Reserved For The Future
Posted by Prof. Goose on July 20, 2006 - 12:32pm
In previous installments of what is becoming a potted series on economics, Stuart looked at interest, and I talked about demurrage, a kind of money tax that is designed to encourage long term thinking.
Some observers, on seeing the idea of negative interest/a money tax, remark that such a currency would have a hard time competing for users if it were to exist in a free market of currencies as it would be less desirable to hold than a currency that became more valuable over time.
Others point out that it's unlikely such a radical change could be brought about short of revolution. In these uncertain times nothing should be discounted but it is probably more profitable to look at less radical alternatives.
There are various other proposals for economic reform. One which I quite like comes from the New Economics Foundation, whos reports are well worth reading if you're interested in environmental/sustainable economics. James Robertsons and Jospeh Hubers 100-page book, "Creating New Money: A Monetary Reform for the Information Age", proposes some changes to our economies that could prove handy in a post peak oil world.
When I was young, I thought that money was important. Now that I am old I know it is. -- Oscar Wilde
Before we can understand this solution, we need to look at the problem.
The previous posts have dealt primarily with interest, the payment of which encourages conversion of assets into currency, and the charging of which encourages competition and growth. This is not always bad but for the case of renewable assets like forests, game reserves, farmland etc it can be problematic.
Does interest cause strife outside of clear-cutting a forest or two? Yes, it does. Last time I gave the parable of the Eleventh Round which boiled the situation down to its simplest form - when peoples money is backed by debt, paying off the interest on that debt can require either environmentally destructive expansion or for people turn on each other to get scarce currency.
The villagers ended up in this sad situation because of this part of the story:
"One more thing," the stranger added. "In one year's time I will return and I want each of you to bring me back an extra round, an eleventh round. That eleventh round is a token of appreciation for the technological improvement I just made possible in your lives."
In practice of course we don't have to show some mysterious stranger our gratitude for the existence of money. In practice, we have to service interest charges on bank loans. It may appear that this only affects people who are actually in debt to a bank, but that's not correct because at heart
Money Is Debt
Map of countries by external debt in $US, from CIA factbook, accessed April 2006.
I called that out because it's vital to understanding our problem and where we go now. The bank notes in your pocket literally represent the debt of somebody else. If everybody in the world were to pay off all their debts, money would simply disappear with a giant sucking noise.
Loans and Profits
It works this way because of how money is created. Intuitively, when the money supply needs to be increased you would expect the government to run the printing presses and minting machines to produce lots of coins and notes, which it could then spend into circulation.
In practice, only about 3% of the money in circulation was created this way. The rest was simply magicked into existence via the fractional reserve system. This system is ridiculously convoluted and not something I want to go into here, suffice it to say that new money is created mostly by commercial banks in the form of interest-bearing bank loans. These loans are not simply re-distributing wealth, rather they are based on the assumption that not everybody will try and withdraw their deposits at once. Legally, banks can therefore lend out more money than they actually have on deposit and rely on statistics to make it all work - the exact amount they can lend is governed by the reserve ratio, normally around 10% but in some cases (such as with the Bank Of England) it's not public and varies between commercial banks.
The ability to simply create money can obviously be enormously profitable, and the profit created like this is called seigniorage, defined as "The profit that results from the difference in the cost of printing money and the face value of that money." In other words, if you printed $100 at a cost of $30 (running the presses) the seigniorage profit would have been $70. Because in the 21st century money is usually issued electronically - at zero cost - this results in pure profit for the issuing institution.
It is private commercial banks keeping the seigniorage money that most concerns Robertson and Huber, and they estimate that it causes about $115 billion/year to be cornered by the private banks in the USA (about £42 billion, or 12p on income tax in the UK). They suggest that as money is a public good, the benefits from issuing it should also be used for the public good and re-allocated to the government, and they propose a mechanism for doing so in which the ancient fractional reserve system is replaced by a much simpler and more direct system.
But the injustice of the current money supply mechanism is not relevant to us here at The Oil Drum, except perhaps that a wise government could use the money to mitigate the effects of peak oil. We are more interested in questions like
Does this change improve our long term thinking? ... and ...
Does this change fix the need of our economy to constantly grow?
The latter question is especially relevant because in a post peak-oil scenario it is possible - even likely - that our economy will not be growing and actually will need to shrink. Unfortunately the money needed to pay the interest on the loans that summon money into existence requires the constant creation of yet more money, which combined with a shrinking economy will lead to significant levels of inflation - perhaps even trigger hyperinflation.
So? Does their proposal do these things? Yes ... I believe it does. Here's why.
Seigniorage reform
The basic idea is to end the system whereby money is backed by personal debt, and replace it with debt free money.
Ben Bernanke
US Federal Reserve
Currently, central banks try to control the money supply through a variety of indirect means. The ultimate lever is the interest rates charged on bank loans - as it gets higher less borrowing and therefore less money creation goes on. As it gets lower more money is created as the number of loans issued goes up.
If this sounds rather imprecise, well, you'd be right. It's widely agreed amongst economists that altering the interest rate will alter the rate of borrowing and therefore increase in the money supply. But how quickly does that take effect? And by how much? What if people don't respond rationally to higher interest rates? Answering these questions is still largely a guessing game.
