Seigniorage, a government (NOT private bank!) privilege.

Self-liquidating credit (that loaned against an asset) does not permanently impact money supply. If the government is prohibited deficit spending then to maintain balance money and credit must be regulated with economic activity.

That is the proper function of the monetary authority, which is vested in Congress under Article 1 Section 8.

The money supply would grow in tandem with real economic output preserving stable prices, rewarding both economic growth AND savings.

KD,

If you really want to go down this rabbit hole, I throughly recommend you read these two excellent works by F.A Hayek:

Monetary theory and the trade cycle

and

The "Paradox" of Savings

both available in the PDF:

http://mises.org/books/hayekcollection.p....

In them Hayek throughly debunks Keynesianism through and through. He also explains how fractional reserve banking creates the business cycle by comparing its dynamics to those in a fixed currency economy. This is not a screed or a polemic. It's just a very through analysis written for an academic economist audience.

Hayek did this all in the 30s. He was on polite speaking terms the whole time with Keynes as they were having their ongoing academic debate. After Keynes' death he said, in a 1970s interview, that he was mystified by the deification of Keynes. After 1945 he switched over to what Joseph Salerno calls "Hayek II" where he would write many books criticizing communism and fascism and advocating for political liberty but never touching banking and credit cycles again.


Here's one of my favorite quotes:

Quote:

Once this is realized, we can also see how nonsensical it is to
formulate the question of the causation of cyclical fluctuations in
terms of “guilt,” and to single out, e.g., the banks as those “guilty”
of causing fluctuations in economic development.113 Nobody has
ever asked them to pursue a policy other than that which, as we
have seen, gives rise to cyclical fluctuations; and it is not within
their power to do away with such fluctuations, seeing that the
latter originate not from their policy but from the very nature of
the modern organization of credit. So long as we make use of
bank credit as a means of furthering economic development we
shall have to put up with the resulting trade cycles. They are, in
a sense, the price we pay for a speed of development exceeding
that which people would voluntarily make possible through their
savings, and which therefore has to be extorted from them. And
even if it is a mistake—as the recurrence of crises would demonstrate—
to suppose that we can, in this way, overcome all obstacles
standing in the way of progress, it is at least conceivable that the
non-economic factors of progress, such as technical and commercial
knowledge, are thereby benefited in a way we should be reluctant
to forgo.

If it were possible, as has been repeatedly asserted in recent
English literature,114 to keep the total amount of bank deposits
entirely stable, that would constitute the only means of getting
rid of cyclical fluctuations. This seems to us purely utopian. It
would necessitate the complete abolition of all bank money—
i.e., notes and checks—and the reduction of the banks to the role
of brokers, trading in savings. But even if we assume the fundamental
possibility of this state of things, it remains very questionable
whether many would wish to put it into effect if they
were clear about its consequences. The stability of the economic
system would be obtained at the price of curbing economic
progress. The rate of interest would be constantly above the level
maintained under the existing system (for, generally speaking,
even in times of depression some extension of credit takes
place).115 The utilization of new inventions and the “realization of
new combinations” would be made more difficult, and thus there
would disappear a psychological incentive toward progress, whose
importance cannot be judged on purely economic grounds. It is
no exaggeration to say that not only would it be impossible to put
such a scheme into practice in the present state of economic
enlightenment of the public, but even its theoretical justification
would be doubtful.
As regards the practical bearing of our analysis on the tradecycle
policy of the banks, all that can be deduced from it is that
bankers will have to weigh carefully the relative advantages and
disadvantages of granting credit on an increasing scale, and to
take into account the demand, now fairly widespread, for the
early application of a check to credit expansion. But the utmost
that can be achieved on these lines is only a mitigation, never the
abolition, of the trade cycle. Apart from this, the only way of
minimizing damage is through a far-reaching adjustment of the
economic system to the recognized existence of cyclical movements;
and for this purpose the most important condition is an
increased insight into the nature of the trade cycle and a knowledge
of its actual phase at any particular moment.1

As you can see, he is almost apologizing here for shedding all this light on the whole FRB system and how it works, saying he's not necessarily against FRB but that doesn't mean we should be willfully ignorant of what it does to distort the production structure of the economy.

