Lawson for Congress

There has been a flurry of recent activity in a series of threads over at the Republican blog Redstate.com. I’ve linked the threads below, and then summarized the final thread’s conversations.

Ron Paul’s Currency Plan and Merovingian France
Answer to Ron Paul’s supporters: the Federal Reserve is the Lender of Last Resort
Attention, Ron Paulites: Please help me understand how alternative currencies will work.

blackhedd begins:

I’m posting this as yet another diary because the other ones have gotten too big to keep track of.

And we are now graced with the presence of some new Paulites here at RedState, so I’m hopeful they’ll be able to enlighten us economic illiterates.

I’ve been trying really hard to understand what you want to do. Here’s where I am so far.

Let’s leave the global financial system alone for a moment. This world deals with everything, including currencies, on a risk-adjusted basis. They can and do respond almost instantaneously to changes in the risk profiles of various assets. They’re also big boys and they can take care of themselves.

However, they’re totally in cahoots with both the US Treasury and the Federal Reserve. (And the ECB, and the Bank of England, Japan, the People’s Bank of China, and so on.)

That badly taints the US dollar as both a store of value and a medium of exchange, because we know the dollar is fictitious, and will be created and destroyed willy-nilly by non-market actors (viz., the Fed) in order to serve the interests of the big financial players.

Ok, so far, that should be non-controversial.

We also know that the Fed is fully capable of preventing disruptions in the financial world from messing up the real world, where people go to work and make goods and services. Not only have they proved it several times, but Ben Bernanke also has spent a lifetime studying how that happened in the Depression, and one supposes he’s learned a few tricks.

Ok, so far, still non-controversial.

Now we come to the interesting part. We the people are getting the shaft, because we’re forced to hold funny money that can have all of its value taken away at the whim of non-market actors that we can’t control.

That’s the problem we’d like to solve here.

Now it’s true that the American people have responded to this situation by holding assets other than cash (most notably, residential real estate). In fact, the national saving rate as a percentage of income is now roughly zero. So one could argue that the whole issue is a non-problem. But leave that aside.

Ok, so the proposal is to give legal status to private “money,” to be 100% backed by gold and/or silver.

How exactly is this expected to work? We know that we want everything to be as unregulated and free-market-based as possible.

We also know (because the Paulites have said it again and again) that there will be no fixed dollar-gold exchange rate, as in past gold-standard periods. Rather, the dollar-value of gold-backed money will be fixed by the already-functioning free market in gold.

Did I get that right? Ok, good.

Now that means there will be depositary institutions (Citigroup for example) that will hold publicly-auditable gold reserves, and offer (presumably) certificates. Now there is no requirement that these depositaries be regulated or chartered. Therefore, as with the Federal government during gold standard periods, gold certificates MUST be fully-convertible on demand. Otherwise there will be no public confidence in them.

Are you all still with me?

Now just as with all forms of private currency (e-gold, Second Life, even the US Government), the depositaries need to make a living. Banks normally make a living by lending money at interest. Now comes the first difficult question for the Paulites:

Do you permit fractional reserve lending?

Uniformly, the Paulites have said no. Presumably you wouldn’t allow anything like the 10% fraction that we have today. But during the late 19th century when we had full gold convertibility, banks were allowed to lend against fractional reserves (they didn’t usually hold gold reserves directly but were required to deposit government bonds with Federal authorities). But of course we won’t do that now, since we’re requiring depositaries to hold their own gold.

In the late 19th Century, what happened is that the specific reserve fraction fluctuated over time, as the public found its own preferred balance between deposits and currency.

The problem with all of this, which the Paulites must address, is bank runs. It’s inevitable that banks will close during panics if they use any kind of fractional reserve. Remember, under full gold-backing by private institutions, there is no credible deposit insurance.

So here’s the most likely outcome:

Depositaries will make their livings as SecondLife and e-gold do now: they will take a small percentage of all gold transactions. In order to keep all the money from ending up owned by bankers, we will then depend on the “natural” inflation of the gold supply that takes place through yearly mining.

Among the things we’ll have to forego: the practice of writing paper checks on bank deposits. All transactions will be done in paper gold certificates. (Of course, these can still be done electronically.)

Also, there will be no more risk capital, since there is no real way to earn a rate of return by lending money. But that’s ok, because the real point is to make sure that the money stays sound.

