Friday, February 27, 2009

Money as debt

I get a big kick out of debunking conspiracy theories. Whenever a new one pops up, I delight in the websites that spawn to take every last claim down. I love Respectful Insolence for amazing posts on anti-vaccinations nonsense, Bad Astronomy for the moon landing, Debunking 911 for the truthers, and talkorigins for creationism. I've spent hours at each of these sites; on talkorigins and Debunking 911 I've read almost every article. It's just a big kick for me to see an expert demolish an arrogant novice.

How can I help but follow in their footsteps when I see a conspiracy theory about my area of expertise?

Money As Debt is a roughly 45-minute presentation that attempts to explain what is wrong with our current monetary system, how it will inevitably lead to disaster, and what to do about it. It is riddled with silly basic errors, made-up evidence, and falsified quotes. It contains almost no citations for any of the arguments it presents. It pretends that it is the only game in town, that economists are completely ignorant of money. And it finally devolves into an outright unsubstantiated, nonsensical, conspiratorial claim about evil international bankers.

It's a real hoot.

Interestingly, it starts out ok. It explains fractional reserve banking, how most of the money supply is created by bank loans, and how runs on banks can lead to harmful deflation.

For those of you not keeping track at home, it works like this. There is a monetary base (M0) made up of hard physical currency, dollars and cents. In the United States, this is created by the Federal Reserve. This printed and coined money is distributed to the population through Open Market Operations and lending to banks.

Individual banks cannot print money, but they can create money by lending. When you deposit money in banks, they don't let it sit in a vault; they lend it out. This process creates money--most of the money invested in banks isn't physically there, even though you never notice when you withdraw from your checking account. This is because banks have to keep some amount of reserves in their vaults. In the United States, this is a required legal fraction called the Reserve Requirement (currently at 10% and not likely to change any time soon).

This all works because of scale economies. The larger a bank is, the less likely it is that it will run into the trouble of people wanting to extract more than is physically in the vault. It takes a bank run to do that, and these are rare, but extremely painful. Milton Friedman pinned the blame of the Great Depression on a series of bank runs cutting the money supply by 1/3rd, and most economists accept this as one of if not the most major cause of the Depression.

Money As Debt explains all of this more or less accurately, though its tone in these beginning stages is fairly conspiratorial. The narrator insists that classes aren't taught about where money really comes from, that the general public is wholly ignorant of this fact. The latter is true but the former is not; every standard Money and Banking or Finance Economics class teaches this fact. It is not a mystery. It is information readily available, even on Wikipedia, as you'll note that I've linked it already. Around the 41 minute mark, the video alleges that surveys of the population and economists shows that neither knows about the fact of money creation by private banks. I beg to differ. I doubt anyone could get a B.S., let alone a PhD, in economics without knowing this basic fact about our monetary system, at least not from any major accredited university. It is not a conspiracy, it is not a secret, and very few economists even think it is a bad thing. Those economists tend to be a fraction of a minority view (Austrian economics). There's no need to go into this debate except to note that it usually takes the form of a property rights debate, rather than the bizarre direction Money As Debt takes it. (See ie here.)

So this is all accurate but with some caveats so far. The narrator goes into the history of banking, which is roughly accurate. I can't fault him for telling a simplified story, but the anthropological and historical evidence on this front is really interesting, especially the repeated patterns of coordination of types of money and the original causes for the popularization of banks. (Highway robbery is among them!) Again, the tone is still annoyingly conspiratorial, as if people weren't willingly contracting with bankers the entire time, as if being in debt isn't good for people sometimes, as if expected value of future goods were completely irrelevant in the production process. But more of that in a minute.

Around 24 minutes in, the video launches into its real point (and real mistake). "Perpetual debt!" it proclaims. The bankers not only lend out money they don't have, but they charge interest on those loans! So you're paying for the use of money that they don't even have, and here's the kicker: the only way to get the money to pay for the interest is to go back to the original money supply, which then gets deposited into banks, which then gets loaned out. . . and the cycle continues forever until there's a massive economy-destroying crisis with bread lines and monsters eating the planet and the bankers OWN EVERYONE FOREVER!

I can't help but describe this hypothesis in mocking language, because it is a true howler on every level. And the mistakes are so many I hardly know where to begin. So I'll just start from the ground up on the most obvious point: the creators of this video have NO IDEA what interest is.

And there's a lot of debate on that point, considering the different objects interest applies to. (In classical economics, "interest" referred to the rents payed to anything; wages are interest to workers, rent is interest to landowners, etc.) But referring specifically to the interest charged by banks, a non-controversial and brief explanation is that the interest rate is the price of future goods relative to the price of present goods.

Human beings tend to have this thing called a discount rate. We discount the value of future consumption relative to present consumption. For example, even if it were 100% certain that I could make this deal happen, would you rather I promise you a candy bar now, or a candy bar exactly one year from now? Most people answer that they would prefer a candy bar now. Now if I were to ask how much you would pay for a candy bar right now, versus how much you would be willing to pay for the 100% guaranteed right to a candy bar a year from now, the difference in prices that you tell me is your current annual discount rate on candy bars.

Virtually everyone prefers present consumption to future consumption, but their discount rates vary. Some people are more patient than others--they have low discount rates. Some are very impatient and want consumption now, future be damned--they have high discount rates. Loans are then voluntary intertemporal trades between these two groups. And interest rates are the price of that trade. If I'm impatient and want to consume now, I can take a loan from someone who is patient and wants to consume later. Since the transaction is voluntary, it is good for both of us. If the interest rate were so high that it wasn't below my discounted value of future goods, then I wouldn't take out the loan.

So how, then, do we pay for interest? Is it by going back to the original money supply, over and over, so that it is a self-selecting cycle and we are forever in debt? Emphatically not! In truth, people use loans not usually for current consumption of goods like televisions or furniture (though this does happen, and these people get badly burned), but for current investment. And if that investment pays out, real goods and services are created. And the money gained from those real goods and services is what borrowers use to pay off their interest rates--and still have some left over, hopefully!

The creators of Money As Debt make it quite clear that they don't understand a lick of this. An interest rate is a price on an IOU, how absurd! A price for something that doesn't exist yet! If you offered me an IOU for a hammer you didn't have, I wouldn't pay you a penny for it is the example it gives. But what if I offered you an IOU for a hammer that you fully expected me to have in the future? If you valued that hammer in the future, why wouldn't you pay me for it?

Money As Debt mentions, at one point, that some have offered "risk to the lender" as an explanation for interest and then quickly dissmises it, but this is not what interest is. Risk does play a factor--the expectations of the lender about the borrower's future income is incorporated into the interest rate. And if a lender has very low expectations, they may refuse a loan or charge an exorbitantly high interest rate. But even in a world of 100% certainty, interest rates would still exist.

The original money supply is mostly irrelevant in this scenario (with a caveat at the end of this entry). The value of a dollar is not intrinsic--it is determined by the amount of goods and services it can purchase. Hence inflation. If the amount of money increases without an equivalent increase in production, a greater number of dollars can only buy the same goods and services, and its value decreases. So we are not stuck forever trying to pay off interest to banks using a failing dollar. Money As Debt decrise inflation as a tax, but inflation is actually great for borrowers and bad for banks, as I'll explain at the end of this post.

