On Private Banks

[softwareNerd]

I've no moral argument against informed (or should be informed) individuals writing whatever contracts they want (consistent with Objective law, of course). If you want to bank at "Bank of Madoff," more power to ya'.

Agreed.

Fractional reserve banking is not immoral per se. It's only immoral, it's only theft, when the creation of this credit, the creation of this leverage impacts the wealth of those not party to the contract.

Maybe/maybe not. "Impact" is too wide to imply rights have been violated. I might do something that impacts my neighbor, and yet is within my rights.

If I can deposit $10 worth of gold in my bank, then write checks for $100 - and no one understands that $100 in checks doesn't represent $100 in gold, or currency, or some real asset, or some real measure of productive efforts, then I've stolen wealth from everyone I convince to take those checks.

What if they fully understand that the bank that wrote the check does not have 100% gold reserves. And, what if knowing that they still take the check, treating it like money?

Perhaps we all should know this is the state of our banking system. Perhaps that's the point everyone's been trying to get me to understand?

I think the main objection you're getting is to ruling out gold-standard but fractional-reserve banking system like we had pre-Fed. If we assume that the folks in (say) 1904 knew how banks worked (i.e. that they did not keep 100% reserves) then it was up to them to accept or reject bank-notes, bank-checks, etc.

It sounds like you're suggesting an argument that goes something like this: even if someone dealt only in cash, he was impacted because the widespread acceptance of bank-notes and checks (by other people) as being "near cash" meant higher prices for the guy who was sticking with cash alone. If that was part of your argument, then there are two issues with it: first is the question of whether such acceptance actually raised prices for the gold-bug; second, whether that type of impact would be a violation of his rights. Even if one grants the first (which I don't quite do), I'd still argue that the gold-bug's rights are not violated by such a price-rise.

[JeffS]

Maybe/maybe not. "Impact" is too wide to imply rights have been violated. I might do something that impacts my neighbor, and yet is within my rights.

Such as? I mean, where do your rights end and your neighbors' begin? You have a right to pursue your happiness in loud music. Does that mean your neighbor's right to pursue his happiness in sleep is not being violated?

What if they fully understand that the bank that wrote the check does not have 100% gold reserves. And, what if knowing that they still take the check, treating it like money?

Then no fraud, no theft, no problem.

I think the main objection you're getting is to ruling out gold-standard but fractional-reserve banking system like we had pre-Fed. If we assume that the folks in (say) 1904 knew how banks worked (i.e. that they did not keep 100% reserves) then it was up to them to accept or reject bank-notes, bank-checks, etc.

I absolutely have no objection to a gold-standard with fractional-reserve banking as long as the credit notes are clearly distinguishable. People must have a way of distinguishing between JP Morgan notes and Bank of Madoff notes. And there should be penalties for counterfeiting another's notes just as we have laws against counterfeiting currency. There will still be inflation, but the effects will be limited by bank. I can either choose not to accept money from that bank, or demand a premium to do so. If I demand a premium, then the leveraging actions of the issuing bank will be borne solely by the depositor.

It sounds like you're suggesting an argument that goes something like this: even if someone dealt only in cash, he was impacted because the widespread acceptance of bank-notes and checks (by other people) as being "near cash" meant higher prices for the guy who was sticking with cash alone. If that was part of your argument, then there are two issues with it: first is the question of whether such acceptance actually raised prices for the gold-bug; second, whether that type of impact would be a violation of his rights. Even if one grants the first (which I don't quite do), I'd still argue that the gold-bug's rights are not violated by such a price-rise.

That is my argument. Even if he deals only in cash (currency), the supply of money (what is reliably used to exchange ownership in goods and services) will go up with the issuance of credit and the gold-bug's existing cash value will decline. When the credit of JP Morgan is no different in form or function from the credit of Bank of Madoff, Bank of Madoff can create as much money as it wants and no one is the wiser. No one is demanding a risk premium, or inflation premium, from Bank of Madoff. Since the inflation of the money supply is not confined to Bank of Madoff depositors, since they're not required to pay a premium to turn their credit into (the presumably safer) JP Morgan notes, the inflation spreads throughout the entire monetary system. The gold-bug no longer has a choice in accepting Bank of Madoff money because he can't tell the difference between JP Morgan credit, Bank of Madoff credit, or gold.

I'm not sure how it could not be a violation of the gold-bug's rights since he's done nothing to cause the devaluation of his cash - his wealth. Doesn't he have a right to protect his property from the actions of others? He hasn't agreed to let his money be inflated, he doesn't use credit, but suddenly everyone except he has more money than real wealth; money that doesn't represent productive activities. There's suddenly a lot more people who are willing to pay more for goods and services and he has to compete with that. He can only compete by producing more - by increasing his productive efforts. Surely there must be some violation of rights here. If there weren't, then what justification is there for making counterfeiting illegal?

If we were dealing with an entirely gold standard, where gold, or gold backed currency was the only thing exchangeable for goods and services, would it not be a violation of your rights if someone paid you in something you thought was gold, but really wasn't? Suppose you're asking 100oz of gold for your services. The buyer gives you a piece of paper that says, "Good for 100oz of gold on demand from the bank of JP Morgan." You know JP's a good bank, you know their credit really is "as good as gold," so you accept the paper. You go to JP Morgan to receive your gold, but they tell you it's a forgery put out by the Bank of Madoff. They'll still take the paper, but they'll only give you 10oz of gold because they know Bank of Madoff isn't good for 100oz of gold. Have your rights been violated?

Edited March 6, 2009 by JeffS

[Paul McKeever]

This thread is long, so perhaps I've missed what I'm looking for.

However, I've seen here numerous references to the idea that because a dollar of bank-issued credit is somehow backed by "future revenues", etc., the issuance of credit that is not backed 100% by currency is not theft.