Robertson and Huber propose a much simpler system, in which the central banks decide by how much the money supply should be changed according to monetary policy (the details can be found in his report and this is just a summary). If the money supply should grow (normal in a growing economy) then the new money is simply issued to the government in the form of a grant. Literally, it is summoned into existance through the will of the monetary policy committee. The government then spends this into circulation - either by using it as a form of revenue to fund public services, or simply distributing it evenly throughout the economy to avoid creating "inflation ripples". Meanwhile, the right of the commercial banks to issue debt-backed money is revoked and the supply of such money gradually phased out.
The more interesting thing is what happens if the central bank decides the money supply should become steady or shrink. Under the present system the only recourse would be to raise interest rates by a huge amount to try and compel the banks to slow borrowing - unfortunately as Stuart has demonstrated this could be rather unlucky for the poor forests (assuming a commensurate rise in interest rates for savers).
But after seigniorage reform, the money supply can be shrunk simply by either halting the flow of new money to the government (over a period of years to allow time for budgetary adjustments) and then by cancelling money raised from the economy via taxation. By using a more direct system, and by issuing money free of interest charges, there is no longer a constant need to grow the economy in order to pay back the interest on the currency. Because the people deciding how much to issue are independent of the government, the profit motive for over-issuing currency is eliminated. It becomes possible to shrink the money supply without triggering collapse.
The proposed system has many other benefits, and I've chosen to only look at economic stability in a steady-state or shrinking world. If you want to learn more I'd definitely suggest the report, it's quite easy to read even for non-economists.
The author of this post is not a professional economist. Take all this with the requisite pinch of salt.Contact
- Content: editors at theoildrum dot com
- Tech support: support at theoildrum dot com
License
This work is licensed under a Creative Commons Attribution-Share Alike 3.0 United States License.
This appears to be brilliant thinking, but I need to read the 100 page report, and I will, before responding further.
My question is: How can we convine TPTB to accept this change as it represents the loss of the present economic system of 'something for nothing'; the loss of the easy path of idle wealth from collecting interest and seigniorage?
Bob Shaw in Phx,Az Are Humans Smarter than Yeast?
The losers in the new system are private bankers, but that's OK because they would still make plenty of money - banking is a very profitable business even without seigniorage. No well run bank will go bust because of this change, especially as it would take years to phase in.
==AC
"The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was every invented. Banking was conceived in inequity and born in sin. Bankers own the earth. Take it away from them but leave them the power to create money, and with a flick of a pen, they will create enough money to buy it back again. Take this great power away from them and all great fortunes like mine will disappear, for then this would be a better and happier world to live in . But if you want to continue to be the slaves of bankers and pay the cost of your own slavery, then let bankers continue to create money and control credit."
~Sir Josiah Stamp, president of the Bank of England and the second richest man in Britain in the 1920's, speaking at the University of Texas in 1927
TPTB = the powers that be
The elite topdogs that have the greatest control and power.
Bob Shaw in Phx,AZ Are Humans Smarter than Yeast?
Methinks the greatest problem is that the whole of TPTB are NOT specific people or organisations as such, public or private, but that a lot of the insane behaviors we are witnessing comes from systemic effects.
That is, all players looking for their "obvious" immediate interests give rise to "emergent" nasty results which are NOT the goals of anyone.
There is no point trying to put all or most of the blame on these or those players in spite of the evidence that some are truly "evil".
Even the evil ones are not "in control" and most often shoot themselves in the foot in the long run.
This is just our simplistic "paranoid monkeys" strategies at work, getting rid of the "bad guys" will cure all.
NO CHANCE to nip evil by a "war" on anything.
The enemy is us!
Against stupidity the very gods themselves contend in vain.
Friedrich Schiller
Exactly! This 'humanimal ecosystem' is no different than than a comparable ecosystem in Nature, except animals compete, our topdogs can purposely choose to cooperate for advantage. Natural keystone species like lions, elephants, hyenas, crocs, hippos, etc all contend for comparative advantage; a 'tight' feedback loop develops to maintain a rough equilibrium.
The topdogs you listed above can create coalitions to vastly elevate their powers. Imagine if the real crocs and lions formed a coalition to ease their mutual harvesting of prey. The lions would drive the game into the water where the crocs are plentiful, and in exchange, the crocs wouldn't attack the lions, and share half the kill. Both get very fat and happy with a much reduced mutual effort. Of course, the wildebeest, zebras, and other animals won't be very happy about the 'team effort' results.
OPEC, and the TX RR Commission were/are team efforts in the energy field. The IMF, World Bank, and various country federal banks could be another organization. The CFR, Bilderbergers, etc could be another. But it is next to impossible to determine how much shared cooperation exists among all these entities, over and above the mutual desire to generate profits. Recall that Jay Hanson said that wordless cooperation can be signaled by body language alone-- no records and nothing to prosecute against.
Bob Shaw in Phx,AZ Are Humans Smarter than Yeast?
If nations don't borrow their funds in transparency and provide annual financial statements, the currency plummets.
In short, no country can employ "printing presses" w/o dire consequences on the int'l stage. Use metacrawler.com or your fav search engine to query "social credit" for in depth critiques. If it sounds too good to be true...
Can I ask you a couple of high level questions?