Now I’m stuck. Paulites, please answer this for me: how can I buy a house or a car? Who’s going to lend me the money to do it? Or do I stick to dollars for any kind of transaction involving finance?

Responses:

Not that hard by Whitfox

Easy enough. As mentioned, there is no fractional-reserve lending. Therefore, during a bank run, all assets are available for distribution. Heck, there’s no other place for assets to be, since banks can’t make loans - they must mantain 100% reserves. Naturally, they’ll be charging a fee for that, not giving interest.

So how do you finance a boat? The rent-to-own model still works without creating currency. After your final payment, the boat is yours. Until then, you’re just renting it, with the option to continue renting until ownership is obtained.

Financing a business is more interesting. Sales of equity are fine. Sales of bonds aren’t, since that again creates money from nothing more than a promise. The closest you can come to the latter is selling assets to the bondholder and getting a rent-to-own agreement in return.

As said, this much is easy. What’s much, much harder is:

* Is the removal of debt from financing actually worth the market restriction you’re getting? You can argue that Treasury bonds are a net loss to the United States, since we taxpayers have to keep paying interest on them. But we’re not talking about Treasury bonds here, but Ron Paul’s new currency.

* Is there any point in making this alternate currency, and then restricting it from current finance opportunities? It’s not clear the markets will be leaping for joy about money that can’t be invested in traditional ways. Also consider any advantage in having precious metals evaporates the instant you invest it into something.

* What’s the cost of the transition? All government mandates have their costs, and reorganizing financial institutions to deal with new restrictions won’t be cheap.

As mentioned on the other thread, I can’t support Ron Paul in this, much as I appreciate the idea of finance reform.

There’s no problem with bond sales by bhday

A company can sell a bond, and put the money to work to pay you a rate of return. If you buy the bond with your hard currency, no “new” money has been created. The company has just assumed an obligation to pay you back.

In fact, this mechanism (selling bonds) is used by the People’s Bank of China specifically for the purpose of “sterilizing reserves”. When new USD come in to pay for exports, the PBC gives the exporter RMB in exchange for their USD. The PBC then sells a bond to Chinese banks and insurance companies to “soak up” an equivalent amount of RMB so no new net RMB are created.

That’s just a temporizing measure, though, since those bonds then become reserve assets in China’s fractional reserve banking system… and the banks will inflate by loaning against those assets…

Although the PBC regulates reserve ratios etc. to try and minimize inflation, they can’t hold it off forever. That’s the reason why EVENTUALLY China’s currency will float.

Amazing how all this stuff is related…

Doesn’t quite work by Whitfox

Say I start up a newspaper, and I get a money from selling a bond. That money buys a printing press and the services of some copywriters. Where’s the money going to come from if I get a payment demand? I may not make enough money to pay it back, even if I sell my used printing press.

This is creating money, not in the form of dollars, but in the form of that bond. It may or may not ever be repaid. If that risk gets included in the contract, we’re really trading partial ownership in the venture for money.

Our finance law giving sales of debt (bonds) so much privledge over sales of equity is one of the places there’s room for improvement, IMO.

Sure it does… by bhday

Bond == Securitized Loan

If you’re starting up a new newspaper, you’d typically get a collateralized loan, or pursue equity investment. If you’re an established media company with a good track record looking to expand, you can likely sell a bond which is just a loan that’s packaged for purchase by investors.

So you want to start up your newspaper, and blackhedd (with a few of his friends) take a hard look at your business plan. They think you’re going to be able to reverse the decline in the print media business with your plan for a new Republican newspaper called the “Daily Red State”.

Because they believe in YOU, and the business plan you’ve proposed for the DRS, they take THEIR EXISTING MONEY and give it to you in exchange for a promise to be repaid over time, with suitable interest to compensate them for the risk. Additionally, because they are debt (instead of equity) investors, they have first claim on the assets of the DRS in the event you can’t pay them back as expected (ie, default).

Again, in the context of “This is creating money, not in the form of dollars, but in the form of that bond. It may or may not ever be repaid. If that risk gets included in the contract, we’re really trading partial ownership in the venture for money.” –> The bond BETTER be repaid, or blackhedd is going to take over your business. The risk of default will ALWAYS be included in the contract. The key difference between debt and equity investors is that debt investors have first claim on the business’ assets in default. Equity investors (people who buy stock) are co-owners of the assets with you so you all succeed (or lose) together.