MAD alleges that banks can continue to lend on into infinity, and that lending->money supply->lending creates an infinite cycle of debt. It claims that there is no effective limit on banks' money creation ability. This is poppycock. There is a monetary base (M0, mentioned earlier) and a money multiplier created by banks. The cycle ends there. Banks cannot print new money; in the United States, the Federal Reserve has this sole responsibility. The maximum amount of money that can be multiplied on any initial stock of the monetary base is given by 1/R, where R is the reserve requirement. So, since our reserve requirement in the U.S. is 10% (1/10), the maximum amount of money that can be created through the printing of any one dollar is $1/.1 = $10. Here you can find a derivation of the maximum money multiplier. The actual value of the multiplier is determined by the velocity of money--the speed at which it changes hands, or the amount of money that ends up back in banks. The actual multiplier is never as high as the maximum value.

Money As Debt puts forth the completely absurd hypothesis that the government could replace all of its tax policy by an equivalent increase in the inflation rate and make the same amount of money. It's true to a point, but becomes so completely false so quickly that it's only worth mentioning as an example of how not to do economics.

Remember how I said that expectations about the future make their way into interest rates? Expectations about inflation and deflation do as well. If I expect 3% inflation in a year, and I normally charge interest at 2%, I will now start charging interest at 5%. This is because the value of the dollar is going to be decreased by 3%, so to get 2% real interest I have to add in the inflation rate. Likewise, I would subtract deflationary expectations from new loans. The same is true for other prices--the competitive equilibrium is for prices to be adjusted according to inflation or deflation. If the government all of a sudden, without any warning, switched all of its financing by tax into financing by inflation, for one period (and not a very long one at that) the two would be equivalent. But if the population expected this to happen--if the government announced it a month beforehand, or they just had extremely good predictive power, or whatever scenario you can think of that puts expectations in people's heads--the government would raise zero revenues when it made the switch. This is because the true value of the dollar would already be accounted for in prices, so the room for the government to subtract value would have disappeared.

Money As Debt points out that modern economic growth is exponential, which means it must also use resources exponentially. This is partially true, with a major caveat. Growth also includes technological growth. When we creatively learn how to produce more products with fewer resources, it doesn't necessarily follow that resource consumption must be exponential as well.

After blathering on about the evils of a monetary system based on debt, Money As Debt goes on to tell us how to fix these problems. But first it takes a silly deviation through history, a particular fascination of mine: the history of "just price" theories.

MAD points out that "usury," the charging of interest rates, has been demonized throughout history and across several cultures. The Bible insists that Israelites not be allowed to charge interest to one another. Various countries in time have outlawed charging interest, and ethical and religious scholars (especially following from Thomas Aquinas) had once conclusively declared interest unethical. In the 1600s and with the rise of mercantilism and then capitalism, this view faded out of favor. But, MAD tells us, in light of its previous analysis, we need to take their ideas seriously again and abolish lending.

But in light of the analysis that interest is the price of intertemporal trade, all of those religious scholars are ridiculously wrong. Interest is the price of a voluntary beneficial transaction, no better or worse than the price of any other transaction. No society that has outlawed interest has ever experienced the kind of exponential growth we have today. All outlawing interest ever did was keep those with high potential future human capital from ever making use of that comparative advantage. It kept poor people from starting businesses, and other people from enjoying the goods produced by those new businesses. And on the note of the wonderful growth we're blessed with today. . .

Imagine a world, MAD asks us at around 30:30, that, instead of exploiting its future capital stocks, restricted itself to consumption of current income. Wouldn't it be wonderful and sustainable? We'd only use resources we have now, and there would be no crashes or collapses or monster debt eating away at us!

Congratulations, guys, you've just imagined a world without any education. That's right: education is exploitation of a future human capital stock. The price of education is the interest rate on borrowed time, and the opportunity cost is the labor children and teenagers could be doing now. Not only that, but a world in which we survived only on current stocks of resources (without saving or investing) is nothing more than a tragedy of the commons. The nice thing about private property is that property owners are best off when they maximize expected value including future capital stocks. The tragedy of the commons what happens in the unfortunate state of collective property ownership, in which, historically, the resource is then immediately plundered into extinction. This is why there are millions of cows in the U.S. but very few buffalo. People consumed their present capital stock of buffalo without any eye to the future, and the result was abject disaster. The wonderful world MAD has imagined for us is indeed sustainable--sustainable in a steady state of permanent poverty, the destruction of all resources, and no education. It's not a happy world of investment in renewable resources. It's a hunter-gatherer society.

MAD goes on to tell us how to fix the monetary system. Should we switch back to a gold standard? No, it tells us, for a few reasons, all of which are completely laughable. First, gold systems still have problems with money tampering by the government--after all, in ancient Rome, one factor that lead to their downfall was the devaluing of gold coins by the government through shaving, mixing in of other metals, and so on. Furthermore, gold isn't very handy; it's heavy and it was always cumbersome for gold-based societies to carry coins around.

. . .

Yes, the creators of this video are so abhorrently ignorant that they haven't even studied what the gold standard is. Under a gold standard, people don't literally carry around gold coins. Paper money and metal coinage, issued by the government, is backed by a guarantee to be worth a certain weight of gold. Since people are carrying paper money, the cumbersome nature of gold coinage does not enter the problem in any way, shape or form. Since the guarantee is for a weight of gold, shaving and metal mixing do not enter the problem in any way, shape, or form. Since MAD at one point mentions the government-backed guarantee of paper money the U.S. once had under the gold standard, the creators are either lying at this point, are deeply confused, or have devolved into such conspiratorial madness that keeping that facts straight is impossible for their irrationality-addled brains. At no point did the United States, or any other country, suffer problems of gold-tampering under the gold standard.

MAD then goes on to tell us that we should have something very similar to syndicalist labor notes, with interest disallowed. In light of my previous discussion of what interest really is, it should be clear enough that this is nonsense. It's worth mentioning that throughout the video, there's an undercurrent of labor theory of value rhetoric--bankers don't actually produce anything real, nor do stockbrokers, investors, etc. The idea of labor notes clinches it, in my eyes, that the producers buy into the LTV. This post is already quite long enough without opening that can of worms, but I'll go ahead and state flatly that the marginal revolution in economics circa 1871 completely eliminated the LTV in the discipline of economics so thoroughly that no major professional economist now takes it seriously. It is as dead in the discipline as creation theories in biology. In any case, I have already explained how banks do in fact create some "real" good or service--that is, the trade of present consumption and future consumption.

Following this is the piss-poor discussion of inflation that I've already gone over. It's furthermore humorous that the creators think the interest the government pays on its loans somehow keeps it from providing more goods and services. It presently finances its current spending through a mixture of taxes and borrowing. If there were no interest--no loans--the government would not be able to pay for nearly as many goods or services, unless, of course, it raised taxes accordingly. Deficit spending is actually still payed for by taxes--taxes of future generations. The language Money As Debt uses is also inaccurate in this bit. In trying to build a picture of bankers as evil, world-owning scum-sucking charlatans, it keeps saying that banks own the government or the government pays interest to banks too. It's true that the bank pays interest to banks, but banks also pay interest to the government when they take loans from the Federal Reserve. Furthermore, the government pays interest not only to banks but anyone who lends money to it. You don't have to be a bank to buy a T-Bill. You (yes, you!) can go out and do it right now. I wouldn't recommend it in our current situation, but they're usually a pretty stable investment.

