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Thomas M. Miovas Jr.
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Before discussing inflation caused by FRB, I think it is worthwhile exploring an easier example: silver.

The close of the 1800's was a crucial period in U.S. history (the "Progressive Era"), which laid the groundwork for much of what FDR did. One of the populist cries was that the poor American farmer is being hurt by falling prices, caused by a rigid monetary standard. William Jennings Bryan gave a famous speech where he said that mankind was being crucified on a cross of gold. A key demand was to allow the coinage of silver.

One major problem with dual (gold/silver) coinage is that the government sets the ratio between those two prices. Having done so, the government then has to maintain that ratio even though the demand and supply of gold and silver is changing. One of the ways around this is to have the gold currency and the silver currency circulate side-by-side and to let the market determine the exchange rate.

Key question: would that be inflationary?

If yes, the follow-up question would be: if FRB should be controlled or restricted, should private citizens also be restricted from coining silver and platinum and using those as a form of money?

It may be inflation of one or deflation of the other -- it depends on whether a new supply of gold and/or silver was discovered and if gold and/or silver has been disposed of. But if it is inflation, then No. They should be able to coin metal and call it anything -- including the weight and percentages of the metals within an alloy.

I think there is an important distinction, however, between discovered metal that causes inflation and a systematic ("artificial?") expansion of the money supply created by FRB.

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How does FRB cause inflation?

I think there is an important distinction, however, between discovered metal that causes inflation and a systematic ("artificial?") expansion of the money supply created by FRB.

Sorry, but you're equivocating between two definitions of "money supply".

Discovering new gold, or a central bank increasing its monetary base, expands the monetary base (what the US central bank I believe calls MB and the UK calls M0).

FRB does not affect the monetary base (be it gold, or central bank issued fiat money). It affects what in the US is called the M2 money supply. Not distinguishing between the M0 and M2, be it in the current system or in a gold based one, is a fallacy. In a gold bases system, the M2 money supply does not refer to gold, it refers to gold plus banknotes plus some electronic substitutes for money. You should also be aware of the further implications of that distinction, such as the multiple definitions of "inflation", depending on which money supply is being expanded.

There are competing theories on what causes prices to rise, for instance. It's unclear that either a discovery of new gold, or FRB, will necessarily cause prices to rise. And the most popular definition of inflation conflates inflation with the rise of prices, so it doesn't even refer to the expansion of any money supply.

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I think there is an important distinction, however, between discovered metal that causes inflation and a systematic ("artificial?") expansion of the money supply created by FRB.

Yes, I acknowledge there's a difference between FRB and metallic currency or commodity currency. I'm trying to explore where the difference lies, by moving from gold to silver and to other commodities... and then to something one step further away, and so on. My hope is that -- by this process -- to show the actual nature of the difference between FRB and a 100% gold-standard.

Here's one last hypothetical on the way to FRB. The S&P 500 is an index of 500 stocks. The SPY is a tradable "share" out of a "basket" of shares that are in the S&P 500. As you see by the link, each share of SPY is worth about $150 today. Imagine a situation where certificates were issued against actual SPYs, so that we had SPY notes. Imagine you were at a hotel. While checking out you could pay in US$, or you could pay in Yen -- and they would use that day's exchange rate to convert it, or (imagine) you could pay in SPY notes and they would use the day's exchange rate to convert it (you get change back in USD$). If people were willing to do this, should that be legal?

Of course people don't want to deal with a note that fluctuates in value. For instance, most shops won't take Yen -- they'll tell you to go to a bank and bring them US$. Similarly, most Americans want their contracts denominated in US$, because that is the "standard and measure of value" in their minds. So, SPY would be very impractical as a currency. However, once again, I'm trying to explore what should be allowed, not what is either stupid or sensible. Let's say there is some situation where some people decide they're fine with accepting SPY notes as money, should that be legal?

Edited by softwareNerd
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  • 2 weeks later...

