Friday, August 17, 2012
Fact and Fiction on Reserve Requirements
In the system we have now, we do use both a reserve restriction and an asset restriction. But, the modern reserve restriction has changed fundamentally, and has nothing to do with the monetarist understanding of reserve restrictions, except in a purely formal sense.
In the day of specie convertibility, reserve restriction had a definite functionality. It served to limit the amount of money subsitutes put into circulation, because by law and custom all such money substitutes had to be convertible into specie on demand. Therefore, the reserve restriction had to do with specie – at the end of the day, banks had to have a certain percentage of specie holdings – reserves – or they would either be shut down or fail. So there were two kinds of money, and reserve restriction had to do with maintaining some ratio between them.
Central banks arose only in response to this specie convertibility arrangement. Bagehot’s Lombard Street describes the process. Banks began depositing their reserves with other banks, big banks, on Wall Street or, in England, at the Bank of England. The latter bank only hesitatingly and with trepidation accepted the responsibility this entailed. For this developing practice led to a gigantic inverted pyramid of money substitutes. Those banks continued to issue money subsitutes against their reserves; but the Bank of England turned around and used these reserves to engage in similar monetary expansion, so that at the end of the day the total amount of specie left to cover all those money substitutes became rather minuscule. This was the problem Bagehot blew the whistle on.
This arrangement of centralized specie reserves only served to facilitate control of the money supply by private bankers. On the face of it, it served the economy by providing the means to generate an elastic money supply far beyond the actual amount of specie available. In practice, it led to dizzying booms and horrendous busts, depending on how specie holdings were manipulated. It also led to the social question, socialism, communism, and the modern labor movement. But that's another story.
Within that context, one can easily see the rationale of reserve restrictions. They helped keep the generation of money substitutes within some reasonable distance of the original specie of which they were supposed to be the direct representation.
Nowadays, we have no specie convertibility requirement, so reserve restrictions have nothing to do with there being real money on the one hand, and money substitutes on the other. All attempts by monetarists to establish Federal Reserve generated money as in some sense “real” money, in terms of which regular banks issue money “substitutes” like in the old days, are only attempts to maintain the fiction of continuity between this system and that one, and to maintain a centralized control of the money supply like in the days of specie of convertibility. But events have shown that the money supply in the modern banking and monetary system cannot be manipulated like it was in the days of specie convertibility. For this we should be very thankful. In formal terms, the money multiplier is still in effect, but in practice it only serves to set some ultimate limit to lending, a limit that is never reached.
We still have reserve requirements today, and they are useful, but for an entirely different reason than in the days of specie convertibility. In fact, using the same word for today’s reserves and for the reserve banking model of yore, of which our Federal Reserve system is an obsolete example, is an exercise in equivocity. Reserves today have a totally different function than reserves then.
This is because there is no money substitute that has to be kept within some sort of relation to “real” money. The money generated by the banking system is all the same, from the central bank to the bank across the street. Rather, what reserve requirements do is keep banks from running into liquidity problems in making the regular payments to customers and other banks that they need to do to stay in business. A reserve serves as a buffer to absorb losses in the case of loan defaults. With bad loans, a bank is left without payments budgeted to come in, income that was budgeted to cover payments, payments that still have to be made. So reserves help to cover such shortfalls. But the center of gravity in the new system is precisely asset valuation, in order to minimize the negative effects of such defaults. If the collateral base accurately approaches the value of the loan, then a default is not a disaster, for the underlying security is still valuable, and can still be used to cover costs. In the case of the credit crisis, a whole mass of similar assets (foreclosed homes) came on the market at the same time, precipitating a collapse in market value of those assets and thus the book value of securities (mark to market).
In this world, a central bank no longer has any function as a reserve bank. The banking system as a whole can serve as a reserve bank, the one for the other. There is absolutely no need for traditional reserve banking with its money multiplier; the system runs on an entirely different principle. The Federal Reserve could go back to being the government’s banker, which is what public banks usually were before the notion of central banking ever got off the ground. The history of the Bank of England provides the foremost example. Both the first and second Banks of the United States were called into being simply to facilitate the fiscal needs of the federal government. The nascent central banking functionality exercised by Biddle had nothing to do with any “lender of last resort” and any money multiplier function. It was only an attempt to keep banks from overstepping specie reserve requirements – to keep them honest. And they didn’t like it, and got Andrew Jackson to do their dirty work for them. Andrew Jackson was not the champion of the people against the banks, but of the banking interest against Nathan Biddle! But that,too, is another story.
Tuesday, August 14, 2012
Private Issue of Money -- the Root of Our Monetary Problem?
In a comment posted under an article by my friend Jerry Bowyer (Where's the Hyperinflation?), "ps61penn62prin64" writes that "private currency monetary systems... are doomed to fail the interest of American citizens."
Bowyer's article discusses the sizeable increase in the money supply generated by the Fed, and how this has -- or has not -- affected the inflation rate. Bowyer concludes that although inflation has not manifested itself because of Fed action, it will. This is because the Fed has "an almost unlimited capacity to produce syrup [i.e., base money] and pump it at high pressure into the system. And they want to do so. They want more money in circulation, because their Keynesian models tell them that easy money is the answer to our economic stagnation."
This view of our monetary system is based on the notion that we have a fractional-reserve system. Which we do, but only in the most formalistic sense. For all practical purposes, our system is not tied to some base money, manipulated by the Fed, allowing it to stretch and shrink the money supply at will. The Fed does not have this unlimited power -- if it did, we'd have been toast (Weimar Germany, anyone?) long ago. If this were true, how do we explain our current struggle, which is a low-interest-rate, low-inflation environment?
But let's now address the issue raised by ps61penn62prin64, as to whether the private issue of currency is the problem.
Right up front, I will state that the state-sanctioned private issue of money, such as is provided for by the Federal Reserve system, by no means need be a problem. Indeed, it is simply a function of "the common law right to borrow" (as Hammond pointed out in his Pulitzer Prize-winning book, Banks and Politics in America, published in 1957). In such a system, banks take a position front and center, as "experts in futurity" to use John R. Commons' pregnant phrase, converting property into liquidity. This is not banks loaning depositors' state-issued money; this is banks loaning money of their own creation. It is not the Jimmy Stewart, but the James Steuart form of banking.
This being so, the banks are creating representations, symbols, of property holdings, and it is these symbols that form the money supply. These symbols, these representations, only reflect a deeper reality -- the reality of the issuing agents' (i.e., banks') balance sheets.The problems we face are thus not problems of liquidity, but of solvency. Our problems are not that there is not enough liquidity, as in the days of the gold standard, nor that there is too much liquidity. Our problems revolve around solvency: that the assets on the books of banks (and this holds for the "shadow banking system" as well) do not match up with the liabilities.
When this happens, we have a freeze-up of credit, as banks only become concerned with restoring balance sheets rather than engaging in fresh lending. This is why we are dealing not with an inflation problem but rather with a disinflation problem.
Originally the Constitution authorized only Congress to create and manage money, in the form of coinage. Coinage is the preeminent form of state-created money. Coinage had always been the prerogative of the state. But with the shift toward a commodity-based money system during the 18th century, power over coinage and over money had been passing out of the hands of the state and into the hands of the bankers. The regime of coinage was already on its last legs at the time of the Constitution's ratification. My forthcoming book will discuss this transformation in detail.
Hence, the Constitution was outdated already at the time of ratification. It did not address the issue of banks. Hammonds' book details the debate surrounding this issue as it developed during the early Republic, as the pros and cons of banks' private money were discussed. The principle was finally accepted in terms of fractional-reserve -- banks were only creating money substitutes, and were under the obligation to provide real money -- specie -- whenever asked.
We labored under this system for a long time. But when we threw off the gold standard, we threw off fractional reserve banking. Our banking system is now asset-based, not reserve-based. It is a system of state-sanctioned, yet market-driven, money. There is nothing wrong with that, in principle. In practice, it can be problematic. The problems mainly come about because we don't understand it, and act in terms of faulty understanding. Especially when governments get in on the action. Then the liquidity bias, fomented by our faulty understanding, gives government room for its misplaced Keynesianism. And we discover once again that the problem had nothing to do with liquidity, but rather with solvency.
And so we need to look at other things than the Fed's production of "syrup" if we want to understand what is going on with inflation rates, interest rates, and thus the economic fundamentals that determine how are economic lives are to be lived.
We need to go from Jimmy Stewart to James Steuart.
Bowyer's article discusses the sizeable increase in the money supply generated by the Fed, and how this has -- or has not -- affected the inflation rate. Bowyer concludes that although inflation has not manifested itself because of Fed action, it will. This is because the Fed has "an almost unlimited capacity to produce syrup [i.e., base money] and pump it at high pressure into the system. And they want to do so. They want more money in circulation, because their Keynesian models tell them that easy money is the answer to our economic stagnation."