This brings us to my absolute favorite part of Money As Debt, where it drops all pretenses of being a serious presentation and straight-up says, "Hey, I'm another idiotic conspiracy theory!" The only thing missing is a dramatic accusation that "THE INTERNATIONAL BANKERS ARE THE JEWS!!!!!"

It starts with a quote:

The inability of the Colonists to get power to issue their own money permanently out of the hands of George III and the international bankers was the PRIME reason for the revolutionary war.

-Benjamin Franklin
Oooooh, Ben Franklin! He was smart! We should listen.

Actually, I was immediately suspicious of this quote. I thought it had been taken out of context. I thought it might not be about the power to "issue" money, but about the Colonists' real, physical money, that Franklin alleged was being stolen from them in the form of taxes.

But I was wrong. The quote wasn't taken out of context. It was completely fabricated. There is no reliable source of Benjamin Franklin ever saying any such thing. To be fair, it appears to be a common misattribution. But it took me three seconds of googling to find out it was a false quote. The people who made Money As Debt could spend the hours and hours it must have taken to narrate and animate this little video, but they couldn't take three seconds to google the quotes they regularly insert.

But that's not even the best part. That single quote is the ONLY piece of evidence to support the next amazing assertion, found at 40:35:
Few people are aware today the history of the United States since the revolution in 1776 has been, in large part, the story of an epic struggle to get free and stay free of control from the European international banks. This struggle was finally lost in 1913, when President Woodrow Wilson signed into effect the Federal Reserve Act, putting the international banking cartel in charge of creating America's money.
Really now? Well, that is interesting; I wasn't aware of that history at all! In fact, I'm pretty sure that settlers in the United States had no trouble using their own monies, such as tobacco, and they weren't arrested for it. But that's an interesting hypothesis anyway. Ahhh, three quick questions: 1) Who are these international bankers, 2) In what sense are they in charge of the Federal Reserve, 3) And, oh yeah, one more, what evidence is there for any of this?

The first question is answered by a graphic accompanying the voiceover about international bankers showing two shadowy figures, one saying to the other, "Anonymity is essential" (41:07). So we don't know who they are. How do we know they exist?

By what exact mechanism do they now or did in the past influence the U.S.'s monetary policy? What clause in the Federal Reserve Act says anything like, "And oh yeah, those dudes over in Europe get to determine the money supply"? They just do, apparently. The government's keeping it secret from you.

What evidence is there for any of this? Well, can't you see, man? The banks are evil, Ben Franklin (at no point in recorded history) said so! Besides, it's a conspiracy theory, and the evidence for them is hidden by definition!

Sorry folks, but this is as nonsense, balls-out crazy as it gets. As any good rationalist knows, absence of evidence is evidence of absence. If you're gonna say there's a shadowy conspiracy of international bankers controlling our money system, instead of Ben Bernanke and the board of governors making decisions, you'd better have a serious smoking gun to back it up.

And there it is. All that's left is a few quotes, and the previously aforementioned sourceless accusation that economists don't know how money is created. Money As Debt is a silly conspiracy theory that starts with a little bit of knowledge about how money is created and skyrockets downward into a mess of confusion and piffle about interest rates, the monetary system, capital, expectations, resources, and debt. A little bit of knowledge is apparently a dangerous thing.

The real issue of our monetary system:

I promised throughout this rant that, at the end, I would delve into the alleged unsustainability of a fractional reserve monetary system, including a discussion of deflation. The debunking of Money As Debt is pretty much done at this point if you're ready to duck out.

I said earlier that money is irrelevant when production is used to pay off interest, because money's real value is determined by the amount of goods and services produced, but that there was a caveat. Here it is: interest rates tend to be made in fixed contracts that don't immediately update if there is inflation or deflation. So in a sense, MAD is correct that we have to go back to the original money supply to feed our debt. If there is deflation, our wages will change (decrease) while our contract debt remains the same, leaving borrowers in a rotten position. If there is inflation, our wages increase while the contract debt remains the same, leaving lenders in a rotten position.

I already mentioned that expectations can deal with some of this problem. If people expect the inflation or deflation, they simply adjust the interest rate accordingly and go on borrowing and lending as normal. If it's unexpected, it can cause losses for banks or borrowers.

Imagine a three period model. At time T1, you take out a loan at some positive interest rate. At time T2, there is a deflation, caused by less saving in banks and more money being kept under matresses. At time T3, your wages drop accordingly, but the interest rate you have to pay to the bank is the same. Disaster for you! Is there any solution to this problem?

The obvious, #1 solution is this: inflate! If the Federal Reserve inflates the monetary base by exactly the amount the money supply has deflated, there is no problem, and it ends there. (What happens when people save more in banks again, you ask? The Federal Reserve can then deflate accordingly. They have this power through transacting in Open Market Operations and setting the Reserve Requirement.)

The less obvious solution is that banks could adjust their contracts. Since deflation is good for lenders, this isn't a likely scenario, but if the deflation is so widespread and borrowing so common that a sufficient number of people are facing bankruptcy, it could still be profitable for a bank to do this.

As I said before, a massive deflation was a major trigger of the Great Depression. So it's pretty clear from history that, if it comes to it, the Federal Reserve should inflate.

But is this sustainable? What if we have an incompetent Federal Reserve chairman? Wouldn't a deflation lead to a total collapse?

Well, it would certainly lead to a recession, perhaps even a significantly deep one. But to answer this question it's useful to have an idea about growth paths and steady states. If the money supply deflates such that borrowers are extremely screwed, the economy will reach a new growth path and a new steady state. It will not be permanently mired in recession. Borrowers will get a kick in the pants and everyone else will go on as normal. Prices will adjust, interest rates will adjust, and the deflated money supply will simply be more valuable. That kick in the pants for borrowers can really hurt, but because of the adjustment of prices, the collapse state is not the new steady state. It is an off-balance state that eventually reaches the same old steady state path when prices have adjusted and the losses from the increased debt are paid for.

MAD makes it out as if this cycle involves an inevitable permanent collapse, and I'm sure its creators are seeing the current recession as evidence of this. But a recession happens in the United States an average of every 7 years. Economists have analyzed the impact of monetary policy on recessions; you shouldn't be surprised to know that the Federal Reserve's problem is usually inflation, not deflation.

If the current monetary system isn't perfectly stable, why don't we switch to one that is?

Well, which ones are? A complete-reserve banking system would involve no money creation by individual banks. But considering that this would probably cripple investment and loans, which are Very Good Things as I've explained, economists don't usually favor it.

The gold standard (or silver standard or whatever) would solve nothing. In fact, we were on the gold standard when the money supply crashed in 1929-1932. Just replace "inflating" with "buying more gold" and you have the same thing.

Free banking, which would allow banks to compete and issue their own currencies, would sort-of solve the problem. Individuals could switch their money to a competing currency if there is inflation or deflation, keeping the value stable over time. But the bank in control of the currency suffering the deflation or inflation would surely inflate or deflate in response. With competition over the right amount of inflation/deflation/whatehaveyou, this type of system may be more stable than our current government-issued fiat currency one. Yet free banking has not survived well, historically, and even without legal tender laws we tend to see people of a region adopting only a single currency. This is an academic question that's begging for more research.