Yes, I acknowledge there's a difference between FRB and metallic currency or commodity currency. I'm trying to explore where the difference lies, by moving from gold to silver and to other commodities... and then to something one step further away, and so on. My hope is that -- by this process -- to show the actual nature of the difference between FRB and a 100% gold-standard.Here's one last hypothetical on the way to FRB. The S&P 500 is an index of 500 stocks. The SPY is a tradable "share" out of a "basket" of shares that are in the S&P 500. As you see by the link, each share of SPY is worth about $150 today. Imagine a situation where certificates were issued against actual SPYs, so that we had SPY notes. Imagine you were at a hotel. While checking out you could pay in US$, or you could pay in Yen -- and they would use that day's exchange rate to convert it, or (imagine) you could pay in SPY notes and they would use the day's exchange rate to convert it (you get change back in USD$). If people were willing to do this, should that be legal?Of course people don't want to deal with a note that fluctuates in value. For instance, most shops won't take Yen -- they'll tell you to go to a bank and bring them US$. Similarly, most Americans want their contracts denominated in US$, because that is the "standard and measure of value" in their minds. So, SPY would be very impractical as a currency. However, once again, I'm trying to explore what should be allowed, not what is either stupid or sensible. Let's say there is some situation where some people decide they're fine with accepting SPY notes as money, should that be legal?

Yes, that should be legal.

PS got busy there for a while; sorry I didn't get back to you more quickly.

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How does FRB cause inflation?Sorry, but you're equivocating between two definitions of "money supply".Discovering new gold, or a central bank increasing its monetary base, expands the monetary base (what the US central bank I believe calls MB and the UK calls M0).FRB does not affect the monetary base (be it gold, or central bank issued fiat money). It affects what in the US is called the M2 money supply. Not distinguishing between the M0 and M2, be it in the current system or in a gold based one, is a fallacy. In a gold bases system, the M2 money supply does not refer to gold, it refers to gold plus banknotes plus some electronic substitutes for money. You should also be aware of the further implications of that distinction, such as the multiple definitions of "inflation", depending on which money supply is being expanded.There are competing theories on what causes prices to rise, for instance. It's unclear that either a discovery of new gold, or FRB, will necessarily cause prices to rise. And the most popular definition of inflation conflates inflation with the rise of prices, so it doesn't even refer to the expansion of any money supply.

I do believe I was making the distinction between M0 and M2; thus, the difference between FRB and finding gold. Unless I'm missing something.

So just to reword it into terms you're using, I think there is an important distinction between increasing M0 (caused by discovering more currency) and increasing M2 (caused by FRB).

Edited by m082844
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I do believe I was making the distinction between M0 and M2; thus, the difference between FRB and finding gold. Unless I'm missing something.

So just to reword it into terms you're using, I think there is an important distinction between increasing M0 (caused by discovering more currency) and increasing M2 (caused by FRB).

But you're referring to expanding both with the same word: inflating money. That's equivocation. Inflating M2 inflates M2. It does not inflate M0. 

 

You are arguing that, by inflating M2, someone takes away from the value of M0. Why would that be?

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You are arguing that, by inflating M2, someone takes away from the value of M0. Why would that be?

Good question. If notes (M2) are implicitly/explicitly accepted as equalling M0, which is safe to say it is, then an increase in M2 will lower the value of M0, will it not?

Do you not equate your digital bank account (M2) to be actual dollars (M0)? Don't you make decisions based on that assumption? I know I do. Everyone I know that has had a similar conversation with me does.

But you're referring to expanding both with the same word: inflating money. That's equivocation. Inflating M2 inflates M2. It does not inflate M0.

Inflation is a general term that subsumes special cases. I mean by inflation that there is a general increase in prices. Increasing M0 obviously has a tendency, all else being equal, to cause inflation. Increasing M2 has the same effect, all else being equal. Edited by m082844
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Yes, that should be legal.

Good, but though legal, the SPY would be impractical. It's major drawback would be its constantly-changing value, as the fortunes of the economy ebbed and flowed. Just recently, we've seen the SPY drop to 50% of its peak. However, risk can be shifted around from one person to another. For instance, someone might put $200 of his own capital and borrow $100 from someone else and invest in the SPY. The SPY can be the collateral for the lender. If the SPY goes down 50%, this person would lose $150 out of his $200, but the lender would still be secure. Now, imagine that this lending was in the form of bonds/notes of $100 each. You would now have a situation where these notes had a pretty stable value.