This view of our monetary system is based on the notion that we have a fractional-reserve system. Which we do, but only in the most formalistic sense. For all practical purposes, our system is not tied to some base money, manipulated by the Fed, allowing it to stretch and shrink the money supply at will. The Fed does not have this unlimited power -- if it did, we'd have been toast (Weimar Germany, anyone?) long ago. If this were true, how do we explain our current struggle, which is a low-interest-rate, low-inflation environment?
But let's now address the issue raised by ps61penn62prin64, as to whether the private issue of currency is the problem.
Right up front, I will state that the state-sanctioned private issue of money, such as is provided for by the Federal Reserve system, by no means need be a problem. Indeed, it is simply a function of "the common law right to borrow" (as Hammond pointed out in his Pulitzer Prize-winning book, Banks and Politics in America, published in 1957). In such a system, banks take a position front and center, as "experts in futurity" to use John R. Commons' pregnant phrase, converting property into liquidity. This is not banks loaning depositors' state-issued money; this is banks loaning money of their own creation. It is not the Jimmy Stewart, but the James Steuart form of banking.
This being so, the banks are creating representations, symbols, of property holdings, and it is these symbols that form the money supply. These symbols, these representations, only reflect a deeper reality -- the reality of the issuing agents' (i.e., banks') balance sheets.The problems we face are thus not problems of liquidity, but of solvency. Our problems are not that there is not enough liquidity, as in the days of the gold standard, nor that there is too much liquidity. Our problems revolve around solvency: that the assets on the books of banks (and this holds for the "shadow banking system" as well) do not match up with the liabilities.
When this happens, we have a freeze-up of credit, as banks only become concerned with restoring balance sheets rather than engaging in fresh lending. This is why we are dealing not with an inflation problem but rather with a disinflation problem.
Originally the Constitution authorized only Congress to create and manage money, in the form of coinage. Coinage is the preeminent form of state-created money. Coinage had always been the prerogative of the state. But with the shift toward a commodity-based money system during the 18th century, power over coinage and over money had been passing out of the hands of the state and into the hands of the bankers. The regime of coinage was already on its last legs at the time of the Constitution's ratification. My forthcoming book will discuss this transformation in detail.
Hence, the Constitution was outdated already at the time of ratification. It did not address the issue of banks. Hammonds' book details the debate surrounding this issue as it developed during the early Republic, as the pros and cons of banks' private money were discussed. The principle was finally accepted in terms of fractional-reserve -- banks were only creating money substitutes, and were under the obligation to provide real money -- specie -- whenever asked.
We labored under this system for a long time. But when we threw off the gold standard, we threw off fractional reserve banking. Our banking system is now asset-based, not reserve-based. It is a system of state-sanctioned, yet market-driven, money. There is nothing wrong with that, in principle. In practice, it can be problematic. The problems mainly come about because we don't understand it, and act in terms of faulty understanding. Especially when governments get in on the action. Then the liquidity bias, fomented by our faulty understanding, gives government room for its misplaced Keynesianism. And we discover once again that the problem had nothing to do with liquidity, but rather with solvency.
And so we need to look at other things than the Fed's production of "syrup" if we want to understand what is going on with inflation rates, interest rates, and thus the economic fundamentals that determine how are economic lives are to be lived.
We need to go from Jimmy Stewart to James Steuart.
Why We Do NOT Have a Fractional-Reserve System
This blog entry is for anyone who believes, as John Tamny here puts it, that “Fractional reserve banking quite simple IS.”
Among the many good points Tamny makes in his article, there is the underlying assumption that our system is, in some important sense, a fractional-reserve system. But is this a valid contention?
My contention is that it is misleading to view our system as a fractional-reserve system, that a truly fractional-reserve system functions in a very different way than ours does, and that the focus on reserves obfuscates the true nature of money. If our system is fractional-reserve, then why don’t we have any panics and deflationary contractions the way we did in the 19th century, the heyday of fractional-reserve banking?
The way it worked then was that there was a specie convertibility requirement. Specie – gold or silver – had to be held by banks for them to issue money substitutes, either notes or deposits. The reserve ratio – required by law – was set at 1:3 or 1:5, although in practice banks would often exceed this ratio. What would happen is that there would be drains of specie, for various reasons, out of the banks, to the big banks in New York, or oftentimes out of the country as well. In the case of the Panic of 1837, it was the government that unwittingly set off the panic. The government began requiring specie payments for land purchases in the western territories, leading to demand for specie that outstripped supply, thus drains of specie, runs on banks by depositors afraid that their particular bank would not be able to maintain specie levels, resultant bank failures, business failures, unemployment, etc.
This is quite definitely a problem of liquidity shortage. The banks’ books balanced, assets matched liabilities; the only problem was the specie requirement, a setup that, in James Steuart’s words, was only demanded by custom, as only specie was considered to be real money – Keynes’ “barbarous relic.” It was finally dispensed with, for all practical purposes, during the 1930s.
Fast forward to today. When does anyone talk of reserve requirements the way they did in the 19th century? When does anyone worry that banks don’t have enough reserves, therefore they ought to pull their savings or cash deposits out of the bank, precipitating a bank run? We don’t have “runs on the bank” any more. Why? Why is the Fed's discount window -- the ultimate source of liquidity in need -- hardly ever resorted to?
The problem we have today regarding bank reserves is of an entirely different order. When we worry about a bank’s reserves, we worry about whether it can deal with a balance-sheet problem: assets that have lost their value, as for instance collateral being marked to market. We have solvency problems today, not liquidity problems. There is plenty of liquidity. The problem is, where the assets aren’t available to exchange for liquidity, the provision of liquidity becomes problematic. The solvency problem then becomes a liquidity problem. Interbank lending rates go through the roof. And commercial/business lending, the heart and soul of economic growth, grinds to a halt.
The protagonist of Fed fiat money as base money would say that this base money forms the reserve, is established by law as reserve against which reserve requirements must be met. So that, if the Fed wished, it could precipitate similar deflationary contractions simply by selling off part or all of its holdings, thereby reducing deposits and/or bank notes in circulation, precipitating a reduction in the money supply by the amount dictated by the money multiplier. This doesn’t happen, our protagonist would say, because of political pressure. But it could, theoretically. Let’s suppose that it did. Does anyone think that the banking system really would participate in reducing the money supply to that degree? Not only would it miss out on the profits involved in lending, such a measure would precipitate a depression. It is my view that as soon as banks realized what the Fed was doing, they would stand up to this obvious insanity and refuse to comply with the legal reserve requirement. What would then happen? I don’t think the government could force compliance across the board, perhaps at one bank or a few banks, but not all the banks. Because the reserve requirement is an entirely artificial arrangement and has nothing to do with actual practice, the way it did in the day of specie convertibility. In those days, it was customers, not the government, that enforced compliance. In our day, the banks would simply refuse compliance, not to customers, but to the government.
For this reason, it is permissible to speak of the modern banking system as a fractional-reserve system only in the most formalistic way. Actual practice makes fractional reserve a non-issue. Reserve requirements do not have the importance that they had in the days of specie convertibility. We have made the transformation that James Steuart foreshadowed, when he pointed out that bank money was not money because an extension of specie – a fortiori of “base money” – but because a representation of the assets put up for security. This “Copernican Revolution” has yet to be adequately acknowledged. Theorists like Hyman Minsky work within its framework. They don’t talk of fractional-reserve requirements, they talk about asset bubbles as problematic because leading to balance-sheet mismatches.
Why do we maintain the fiction of the centrality of fractional-reserve? Because the system we now have grew out of a true fractional-reserve system. We removed the base money component, and the Fed has endeavored to maintain the illusion that its money somehow is as important as specie used to be. But Fed action does not produce automatic changes in the money supply the way gold inflows and outflows did in days of yore. Fed action can only indirectly induce changes in the money supply by influencing interest rates, and thus making lending more or less attractive. In our system, the liquidity problem has receded; it is solvency (balance-sheet) problems that we have to worry about.
To make my point crystal clear: our system may be labelled fractional-reserve in the same way that England may be labelled a monarchy. In terms of law, England is a monarchy. But if the queen ever attempted to exercise the power of a monarch, the monarchy would be peremptorily abolished. In the same way, in terms of law we have a fractional-reserve system. But if the Fed ever attempted to exercise the power inherent in such a system, such as absolute reductions of the money supply by virtue of the money multiplier mechanism, it would be peremptorily abolished as well.
Among the many good points Tamny makes in his article, there is the underlying assumption that our system is, in some important sense, a fractional-reserve system. But is this a valid contention?