In North America, we have two decades 'til we reach the aged population of japan. Italy and Germany are much closer. For the most part, a larger GDP affords the wages for growing labour force. By 2050, most nations will see that growth naturally extinquished. And the Main stream media (msm), politicians, pundits and especially economists must learn that Recession is NOT A DIRTY WORD.
On your second question, first past the post (fptp) electoral system in north america and the uk is the scourge of good long term planning and economic strategies. Legislators at all levels from municipal to Fed'l are always cognizant of the next Election and ramifications of their voting pattern. They face tough decisions on sustainable economies, social programs, health care, safety nets, pensions and the environment. We knew ten years ago that we had to go back to nuclear but it was not sexy to say that before ballot day.
OTOH, concensus gov't often gives bad legislation too due to lack or knowledge resources for good planning.
Deficit Borrowing in the 70's & 80's was for the most part disgusting but did serve the purpose of implementing a more social conscious agenda that was permeating the West and funded infrastructure for the Baby Boom ... schools, colleges, universities, subdivisions, plazas, urban growth in general. But you can't do it forever and few countries are following our (keynesian) lead in Canada to sock money away in the good times. We have had 8 successive annual surplus budgets and have paid down our nat'l debt by 12%. Part of our good fortune is that we are the main exporter of gas and oil to the USA and we luv it when u want to pay $12 for nat'l gas or $75 for oil when our cost of production has virtually not moved in 24 months.
There are norms for federal, state/prov & municipal jurisdictions on the acceptable level of debt to GDP and deficit to GDP. Staying within the norms on the short and medium term will allow their govt's freedom and flexibility. Long term continuation will mean currency deterioration, deferred infrastructure mainenance and/or an approaching wall of taxation or privatization of their assets.
Inflation used to save individuals and jurisdictions from bad planning. It was the grand forgiver. But that is a concept of the past. Central banks will not let us go down that path anymore. Those who try pay the consequences badly (e.g. Argentina).
There are no empirical examples of g-20 nations that abide by conventional norms of implementing fiscal and monetary policy that face a debt wall. No collapses. Not one. If a g-20 nation fell, it was due to other political circumstances ... not economic.
Some will point to Argentina. But they skoffed and long term debt agreements and went short term while increasing deficits, taxation laxness and poor tax collection. And the holders of their notes refused to renew for further terms. Expecially when Argentian ignored IMF guidance. They paid the price for their cockiness and a try at something outside the norms...
The system is a simplification of what we use today: independent central banks decide monetary policy and try to control the amount of money in the system - independent of government.
This proposal does not imply that politicians can choose how much money to pump into the economy. That decision is still in the hands of the central bankers: just as it (mostly) is today.
In fact this system is more accountable, because central bankers are merely well paid to manage the economy, there is no personal profit motive for them to inflate the money supply unlike with private bankers who are always under the so-called "moral hazard".
The report does discuss why this would not lead to runaway inflation. I suggest you read it.
Er, where did I say that? I said that because private bankers can create money they have a strong profit motive to do so, regardless of what is good for the economy.
Central bankers today try and control that via interest rates, but interest rate adjustments only indirectly affect the demand side - and banks can use other tricks to make loans more attractive again to offset the higher rates.
Central bank profit has nothing to do with this. The large profits are being made by private banks who capture the seigniorage revenue.
What an asshole. Someone offers a different view and you lump him in with David Icke [correct spelling BTW]. What kindergarten tactics...
==AC
Holy crap!!! I feel like I'm in fifth grade again...
You are either the pot or the kettle.
It was in response to this comment.
BTW
I like to be the kettle...
==AC
The American currency--paper dollars or electronic dollars credited to bank accounts--is created at will by a privately owned organization called the United States Federal Reserve.[1] The Federal Reserve creates money to lend to the US government at interest--and the US Treasury packages this debt as an "asset."
It's the current system that lacks checks and balances. Rules that once exists are broken down in the name of free markets. The collapse of the gold standard, for example. I would like to know the current M3 figures. And you only have to look at the huge twin deficit of the USA to know that the exchange system isn't working.
In the name of National security, company's traded at the New York stock exchange can be allowed to report incorrect number. [Intelligence Czar Can Waive SEC Rules. Now, the White House's top spymaster can cite national security to exempt businesses from reporting requirements http://www.businessweek.com/bwdaily/dnflash/may2006/nf20060523_2210.htm?campaign_id=rss_daily, ]
<snip> President George W. Bush has bestowed on his intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations. Notice of the development came in a brief entry in the Federal Register, dated May 5, 2006, that was opaque to the untrained eye. <end snip>
For American middle class stocks are there retirement funds. The paradigma is that in the long rum they have to up. Why would a government allow companies these hidden numbers on balance sheets? Maybe to prevent another Enron to happen?
But central banks do think about a collapse of the worldwide banking system. And in the conclusive chapter of annual report of the Bank of International Settlements they speak of a "tipping point" in the world capacity to produce oil and commodities.
<snip page 141>
Again, there are considerable uncertainties. To be more pessimistic, if the global disinflationary effects of lower-priced goods from emerging economies have been underestimated, then the consequences of the waning of this influence could also be unexpected. In addition, there is a great deal of uncertainty as to whether the world has hit a "tipping point" in its capacity to supply more oil and commodities, with the implication that prices might stay higher for longer than has historically been the case. To be more optimistic, there are still many lower-cost jurisdictions in the emerging market economies, not least central and western China, and production will eventually move there as well. And advancing technology could well compensate for the increased difficulty of finding new reserves of commodities. Yet both of these adjustment processes will take time. Given current levels of global demand, the risk would be continuing inflationary pressures in the interim. Moreover, to the extent that the credibility of central bankers has been enhanced by the earlier, fortuitous circumstances, this credibility could also be tested. It would, of course, need to be vigorously defended.