Now, consider a new feature added to this. Suppose only $50 of the borrowed money were used to buy SPY, but the rest was kept on hand. If the lender wanted, he could ask for up to 50% of his money back at any time, "on demand". Finally, consider a feature where money was borrowed from thousands of lenders and each could ask for his money back, "on demand". This would work as long as not more than 50% was demanded, across all borrowers. So, there would need to be some type of contractual clause dealing with such situation. For instance, the borrower might say that once the draw-down reached (say) 25%, he would start to sell his SPY -- absorbing losses himself, until he had enough to pay back the lenders.

In outline, this is how a good FRBank works. It starts with a layer of owner's capital. Then, it borrows using some long-term loans, some medium-term loans and some short-term loans. Finally, it borrows some money that is payable back "on demand". All this money is used to invest in real assets: things like the SPY, but also home-mortgages, auto-loans, and so on. When a good FRBank lends money or invests, it makes sure that it has a margin of safety. So, when it gives a home-mortgage, it considers how much home prices might drop, and lends in a way that assures its collateral is secure. In doing so, all its borrowings and demand-deposits are always backed by more than 100% of real assets -- which are the collateral that the FRBank has demanded whenever it has loaned money. [Of course, unsecured loans may be part of the mix; but, in the aggregate a good FRBank lends against good collateral.]

In effect, homes, cars, and businesses are monetized under such a scheme, and notes representing such assets -- but denominated in a fixed amount of underlying money (say gold) -- circulate nearly at par with gold itself.

PS got busy there for a while; sorry I didn't get back to you more quickly.

Sometimes it is better when a discussion takes a few months to chew on. Edited by softwareNerd
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Good question. If notes (M2) are implicitly/explicitly accepted as equalling M0, which is safe to say it is, then an increase in M2 will lower the value of M0, will it not?

Do you not equate your digital bank account (M2) to be actual dollars (M0)? Don't you make decisions based on that assumption? I know I do. Everyone I know that has had a similar conversation with me does.

I know. It's because none of you know the difference. But now you do, so it's time to stop.

No, I don't consider bank deposits the same as actual dollars. And, as we speak, neither do 1,116,000 people living on an island in the Mediterranean. In fact, as of today's ECB policy changes regarding bank bailouts, neither do Italians, Spaniards or Portuguese.

I don't even consider bank deposits smaller than $100.000 Euros/Dollars as actual money, even though they can be treated as such for the most part (due to the government backed insurance schemes). Just because the government abusively uses taxpayer money to back a bank, doesn't change the fact that banks can and do fail, and money in a bank is not the logical equivalent of money in your hand.

Inflation is a general term that subsumes special cases. I mean by inflation that there is a general increase in prices. Increasing M0 obviously has a tendency, all else being equal, to cause inflation. Increasing M2 has the same effect, all else being equal.

If by inflation you mean a general increase in prices, then you need to prove that FRB causes a general increase in prices. Until then, I don't see the problem.

P.S. "has a tendency to cause inflation" is a nonsensical phrase. Causation doesn't have a will, or tendencies. It either causes inflation, or it doesn't. If it only leads to inflation in one set of circumstances, but not another, then that's because it's not really the cause. Something else is causing the inflation.

Edited by Nicky
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Good, but though legal, the SPY would be impractical. It's major drawback would be its constantly-changing value, as the fortunes of the economy ebbed and flowed. Just recently, we've seen the SPY drop to 50% of its peak. However, risk can be shifted around from one person to another. For instance, someone might put $200 of his own capital and borrow $100 from someone else and invest in the SPY. The SPY can be the collateral for the lender. If the SPY goes down 50%, this person would lose $150 out of his $200, but the lender would still be secure. Now, imagine that this lending was in the form of bonds/notes of $100 each. You would now have a situation where these notes had a pretty stable value.

Now, consider a new feature added to this. Suppose only $50 of the borrowed money were used to buy SPY, but the rest was kept on hand. If the lender wanted, he could ask for up to 50% of his money back at any time, "on demand". Finally, consider a feature where money was borrowed from thousands of lenders and each could ask for his money back, "on demand". This would work as long as not more than 50% was demanded, across all borrowers. So, there would need to be some type of contractual clause dealing with such situation. For instance, the borrower might say that once the draw-down reached (say) 25%, he would start to sell his SPY -- absorbing losses himself, until he had enough to pay back the lenders.