My contention is that it is misleading to view our system as a fractional-reserve system, that a truly fractional-reserve system functions in a very different way than ours does, and that the focus on reserves obfuscates the true nature of money. If our system is fractional-reserve, then why don’t we have any panics and deflationary contractions the way we did in the 19th century, the heyday of fractional-reserve banking?
The way it worked then was that there was a specie convertibility requirement. Specie – gold or silver – had to be held by banks for them to issue money substitutes, either notes or deposits. The reserve ratio – required by law – was set at 1:3 or 1:5, although in practice banks would often exceed this ratio. What would happen is that there would be drains of specie, for various reasons, out of the banks, to the big banks in New York, or oftentimes out of the country as well. In the case of the Panic of 1837, it was the government that unwittingly set off the panic. The government began requiring specie payments for land purchases in the western territories, leading to demand for specie that outstripped supply, thus drains of specie, runs on banks by depositors afraid that their particular bank would not be able to maintain specie levels, resultant bank failures, business failures, unemployment, etc.
This is quite definitely a problem of liquidity shortage. The banks’ books balanced, assets matched liabilities; the only problem was the specie requirement, a setup that, in James Steuart’s words, was only demanded by custom, as only specie was considered to be real money – Keynes’ “barbarous relic.” It was finally dispensed with, for all practical purposes, during the 1930s.
Fast forward to today. When does anyone talk of reserve requirements the way they did in the 19th century? When does anyone worry that banks don’t have enough reserves, therefore they ought to pull their savings or cash deposits out of the bank, precipitating a bank run? We don’t have “runs on the bank” any more. Why? Why is the Fed's discount window -- the ultimate source of liquidity in need -- hardly ever resorted to?
The problem we have today regarding bank reserves is of an entirely different order. When we worry about a bank’s reserves, we worry about whether it can deal with a balance-sheet problem: assets that have lost their value, as for instance collateral being marked to market. We have solvency problems today, not liquidity problems. There is plenty of liquidity. The problem is, where the assets aren’t available to exchange for liquidity, the provision of liquidity becomes problematic. The solvency problem then becomes a liquidity problem. Interbank lending rates go through the roof. And commercial/business lending, the heart and soul of economic growth, grinds to a halt.
The protagonist of Fed fiat money as base money would say that this base money forms the reserve, is established by law as reserve against which reserve requirements must be met. So that, if the Fed wished, it could precipitate similar deflationary contractions simply by selling off part or all of its holdings, thereby reducing deposits and/or bank notes in circulation, precipitating a reduction in the money supply by the amount dictated by the money multiplier. This doesn’t happen, our protagonist would say, because of political pressure. But it could, theoretically. Let’s suppose that it did. Does anyone think that the banking system really would participate in reducing the money supply to that degree? Not only would it miss out on the profits involved in lending, such a measure would precipitate a depression. It is my view that as soon as banks realized what the Fed was doing, they would stand up to this obvious insanity and refuse to comply with the legal reserve requirement. What would then happen? I don’t think the government could force compliance across the board, perhaps at one bank or a few banks, but not all the banks. Because the reserve requirement is an entirely artificial arrangement and has nothing to do with actual practice, the way it did in the day of specie convertibility. In those days, it was customers, not the government, that enforced compliance. In our day, the banks would simply refuse compliance, not to customers, but to the government.
For this reason, it is permissible to speak of the modern banking system as a fractional-reserve system only in the most formalistic way. Actual practice makes fractional reserve a non-issue. Reserve requirements do not have the importance that they had in the days of specie convertibility. We have made the transformation that James Steuart foreshadowed, when he pointed out that bank money was not money because an extension of specie – a fortiori of “base money” – but because a representation of the assets put up for security. This “Copernican Revolution” has yet to be adequately acknowledged. Theorists like Hyman Minsky work within its framework. They don’t talk of fractional-reserve requirements, they talk about asset bubbles as problematic because leading to balance-sheet mismatches.
Why do we maintain the fiction of the centrality of fractional-reserve? Because the system we now have grew out of a true fractional-reserve system. We removed the base money component, and the Fed has endeavored to maintain the illusion that its money somehow is as important as specie used to be. But Fed action does not produce automatic changes in the money supply the way gold inflows and outflows did in days of yore. Fed action can only indirectly induce changes in the money supply by influencing interest rates, and thus making lending more or less attractive. In our system, the liquidity problem has receded; it is solvency (balance-sheet) problems that we have to worry about.
To make my point crystal clear: our system may be labelled fractional-reserve in the same way that England may be labelled a monarchy. In terms of law, England is a monarchy. But if the queen ever attempted to exercise the power of a monarch, the monarchy would be peremptorily abolished. In the same way, in terms of law we have a fractional-reserve system. But if the Fed ever attempted to exercise the power inherent in such a system, such as absolute reductions of the money supply by virtue of the money multiplier mechanism, it would be peremptorily abolished as well.
Jimmy Stewart Banking versus James Steuart Banking
In his excellent book The New Lombard Street, Perry Mehrling writes of "a world that never was ... Jimmy Stewart banking of blessed memory" (p. 117). This is an obvious reference to one of Jimmy Stewart's most famous roles: George Bailey in the holiday classic movie It's a Wonderful Life. In the movie, Bailey is a small banker forced into near-bankruptcy by the inadvertent misplacement of the bank's holdings, holdings that are the deposits of its customers. When those customers catch wind that the bank's holdings are gone, there comes the prototypical "run on the bank,"which precipitates Bailey's attempted suicide. For the rest of the story, watch the movie. For now, what's important is the model of banking this presents. Merhling summarizes it: "In traditional banking, so nostalgic memory reminds us, banks took deposits from households in their community and made loans to other households in their community. It was a simple business...." And this is the model that many still consider to be what banking is all about, with any deviation being a sign of imminent destruction.
But that is not at all what banking is all about. In fact, Jimmy Stewart banking has been a rarity in history, if in fact it ever really was practiced. This is because bankers have instead practiced fractional-reserve banking, which means that deposits of whatever is considered to be real money are held, not to be lent out, but to serve as a base upon which a circulating medium may be erected. That is to say, money substitutes are put into circulation as if they were real money; the banks manufacture and maintain these money substitutes, either by means of notes, checks, or whatever other medium technology can provide; and society is freed from the restrictions of a scarce money supply. In former days, when specie -- gold and silver -- were the only true forms of money (copper serving for small change only), such an "elastic" money supply was a godsend. But it could just easily be turned into a curse, as we shall see.
I said that Jimmy Stewart banking was a rarity. The best example history provides is the Bank of Amsterdam from the 17th and 18th centuries. It received deposits of specie and held them in its vaults. It did this for a fee. Depositors could conduct transactions on the books with each other, freeing them from the need to safeguard and exchange actual specie holdings. By law, the bank could not allow overdrafts. So this was a strict "warehousing" function that the bank provided, which allowed it to serve as a clearinghouse of monetary transactions for all its depositors. And its depositors were all the great ones of Europe.
There was a problem here, though. What no one knew, was that the bank was surreptitiously lending both to the city of Amsterdam and to the East India Company. In 1794, its demise became a foregone conclusion when it came to light that the bank had been making millions of guilders of loans to these entities. So even here, Jimmy Stewart banking was more a pretense than a reality.
Surreptitious lending of deposits was bad enough. The real problem with this system was the power it gave to any who might gain control -- corner the market -- on whatever served as base money. In the days of bimetallism, when both gold and silver served as base money, such overtures to manipulation were difficult to realize. The combined market for gold and silver was too large. But such manipulation did become feasible when the switch was made to the gold standard. Gold was a very scarce medium, and during the days of the gold standard, holdings of it were centralized, leading to the serious opportunity for manipulation by a coterie of banking families -- J.P. Morgan being the most conspicuous example.
Hence, the days of the gold standard were the heyday of fractional-reserve banking. The only "true" money was gold, and the bankers controlled that market, and thus the availability of true money. Banks generated money substitutes as multiples of their gold holdings; but when markets dictated gold outflows out of the country, the money supply contracted by the same multiple, leading to harrowing busts that make contemporary crises seem walks in the park.
But in the midst of -- or rather, at the start of -- the fractional-reserve era, another form of banking existed, at least in the mind of one man. And as a matter of fact, this form of banking has held sway ever since the collapse of the gold standard in the 1930s. This is not Jimmy Stewart banking, but James Steuart banking.
James Steuart was a Scottish baronet who lived in the 18th century, had once supported Bonnie Prince Charlie's bid for the throne of England, and consequently was forced to live in exile for 18 years. While in exile, he wrote a work the importance of which has yet to receive the recognition it deserves: An Inquiry into the Principles of Political Economy (1767). In that work, he espouses a view of banking derived from practice but without the prejudice towards specie that blinded his contemporaries. Steuart realized that the function of banking did not lie in extending base money into money substitutes; rather, the function of banking was to convert property into money. He used the metaphor of "melting down" property, a reference to the melting down of plate and other forms of precious metal so that it could be converted into coin. For Steuart, property was "melted down" into money -- "symbolical" money, as he put it -- when it was put up as security for a loan. This security represented the true money base, because at the end of the day, should the borrower default on the loan, the loan's real worth was simply the value of the security that had been pledged.
