Matt Wittleif
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Folks, my limited blogging on this site is likely going to continue. I am going to be the campaign manager for Mike Wherry who is the likely nominee for Indiana Secretary of State for the Libertarian Party. Of course, we will welcome your support since this is the ballot access race in Indiana.
Visit www.mikewherry.com.
Visit www.mikewherry.com.
The Money Tree
They say that money doesn't grow on trees. That's true. It grows in banks.
I'm not talking about compounding interest either. I'm talking about creation of money right out of thin air. It is well known and understood that the Federal Reserve (and other central banks) print money at will. What's not so well understood is that regular commercial banks essentially do the same thing. To understand this, we have to explore the nature of money, credit, and the modern banking system.
Money can be described in several ways and has a variety of characteristics.We should begin with the Merriam Webster definition: "something generally accepted as a medium of exchange, a measure of value, or a means of payment." In early simple economies, barter was the principle means of exchange. This ultimately evolved to commodity money. Items which had a useful value on their own, are easily transportable, do not lose value or deteriorate, and are reasonably commonplace would serve as commodity money. Over the centuries, metal coins evolved out of being simple commodity money into serving as government issued currency. Generally, the metal coins face value as issued would be equivalent to the metal's value independently. Of course, governments were notorious for devaluing the coins in a variety of ways.
Commodity money gave rise to modern fiat monetary systems. This evolution came to past after many centuries and after the introduction of paper currency. The United States ushered in the new era in 1971 when President Nixon "closed the gold window" removing the last link between the U.S. Dollar and gold. Fiat currency has its value because the government declares it to have value. Essentially, a U.S. Dollar as issued in paper (specifically, a Federal Reserve Note) is a debt of the Federal Reserve backed, not by gold or any commodity, but by a debt obligation of the U.S. Treasury (notwithstanding the other assets which the Fed has added to its balance sheet since the onset of the Global Financial Crisis).
Let's follow the circle: the U.S. Treasury issues debt (bills, notes, or bonds) which is purchased by investors such as large banks; the Federal Reserve buys Treasuries from large banks in return for freshly printed cash; this cash makes its way out to businesses and consumers via transactions with the banks; the money is used to pay taxes going to the coffers of the U.S. Treasury; and, finally, the U.S. Treasury repays the Federal Reserve on its debt obligation ending the circle with the destruction of the currency. This process is how our money derives its value. This complex circuit is important, but it does not tell the entire story. Much of this process is digital. Who pays their taxes by sending paper currency to the IRS? No one. Bank accounts are increased and decreased digitally by computers throughout this entire circuit.
This is where it gets interesting. Throughout this process, the various entities may also use credit as money. When someone uses a credit card or receives a loan, cash is usually not involved in the transaction. And, as most everyone knows, in our system of fractional reserve banking, banks can and do extend credit beyond their cash reserves. The typical example of how this works goes something like this: Joe deposits $1000 with Bank ABC; Bank ABC then lends $900 to Jane maintaining $100 in reserves; Jane spends $900 at the store who deposits the cash with Bank XYZ; Bank XYZ lends $810 to Jack (keeping 10% or $90 in reserves; ... and so on. This process expands the money supply without the issuance of new cash. Jack still has $1000 which he can spend on goods and services. But, Bank XYZ also has $810, and everyone else on down the chain. The size of the reserve requirement will determine how much money is created via bank credit. If the reserve ratio is 10%, then this process would ultimately create $9000 if exhausted completely.
However, this is not how the real world actually works. This is the important part of the story. Banks do not wait to receive deposits before they lend out new money. A bank does not need to physically have $250,000 on hand (in cash or even in assets) to issue a loan of such size on a house. If a bank issues such a loan, they simply need to ensure they meet their reserve requirement which can be done by receiving a loan from another bank. This chain ultimately goes bank to the large privileged banks who can access funds directly from the Federal Reserve. The Fed is ultimately reacting to this credit creation cycle in its operations with these banks (as described above). If you want to read more about how banks defy common wisdom and create credit out of this air, visit George Washington's Blog and read this and this.
We've already established that credit is, in effect, money. It does not behave significantly different than cold hard cash. Many economists and fiscal conservatives have rightly criticized the Fed and its expansionary monetary policy. But, what is lost in the argument is that the private banking system has been expanding credit for decades. They have been free to do so via the implicit rules and policies of a fiat-currency, fractional-reserve system. The implication is that the money supply, and its impact on inflation, must be analyzed from the perspective of credit expansion - not the expansion of the Fed's balance sheet. The Fed has tried desperately to stave off deflation by "printing money" to buy all sort of dubious assets and monetizing the federal deficit. But, this has had little inflationary impact. Why? Banks are still not expanding credit.
