Tuesday, March 9, 2010

Ideas on Monetary Reform

By Tom Hagan (as posted on his blog)

[Includes edits entered on February 10.]

There are two basic arguments for monetary reform:

1. The present system induces an inexorable increase in inequality - the "unfairness" argument – “Them That Has, Gets.”

2. The present system is unsustainable over the long run, doomed eventually to collapse in just the kind of credit crunch we are now experiencing - the "instability" argument.

"Unfairness" is by far the weaker of the two charges against the existing system, though more easily shown. The Gini index, for instance, reveals the dramatic ascent of the US in recent years into the stratosphere of inequality. The problem is, people tend to dismiss such irrefutable evidence with some version of "The poor will always be with us", which is to say, "Inequality is inevitable".

JFK, given the argument that some upcoming legislation was “unfair”, responded with "Life is unfair." And so it is. If inequality is inevitable, why fight it? The old Andrews Sisters song says it all: inequality is inevitable, therefore we must simply bear it with a smile. Here it is - "Them That Has, Gets":


Is our present system doomed?

But if the unfairness argument can be dismissed, the argument that the system is doomed is not so easily ignored. In fact, if the instability argument can be shown to be true, then even those who ostensibly benefit from the present system will be brought up short, and, if convinced, might even join the call for reform. Something like Henry Ford deciding to pay his workers a living wage, so they could afford the cars he wanted to sell. Nowadays Wall Street bankers have convinced themselves that the unpleasantness of 2008 was caused not by any inherent instability in the system, but by various errors of judgment that can now be corrected. But suppose they believed instead that the crash in 2008 portended financial doom?

A simple thought experiment can illustrate the inevitable consequences of the present system. In recent years the benefits of increased labor productivity have flowed to the top, not out to the ever-more productive labor force still employed to produce the GDP, both here and abroad.. Average wages have stagnated, manufacturing jobs have disappeared, and bankers are getting paid more than ever. Inequality has increased. Extrapolate that out, and what happens? When the last robot is installed, meaning only capital is necessary henceforth to produce goods, and labor is needed no longer, what will happen? Who will buy the goods? The owners of capital will have enough income to purchse the GDP, but the entire former labor force will be unemployed, with no money for purchasing anything. Is that even an imaginable end-state? Isn’t it obvious even to those now reaping the benefits of the present system that the current method of wealth distribution can’t last, no matter whether it’s “fair” or not?

Forget manufacturing for the moment, and just contemplate the money system itself. “Them that has, gets” sing the Andrews Sisters. Isn’t that true? Isn’t it a common dream to acquire a pile big enough to make productive work unnecessary, enabling a life of leisure, living off “unearned income” of interest, dividends and capital gains? And once the pile is that big, doesn’t it keep growing ever bigger? Until what? Until everything is owned by one person? Again, is that an imaginable end-state? Wouldn’t society collapse long before that happened? What mechanism, short of violent revolution, prevents such a result?

“Helicopter money” to the rescue?

Many observers, from Henry Ford to Henry George, have seen the flaw of unsustainability and inevitable failure in what most of us assume to be our indefinitely sustainable system for creating and allocating wealth. Recognizing that stimulating the economy by increasing our present debt-based money supply by lowering interest rates to induce more lending might not always work once interest rates were very low, Milton Friedman and Ben Bernanke both speculated that increasing the money supply to stimulate the economy (and coincidentally redistributing wealth) could always be accomplished by printing dollar bills and dropping them from helicopters – that’s why he’s “Helicopter Ben”.

Now that the Federal Reserve can’t get the economy moving by lowering interest rates, the process has been likened, not for the first time, to “pushing on a string’. Banks, even though they can borrow money at a zero interest rate, still won’t make the loans that would end the credit crunch. Instead, they continue to sit on “excess reserves”, meaning they could make loans but won’t, until they find borrowers they trust, and are sure their loans won’t be devalued by steep deflation.