Now then, this symbolical money no longer represented base money, it represented the property put up as security. Therefore, it was this property that served as money base, not specie. Steuart foretold the emancipation from gold and silver that the world would only come to accept after the onerous experiences of a Great Depression and two world wars. And that emancipation was not only from a superstititious view of money, but also from a class of men who, using this money, gained control of the nations.
The money systems of today are based on Steuart's principle, not Stewart's. Nor do we practice fractional-reserve banking in any material sense of the term, although in formal terms our system is a fractional-reserve one. After all, our system of central banks is called the Federal Reserve System. But for all practical purposes, reserve requirements do not determine the money supply, nor do they precipitate bank failures the way they did in the 19th century. Rather, it is the willingness of property-owners to put up marketable assets as security for loans that determines the money supply. And it is the quality of those assets on the balance sheet that determine the solvency, and thus survivability, of a bank.
But that is not at all what banking is all about. In fact, Jimmy Stewart banking has been a rarity in history, if in fact it ever really was practiced. This is because bankers have instead practiced fractional-reserve banking, which means that deposits of whatever is considered to be real money are held, not to be lent out, but to serve as a base upon which a circulating medium may be erected. That is to say, money substitutes are put into circulation as if they were real money; the banks manufacture and maintain these money substitutes, either by means of notes, checks, or whatever other medium technology can provide; and society is freed from the restrictions of a scarce money supply. In former days, when specie -- gold and silver -- were the only true forms of money (copper serving for small change only), such an "elastic" money supply was a godsend. But it could just easily be turned into a curse, as we shall see.
I said that Jimmy Stewart banking was a rarity. The best example history provides is the Bank of Amsterdam from the 17th and 18th centuries. It received deposits of specie and held them in its vaults. It did this for a fee. Depositors could conduct transactions on the books with each other, freeing them from the need to safeguard and exchange actual specie holdings. By law, the bank could not allow overdrafts. So this was a strict "warehousing" function that the bank provided, which allowed it to serve as a clearinghouse of monetary transactions for all its depositors. And its depositors were all the great ones of Europe.
There was a problem here, though. What no one knew, was that the bank was surreptitiously lending both to the city of Amsterdam and to the East India Company. In 1794, its demise became a foregone conclusion when it came to light that the bank had been making millions of guilders of loans to these entities. So even here, Jimmy Stewart banking was more a pretense than a reality.
Surreptitious lending of deposits was bad enough. The real problem with this system was the power it gave to any who might gain control -- corner the market -- on whatever served as base money. In the days of bimetallism, when both gold and silver served as base money, such overtures to manipulation were difficult to realize. The combined market for gold and silver was too large. But such manipulation did become feasible when the switch was made to the gold standard. Gold was a very scarce medium, and during the days of the gold standard, holdings of it were centralized, leading to the serious opportunity for manipulation by a coterie of banking families -- J.P. Morgan being the most conspicuous example.
Hence, the days of the gold standard were the heyday of fractional-reserve banking. The only "true" money was gold, and the bankers controlled that market, and thus the availability of true money. Banks generated money substitutes as multiples of their gold holdings; but when markets dictated gold outflows out of the country, the money supply contracted by the same multiple, leading to harrowing busts that make contemporary crises seem walks in the park.
But in the midst of -- or rather, at the start of -- the fractional-reserve era, another form of banking existed, at least in the mind of one man. And as a matter of fact, this form of banking has held sway ever since the collapse of the gold standard in the 1930s. This is not Jimmy Stewart banking, but James Steuart banking.
James Steuart was a Scottish baronet who lived in the 18th century, had once supported Bonnie Prince Charlie's bid for the throne of England, and consequently was forced to live in exile for 18 years. While in exile, he wrote a work the importance of which has yet to receive the recognition it deserves: An Inquiry into the Principles of Political Economy (1767). In that work, he espouses a view of banking derived from practice but without the prejudice towards specie that blinded his contemporaries. Steuart realized that the function of banking did not lie in extending base money into money substitutes; rather, the function of banking was to convert property into money. He used the metaphor of "melting down" property, a reference to the melting down of plate and other forms of precious metal so that it could be converted into coin. For Steuart, property was "melted down" into money -- "symbolical" money, as he put it -- when it was put up as security for a loan. This security represented the true money base, because at the end of the day, should the borrower default on the loan, the loan's real worth was simply the value of the security that had been pledged.
Now then, this symbolical money no longer represented base money, it represented the property put up as security. Therefore, it was this property that served as money base, not specie. Steuart foretold the emancipation from gold and silver that the world would only come to accept after the onerous experiences of a Great Depression and two world wars. And that emancipation was not only from a superstititious view of money, but also from a class of men who, using this money, gained control of the nations.
The money systems of today are based on Steuart's principle, not Stewart's. Nor do we practice fractional-reserve banking in any material sense of the term, although in formal terms our system is a fractional-reserve one. After all, our system of central banks is called the Federal Reserve System. But for all practical purposes, reserve requirements do not determine the money supply, nor do they precipitate bank failures the way they did in the 19th century. Rather, it is the willingness of property-owners to put up marketable assets as security for loans that determines the money supply. And it is the quality of those assets on the balance sheet that determine the solvency, and thus survivability, of a bank.
Wednesday, December 28, 2011
How to Make the Euro Project Work
The euro seems to be on its last legs, and the vision which inspired its genesis seems to have vanished from the politicians sponsoring it. The recent spat with England and Prime Minister Cameron has only served to highlight the vacuum in vision. Previously, whenever England was scapegoated, English politicians skulked like whipped curs, and Euro-politicians adopted that practiced condescending, look-askance stance toward the wayward one. This time around, the feeling among English politicians and electorate was more relief than abashedness, and the pose of superiority by the likes of Premier Sarkozy could hardly be attempted, let alone maintained. The media did its best to foster the impression, and the attempt failed.
So what now? What of the grand vision of a single currency binding fiscally responsible, growth-oriented economies into a viable, synergistic whole? What we now have is a ramshackle construction inviting the incurrence of debt and inhibiting its repayment, a growth-crippling currency combined with a debt overhang that makes the US dollar seem a safe haven.
But was this ever the end which was envisioned? Was the euro ever simply to have facilitated fiscal responsibility and economic growth? Was there perhaps another goal envisioned by its founders, a goal which perhaps now has been lost sight of by those who were to carry the torch?
In point of fact, the euro is simply one building block in an entire agenda. What is needed to save the euro is to understand that agenda. The euro needs to be set off against other, equally desired, institutions in order to take firm root.
There is a simple calculus that all politicians from Northern to Southern Europe have to make: the euro comes with a price, and that price is for the nothern nations to assume the fiscal burden of the southern nations. That burden consists of, on the one hand, debt, and, on the other, the continued flow of transfer payments. These transfer payments are the key to the entire project. Welfare payments, subsidies, pensions, they all need to be included in a blanket agreement without which a common currency cannot survive.
Of course, the southern countries would be only too happy to establish such an arrangement, and so the northern countries need to make specific that this takeover involves not only liabilities but assets -- specifically, control of the political machinery by which the decisions are made over such transfer payments. The southern countries have to relinquish political control of their citizenries.
In turn, this cannot be done only for the southern countries. Such an arrangement will require the transfer of political responsibility over welfare-state decision-making to the level of the European Union, for the northern as well as the southern countries. Germany, the Netherlands, France, Belgium, will likewise have to yield democratic control to Brussels and Strasbourg.
Can such a system be called democratic? Strictly speaking, yes, because it will still be a one-man, one-vote system. But as it stands here described, the price would be too high for the northern countries to pay. They will not relinquish their national parliaments in favor of the European Parliament without, to use a common-law notion, "consideration."
That consideration must be a form of control. Behind the democratic facade, there must be a predominance of control lodged in the northern countries. How can this best be achieved?
Through control of the central bank, and short-term interest rates. A tight monetary policy favors the more economically powerful areas -- the "core" -- of a currency region, and keeps the weaker areas -- the "periphery" -- more or less in thrall.
Would that be enough? Possibly. A monetary policy geared to the needs of the northern countries would ensure enough prosperity in those countries to shoulder a good deal of the welfare-state burden of the southern countries, without precipitating an inflationary spiral, which is what would take place if monetary policy were geared toward the southern countries. And the southern countries would console themselves with the awareness that their sky-high unemployment rates and exuberant levels of welfare payoffs were covered. The facade of a European Parliament would give the impression of democracy, and, for the rest, all residual conflicts could be worked out on the pitch -- of what use is the UEFA Champions' League if not this?
