Could Someone Please Explain the Money Supply?

[Copernicus]

Thanks to Andy Fox for tracking this paper down

In my example the government already had the gold, it just hadnt issued the paper money in that quantity. It might have acquired that gold by its own mining operations, by conquest etc.

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I don't understand. After the gov't gives some tax revenue to the Fed to cover the bonds, the Fed will still have gotten something for nothing - even assuming that the money printed doesn't exceed the governments ability to tax and cover that money.


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Maybe your confusion is coming from the thin separation between the Fed and the Government? Forget the Fed...lets just say its a government that issues its own money. It has an asset that is backing the money it issues. It may have 50 trillion in bullion and only issued 40 trillion in paper money, or it might have the ability to tax its citizens for 50 trillion, even though its currently only taxing them for 40 trillion and issued that much paper money.

The following from Sproul might help as well, since your "getting something for nothing" is equivalent to claiming that the dollar is fiat money.

"JIMB:
Some reasons to doubt the existence of fiat money:
1) It creates a free lunch for its issuer, which would attract rival moneys. For example, if Mexico gets a free lunch by issuing pesos, then the US could take that free lunch away by circulating dollars in Mexico. The more dollars invade, the bigger the US free lunch, and the lower the peso falls, with no stable solution short of zero. But if you recognize that the peso's value is equal to its backing, this puzzle disappears.
2) If money is unbacked, why do all banks hold assets (gold, bonds, etc) against the money they issue? Why not just print it and spend it?
3) The only justification ever given for claiming the dollar is fiat money it the fact that the dollar is physically inconvertible. That completely ignores the fact of financial convertibility, and the fact that there is a clear difference between being inconvertible and being unbacked.
Fiat money sounds an awful lot like phlogiston, ether, and caloric, which don't exist either."

[Copernicus]

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This is not quite correct. If they have $10k on hand, they can make loans for $100k.

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No, your statement is incorrect and he was right. The fractional reserve system requires a bank to keep a percentage of its assets in reserve, to cover demands by its depositors for withdrawals.

You deposit $1,000, the bank reserves $100 and invests (via loans, bonds etc) $900. The amount it reserves depends on the nature of the deposit. Eg CDs have severe penalties for early withdrawal because they have a lower reserve requirement, so withdrawal has to be limited.

[Copernicus]

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As far as I understand banks create money, out of nothing, by lending. They must keep a certain percentage on hand, mandated by the Fed. So let's say a bank has $10,000 and has to keep 10%, they loan the remainding $9,000 and viola new money exists. Now where this 9k comes from is beyond me--I assume the Fed loans it to banks? Not sure. Don't think anyone covered this yet. Anybody care to explain further or correct me?

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The entire $10,000 came from a deposit somebody made. There is no "creation of money" by the bank.

[Brainwalter]

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The Fed may or may not be getting something for nothing. As long as the money printed doesnt exceed the governments ability to tax and cover that money, there is no free ride, they are just accomodating the needs of the market.

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I must confess I don't understand this statement (and the statement that the government's taxing ability "backs" the dollar). You say that what makes the dollar valuable (what backs it) is the government's ability in the future to tax and "cover" it or "back it up". But that ability is also denominated in US greenback fiat dollars, isn't it? So what makes that valuable? Isn't this circular? Or are you saying that the ability to tax makes the dollars valuable because you might need them one day because you will be required to give them to the government? Are they in fact future tax credits?

The other way you hear the statement is that the US dollar is backed not by any valuable commodity but by the "full faith and credit of the US government". My question is, what is that faith placed in, what promise must they keep that supposedly gives backing and value to the dollar?

[pvn]

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As far as I understand banks create money, out of nothing, by lending. They must keep a certain percentage on hand, mandated by the Fed. So let's say a bank has $10,000 and has to keep 10%, they loan the remainding $9,000 and viola new money exists. Now where this 9k comes from is beyond me--I assume the Fed loans it to banks? Not sure. Don't think anyone covered this yet. Anybody care to explain further or correct me?

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All the answers you seek, in plain english: http://www.mises.org/money.asp

[tolbiny]

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Thanks to Andy Fox for tracking this paper down

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The introduction to this paper is terrible, I see no reason to continue reading a farce like this on the first page of the introduction:

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The banker's loan triples the supply of paper dollars. One might expect that the value of the dollar would fall--perhaps to one-third of an ounce of silver. This is incorrect. No matter how many dollars are issued, each dollar remains worth 1 oz of silver...

