Tag Archives: Money/Economy/Taxes

Gorbachev era Economist on History, Socialism & Healthcare

Dr. Yuri Maltsev was a member of then-President Gorbachev’s perestroika reform team. In this great interview with Radio Free Market, he corrects the generous perception historians have of Gorbachev, illustrates the flaws of Socialism, and speaks at length about the healthcare in America.

Much of the early discussion in this interview traces Dr. Maltsev’s essay (here).

What is Fractional Reserve Banking?

This is an important essay for anyone who wants to understand banking.

The first bankers were goldsmiths, who owned safes in which to store the raw materials of their profession. Wealthy individuals paid goldsmiths a fee to store their gold, and goldsmiths issued them receipts. Eventually these individuals started using the warehouse receipts as fiduciary media; meaning that rather than go to the goldsmith and redeem one’s gold in order to purchase something, these individuals started endorsing over their warehouse receipts. Thusly, the warehouse receipts circulated in the economy rather than the gold itself. Over time the goldsmiths realized that they could issue warehouse receipts in excess of the gold held in their vaults and reap a profit, because at no time did all the people who owned warehouse receipts for gold travel to the bank at the same time to redeem their certificates for gold specie. Now, the goldsmiths did not simply spend the excess receipts on consumer goods; rather, they lent them to borrowers and earned interest. (Doubtless the goldsmiths and even some economists today do not consider this practice to be fraud.) Since there now were more warehouse receipts for gold circulating in the market than gold in the vault to back them, it was said that the gold reserves amounted to only a “fraction” of the outstanding claims.

. . . .

All would be well until the public became concerned that the bank had over-issued certificates. (Sometimes rumors were started by his competitors.) Then the holders of the certificates would “run” to the bank to redeem them for gold. A bank run had been born.

. . . .

Notice that the certificates backed 100% by gold could always be redeemed without any difficulty. Thusly, such money could never be the source of inflation or deflation. But the excess certificates were not back 100% by gold; they were backed by the promise of the borrower to repay–that is, this money was backed by DEBT! If the debt could not be repaid, these excess money certificates could not be redeemed for gold.

. . . .

Of course, money certificates today are backed by nothing—not gold, nor silver, nor cockleshells. The money we use is fiat money, and yet governments everywhere maintain the fiction that banks must hold reserves in some small percentage amount in order to cover their customers’ deposits. But what are these reserves? These reserves are debt, too.

. . . .

In the U.S. the only money that may be used legally “for all debts public and private” is a Federal Reserve note. These notes—the money we carry in our wallets—are referred to as “standard money”. There is no recourse to anything beyond these paper notes. If a person wished to “redeem” his Federal Reserve note, he could go to the nearest Federal Reserve Bank and redeem it for…another Federal Reserve note.

. . . .

If that person deposited his Federal Reserve note in a bank, the bank would create a demand deposit, also known as a checking account. The bank would send to the Federal Reserve Bank the Federal Reserve notes that it collected whose numbers were above what it deemed necessary to meet the normal needs of its customers for pocket cash. These notes would be deposited in the bank’s reserve account at the Fed. (A bank’s “reserve account” is nothing more than a checking account.) But the bank would not be required to maintain a 100% reserve account balance to match the total of all of its demand deposits. It is required to hold only a fraction in reserve–along a sliding scale, the fraction becoming greater for larger banks–to meet the withdrawal needs of its customers. The rest of his reserve account balance is “excess”, meaning not required to meet his “reserve requirement”.

So what can a bank do with its “excess reserves”? It can create a loan to another of its customers, credit that customer’s demand account, which will increase its reserve requirement and reduce its excess reserve position at the Fed by a fraction of the amount of the loan. The bank—actually, the banking system–can continue to lend and create demand deposits in this fashion until its reserve account balance matches its “reserve requirement”. This is how banks create money out of thin air, and one can readily understand the enormous ability of the banks to expand the money supply from this updated fractional reserve banking practice.

The key point is that the bank created the new demand deposit by creating a loan—the loan is an asset on the bank’s books and the demand deposit is a liability. Thusly, money in our bright new world of fractional reserve banking is backed by DEBT! In order for a deposit to be redeemed would require that the loan be repaid. If the loan cannot be repaid, the bank cannot meet its withdrawal obligations and goes bankrupt.

. . . .

Enter a new player–the central bank. Our Federal Reserve Bank (or European Central Bank, or Bank of England, or Bank of Japan, or Bank of China) was created to prevent bank insolvency. The central bank stands ready to loan our bank unlimited funds so that it may honor its deposit withdrawal obligations. . . . but where did the Fed get the funds to place in our troubled bank’s reserve account? Why, it created them out of thin air, too! . . . The central bank has become a money creation machine.

. . . .