Theft is a non-consensual transfer of wealth from one person to another.

Money - to Objectivists - does not properly include fractionally-backed (or, in Canada, 0-reserve backed) credit, "future revenues" and the like. The problem of inflation starts at the identity of money, as it is properly defined:

Wealth represents goods that have been produced, but not consumed

...All the physical goods and services he needs for his project must actually exist and be available for trade—just as his payment for them must actually exist in the form of physical goods (in this case, shoes). An exchange of paper money (or even of gold coins) would not do any good to any of the parties involved, if the physical things they needed were not there and could not be obtained in exchange for the money.

...When a rich man lends money to others, what he lends to them is the goods which he has not consumed.

This is the meaning of the concept “investment.” If you have wondered how one can start producing, when nature requires time paid in advance, this is the beneficent process that enables men to do it: a successful man lends his goods to a promising beginner (or to any reputable producer)—in exchange for the payment of interest. The payment is for the risk he is taking: nature does not guarantee man’s success, neither on a farm nor in a factory. If the venture fails, it means that the goods have been consumed without a productive return, so the investor loses his money; if the venture succeeds, the producer pays the interest out of the new goods, the profits, which the investment enabled him to make.

...Such is the meaning of the term “credit.” In all its countless variations and applications, “credit” means money, i.e., unconsumed goods, loaned by one productive person (or group) to another, to be repaid out of future production.

...The most disastrous loss—which broke their tie to reality—is the loss of the concept that money stands for existing, but unconsumed goods.

The system’s complexity serves, occasionally, as a temporary cover for the operations of some shady characters. You have all heard of some manipulator who does not work, but lives in luxury by obtaining a loan [NOTE: a deposit is a loan to a bank], which he the repays by obtaining another loan elsewhere, which he repays by obtaining another loan, etc. You know that his policy can’t go on forever, that it catches up with him eventually and he crashes. But what if that manipulator is the government.

...It borrows money from you today, which is to be repaid with money it will borrow from you tomorrow, and so on. This is known as “deficit financing.” It is made possible by the fact that the government cuts the connection between goods and money. It issues paper money, which is used as a claim by any goods, it is not backed by gold, it is backed by nothing. It is a promissory note issued to you in exchange for your goods, to be paid by you (in the form of taxes) out of your future production.

...Do you think a spending orgy of this kind could be paid for out of current production? No, the situation is much worse than that. The government is consuming this country’s stock seed—the stock seed of industrial production: investment capital, i.e., the savings needed to keep production going. These savings were not paper, but actual goods. Under all the complexities of private credit, the economy was kept going by the fact that, in one form or another, in one place or another, somewhere within it, actual material goods existed to back its financial transactions. It kept going long after that protection was breached. Today, the goods are almost gone.

Credit, as defined by Ayn Rand, does not include mere promises to pay goods that do not yet exist. Money must be existing goods (e.g., gold), and credit is a loan of existing goods; of things already produced.

Gold was a good form of money precisely because its quantity could not be easily expanded. Those who saved their gold, during a time of economic growth, would find that their gold was worth more - that the same amount of gold could buy more things. Yes, it is possible to expand the supply of gold coin, but gold was a good form of money not because its quantity could be expanded, but because its quantity could not be expanded at will.

Such is not the case with fiduciary media. Fiduciary media can be expanded at will. In Canada, there is zero reserve requirement. Under the Basel II accord (and international agreement among banks), the reserve requirement for loans to governments is zero (because, of course, governments legally can steal, in the form of taxation). If John holds 10% of the money supply on day 1, and banks collectively double the supply of "money" by issuing credit (all backed by, say, it's faith in GM's ability to make money in the future: future wealth; future goods; in other words, credit backed only by "YOU" [as Ayn Rand said in relation to the same practice when exercised by governments], and faith in your ability to make goods in the future), John will end up with 5% of the money supply after the credit expansion. Had the economy doubled without the bank doubling the money supply, John's savings would have doubled in purchasing power. However, because the banks doubled the supply of dollars (by creating, then lending out, credit that was NOT existing goods but faith in their ability to obtain goods in the future) the bank has obtained, fully the accrual in purchasing power that John's savings otherwise would have realized. It transferred John's accrual in buying power - John's wealth - to itself, without his consent. This is known in most circles as "theft". Calling it such is not a slur: it is an identification.

If one wants to make arguments that Rand was wrong, and that lending credit that is backed by future goods (e.g., promises to pay future goods), that's fine. But let's not confuse that with Objectivism.

Existing. Goods.

Edited March 7, 2009 by Paul McKeever

[softwareNerd]

If one wants to make arguments that Rand was wrong, and that lending credit that is backed by future goods (e.g., promises to pay future goods), that's fine. But let's not confuse that with Objectivism.

So you think Rand was arguing against the practice of fractional-reserve banking, and did not think to say it?

[JeffS]

So you think Rand was arguing against the practice of fractional-reserve banking, and did not think to say it?

Well, she may not have named it, but she did argue against it. Fractional reserve banking is the process of loaning money which is backed only partially by assets. Therefore, some of the "goods" loaned are not "goods which [have] not [been] consumed."

[Jake_Ellison]

Well, she may not have named it, but she did argue against it. Fractional reserve banking is the process of loaning money which is backed only partially by assets. Therefore, some of the "goods" loaned are not "goods which [have] not [been] consumed."

No it isn't. F.R.B. is when banks lend out say 90% of people's deposits, keeping only the rest in reserve. (to be payed out when someone makes a withdrawal)

How about this? Either one of you guys, follow the money with a concrete example of how this extra money is created, step by step, and tell me where the theft occurs, and what the specific act of force or deception is which made it theft(or fraud).