So what now? What of the grand vision of a single currency binding fiscally responsible, growth-oriented economies into a viable, synergistic whole? What we now have is a ramshackle construction inviting the incurrence of debt and inhibiting its repayment, a growth-crippling currency combined with a debt overhang that makes the US dollar seem a safe haven.
But was this ever the end which was envisioned? Was the euro ever simply to have facilitated fiscal responsibility and economic growth? Was there perhaps another goal envisioned by its founders, a goal which perhaps now has been lost sight of by those who were to carry the torch?
In point of fact, the euro is simply one building block in an entire agenda. What is needed to save the euro is to understand that agenda. The euro needs to be set off against other, equally desired, institutions in order to take firm root.
There is a simple calculus that all politicians from Northern to Southern Europe have to make: the euro comes with a price, and that price is for the nothern nations to assume the fiscal burden of the southern nations. That burden consists of, on the one hand, debt, and, on the other, the continued flow of transfer payments. These transfer payments are the key to the entire project. Welfare payments, subsidies, pensions, they all need to be included in a blanket agreement without which a common currency cannot survive.
Of course, the southern countries would be only too happy to establish such an arrangement, and so the northern countries need to make specific that this takeover involves not only liabilities but assets -- specifically, control of the political machinery by which the decisions are made over such transfer payments. The southern countries have to relinquish political control of their citizenries.
In turn, this cannot be done only for the southern countries. Such an arrangement will require the transfer of political responsibility over welfare-state decision-making to the level of the European Union, for the northern as well as the southern countries. Germany, the Netherlands, France, Belgium, will likewise have to yield democratic control to Brussels and Strasbourg.
Can such a system be called democratic? Strictly speaking, yes, because it will still be a one-man, one-vote system. But as it stands here described, the price would be too high for the northern countries to pay. They will not relinquish their national parliaments in favor of the European Parliament without, to use a common-law notion, "consideration."
That consideration must be a form of control. Behind the democratic facade, there must be a predominance of control lodged in the northern countries. How can this best be achieved?
Through control of the central bank, and short-term interest rates. A tight monetary policy favors the more economically powerful areas -- the "core" -- of a currency region, and keeps the weaker areas -- the "periphery" -- more or less in thrall.
Would that be enough? Possibly. A monetary policy geared to the needs of the northern countries would ensure enough prosperity in those countries to shoulder a good deal of the welfare-state burden of the southern countries, without precipitating an inflationary spiral, which is what would take place if monetary policy were geared toward the southern countries. And the southern countries would console themselves with the awareness that their sky-high unemployment rates and exuberant levels of welfare payoffs were covered. The facade of a European Parliament would give the impression of democracy, and, for the rest, all residual conflicts could be worked out on the pitch -- of what use is the UEFA Champions' League if not this?
Thursday, November 11, 2010
Much Ado About Easing
"Quantitative Easing" is the latest thing to get in a tizzy about these days. Everyone seems to have an opinion on quantative easing, either in favor (deflation-countering inflation is a good thing) or opposed (depreciation is a bad thing).
An investment analyst whose work I recommend, Nicholas Vardy, the "Global Guru," recently jumped on the QE bandwagon. The sentiment among global growth prognosticators has recently turned bullish. The question for Vardy is, "So what really has changed since the end of the summer?" And his answer, "of course, is quantitative easing." What is the effect of quantitative easing? "An extra $600 billion sloshing around global financial markets has two effects. First, it devalues the dollar, sending dollar-denominated commodity prices higher. Second, with interest rates forced down, investors are sent on a desperate chase for yield, driving up the prices of all assets in emerging markets."
The problem with this argument is, so-called quantitative easing does not cause $600 billion to begin sloshing around financial markets. It doesn't slosh around anywhere but the Fed's primary dealers' balance sheets. Now these primary dealers are commercial banks, and the money they have credited to them by the Fed, in exchange for the Treasuries they sell, is money which is added to their balance sheets. Hence, there is $600 billion more sloshing about there, not on the financial markets. For that money to enter financial markets, these banks have to lend. That is the way our two-tier banking system works. Now, the question is, are there market players out there willing to borrow, and put up the necessary collateral, in order to come by that additional $600 billion, in order to drive up securities prices on financial markets? That is the missing link that must be shown to exist in order for fears of depreciation to be grounded.
Vardy's second point, regarding lower interest rates and the "desperate chase for yield," is more to the point. Indeed, this is the primary effect of "quantitative easing," which is to flatten the yield curve from the long end. By doing this, the Fed may well be trying to force banks to lend more because the alternative, profits gained from borrowing at zero interest to buy interest-yielding treasuries, will narrow. I think that is the Fed's end game, not fomenting inflation/depreciation, which depends on a lot more than simple quantitative easing. But the Fed could achieve such a goal more quickly and surely by simply raising interest rates at the short end, thus flattening the yield curve from that side, which would do much to encourage lending. After all, the October 2010 Senior Loan Officer Opinion Survey doesn't show any increased lending activity at all. When such lending activity does increase, that is when we need to start worrying about inflation, depreciation, and cutting back on the Fed balance sheet.
An investment analyst whose work I recommend, Nicholas Vardy, the "Global Guru," recently jumped on the QE bandwagon. The sentiment among global growth prognosticators has recently turned bullish. The question for Vardy is, "So what really has changed since the end of the summer?" And his answer, "of course, is quantitative easing." What is the effect of quantitative easing? "An extra $600 billion sloshing around global financial markets has two effects. First, it devalues the dollar, sending dollar-denominated commodity prices higher. Second, with interest rates forced down, investors are sent on a desperate chase for yield, driving up the prices of all assets in emerging markets."
The problem with this argument is, so-called quantitative easing does not cause $600 billion to begin sloshing around financial markets. It doesn't slosh around anywhere but the Fed's primary dealers' balance sheets. Now these primary dealers are commercial banks, and the money they have credited to them by the Fed, in exchange for the Treasuries they sell, is money which is added to their balance sheets. Hence, there is $600 billion more sloshing about there, not on the financial markets. For that money to enter financial markets, these banks have to lend. That is the way our two-tier banking system works. Now, the question is, are there market players out there willing to borrow, and put up the necessary collateral, in order to come by that additional $600 billion, in order to drive up securities prices on financial markets? That is the missing link that must be shown to exist in order for fears of depreciation to be grounded.
Vardy's second point, regarding lower interest rates and the "desperate chase for yield," is more to the point. Indeed, this is the primary effect of "quantitative easing," which is to flatten the yield curve from the long end. By doing this, the Fed may well be trying to force banks to lend more because the alternative, profits gained from borrowing at zero interest to buy interest-yielding treasuries, will narrow. I think that is the Fed's end game, not fomenting inflation/depreciation, which depends on a lot more than simple quantitative easing. But the Fed could achieve such a goal more quickly and surely by simply raising interest rates at the short end, thus flattening the yield curve from that side, which would do much to encourage lending. After all, the October 2010 Senior Loan Officer Opinion Survey doesn't show any increased lending activity at all. When such lending activity does increase, that is when we need to start worrying about inflation, depreciation, and cutting back on the Fed balance sheet.
Monday, August 30, 2010
Why the Fed Should Boost Interest Rates
If the Fed wants to boost economic activity, it should think about raising the federal funds target rate. Why? Wouldn't that restrict lending? Paradoxically, it would likely increase lending.
This would force banks to engage in more lending in order to make a profit. Currently, banks can make money doing virtually nothing, as they borrow money from the Fed at zero percent interest and use that money to buy government bonds yielding 2-3%. This blog makes the same point. If banks can make a profit without risk -- because government bonds carry no risk -- then why lend at risk? But if the Fed raises its rates, then this margin will shrink and banks will be forced to engage in riskier activity, such as lending to business and consumers. Perhaps then, as the big banks move away from risk aversion, interbank rates would drop, facilitating borrowing across the board.
The argument is that raising rates will plunge the economy into a depression. With bonds trading at yields of less than 2%, bond markets, it is said, are signalling that inflation is dead. But is this not to reverse the actual situation? Are bonds not trading at this low a level because the baseline rate is zero? Raise the rate, and these short-term rates will also rise. This will simply have the effect of flattening the yield curve -- 30-year rates remain stubbornly above 3 1/2%. As long as the yield curve does not invert, is there a problem with that?
St. Louis Fed chairman Thomas Hoenig has been arguing for some time that the federal funds rate needs to be moved out of the zero percent range. His argument makes sense. The Fed can do more to boost economic activity than lower rates.