Thusly, all central banks are the source of what the public calls inflation, creating money out of thin air to prop up bank credit expansion made possible by fractional reserve banking. The entire Rube Goldberg mechanism is a thing of frightening beauty, beloved by college professors who force their students to understand all the gory details, but especially beloved by bankers and politicians who can literally paper over bad debt with massive increases in the money supply. . . . The long-term harm to the economy is found on many fronts, from higher prices (perhaps even hyperinflation) to moral hazard to civic unrest as interest groups fight one another to feed at the government’s feed trough. Each dollar of new money, born of debt and not production, reduces the purchasing power of all other dollars already circulating in the economy. Nothing has been produced, not one nut or bolt, not one new car…nothing. But more money creates the temporary illusion of prosperity. One’s home increases in value. One’s 401K increases in value. Jobs are plentiful. New office buildings pop up to house all the new businesses that are born. The only problem is that nothing has been built on true savings, only debt. Yes, it is a brand new world, but it is a frightening one that cannot last. (Read more from patrickbarron.blogspot.com)

Deflation Theory Is Lemon We Have All Been Sold

Aug. 18 (Bloomberg) — For much of the last year, central bankers, industrial leaders and politicians have been warning us about deflation. Falling prices, they tell us, will create another 1930s-style depression. The only answer is to print money furiously.

Now it turns out the theory is a lemon.

Deflation is no threat at all.

It doesn’t prevent an economy from functioning, and it doesn’t stop it from recovering either. The evidence suggests a period of sustained deflation might be what indebted economies need to get them back on the right track.

U.K. Chancellor of the Exchequer Alistair Darling said in a speech earlier this year that the Bank of England must be “prepared to act” to prevent price deflation.

“We are very keen on avoiding deflationary risk,” said European Central Bank President Jean-Claude Trichet in an interview this month. Much the same message has been pumped out around the world by economic leaders.

Nor have they been slow to put their freshly minted money where their mouth is. The Bank of England has embarked on a program of “quantitative easing,” or creating new money, to stave off the threat.

The trouble is, the theory doesn’t stack up.

Deflation, after all, has already arrived.

. . . .

Deflation may be bad for particular interest groups, which happen to be very powerful. It is bad for chief executives. It is easier to keep your profits rising in a mildly inflationary environment. You can just jack up your prices a bit, and you can often cut workers’ wages by stealth by holding wages steady.

The banking industry, which has come to rely on inflation to make highly leveraged loans sustainable, also dislikes deflation. Likewise, it is bad for governments, which use inflation to reduce the value of their debts.

On the other hand, deflation is good news for savers, who get richer just by hanging on to their cash. And it is beneficial for consumers, who get cheaper prices. It is usually good for workers as well, as they can generally hold the value of their wages, even while prices fall.

There are winners and losers, just as there are from most economic developments. The important point is that the people who lose are more powerful than the people who gain. That might explain why we hear about the dangers of deflation, and not about its advantages. It still doesn’t make them right.

There is no threat from deflation. It may even be desirable if it encourages a balance between saving and consumption, and discourages governments and banks from taking on debt. (Read more from bloomberg.com)

Is Ben Bernanke The “Machiavelian Monster” Equivalent Of Nicholas Biddle?


Mises does a great profile of Nicholas Biddle (1786-1844), president of the Second Bank of the United States – the central bank that preceded the Federal Reserve, and provides some useful analogues to not just the current Chairman of the Fed, but to all Fed-friendly crony insitutions that are doing all in the power to perpetuate the hegemony of Wall Street.

Like Ben Bernanke today, Nicholas Biddle cultivated the veneer of a benign civil servant calculating serenely far above the political fray. In reality he, like Bernanke, was up to his neck in the backroom game of power.

When Biddle’s bureaucratic cradle was rocked, he quickly morphed into a Machiavellian monster. Keep that in mind as Ben Bernanke gets progressively cornered by Ron Paul and the bourgeoning anti-Fed movement. (Already the Fed is less popular than the IRS.)

When you hear about the Federal Reserve Transparency Act getting stalled in committee, think of Daniel Webster, bought and paid for with central bank money. When you read Fed apologia in the New York Times, The Economist, and the Wall Street Journal denouncing the “reckless populism” of the Act, think of the newspaper editors in Biddle’s pocket.

The full must read article can be found here. (From zerohedge.com)

Bailout Propaganda Begins

Nearly a year after the federal rescue of the nation’s biggest banks, taxpayers have begun seeing profits from the hundreds of billions of dollars in aid that many critics thought might never be seen again.

via As Biggest Banks Repay Bailout Money, the U.S. Sees a Profit – NYTimes.com.

It was inevitable that the same people who pushed through the multi-trillion-dollar bailout of Wall Street would come out later on and tell us what a great idea theirs turned out to be, in retrospect and under the light of evidentiary examination. And we’re getting that now, with a pair of reports, the above one in the New York Times and another in the Financial Times, telling us the bailout is working because the government has made some money on TARP. They came to this conclusion by quoting Fed officials, who apparently calculated how much interest the Fed earned on TARP investments above what it would have earned on T-bills. The amount so far, according to these worthy gentlemen: $14 billion.

This is sort of like calculating the returns on a mutual fund by only counting the stocks in the fund that have gone up. Forgetting for a moment that TARP is only slightly relevant in the entire bailout scheme — more on that in a moment — the TARP calculations are a joke, apparently leaving out huge future losses from AIG and Citigroup and others in the red. (Read more from trueslant.com)