Let's analyze this a little deeper. Why are banks not expanding credit? Largely because consumers are not willing to take on more debt. We have hit the wall. We have had our inflation moment. As we pay down debt (or default) and credit is destroyed, we will experience deflationary forces. Admittedly, this is not the whole story. The international perception of the Dollar is still a major factor in the inflation/deflation debate. But, with the financial challenges of Europe, a Japanese economy which has been stagnant for more than a decade, and no other major economies ready to challenge, the Dollar will reign supreme in the interim.
But, there is another problem with all of this. The banks do have a money tree. They have an implicit license to print money. Sure, they cannot literally print money. But, is this still not counterfeit? Is this still not fraud? They make money on this process by collecting interest. I ask my readers to consider this carefully and study the evidence. If the banking system is engaging in a process that is tantamount to counterfeit, what should be done? This is hardly an example of free-market enterprise. The next time that you begin to reflexively defend banks against reform, vilification, and other abuses in the spirit of free-market capitalism, ask yourself if they deserve such a defense or if they are essentially nothing more than a rouge arm of the Federal government.
I'm not talking about compounding interest either. I'm talking about creation of money right out of thin air. It is well known and understood that the Federal Reserve (and other central banks) print money at will. What's not so well understood is that regular commercial banks essentially do the same thing. To understand this, we have to explore the nature of money, credit, and the modern banking system.
Money can be described in several ways and has a variety of characteristics.We should begin with the Merriam Webster definition: "something generally accepted as a medium of exchange, a measure of value, or a means of payment." In early simple economies, barter was the principle means of exchange. This ultimately evolved to commodity money. Items which had a useful value on their own, are easily transportable, do not lose value or deteriorate, and are reasonably commonplace would serve as commodity money. Over the centuries, metal coins evolved out of being simple commodity money into serving as government issued currency. Generally, the metal coins face value as issued would be equivalent to the metal's value independently. Of course, governments were notorious for devaluing the coins in a variety of ways.
Commodity money gave rise to modern fiat monetary systems. This evolution came to past after many centuries and after the introduction of paper currency. The United States ushered in the new era in 1971 when President Nixon "closed the gold window" removing the last link between the U.S. Dollar and gold. Fiat currency has its value because the government declares it to have value. Essentially, a U.S. Dollar as issued in paper (specifically, a Federal Reserve Note) is a debt of the Federal Reserve backed, not by gold or any commodity, but by a debt obligation of the U.S. Treasury (notwithstanding the other assets which the Fed has added to its balance sheet since the onset of the Global Financial Crisis).
Let's follow the circle: the U.S. Treasury issues debt (bills, notes, or bonds) which is purchased by investors such as large banks; the Federal Reserve buys Treasuries from large banks in return for freshly printed cash; this cash makes its way out to businesses and consumers via transactions with the banks; the money is used to pay taxes going to the coffers of the U.S. Treasury; and, finally, the U.S. Treasury repays the Federal Reserve on its debt obligation ending the circle with the destruction of the currency. This process is how our money derives its value. This complex circuit is important, but it does not tell the entire story. Much of this process is digital. Who pays their taxes by sending paper currency to the IRS? No one. Bank accounts are increased and decreased digitally by computers throughout this entire circuit.
This is where it gets interesting. Throughout this process, the various entities may also use credit as money. When someone uses a credit card or receives a loan, cash is usually not involved in the transaction. And, as most everyone knows, in our system of fractional reserve banking, banks can and do extend credit beyond their cash reserves. The typical example of how this works goes something like this: Joe deposits $1000 with Bank ABC; Bank ABC then lends $900 to Jane maintaining $100 in reserves; Jane spends $900 at the store who deposits the cash with Bank XYZ; Bank XYZ lends $810 to Jack (keeping 10% or $90 in reserves; ... and so on. This process expands the money supply without the issuance of new cash. Jack still has $1000 which he can spend on goods and services. But, Bank XYZ also has $810, and everyone else on down the chain. The size of the reserve requirement will determine how much money is created via bank credit. If the reserve ratio is 10%, then this process would ultimately create $9000 if exhausted completely.