All this should trigger talk about how the present money system works, and in particular discussion of whether the current credit freeze is a manifestation of exactly the kind of ultimate instability described above: a lack of purchasing power on the part of a big chunk of the population, maybe because they have hit a debt ceiling, and just can’t afford to borrow any more. That certainly seems to be what is happening. Isn’t it time to start dropping helicopter money?

Let's issue Greenbacks instead.

True, that helicopter talk was always in jest, but there is actually some truth to it. In fact, there’s a much better way to create money and spread it around without involving the banks: have the Treasury print money, US-owned Greenbacks, and spend it into the economy for needed infrastructure. Why isn’t this being discussed? Note that the money supply increases, but US debt does not. Increasing the money supply is eventually inflationary, but only after full employment is reached will prices begin to rise. Until then, printing and spending Greenbacks does exactly what we want: increases the money supply, puts people to work, and stimulates the economy without increasing US debt or causing price inflation. So why isn’t it being discussed? At the same time, it decreases inequality. Ah, maybe that’s why talking about it is beyond the pale. It doesn’t further enrich the bankers at the expense of everyone else. Or maybe they want to avoid cracking open the door to allow government, rather than the banks, to create new money.

What caused the crash?

Which leads us back to discussing the stability of our money and baking system. Is it in fact inherently unstable? There are those who hold that it is, because in any system where banks are allowed to create money by lending it out, almost the entire money supply quickly comes to consist of the loans they make. But banks lend only principal, and what they are owed back is principal plus interest. This means they are owed back more money than exists, so the system would quickly grind to a halt, unless the banks keep increasing the money out on loan, the total debt, so enough money always exists for paying back principal plus accrued interest. So the system works as long as debt can keep increasing. But nothing can increase forever in a finite world, and the time must come when creditable borrowers can no longer be found. When that happens, the banks stop lending, and the system crashes. Banks no longer make loans, whether their “reserves” are adequate or not.

Or the banks keep lending anyway, staving off the inevitable crash by making “liar loans” to borrowers who will never pay them back. They can stave off the crash still further by packaging up the liar loans into “Mortgage Backed Securities” and selling them off to unsuspecting buyers. But eventually the loans go bad, banks start failing, and the system crashes.

Is this what is happening now? If so, the “liar loans” did not CAUSE the crash, they just allowed it to be deferred for a while, perhaps thereby making the eventual crash worse. Without "liar loans", we still would have had a crash, but sooner. Importantly, this would mean that all the “cures” based on the diagnosis that “liar loans” caused the crash can’t work – they are cures for another disease altogether. The disease can't be cured until it is correctly diagnosed.

Rebuttals to criticism of Fractional Reserve Banking

I have seen a rebuttal to this theory to the effect that no, the system can be stable because the interest paid back to the banks is not re-invested by them as loans, but is spent into the economy for goods and services. But this argument falls down if any part of the interest payment is re-lent out, and obviously that is the case in real life. So the system may crash later, but eventually it will crash.

Another argument goes that if the bank is owned by the public, so its profits go back to the body politic, then it is stable no matter what use it makes of the interest it collects. This means that a publicly owned bank like the Bank of North Dakota is fundamentally stable, whereas all of its privately owned counterparts are not. This is an intriguing idea. I would love to see it explored. How does it affect the money system in total? Suppose ALL banks were owned by the public? If a public bank practicing fractional reserve banking is stable, does that destroy the argument of the American Monetary Institute that ALL fractional reserve banking is unstable, and therefore evil?

What about the arguments against the stability of the existing system raised by the advocates of social credit? Are they obviated by public ownership of the banks?

It is truly interesting how few of these questions are ever raised by academic economists. This unfortunately gives credence to the notion that economics as it is practiced is there only to provide a fig leaf for the oligarchy, to hide what is really going on: a gradual transfer of all wealth into the hands of a few bankers. Can this be true? How can academic economists, almost all of them, blithely assume the stability of our existing money and banking system, without questioning whether it is doomed to crash?

No comments:

Post a Comment