What grounds are there for believing that "imbalances" pose a threat to the optimistic view looking forward? It is not hard to identify a large number of significant and sustained deviations from historical norms in important macroeconomic variables. However, concerns about disruptive reversions to more "normal" values have to be qualified to the extent that such deviations can be explained and justified as being of a lasting nature. Unfortunately, recourse to such "fundamentals" does not seem adequate to explain either the extent or the duration of the unusual circumstances currently being observed. This leaves room for a complementary explanation: these phenomena might be linked to there having been such abundant global liquidity over such a long period.
<end snip>
And the central banks do prepare themselves for collapse.
<snip page 148>
Making such preparations in advance of trouble would complement the wide variety of other measures which have been taken over the years to improve the underlying health of financial institutions, markets, and payment and settlement systems. A more recent suggestion that merits greater attention is the possibility of setting up "off the shelf banks" in advance of difficulties. The idea is to establish a legal entity that would be able to assume, at very short notice, the vital functions of a failed financial institution and thus mitigate the knock-on effects of closure. This would be another way to limit regulatory forbearance, which has often been a problem in the past.
<end snip>
Or is this path another way to overcome check and balances?
----
Personally I don't think that USA invested money of collective retirement funds from the Netherlands or elsewhere will be paid back in the end. Beside agriculture, defense equipment, software and Hollywood, there isn't much industry left to payback. And you can't pluck a bald eagle.
Time will tell, but I know that real wealth comes from nature.
Bart Blaauwendraad
The Netherlands
A cheetah can't spend more energy on finding it's preys than it's getting from them.
[1] In 1982 the US 9th Circuit Court of Appeals ruled that:
"Examining the organization and function of the Federal Reserve Banks, and applying the relevant factors, we conclude that the Reserve Banks are not federal instrumentalities for purposes of the FTCA, but are independent, privately owned and locally controlled corporations."
JOHN L. LEWIS, Plaintiff/Appellant, vs. UNITED STATES OF AMERICA, Defendant/Appellee. 1982 No. 80-5905
Global commodities face peaks. Some are trying to meaure it. Methinx i saw one by the Ugo Bardi at the ASPO-5 english documents archive. If and when i come across it again i'll send a link to this pdf.
Unfortunately it is discussions on sustainabiity that lead to all the die-off whacko's joining the thread and their glee to see the population down to 1 billion to better sustain those commodity reserves. It can be a good discussion but their nihilistic rhetoric often taints the debate.
Warehouse receipts make good money.
Yes because when you finally understand that you truly will understand nothing at all and the world seems a much nicer place...
==AC
~Bill Clinton, 1992
"[T]he powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country, and the economy of the world as a whole. This system was to be controlled in a feudalist fashion, by the central banks of the world acting in concert, by secret agreements, arrived at in frequent private meetings and conferences.
The apex of the system was the Bank for International Settlements in Basle, Switzerland, a private bank owned and controlled by the world's central banks, which were themselves, private corporations. The growth of financial capitalism made possible a centralization of world economic control, and use of this power for the direct benefit of financiers and the indirect injury of all other economic groups."
~Carroll Quigley, Tragedy and Hope: A History of the World in Our Time (New York: Macmillan, 1966) p.324
Buy it and READ it;
http://tinyurl.com/zs3jy
But never fear. When things get bad enough for Joe average he'll find more benefit from skirting the laws and using self regulated mutul credit systems to meet his daily needs, and to find himself useful employment.
Trouble will come when the banks of the dying paradigm try to enforce their land and mining rights claims.
- Stock price volatility index
- Price of crude oil
- Implied volatility of crude oil
- U.S. Dollar Index
- Two-year Treasury bond
- An index of gold stocks
The historical series goes back to August 2001, and interestingly was going up steeply before 9/11 (and continued upwards for several weeks thereafter). It seems we've come DOWN to a plateau since the all-time high just before US forces entered Afghanistan.http://www.slate.com/id/2146153/
If you make the assertion, you should back it up, or at least explain it.
If you can't be bothered to become educated, feel free to live in a world where one government wouldn't attack anothers currency, because governments are run by polite people who act in a civil way. Because to doubt a currency war happened - either governments are to incompentent to run one, or they are too polite to do such.
And there is a documented case of the US sabotosing the software in valves that were used on a big gas pipeline. Resulted in a nice explosion.
Those are the observable things I've seen reported. I'm sure there are more....but the Jack's of the world won't bother with doing some reading.
It's long but I was amazed at how bluntly a member of the federal reserve system wrote about America's current and future financial standing.
(PDF File)
http://research.stlouisfed.org/publications/review/06/07/Kotlikoff.pdf
Demurrage already exists.
I'm sorry Mike but private banks do not have seigniorage power. Maybe I should take it up with Huber and Robertson but you're abusing the word if you call this seiginorage. Private banks do not issue currency; they loan money. There is a big difference. They central bank controls the printing press and the government (mostly) receives the profits from the issue of new currency.
