Well, I suppose I'll have to guess what your objection is.

My first guess is that we have a problem of terminology.

Is the word "existence" unacceptable? My borrowed gold scenario works unchanged if one says, "borrowed into availability" or "borrowed into circulation".

My second guess is that you hold that money issuance happens by some other mechanism.

But you said last week,

Thanks to this fractional reserve mechanism, one dollar in a bank's vault adds to the money supply as much as nine dollars in a guy's wallet.

How does that occur if not by borrowing?

[Capitalism Forever]

Well, I suppose I'll have to guess what your objection is.

My greatest objection is that I have no idea what the hell you mean by it.

Money is an asset. Assets are created by production; borrowing simply involves a transfer of custody; so does stealing. Production is the only kind of action that brings money into existence.

My borrowed gold scenario works unchanged if one says, "borrowed into availability" or "borrowed into circulation".

It still doesn't make sense with "circulation." Circulation is when money changes hands repeatedly and continuously. And the primary reason for such transfers of money is that there is a countervailing transfer of goods, which the buyer values more than the money he spends on them. So continuous spending is what brings money into circulation, and production is the only kind of action that makes continuous spending possible.

And when you say "availability," you have to specify to whom. When money is borrowed, it becomes available to the borrower, and it stops being available to the lender. One person can borrow money into availability to him, but borrowing cannot increase the aggregate amount of money available in the economy.

The tersest definition of money is: a liquid asset. That is, an asset that can be traded for other assets at little cost; a medium of exchange. So the amount of money available in the economy is determined by two things:

1. The amount of assets in the economy;

2. What portion of those assets are liquid.

Gold is inherently liquid. Most other products are not--but they can be made liquid, by issuing paper or electronic titles to them. Since assets serving as collateral necessarily have such titles, they too become liquid assets and contribute to the money supply.

You seem to be thinking that they serve as collateral because we need them to be liquid. But that is getting things backwards. The loans are made because they are good for the lender and good for the borrower; and for that reason, they would be made regardless of whether they increase the money supply. It is not the growth in money supply that causes the loans; it is the loans that cause the growth in money supply. The debtors pay interest because they are better off thanks to the loans, not because they want to help other people make their assets liquid.

And you'll note that, while the above process does involve borrowing and lending, it is not the borrower that obtains the means of exchange. If, say, you buy a home on mortgage, what you obtain is a home; it is the seller of the home that gets the cash. So--if you insist on using such language--the correct thing to say is that money is lent into existence.

[Trudy Cool]

My greatest objection is that I have no idea what the hell you mean by it.

That's fine. I'll do whatever it takes to make my meaning clear.

Money is an asset. Assets are created by production; borrowing simply involves a transfer of custody; so does stealing. Production is the only kind of action that brings money into existence.

I've tried very hard to keep the word "money" out of this because of the complications of its various functions. I try to ensure always to use the term medium of exchange, because that is a clear cut function. The medium of exchange need not be a physical asset, but if it isn't, it must be a claim on an asset.

When you say "Production is the only kind of action that brings money into existence.", you seem to be denying the process of "monetization of assets".

If I have a piece of land, it is illiquid and non-fungible and therefore a dreadful medium of exchange (but an excellent store of value). If I "monetize" it with a mortgage, the lender makes available to me a liquid, fungible claim-check on land to which he now holds title. When I spend some of that claim check into circulation I have placed new media of exchange into public availability that was not available before. That is what I mean by borrowing it into existence.

Meanwhile the fungible fragments of my claim to my land have left my hands to spread far and wide across the marketplace. I must produce for sale enough to recoup an equivalent amount to reclaim title.

The core point is that from the time I first spend those claim checks I have increased the global money stock by the value of my land. With each payment I decrement the money stock back down again. My borrowing brought into existence something that was not there before (a fungible claim on my land), and snuffs it out when I cancel my debt.

It still doesn't make sense with "circulation." Circulation is when money changes hands repeatedly and continuously. And the primary reason for such transfers of money is that there is a countervailing transfer of goods, which the buyer values more than the money he spends on them. So continuous spending is what brings money into circulation, and production is the only kind of action that makes continuous spending possible.

In the above example land also brings a "circulant" into availability, for the duration of the term of the mortgage.

