1. Monetary Reform
When the government controls the monetary printing press, and thus
controls the value of the money that we earn, what civil liberties do we truly
have? The government uses the printing press, under the euphemism, ‘monetary
policy’, to print more money, making our money worth less by increasing the
total money supply. The money that they print they usually give to bankers,
often in return for government bonds. This allows the government, by way of the
supposedly independent central bank, to amass more and more debt and allow that
debt to be paid off more easily, as the worth of the money it is denoted in
falls by their policies, at the expense of every creditor and person on a fixed
income in the country. Besides this, inflation is the prime mover behind the
dreaded business cycle. When the central bank artificially lowers the interest
rate through its printing of money by pumping that new money into the banking
system first, the interest rate is in fact distorted below its free-market rate.
Thus, businessmen, tempted by the low rates, tend to borrow more to invest in
more time-consuming production processes, while at the same time, the inflation
caused by the government actually leads to a reduction in the pool of the real
savings of the populace, with people more eager to spend their depreciating
currency and businessmen led to overconsumption by the illusion of higher
nominal profits which are just the result of inflation. The boom that ensues is
based on an illusion (because no new savings have actually been accumulated, which would allow sustainable investments in more time-consuming production processes), and must be followed by a bust when inflation slows and credit
thus starts to contract. In the process, real wealth of the country is used up
by businessmen who malinvest and consume some of their capital, believing more
real savings are available to be lent than actually are and believing that
their profit margins are greater than they really are. Thus, the evils of
inflation are numerous, and the apparent benefits are illusory. It allows
government to live beyond its means at the expense of money holders, creditors, and those who in general are late to receive the new money printed as it flows through the economy, reduces the incentive to save, causes the business cycle, and leads
to capital consumption.
The way to stop this is to return to
a sound currency, ie. one not subject to government manipulation. Ultimately,
some kind of gold standard would be a good choice, as gold emerged historically
as the commodity most suitable to be used as a medium of exchange throughout
most of the civilized world due to its divisibility, scarcity, non-perishability,
and uniformity.
The banking system is intimately
linked to the currency system. Fractional reserve banking, ie. the bank
printing more gold claim notes than they had gold in their vaults, was
responsible for inflation in the days before fiat money and central banks and
continues to play a role in the inflation of the fiat money supply. While some
would disagree, I am willing to allow this practice with conditions. The first
is that the government must not step in to bail out or help ailing banks in any
way. If a bank prints too many claims to gold and is caught in a bank run, that
is its own folly and other banks and their customers will learn from their
misfortune. The second is that customers of the bank must be explicitly
notified that not all of their demand deposits are in fact held in reserve, and
every bank note printed must indicate that bank’s reserve policies. This will
allow them to make an informed decision about which bank to trust with their
money, a fractional reserve bank, or a bank that keeps 100% reserves. In
effect, fractional reserve notes would not really be money at all (ie. a medium
of exchange that is widely accepted as final payments for goods and services),
but lottery-type, first-come-first-served claims to a pool of money kept at the
bank and which yields interest payments. Under these conditions, it is very
possible that fractional reserve banking would just die out, leaving only 100%
reserve banking.
All that said, I will now discuss a
way to get from the present disastrous monetary situation to the better one
described above:
The goals of a monetary and banking reform should be the
following:
1. To stop inflation of the money supply by the central bank,
ie. stop printing new money.
2. To substantially limit the practice of fractional-reserve
banking, replacing it with 100% reserve banking for withdrawal-on-demand
accounts. This will stop inflation of the money supply and will prevent the
prospect of major deflations and bank runs in the future.
3. To prevent a major deflation and bank run in the process
of reform.
In order to achieve this, I suggest the following,
step-by-step plan:
1. Engage in one last spurt of central bank money printing in
order to make the monetary base (the amount of money that would exist if all commercial banks ran on 100% reserves) correspond with the True Money Supply (includes entries in checking and savings accounts at fractional reserve banks). Give
this money to the commercial fractional-reserve banks in exchange for the
assets that are supposed to be backing up the withdrawal-on-demand accounts’
money. Prohibit the expansion of the money supply via fractional-reserve
banking as a fraudulent activity in the future, banks can only engage in the
practice if they issue separate fractional-reserve notes that clearly state the
nature of these claims on each and every note.
2. Set up a government holding company to hold all of these
assets and collect the money due from them.
3. Liquidate the central bank and transfer all of its assets
to the holding company.
4. Declare that the holding company is now responsible for
paying off as much of the government’s outstanding debt as possible with the
cash gained from its assets, and that the rest of the government is no longer
responsible for the debt. The company will be owned and controlled, pro-rata,
by the creditors of the federal government.
5. Holding company aside, balance the governmental budget and
pass a constitutional amendment prohibiting the further issue of government
bonds.
6. Make clear that any person or institution that tries to
increase the money supply by printing more base money notes will be treated as
a criminal counterfeiter.
7. Repeal all legal tender laws and any laws intervening with
the field of money and banking, besides basic laws against force and fraud;
especially be sure to repeal sales taxes and capital gains taxes on precious
metals. This will then give people the choice of continuing to use the now
(probably only temporarily) stable paper money or of moving to a commodity
standard such as gold.
The benefits of this plan are that it eventually reaches the goal of a sound monetary and banking system, while avoiding traumatic episodes of heavy deflation or bank runs. The disadvantages are mainly moral, ie. why are the banks and the government, the two main perpetrators of the deplorable state of affairs, essentially rewarded and bailed-out of the mess of their own making? On the other hand though, if we went the deflationary route and just withdrew government support from the commercial banks and let them fail in a run, this would be unfair to debtors who would be crushed by the deflation and to depositors who, though they probably should have known better, nevertheless thought that the bank was keeping their money safe for them. Also, politically, this route would be suicidal, as a leader who presided over massive deflation and bank runs would not last very long in office. Though there are of course some political sacrifices in my proposed method, they are less severe and could be offset by the subsequent stabilization of the monetary and financial system.
(Note: For any reader interested in learning more about inflation and how the current banking system generates it with government support, I strongly recommend Murray Rothbard's The Mystery of Banking. It is available for free PDF or EPUB download in the Literature section of www.mises.org)
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