When a private bank issues credit and thereby increases the amount of currency and money equivalents (eg. bank account deposits) in circulation it doesn't actually print the money.
Fundamentally the fractional reserve system is almost impossible to stop. When someone issues an IOU for X dollars they are doing essentially the same thing as a bank does when they write down in your bank book that they owe you X dollars. You don't actually think the pretty numbers on your bank statement mean anthing more than the bar napkin apon which your friend scralled I.O.U. $20 do you?
Also, the idea that society isn't being paid for this is wrong--banks pay taxes if they make profits.
Finally, that goofy court case cited above was essentially a personal injury lawsuit, which was put out of its misery expeditiously and correctly under a specific ruling about the fact that the Fed member banks aren't run, in a day to day way, by the Federal govt. Not really an indictment of the system.
However well intentioned, the economics discussions on this site tend to get very far from reality very fast. I find the site very valuable for comments on hydrocarbons--but economics here is a wasteland.
That's a subjective value statement. The reports moral argument is that money is a public good like air, and there is no reason why it should be controlled for private profit.
If you believe banks should be allowed to profit off it, simply because, that's fine but it's not an economic statement. It's an ideological one.
That's another subjective value statement ;)
It's widely agreed that our current system requires constant growth to be stable. If you have a better proposal for what to do about that, then put it forward!
The Sailorman has landed.
All will be clarified.
Or just buy my book cheap, used on Amazon.com
"Economics: Making Good Choices," 1996.
Economics is easier than biology, mainly because biologists know much, whereas economists know relatively little.
Also, contrary to the beliefs of some, you do not need to be able to do Lagrangian multipliers or Bordered Hessians to understand advanced econ.
In fact, really advanced econ is easier than the basic stuff, because it all comes down to:
"X was the first guy to say Y."
"Yes, but then Z refuted X."
"Aw, WTF, let's go out for a beer--that will maximize joint utility."
"BS: I'm a satisficer. Herbert Simon pointed out that . . ."
Yes I think you should - the usage of the word is consistent with the economic literature I've read.
You seem to be using it to exclusively mean coins and bank notes. Yes the seigniorage revenue from that goes to the government. But as the report points out, most money is no longer created physically. They claim 95% is purely electronic. It seems reasonable to use the word to describe this "minting" of cash too, except with zero production cost.
Two major differences:
For the most part the profit is based on savvy matching of funds. Lending out funds for more absolute dollars in interest than the institution is paying out in interest for its acquired funds. This is not rocket science and it is not soley the domain of the rockefellers and germans. Attempting to use the wrongful mystiques of a bygone era and premising that the big bad banks are part of a global conspiracy to screw the proletariat is stuff of fantasy. Sorry, but i'm oudda of this thread...
There are many good writings on modern applications of fiscal/monetary policy and macroeconomics.
Some is yes. That's why banking would still be profitable in a full reserve system. Some isn't.
Sorry that you read that into the proposal. I think it's really a very dry document and it could use some fantasies and conspiracies. Alas there are none, just tables of economic facts and a proposal to alter the accounting of the nation.
Maybe you could learn the true intentions of bankers from one of our "precious" founding fathers?
"If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered."
~ Thomas Jefferson
That couldn't be it, could it? Why that would be, dear I say it, a CONSPIRACY!!!! We have come so far so many laws to prevent this, right?
"When plunder has become a way of life for a group of people living together in society, they create for themselves in the course of time a legal system that authorizes it, and a moral code that glorifies it."
~Frederic Bastiat
Sorry to be the one that tells you this but we have a "legal system that authorizes it, and a moral code that glorifies it".
==AC
I just took my money/banking/theory econ course and this is right up my ally. The above statement is incorrect. Anybody can not open a bank and I ask you to prove your point if it is so easy. First off, banks are state regulated. This means you need a state charter to open. To get a state charter you must file hundreds of pieces of paper with the state gov and they will decide if you get a charter. This is where things stop most times. Any bank in the federal reserve system enjoys leverage.
Even my econ proff freely admits banks basically create money and no longer print hardly any of it. The only seniorage made by the Fed is when they purchase the cash bills from the Trez, and when they pay like $.40 a bill and it's worth $100, there's tons of money to be made!
One bank I know is a public sector specialist, the bulk of its balance sheet assets are made of 0% risk weighted assets (OECD sovereigns, and related public sector).
They feel they are running conservatively with an equity:asset ratio of 1:100. Spreads are very thin so they need the leverage to compensate. Their Basel Tier 1 ratio is above 8% so appears very conservative (the 0% risk weighting on a large part of the loan book keeps the RWA's low, raising the ratio..), and given the record of OECD public sector debt I would actual agree with that bank's mangement that they are rather conservative - OECD governments are highly highly unlikely to default. As long as the rating agencies also agree, they maintain a high rating and its all fine. :-)
Key thing to any equity:asset ratio is that it is what is in the loan book that matters! (not the leverage)
If any one is looking for a weak spot in this system, as most banks are relatively conservatively run, I would look outside the banking system.
I think Freddie and Fanny's leverage in terms of equity:assets must also be close to 1:100, and their assets are not public sector quality..