In outline, this is how a good FRBank works. It starts with a layer of owner's capital. Then, it borrows using some long-term loans, some medium-term loans and some short-term loans. Finally, it borrows some money that is payable back "on demand". All this money is used to invest in real assets: things like the SPY, but also home-mortgages, auto-loans, and so on. When a good FRBank lends money or invests, it makes sure that it has a margin of safety. So, when it gives a home-mortgage, it considers how much home prices might drop, and lends in a way that assures its collateral is secure. In doing so, all its borrowings and demand-deposits are always backed by more than 100% of real assets -- which are the collateral that the FRBank has demanded whenever it has loaned money. [Of course, unsecured loans may be part of the mix; but, in the aggregate a good FRBank lends against good collateral.]

In effect, homes, cars, and businesses are monetized under such a scheme, and notes representing such assets -- but denominated in a fixed amount of underlying money (say gold) -- circulate nearly at par with gold itself.Sometimes it is better when a discussion takes a few months to chew on.

I like your positive attitude. I'm going to mull your example over for a bit until I have a clear understanding of its implications. I think it's a good example.

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I know. It's because none of you know the difference. But now you do, so it's time to stop.

No, I don't consider bank deposits the same as actual dollars. And, as we speak, neither do 1,116,000 people living on an island in the Mediterranean. In fact, as of today's ECB policy changes regarding bank bailouts, neither do Italians, Spaniards or Portuguese.

I don't even consider bank deposits smaller than $100.000 Euros/Dollars as actual money, even though they can be treated as such for the most part (due to the government backed insurance schemes). Just because the government abusively uses taxpayer money to back a bank, doesn't change the fact that banks can and do fail, and money in a bank is not the logical equivalent of money in your hand.If by inflation you mean a general increase in prices, then you need to prove that FRB causes a general increase in prices. Until then, I don't see the problem.

P.S. "has a tendency to cause inflation" is a nonsensical phrase. Causation doesn't have a will, or tendencies. It either causes inflation, or it doesn't. If it only leads to inflation in one set of circumstances, but not another, then that's because it's not really the cause. Something else is causing the inflation.

I'm a bit surprised. You don't make purchase considerations based on how much money you have in the bank?

FRB has a tendency to cause price increases due to other factors that affect prices. All else being equal, FRB causes price increases due to an increase in M2 whenever it is used.

I think this is a well known example: a bank lends out a percentage of someone's deposit and it gets spent and deposited again. Now the aggregate total of money people think they have in a bank went up. Beacuse of this, when they calculate what they can buy, they are more confortable spending than if the available money left as it was lent out in the first place.

Edited by m082844
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I like your positive attitude. I'm going to mull your example over for a bit until I have a clear understanding of its implications. I think it's a good example.

. Thought about it.

If FRB causes price increases, and uses real assets with increased prices to back deposits, then given a bank run situation the prices of real assets will decrease making it impossible for the bank to cover a large portion of its depositors.

This is my complete thoughts on the subject as far as I've been able to take the implications of FRB. http://lifeordeathpolitics.wordpress.com/2012/05/31/the-key-to-understanding-the-fed-the-dangers-of-fractional-reserve-banking/

I would start where it says "A second system of banking is called fractional reserve banking,". The rest is background info.

If a contradiction is in my thinking, it is likely to be there.

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If FRB causes price increases, and uses real assets with increased prices to back deposits, then given a bank run situation the prices of real assets will decrease making it impossible for the bank to cover a large portion of its depositors.

Actually, the price of assets will not decrease substantially if there is a run on a single bank, only if there if there is widespread panic.

Anyhow, at this point it is probably time to "agree to disagree". So, I'll simply summarize my view on FRBanks.

In moral terms, the only issue with FRBanking arises if the depositor thinks he is entering into a contract of bailment. If the depositor clearly understands his money has been lent out, and if he agrees to how a run will be handled, he and the FRBanker should be free to enter into an FRBanking deal. Others should be free to accepts or reject notes and checks of such banks. The government has no business stopping such contracts. Even if people wish to use toilet paper as money, as long as they all want to do so, it should be their right to do so.