Inflation targetting would sort-of solve the problem. If the Federal Reserve aimed for 2% inflation per year, they would be obligated to massively inflate during deflationary periods and vice versa. But this is pretty much what we have now minus a little bit of discretion. Either way, it still requires effort on the part of the Federal Reserve to study money in the economy and match its output accordingly.

But to say that our current system necessarily lends itself to disaster, especially a steady-state collapse, is completely unfounded. In the United States, even with the worst economic crisis we've ever experienced, the balanced path was still lots and lots of growth.

If you want a good, non-conspiracy video about the Great Depression and deflation, watch Volume 3 of Milton Friedman's Free To Choose series.

37 comments:

Anonymous said...

While I have the impression that you've done your research and know what your talking about, you didn't quite grab me with most of your points. To be honest I didn't make it through the article, though I read parts of it throughout.

I got to your point about what loans are used for. "In truth, people use loans not usually for current consumption of goods like televisions or furniture (though this does happen, and these people get badly burned), but for current investment. And if that investment pays out, real goods and services are created."

In my opinion and experience, debt is used primarily to provide for basic living needs, such as vehicles, houses, education, etc. These are things that everybody needs and few come into this world lucky enough to be given them without incurring debt.

It makes no sense that one could profit from debt, otherwise we would all just be borrowing and investing as much as we could. It just doesn't add up. It is generally assumed that interest on bank loans will gobble up any profits on investments and then some, unless you hit on a real winner.

Perhaps I am misinterpreting what you mean by "current investment" - if so, please elucidate.

If MAD assumes a conspiratorial tone, you have certainly written a piece with some serious arrogance that, to me, wasn't quite borne out in the substance.

For myself, as always, remaining skeptical...

Swimmy Lionni said...

Hi there! Thanks for commenting. You write, "It makes no sense that one could profit from debt, otherwise we would all just be borrowing and investing as much as we could. It just doesn't add up."

Extrapolate that logic out to any other trade we make. "It makes no sense that one could profit from starting a business, otherwise we would all just be starting as many businesses as we could." "It makes no sense that one could profit from buying a car, otherwise we would all just buy as many cars as we could."

The solution to this conundrum is diminishing marginal utility. We can profit on all sorts of transactions, but not necessarily an infinite number of them, because there's not an infinite demand for what we can produce.

Your examples of basic needs that people borrow for are actually great examples of debt producing profit! People buy cars so that they can get to work. If the debt people incurred for such things were so great it ate up all the profits, there wouldn't be any money left over for anything else--so why work anyway? If the debt people incurred to get a college education weren't expected to be lower than the money they make with their degrees, why would they go to college in the first place? In truth, a college degree is often more profitable than a high school education even with student loans factored in.

As for housing, people can choose to rent instead, so they do not need a loan for this basic need. But even then, buying a house can be profitable. For one, it can appreciate in value (as most housing did until very recently). Second, there are non-monetary forms of profit; it can be profitable to raise kids in a spacious house rather than an apartment.

And think about this: Bank loans aren't the only things around that take interest. Stocks and bonds are other forms of lending, and if debt weren't profitable, it would be impossible for publically-owned companies to make any money.

Anonymous said...

Thankyou for your blog article, it is clear that the MAD film has tried to oversimplify the process of money creation. But I still don't understand why USA Govt needs to pay interest to the federal reserve bank for the money it needs to inflate the economy with in a recession. I also understand that UK and France nationalised their reserve banks after WWII, does this mean the interest they pay comes back to the govt?

Swimmy Lionni said...

The Federal Reserve Bank is, in the U.S., independent of the federal government. Even though it is technically a part of the government, neither Congress nor the president can make them inflate, cancel debts, etc. without passing a law. (A law that, one hopes, would be very politically unpopular, considering that virtually every monetary policy expert in the world agress that central banks should retain independence.) Remember also that the Federal Reserve, not congress, has the power to inflate the money supply. The government only has to pay interest to the Federal Reserve to the degree it has borrowed money from it.

To Congress, the Federal Reserve is another bank. Yes it could "control" the Fed's actions through legislation, but it could do the same for any other bank as well.

I do not know much about the UK and France nationalizations. If a bank is truly owned by the government, then yes, the government can do what it wants with the profits, including earned interest. This is trouble. Historically it's turned out to be bad news when the spenders and the money creators are the same people.

Anonymous said...

While I did not fully go through your post I have to agree with a commenter above which shows your clearly arrogant tone throughout the post.

I actually stopped reading when you denied the fact that inflation is a tax. Federal Reserve chairman Ben Bernanke acknowledged and accepted the fact that inflation IS a tax.
source: http://www.youtube.com/watch?v=lFVHlMulTPs

So credit to you for going through the trouble of writing this up and researching but I will take Bernanke's acknowledgment over your argument.

Swimmy Lionni said...

I at no point denied that inflation is a tax. I said that you cannot exchange taxes for inflation one-for-one because rational expectations reduces the amount of money government can make through taxation. This is standard economic theory; Ben Bernanke believes it as much as anyone else, and Edmund Phelps won the 2006 Nobel Prize for his account of inflation, rational expectations, and economic stimulus.

If you're willing to trust Wikipedia more than this arrogant blogger, the relevant sentence can be found in the seigniorage article:
"Ultimately, banks or governments relying heavily on seigniorage and fractional reserve sources of revenue will find it counterproductive. Rational expectations of inflation take into account a bank's seigniorage strategy, leading to economy damaging hyperinflation. Instead of accruing seigniorage from fiat money and credit most governments opt to raise revenue primarily through taxation and other means."

Alternatively, if you're looking for a much longer and authoritative explanation of the theory of rational expectations and its history, you can try this Concise Encyclopedia of Economics entry by Thomas Sargent.

Anonymous said...

I certainly won't defend MAD here, but I think things need to be changed beyond just a little tweak here or there. The entire basis for money based on debt is assuming infinite growth is possible. I will say that infinite refinement is possible, but there seems to be a finite amount of resource in terms of human survival. So maybe our system isn't in need of being discarded, but it certainly needs to be rethought in light of current circumstances. We're dealing with absolutes in terms of resource on some level. This is just simple physics and biology. You cannot live on an SUV no matter how big it is. It is downright ignorant to believe that technology will bail us out and let us keep consuming and "growing" the way we have for the last 200 years. We will reach a point in which our planet is no longer habitable, it may not be within our lifetime. Unfortunately the current socio-economic model is ushering us toward the cliff faster than we can even keep up with what's happening. So obviously it's probably time to change it so that at least we have the ability to predict futures in human survival. At this moment we are so caught up in who has what that we have lost sight of what is possible with what we've got as a whole.

Anonymous said...

I wonder if anyone actually comprehended your blog post who left a comment? It doesn't appear so. This stuff is pretty complicated, and I appreciate your ability to explain how the banking system works.

I think people are scared, and they don't understand the banking system, so they are looking to simple solutions. Stuff like MAD gives them a tidy solution since it doesn't invite the viewer to research how this stuff actually works.

I'm glad you linked to the Labor Theory of Value, which is something that really seems to drive a lot of this populist nonsense. People like the idea that their work produces value in a linear fashion. It gives credence to the universal idea that all it takes to be successful is to work really hard and riches will come your way.

Your best bet is to stop dreaming about the destruction of the economy and learn how it actually works.

Anonymous said...