This would force banks to engage in more lending in order to make a profit. Currently, banks can make money doing virtually nothing, as they borrow money from the Fed at zero percent interest and use that money to buy government bonds yielding 2-3%. This blog makes the same point. If banks can make a profit without risk -- because government bonds carry no risk -- then why lend at risk? But if the Fed raises its rates, then this margin will shrink and banks will be forced to engage in riskier activity, such as lending to business and consumers. Perhaps then, as the big banks move away from risk aversion, interbank rates would drop, facilitating borrowing across the board.
The argument is that raising rates will plunge the economy into a depression. With bonds trading at yields of less than 2%, bond markets, it is said, are signalling that inflation is dead. But is this not to reverse the actual situation? Are bonds not trading at this low a level because the baseline rate is zero? Raise the rate, and these short-term rates will also rise. This will simply have the effect of flattening the yield curve -- 30-year rates remain stubbornly above 3 1/2%. As long as the yield curve does not invert, is there a problem with that?
St. Louis Fed chairman Thomas Hoenig has been arguing for some time that the federal funds rate needs to be moved out of the zero percent range. His argument makes sense. The Fed can do more to boost economic activity than lower rates.
Thursday, August 19, 2010
What is Common Law?
Common Law is a term I use as an umbrella concept, shorthand for a comprehensive world-view of limited sovereignty, restricted government, private law (property and contract), the self-reliant citizen, the market order not only of goods and services but of credit and debt and goodwill, of coordination of equals rather than command by superiors of inferiors. Another term for this is the rule of law. But because that latter term is fuzzy and not often filled in with concrete content, I resort to common law, which is the better term for that reality anyway.
But the term common law does generate some confusion. Usually when one hears it, one thinks of the historically determined Anglo-Saxon and cognate legal systems, with all of their peculiarities and practices, which only the practicing lawyer has occasion to master.
Indeed, this is a valid viewpoint. For one salient characteristic of true common law is that it develops practically through the process of adjudication, in the courtroom, through the dialectic of adversarial thesis and antithesis. Here, of course, lawyers rule the roost. But that does not mean that common law is not also something more than mere practitioners' fodder.
Hence, it cannot be that the practicing lawyer "owns" this system, and views any incursion by "laymen" to be illegitimate. But alas it is more often so than not. Yes, the guild mentality reigns here as everywhere else, despite the fact that in a democracy, the law ought to be a domain open to the citizen, accessible to his inquiry, amenable to his uses. Ah, for a return to the days of a truly liberal conception of citizenship, where the professional saw his task as aiding the gentleman citizen rather than lording it over the unclean and untutored! But that is a subject for another day.
We need the historically grown positive law, even for legal and political philosopy, even for economics, because without it we are all at sea. Which means that the practitioners of that law cannot withhold it as their own private domain. The law is of and for us all. And, to properly understand common law, one must understand the philosophy behind the very notion of a common law.
Very simply, common law is law which applies across the board in a given jurisdiction, applies to all equally. It is the uniform law of a sovereign polity. And, beyond this, it is the general equity behind all positive law. So it is both basic principles, and practical application thereof in a universal way. Opposed to this regime is the regime of privilege, where the rulers exercise their wills to impose commands or orders or distributions, rather than allowing matters to be arranged by free and equal individuals in the give-and-take of bargaining owners. The regime of privilege ruled the roost in pre-modern Europe, and has since taken up its positions in modern government, with its war against the rule of law in favor of favoritism, privilege, and interest-group-based politics.
To combat privilege we need to recover the concept of the common law. I hope to set up a web site soon dedicated specifically to exploring the common law paradigm. This will integrate the various books I've written, and will write, on the subject, as well as other work in the fields of law, politics, and economics, so as to see them in the light of this same paradigm.
Stay tuned.
Tuesday, August 17, 2010
The New Normal
Rush Limbaugh discussed the concept of the "New Normal" on his radio show yesterday. He was pretty much on target: the "New Normal" is considered by many to be some inevitability, for which the Obama government is not responsible. I discuss the concept at length in my upcoming book Common-Law Investing. What I try to make clear is that the "New Normal" is not anything inevitable but simply the result of overspending government, entitlement-mentality citizenry, and the dysfunctional dependency fostered between these two. And I make clear that there is an alternative, in terms of investment, to this "New Normal," and that is emerging-markets countries where this kind of dysfunctional politics has been abandoned in favor of market discipline. The "New Normal" is not inevitable but it certainly is a good possibility given the state of mind of First World citizenries these days. That's bad news, but the good news is that emerging markets offer an alternative to those who do not buy into it.
Tuesday, August 11, 2009
New Book: Common Law & Natural Rights
I haven't been posting much lately, and there's a reason. I've been busy writing a new book. And it's ready for the reading public. The title is Common Law & Natural Rights: The Question of Conservative Foundations, and it is an examination of natural rights as the foundation for conservatism, as opposed to the common law. It is the contention of the book that natural rights has served neither conservatism nor contemporary polities well. The reliance on natural rights and its daughter, the separation of powers, has led to overweening government, based on absolute democracy. The common law as a self-contained, independent bulwark of liberty is proposed as the alternative. For more information, follow this link.
Regarding the Stahl book on constitutional law, it is nearly finished. I hope to have it ready for publication within a month or two. Stay tuned.
Regarding the Stahl book on constitutional law, it is nearly finished. I hope to have it ready for publication within a month or two. Stay tuned.
Tuesday, March 24, 2009
Responses to the Geithner Plan...
are lukewarm at best. Today's Wall Street Journal op-ed ("The Geithner Asset Play") raises the appropriate objections. The goal of the plan, which is to rid banks' balance sheets of unmarketable assets, really is something that has to be done if credit relations are to be restored. But it seems that Geithner wishes to accomplish this, once again, on the backs of the taxpayer. Why not try something such as was suggested by Larry Kudlow (see my blog here), whereby mark-to-market accounting rules are eased -- something which will cost the taxpayer nothing. John Berlau notes that Geithner's plan mentions nothing about mark-to-market.
Furthermore, Paul Krugman's running commentary on the plan ("The Conscience of a Liberal") is well worth perusing, even if sprinkled -- liberally -- with really funky liberalism.
Furthermore, Paul Krugman's running commentary on the plan ("The Conscience of a Liberal") is well worth perusing, even if sprinkled -- liberally -- with really funky liberalism.
Friday, March 20, 2009
What the Fed is Up To
The recently announced Fed action has been characterized as a massive exercise in printing money, in "pumping liquidity". But such characterizations, once again, are misleading.
Take a Wall Street Journal article from March 19th, 2009, by John Hilsenrath. In "Fed in Bond-Buying Binge to Spur Growth" he wrote,
First, has the Fed been "printing money"? Let's look at a few graphs, downloaded from the Fed web site, to determine if that's the case.
First, the trend line of the amount of assets on the Fed's balance sheet:
This means that the Fed has done a lot of buying since mid-2008. How has it paid for this? By printing money? Let's look at the trend line of liabilities over the same period:
Here you can see that the amount of currency in circulating (money printed) is roughly stable, while the amount of deposits at depositary institutions has ballooned. The Fed, thus, bought up all those assets by crediting the accounts of depositary institutions (mainly banks).
What does this do? It enables these depositary institutions to lend. How much they are able to lend is a function of how much they have on account at the Fed. Those Fed deposits, plus their own cash on hand (vault cash), constitute what is known as the money base. The money base was fairly stable through mid-2008, and then went through the roof, from $800-plus billion to over $1.5 trillion in March 2009 (see the table here).
So the money base, and thus the amount available to lend (which, with our fractional reserve banking system, is a multiple of the money base), has nearly doubled.
But the money supply, actual money put into the economy, has not. Here are the figures for the broadest money supply counter (monetary aggregate), M2. In March 2007, M2 stood at $7.111 trillion. In February 2009, it came to $8.275 trillion, an increase of about 16%. Nearly all of that increase has occurred recently: the year-on-year gain (February 2008-February 2009) was 9.8%, the six-month gain was 15.3%, and the three-month gain was 15.2%. Still, the gain is not nearly what one would expect given a near-doubling of the money base.
The conclusion: the Fed hasn't been printing money, it has been expanding the money base and thus the amount banks can lend. But even in that case, the banks can't lend what people won't borrow. Given the none-too-precipitous increase in the money supply, it doesn't appear that borrowing has increased much even given the enormous increase in potential for lending (look here for confirmation).
It would seem to me that the Fed's purpose in buying up the more unorthodox assets, which underlies the big increase in assets on its balance sheet, is 1) to stabilize the mortgage market by buying up mortgage-backed assets from Fannie Mae et al., 2) to bring down long-term interest rates by buying up long-term Treasury bills.
Bringing down long-term rates is a new way for the Fed to operate. It apparently is working, or at least has a chance of working. By bringing down long-term rates the Fed hopes to spur investment (see Hilsenrath's article from March 20th, 2009, "Excess Capacity Keeps Heat on Fed").