Fractional reserve lending doesn't create the business cycle. The business cycle is created by the mathematical fact that two exponential functions always run away from one another.

Since nobody will ever lend INTENTIONALLY at a loss, you therefore have two compound functions (rate of required return in GDP growth and rate of interest charged) that always have a spread.

And as a consequence, contractions to clear out the weakest credits are inevitable. Attempting to violate the laws of mathematics is how you turn an ordinary and mathematically-necessary recession into a depression.

At the core of all this is not the prices vs purchasing power graph. That is just a symptom, not the cause. The cause can be found by considering the question: Shouldn't constructing capital lower prices? A man digs a well because he doesn't want to walk to the far away river every morning to fetch water. He is thus investing time in digging the well to receive the dividend of lower cost of production in terms of his time in the future. This is how all progress is made in an economy.

When we build more houses, on a massive scale, shouldn't the price go down? In the economy as it's presently set up, it goes up. That's because the money multiplier creates new "reserves" every time someone gets a new loan to buy a house. In a fixed money system, the construction of each new house, relative to the population's output would cause the price of housing to fall. Creation of factories would cause prices to fall. Building of infrastructure would cause prices to fall. The factories, houses, and infrastructure would have to be built efficiently enough to make a profit when targeting the lower price points.

Instead. we have relentless bank money creation causing prices to rise and justifying investment in projects that destroy wealth by, for example, building never occupied McMansions on productive farm land in the central valley. The farms are overbuilt because the supply of credit is channeled unevenly in the economy into whatever the current regulatory political framework chooses to channel credit to. In China, btw, they at least attempt to steer this around by directing bank lending policy while in the U.S we largely let the banks get themselves into whatever ponzi bubble they happen to fancy at the moment.

The money supply expansion constantly removes the benefit that increases in efficiency in production would otherwise give to the general population by skimming them off the top in the form of interest on money created out of nothing. When the rate of productivity increases in the underlying economy slows, there's a deficit of wealth for the population to live and pay the interest to the money printers and thus new calls for "austerity" are made such that the consumption of the bankers is supported and the population's is reduced. During times of exploding productivity, the capacity of the economy is increased faster than the rate of money expansion so the bankers are satisfied at their extraction from the rest of the economy and everything appears normal. It's when the productivity decreases or the debt burden starts suffocating investment in productive capital that the crash arrives. The boom could go on forever if the productivity of the economy increased at an exponential rate, such that the bankers could take 99.999999% of the output and the population could live comfortably on the rest. Unfortunately, things usually start to break down much sooner than that.

Right, it's called productivity improvement and it is why the natural state of all economies is a mild DEFLATION.

The Central Banksters and governments do their level damndest to convince you otherwise, but if you think about this for even the tiniest amount of time you will inevitably come to that conclusion.

As far as fractional reserve banking goes, here' my take on it and the so-called "business cycle," FWIW (which is probably EWYPFI)...

Tickerguy wrote..

Do we need "100% Reserve" banking? Technically, no. But we do need one dollar of capital. That is, there's nothing particularly wrong with lending against an asset that is fairly value at the market price, even though it "creates credit", because if payment is not forthcoming there is no loss; the collateral is seized and sold, resulting in the borrower's bankruptcy (which is what should happen, since he borrowed imprudently.) Without this ability ordinary self-liquidating trade credit such as a letter of credit in international trade, a common commercial transaction that presents no counterfeiting risk, would be impossible.

Also, if firms were unable to encumber their non-financial assets in exchange for credit money, it would hinder the growth of productive enterprises relative to real demand. History seems clear to me (apparently congruent with Downside's Hayak quote, even) that fractional reserve banking has been the system upon which the unprecedented prosperity that modern capitalism has produced is based. But since the 80's, as KD's charts clearly show, it has morphed into a grotesque and dangerous caricature of itself.