Hmmm -- so Federal Reserve can print money -- correct? and who are the FED?

via Wiki --
"In the current system, private banks are for-profit businesses but government regulation places restrictions on what they can do. The Federal Reserve System is the part of government that regulates the private banks. The balance between privatization and government involvement is also seen in the structure of the system. Private banks elect members of the board of directors at their regional Federal Reserve Bank while the members of the Board of Governors are selected by the President of the United States and confirmed by the Senate."

Now we know what happened to regulations in the past 20-30 years... The banks are so deep pocketed that they managed to buy their way out of regulations and do whatever they want.

It's funny when the going gets tough -- everyone wants to be a banker (remember JPM, MS, etc...).
The root evil of our money system is the involvement of the bankers within. They will do their best to undermine any effort to govern them.

Shumi said...

Great post! Thoroughly and correctly points out all the many mitakes present in this MaD video. Just another conspiracy movie on the topic "somebody (this time - the bankers) secretly rules the world".

Also want to agree with the opinion in one of the above posts - the majority of people who posted comments have very limited (if at all) understanding of what you wrote in this post. Ideal audience for MaD-like types of movies :)

Marc said...

PART 1
Thanks for an enlightening post. The subject of money and money creation fascinates me. Over the years I have read countless business articles and watched innumerable economists and talking heads on news and finance programs pontificate about all things financial but very rarely have I come across anyone discussing where our money all comes from or where it goes. I am sure you are correct in your claim that economists are universally aware of the mechanics of money creation but I hope you will agree that they are doing a very poor job educating the public on a very important subject. Despite being a reasonably intelligent and curious university graduate I was wholly unaware of fractional reserve banking and the operations of the Federal Reserve until I was 36 years old. I always thought that loans were made from money held on deposit and that the ultimate source of all money was the U.S. Treasury. Like most people I’m sure, I honestly didn’t spend a lot of time thinking about the subject. That is until I watched Money as Debt. Although by that time I had already delved into the subject a bit, I have to confess that the presentation left a strong impression on me. Since viewing it I have attempted to educated myself further on the topic and have always been attentive to any information or opinions that would confirm or contradict its assertions. Therefore I was glad to come across your blog.

You punctured a lot of holes in MaD, and I’m grateful for the education. Yet, despite your lengthy and well-articulated critique of the presentation, I feel that you have failed to contradict its most salient point. This being that since all money is created as debt and since all loans must be repaid with interest, new money must always be borrowed into existence to facilitate the payment of that interest. Put another way, if all debts could be repaid there would be no money left in the system. This fact is independent and little related to the creation of any new wealth or services brought into existence through the industry of borrowers.

I believe the closest you get to challenging this idea is the paragraph in which you write “There is a monetary base (M0, mentioned earlier) and a money multiplier created by banks. The cycle ends there. Banks cannot print new money; in the United States, the Federal Reserve has this sole responsibility.”

OK, the Fed is the ultimate source of our money supply. But that money doesn’t just enter into the system without a price. Interest must ultimately be paid. The Fed is the Central Bank after all. Furthermore, the Fed WILL issue more money when insufficient “liquidity” demands it.

For simplicity’s sake let’s consider an example of extremes so that what I believe to be the obviousness of our predicament can be illustrated. First, let’s take the entire banking system including the Federal Reserve itself and call it “The Bank”. Now let’s consider that everyone in the country, including government, goes to The Bank to get a loan. Every penny of these loans will be put towards some productive effort, instead of into some depreciating asset like a new car or front-loading washer. As we did with the banks, let’s pool all of these loans into one huge national “Loan” with an average term of, say, 10 years at an average rate of, say, 10%. The numbers don’t really matter. Since The Bank creates both the monetary base and the money multiplier, this Loan becomes the nation’s money supply.

Lucy the Lumberjack uses her borrowed money to buy an axe and start a lumber yard. Bob the Barber puts his new money to use devising a way to cut more hair in a shorter time for a better price. Everyone else in the country also puts their loan money to productive and efficient use.

Marc said...

PART 2
The country becomes enriched with new wealth and improved services. The flood of new goods and services might have the effect of driving down prices, or it might not if the amount of the newly borrowed money flowing through the system is balanced against it. On this point I’m not sure, but then that’s not what is truly important. The real problem is that The Loan must be repaid to The Bank, and paid off within 10 years. Unfortunately, every new loan payment reduces the money supply just a little bit more and, due to the added expense of interest payments, in 6.306 years there won’t be any money left in the system to pay The Loan with. No matter what numbers you use for The Loan term or rate, there will come a time when the money runs out. All the fresh lumber and haircuts in the world aren’t going to change that fact.

So what must be done? The only solution in this system is to borrow more money from The Bank (ultimately the Fed), in order to create that which is necessary to service old debt. This new borrowing creates inflationary pressure that can only be offset by the creation of more wealth to balance it against. It’s obvious at this point in the example that the country has become trapped in a never-ending state of debt and monetary inflation. Eventually, when garages and storage units are overflowing with years of wealth accumulation (already happening?) and people can stomach no more than 5 super-efficient haircuts a day the gains in production will no longer be adequate to stave off the relentless demand of money creation. Hyper-inflation will proceed to ruin the currency and our economy will collapse. Barring exponential increases in efficiency and recycling, our environment will likely be plundered in this doomed process as well.

The fundamental problem is mathematical in nature. Any quantity compounded at a given percentage will grow in logarithmic fashion until its value approaches infinity at a rapidly quickening pace. Our entire money supply is lent to us at a rate that can be averaged. This will inevitably result in a money supply which will grow until it explodes out of control. If our inflation continues at its average historically rate of about 3.5%, it will take only 20 years for the constant creation of new debt to devalue the dollar to half of its current buying power.

It’s true that the creator of Money as Debt provided little if any evidence for a global conspiracy aimed at enslaving the world. Even the Federal Reserve doesn’t look quite so evil when you realize that it passes most of its revenue right back to the Treasury. And yet…There are definitely winners and losers in our current system, and right now those who lend are collecting an ever-growing piece of the pie at the expense of those who borrow. The system inherently brings an ever-increasing percentage of available money into the hands of lenders, who comprise a very small percentage of the population. And money buys power. Those at the top of the economic pile might not all be aware of this but they would be fools not to be, and in the final analysis how can power NOT become concentrated in a system like this? I agree that there is almost certainly no centralized conspiracy to dominate the world. Unfortunately there doesn’t need to be. Simple, individual human greed will suffice to eventually make serfs of us all. Unless lenders agree to part with their money, or a better form of money is introduced, the likely result of all this will be bloody revolution and gorillas eating our babies.

Finally, I’d like to say that there would be fewer Money as Debt videos to aggravate snarky economists if the general public could get better facts from a classroom. I really think your field needs to get off its collective rear end and find a way to inform the public about how the financial world really operates. How else will concerned citizens ever have the tools necessary to adequately confront and address the perpetual tragedy of economic crises like the one we are engaged in now?

Swimmy Lionni said...

Thanks for your comments, Marc. I'm glad you found my post informative. Hopefully this comment will be informative as well.

You're still making a similar mistake to that made in Money As Debt. You write, "all money is created as debt. . . But that money doesn’t just enter into the system without a price. Interest must ultimately be paid. . . Our entire money supply is lent to us at a rate that can be averaged."