Let's start with Farmer John selling a pig, and getting 100 $ for it, which he promptly deposits into a bank called A. You take over from here, all the way to the point where somebody rips Farmer John off. No hypotheticals, focus only on specific things that can happen to this 100 $ and the farmer who owns it.

Edited March 7, 2009 by Jake_Ellison

[JeffS]

No it isn't. F.R.B. is when banks lend out say 90% of people's deposits, keeping only the rest in reserve. (to be payed out when someone makes a withdrawal)

How about this? Either one of you guys, follow the money with a concrete example of how this extra money is created, step by step, and tell me where the theft occurs, and what the specific act of force or deception is which made it theft(or fraud).

Let's start with Farmer John selling a pig, and getting 100 $ for it, which he promptly deposits into a bank called A. You take over from here, all the way to the point where somebody rips Farmer John off. No hypotheticals, focus only on specific things that can happen to this 100 $ and the farmer who owns it.

Okay, but this is a hypothetical, Jake.

Farmer John deposits $100 into Bank A. Total wealth in the economy $100.

Bank A loans $90 to Jim. Total wealth in the economy $190. Where did the extra $90 come from? Farmer John certainly has wealth, right? He has $100 in currency in the bank. He can go pick up his currency anytime he wants. Jim has wealth, right? He's got 90 real dollars in his hand. Farmer John just got ripped off. He used to have 100% of the wealth in the economy, now he's only got 100/190ths, or 53% of the total wealth. His money has just been devalued by 47%.

Are you arguing FRB doesn't result in expanding the money supply?

[agrippa1]

No it isn't. F.R.B. is when banks lend out say 90% of people's deposits, keeping only the rest in reserve. (to be payed out when someone makes a withdrawal)

How about this? Either one of you guys, follow the money with a concrete example of how this extra money is created, step by step, and tell me where the theft occurs, and what the specific act of force or deception is which made it theft(or fraud).

Let's start with Farmer John selling a pig, and getting 100 $ for it, which he promptly deposits into a bank called A. You take over from here, all the way to the point where somebody rips Farmer John off. No hypotheticals, focus only on specific things that can happen to this 100 $ and the farmer who owns it.

Okay, here's one. Farmer Jim applies for a $90 loan to buy a goat from trader Joe, and is turned down. He goes to his local AGORN chapter and accuses the bank of refusing his loan because of the color of his skin (he's sort of a bluish purple). AGORN activists walks in on a bank board meeting and demands justice, accompanied by an FHA inspector looking for GRA violations. A representative from Grannie Mae assures the bank that if they give a 0%-down Option ARM to farmer Jim, they'll purchase the loan and assume the risk. They package the loan up in an MBS and offer it on Wall Street, implicitly guaranteeing it against default to allow it to sell with a lower effective interest rate than demanded by the risk. Unintentionally, they offer a better return than zero-risk, while implying zero risk. Investors from Wall Street fall all over themselves trying to buy the MBS because it represents the best risk-adjusted return available. Farmer Jim buys the goat from Trader Joe for $90, which Joe deposits in the bank. (bank has $190 in deposits, $100 in cash)

Farmer Jim, it turns out, has a low credit rating for a reason. He was hoping to flip this goat, but when he finds out he owes more than his goat is worth, he mails a jingle gram to his bank and walks. The bank can only get $45 for the goat, so the gov't steps in, sells the goat for $45 to Trader Joe (who withdraws the money from the bank) prints 45 $1 bills to cover the difference and bails $90 to the bank, which becomes solvent again.

The bank now has $145 in cash on hand, and $145 in deposits. Money has been inflated by 45%, but there's been no increase in real wealth. So you still have $100 in the bank, but it's only worth $68.97 in "old" dollar value. The government has stolen $31.03 in old dollar value from you. Trader Joe still has his original goat, but now has $45 in the bank, which in "old dollars" is worth... $31.03.

That's why FRB with government guarantees is fraudulent and immoral.

[softwareNerd]

Well, she may not have named it, but she did argue against it. Fractional reserve banking is the process of loaning money which is backed only partially by assets. Therefore, some of the "goods" loaned are not "goods which [have] not [been] consumed."

No, Jeff, she most definitely not argue against it. That is a misunderstanding of what Rand wrote. From what I can tell, Paul is taking what Rand said about the real nature of money (i.e. the fact that it represents something real) and extrapolating from there.

Unfortunately this discussion is simply not holding to a single context. Nobody here is arguing for a governmental fiat currency, nor is anybody here arguing for "fractional reserve banking with government guarantees".

In the context of a proper gold-based currency, fractional reserve banking is perfectly moral. Elsewhere, people have argued (elsewhere) that under the right type of political system, with no fiat currency, no government guarantee, and more widespread clarity of the nature of bank-notes, fractional reserve banking would be far less prevalent (not as broadly practiced, and with much less leverage). This might well turn out to be the case; but does not speak to the morality or legality of the (presumably lesser) FRB that still is practiced under such a Capitalist system.

The the context that folks want to discuss is the current system we have, or some gold-standard where the government provides some form of guarantee, then go ahead and discuss that; but it won;t shed light on the morality and legality of such a system in the context of a rights-respecting system.

[softwareNerd]

Okay, but this is a hypothetical, Jake.

Jeff, in your example, Jim does not have $90 of wealth. His $90 asset is balanced by a $90 liability. The wealth in the economy did not change.

Added: Also, the amount of gold-money (assuming it is gold) is unchanged @ $100. Gold money is not the same as a bank-note representing a claim to gold under certain conditions.

Edited March 7, 2009 by softwareNerd

[Jake_Ellison]

Okay, but this is a hypothetical, Jake.

Farmer John deposits $100 into Bank A. Total wealth in the economy $100.