The danger is, of course, that by engaging in all this spending it has provided way too much lending potential to banks which could lead to inflation. Hilsenrath's "Excess Capacity" article shows just how much the Fed is expanding the money base by doing this. But on the other hand, it can head off the danger of rampant inflation by raising interest rates, as well as by selling off those self-same assets.
So this is an area which bears watching but is not yet cause for alarm. The Obama government's fiscal policy (not to mention war on capitalism) is where one really needs to watch out.
Take a Wall Street Journal article from March 19th, 2009, by John Hilsenrath. In "Fed in Bond-Buying Binge to Spur Growth" he wrote,
The Fed had already cut its benchmark interest-rate target to near zero. Unable to go lower, the central bank now is essentially printing money to raise the supply of credit and thus push down the longer-term rates paid by families and companies on mortgages and other key loans. The impact was immediately felt.
First, has the Fed been "printing money"? Let's look at a few graphs, downloaded from the Fed web site, to determine if that's the case.
First, the trend line of the amount of assets on the Fed's balance sheet:
This means that the Fed has done a lot of buying since mid-2008. How has it paid for this? By printing money? Let's look at the trend line of liabilities over the same period:
Here you can see that the amount of currency in circulating (money printed) is roughly stable, while the amount of deposits at depositary institutions has ballooned. The Fed, thus, bought up all those assets by crediting the accounts of depositary institutions (mainly banks).
What does this do? It enables these depositary institutions to lend. How much they are able to lend is a function of how much they have on account at the Fed. Those Fed deposits, plus their own cash on hand (vault cash), constitute what is known as the money base. The money base was fairly stable through mid-2008, and then went through the roof, from $800-plus billion to over $1.5 trillion in March 2009 (see the table here).
So the money base, and thus the amount available to lend (which, with our fractional reserve banking system, is a multiple of the money base), has nearly doubled.
But the money supply, actual money put into the economy, has not. Here are the figures for the broadest money supply counter (monetary aggregate), M2. In March 2007, M2 stood at $7.111 trillion. In February 2009, it came to $8.275 trillion, an increase of about 16%. Nearly all of that increase has occurred recently: the year-on-year gain (February 2008-February 2009) was 9.8%, the six-month gain was 15.3%, and the three-month gain was 15.2%. Still, the gain is not nearly what one would expect given a near-doubling of the money base.
The conclusion: the Fed hasn't been printing money, it has been expanding the money base and thus the amount banks can lend. But even in that case, the banks can't lend what people won't borrow. Given the none-too-precipitous increase in the money supply, it doesn't appear that borrowing has increased much even given the enormous increase in potential for lending (look here for confirmation).
It would seem to me that the Fed's purpose in buying up the more unorthodox assets, which underlies the big increase in assets on its balance sheet, is 1) to stabilize the mortgage market by buying up mortgage-backed assets from Fannie Mae et al., 2) to bring down long-term interest rates by buying up long-term Treasury bills.
Bringing down long-term rates is a new way for the Fed to operate. It apparently is working, or at least has a chance of working. By bringing down long-term rates the Fed hopes to spur investment (see Hilsenrath's article from March 20th, 2009, "Excess Capacity Keeps Heat on Fed").
The danger is, of course, that by engaging in all this spending it has provided way too much lending potential to banks which could lead to inflation. Hilsenrath's "Excess Capacity" article shows just how much the Fed is expanding the money base by doing this. But on the other hand, it can head off the danger of rampant inflation by raising interest rates, as well as by selling off those self-same assets.
So this is an area which bears watching but is not yet cause for alarm. The Obama government's fiscal policy (not to mention war on capitalism) is where one really needs to watch out.
Wednesday, March 18, 2009
And We Have a Winner
The solution to the toxic asset problem, and the credit crisis, may well be the one propounded by Holman W. Jenkins in his Wall Street Journal column of March 18 2009: "Needed: A Bailout That Doesn't Look Like One." The root of the crisis is bad assets (securitized subprime loans) on banks' balance sheets. Mr. Holman's column discusses how these assets can be most easily taken care of. It looks so easy that a child could do it. But there's the rub. It's too easy. After all, it would constitute the waste of the opportunity this "crisis" affords to Cloverfield government.
(Update March 20th: Larry Kudlow offers an alternative approach to solving the crisis. He may be right that no further action is required than the switch to cash-flow accounting from mark-to-market accounting, together with the normalized yield curve on short- and long-term loans. Who's to say? Not me.)
(Update March 20th: Larry Kudlow offers an alternative approach to solving the crisis. He may be right that no further action is required than the switch to cash-flow accounting from mark-to-market accounting, together with the normalized yield curve on short- and long-term loans. Who's to say? Not me.)
Tuesday, January 13, 2009
Cloverfield Government
Well it's about time I woke up from hibernation to begin posting again. Not much to say for awhile there, not to mention being preoccupied with finishing the next volume of the Stahl translation, about the state and constitutional law. I hope to have it published within a month (that's quite optimistic though). At any rate, I did have a thought to communicate! And that is this. I finally got around to watching the movie "Cloverfield." It's not one of those movies my wife likes to see, so it sat around gathering dust until she went out of town for a few days, at which point I blew the dust off of the said DVD and watched it. What a grotesque movie, yet very well done, because it seemed real enough to actually have happened. But, here comes the thought I wanted to communicate: the monster in Cloverfield, while highly believable, was not quite up to the times. If he really wanted to come over as a modern-day monster, he would have gotten on the national news, have blamed all the carnage in Manhattan on the army, and stated that he really was there to fix things, to restore order, to rebuild, he being the only entity large enough to be able to do that. After all, isn't that what our government has done? Destroyed the economy through years of either parasitic or blatantly destructive action (e.g., subprime mortgage sponsorship), and then blame the entire mess on the victims, to wit, business and the market. We have a Cloverfield government; but there are those who are filming with their camcorders for posterity's sake. This hopefully will allow future generations to learn from our mistake, not to listen to big ugly green monsters, replete with giant teeth, in politicians' clothing.
Wednesday, November 5, 2008
What Went Wrong
McCain-Palin lost this campaign when they fell for the Democrat bait in wrongly responding to the banking crisis. This post of mine explains the details.
The anti-capitalist mentality must be hit between the eyes once and for all. But when even conservatives fall into it, you know you have an uphill battle.
There are powers behind the scenes which seem to understand this. It could be that such powers (e.g., George Soros) precipitated the credit crisis, anticipating such an outcome. Somehow Henry Paulson got maneuvered into it. The arch-liberal Paul Krugman alludes to this.
Perhaps someday we'll know the truth about what actually happened in this election. Right now, our work is cut out for us.
The anti-capitalist mentality must be hit between the eyes once and for all. But when even conservatives fall into it, you know you have an uphill battle.
There are powers behind the scenes which seem to understand this. It could be that such powers (e.g., George Soros) precipitated the credit crisis, anticipating such an outcome. Somehow Henry Paulson got maneuvered into it. The arch-liberal Paul Krugman alludes to this.
Perhaps someday we'll know the truth about what actually happened in this election. Right now, our work is cut out for us.
Monday, November 3, 2008
Crossroads
America is at a crossroads.
This election can go one of two ways: victory for Barack Obama, or victory for John McCain.
If McCain wins, it will mean that God has granted us more time to get our house in order before He lowers the boom. The Constitution will continue on life support, so to speak, with issues regarding abortion, homosexual marriage, and the like -- fundamentally, the question of the source of law, God or man? -- still yet having to be dealt with decisively, or else He will give us over forever to the forces of the Kingdom of Man.
If Barack Obama wins, then all bets are off; God will have given us over to the forces of the Kingdom of Man, and Man, both through the legislature and through the courts, will enact an agenda of godlessness that will dwarf any previously enacted in the United States of America, making it difficult to see how we will ever get out of it.
If McCain wins, muddledness continues until America chooses for life, for godliness, for divine standards of justice (read: the Ten Commandments); if Obama wins, clarity obtains: the choice is made, the die is cast. It will spell the triumph of the Entitlement Mentality, which is the root of political evil.
(By the way, no, I do not speak for God, but I do claim to be able to speak in general accordance with His will; after all, I have His promise: "Then said Jesus to those Jews which believed on him, If ye continue in my word, then are ye my disciples indeed; And ye shall know the truth, and the truth shall make you free " (John 8:31-32).)
This election can go one of two ways: victory for Barack Obama, or victory for John McCain.
If McCain wins, it will mean that God has granted us more time to get our house in order before He lowers the boom. The Constitution will continue on life support, so to speak, with issues regarding abortion, homosexual marriage, and the like -- fundamentally, the question of the source of law, God or man? -- still yet having to be dealt with decisively, or else He will give us over forever to the forces of the Kingdom of Man.