However, this is not how the real world actually works. This is the important part of the story. Banks do not wait to receive deposits before they lend out new money. A bank does not need to physically have $250,000 on hand (in cash or even in assets) to issue a loan of such size on a house. If a bank issues such a loan, they simply need to ensure they meet their reserve requirement which can be done by receiving a loan from another bank. This chain ultimately goes bank to the large privileged banks who can access funds directly from the Federal Reserve. The Fed is ultimately reacting to this credit creation cycle in its operations with these banks (as described above). If you want to read more about how banks defy common wisdom and create credit out of this air, visit George Washington's Blog and read this and this.
We've already established that credit is, in effect, money. It does not behave significantly different than cold hard cash. Many economists and fiscal conservatives have rightly criticized the Fed and its expansionary monetary policy. But, what is lost in the argument is that the private banking system has been expanding credit for decades. They have been free to do so via the implicit rules and policies of a fiat-currency, fractional-reserve system. The implication is that the money supply, and its impact on inflation, must be analyzed from the perspective of credit expansion - not the expansion of the Fed's balance sheet. The Fed has tried desperately to stave off deflation by "printing money" to buy all sort of dubious assets and monetizing the federal deficit. But, this has had little inflationary impact. Why? Banks are still not expanding credit.
Let's analyze this a little deeper. Why are banks not expanding credit? Largely because consumers are not willing to take on more debt. We have hit the wall. We have had our inflation moment. As we pay down debt (or default) and credit is destroyed, we will experience deflationary forces. Admittedly, this is not the whole story. The international perception of the Dollar is still a major factor in the inflation/deflation debate. But, with the financial challenges of Europe, a Japanese economy which has been stagnant for more than a decade, and no other major economies ready to challenge, the Dollar will reign supreme in the interim.
But, there is another problem with all of this. The banks do have a money tree. They have an implicit license to print money. Sure, they cannot literally print money. But, is this still not counterfeit? Is this still not fraud? They make money on this process by collecting interest. I ask my readers to consider this carefully and study the evidence. If the banking system is engaging in a process that is tantamount to counterfeit, what should be done? This is hardly an example of free-market enterprise. The next time that you begin to reflexively defend banks against reform, vilification, and other abuses in the spirit of free-market capitalism, ask yourself if they deserve such a defense or if they are essentially nothing more than a rouge arm of the Federal government.
Check This Out
Well, it's been another long hiatus. But, check it out: new site design! Hope you like it.
As for content - I don't have anything of my own to post, but I'd like to invite you to read this post over at Oftwominds. I'm a fan of this blog as the author, Charles Hughes Smith, posts on a variety of subjects from economics/finance, self-help/survival, social evolution, food/health, etc. This particular post provides a detailed look at the economy and the way forward. He's a short-/mid-term dollar bull while bearish on the overall economy. It's chock-full of links to some of his own articles as well as a few other blogs.
As for content - I don't have anything of my own to post, but I'd like to invite you to read this post over at Oftwominds. I'm a fan of this blog as the author, Charles Hughes Smith, posts on a variety of subjects from economics/finance, self-help/survival, social evolution, food/health, etc. This particular post provides a detailed look at the economy and the way forward. He's a short-/mid-term dollar bull while bearish on the overall economy. It's chock-full of links to some of his own articles as well as a few other blogs.
Quick Thoughts on Chartalism
Chances are that you've never heard of chartalism (unless you arrived here because you Googled the word). I've been reading an increasing number of articles which argue certain points which are central to the economic theory of chartalism. This theory is centrally focused on characteristics of a fiat currency regime. The basic assumptions and conclusions are sound although I have not studied it enough to have a fully informed opinion. Further, I disagree on principle with some conclusions on the surface level.
So what is it all about? Basically, the chartalists suggest that the state issues fiat currency via government spending and recoups (destroys) the money via taxation. Thus, fiat issue is no more than printing money and, if the government did not do so, there would be no money for citizens. This extends to a conclusion that the private sector cannot save money unless the government runs a deficit. This is further shown by using simple algebra with the formula for GDP. This reinforces the argument of the adherents.
I see a few basic flaws in this theory. First, if there were no fiat money, that would not destroy economic activity. There would be, at a minimum, barter activity. Second, it seems to ignore debt (or at least under-appreciate its role like most all schools of economic thought). Since private banks issue credit, the state is not the only entity which can issue currency (depending on one's definition).