Bank A loans $90 to Jim. Total wealth in the economy $190. Where did the extra $90 come from? Farmer John certainly has wealth, right? He has $100 in currency in the bank. He can go pick up his currency anytime he wants. Jim has wealth, right? He's got 90 real dollars in his hand. Farmer John just got ripped off. He used to have 100% of the wealth in the economy, now he's only got 100/190ths, or 53% of the total wealth. His money has just been devalued by 47%.

Are you arguing FRB doesn't result in expanding the money supply?

Actually, it didn't. Farmer John indirectly lent Jim 90 bucks. He'll get it back with interest, and the bank gets a little off the top for their troubles too. But he can ask for it back anytime, and he'll have a 100 $ and Jim will have nothing again.

Not to mention the fact that the point was to point out the use of force or deception which makes this theft or fraud. (the way agrippa1 does in the next post) You didn't, you just described a voluntary transaction, with everything out in the open. No force, no deception.

Oh and I forgot: you seem to be advocating against Farmer John actually making deals using that 100$, while at the same time Joe is spending the 90$. I disagree with you that they're both spending the same money, at the same time (I think John is using the money he has in the bank only as a guarantee that he'll pay when he gets it back-and the fact that the bank has a limit on how much they must have in reserve guarantees that when John actually pays, Jim no longer has the 90$), but that doesn't even matter: call it what you want-what you are advocating for is to turn something into theft (and have the government stop it), without that necessary condition Ayn Rand insisted on precisely to prevent these rationalizations: the use of force.

Agrippa1:

I couldn't agree more. My problem is with the statement FRB is theft, in general, which is what Jeff and Paul are saying.

Edited March 7, 2009 by Jake_Ellison

[Steve D'Ippolito]

As of post 57. Farmer John has deposited 100 gold dollars in the bank. The bank turned around and lent 90 of them to Jim. At this point what John has is an IOU (that hopefully is interest bearing) from the bank for $100, and Jim has $90. The bank has $10. This would become quite readily apparent if John were to ask the bank to give him his money back. In present day life (where the money isn't gold, the friendly neighborhood fed quickly hands the bank $90 to give to Jim, figuring they can pay it back later (like when Jim pays his loan back, or someone else deposits money). Under LFC the bank either crashes *or* I could imagine it would quickly borrow the money from another bank.

(Also IRL/LFC, it's far more likely that John would only want $15 of his money... this would correspond to an unusually large (but not total) percentage of customers wanting cash all at once.)

No fraud here. As Jake said, John has used the bank as a broker to loan money to Jim.

However, the folks who complain that FRB is theft follow this one more step. John is able to spend the $100 that's in the bank *without* withdrawing it, by (say) writing a check or possibly even wire-transferring it. Perhaps he has gone to Farm Supplies Guy Rick and bought some fertilizer, for $100. In which case the reality is, he has given Rick the bank's IOU for $100. That $100 IOU has some value, of course, but it is not the original gold, which Jim has. But this too can be done without the intermediation of the bank. If Jim owed John the money directly rather than via a bank, then John could tell Rick, "I don't have all of the money, but Jim owes me $90, here's $10 and I'll have him pay you the rest--with interest."

(In real life, the bank has a lot of different depositors, and your IOU from them is from a pool of loans. Factored into your interest rate are the odds that some of the loans will default. The bank functions as a way to pool the risk of loans not being paid, and that works fairly well as long as the economy doesn't tank unexpectedly, causing an unusually large number of loans to fail. Or as long as the bank makes intelligent lending decisions. Before the days of credit reports, a loan officer had to be a good judge of character. Nowadays the credit report often serves as a substitute for that.)

In the early years of the United States, banks actually issued their own paper money, backed by their reserve *and* the value of the loans they had made. It was understood by everyone that the note was only worth something if the bank was sound, and notes tended to be worth less the further you were from the bank, because it was harder to know the status of that bank. Merchants would routinely see a $10 note, and refuse to accept it for any more than (say) $8 of the purchase, for that reason. And as recently as 20 years ago, my credit union reported my balance to me in "shares", not "dollars" because what I really had was a share of the loans. (A share was readily convertible to a paper dollar, which (sort of) serves as money these days.)

People knew, in other words, that there was actual specie (gold and silver) and banknotes, and the *quality* and hence the value of the banknotes varied.

There were other things going on too--the banknotes did not all have the same design, so it was relatively easy to counterfeit them, another consideration that caused even genuine banknotes to be discounted, particularly far from where they were well known. Catalogs were printed describing what genuine notes looked like, to no avail.

At which point the US government stepped in. At first, they printed standardized bank notes, the National Bank Notes. A bank would order a supply of these and issue them. They looked identical except for a spot for the name and charter number of the bank. This lasted until at least 1929. There was more and more regulation, and of course the Fed was created to do many things (many of which are useful and would no doubt be done by private enterprise if the Fed did not exist and the government got the hell out of the way and allowed it to happen) including serve as the panic lender, and serving as the clearinghouse for checks. These initial steps seem benign *but* the question must be asked: Why did the federal government as opposed to private enterprise have to do this? Answer: no reason I know of.

At some point though people came to regard the paper in their pockets as being real money--a process that accelerated when the government stopped using gold and then later stopped using silver, and it turns out the Fed can print as much of it as they want. THAT is where the fraud began, and it's this quasi-governmental entity that does it, and banks nowadays are part of this system by law (i.e., by misused government force).

[agrippa1]

Agrippa1:

I couldn't agree more. My problem is with the statement FRB is theft, in general, which is what Jeff and Paul are saying.