These related thoughts are not quite accurate. Not all money is created as debt. Only some money is created in the process of loaning money. The fact that the Federal Reserve is a bank does not imply that any new money it prints enters the public as debt. If the Fed prints a dollar and gives it to a bank, that bank can lend the dollar (the money will enter the economy as debt) or spend the dollar (the money will enter the economy as a piece of paper). If the bank spends the dollar, nobody owes the Fed anybody any interest on it whatsoever.

What I tried to get across in my post is that the monetary base matters where MAD treats it as if it doesn't at all. Since the money supply is made up of the monetary base times the multiplier, MAD's insistence that multiplied money is "fake" is only half the story. The monetary base, made up of all the dollar bills and coins in circulation, makes up a large portion of the money supply as well.

The economy doesn't need a perpetual cycle of debt just to have any money at all. The monetary base is created without any debt.

Here's the first lesson: if all lending in the economy were to cease at the same time, money would not disappear. We would have less money, but not no money. We would have, exactly, the monetary base.

Here's the second lesson: if all lending in the economy were to cease at the same time (money multipler = 1) and the Federal Reserve were to print a whole lot of money at the same time--specifically, if the Fed were to multiply the monetary base by whatever the money multiplier was the day before lending stopped--there would be no change in prices.

To state it more succinctly, in math:

M = Money supply, MM = Money Multiplier, MM' = second money multiplier, pi = inflation rate

Day 1: M = M0*MM (MM > 1)
Day 2: M = M0*MM'*pi (MM' = 1, pi = MM)
Therefore in Day 2, M = M0*1*MM. No change.

MAD is centrally about the insustainability of fractional reserve banking. But because it ignores the impact of the monetary base, it is simply wrong. The money multiplier can change rapidly and there will be no complete economic collapse as long as the monetary base remains intact. Furthermore, with discretion over the monetary base, the Federal Reserve, which MAD paints as a kind of Ultimate Bad Guy, can actually prevent an economic collapse by responding to changes in the multiplier.

I know this is complicated, and you're right that economists don't do a very good job teaching it. Our illustrations rely very heavily on mathematical formulas that aren't necessarily intuitive. But perhaps we are willing to sacrifice some ease of understanding for intellectual rigor.

Money As Debt is a prime example of what happens when you drop the mathematical rigor completely, and it's a disaster. It has people thinking that all money enters the economy as debt, for instance. It fools people into thinking that real growth is entirely reliant on debt. But basic economics begins its analysis with a static monetary base, varying productive capabilities between individuals, and varying tastes, and guess what? That's all you need to get a prosperous economy with fair amounts of growth. Debt only allows that economy to be even more productive, as it allows productive capabilities to vary to a greater degree.

Marc said...

PART 1

Swimmi,
Thanks so much for your reply. Since your original post on MaD is over a year old I worried that you wouldn’t care to revisit this topic.

I carefully read over your reply a few times and then got busy doing some homework to try and verify the points you made. After all, the reason I came across this blog in the first place was to find any information that would give me hope for America’s future. You contradicted MaD’s assertion that all money originates as debt and I was very encouraged to read that. I want to believe brotha! But with all due respect the more I read about how the Fed makes money the more I feel your claim doesn’t bear out.

Apparently the Fed injects money into the economy through the temporary purchasing of treasury securities (and other securities to a lesser extent) in exchange for “new money”. This money goes into the reserves of the banking system, allowing it to be multiplied by the banks’ lending operations. So can this truly be called an interest-free monetary base? I don’t think so, because although the seller is getting fresh Fed money, the Fed is getting an interest-bearing security in return, interest which must be paid through taxation or new borrowing. Essentially, our base money is itself based upon earlier debt. That doesn’t sound right. To add insult to injury, the Fed is now paying interest to banks for their monetary base reserve deposits. (http://blogs.wsj.com/economics/2009/09/16/fed-paying-interest-on-reserves-a-primer/tab/article/)So much for debt-free base money.

Bank reserves are only part of the monetary base though. What about the rest of it in the form of cash and coins in the hip pockets and sofa cushions of American citizens? (http://www.visualeconomics.com/the-value-of-united-states-currency-in-circulation/) All this was simply converted on demand by banks from reserves on deposit with the Fed -- reserves which, as I said, were created through the purchasing of interest bearing debt obligations. Am I the only one who thinks the whole thing feels like an enormous shell game?

A curious aside; The St. Louis Fed reports that our monetary base in 2008 was valued at roughly 850 billion dollars. (http://research.stlouisfed.org/fred2/graph/?s[1][id]=AMBNS) while the U.S. Treasury claims (http://www.visualeconomics.com/the-value-of-united-states-currency-in-circulation/) that all physical currency in circulation in 2008 amounted to about the same total. So where is all of the extra money on deposit as bank reserves--money supposedly underpinning the remainder of our money supply? If M0 is defined as both currency and reserves, then something isn’t adding up. Moving on…

In defense of the stability of our money system you stated: “Here's the first lesson: if all lending in the economy were to cease at the same time, money would not disappear. We would have less money, but not no money. We would have, exactly, the monetary base.”

I have to disagree here too. Even in the absence of new lending, old lending must still be repaid until all debts are settled, and with interest. New lending is irrelevant to that point. And the monetary base will not suffice to repay it all, not by a long shot. Just take a look at the numbers:

Marc said...
This comment has been removed by the author.
Marc said...

Total U.S. money supply (M3), 2008 (estimated from graph projection): between 11 and 12 trillion dollars (btw indicating an effective money multiplier of about 7)
Historical U.S. monetary supply:
http://en.wikipedia.org/wiki/File:Components_
of_the_United_States_money_supply2.svg

GDP, 2008: about 14 Trillion dollars
Historical GDP: http://www.data360.org/dsg.aspx?Data_Set_Group_Id=230

Total U.S. debt to GDP ratio, 2008: over 350%
Historical debt burden: http://1.bp.blogspot.com/_vIR9lEpVYYw/
SsYfnEao4AI/AAAAAAAAJpI/cZdCvbpW-20/s400/public-and-private-debt-burden.jpg

Therefore, total private and public debt in 2008 must have been roughly 50 Trillion dollars, give or take a few trillion. This makes our debts about 5 times the broadest measure of our total money supply (M3). Given this, how can the case be made that money would not disappear if all debts were repaid?

Going back to the issue of whether our base money is free or not, I don’t think it really matters a great deal in the broader analysis. We are in fact already drowning in un-payable debt. And even if Bernanke cranked out cash and dropped it out of helicopters into the waiting arms of desperate American citizens, I believe we would still have a final inevitable day of debt reckoning. Due to fractional reserve banking and the perpetual issuance of government securities, there must be some real average value for the interest rate on the total money supply, even if the rate on, say, 14% of it (base money) is zero (which I don’t believe it is). Any value compounded always leads to infinity.

Just for shits and giggles, here’s a graph of our national debt over time adjusted for inflation, currently at 12.7 trillion dollars:
http://www.brillig.com/debt_clock/inflation.gif

To me this graph, as well as the monetary supply graph linked above it, appears to resemble the section of a logarithmic function right before it shoots off up the steep end of the hockey stick. I wonder if any of these graphs have ever made a similar impression upon you. And haven’t you ever wondered how our society managed to generate this stupefying level of indebtedness and sheer volume of dollars? Our population increase is nowhere near that great. Are we really generating a exponential increase in goods and services? Does any of this appear “stable”? If not, do you believe it is all due to mismanagement, or bad governance? Wouldn’t you say that it’s more likely these colossal numbers and alarming trends are the result of something more fundamental and systemic?