Regardless, NO NEW MONEY HAS BEEN CREATED. The dollars that Blackhedd Syndicate, LLC loan you were earned by them, and not created out of thin air by a fractional reserve banking system.

Regarding, “Where’s the money going to come from if I get a payment demand? I may not make enough money to pay it back, even if I sell my used printing press.” –> Your creditors expect you to get the money to pay the interest and principal back over time from your customers, and successful execution of your business plan. If they call in the loan and take over your business because you’re not successful and default on the loan, then they (and you) are likely to take a loss. But that’s the free market at work, and perhaps everyone overestimated the popularity of a daily newspaper comprised of insightful blog postings from redstate.com.

But again, no new money is created when an owner of capital (Blackhedd Syndicate, LLC) lends its existing money to someone else. It’s just when banks create new capital out of thin air by lending 10x as much money as they have in the vault that things get, well, inflationary.

Fiat currency + Fractional reserve banking –> Rewards debt and speculation, benefits banks at the expense of the capital owners

Sound currency + “Honest” (not fractional reserve) banking –> Rewards saving and investment, puts banks and their customers (who are the owners of capital) on equal footing

The problem with this picture is deflation by blackhedd

You’re pretty astute about how I and my partners would go about evaluating a new media venture, and how we would expect to be rewarded for making the investment. You’re even perceptive about what would make me take an interest in the venture in the first place.

But the net result of successful business activity is always the production of goods and services that improve people’s lives in ways that are tangible enough to attach a price to.

In a strict sound-money world, as both production levels and productivity levels increase (the latter as a direct cumulative result of the increase in physical capital), the price that ordinary people pay for goods and services must fall.

And so does the price they receive for their labor. Remember, I’m not going to fund the newspaper unless I get my coupon payments every six months, plus return of the principal when the bonds run off. Multiply me by all the other investors, and over time we become a class of fat cats with most of the gold, while no one else has very much to speak of.

Over a hundred years ago in Chicago, a Presidential candidate with a huge voice said what I just said, but in a much more concise and compelling way:

“You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold!”

We’re getting closer… by bhday

blackhedd, this is great. We’re getting there.

Regarding “But the net result of successful business activity is always the production of goods and services that improve people’s lives in ways that are tangible enough to attach a price to…. In a strict sound-money world, as both production levels and productivity levels increase (the latter as a direct cumulative result of the increase in physical capital), the price that ordinary people pay for goods and services must fall… And so does the price they receive for their labor.”

You’ve illustrated a potential cause of price deflation for whatever goods/services are subject to increased production and increased productivity levels. But the subsequent argument about wage deflation does not follow from that. Just because a particular item is cheaper now due to greater production or productivity does NOT imply that anyone’s time or labor is less valuable.

The bottom line is that in a free monetary system, where gold or silver or platinum (or whatever) is transferred among buyers and sellers as a medium of exchange, the purchasing power of any individual unit of money WILL NOT REMAIN CONSTANT over time. It will fluctuate, appropriately, based upon the supply and demand for money itself.

I repeat, we “sound money” folks are not against inflation or deflation per se. Inflation is a loss of purchasing power of an individual monetary unit — and in an “honest” system, that simply reflects a decreased demand for money. Deflation is a gain of purchasing power of an individual monetary unit, and simply reflects an increased demand for money.

Perhaps this example will help. Most people get stuck on sound money because they are obsessed with the “quantity” of money. Will we have enough money to create growth? What if there isn’t enough “circulating” because people are hoarding it? (You said earlier that you’re real concern is ECONOMIC ACTIVITY, not MONEY… and I agree 100%. Let’s just see how this plays out.)

Let’s take the case of folks irrationally hoarding gold coins, taking them out of circulation. What happens? The purchasing power of the remaining gold coins go up, and prices go down. Voila, deflation. The money you have now buys more stuff. How is that a problem? Does that hurt economic activity? If you were saving to make an investment, or start a new business, your now-increased purchasing power might be the impetus for pulling the trigger on your latest entrepreneurial venture. Your investors likewise feel that their dollars will now provide enough working capital to fund the business plan, and you start creating value and true wealth in the market. All because prices of goods had fallen (or the purchasing power of your money had increased).

