Friday, January 16, 2009

Money as Debt

(Please read post before viewing)



A few months ago, Glenn McIntosh sent me the link to the above video clip. I hesitated to embed it until I had a chance to review it more carefully--and I finally have. Some parts are excellent; some are equally disastrous. The first 20 minutes provide a clear and well illustrated explanation of how, currently, our money is based not on value but on debt. Accepting the legitimacy of a system where money is debt creates the foundation upon which are built many of the errors in mainstream economic thought. To understand how and why a free market works, to properly interpret Say's Law of Markets, to understand the fatal flaws of Keynesian economics, it is essential first to understand money- what we currently call "money" and what money more properly should be.

I received the link at the same time I was reading The Mystery of Banking by Murray Rothbard. The whole book is worth reading, but the first 100 pages in particular provide a helpful introduction to money, its history, its role in an economy, and the importance of understanding how the law of supply and demand function in regards to money itself. What I found particularly informative is the role of credit expansion (via fractional reserve banking) on the supply of money. I don't agree with Rothbard's assessment that the creation and use of fiduciary media is by nature fraudulent, but he explains quite well how money is created from "thin air" through the pyramiding of debt. This aspect of the "money supply" is essential to understand in order to comprehend today's events. (Even with rock-bottom interest rates and a skyrocketing monetary base, we are experiencing a deflation through the collapse of that credit pyramid.) The table of contents can direct your reading to specific subjects of interest, but I would strongly recommend reading at least the section on fractional reserve banking (pg. 94-103) to complement the first 2o minutes of the video clip.

The clip provides a quick introduction to some of the same ideas. The explanation and visual presentation of the structure of the system is accurate. The analysis of the cause (evil bankers and unsustainable growth) and the offered solutions (total government control of money and/or reversion to a barter economy based on the labor theory of value) are ridiculous. Also, the author fails to see the essential supporting role government has in the expansion of credit via legal tender laws and the Federal Reserve.

Some of the good points the clip makes:

1. "Money used to represent value. Now money represents debt."
2. A major problem with fiat paper money is that it allows government and banks to loan what doesn't exist. What does exist is real savings --the excess of production which is not immediately consumed and therefore available for investment in the production of goods in the future. Paper money allows the pretense that wealth is being transferred and invested, when in fact nothing is. Eventually reality has to catch up because you can't get something from nothing.
3. How the threat of bank runs provides an important check on credit expansion (and the unstated implication of the moral hazard provided by reserve requirements and federal deposit insurance.)
4. The government directly creates less than 5% of the money in circulation. The rest is created indirectly through bank credit.
5. Also implied is the mechanism for monetary contraction through a collapse of the credit pyramid when there is a decline in the value of the assets at the base of that pyramid.
6. "Inflation is a flat tax on money." Because it is not directly voted on, it is "taxation without representation." Inflation is a huge wealth redistribution program that takes wealth form savers and gives it to spenders. This is not an unintended consequence of Keynesian economics, but the intended consequence.

Some of the key errors in the latter half:

1. Charging interest is unethical in all cases.
2. Money is "just an idea" and can be "whatever we choose it to be." (See An Argument for Commodity Money)
3. Economic growth is unsustainable because it will deplete "finite resources." (See Finite Resources vs. Infinite Resourcefulness)
4. Equating inflation/deflation with rising/falling prices irrespective of cause. (see Inflation and Deflation)

Some of the ideas I need to consider further:

1. If money is debt, then "No debt, no money."
2. The driving force of the endless need to expand the money supply is the need to create enough new money to pay the interest on the debt.

Thanks to Glenn for the tip. I hope you find the clip informative as well.


Up date 1/16/09: Related to this topic is an excellent post at The Rational Capitalist on The History of Money and Banking. The post discusses the origins of fractional reserve banking, and the concepts of bailment, loan and deposit contracts. Some of the problems of fractional reserve banking are nicely illustrated through his example of bike stoarage and bike-claim tickets. I had intended to write a post along these lines sometime in the future, but now I don't have to. I love the dividsion of labor!!
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1 comment:

Philosophical Mortician said...

Here is an Austrian defense of fiduciary media.

http://mises.org/journals/rae/pdf/RAE9_2_5.pdf