If Barack Obama wins, then all bets are off; God will have given us over to the forces of the Kingdom of Man, and Man, both through the legislature and through the courts, will enact an agenda of godlessness that will dwarf any previously enacted in the United States of America, making it difficult to see how we will ever get out of it.
If McCain wins, muddledness continues until America chooses for life, for godliness, for divine standards of justice (read: the Ten Commandments); if Obama wins, clarity obtains: the choice is made, the die is cast. It will spell the triumph of the Entitlement Mentality, which is the root of political evil.
(By the way, no, I do not speak for God, but I do claim to be able to speak in general accordance with His will; after all, I have His promise: "Then said Jesus to those Jews which believed on him, If ye continue in my word, then are ye my disciples indeed; And ye shall know the truth, and the truth shall make you free " (John 8:31-32).)
Monday, October 27, 2008
Turnabout is Fair Play
Well, the Democrats have fallen into the carefully laid trap laid for them by the devious McCain campaign. I say, turnabout is fair play. The Democrats started this by springing their carefully laid trap on McCain back in mid-September, when he was still enjoying the Palin Bounce. That's when Secretary Paulson (a Democrat) let Lehman Brothers go under, prompting Paul Krugman to write, "Henry Paulson’s decision to let Lehman fail, on Sept. 14, may have delivered the White House to Obama." It certainly precipitated the credit crisis and prompted McCain's knee-jerk condemnations of Wall Street greed, thus diverting criticism from where it truly was merited, namely, Washington Democrats and the sub-prime culture.
So McCain fell for their ruse. It has taken him a while to get back on message, more appropriately putting the criticism at the Democrats' doorstep. Then along came Joe the Plumber, who got Obama to admit that what he was after was wealth redistribution. This prompted shocked responses from the Obama campaign and from the media in general, who argued that it was not redistribution but "tax cuts" that Obama was after. (Joe the Plumber, they claimed, was a McCain plant, a Rove ruse. If so, perhaps the monicker "McBrilliant" will be dusted off for use again.)
They argue this because they know that opinion polls decisively show that Americans favor wealth creation over wealth redistribution to deal with economic difficulty. They do not like this line of questioning, as witness the over the top response to direct questions on the subject, asked by an honest journalist by the name of Barbara West.
But now there has surfaced audio of Obama arguing in favor of "economic justice" and "redistributive justice," that the very liberal Warren Court really wasn't that liberal because it did not take the step toward this kind of justice, and that community organizing is necessary to organize power to get redistributive justice accomplished in the legislature.
How is the Obama campaign and the media going to spin this? My guess is, by ignoring it. Will they get away with it? Time will tell. I'm sure that talk radio and Fox News, not to mention the blogosphere, will do their best to get this out there. If it does, perhaps people will begin to question the content of Obama "hope and change."
What a ploy, John! Well, perhaps it wasn't in your campaign strategy after all, but it sure couldn't have come at a better time. Or in a better way. They cannot argue their way out of this, they can only hope that people will not pay attention.
So McCain fell for their ruse. It has taken him a while to get back on message, more appropriately putting the criticism at the Democrats' doorstep. Then along came Joe the Plumber, who got Obama to admit that what he was after was wealth redistribution. This prompted shocked responses from the Obama campaign and from the media in general, who argued that it was not redistribution but "tax cuts" that Obama was after. (Joe the Plumber, they claimed, was a McCain plant, a Rove ruse. If so, perhaps the monicker "McBrilliant" will be dusted off for use again.)
They argue this because they know that opinion polls decisively show that Americans favor wealth creation over wealth redistribution to deal with economic difficulty. They do not like this line of questioning, as witness the over the top response to direct questions on the subject, asked by an honest journalist by the name of Barbara West.
But now there has surfaced audio of Obama arguing in favor of "economic justice" and "redistributive justice," that the very liberal Warren Court really wasn't that liberal because it did not take the step toward this kind of justice, and that community organizing is necessary to organize power to get redistributive justice accomplished in the legislature.
How is the Obama campaign and the media going to spin this? My guess is, by ignoring it. Will they get away with it? Time will tell. I'm sure that talk radio and Fox News, not to mention the blogosphere, will do their best to get this out there. If it does, perhaps people will begin to question the content of Obama "hope and change."
What a ploy, John! Well, perhaps it wasn't in your campaign strategy after all, but it sure couldn't have come at a better time. Or in a better way. They cannot argue their way out of this, they can only hope that people will not pay attention.
Sunday, October 26, 2008
The King's Heart
There is another Bible verse we should remember during this time of troubles:
"The king’s heart is in the hand of the LORD, as the rivers of water: he turneth it whithersoever he will" (Proverbs 21:1).
The king is the sovereign; in our Republic, it is the people who are sovereign. So, to paraphrase Solomon, the people's heart is in the hand of the Lord to turn it in whatever direction He wishes.
Do we believe that? Do we believe He can actually turn the hearts and minds of the people in the face of the onslaught of monolithic media representations?
Is there anything too difficult for God? Not according to the archangel Gabriel, this time speaking to a frightened teenager by the name of Mary: "For with God nothing shall be impossible" (Luke 1:37).
Pray now or forever hold your peace.
"The king’s heart is in the hand of the LORD, as the rivers of water: he turneth it whithersoever he will" (Proverbs 21:1).
The king is the sovereign; in our Republic, it is the people who are sovereign. So, to paraphrase Solomon, the people's heart is in the hand of the Lord to turn it in whatever direction He wishes.
Do we believe that? Do we believe He can actually turn the hearts and minds of the people in the face of the onslaught of monolithic media representations?
Is there anything too difficult for God? Not according to the archangel Gabriel, this time speaking to a frightened teenager by the name of Mary: "For with God nothing shall be impossible" (Luke 1:37).
Pray now or forever hold your peace.
Friday, October 24, 2008
Struggle in the Heavenlies
What is happening now is a spiritual struggle the likes of which we may not have seen in our lifetimes. The forces of ungodliness and overthrow, of disorder and irreligion, of Anti-Christ, are unleashed in such coordinated fashion as to be unprecedented. Therefore our calling is contrition and prayer, for if God does not see fit to deliver us from the hands of our enemies, they will conquer us.
The spiritual struggle is going on "in the heavenly places" (e.g., Ephesians 3:10) as well as on Earth. It is like what the archangel Gabriel was alluding to when he said to Daniel (Book of Daniel, ch. 9):
10 And, behold, an hand touched me, which set me upon my knees and upon the palms of my hands.
11 And he said unto me, O Daniel, a man greatly beloved, understand the words that I speak unto thee, and stand upright: for unto thee am I now sent. And when he had spoken this word unto me, I stood trembling.
12 Then said he unto me, Fear not, Daniel: for from the first day that thou didst set thine heart to understand, and to chasten thyself before thy God, thy words were heard, and I am come for thy words.
13 But the prince of the kingdom of Persia withstood me one and twenty days: but, lo, Michael, one of the chief princes, came to help me; and I remained there with the kings of Persia.
The angels themselves were in a struggle with the political leaders of the day. And I am sure they are struggling with the forces of evil even as we speak. But our prayers are necessary, just as Daniel's prayers and confession of sin were the catalyst of Gabriel's appearance to him.
There is so much at stake in this election. Far more than mere economics. Pray for God's mercy -- we cannot hope for more than that.
The spiritual struggle is going on "in the heavenly places" (e.g., Ephesians 3:10) as well as on Earth. It is like what the archangel Gabriel was alluding to when he said to Daniel (Book of Daniel, ch. 9):
10 And, behold, an hand touched me, which set me upon my knees and upon the palms of my hands.
11 And he said unto me, O Daniel, a man greatly beloved, understand the words that I speak unto thee, and stand upright: for unto thee am I now sent. And when he had spoken this word unto me, I stood trembling.
12 Then said he unto me, Fear not, Daniel: for from the first day that thou didst set thine heart to understand, and to chasten thyself before thy God, thy words were heard, and I am come for thy words.
13 But the prince of the kingdom of Persia withstood me one and twenty days: but, lo, Michael, one of the chief princes, came to help me; and I remained there with the kings of Persia.
The angels themselves were in a struggle with the political leaders of the day. And I am sure they are struggling with the forces of evil even as we speak. But our prayers are necessary, just as Daniel's prayers and confession of sin were the catalyst of Gabriel's appearance to him.
There is so much at stake in this election. Far more than mere economics. Pray for God's mercy -- we cannot hope for more than that.
Wednesday, October 22, 2008
Stocks Are Down...
and the polls seem to show a looming Democrat victory on November 4. Of course, the real reason stocks are down is "investors sorting through earnings reports" or some such claptrap. Ignore the elephant in the room, guys.
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