Basically banks have 2 forms of capital, "Tier 1" and "Tier 2"; following Basel rules Tier 1 must exceed 4% and total capital ("Tier 1" and "Tier 2") must exceed 8% of total risk weighted assets (i.e. loan volume - once a bank has made a loan, it is booked as an asset on the bank's balance sheet. I'll come back to the weighted part later..).
(NB In the interest of full disclosure, there's is also Tier 3 which counts to total capital, but that is basically a weird, infrequently used form of Tier 2 where the regulator decides when to default, not the bank).
"Tier 1" is the most important part here - it is basically the bank's equity and is usually very similar to the shareholder equity number on the balance sheet. You can look up Tier 1 in virtually every bank's annual report.
As a bank makes money, it builds its Tier 1, like its shareholder equity. Alternatively, there are some hybrid debt instruments which the bank can sell which can also count toward Tier 1, if a bank wants to increase its asset-issuance capacity. These instruments are basically quasi-equity, called "hybrid Tier 1". The types of things regulators looks for in a "hybrid Tier 1" instrument are non-cumulative coupons (if a bank misses a coupon payment, it does not have to make it up in the future which makes this like a dividend payment, rather than a coupon payment for a debt instrument) and no set maturity date (issuing banks can get round this with set-up coupons and call provisions, which pretty much guarantee they will be called after 5 yrs etc.). Hybrid Tier 1 will be limited to quite a low amount of total Tier 1 capital, i.e. 15%. And it is the regulator who decides whether the Hybrid Tier 1 meets its criteria to be counted as equity, or whether it is merely subordinated debt.
Tier 2 is basically subordinated debt. It splits into lower-tier 2, which is pretty much vanilla subordinated debt, and upper tier 2 which is slightly more quirky. Upper Tier 2 is basically "hybrid debt", like Hybrid Tier 1 was "hybrid equity". There are further complications caused by the fact that as subordinated debt gets closer to maturity (i.e. under 5 yrs), less of it can be used to count towards capital, and hence step-up coupons and call features are often used to allow/force the issuing banks to call them when they are 5 years from the offical date maturity. The step-ups in coupon payments are quite large, so that bond-holders know the bank will almost certainly call the debt.
Overall, the capital of a bank is made up of the share holder capital (roughly Tier 1), hybrid Tier 1 (deeply subordinated debt which looks like equity to the regulator) in addition to Tier 2 debt which is mostly vanilla subordinated debt.
The bottom half of the ratio is "risk weighted assets" ("RWA"), where individual assets (i.e. loans) are given different weightings according to their riskiness. Most corporate and unsecured consumer debt will be 100% weighted (i.e. the face value of the loan counts in full towards the risk weighted asset sum), and hence the 4%/8% ratio will count in full. Some public sector type debts may only be 20% risk weighted, hence the effective amount of capital the bank needs to use are much reduced (to 20%, i.e. 0.8% / 1.6%, because a 1bn loan will only count for 200m RWA). Residential mortgages with collateral may also have a lower ratio than 100% (i.e. 50% etc. depending on the value of the collateral). Finally OECD government debt is currently 0% risk weighted, and so it does not consume any of the bank's capital (except for a small charge associated with the market risk). The lower the risk-weighting, generally the lower the margins and the safer the debt, hence the argument is the bank would need to set less capital aside. OECD government debt is given a 0% weighting and is therefore deemed to be close to risk free, aside from a small seperate charge for market risk. However the spreads on it are quite low so it is not very profitable to compensate.
These weightings are currently being updated under Basel 2, and will therefore change after 2008.
The Tier 1 ratio is most important, and banks try to remain well above 4%. Retail banks with a secure deposit base and more predictable default patterns can afford to go lower, and often target 5-6% Tier 1 ratio. Commercial banks may prefer 7%+, and some specialist banks dealing with commercial real estate may prefer 8%+.
Hope this helps - let me know if you think any parts are confusing, or over simplified!
"The profit that results from the difference in the cost of printing money and the face value of that money."
If you think private banks "create" money in the same way, you don't understand the banking system.
The key difference between seigniorage and credit creation is that the money a private bank loans out has to be received first either as a deposit or as a loan from another bank.
The bank account statement isn't legal tender either.
I think we're quibbling over a minor point though.
Money a private bank loans out can be created via the fractional reserve - some of it must have been received either as a deposit or loan from another bank, but most of it can be created.
You are mistaken, a bank cannot lend money without first having it. They can extend credit but as soon as someone exercises the line of credit by buying something, the seller is going to be demanding payment and that is where real money is necessary to settle the transaction.
So when the bank says "here, I have loaned you $1000 and it is now sitting in your account" and behind the scenes they just adjust a number in a database, I have been saying they created money/currency. And you have been saying that they don't create money they create credit which is converted into minted money when you go to an ATM.
Right?
The thing to remember is that a bank account statement is no more money than the bar napkin IOU , or a T-bill or stock in IBM or any other fairly liquid asset. You can convert it to real money but it isn't actually money. It's a near money equivalent.
The main benefit of such a narrow banking system, when compared to one based on fractional reserve banking, would be the avoidance of credit booms and busts (M1 would be equal to M0 at all times), including the most acute form of credit busts, bank runs (why rushing to withdraw deposits if all the money deposited is always in the bank?).
Fisher, Irving (1935), 100% Money. New York: Adelphi Company.