Nonetheless, this is important. Governments can and do print money. The U.S. Dollar is essentially backed (primarily) by U.S. Treasuries. In other words, the value of the Dollar is derived by the use of it to pay government debt. The point remains that next time you find yourself in a debate about the nature of the state and deficit spending, one can not summarily dismiss the notion that deficits don't matter or the suggestion that the U.S. will not default on its debt. There are shades of gray to this. Again, I don't completely agree with all the assumptions or conclusions of this theory. But, well-informed (and sometimes even well-intentioned) adherents will make good points - specifically that this theory is sound due to its identity relationship from the GDP math.
One of the main goals of Stop Taking Soma! is to educate and inform. Shouting matches between ideological opponents and semi-informed debate participants are a problem in the political environment. If libertarians (small "l" or big "L") or other marginalized political (or economic) groups fail to understand the perspective of our opponents, we will risk continued marginalization and be reduced to nothing more to uninformed noisemakers.
For more on chartalism and its post-Keynesian cousin circuitism, visit the forum on Steve Keen's blog and read this thread. (Full disclosure: I have not yet read it.)
So what is it all about? Basically, the chartalists suggest that the state issues fiat currency via government spending and recoups (destroys) the money via taxation. Thus, fiat issue is no more than printing money and, if the government did not do so, there would be no money for citizens. This extends to a conclusion that the private sector cannot save money unless the government runs a deficit. This is further shown by using simple algebra with the formula for GDP. This reinforces the argument of the adherents.
I see a few basic flaws in this theory. First, if there were no fiat money, that would not destroy economic activity. There would be, at a minimum, barter activity. Second, it seems to ignore debt (or at least under-appreciate its role like most all schools of economic thought). Since private banks issue credit, the state is not the only entity which can issue currency (depending on one's definition).
Nonetheless, this is important. Governments can and do print money. The U.S. Dollar is essentially backed (primarily) by U.S. Treasuries. In other words, the value of the Dollar is derived by the use of it to pay government debt. The point remains that next time you find yourself in a debate about the nature of the state and deficit spending, one can not summarily dismiss the notion that deficits don't matter or the suggestion that the U.S. will not default on its debt. There are shades of gray to this. Again, I don't completely agree with all the assumptions or conclusions of this theory. But, well-informed (and sometimes even well-intentioned) adherents will make good points - specifically that this theory is sound due to its identity relationship from the GDP math.
One of the main goals of Stop Taking Soma! is to educate and inform. Shouting matches between ideological opponents and semi-informed debate participants are a problem in the political environment. If libertarians (small "l" or big "L") or other marginalized political (or economic) groups fail to understand the perspective of our opponents, we will risk continued marginalization and be reduced to nothing more to uninformed noisemakers.
For more on chartalism and its post-Keynesian cousin circuitism, visit the forum on Steve Keen's blog and read this thread. (Full disclosure: I have not yet read it.)
Cool Trilemmas
I'll admit that my vocabulary did not contain the word "trilemma" until a few weeks ago. It's a natural extension of the commonplace "dilemma" where we have three options. Then, in a span of no more than days, I was exposed to two interesting trilemmas.
The first trilemma that I would like to introduce is the so-called "Impossible Trinity". This hypothesis states that a national economy can only achieve two of the following three characteristics: a fixed exchange rate, free capital movement, independent monetary policy. A nation with a fixed exchange rate is able to maintain a stable currency as it relates to the rest of the global economy. China, for example, maintains a fixed exchange rate by pegging its currency to the U.S. Dollar. Nations with free capital movement allow goods and services to be (relatively) freely traded by private citizens across borders without significant taxes or other restrictions. This is a common feature of globalization. Finally, independent monetary policy implies that a nation's banking system (usually via the central bank) can set interest rates and manage the supply of money without outside interference.
This trilemma is an important one to understand (and I think it is generally accurate) in the context of global political economy. Using the China example again, it is clear that as they open up their economy to freer movement of capital, they have to cede monetary authority in order to maintain their fixed exchange rate. This is one major factor in the accumulation of U.S. debt by China. If they wanted to exert a more independent monetary policy, they would either have to be more restrictive in managing capital flows (i.e. less exports to the U.S.) or abandon their fixed peg to the Dollar.