Now let’s look at the flip side. All of sudden these irrational hoarders start dying off, and their relatives find these massive supplies of coins in walls, mattresses, and closets. Assuming the relatives choose to spend or invest the coins, they will then re-enter the economy. Just as the hoarding drove demand for money up (and price levels down), this “dishoarding” drives demand for money down (and price levels up). So more money available means higher prices, or inflation. Is that a bad thing? No… as I’m sure you’d agree, this money is now available for spending or investing… it may be spent on goods and services, or invested still your NEXT entrepreneurial venture. So while low prices may have been the impetus for investment in the deflationary environment, access to this newly-freed capital will be the impetus for investment (and subsequent growth) in the inflationary environment.

Get it? The quantity of money ultimately DOESN’T matter. Prices will adjust to their appropriate monetary ratio based upon the availability of the “moneystuff”, whatever it is.

So we sound-money types don’t fear inflation or deflation *in a free market*. But we should ALL fear inflation AND deflation in a “managed” system with a fiat currency and fractional reserve banking… because the boom/bust cycles that result disrupt what we all want, which is real economic growth.

***

Regarding ” Remember, I’m not going to fund the newspaper unless I get my coupon payments every six months, plus return of the principal when the bonds run off. Multiply me by all the other investors, and over time we become a class of fat cats with most of the gold, while no one else has very much to speak of.”

Huh? That doesn’t make any sense to me at all. First of all, you’re a CREDITOR, not an investor. You loaned me the money to start a paper. I pay you back out of my earnings as expected and you receive your desired rate of return. No more, no less. But I participate in the upside of my equity position, and when Rupert Murdoch decides he wants to buy the DRS, I (and my equity partners) have a huge payday. But on the balance, we all do well — we should, we created real value in the market.

***

Regarding ” Over a hundred years ago in Chicago, a Presidential candidate with a huge voice said what I just said, but in a much more concise and compelling way:
“You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold!” –> Ironically, we’re kind of on the same page here. There’s no reason that ONLY gold should be coined into money. Silver will also work fine, as well. There’s no need to fix a ratio between the two, however, as that will also take care of itself.

Alright, hang on… by bhday

This shouldn’t hurt a bit

First, I also disagree with the assertion, “Fed is fully capable of preventing disruptions in the financial world from messing up the real world.” –> As previously stated, eons of history suggest otherwise. Which is why we’re having this discussion.

Regarding the question, “Ok, so the proposal is to give legal status to private “money,” to be 100% backed by gold and/or silver. How exactly is this expected to work?” –> Easy. Just repeal the legal tender laws. The only institution that will be *required* to accept Federal Reserve Notes for settlement of debts is the federal (and perhaps state and local?) government (i.e., you could always pay taxes in Federal Reserve Notes). Anyone else can take ‘em or leave ‘em. Most folks would continue to take ‘em, but they would be instantly subject to open market competition.

Regarding the question, “The problem with all of this, which the Paulites must address, is bank runs. It’s inevitable that banks will close during panics if they use any kind of fractional reserve. Remember, under full gold-backing by private institutions, there is no credible deposit insurance.” –> “Honest” banks that support hard currency would (again) distinguish between time deposits and demand deposits (that’s where we’ve again lost our way). A time deposit (i.e., a CD) pays interest, but CANNOT be withdrawn until it matures — because the money literally isn’t in the vault, it’s out working and earning you interest. A demand deposit (i.e., a checking account) is something that YOU pay for, for the convenience of drawing against it via Web banking, checks, ATMs, or whatever. (You could still write checks, though… we WOULDN’T need to eliminate “the practice of writing paper checks on bank deposits”.)

Your demand deposits would sit in the vault until you needed them, no loans would be written against them. Your time deposits would be put to work following the risk/reward profile YOU choose (or maybe you’d continue to invest in stocks, real estate, or whatever). Complete confidence in demand deposits == No runs on banks. The previously-cited financial instabilities during the “gold standard” eras resulted from fractional reserve banking gone awry, not the currency itself.

In this world, you wouldn’t NEED deposit insurance. But you’d probably look for an independent “Consumer’s Reports” seal of approval on your bank of choice to ensure it had the appropriate audits and internal controls in place.

Regarding “In order to keep all the money from ending up owned by bankers, we will then depend on the “natural” inflation of the gold supply that takes place through yearly mining.” –> I’d question this assertion, as there’s no one forcing you to use one bank or another to intermediate transactions. And banks have expenses, too. It’s not like they will be earning “abnoral profits” if there’s truly a free market for their services. They’ll pay employees who will spend money, etc.