And finally, here’s a graph that shows the inflation-adjusted increase in after-tax household incomes between 1979 and 2005:

http://en.wikipedia.org/wiki/File:Income_gains.jpg

For me at least, this chart illustrates my previous point about the rich acquiring an ever greater share of the proverbial pie. Although many factors can account for these numbers, such as the role of education on income, I believe that the deepest underlying explanation is the flawed nature of our debt-based economic system. I completely agree with you that such a system can fosters fantastic growth, massive increases in productivity and higher standards of living. But I believe that in the long run it will all prove to be much costlier than any of us imagined.

Thanks for your patience reading all this. And please forgive me for using internet research to back up my points. I’m much too lazy to drive to the library.

Swimmy Lionni said...

Marc,

You write, "The St. Louis Fed reports that our monetary base in 2008 was valued at roughly 850 billion dollars. while the U.S. Treasury claims that all physical currency in circulation in 2008 amounted to about the same total. So where is all of the extra money on deposit as bank reserves--money supposedly underpinning the remainder of our money supply? If M0 is defined as both currency and reserves, then something isn’t adding up."

The Federal Reserve reports the elements of the monetary base every month, including money in circulation and money held as reserves, and no math is adding up wrong. My best guess is that the visualeconomics blog you linked mislabeled the monetary base as money in circulation. In any case, if money in circulation and the monetary base were the same total dollar amount--that is, if banks weren't holding any reserves--then it would be impossible to withdraw any money from the bank, as that is where their money comes from.

You also write, "Given this, how can the case be made that money would not disappear if all debts were repaid?"

The monetary base is hard, physical currency. Dollars, cents. Unless you're claiming that all banks destroy all cash made in payment of a loan, it is physically impossible for that money to disappear. In your scenario, in which the bankers are no longer lending, they would likely go out and spend that money, leaving us with cash in circulation.

The rest of your comments seem to have some confusion about the mythology of deficits. You also write, "Any quantity compounded at a given percentage will grow in logarithmic fashion until its value approaches infinity at a rapidly quickening pace." Compound interest can indeed generate vast growth. But the present value of a debt claim of infinite life is not infinite. See here.

As for the rest of the mythology of deficits, perhaps I should have written more about this in my original post, but I can't possibly do better than Lauren Feinstone's essay in Steven Landsburg's the armchair economist. Thankfully, this is available online: here!

Take the parable it teaches to heart. Interest is not all doom and gloom. The problem with the national debt is that our last few congresses and presidents have spent too damn much. The interest part doesn't worry me one bit.

Marc said...

PART 1

Swimmy,

Yes, I would claim that in the dying throes of attempted mass debt repayment, even hard currency would be destroyed. It is extremely improbable that we would ever get to that point, but it is at least theoretically possible. After all, if hard currency can be delivered to the public in exchange for a debit on a bank’s reserves, then hard currency can be returned to the Treasury for a credit to its reserves. Reserves aren’t composed entirely of hard cash sitting in private bank vaults. If that were the case, then the Fed couldn’t create reserves (base money) through open market operations. Furthermore, as a physical matter, the Treasury routinely destroys money as it becomes worn out and creates new currency to replace it. In a cash destroying scenario, the Treasury would destroy but not create.

I loved the Mythology of Deficits chapter you provided. It has changed the way I look at government deficits. One good point it makes is that irresponsible spending is to be feared. Another is that ALL money earns interest, both the money you borrow and the money you save. So as far as government debt is concerned, a dollar borrowed is a tax dollar John Q. Public gets to earn money on. In fact, applying its lessons to personal spending would suggest that people with low interest mortgages should avoid paying off any principal and use the money they would have spent investing in higher yield investments.

While I didn’t disagree with anything Ms. Feinstone wrote, I didn’t find anything there to change my mind on our national debt problem either. To illustrate her points Feinstone uses the simple analogy of a man representing the American public with $1,000 in his pocket and debts of $100. I will attempt to duplicate her analogy but using the numbers appropriate to our current financial situation. I’ll be as simplistic with interest rates as she was:

America has $1,000 (initial money supply). Its purchasing agent Big Gov spends $1,200 (National Debt) on some nice clothes. Yikes! Meanwhile, America on its own behalf goes on a shopping spree totaling $3,400 (Private Debt). America can’t pay off the $4600 tab because it doesn’t have enough money. So it must borrow from The Bank (major lenders and the Fed) at 5% interest. Unlike the example presented in The Mythology of Deficits, America doesn’t have enough money to simply set aside $4,600 to cover the interest payments, but it must make those payments nonetheless. Interest amounts to $230 the first year. Subtracting the $50/year in interest that The Bank pays America for keeping its money on deposit leaves a payment of $180/year. In six years all of America’s money will be used up making these payments.

America doesn’t have any income per se (not to be confused with GDP); it just has a money supply and it can’t afford to deflate it. So America needs to borrow that $180/year from The Bank. Of course, that money comes at an interest rate of 5% too. The Bank creates the money and puts it in its own account. In 50 years, America still has a money supply of $1000 but now The Bank is sitting on $40K in interest it generously gave itself with claims on another $53K in outstanding debt. Any increase in America’s non-Bank owned money supply necessary to meet the demands of a growing population or economic production would need to be borrowed from The Bank too. At interest of course.

Marc said...

PART 2

Now consider that America, The Bank and Big Gov are in fact a closed system (disregarding international trade here). Those who run The Bank live and spend in America too. And after 50 years of collecting interest payments the bankers now have over 97% of the money, minus what little they consumed. The same thing applies to every economy in the world. The entire planet is awash in debt. The amazing thing is that we owe this money to ourselves. Inflation, and debt and interest might increase the money supply, but even if all the world’s currencies went supernova like the Zimbabwe dollar, it wouldn’t really matter. After all, we could just lop a couple dozen zeros off all the numbers and be back to where we started. As I stated in earlier posts, the true “evil” of this system is that it relentlessly increases the concentration of available money into the hands of a small lending class of people. This creates inequalities and social tensions that cannot end well.

As Feinstone pointed out, irresponsible spending is the ultimate culprit. My example here is in agreement. But interest is the means by which we are forever punished for our crimes of spending. I would say that there is point of no return in our economic system if we ever spend more than we have. The global economy is like a spaceship orbiting a black hole at a distance. This can continue forever, but God forbid it should ever fly past the event horizon. Gravity, like interest, guarantees that it will never emerge again.

As I see it, our only escape is to introduce debt free money into America with which to pay off debt principal. I believe the way to do this is for Big Gov to create its own dollars and spend them into the American money supply through well-planned infrastructure creation or upkeep. The money created will be destroyed as debts are paid off resulting eventually in a debt free nation with a solid monetary base and an infrastructure that promotes good economic development.

Marc said...

Oops. In my last parable, I neglected to account for the taxation Big Gov would assess on interest gains made by The Bank. This taxation has the effect of slowing the concentration of money into the hands of the lending class, but by no means stops it.

Clay Shanks said...

Yeah... I think Marc makes some excellent points. Although, I think the key to all of this is a shift in human conciousness or some sort of singularity event.

Anonymous said...

A really helpfull article,thank you for that. But to people used to the effectfull suggestive youtube videos with added effects it may be too long to read?

How about a short-version?

Trent said...