The second trilemma comes courtesy of Dani Rodrik, a Turkish economist at Harvard. Rodrik suggests that the world economy is subject to the following: we cannot simultaneously achieve a deeply integrated global economy, maintain national sovereignty, and operate democratic governments. We can only achieve two of the three at any time. This argument appears to hold true. If we want advanced globalization while maintaining the nation-state, governments would have to forgo much domestic policy - national policy would be focused on policies which enable global economic integration (this appears to be the general direction today, in my opinion, fueled by financial elite corporatism). The second choice would be to pursue globalization while protecting democratic principles. Such an option would require a global government which could act in the interest of the entire world under a democratic framework. Third, we could maintain democratic government and national sovereignty while settling for less global economic integration. Rodrik suggests that this is what the Bretton-Woods system sought to achieve.
So, in summary, trilemmas provide cool thought experiments. These two are interesting and are good to keep in mind when attempting to understand the working of the global political and economic system.
The first trilemma that I would like to introduce is the so-called "Impossible Trinity". This hypothesis states that a national economy can only achieve two of the following three characteristics: a fixed exchange rate, free capital movement, independent monetary policy. A nation with a fixed exchange rate is able to maintain a stable currency as it relates to the rest of the global economy. China, for example, maintains a fixed exchange rate by pegging its currency to the U.S. Dollar. Nations with free capital movement allow goods and services to be (relatively) freely traded by private citizens across borders without significant taxes or other restrictions. This is a common feature of globalization. Finally, independent monetary policy implies that a nation's banking system (usually via the central bank) can set interest rates and manage the supply of money without outside interference.
This trilemma is an important one to understand (and I think it is generally accurate) in the context of global political economy. Using the China example again, it is clear that as they open up their economy to freer movement of capital, they have to cede monetary authority in order to maintain their fixed exchange rate. This is one major factor in the accumulation of U.S. debt by China. If they wanted to exert a more independent monetary policy, they would either have to be more restrictive in managing capital flows (i.e. less exports to the U.S.) or abandon their fixed peg to the Dollar.
The second trilemma comes courtesy of Dani Rodrik, a Turkish economist at Harvard. Rodrik suggests that the world economy is subject to the following: we cannot simultaneously achieve a deeply integrated global economy, maintain national sovereignty, and operate democratic governments. We can only achieve two of the three at any time. This argument appears to hold true. If we want advanced globalization while maintaining the nation-state, governments would have to forgo much domestic policy - national policy would be focused on policies which enable global economic integration (this appears to be the general direction today, in my opinion, fueled by financial elite corporatism). The second choice would be to pursue globalization while protecting democratic principles. Such an option would require a global government which could act in the interest of the entire world under a democratic framework. Third, we could maintain democratic government and national sovereignty while settling for less global economic integration. Rodrik suggests that this is what the Bretton-Woods system sought to achieve.
So, in summary, trilemmas provide cool thought experiments. These two are interesting and are good to keep in mind when attempting to understand the working of the global political and economic system.
Twenty-Five Days
Well, it looks like it's been twenty-five days since my last post. That's pretty bad! My excuses aren't necessarily that great, but it's been a combination of three factors: a) busy work/personal life stuff, b) getting more up-to-speed on local issues/politics, and c) reading some books.
In the meantime, Sen. Evan Bayh (D-IN) announced that he would not run for re-election. This was a bit of a surprise and big news here in Indiana. Bayh timed his announcement well with clear knowledge that no Democrat would be able to get enough signatures to have ballot access in the primaries. This will allow the party insiders to choose the candidate rather than the electorate.
I truly do hope to post more regularly going forward, but I am undecided on how I plan to focus my efforts. I have some desire to focus on more local issues - especially as the 2010 election cycle ramps up and I get more involved with the local LP. This blog may not be the best outlet for that. The national/global/economic scene always interests me, but I probably won't churn out content as frequently and would prefer to focus on analytically-driven essays rather than the news cycle.
I'm open to all comments, feedback, and requests... I'd like to thank everyone who frequents the site and enjoys my ramblings.
In the meantime, Sen. Evan Bayh (D-IN) announced that he would not run for re-election. This was a bit of a surprise and big news here in Indiana. Bayh timed his announcement well with clear knowledge that no Democrat would be able to get enough signatures to have ballot access in the primaries. This will allow the party insiders to choose the candidate rather than the electorate.
I truly do hope to post more regularly going forward, but I am undecided on how I plan to focus my efforts. I have some desire to focus on more local issues - especially as the 2010 election cycle ramps up and I get more involved with the local LP. This blog may not be the best outlet for that. The national/global/economic scene always interests me, but I probably won't churn out content as frequently and would prefer to focus on analytically-driven essays rather than the news cycle.
I'm open to all comments, feedback, and requests... I'd like to thank everyone who frequents the site and enjoys my ramblings.