Regarding, “Also, there will be no more risk capital, since there is no real way to earn a rate of return by lending money.” –> This part is emphatically NOT true. The key difference is that YOU will be lending YOUR money, and not allowing the bank to create new money out of thin air based on your deposit. If YOU have the money, you can choose to buy a bond, or a CD, or any other instrument that then allows YOU to lend your money to someone else. You can use a bank as an intermediary, or perhaps even you could create an “S&L” with your friends and loan to people YOU trust. The heart of the current system’s immorality is that it CREATES NEW MONEY in loans, and takes value from YOU, who put the deposits there in the first place.

Regarding, “Now I’m stuck. Paulites, please answer this for me: how can I buy a house or a car? Who’s going to lend me the money to do it? Or do I stick to dollars for any kind of transaction involving finance?” –> Again, lots of options. You can borrow for things that make sense. Does it make sense to borrow money for a depreciating, non-revenue generating asset? Uhhh… not really. So you really *should* save for a car. Should you borrow to start or expand a business? Sure. But you can also look for investors. Should you borrow for a house? If the the real estate market isn’t inflated beyond belief due to loads of cheap money, that’s not the worst thing in the world to do.

If none of this makes any sense, I’d highly recommend that you read Dave Ramsey’s book, “Total Money Makeover”. We have a belief system regarding consume debt that is (as you’ve noted) both highly rational (due to our inflationary currency) but ultimately self-destructive.

I should also note that you *could*, if you wanted, by bhday

purchase private deposit insurance. The insurer would be incented to watch the bank closely, and it would be cheapest to buy insurance for deposits in the best banks.

The free market would be an amazing thing…

How do I get compensated for taking risk? by blackhedd

In what follows, I’m assuming that your new commodity-money system operates alongside of the existing financial-money system, and only supplants it to the degree that free markets determine.

If I may assume that (and nothing any of the Paulites have said contradicts it), that simplifies the analysis because I don’t have to throw away the whole existing infrastructure that is based on capital-asset pricing models.

That allows us to concentrate strictly on personal business that would now be transacted in commodity money.

You disposed of the problem of bank runs as I expected you would: by strictly ruling out fractional reserves. Strictly speaking, this rules out commercial banking as well.

Insofar as demand deposits are concerned, we’re in agreement. The reason to continue having them is that gold is cumbersome and inconvenient to hold compared to paper or electronic gold-certificates, so someone has to be the custodian of the physical metal. And since that someone (I call it a depositary, you call it a bank) needs to be paid to provide the service, you and I agree that they should take a small fee either for every transaction or a yearly fee for deposits.

As you say, the services provided to demand-depositors are something they have to pay for. We’re agreed on this point. Now my point about this that you brushed past is that since the total amount of gold is fixed, if the depositary/bank takes, let’s say, 50 basis points per year from your deposits (about the load of the most efficient mutual funds), then after a couple hundred years, the bank owns everything and the depositors own nothing. Of course, the “natural” inflation of the gold supply through mining takes care of this little problem.

On to time deposits. What you’re proposing amounts to this: I give my money to a bank, which gives me in return a piece of paper that is no different from a traditional coupon-bearing fixed-income security.

The bank, in turn, uses its resources (of wisdom, judgment of character, personal contacts, and knowledge of current business conditions) to invest my money in ways that will bring them a high enough return to make coupon payments to me, and still have a profit for themselves.

Now in a low or no-inflation world, interest rates are generally very low, because (obviously) investors don’t need to be compensated for the (nonexistent) risk of inflation.

But investors still need to be compensated for taking credit risk and market risk. What if the bank invests the money from my CD in a business that fails?

So the rate of interest can never be zero. But in a strictly non-inflationary world, a non-zero interest rate is socially unsustainable because, given enough time, the investors own everything and the people own nothing.

So what rate of interest is low enough to forestall this outcome, yet high enough to make investments worth making? That’s why I said that there is no risk capital in your world, and we still need my world of finance and capital assets backed by (somewhat) inflationary money.

My conclusion at the end of the day is that your system is useful primarily as a hedge against total catastrophe, which can result from market failures, government malfeasance, incompetence, or all three.

Since Paulites consider total catastrophe to be a foregone conclusion with only the timing in doubt, this is a very reasonable hedge for them to buy.