If you focus in on where the fraud is in my example, it is not just in the government assuming the risk of loans, it is in any action that seeks to hide the true risk of deposits. The government gets away with it because it's difficult for people to reach a conceptual understanding of how inflation is theft. (I hate to admit, I had to read Egalitarianism and Inflation about five times before I started really getting it). Banks do the same thing, but they operate through the technique of hope, that is, they don't plan on being able to recover from a bankrupting wave of defaults and runs, they simply hope for the best. By telling customers that their deposits are actually dollar deposits, rather than shares of outstanding loans plus cash on hand, they are implying something which just isn't so. Even as a run ensues, they cling to hope, paying out full value to the first withdrawing depositors, until they run out of money and go bankrupt. The rest of the depositors are stuck, either selling their accounts to other banks for less than their dollar value, or waiting for a liquidation process that will also pay them less than the nominal value. The first waves of withdrawers pull out more than their share of what the loans are worth, and in this manner also, the bank defrauds many customers, to the benefit of the few early, lucky ones.

A bank can take many actions to reduce the risk of defaulting loans, such as large down payments (reduce the loan amt far below the collateral value), high interest rates (front load payments to quickly reduce exposure to below the minimum expected value of the collateral), credit checks (to filter out high default risks), and avoiding mark-to-market (weigh historical value of collateral rather than present value, to filter out bubbles).*

If a bank insists on telling customers that their deposits are actually dollar-valued, rather than conditional on the performance of loans, then there is some fraud involved. The inherent fraudulancy or non-fraudulancy of FRB depends entirely on how well the banks communicate the risk that some of your deposits may be lost in a wave of defaults, and on how well they safeguard against bank-runners extracting more than their current share of (devalued) deposits.

*[aside: I don't think I need to note that the government, through CRA, FNMA and FHLC, mandated that none of these risk-reduction actions need be taken by lenders. If there's any one who doubts that CRA was the culprit in the credit meltdown, just ask yourself how any lender could compete in such an environment without suspending the same measures. The lowest price asked in a market is the market price; a price above the market price will yield no buyers. That's why Fan & Fred could control the price of the market with only a 30% market share.]

[JeffS]

I hope no one minds if I include all responses in one post.

No, Jeff, she most definitely not argue against it. That is a misunderstanding of what Rand wrote. From what I can tell, Paul is taking what Rand said about the real nature of money (i.e. the fact that it represents something real) and extrapolating from there.

He's also considering the fact that the real nature of money can be both currency (that which is legal tender of the government) and credit. As the last Rand quote points out, the divorce of credit from existing, but unconsumed goods, represents a theft of future production:

"Under all the complexities of private credit, the economy was kept going by the fact that, in one form or another, in one place or another, somewhere within it, actual material goods existed to back its financial transactions. It kept going long after that protection was breached. Today, the goods are almost gone."

Unfortunately this discussion is simply not holding to a single context. Nobody here is arguing for a governmental fiat currency, nor is anybody here arguing for "fractional reserve banking with government guarantees".

Do you agree that inflation, as classically defined (an increase in the money supply), results in wealth destruction?

In the context of a proper gold-based currency, fractional reserve banking is perfectly moral.

I think it needs something else: time deposits. If the depositor understands he won't get his wealth back for some specified period of time, and he doesn't get his wealth back for some specified period of time, then we don't have the problem of multiple instances of the same produced, yet unconsumed goods circulating through the economy.

Jeff, in your example, Jim does not have $90 of wealth. His $90 asset is balanced by a $90 liability. The wealth in the economy did not change.

If we use Rand's definition of wealth as, "Wealth represents goods that have been produced, but not consumed," then Jim does have $90 of wealth. That money would not have existed had Farmer John not raised and sold his pig. Those goods were produced, but not consumed by Farmer John. Nor have they been consumed by Jim (at least until he spends them). Jim may not have a positive net worth, but he certainly has wealth. If he didn't have wealth of some sort, how would he pay for anyone else's production? What would he do with the $90.

Added: Also, the amount of gold-money (assuming it is gold) is unchanged @ $100. Gold money is not the same as a bank-note representing a claim to gold under certain conditions.

Are they not treated the same? Couldn't Farmer John use his $100 account to buy things? Couldn't Jim use the $90 in currency to buy things? If the bank simply issues Jim a note for $90, could he not buy things with that? This is the point Rand is making: both the gold and the notes are used interchangeably. It used to be that the notes and the gold maintained their connection - they both represented produced goods that had not yet been consumed. Today, they do not have that connection. Instead, credit (ignoring the fact that the same thing has happened to our currency) now represents goods not yet produced. Rather than lending "the goods which he has not consumed," the "rich man" is lending goods which he has not produced.

Actually, it didn't. Farmer John indirectly lent Jim 90 bucks. He'll get it back with interest, and the bank gets a little off the top for their troubles too. But he can ask for it back anytime, and he'll have a 100 $ and Jim will have nothing again.

Farmer John can't ask for it back anytime from Jim, unless you're suggesting Jim took out a callable-at-will loan. That would be highly irregular. Even credit card issuers can't demand you pay them anytime they want you to. Even then we would have to assume Farmer John is a party to the loan contract, but that would be highly unusual, too. The contract is between the bank and Jim. The only way Farmer John could get his money back from Jim is if he convinced the bank to unilaterally break the loan contract with Jim - surely you're not arguing they should be able to do that?

Not to mention the fact that the point was to point out the use of force or deception which makes this theft or fraud. (the way agrippa1 does in the next post) You didn't, you just described a voluntary transaction, with everything out in the open. No force, no deception.

What if there's another person, Tom, who banks at Bank B, and he has $100 in his bank account? He banks at Bank B because they don't use FRB. At the start of our hypothetical there is $200 in the economy: Tom's $100 in Bank B, and Farmer John's $100 in Bank A. There's $200 of wealth in the economy; Tom has 50%, Farmer John has 50%. Then Bank A makes the loan to Jim. Tom has $100, which he uses to buy things; Farmer John has $100 which he uses to buy things; and Jim has $90, which he uses to buy things. How much wealth (or currency, if you prefer) is now in the economy? $290. Tom, who has not agreed to the leveraging of his wealth, no longer has 50% of the economy's wealth, he has 100/290ths of the wealth - 34%. Has no fraud, no deception, been used on him?

