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Author Topic: Why do governments like using fractional reserve banking?  (Read 1309 times)
JohnDoe
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September 12, 2011, 03:06:17 AM
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Why don't they expand the money supply by paying for stuff instead of using this shitty credit scheme? They could fund a significant portion of the budget this way. In the US M2 is at like $ 10 trillion and last time I checked it was expanding by almost 10% a year. This would mean a trillion in revenue, enough to completely slash the individual income tax. I'm sure some less bloated governments would be able to completely fund themselves like that without necessarily causing hyperinflation.

Am I missing something here?
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JohnDoe
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September 12, 2011, 03:11:21 AM
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They would have even more control of liquidity with my way. Did you even bother to read the OP?
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September 12, 2011, 03:20:52 AM
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By paying for stuff?  If you continually print more money and use it you will cause horrific runaway inflation and has been seen a million times over the globe for the past 2,000 or so years.  This is why the interest rate is dropped so low right now, as it should be.  In fact, I think that in an unmanipulated economy the currency supply at the moment would actually be decreasing instead of pretty much zero.

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JohnDoe
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September 12, 2011, 03:33:19 AM
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By paying for stuff?  If you continually print more money and use it you will cause horrific runaway inflation and has been seen a million times over the globe for the past 2,000 or so years.  This is why the interest rate is dropped so low right now, as it should be.  In fact, I think that in an unmanipulated economy the currency supply at the moment would actually be decreasing instead of pretty much zero.

I guess you were unable to imply from my example that it would be used to pay for an amount equal to the current level of money expansion.

Guys, I created this topic with the hopes of having a rational, non-emotional discussion about it. If I was looking for Austrian zealotry I would have gone to ronpaulforums.com.
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September 12, 2011, 11:52:25 AM
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Why don't they expand the money supply by paying for stuff instead of using this shitty credit scheme? They could fund a significant portion of the budget this way. In the US M2 is at like $ 10 trillion and last time I checked it was expanding by almost 10% a year. This would mean a trillion in revenue, enough to completely slash the individual income tax. I'm sure some less bloated governments would be able to completely fund themselves like that without necessarily causing hyperinflation.

Am I missing something here?

Think of it as a back room deal for the benefit of both bankers and politicians.  Bankers like having the currency creation system under their control, and politicians like that it gives them an unlimited checkbook.

Fractional reserve and deficit spending are like two unstoppable forces of nature.  Bankers will always find ways to loan out more than they have, and politicians will always find ways to spend more than they have.  The Federal Reserve system is a way to combine the two, neutralizing all opposition to both.

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JohnDoe
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September 12, 2011, 02:02:10 PM
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Think of it as a back room deal for the benefit of both bankers and politicians.  Bankers like having the currency creation system under their control, and politicians like that it gives them an unlimited checkbook.

Fractional reserve and deficit spending are like two unstoppable forces of nature.  Bankers will always find ways to loan out more than they have, and politicians will always find ways to spend more than they have.  The Federal Reserve system is a way to combine the two, neutralizing all opposition to both.

Yeah, I get that. What I'm really trying to find out is if there's anything economically wrong with my proposal, and why people have never tried to push for it in the case that it is a viable method.
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September 12, 2011, 02:32:14 PM
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>In the US M2 is at like $ 10 trillion and last time I checked it was expanding by almost 10% a year.

actually the m2 on average is about 6% a year, this year it might hit 10% due to que2, last year it was a little over 5%, the m3 actually declined the year before causing a minor bit of deflation. It has to expand some as the economy and population grows.

China has a larger money base, an economy 1/3 the size of ours and they arent the worlds reserve currency and last year they expanded their supply by nearly 20%(most countries did in response to the recession), it help exports and reduces foreign consumption at home.

It really has shit to do with power over the people but power over the economy.

Good luck not getting Austrian zealotry here.

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September 12, 2011, 02:35:23 PM
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The government needs easy credit, which means that it needs banks, which means that it can't mess with something so fundamental to the modern banking system.

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September 12, 2011, 04:51:19 PM
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They could fund a significant portion of the budget this way. In the US M2 is at like $ 10 trillion and last time I checked it was expanding by almost 10% a year. This would mean a trillion in revenue, enough to completely slash the individual income tax.

