Thursday, May 21, 2009

Our Money is Not Real

Economic depressions are all the result of one single phenomenon – government sponsored fraud. If we eliminate the monetary fraud that empowers our politicians, we will have a stable economy that provides growth and full employment without the need for manipulative political institutions like the Federal Reserve. How the government, through its enabling of monetary fraud, causes economic downturns can be explained simply in the following few short paragraphs.

The marketplace, when it is not disturbed by government intervention, is an adaptive system that is self-correcting, eliminating the possibility of long-term downturns. Supply always changes to meet demand as producers change their prices and offerings to meet consumer needs. Massive unemployment is avoided because workers, like other producers, must occasionally change their services and their rates to meet the true sovereign of the market – the consumer.

Large adjustments in consumer demands that are pervasive across the economy are the result of an unstable monetary policy that causes surpluses and shortages of money. These monetary surpluses (known as inflation) and their corresponding shortages (known as deflation) cannot occur if the economy’s money is real. If money is real, its existence remains relatively constant through time without inflation or deflation. On the other hand, if it grows with our “irrational exuberance” and shrinks as our consumer confidence shrinks, it is not real and its volatility is caused by its fraudulent foundation.

How has our government enabled a form of money that is essentially fraudulent, causing depressions and credit meltdowns? To answer this question, we need to first recognize the vaporous quality of our money. The vast majority of our money has no physical existence at all. It is not backed by gold, green paper, or anything else. We can claim to have a thousand dollars in the bank simply because the bank says we can. Our money, known among economists as “fiat” money, is just a recorded number that our bank is required to keep accurate track of. Fiat money exists for no other reason than the right authorities say it does and this nebulous nature of our money is, as we will see, the reason why it can mysteriously come and go from our economy.

To understand fiat money we have to understand that fiat money is produced by our banks; not by the treasury department, the mint, or some other government organization. It is produced as if it was counterfeit currency, by private companies that actually increase their profits by making more of it through a practice that is essentially fraudulent. Banks become profitable businesses by producing as much fiat money as they can. To see how this is done, let us take three simple examples of a bank issuing credit:

1. The owner of the bank loans out $1,000 of his own money. In this case, the borrower has $1,000 more to spend, but the banker has $1,000 less, so the total effect of the transaction does not inflate or deflate the economy. This was the original form of credit but it is now almost nonexistent.

2.The owner of the bank loans out $1,000 that he has borrowed from his customers. He has given the loaning customer a $1,000 CD and he has given the borrower $1,000 as a loan. The total effect on the economy is again innocent. The borrower has $1,000 more to spend for the period of the loan, let us say two years, but the CD holder, who cannot claim his money for the two year period of his CD, has $1,000 less to spend. Again, there is no inflation or deflation. This form of credit, however, is minor and not important for the subject of this post.

3. The owner of the bank accepts $1,000 from a depositor into a checking account. He promises, with the government’s help, to keep the money safe, however, in truth, he actually loans the $1,000 out to a borrower (the government actually requires him to keep a small token of the checking out in a "fractional reserve," but the amount is insignificant and is ignored here for simplicity sake). There are now two people who are walking around claiming to have the original $1,000, the depositor, with his check book, and the borrower. The original $1,000 has turned into $2,000 in the economy’s money supply. This is called inflation.

The vaporous quality of our money is caused by the loaning out of our deposited money. Loaning out money that the depositor has a right to immediately demand is the source of the fiat currency that represents most of the money in our economy. When there are lots of borrowers with “irrational exuberance,” our economy inflates and when there are foreclosures and fewer borrowers we have deflation and rising unemployment as employers run out of the cash needed to make payrolls. Our government’s endorsement of the duplicating of depositors’ money through “fractional reserve” banking is the source of all monetary instability.

But fractional reserve banking is not only the source of our vaporous and unstable money supply, it is essentially fraudulent. If the banker is promising to keep the depositor’s money in safekeeping while loaning it to borrowers, his promise is made under false pretenses. On the other hand, if the depositor is making the claim that he actually has the money in a safe place while it has gone to a borrower, he is, perhaps unwittingly, making a false claim – his claimed money is really unavailable to him.

Once the government begins to enable this fraudulent money juggling, it either has to have the courage and integrity to fix the problem or it has to hide the problem through a series of techniques that protect the local banks from getting caught appropriating their depositors’ money. This is precisely the reason why politicians created the Federal Reserve System in 1913. Through a central bank, any local bank that ran short of money could be protected by the central bank. This plan, of course, failed in the Great Depression when the number of local banks with shortfalls became too great. Now the government had to take another step to cover its mistake, creating the FDIC which insured depositors even in periods of massive shortfalls. The FDIC, of course, only works because now the bank failures are covered directly by the taxpayer (the ultimate but involuntary insurers). Once the government begins to correct its distortions of the marketplace it needs to cover its ineptitude with even greater market distortions.

The only regulation that is needed to protect bank deposits is the enforcement of the law against fraud. If a bank promises to keep your money in a safe place and then is caught using it for another purpose, the officers of the bank are guilty of fraud and should go to jail. Enforcing this simple regulation would eliminate the need for the Federal Reserve System and the FDIC and would allow our economy to be based upon money that is real.


James said...

A clear and concise analysis. I hope it shatters some illusions, even as it informs.

Robert Meldahl said...

Thanks for the comment James.

An important addendum to the essay. Since the time of Lincoln, courts have protected defaulting bankers with the legal fiction that a deposit is not really a deposit and that it is, in fact, a loan to the bank by the depositor. However, this is purely politically motivated nonsense. It would mean that the depositor is now the fraudulent party, using his money once as a loan to the bank and then reusing the same money again to pay his electric bill. It has just moved the fraud from the banker to the depositor. It still leaves the banker as a accessory to the fraud, covering the depositor's duplicity by using other people's money to pay the original depositor's electric bill.

In any case, inflation by credit expansion (which represents virtually all inflation) is still based upon fraud, the use of false pretenses to gain goods or services.