Column by Anonymous Person.
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A social institution doesn’t deteriorate society if it is worth its name. One thing it definitely doesn’t do is conduct anti-social behavior, such as fraud. Yet here we are, untold trillions in debt, with a Federal Reserve bank chairman, Ben Bernanke, who has claimed that the purpose of the Fed is simple--that of preventing bank runs.
What could be more benign? You don’t want your bank of choice to be overrun by people pulling out their money, do you?
Of course, I’m only setting up my point, which is that a decent, social institution wouldn’t have to make such a promise. What promise? That it will bail out banks for not keeping your money where it belongs.
My knowledge of Austrian economics permits me to only make a fairly modest prediction about the future of our economy and monetary system. If we keep inflating the money supply through fractional reserve banking, then we’re facing trouble. It might come in many forms; it may disrupt various businesses and individuals differently. But at either rate, we are heading towards trouble, and it is wholly avoidable.
I don’t need any measurements to precisely tell me this. A simple understanding of barter and money in a voluntary society work to know that we are headed toward continuous calamity with our current monetary system.
Imagine a grain silo, like that which would have been used in the 19th Century by farmers to store grain. All the grain is fungible. That is, it’s all the same, so that even if you haul in a ton of grain, and I haul in a ton, which gets mixed together, then no matter which mix of both our grain that you later withdraw of your ton, it makes no difference because each piece of grain is the same size and quality.
You store your grain in a silo, and for the silo owner’s service, he charges a small fee. That way, you don’t have the burden of getting your own silo and storing grain. This is the smooth function that a bank should serve with your money--charging a small rate for storing your money.
After all, money is, or at least should be, a good almost like that of any other. Historically, gold became a currency because of its relative scarcity and its fungible nature. It doesn’t matter if you take out from the bank your exact gold coin you deposited, or one that I did and got dumped in with all the others.
But now, imagine that your bank tries to cheat the system to make a little extra money. Instead of storing 100% of the money you deposited, it keeps only 50% of it. It loans out the rest so it can make money on the interest it charges. Your money is no longer secure, but the bank promises that 100% of it is there.
If people learn of this practice, they may make a dreaded run on the bank to pull out their money and place it in a more reputable bank. This is no good for the bank that is loaning out your money, obviously. Its scheme will fail against the threat of competitors that want their customers’ trust.
Enter a central, government-operated bank. One that not only promises to back up the deposits of the bank that loans out 50% of your money, but practically requires that all banks loan out 50% of their deposits, or even over 90%. Now, the fraudulent bank has protection from competition that a voluntary banking system provides to help ensure honesty in bank accounting. With such a central bank, all banks are protected from having to keep your money as per their agreement with you.
Some help. There’s a further consequence of loaning out most of the money that’s deposited, though. A metal like gold is no longer used as money, but paper notes--dollars--are used in place of gold coins since they’re easier to carry around. They should be redeemable immediately for the gold they are backed by, but the central bank, in an attempt to make “easy” money more widely available, mandates that dollars are no longer backed by gold except in a very small amount. The paper notes are essentially worthless, and get loaned out at a rate of over 90% by banks.
The money that gets circulated in these easy loans first goes to some people. Then, in purchases or further bank deposits, goes to yet more people, and so on. So a few dollars can become thousands.
That sort of sounds like a good thing, doesn’t it? More money? Well, the problem is that precisely the opposite is really happening. The money that gets circulated by these easy loans makes the amount of money relative to goods and services in an economy go up. In other words, other things being equal, the amount of actual goods and services that the money can purchase doesn’t change. What changes is the evaluation by the first people to get the money who can then purchase more, and then the next people, and so on, until the money gets to the last people to receive it. The evaluation of money to goods has been adjusted by the functioning of a money economy, and their money can no longer be used to purchase as much in goods and services as it could when the easy money was first loaned out. The chickens have come home to roost, so to speak, and people realize that this increase in money can’t purchase more since the ratio of money to goods has gone up on the money side of the equation. The consequence is a painful adjustment to the newly less effective money in the form of adjustments in the structure of businesses and job losses.
This is a very simple explanation of Mises’ theory of the business cycle, and it is still very much at play today. Money is created out of thin air, and, with the backing of the Federal Reserve, loaned out so that if everyone wanted to withdraw their money, the banks couldn’t possibly redeem all their deposits since their customers’ money is no longer there. They are committing a fraud. Businesses must undergo painful adjustments to the newly decreased purchasing power of money, and capital is reallocated and jobs are lost. And, people’s money is worth less because of the increase in money.
This is the case when other things are equal. Things are never equal, but what it means is that even if, for instance, a price goes down for a particular good, that it is still higher than what it would have been if there had been no fiat money, created out of thin air, that the bank loaned out.
This is why this lesson has modest implications, in a way. We can’t say for sure how much the purchasing power of money decreased. All we can say is that it does decrease.
This process has been going on and making it easier for the government to finance all manner of anti-social programs, such as wars and something approaching a police and surveillance state. These are evils that can be avoided, and I sympathize with the police officers and soldiers in many cases as much as the unintended victims of war and police actions. They are often good people who believe in what they’re doing, and they get emotionally and physically scarred and killed, along with their families who suffer. Taxation alone doesn’t provide the funds needed for a massive warfare state. They depend on the easy money process of central bank-backed fractional reserve banking.
Sound money means 100% backing of deposits, plain and simple. With every inflationary increase in the money supply, we are sowing the seeds for what is known as the boom and bust business cycle. On a simple, personal level, it means a move toward civility and society. In any interaction between you and me, we both expect transparency and honesty, so we should demand this from our banking institutions. There is so much needless confusion over what will fix our economy, and an important step is to simply stop fraudulent banking.