Simons, Henry C. (1934), "A Positive Program for Laissez Faire: Some Proposals for a Liberal Economic Policy". In H. D. Gideonse, ed. Public Policy Pamphlet No. 15. Chicago
Simons, Henry C. (1936), "Rules Versus Authorities in Monetary Policy". Journal of Political Economy. (February, pp. 1-30.)
So our money is not as ephemeral as this makes it sound. Those dollar bills are very real claims on someone's land. It's diffuse, so you can't say specifically which piece of which person's land, but collectively the money is backed in this way. The money doesn't just appear out of thin air the way the author describes it.
IMO there are no good new ideas with regard to money. All the good ideas are old.
I think Hayek's proposals deserve a try, as I have suggested before.
100% reserve banking, in addition to the names cited above, was also backed by Milton Friedman back in the 1940s, long before anybody had heard of him.
Variations on the "social credit" idea go back I am not sure how far, but probably to Plato or Aristotle or one of those other old Greeks who stole all our good ideas. Plato hated money with a passion. He believed its corrupting force to be so powerful that the guardians and rulers would be allowed to touch neither gold nor silver. On the other hand, he had some much more commonsense ideas in his final book, "The Laws."
Our current system makes me extremely uneasy. It depends entirely upon the character of a few men (and hardly any women). Oh, while I think of it, the "Treatise on Money" by John Maynard Keynes is one of the most overlooked books of the twentieth century, IMO.
'The greatest principle of all is that nobody, whether male or female, should ever be without a leader. Nor should the mind of anybody be habituated to letting him do anything at all on his own initiative; neither out of zeal, nor even playfully...There is no law, nor will there ever be one, which is superior to this, or better and more effective in ensuring salvation and victory in war. And in times of peace, and from the earliest childhood on should it be fostered - this habit of ruling others, and of being ruled by others.' -- Plato
Holy crap!!! I feel like I'm in fifth grade again...
==AC
This claim interested me because it seemed to fly in the face of common sense, so I stayed up late last night researching it.
In fact it is sort of correct. More than correct ... several figures I saw thought the total value of real estate was more than the total money supply!
Yikes! How did that happen?
Dig further and you start coming across rather nasty stories about how the US housing bubble is working; then you realise that the figure claimed to be "total value of real property" is actually the total value of outstanding mortages and derivative instruments, something very different!
Some comments:
- The 100% reserve banking system, though originally designed by Simons as part of a fiat money system, is also suitable for a precious metals-based monetary system (because the fractional reserve banking system demands a lender of last resort, and the gold standard does not allow one to exist.)
- The interest issue is not really big, because after Hubbert's Peak, since real GDP Growth rates will become negative for a long time, so will real "risk-free" interest rates, and therefore there will be no financial incentive for clearcutting the forest. See Appendix for the demonstrating math.
- The 100% reserve banking system is undoubtedly better than fractional reserve banking, and will probably be the system in effect in the very long term. Its chances for implementation in the medium term, though, are nil, not the least because of vested interests. Besides, you also have to think of the transition issues. Today, the majority of Americans are deeply in debt, so they will welcome inflation that melts that debt away (can you hear them as a chorus singing to Bernanke "'flate my debt away"?). And you don't need hyper for that. Just 7% per year cuts real value in half in 10 years.
Inflation is bad for:- creditors (most of whom are foreigners)
- very poor people who were never able to take up any debt and whose income is spent mostly on essential items whose prices will rise the most.
Appendix:From the Fisher Equation of the Quantity Theory of Money, MV = Py, assuming V=1.
At t=0, let be:
y0 the real Net National Income (can be subsituted by real GDP, since we will deal with its growth rate, which will not differ substantially)
M0 the monetary stock (M1 or M2 depending on country)
P0 the price level = M0 / y0
Let's call Real Purchasing Power at t=0 what an initial amount A0 can buy:
RPP0 = A0 / P0 = A0 y0 / M0
Let that initial amount A0 be invested in a risk-free vehicle that yields a nominal interest rate NIR.
At t=n, we have:
yn = y0 (1+yGR)exp(n)
Mn = M0 (1+MGR)exp(n)
Pn = Mn / yn
An = A0 (1+NIR)exp(n)
where
yGR: real Net National Income Growth Rate (approx real GDP Growth Rate)
MGR: Monetary stock Growth Rate
How much can An buy at t=n?
RPPn = An / Pn = Ao (1+NIR)exp(n) y0 (1+yGR)exp(n) / [M0 (1+MGR)exp(n)]
RPPn = RPP0 (1+NIR)exp(n) (1+yGR)exp(n) / (1+MGR)exp(n)
Now, you want RPP to grow at a certain annual Real Interest Rate, RIR, so:
RPPn = RPP0 (1+RIR)exp(n)
From the last two equations:
(1+RIR)exp(n) = (1+NIR)exp(n) (1+yGR)exp(n) / (1+MGR)exp(n)
Taking the nth root:
(1+RIR) = (1+yGR) (1+NIR) / (1+MGR)
Now, a key concept is that to make risk-free a vehicle that yields a nominal interest rate NIR, NIR has to be <= MGR (otherwise you need to capture an ever growing share of the monetary stock).
That implies RIR <= yGR
No wonder I'm an Anarcho-Syndicalist Revolutionary!