And when you say "availability," you have to specify to whom. When money is borrowed, it becomes available to the borrower, and it stops being available to the lender. One person can borrow money into availability to him, but borrowing cannot increase the aggregate amount of money available in the economy.

The context was my Borrowed Gold scenario, so "Availability" was implicit. Midas makes a medium of exchange available to the participants, by monetizing their watches.

The tersest definition of money is: a liquid asset. That is, an asset that can be traded for other assets at little cost; a medium of exchange. So the amount of money available in the economy is determined by two things:

1. The amount of assets in the economy;

2. What portion of those assets are liquid.

Gold is inherently liquid. Most other products are not--but they can be made liquid, by issuing paper or electronic titles to them. Since assets serving as collateral necessarily have such titles, they too become liquid assets and contribute to the money supply.

Nothing you say here is false, but there are things that are out of place, in my opinion. Once again, while the validity of my Borrowed Gold example remains unacceptable, most of what you say here comes later.

The one thing that is central is your remark, "Most other products are not--but they can be made liquid, by issuing paper or electronic titles to them". This is the crux of the matter, but you dismiss it as unimportant. I absolutely agree that "making them liquid" is key, but what happens within that all important action "issuing". While the innards of that remain unclear, nothing else can be understood, agreed upon or resolved.

My Borrowed Gold example shows "issuance" without paper, without fractional reserve and (if you wish) without interest. That scenario shows assets (wristwatches) monetized for a fixed term, with someone else's gold coins. The inherent boom/bust cycle shows itself in any intermediated monetization of assets. My Private Paper scenario, and the Larkin Merchandise bonds historical case, describe self-monetization of assets and a complete lack of boom/bust cycle.

My desire in coming to this forum was to find a group of people willing to examine the two cases and discusses the differences.

You seem to be thinking that they serve as collateral because we need them to be liquid. But that is getting things backwards. The loans are made because they are good for the lender and good for the borrower; and for that reason, they would be made regardless of whether they increase the money supply. It is not the growth in money supply that causes the loans; it is the loans that cause the growth in money supply. The debtors pay interest because they are better off thanks to the loans, not because they want to help other people make their assets liquid.

I'm saying we need a medium of exchange. If changes in the quantity of it are not synchronized with demand for production, production is distorted to the detriment of producers and consumers.

Intermediated monetization of assets (lending/borrowing into existence) is desynchronized.

Self-monetization and clearing are synchronized and thus to be preferred.

And you'll note that, while the above process does involve borrowing and lending, it is not the borrower that obtains the means of exchange. If, say, you buy a home on mortgage, what you obtain is a home; it is the seller of the home that gets the cash. So--if you insist on using such language--the correct thing to say is that money is lent into existence.

If that is the terminology you prefer, I have no objection. It does not change the underlying mechanism.

[hunterrose]

I have sought out an intellectually challenging forum to assess the alternatives I propose.

We aim to please

My Borrowed Gold scenario has to be accepted as valid before I can proceed, otherwise this discussion will continue without focus.

It's acceptable.

If changes in the quantity of [a medium of exchange]are not synchronized with demand for production, production is distorted to the detriment of producers and consumers.

I agree that changes in the circulating supply of money can be detrimental to others, but don't think it can be systematically counteracted without resorting to systems more unstable than gold or force. Nonetheless, I'm interested in seeing where this goes.

[Clearing Economy and Private Paper Economy] both show a medium of exchange that is available in limitless supply, but adjusts organically and nearly instantly to demand for goods and services. Moreover, when their value standard is well chosen they are also freed completely from inflation and deflation.

What prevents a person with from having a nigh-infinite negative balance in a Clearing Economy? What would interest be paid in, if not (further negative) accounting units?

Couldn't banks could just as easily store the paper notes and loan them out to others, creating the same problem in the Private Paper Economy being attributed to gold lending?

[Capitalism Forever]

My Borrowed Gold example shows "issuance" without paper, without fractional reserve and (if you wish) without interest. That scenario shows assets (wristwatches) monetized for a fixed term, with someone else's gold coins. The inherent boom/bust cycle shows itself in any intermediated monetization of assets.

If Midas charges no interest, why is there an inherent boom-bust cycle? Isn't the bust in your scenario caused by the accrual of interest, and Midas's failure to bring in additional gold in order to monetize further assets?

