First, some background. I have a bit of graduate training in economics (PhD drop out) and I am somewhat familiar with alternative schools of thought such as Austrian and Marxian economics. My understanding of this is not perfect, and I welcome any corrections from someone more knowledgeable than me. It is worthwhile to note that in none of my courses did we model the fed or the banking system (outside of very simplistic stuff in macroeconomics 101 which is so outdated that economists dont even use it anymore), and all our models were like insert money here. In general, mainstream economists assume money to be completely irrelevant in the long term. They figure that if we create $1000 and distribute it out to everyone, in the long run prices will rise to compensate, leaving everyone exactly as well-off they were before. Money creation can only affect the system in the short run, where -according to old-school Keynesian economics (actually a bastardization of Keynes work based on John Hicks interpretation of Keynes) -it increases aggregate demand, allowing us to recover from a slump. This was the original justification for the Fed doing what it does, creating money out of nothing to stimulate the economy. Now in the 70s this hicksianism was challenged by the rational expectations school, which essentially argued that economic agents, based on proper micro foundations, would not be fooled by the Fed making more money and would automatically adjust their actions to compensate, leaving us again with the view that money is irrelevant. In turn, this has been challenged by the New Keynesian (actually new hicksian) school, which agrees that economic agents should be based on microfoundations, but argues that stickiness of prices and wages (slowness to adjust) means that money creation is still effective in the short run to stimulate the economy.I believe this whole debate conceals a vastly important issue. Because they model the economy without money, as if it were a barter system, mainstream economists fail to realize (but the Austrians have consistently pointed out) that when money is created, it is never distributed evenly throughout the population (Milton Friedman imagined it being dropped by helicopters). Some people get that money first, and they get to use it while its value is still high (prices havent yet risen to compensate). As they spend the money, it gets distributed throughout the population, prices rise, and its value decreases. Basically, the last person to get that newly created dollar is screwed, because it is no more valuable than his old dollars. In fact, it is worth less than his old dollars, and his old dollars are worth less too because all dollars are now worth less. The traditional complaint about money creation is that it devalues your savings. That is true, but I think that the distribution issue is as important if not more important (poor people dont have any savings anyway).Essentially, the uneven distribution of new money amounts to a massive transfer of wealth from the poor to the rich, and we dont even notice it because it is completely invisible and it doesnt show up on any balance sheets. On top of concrete inequality that can be measured (income and wealth inequality as measured in inflation-adjusted dollars), we have this invisible inequality that results from the rich getting newly printed dollars first. It is as if their millions and billions arent enough, they demand the right to counterfeit money as well. And they make this demand on the basis of a highly questionable theory, originally based on a misinterpretion of Keynes, then challenged both from within mainstream economics and without.To make this a little more concrete, here is what happens when new money is created, as far as I understand it. The Fed charges an interest rate, which it can increase or decrease according to policy. When banks borrow from the Fed at this interest rate, that money they borrow comes out of nothing, it is just created by adding some numbers on a spreadsheet somewhere. Then, they can loan this money out at according to the reserve ratio, which means if they borrowed $100 from the Fed they can loan out $80 (if the required reserve ratio is 20%). That represents $80 in new money creation, in addition to the $100 the Fed just created, for a total of $180 in new money. That $80 can then be lent out to another bank, which allows that bank to lend out $64, and so on. If the money is lent out 10 times, then you can calculate that the total amount of money created if $500: 5 times more than the original amount that the Fed created when the first bank borrowed from it.Now the reason I put loan in quotes is because this is not loaning in the conventional sense of the word. Normally, when you loan someone money it requires actually giving them that money, so that you cant use it yourself. It sounds ridiculous, but in fact the bank just keeps the money that it lends out. Its as if when a friend asks you to borrow $5, you turn on your counterfeit money printing press and print out 5 fake dollars and hand it to him. So yeah you lent him money, if you want to call it that. In effect it is totally misleading to think of the fractional reserve system as limiting the amount a bank can lend - it is better to think of it as a system regulating how much money banks can create out of nothing.All of this is fairly standard, Econ 101 stuff. Interestingly though, thats where the analysis stops. The story ends, we can all go home, safe in the knowledge that the Fed can control the money supply. But wait a second, doesnt all that money have to be paid back? I mean even if you loan your friend $5 of counterfeit money you just printed, he still has to pay that $5 back (plus interest). So what follows is my own analysis. The 10th bank will have to come up with $10 plus interest to pay back the 9th bank, the 9th bank will have to pay back $13 plus interest to the 8th bank, the 8th bank will have to pay back $16 plus interest to the 7th bank, and so on. The 1st bank (the one that initially borrowed from the Fed), will have to pay back the $100 that it borrowed, plus whatever interest rate the Fed set (sometimes it is zero, or effectively negative because of inflation).Now if we consider the 9th bank, it would have to set its interest rate so that it gets back more than $13 on the $10 it loans to the 10th bank, right? Because it knows it has to pay the 8th bank $13, and it wants to make a profit. So lets say it charges $2 in interest. That means the 10th bank has to somehow come up with $15. Where is it going to get $15? It only has the $10 it borrowed to lend out and make a profit off of. It would have to charge an interest rate more than double that of the 9th bank, a 50% interest rate in fact, in order to turn $10 into $15. In fact, the only way it can pay back the money is to borrow even more money, which means the whole chain has to be intiated all over again, with the 1st bank borrowing from the fed and lending to the 2nd bank, etc. You would think that the fact that all the money having to be paid back would destroy all the new money that as just created, but the fact that more money has to be created for that to even work means that money creation is always outpacing money destruction.I believe it is this impossibility at the heart of the banking system that keeps the craziness going. If we dont keep the printing presses on, the whole system falls apart. The system is self-justifying, its an insatiable beast that demands more and more virgin sacrifices in the form of the Fed creating more money. Meanwhile, the banks profit off of this counterfeit money. And like I said in the beginning, that new money represents more purchasing power because the banks are the first one in the chain to get it. By the time the new money filters down to Jane Doe working at Walmart its practically worthless.So essentially, the entire system is set up for no good reason, it only serves itself, and it is completely raping the working class.It is almost beside the point whether new money creation is necessary or not. We can debate the finer points of Keynesian (hicksian) economics versus Austrian all day, but can we at least agree that IF we must create new money to stimulate the economy, this is probably the most insane way of going about it? I mean why not just write us all a check for $1000 instead? In my view, its all well and good to propose taxes on the rich to even out income inequality. But hey, how about we start out by removing the fractional banking system which amounts to a reverse Robin Hood system of taxing the poor to benefit the rich?Hello, users of CMV! This is a footnote from your moderators. Wed just like to remind you of a couple of things. Firstly, please remember to read through our rules. If you see a comment that has broken one, it is more effective to report it than downvote it. Speaking of which, downvotes dont change views! If you are thinking about submitting a CMV yourself, please have a look through our popular topics wiki first. Any questions or concerns? Feel free to message us. Happy CMVing!
Posted on: Tue, 20 Jan 2015 04:07:04 +0000
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