The history of FRBanking shows that every now and then a bank run takes place on some banks, and sometimes across the system. Handled correctly, each such run should have resulted in the next generation of depositors demanding more specificity in the contracts under which they deposit money in the bank. Instead, governments invariably stepped in, forcibly breaking contracts or guaranteeing payment. Either way, the system was not allowed to evolve into a proper free-market system. In the U.S., the final straw was the 1908 bank runs that ended up with the creating of the Federal Reserve Board, and finally going onto a fully-fiat standard in 1993.

However, FRBanking, done right, could have evolved into a system that allowed depositors to monetize assets other than gold, silver etc. The crucial aspect that was not allowed to evolve was the contractual terms of the deposit agreement, particularly how a bank-run would be handled. One can speculate on what such terms might have been: for instance, there would probably be some terms that penalized withdrawals during a run, leaving non-withdrawing depositors holding claims to bank assets worth more than their deposits. Real experiences with different types of terms would have allowed the system to evolve. If no terms were found practical, the system would have faded away. Perhaps few would have been interested... but, it still would be legal.

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Actually, the price of assets will not decrease substantially if there is a run on a single bank, only if there if there is widespread panic.

Anyhow, at this point it is probably time to "agree to disagree". So, I'll simply summarize my view on FRBanks.

In moral terms, the only issue with FRBanking arises if the depositor thinks he is entering into a contract of bailment. If the depositor clearly understands his money has been lent out, and if he agrees to how a run will be handled, he and the FRBanker should be free to enter into an FRBanking deal. Others should be free to accepts or reject notes and checks of such banks. The government has no business stopping such contracts. Even if people wish to use toilet paper as money, as long as they all want to do so, it should be their right to do so.

The history of FRBanking shows that every now and then a bank run takes place on some banks, and sometimes across the system. Handled correctly, each such run should have resulted in the next generation of depositors demanding more specificity in the contracts under which they deposit money in the bank. Instead, governments invariably stepped in, forcibly breaking contracts or guaranteeing payment. Either way, the system was not allowed to evolve into a proper free-market system. In the U.S., the final straw was the 1908 bank runs that ended up with the creating of the Federal Reserve Board, and finally going onto a fully-fiat standard in 1993.

However, FRBanking, done right, could have evolved into a system that allowed depositors to monetize assets other than gold, silver etc. The crucial aspect that was not allowed to evolve was the contractual terms of the deposit agreement, particularly how a bank-run would be handled. One can speculate on what such terms might have been: for instance, there would probably be some terms that penalized withdrawals during a run, leaving non-withdrawing depositors holding claims to bank assets worth more than their deposits. Real experiences with different types of terms would have allowed the system to evolve. If no terms were found practical, the system would have faded away. Perhaps few would have been interested... but, it still would be legal.

Good argument. At best all I have is that FRB harmful so long as everyone is honest, but should be legal. You've managed to change my mind. In a free system I can avoid the damage of FRB, but in our current system it's more difficult.

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I am extremely hesitant to get back involved in this thread, for various reasons, but it has taken off and i wanted to point out that I regret starting this thread because I had a false premise in my opening statement / essay. That false premise was that FRB involved the printing out of bank notes to act as money and that I thought it was immoral to print out more bank notes than one has assets for. So, I wanted to delete this thread but don't have that power.

 

FRBanking is no more than the depositor agreeing that his deposited assets can be loaned out by the bank under certain terms and conditions. One of those would be that since your deposits are being loaned out, you may or may not have full access to your deposits at any given time. If your assets are being loaned out, then you no longer have a right to them depending on the agreement you have with the bank. If you are loaning your car to your neighbor, you no longer can drive it until he returns it. In the case of money or other assets deposited in a bank, you agree that it can be loaned out and that you may not be able to use it, and that the bank will pay you a percentage of what they make by loaning out your money. So long as the agreement is understood and agreed to, and you realize you may not have full access to your deposits, then there is no issue with the bank loaning out your money on those terms. Understood this way, Fractional Reserve Banking is both moral and should be legal. It's a private agreement between you and your bank and is really nothing more than loaning your car to your neighbor, for a price, and realizing you cannot drive your car if your neighbor has it.

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