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Either this is a strawman, or a misunderstanding of how inflation/money works. In his example dollars aren't the currency, silver is, the fact that a receipt for 1 oz of silver is still worth 1 oz of silver is irrelevant since the value of the actual silver will also decline. I guess I will have to read on.

Ahhh, here is the trick, hidden in a footnote.

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in this essay I interpret the real bills doctrine as requiring that loans be made for sufficiently valuable collateral

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A slight of hand on which the paper is entirely based. Essentially what he has said is that as long as money is not issued beyond the value of collateral then it isn't fiat money. Correct, but of course that is the frickin definition of fiat money. In his abstract he says this
"I make the claim that fiat money does not exist" and then uses a definition of money that is not fiat to prove that it doesn't. Which would be like me saying "zebras do not exist" and then basing my paper on the assertion that no horse like animal can have stripes. His whole paper is more and more crap like this, the section of convertibility being the biggest.

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A dollar that is expected to be converted into one ounce of silver after n periods

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He's done it again. Expected by whom? The fact that a bill has the words "exchangeable for 1 ounce of silver" on it does not mean that people in the market will be willing to trade one ounce of silver for it. He extends this charade by saying that if the fed issued bills for its 1 billion dollars in gold at the rate of 1 dollar = 1/35 ounce of gold and then suspended redemption indefinitely that a dollar is still worth 1/35 of an ounce of gold because the fed says it is, even if the fed were then to get rid of its stock of gold. But what the fed says there is irrelevant since it is the interactions between individuals that make up the market and represent the market evaluation of gold. Individuals would stop being willing to trade their 1 ounce of gold for 35 bills and the market value of the dollar drops (in the scenario he concocted).

Lets look at his conclusions for some more examples of the flaws in this paper.

Conclusion 1: An increase in the quantity of money is normally not inflationary, as long as the money is adequately backed.

Well duh, because he has already defined money as being backed by something valuable, hence the money supply cannot increase without value being produced hence money remains at the same value. Its a circular definition.

already covered #2

3. If fiat money existed, that would create profit opportunities for the issuers of rival moneys. Rival moneys would be issued as long as their value exceeded their backing, so the value of fiat money would be driven to zero.


Well duh, that's why governments (who issue fiat money) outlaw competing minters. Thats why they are going after E-gold, because the US dollar would eventually drop to 0 if competition were allowed.

[The once and future king]

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3. If fiat money existed, that would create profit opportunities for the issuers of rival moneys. Rival moneys would be issued as long as their value exceeded their backing, so the value of fiat money would be driven to zero.


Well duh, that's why governments (who issue fiat money) outlaw competing minters. Thats why they are going after E-gold, because the US dollar would eventually drop to 0 if competition were allowed.

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This is universal to States though. In Germany there is a massive independent currency movement.

[ianlippert]

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3) The only justification ever given for claiming the dollar is fiat money it the fact that the dollar is physically inconvertible. That completely ignores the fact of financial convertibility, and the fact that there is a clear difference between being inconvertible and being unbacked.


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I dont think it really matters if the dollar is backed by anything. The important part is that we have a free market in money. We already have this to a certain extent with the international money markets. But I still think that there is a certain amount of inflation the american government can get away with simply because people no nothing about our money supply.

[tolbiny]

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3. If fiat money existed, that would create profit opportunities for the issuers of rival moneys. Rival moneys would be issued as long as their value exceeded their backing, so the value of fiat money would be driven to zero.


Well duh, that's why governments (who issue fiat money) outlaw competing minters. Thats why they are going after E-gold, because the US dollar would eventually drop to 0 if competition were allowed.

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This is universal to States though. In Germany there is a massive independent currency movement.

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Have any links handy?

[iron81]

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Well duh, that's why governments (who issue fiat money) outlaw competing minters.

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No, they don't.

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Andrew Williams, a spokesman for the Federal Reserve in Washington, D.C.:

"There is no law that says goods and services must be paid for with Federal Reserve notes. Parties entering into a transaction can establish any medium of exchange that is agreed upon."

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