Since I’m a financially-oriented guy, I take a risk-adjusted view of everything. Since you’re willing to buy a hedge against total catastrophe, I’m willing to sell it to you. Let’s meet in New York next chance you get and discuss deal terms.

 

 

 

Wow, maybe this WILL take a while… by bhday

Ok, deep breath… Here we go:

Regarding “That allows us to concentrate strictly on personal business that would now be transacted in commodity money.” –>

What? I’m starting a business here, a real entrepreneurial venture called the Daily Red State, with your commodity money that you earned through great effort. There’s no distinction between “personal” and “commercial”.

***

Regarding “You disposed of the problem of bank runs as I expected you would: by strictly ruling out fractional reserves. Strictly speaking, this rules out commercial banking as well.” –>

Hmmm… Why does this rule out commercial banking? A bank simply holds deposits (demand deposits for a fee, and time deposits that earn interest). An HONEST bank just doesn’t confuse the two, and never lends out more than its depositors have allowed it to. Commercial or retail, there’s no difference. This free market system would encourage and reward honest banks.

***

Regarding “As you say, the services provided to demand-depositors are something they have to pay for. We’re agreed on this point. Now my point about this that you brushed past is that since the total amount of gold is fixed, if the depositary/bank takes, let’s say, 50 basis points per year from your deposits (about the load of the most efficient mutual funds), then after a couple hundred years, the bank owns everything and the depositors own nothing. Of course, the “natural” inflation of the gold supply through mining takes care of this little problem.” –>

What? All we’re talking about is a network of warehouses that store physical assets. Those warehouses will compete in a free market for their services, which are not highly technical. That competition will make the storage service available as cheaply as possible — because if anyone starts earning “abnormal” profits, you are free to open a competing warehouse next door. In the absurd case you postulate, if a bank could truly own EVERYTHING just by guarding the gold at 50bp per year, then EVERYONE (myself included) would open a bank to do just that. That

Economically, here’s what happens: The person paying the storage fee is the person holding the “demand” on the gold. After you loan me your sound money at 8% to start the DRS, I have claim on that gold. My carrying cost for this capital is 8.5% (8% interest, plus 0.5% storage fee). But I am going to deploy this capital into printing presses and other investments that I expect to grow at 20%. (You believe it too, which is why you gave me the loan.) So not only am I going to earn a better rate of return than the interest plus the storage fee, that storage fee will go down as I start spending the money.

The point you make is actually a strong argument for the *pro-growth* nature of free-market money in an honest (non-fractional-reserve) banking system. There IS a cost to just leaving gold idle in the vault. You could take it out of the vault and hide it in your mattress, but that doesn’t scale too well. What you’ve illustrated is that in this environment capital does NOT benefit from being lazy — it will always seek to be invested in a way that maximizes its return, and certainly will cover the (very small) storage fee.

***

Regarding “On to time deposits. What you’re proposing amounts to this: I give my money to a bank, which gives me in return a piece of paper that is no different from a traditional coupon-bearing fixed-income security… The bank, in turn, uses its resources (of wisdom, judgment of character, personal contacts, and knowledge of current business conditions) to invest my money in ways that will bring them a high enough return to make coupon payments to me, and still have a profit for themselves… Now in a low or no-inflation world, interest rates are generally very low, because (obviously) investors don’t need to be compensated for the (nonexistent) risk of inflation… But investors still need to be compensated for taking credit risk and market risk. What if the bank invests the money from my CD in a business that fails?” –>

Well, the bank better not make too many bad investments, or else they will lose their depositors’ money. But they will ONLY lose the money that was put at risk. And that risk could be minimized by (again) private insurance. So let’s say that the bank (or ANY institution — doesn’t need to be a “bank”) offered an interest-bearing deposit that gave you 5% interest over 6 months. The prospectus said that the deposit funded short-term working capital needs for your local gas and electric utility company. Would you invest in that? Sounds pretty safe to me. But it’s your choice. Say you could also buy principal protection insurance for another 50bp. Thus, your RISK-FREE return was 4.5%. Does that sound better to you? You’re still covering the storage cost, and you’ve preserved your buying power over time since interest rates reflect the supply and demand for money discussed in my prior post.

The free market can provide all that, and more. It slices, it dices… it’s the invisible hand! (Meanwhile, the bank has been forced through competition to get quite lean, and charges the utility 6% to borrow the funds. It can be profitable on a spread of 1% due to the lack of government regulations and compliance requirements. It just needs to satisfy its private insurers demands for transparency and internal controls).