Government taxes economic activity, GDP if you will. Every time you make an economic exchange you usually pay some form of tax, and the same limited monetary base (~$2 Trillion) circles around the economy and creates a large annualized revenue (~$5 trillion) that the government promptly spends upon collection thus enabling the cycle to continue.

If the government would try to target the same level of revenue to GDP ratio (30%-ish) by monetary seigniorage alone the effect would be runaway hyperinflation, no doubt about that. A single trillion added to the monetary base would instantly inflate all prices by 50%, and once inflationary expectations set in the government would find it very difficult to capture more than a few percent of GDP via direct monetary expansion.

A trillion of extra M2 is not the same as direct printing by the government, it's a trillion deposited in the banking system and not circulating in the economy, it's a claim on future revenue against the debt holder and his collateral. Most importantly it's a choice of the "economy" where some agents decide to save and others to take credits and invest. The notion of credit is a natural one and appears in various forms in all monetary systems.

The root of all evil is government interference in the credit market via:
 - interest manipulation in the name of "economic development" - the decision to take on debt is skewed over saving, the economy is transformed in a consumerist series of bubbles; government gets easy access to loans at low interest and can increase debt spending, a perverse form of taxation
 - deposit insurance policies that masks the risk of investing via a bank: the owners of capital have a risk free investment insured by the central bank, and the private bankers have the liberty to take infinite risks, moral hazard ensues
JohnDoe
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September 12, 2011, 09:18:46 PM
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If the government would try to target the same level of revenue to GDP ratio (30%-ish) by monetary seigniorage alone the effect would be runaway hyperinflation, no doubt about that. A single trillion added to the monetary base would instantly inflate all prices by 50%, and once inflationary expectations set in the government would find it very difficult to capture more than a few percent of GDP via direct monetary expansion.

A trillion of extra M2 is not the same as direct printing by the government, it's a trillion deposited in the banking system and not circulating in the economy, it's a claim on future revenue against the debt holder and his collateral. Most importantly it's a choice of the "economy" where some agents decide to save and others to take credits and invest. The notion of credit is a natural one and appears in various forms in all monetary systems.

Thanks, this is the kind of discussion I was looking for.

Current monetary base is ~1 trillion but the federal budget is ~3.5 trillion so it looks like 1 trillion of federal spending is indeed a trillion deposited in the banking system and removed from circulation for the most part. According to Ron Paul: "M3 is the best description of how quickly the Fed is creating new money and credit."

Also what about quantitative easing? That's basically the Fed directly buying up assets to create excess liquidity, so why didn't 2 trillion in quantitative easing create runaway hyperinflation?

Anyway, even if money created my way was directly added to the monetary base, which I believe is false, then the part of the budget that would be payed with newly conjured money could be the one that's most likely to remain out of circulation, like interest payment to foreign governments and big military contracts.
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September 12, 2011, 09:20:41 PM
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the federal reserve is not part of our government. they call it "federal" to trick people to thinking it is part of our government. it is a private bank that prints and loans our money to our own banks at interest. tons of documentaries about how it is destroying our country and economy while the global elites get rich.

www.infowars.com - has a ton of info on it.

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September 12, 2011, 09:46:05 PM
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Am I missing something here?
You are not missing anything, you are on target:the banking system is organized in a cartel by the central bank.
Being at the sole source of liquidity enables the financial sector to capture the lion's share of the value added by the entire economy.

There is no study proving that 100% of the money creation must be issued by banks as credit to best serve the general interest of society.
In fact, it is very likekly that the economic optimum is NOT 100%.

Government propaganda is typically all about interest rates, reserve requirements and capital requirements: not a single state-sponsored economist will dare suggest that may be, one day, money could be created in a different way.

Meanwhile, money supply growth by direct distribution to people entails an understanding of the concept of a universal dividend IMHO: the government would distribute money to people who are not borrowers, including the neediest.
Income taxes would enable the government to reclaim the distribution from the richest.
In short, the economic optimum for money supply growth is a mix of credit issuance and universal dividend distribution.