Oh and I forgot: you seem to be advocating against Farmer John actually making deals using that 100$, while at the same time Joe is spending the 90$. I disagree with you that they're both spending the same money, at the same time (I think John is using the money he has in the bank only as a guarantee that he'll pay when he gets it back-and the fact that the bank has a limit on how much they must have in reserve guarantees that when John actually pays, Jim no longer has the 90$),

Then Farmer John is consuming goods (whatever he buys) based upon future production (the return of his $90 from Jim, assuming Jim does, in fact return his $90). This is exactly what Rand was arguing against. Reality doesn't allow us to consume what has yet to be produced.

I think something needs to be made very clear that I thought was clear from the beginning.

I don't have a problem with FRB, per se. I don't think Ms. Rand or Mr. McKeever have a problem with FRB, per se. Fractional reserve banking can be a very useful and moral tool for increasing production, and therefore wealth. The proper use of FRB would require: 1) time deposits where the depositors are informed that their funds will be loaned out, and 2) a currency that is backed by something difficult to create more of - e.g., gold. If Farmer John knows he won't be able to get his money out for some period of time - say, a year, then he won't be able to use it while Jim is using it. Since he won't be using it at the same time Jim is using it, there is no increase in the money supply, therefore no inflation, therefore no reduction of anyone else's wealth. If the currency is backed by something difficult to create more of, then the government won't be able to inflate the money supply at will. The difficulty in creating more of whatever backs the currency will determine the degree of inflation. During years when we had a gold standard, or a gold exchange standard, inflation ran damn close to zero (like .1%, IIRC). Since the rate of inflation will be non-existent, or so very low as to be effectively non-existent, there will be no wealth destruction. Even if someone makes a big gold find, getting it out of the ground represents productivity so the inflation that gold has to the money supply is matched with increased production; i.e. the economy expands at the same rate the money supply expands.

This is not the situation we have in banking today. ALL deposits are subject to some degree of reserve requirement less than 100%. That means Farmer John can deposit $100 of wealth on Monday, write a check for $100 on Tuesday - the same day the bank loans $90 to Jim, and Jim can write a check, or spend his $90 loan on Wednesday. I simply cannot see how this is not an increase in the money supply and therefore a destruction of wealth. Even if we assume everyone is perfectly informed of what will happen, and agree to those terms, surely we can all agree that the money supply increases, that no increase of production has occurred, and therefore purchasing power has decreased? Leaving aside the ethical questions, isn't the effect of FRB to increase the money supply and therefore reduce purchasing power?

[softwareNerd]

Do you agree that inflation, as classically defined (an increase in the money supply), results in wealth destruction?

I'm not sure what this means. If it means the more gold was found, then no it does not lead to wealth destruction. If it means people decided to use Silver alongside gold as a second currency; again no. If it means that people use notes backed by some other asset -- like bank properly notes are -- then, once again, no.

[JeffS]

I'm not sure what this means. If it means the more gold was found, then no it does not lead to wealth destruction. If it means people decided to use Silver alongside gold as a second currency; again no.

I mean only increase the money supply without doing anything else. If more gold is found, you can't increase the money supply wihout productive effort, i.e. digging it out of the ground. In our system, there are only two ways to increase the money supply: print more dollar bills, print more bank IOUs. Do you believe that when the government prints more dollar bills, and all other things stay the same, the result is wealth destruction?

If it means that people use notes backed by some other asset -- like bank properly notes are -- then, once again, no.

What do you mean by "bank properly notes are?" If you mean, "bank notes properly are," then would a bank note be properly backed if there's only 10% of that asset available for repayment? How about 1%? .01%? .0001%? What fraction of the IOU should be real, existing, unconsumed goods, and what fraction can be something unreal and non-existent?

[Jake_Ellison]

Do you agree that inflation, as classically defined (an increase in the money supply), results in wealth destruction?

I hate to keep going at it with variations of the same argument, especially since you are ignoring it, but here's one last attempt:

-"destruction" has a specific meaning: it involves physical force. You continue to accuse people of theft, and destruction, without the use of force.

That is a classic left wing argument: the upper class is doing something magical to hurt the middle and lower class, or they deny them opportunities, and those are forms of injustice. Therefor the government needs to step in, and create social justice.

So let's take this to its logical conclusion: there is massive theft going on, it is the government's job to prevent it: Write down the law Congess ought to adopt, and the courts ought to enforce, starting tomorrow.

If your law contains no initiation of force, I will have no problem with it.

[softwareNerd]

I mean only increase the money supply without doing anything else. If more gold is found, you can't increase the money supply wihout productive effort, i.e. digging it out of the ground.

That still does not answer the question about whether you would classify such an increase as inflation. Let's assume we're in the late 1800's with gold being used as the most enduring form of money. I can pay a few laborers 1 oz of gold to do a day's work, which will include some digging and separating, ending up with 10 oz of gold. Gold increases. I assume you would say that money increases (and I would agree). I was asking if you considered this to be inflation. The other example was silver. Suppose some people already have silver coins -- say coined by a previous government. These are not used as money, but only collected. For whatever reason, these become recognized more widely, and accepted by shopkeepers and others (at some gold/silver exchange rate). Would you classify this as inflation of the money supply?

I'm going to skip over your question about government printing of fiat money. Nobody here has claimed any legitimacy for such money. So, I think it simply confuses the issue.

What do you mean by "bank properly notes are?" If you mean, "bank notes properly are," then would a bank note be properly backed if there's only 10% of that asset available for repayment? How about 1%? .01%? .0001%? What fraction of the IOU should be real, existing, unconsumed goods, and what fraction can be something unreal and non-existent?