***

Regarding “So the rate of interest can never be zero. But in a strictly non-inflationary world, a non-zero interest rate is socially unsustainable because, given enough time, the investors own everything and the people own nothing… So what rate of interest is low enough to forestall this outcome, yet high enough to make investments worth making? That’s why I said that there is no risk capital in your world, and we still need my world of finance and capital assets backed by (somewhat) inflationary money.” –>

I’m not following the assertion that nonzero interest rates imply all wealth flows to investors over time, and “people own nothing”. The reality is that in a free-market monetary system, ALL the people (and institutions) are investors. There is no difference between saving and investing. Say you (as a corporation or individual) keep two months’ worth of money in a demand deposit account. You pay your bills out of that account, live within your means, and structure the rest of your assets in equity investments, real estate, fixed income, and short-term certificates of deposit for ready access to emergency capital. YOU are the investor. I am the investor. We all are investors. As we invest, we are by definition taking risk. All our investments are risk capital in different types of assets. We DO NOT want all our assets just sitting in a demand account, withering away. That would be irrational. So we manage our demand deposit balance accordingly.

Now granted, this system is NOT for everyone at first. The only people who will participate are those who understand that true wealth comes from creation of value in the marketplace (like you said earlier), and not from some misguided effort to finance conspicuous consumption. Folks with credit card debt, subprime mortgages, car loans, and so forth will probably feel more comfortable in the inflationary world, where they can try to get ahead on the hamster wheel of paying down their debt with a depreciating paper currency. While prior discussions have characterized that behavior as “rational” and “smart”, in the long run it’s a form of slavery to the banking industry. But the banking industry isn’t complaining.

But that’s at the micro level. At the macro level, the real problem comes when a nation of debtors with a national debt can no longer sell bonds to China because they no longer need, or want, to support their fixed RMB exchange rate. Then we’ll all be competing with a billion Chinese to buy food and energy in the global market with an even weaker paper currency:
http://www.redstate.com/stories/economy/sino_american_economic_relations…
http://blog.lawsonforcongress.com/2007/08/12/the-china-conundrum/

***

Regarding “My conclusion at the end of the day is that your system is useful primarily as a hedge against total catastrophe, which can result from market failures, government malfeasance, incompetence, or all three. Since Paulites consider total catastrophe to be a foregone conclusion with only the timing in doubt, this is a very reasonable hedge for them to buy. Since I’m a financially-oriented guy, I take a risk-adjusted view of everything. Since you’re willing to buy a hedge against total catastrophe, I’m willing to sell it to you. Let’s meet in New York next chance you get and discuss deal terms.” –>

The problem is that when that hedge pays off, your paper money, contracts, and promises will be worthless. Seriously, all we RonPaul™ supporters are asking for here is free choice. The dynamics have changed — this time, the cross is not of gold, it’s of paper. WJB did not want to be limited to gold, we don’t want to be limited to paper.

I would caution you not to be too comfortable with our current position, and more importantly our trajectory, as a nation and an economy. We have a number of challenges facing us, and the stability of our currency within the international monetary system is a significant one. The governmental assault on domestic job creation and the entrepreneurial environment is also critical. It’s not too late to make a difference, but folks need to get educated on these topics, and quickly.

Reply To This — User Info — #44

To re-emphasize… by bhday

First, I hope these posts have illustrated how a free-market commodity currency in a non-fractional-reserve banking system is the *most* pro-growth monetary system imaginable. Since there is a small but real cost for holding commodity money in a demand deposit account, all monetary assets will immediately, and efficiently, be assigned through investment to their highest-yielding (and thus most valuable) use. That’s the key to responsible growth. It doesn’t require subsidies, “adding liquidity”, or social engineering. Just let the market do its job separating the good ideas from the bad.

Second, while I welcome the discussion, at some point I need to suggest that you read the following books:
What Has the Government Done to Our Money? (Murray Rothbard, available from www.mises.org)
Economics in One Lesson (Henry Hazlitt)
Economics for Real People (Gene Callahan)

They’re straightforward easy reads and debunk a lot of myths and misunderstandings that permeate our current dialog.

 

 

This entry was posted on Sunday, August 19th, 2007 at 6:52 pm and is filed under Ron Paul, debt, free market, gold standard, monetary reform. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.