[Trudy Cool]

What prevents a person with from having a nigh-infinite negative balance in a Clearing Economy? What would interest be paid in, if not (further negative) accounting units?

Clearinghouses have a wide variety of ways of dealing with that issue.

During creation of the IMF Keynes proposed that when countries that went too far below zero the IMF would just reset them to zero! You can imagine how well that went over with the US delegation, when the US would become the largest creditor to the IMF by a wide margin. For those kinds of dangers it demanded, and got, sufficient voting rights that (along with a British vote) gave it a veto over all decisions. Now, the US is the largest debtor by an even wider margin, and still carries an effective veto with Britain's support. That's a classic case of -- out of the frying pan (reset to zero) and into the fire (veto rights).

A far better mechanism than either of the above disasters is AR/AP clearing. Every economic unit has accounts payable and accounts receivable. These are submitted periodically to the clearinghouse and paired off, your AP with my AR. The clearinghouse would clear your APs up to the limit of the value of your (paired up) ARs. This has reduced advantages from the unrestrained clearing I show in my post 113324, but is protected from the danger you highlight. There are other techniques.

Couldn't banks could just as easily store the paper notes and loan them out to others, creating the same problem in the Private Paper Economy being attributed to gold lending?

I don't have a problem with this, in fact it's very important. Borrowing for growth is vital. How it actually works is extremely interesting. It's one of the things I'm hoping to explore.

My concern for now though is with the proportion of self-issued money to borrowed money. Right now we have a situation where 100% of US dollars entered circulation through bank lending. Against that, I read on the BBC website that airline frequent flyer points in aggregate represent the second largest "currency" in circulation, behind the dollar! I can't corroborate it, and it's not important to me whether it's true or not for the purposes of this discussion. The interesting thing is the issuance mechanism, and the fact that one of the big supermarket chains (John something) in Britain accept British Airways points for purchase of groceries.

The airlines are not taking full advantage of the power they hold in their hands, (and probably can't because of their utter dependance on the credit card companies). Imagine an airline that paid a percentage of it's AP and payroll with frequent flyer points, as well as pushing them backwards to their customers. As long as they scrupulously accepted them at par for payment of services they'd have a bona fide global currency. If they could drive the percentage of AP and payroll up to 100, they'd be completely insulated from the boom/bust phenomenon. Better stated, their insulation would be proportional to the precentage of payments they could make in points.

If you extrapolate that to a situation where many companies acheive the same insulation, I expect you can see a consequent smoothing out of the boom/bust cycle generally.

I don't oppose lending or even lending at interest. I'm arguing that it is increasingly distortive to trade as it grows to 100% of the way the medium of exchange is created.

[Trudy Cool]

If Midas charges no interest, why is there an inherent boom-bust cycle?

It is easy to wipe out the boom/bust cycle in my Borrowed Gold scenario -- change the term from 3 hours to 3 days and the period from 15 mins to 6 hours. Since the party is only 3 hours you have a stable money stock throughout.

Even with that, those with unpopular offerings will end up short, but at least the artificial time pressure, and the artificial scarcity as time goes on, are removed

Isn't the bust in your scenario caused by the accrual of interest, and Midas's failure to bring in additional gold in order to monetize further assets?

The bust is caused by the term of lending coinciding with, or falling short of, the duration of the dinner party. Interest exacerbates the problem.

Further monetization or lack of it isn't a failure on Midas' part, he'd be perfectly willing to lend more. I keep it out of the scenario, explicitly, in order to focus completely on the core function. If you want to pursue that topic there are some other really interesting phenomena that crop up.

[Capitalism Forever]

It is easy to wipe out the boom/bust cycle in my Borrowed Gold scenario -- change the term from 3 hours to 3 days and the period from 15 mins to 6 hours. Since the party is only 3 hours you have a stable money stock throughout.

What happens if the party goes on indefinitely, and the maturities of the loans are spread out about evenly (e.g. one or two loans maturing every hour? That is the analogous equivalent of how a real-life economy works, and I don't see why a boom-bust cycle is inherent in it.

Further monetization or lack of it isn't a failure on Midas' part, he'd be perfectly willing to lend more. I keep it out of the scenario, explicitly, in order to focus completely on the core function.

I thought monetization was precisely the core function we were supposed to be focusing at, wasn't it?