Yes, sorry, mistyped. A bank note is a claim to assets and is fully backed by real assets. A fractional reserve currency simply means that only a fraction of the note is backed by the most liquid type of asset: gold etc. However, the rest of it is backed by other assets, from slightly less liquid, to fairly illiquid.

[JeffS]

I hate to keep going at it with variations of the same argument, especially since you are ignoring it, but here's one last attempt:

-"destruction" has a specific meaning: it involves physical force. You continue to accuse people of theft, and destruction, without the use of force.

Then what would you call it when I give you something I don't have in exchange for something you do have, Jake? Is fraud force?

That is a classic left wing argument: the upper class is doing something magical to hurt the middle and lower class, or they deny them opportunities, and those are forms of injustice. Therefor the government needs to step in, and create social justice.

So let's take this to its logical conclusion: there is massive theft going on, it is the government's job to prevent it: Write down the law Congess ought to adopt, and the courts ought to enforce, starting tomorrow.

If your law contains no initiation of force, I will have no problem with it.

The laws would be simple: 1) The US unit of currency shall be valued in [insert some difficult to obtain, real material - gold, if you wish].

2) Banks shall not loan out currency they do not have.

[JeffS]

That still does not answer the question about whether you would classify such an increase as inflation. Let's assume we're in the late 1800's with gold being used as the most enduring form of money. I can pay a few laborers 1 oz of gold to do a day's work, which will include some digging and separating, ending up with 10 oz of gold. Gold increases. I assume you would say that money increases (and I would agree). I was asking if you considered this to be inflation.

It is inflation. The money supply has increased, and that is the definition of inflation. What I was attempting to draw a connection to was the fact that no wealth destruction has occured as a result of the increase in money. Since the money has to be dug out of the ground, the cost of that money includes the cost of digging it out of the ground. Your laborers have exchanged their physical efforts for money - they have produced something. You, as a function of owning the mine, have produced something. In short, the economy has grown - production has increased - as much as the amount of money entering the economy.

The other example was silver. Suppose some people already have silver coins -- say coined by a previous government. These are not used as money, but only collected. For whatever reason, these become recognized more widely, and accepted by shopkeepers and others (at some gold/silver exchange rate). Would you classify this as inflation of the money supply?

That depends, does the silver already exist? If it does, then that silver represents production already in the economy - it's goods already produced, but not yet consumed. Those who own silver would've had to exchange their unconsumed goods for others' unconsumed goods at some time prior to it being accepted as money. Since there would be a gold/silver exchange rate, then it's no different from using 4 quarters instead of a dollar, or using a 1.4 Euros instead of a dollar. It would not be inflation.

Now, if the silver has to be dug out of the ground, then it follows the same path as gold above.

I'm going to skip over your question about government printing of fiat money. Nobody here has claimed any legitimacy for such money. So, I think it simply confuses the issue.

Actually, I think it goes to the very heart of the matter for two reasons:

1) It helps me identify where the resistance is coming from. If it's easy to see how the government printing money is inflation, then at least we agree on the definition of inflation. If we can't agree that government printing money is inflation, then we won't be able to agree on anything.

2) Why is it wrong for the government to print off fiat money - money backed by no goods, backed by no production, but it's not wrong for banks to print off something just as good as money which is also not backed by any goods or production?

Yes, sorry, mistyped. A bank note is a claim to assets and is fully backed by real assets. A fractional reserve currency simply means that only a fraction of the note is backed by the most liquid type of asset: gold etc. However, the rest of it is backed by other assets, from slightly less liquid, to fairly illiquid.

Such as? What assets back a bank note? In our Farmer John example, when John spends his $100 at Home Depot, and Jim spends his $90 at Home Depot, what assets does Home Depot get? What real, existing, unconsumed goods does Home Depot get in exchange for the very real, existing, unconsumed goods it sold to John and Jim?

[Steve D'Ippolito]

Such as? What assets back a bank note? In our Farmer John example, when John spends his $100 at Home Depot, and Jim spends his $90 at Home Depot, what assets does Home Depot get? What real, existing, unconsumed goods does Home Depot get in exchange for the very real, existing, unconsumed goods it sold to John and Jim?

It's the loan that Jim owes to the bank. Yes, if Jim owes the bank $90, it's carried on the bank's books as an asset.

[Jake_Ellison]

Then what would you call it when I give you something I don't have in exchange for something you do have, Jake? Is fraud force?

Yes.

The laws would be simple: 1) The US unit of currency shall be valued in [insert some difficult to obtain, real material - gold, if you wish].

2) Banks shall not loan out currency they do not have.

1. What do you mean by "shall be valued in"? If you mean that the government would impose gold as the only currency individuals are allowed to trade in, that's an obvious initiation of force.

2. That is not an objective law. You are giving specific individuals or groups (banks) special status, and limiting their rights compared to other individuals or groups. Laws should apply to all individuals or groups equally. If you wish to rephrase that law to apply to all, equally, please do so: In its current form the government is involved in the economy (because in order for someone to become a bank, they would have to be designated as such by a bureaucrat), and it has the right to discriminate between individuals based on whether they are banks or not.

Edited March 8, 2009 by Jake_Ellison

[softwareNerd]

It is inflation. The money supply has increased, and that is the definition of inflation. What I was attempting to draw a connection to was the fact that no wealth destruction has occured as a result of the increase in money. Since the money has to be dug out of the ground, the cost of that money includes the cost of digging it out of the ground.

Yes, but... that's why I gave the example of 1 oz being paid to workers, who end up with 10 oz. I'm interested in whether the increment -- 9 oz of gold -- is inflation.

Let me change the concretes of the example: I find a map in my attic, giving clues to the famous Robin Hood treasure. That summer, I go exploring in Sherwood Forest and find 1000 oz of gold. Is that inflation? If not, why not? Is it because it was already there, even though nobody even knew it and it was (for the economy) nearly non-existent? Or is it because I expended some effort to find it?