What a properly-run fractional system would accomplish, by enforcing the One Dollar of Capital for unbacked credit emissions and Mark to Market for all assets against which credit is lent, coupled with sound reserve requirements, is to take market exposure off the backs of taxpayers (via Congress) and savers (via the Fed), and put it back where it belongs, on the banksters. It would force them to do due diligence on the assets against which they lend, absent of which, they get to eat them.

What such a system would not do, however, is the one thing that everyone from the Austrians, to the Monetarists and Keynesians and their neoCON pals, seeks like the Holy Grail. And that is to revoke the long-wave cycle.

Ain't gonna happen, no way no how. And KD has shown why (although it's been a while; in "The Price of Capitalism"*) via the mathematics of exponential growth. For not only does every financial system ever devised that allows debt (and that would be all of them) compound that debt at an exponential rate, so does the productive capacity of every real economy, just at a lesser rate than the debt. It has to because population compounds exponentially too.

There are two ways out. One is to institute a biblical-style Jubilee, where every generation on a date-certain all debt self-liquidates. Short of that, when balance sheet events occur -- and they surely will, fractional reserve banking or no fractional reserve banking -- you've got to allow the free market to reset asset values. There is no other way.

*Bad link?
http://tickerforum.org/cgi-mt/akcs-www?a....

Here: http://market-ticker.org/akcs-www?single....

Thanks.

"He also explains how fractional reserve banking creates the business cycle by comparing its dynamics to those in a fixed currency economy. "

How do these guys get a PhD?

A 30 second glance at the USA's GDP cycles in the 19th Century proves that CB's don't create the business cycle, nor does fiat currency, nor the non-imposition of gold as currency.

Anyone care to comment on this? Sent to me by a friend, and I'd like to have a reasoned response to it. No better place than Ticker Forum for reasoned responses.

New money must be introduced into the economy or it will stop growing and become a "zero sum" system with a set in stone number of dollars, that will eventually collapse. It is impossible for the US govt to live within its means. Even if it only spends one dollar, it must borrow that dollar from the Fed with interest or sell a bond that it must pay back with interest. And the only way to stop spending is complete abolishment of the govt. No national defense, no laws, no anything.

It will never happen, but the US treasury should issue its own money and eliminate the Fed. I am not a conspiracy theory guy, but there is one that I believe. Lincoln told the treasury to issue its own money. It was the first green colored money we had (ergo "greenbacks"). The "Fed" wasn't established yet, but the US was borrowing money from a group of banks and Lincoln wanted to stop that and he was opposed to establishing a "Fed". I think this is the real reason he was assassinated.

Woodrow Wilson was one of the worst presidents ever. He was a puppet of the big banks, and among his many terrible actions was allowing the establishment of the Fed.

Dashing: the problem is with "collapse". Pure FUD and bull****.

If by "collapse" you mean "people might eventually default", then yes.

Lots of other silliness, why can't the government just spend a dollar that it collects in taxes first? If the government is both the manager of the quantity of dollars and an entity that spends dollars, it can make sure not to spend more than it collects.

Also, there's no iron clad law that says people must never default. Nor is there an iron clad law that says you need more money in the system to support a growing economy. More money in a growing economy might keep nominal prices stable rather than prices experiencing slow deflation, but choosing one or another is a value judgement based on how someone wishes to social-engineer the economy.

If the velocity of existing money increases, it effectively produces the same outcome as throwing more freshly created money at the system.

But, all of this is based on interest and exponential functions and real existing "stuff", real existing stuff isn't going to grow exponentially forever, so defaults are going to happen.

Political constraints on how much money the government spends is the only meaningful input into the system. The difference between the Fed and the Treasury creating the money is mostly academic.

Remember, a dollar borrowed from the Fed is paid back with interest, and the interest is credited back to the Treasury. So, it's not really borrowed, that's just accounting games to fool people (like your friend).