Really great article! I was intensely skeptical of MAD, now I think the film is laughable. Great insight.

I thought I'd just add one perspective to your analysis; near the end you commented that "free banking has not survived well, historically, and even without legal tender laws we tend to see people of a region adopting only a single currency. This is an academic question that's begging for more research." I would expect this failure is due to high transaction costs; it costs time (and money?) to convert Franks to Marks or Pounds discouraging trade across borders (or between currencies). With a single currency these costs are done away with, albeit at the cost of monetary fluctuation.

krishna said...

Man you are completely off the point.

Anonymous said...

What about MADs point that we are headed for eventual collapse. You say that when there is deflation the Fed has a solution "inflate!". But how does the Fed do that? By lowering interest rates and pumping cash into subsidiary banks, right? But what about when we hit 0% interest rate, as we are at now, that lever is maxxed out. As for cash injection for banks to lend, what if people don't have an appetite for more debt? Like now?

That's the whole point. The system is sustainable as long as there is the potential for growth into new markets. But what about when all new markets have been saturated and growth comes to an end? Then the "normal" situation ends. The fed cannot reverse the deflation.

For someone who criticizes MAD as too simplistic, I think you can fathom that "if you're facing deflation, inflate! If you're facing inflation, deflate!" is far too simplistic, as well as incorrect when we exit the "normal" economic conditions.

When growth ends, the societal benefits of capitalism ends. The capitalist class (the wealthy) consolidate their winnings and achieve unassailable power. Capitalism morphs into capitalist fascism.

And with the Supreme Court subjugation of our democratic institutions in favor of money, they will achieve total control of government as well as commerce.

They control the Congress. They control the Presidency. They control the Courts.

Fathom for a moment the implications of that. What are their motives? Do they give a rat's tail about the welfare of the public at large?

THIS IS THE SITUATION WE ARE FACING NOW

Anonymous said...

I read most of the article and the comments, and I am just reassured that the movie "money as debt" is hitting the right spot. It may seem too simplistic and not into the details, but in the end after all debates it comes to this:

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."
Henry Ford

Pragmatist said...

Your post makes a number of very good points and I agree that the conspiratorial tone of MAD is annoying and adds nothing too its credibility. Unfortunately it is correct (and you are not on the main issue - creation of money. When the bank issues new debt (for interest) nobody forgoes present consumption in order to allow the borrower to fund current consumption. Instead, the value of the credit created is stolen from the holder of every other dollar in circulation by inflating the money supply.

If banks were the intermediary between those who forgo present consumption (lenders) and those who forgo future consumption (borrowers) then we would have a full-reserve banking system, which is essentially that proposed by MAD.

RogerGLewis said...

I was sent this post by a friend we have been in correspondence about various renewable energy questions.
There are conspiracy theories for everything at least as many as there are economics schools of thought there are uncomfortable parallels to both when one considers that both are belief systems and both schools of thought have what might be considered more exotic and other more rational or mainstream propositions.
Money and the monetary system is a concept and I would question the objectivity of the original post in a Kantian sense. Representing itself as a reasonable debunking of objections to Debt money I think is intellectually dishonest.
I have not seen the offending film but this blog is no less a pseudo authoritative piece of rhetoric and that is the problem for Economics its premise is client driven and the pluralities in its subjective assumptions are not sufficiently countered by a righteous sense of the fallibility of these self styled masters of the universe.
Its all really rather comical.

whaha said...

By the way, there is a revised edition of MaD that hasn't got all those unsourced quotes and far more important there is a MaD II and a Money as Debt III: Evolution beyond Money where the author explains his solution to the debt-based consumer-driven economy.

It focuses it's attention on the problem of money as a single uniform commodity and presents a system that tackles it.

Anonymous said...

Money Debt System

Lets follow the money.

- Consumer pays interest to loans that Banks does not have as Reserves. They work based on fractional Reserve. Loan 10 times the reserve holdings (just paper)

- Bank is loaned money by government - Same principle - So bank pays interest to Government.

- Government pays interest money for borrowing money from Federal Reserve. How do they pay their interest?
1. By the interest they receive from lending institutions.
2. By taxing the citizens.

Q. Where does Federal Reserve get the money?
A. They print money out of thin air.

Q. What is the basis for printing money? GOLD.
A. Who owns GOLD? Find the Answer...

Q. Why can't money be printed based on Aluminium which is plenty in natural resources? WHY GOLD? Why precious Metal? Who decides which metal is precious or Which commodity is precious?

Gotta figure out who owns Gold Mines, who decides how much Gold should be made? Who has the quantity based on which money has to be printed.

If Gold is less , use Aluminum. Whats the difference?

Anonymous said...

I was interested in your rather lengthy blog debunking "Money as Debt" until I got to the sixth paragraph your following sentence --" There is a monetary base (M0) made up of hard physical currency, dollars and cents. In the United States, this is created by the Federal Reserve." This told me that you yourself have no clue what you are talking about. The Federal Reserve does not create hard currency. The U.S. mint under the supervision of the Treasury Dept creates hard currency not the Federal Reserve. The Federal Reserve is a quasi-governmental agency made up of private for profit banks. The Federal Reserve says it best when they were sued by Bloomberg to disclose who they lent $2.1T to in 2008 during the crisis. The Fed explained that they were not required to disclose this information because they were private for profit entities, not a government agency. Therefore, I have debunked your debunking and concluded that you simply don't like what "Money as Debt" has to say.

Anonymous said...

Oh, and BTW I loved your fear that the basic premise of "Money and Debt" was simply a veiled cover for anti-semitism. If you are jewish, be careful. Don't let your defense of bankers become your tar baby.

Hju banii said...

I am glad that yo keept me ocuppied with your article.I read it with much interest!

Amber North said...

Marc is correct all money including base money is lent into existence. Notice no reply from swimmy. All money is debt and the system is dependent on ever growing debt. The quantitative theory of money is now CV=PT were C= total credit.

Paul Grignon said...

Please do some research on my website so you actually know what I am saying instead of making up your own straw men to knock down. I have "horses' mouth" sources for everything I claim and have posted an extensive analysis and logical proof I have invited hundreds of economists to refute. So far no one has. You could be the first!

http://www.moneyasdebt.net/

http://paulgrignon.netfirms.com/MoneyasDebt/Where_does_Money_Come_From.pdf

http://paulgrignon.netfirms.com/MoneyasDebt/Analysis_of_Banking.html

http://paulgrignon.netfirms.com/MoneyasDebt/twicelentanimated.html

Paul Grignon, creator of Money as Debt

Swimmy Lionni said...

Amber: I have not replied to the comments because I cannot change the minds of people commenting on this post. Might I recommend this series of blog posts?

Paul: Instead of providing refutations you won't accept, how about a public bet instead? Predictive power is the real strength of any belief, so I think this is both a faster and better avenue of resolving differences in belief.

Email me (swimmy -> gmail) and we can work out the details of

1) what you think would count as "collapse" (I take it you have something more serious than a recession in mind; if not, of course, we can't make a wager, since recessions happen for a variety of reasons.)

2) when you think it will happen

I'll even give you favorable odds. Then, when you're proven right, your analysis will look much more plausible.

If you think it's not worth it, I can happily put you in contact with a PhD economist who will be higher-status than I am and therefore a better target.

I fully subscribe to the bettor's oath.

Expatriate Tax Services said...

I agree with most of your points. Well said.