If the latter, I really don't understand how expending effort is the criteria of whether some increase in gold is inflation. Even the government expends some effort when printing fiat currency. [While I agree that fiat currency is wrong, I don't think the expending of effort is the key.]

Next, an example to probe the second issue: the issue of credit. Suppose I own a cafe near a large university. One medical student hits some financial trouble. He's going to be a doctor soon, and asks me to take an IOU that he'll pay up in a year, so that he can eat at the cafe for the last 6 months of the semester. I take his IOU. Is that inflation?

If it is, are you saying that it is theft or fraud in some way (I assume not). Now, instead of running a cafe, does it change in any material way if I own a Home Depot, and give my customers terms like that: this time taking IOUs guaranteed by them, or by their bank?

[y_feldblum]

Inflation tends to be a phenomenon of fiat money, not of a fully-backed commodity money, because a commodity with unstable value would not come to be used as money, and if it did come to be used as money, people would tend to switch to a more stable commodity to use as money. It is true that vast sources of additional commodity (the same commodity as that currently in use as money) may be found and thus the relative value of a unit of that commodity will fall. But one of the characteristics of a commodity which makes that commodity good for use as money is that it is difficult to find and produce that commodity. Thus, if a commodity is in use as money, then it will have been seen to be hard to find and produce relative to all other commodities which could also be used as money. Moreover, if new sources of a commodity currently in use as money are found and the relative value of a unit of that commodity falls, people will tend to judge other commodities as better for use as money - no-one is locked in to use a commodity with an unstable value as money.

[JeffS]

It's the loan that Jim owes to the bank. Yes, if Jim owes the bank $90, it's carried on the bank's books as an asset.

Jim's loan is only for $90, Home Depot has claims against Bank A for $190. Where's the other $100 going to come from?

Yes. [fraud is force]

Then I'm confused where our disagreement is. You asked me to show you force, I showed you a case where John and Jim both have claim to the same thing. Is there no case of fraud here?

1. What do you mean by "shall be valued in"? If you mean that the government would impose gold as the only currency individuals are allowed to trade in, that's an obvious initiation of force.

2. That is not an objective law. You are giving specific individuals or groups (banks) special status, and limiting their rights compared to other individuals or groups. Laws should apply to all individuals or groups equally. If you wish to rephrase that law to apply to all, equally, please do so: In its current form the government is involved in the economy (because in order for someone to become a bank, they would have to be designated as such by a bureaucrat), and it has the right to discriminate between individuals based on whether they are banks or not.

Well, I'm no lawyer. As to 1: I mean the currency, whatever it is, is backed by real assets - something difficult to create or produce. As to 2: How about: No one can loan out currency they don't have?

Yes, but... that's why I gave the example of 1 oz being paid to workers, who end up with 10 oz. I'm interested in whether the increment -- 9 oz of gold -- is inflation.

Do you mean the profit is 9oz? Doesn't that belong to the owner of the mine - you, in this example?

Let me change the concretes of the example: I find a map in my attic, giving clues to the famous Robin Hood treasure. That summer, I go exploring in Sherwood Forest and find 1000 oz of gold. Is that inflation? If not, why not? Is it because it was already there, even though nobody even knew it and it was (for the economy) nearly non-existent? Or is it because I expended some effort to find it?

If the latter, I really don't understand how expending effort is the criteria of whether some increase in gold is inflation. Even the government expends some effort when printing fiat currency. [While I agree that fiat currency is wrong, I don't think the expending of effort is the key.]

Well, even though I keep getting chastised for not anchoring my examples in the real world, I'll deal with this one.

Yes, it would be inflation. Eventually, that gold is going to make it to the economy. Expending effort is not the criteria upon which one decides whether it's inflation. There is only one criteria: does it increase the supply of money?

Why do you believe fiat currency is wrong?

Next, an example to probe the second issue: the issue of credit. Suppose I own a cafe near a large university. One medical student hits some financial trouble. He's going to be a doctor soon, and asks me to take an IOU that he'll pay up in a year, so that he can eat at the cafe for the last 6 months of the semester. I take his IOU. Is that inflation?

Yes. You're increasing the supply of money. In this case, you're creating your own money.

If it is, are you saying that it is theft or fraud in some way (I assume not). Now, instead of running a cafe, does it change in any material way if I own a Home Depot, and give my customers terms like that: this time taking IOUs guaranteed by them, or by their bank?

In this case, you're not creating money, your customers are (or their banks are). So, the money supply has been inflated. If you want to accept that money, that's up to you. As long as everyone is informed, then there is no fraud as long as there are no other market participants but you and your customers. (I don't think Ms. Rand would accept this argument. I think she would call it fraud whether everyone were informed or not.)

But there are other market participants - there are other people who shop at your Home Depot. Let's consider the reality of this example. A great slew of people come into your coffee shop (or HD) and want only one thing (let's keep it simple). They're all paying with credit from their banks, so they've all got as much credit as their banks can create. What will happen to the price of that one thing which everyone is demanding? It will go up. Now, I always pay with currency. I've been saving currency for a long time so I can buy this one thing at your coffee shop (or HD). Last week, I had enough currency to buy this one thing. I go to your coffee shop to buy this one thing, and what do I find? I no longer have enough currency to buy this one thing because you've been accepting a whole slew of things which do not represent unconsumed goods, but rather future goods, as money. As a result, everyone with a printing press has been bidding up the price on the one thing I want to buy. My currency is no longer worth what it was. Have I been wronged? My unconsumed productivity has been devalued by all those banks creating their own money.

Do you think counterfeiting should be illegal? If so, why? Would it still be wrong to pass counterfeit bills if everyone knew they were counterfeit, but still accepted them?