To perhaps go to the simplest question of all - Mike's story of the "11th round" - if it were really an analogy for debt, then the villagers could give all their "rounds" back to the stranger at the start and be done with it, if they didn't like the arrangement. Or if they felt 10%/year interest was too high, one among them could loan out "squares" as an alternative with a competitive interest rate, say 5% instead. Whatever. But if they were happy with the 10% rate, there is still another alternative - happily pay the 1 round to the stranger, then sell him a chicken to get it back. Yes, you're trading chickens to a stranger in exchange for knowledge about money - but then, he is an extra mouth to feed in the community now, isn't he?
The truth is, there is no hard link between debt-backed currency and growth. Interest is just another thing you pay money for, and it goes back into the community to pay for other things like anything else. It allows growth, certainly - but it also allows declining economic activity. The money supply can grow and shrink no matter what the interest rate is. This myth of a link is, as Freddy stated up above, just one of those urban legends that seems to sweep through the internet (and life too) once in a while. It's really not an issue, and changing monetary systems would be simply a painful way to get absolutely nothing done at all on the real serious issues before us: replacing fossil fuels.
For one thing, your solution assumes the banker actually wants 10 chickens (every family would have to do that trick to pay back more than what they actually have in circulation). It's also irrelevant that a more competitive interest rate could exist - any interest at all in a closed system will cause problems because there is no way to give everybody the extra out of nowhere (except for growth or competition).
For another, central banks tend to react badly to competing currencies. We have legal tender laws to give the official currency an advantage over others. Look at what happened to the Austrian stamp scrips for instance.
And finally, I didn't write the story. The author is a man who helped designed the Euro and led a successful career as a central banker in Belgium. This man has also been named the worlds top currency trader by Business Week.
Money that is returned as interest does not leave circulation or decrease the money supply - it goes back into the money supply as deposits and reenters the economy, just like payment for anything else. Interest is just a particular kind of payment that rewards those who have accumulated assets denominated in the currency, there's nothing special about it.
Perhaps even confusion about the difference between money supply and wealth exists at the highest levels - nevertheless this whole argument is completely nonsense when you think carefully about what these different things mean.
Again I'm going to have to defer to authority - the man who wrote the story is one of the worlds top currency traders and central bankers. Do you really think it's likely that a guy who has made millions from the money system doesn't understand it?
Money returned as interest does not directly affect the money supply, and the story never claimed it did. It shows that if everybodies money is debt, then everybody must pay back interest which cannot be done with a fixed money supply. So the actors must compete - some must lose so others may win. Or the money supply can be expanded in line with GDP expansion.
That's the whole crux of the issue - if the GDP is not expanding then it is not safe to expand the money supply, and "winning" the extra money needed to make interest payments becomes more important. So society ends up with more losers.
Despite the credentials of whoever came up with the story, it shows no such thing. With debt there is always a borrower and a lender; net debt in the economy is zero (what is debt for the borrower is an asset for the lender). Therefore net interest is zero. The interest paid in the story doesn't evaporate, it goes to the lender, and remains a part of the money supply unless the lender deliberately removes it. Which the lender certainly can do, as can anybody else who, instead of using their money to trade, hoards it under a bed.
As I said, it's difficult to explain, and people come up with all sorts of poor analogies that do not do justice to it, but the simple truth is, debt-backed money does NOT have the defects you (and unfortunately many others) claim, and there is no compulsion to growth either of the money supply or of total world wealth caused by interest rates; rather, having capital available for loans enables growth - which is generally seen as a good thing. If you want to disable growth, go ahead and demolish our institutions of finance. But I don't see why that's such a great goal...
In fact, the only way out of our fossil fuels predicament is massive capital investment in new clean energy - solar, wind, nuclear. That will only happen if capital and debt markets are free to greatly expand investment.
Don you teach, so maybe you could answer this question I never got to ask in class. The way I was stringently taught, was the good ol FED does not control interest rates. They control the MS, which in turn controls the interest rate. However the more I think about this, the more BS I want to call. First off WHO says the FED doesn't directly control interest rates. I've never worked at a bank, but my proff described the NY fed as hyper nimble and able to apply the new higher interest rates asap when called on.
Now if this were true, then it would imply speed. He is saying that the NY fed starts selling bonds like crazy to take liquidity out of the system. Now this in effect causes rates to go up. While I understand the reasoning I think this is crap. It seems more direct, and rational to simply "set" the new rate. If I'm the lender of last resort, then I have the power and full control of monetary policy. I can simply tell all banks in the system that money costs 25bp higher today than an hour ago and that will work too, right?
The reason I'm confused about this is the inflation rate. Now I understand cost push etc, so I would assume that oil rising as fast as it has, in short time has contributed to inflation in a large way, but it's not going away. If the Fed has tightened the belt 17 times straight why is liquidity still so high? Going from 1% to where we are now, you would think there would be a large contraction, but there has not at least according to MAR06 M3 data. Combine that with recent discontined M3 data and this is why I come to the conclusion that maybe the S&D of money and "setting" interest rates is BS. Where did I go wrong?
I'd like to thank you for doing what you're doing, if you feel like you're shoveling shit against the tide, well, rest assured you are. but folks who think into the future must start somewhere
again thanks
The more I learn about the worlds financial system the less I like it. For instance consider the rather shady way in which Freddie Mac and Fannie Mae seem to operate. That's a US problem but really, if the American economy tanked then it'd affect everywhere very fast.