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September 12, 2011, 10:29:18 PM
 #13

Fractional reserve actually started with gold receipts.  As government-issued currency took over, the existing system was just continued.  Banks love it of course - it means that we basically have to keep getting more and more in debt to them to keep the money supply expanding, until they own everything (and they're not far from it).

Governments don't get much out of it, but no one wants to unwind the system: gradually contracting the money supply would be an economic drag, and politicians are all about what will get them reelected in a few years.  And you can't just suddenly change away from it by abolishing the system and printing a bunch of new money to replace it:  98% of people don't even understand what fractional reserve banking is, so they won't understand why someone's trying to "ban all banks", especially since the banks will start running huge advertising campaigns to further confuse the whole issue.

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September 13, 2011, 09:56:07 AM
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Governments don't get much out of it, but no one wants to unwind the system: gradually contracting the money supply would be an economic drag, and politicians are all about what will get them reelected in a few years.
You are assuming that credit issuance is the only way to create money.
This assumption is wrong since money can be created by distribution of a universal dividend without an increase in the money supply.
In that case, there is no need for extra money printing since the amount of dividend diistributed is deducted from the money supply growth allowed to banks by the central bank.
The central bank would simply have to increase the capital requirements and reserve requirements imposed on banks so that they could create less money via credit issuance.

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September 13, 2011, 12:50:31 PM
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Current monetary base is ~1 trillion but the federal budget is ~3.5 trillion so it looks like 1 trillion of federal spending is indeed a trillion deposited in the banking system and removed from circulation for the most part. According to Ron Paul: "M3 is the best description of how quickly the Fed is creating new money and credit."

First some facts: current US Dollar monetary base increased from 2 trillion in 2010 to 2.6 trillion in August and the total government revenue is around 4.6 trillion , 30% of GDP. The M3 is a very broad form of money that include time deposits and long term bonds and which the central bank has very little control over and which being very illiquid has little bearing on inflation. I would take everything Ron Paul says with a grain of salt.

Now on to the main issue:

Quote
Also what about quantitative easing? That's basically the Fed directly buying up assets to create excess liquidity, so why didn't 2 trillion in quantitative easing create runaway hyperinflation?

Not all money is created equal. I believe it's a classic case of pushing on a string: the QE rounds replaced MBS and treasuries the banks held with freshly conjured dollars, but those are not hitting the market since banks are weary about lending in a recession. The newly printed money sits idle as excess reserves.



When those dollars hit the market the Fed can sell the assets it acquired and sterilize (destroy) any excess liquidity thus preventing inflation. This is major point of contrast with direct spending by the government which will never tax and destroy currency.

There is also another point Austrians make very nicely: inflation travels unevenly through the economy and some groups (bankers) who get easy money have a net advantage over those at the bottom of the social scale, which have a fixed income and are force to see their wealth vanish. What I'm trying to say is that the bulk of the inflation caused by QEs might be still to reach the man on the street.

As an anecdotal evidence about the evils of direct money creation by the governments, you can look at Zimbabwe's case that derived only 50% of it's revenue by creating a 10^25 inflation during a five year period. Even Mugabe could not dispense with the revenue from taxes and the exploitation of the country's mineral resources.

IMHO, it doesn't matter how fiat money is created: as loanable funds or as tokens spent directly into the economy. The most important thing is that governments:
 - don't confuse money creation with a revenue source (Mugabe)
 - don't distort the credit market for the purpose of makeshift development and control over the economy for their bank cronies (Bush, Obama et all)
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September 13, 2011, 08:14:58 PM
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Not all money is created equal. I believe it's a classic case of pushing on a string: the QE rounds replaced MBS and treasuries the banks held with freshly conjured dollars, but those are not hitting the market since banks are weary about lending in a recession. The newly printed money sits idle as excess reserves.



When those dollars hit the market the Fed can sell the assets it acquired and sterilize (destroy) any excess liquidity thus preventing inflation. This is major point of contrast with direct spending by the government which will never tax and destroy currency.

There is also another point Austrians make very nicely: inflation travels unevenly through the economy and some groups (bankers) who get easy money have a net advantage over those at the bottom of the social scale, which have a fixed income and are force to see their wealth vanish. What I'm trying to say is that the bulk of the inflation caused by QEs might be still to reach the man on the street.


Exactly, Fed stays one level higher than government

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