Incredible confusions Part 1: ‘Positive Money’ and the fallacy of the need for a state money producer

Printed money

Photographer Graeme Weatherston.

I am usually inclined to encourage the inquiry of the fundamental aspects of money and banking. This is because I tend to believe that only by going back to first principles is it possible to cut through the thicket of widely accepted but deeply flawed theories that dominate the current debate in mainstream media, politics and the financial industry. From my own experience in financial markets I can appreciate how convenient and tempting it is in a business context, where quick and easy communication is of the essence, to adopt a certain, widely shared set of paradigms, regardless of how flimsy their theoretical foundations. Fund managers, traders and financial journalists live in the immediate present, preoccupied as they are with what makes headlines today, and they work in intensely collaborative enterprises. They have neither the time nor inclination to question the body of theories – often no longer even perceived as ‘theories’ but considered accepted common wisdom – that shapes the way they view and talk about the outside world. Thus, erroneous concepts and even outright fallacies often remain unquestioned and, by virtue of constant repetition, live comfortably in the bloodstream of policy debates, economic analysis, and financial market reportage.

This goes a long way in explaining the undeserved survival of a number of persistent modern myths: deflation is the gravest economic danger we face; Japan has been crippled by deflation for years and would grow again if it only managed to create some inflation; lack of ‘aggregate demand’ explains recessions and must be countered with easy monetary policy; and money-printing, as long as it does not lead to higher inflation, is a free lunch, i.e. we can only expect good from it. None of these statements stand up to scrutiny. In fact, they are all utterly absurd. Yet, we can barely open a newspaper and not have this nonsense stare us in the face, if not quite as bluntly as stated above, than at least as the intellectual soil from which the analysis or commentary presented has sprung. Deep-rooted misconceptions can only be dismantled through dissection of their building blocs and a discussion of basic concepts.

The dangers of going back to basics

However, going back to basics and to first principles, analyzing critically the fundamental aspects of our financial system, is not free of danger. Here, too, lies a minefield of potentially grave intellectual error, and when things go wrong here, at the basic level, the results and policy recommendations derived from such analysis are bound to be nonsensical too, if not even more nonsensical than what the mainstream believes. In this and the following essays I am going to address some of the erroneous notions at the fundamental level of money and banking that seem to have gained currency in the public debate of late.

I get periodically confronted with these confusions through readers’ comments on my website. Some of the questions and suggestions expressed there reveal the same, or very similar, errors and misunderstandings, and these often seem to have their origin in other publications circulating elsewhere on the web. Among them are the following fallacies, in no particular order:

  • The idea that the charging of interest, or in particular the charging of interest on money, is a fundamental problem in our financial system.
  • The notion that there must be a systematic shortage of money in the economy because banks, through fractional-reserve banking, bring into circulation only amounts of money equivalent to the principal of the loans they create but not the necessary amount to pay the interest on these loans.
  • The notion that it is a problem that money-creation is tied to debt-creation (again, as a consequence of fractional-reserve banking) and that it would be possible and advantageous to have the state issue money directly (debt-free) rather than have the banks do it.
  • The idea that schemes are feasible that allow the painless shrinkage or even disappearance of the national debt.

 All these ideas are nonsensical, based on bad economics and fundamental logical flaws, and to the extent that they entail policy proposals, these policies, if enacted, would not only not give us a stable and more prosperous economy but would surely lead to new instabilities or even outright chaos.

None of these misconceptions originate, or even resonate, as far as I can tell, with the ‘mainstream’. The mainstream– the financial market professionals, the central bankers, financial regulators, and the media – remain resolutely uninterested in dealing with fundamental questions of money and banking for the reasons given above. Here, the discussion continues to centre on how the economy can be ‘stimulated’ more, what ‘unconventional’ policies the central banks may still have up their sleeves, and if the central banks need new targets or better central bankers. Icebergs or no icebergs, these deckchairs need re-arranging.

But, outside the mainstream, among certain think tanks, ‘activists’, bloggers and some economists, even those at the IMF, the appetite for fundamental analysis has grown. In many cases this has led to utter confusion, as I will show in this set of essays.

I should declare a personal interest here. I feel the need to make my disagreements with these ideas and the resulting policy proposals as clear as I can as, on more than one occasion, casual readers of my website seemed to have assumed some sympathy on my part with the erroneous ideas put forward by others. The mere fact that somebody else also focuses his or her attention on the system’s same fault-lines, such as, for example, the instabilities created by fractional-reserve banking, has led them to believe that we must share considerable intellectual ground and arrive at similar conclusions and policy recommendations. Sometimes this confusion may be the result of a lack of familiarity with my work, sometimes with a lack of knowledge of or attention to the precise concepts articulated by others. In any case, this confusion needs to be cleared, partly because I do not want to be associated with what I consider economic nonsense, and partly because articulating the differences – and highlighting what, in my view, are the mistakes of the other side – should further clarify the issues and improve the debate. As I already said, the mix-up is usually greatest when the topic is fractional-reserve banking. So let me start right here:

Fallacy 1: As fractional-reserve banking is a source of economic instability, it would be better to force the banks to become fully-reserved banks with no ability to create money, and have the state create all money directly and inject it – wisely – into the economy. This would allow us to enjoy the benefits of more money without suffering the disadvantage of more debt. We may even use this process to reduce or eliminate existing debt.

This is the position of UK ‘think tank’ – or pressure group? – Positive Money, which has proposed legislative changes in the UK based on its analyses. Positive Money enjoys the support of the UK’s left-leaning ‘new economics foundation (nef)’ (so egalitarian and new age is nef that it doesn’t allow any capital letters undue dominance in the writing of its name) and of the Centre for Banking, Finance and Sustainable Development at the University of Southampton. Together these organizations have submitted a policy proposal to the Independent Commission on Banking.

The starting point of ‘Positive Money’s’ thesis – namely, that fractional-reserve banking is a source of economic instability – is essentially correct. But – as I will show in this essay – their analysis of fractional-reserve banking is incomplete, and their view lacks entirely any deeper understanding of money demand and of how changes in money demand are being met naturally in a market economy. Moreover, Positive Money has no perception of the necessary – and necessarily disruptive – effects of money-injections into the economy, regardless of who injects the money, and seems completely blind to the obvious disadvantages of channeling all new and free money through the state bureaucracy. Having shown – a bit flimsily and without resorting to any theories of capital or business cycles – that fractional-reserve banking is problematic Positive Money seems to have exhausted its critical faculties and jumps hastily to the conclusion that the privilege of money-creation should be given to a wise, independent and benevolent state agency. The arguments of Positive Money are economically unsound and politically naïve and dangerous.

If these resolutely anti-banking and pro-government proposals sound familiar to readers of this website, it is because they resemble the ones put forward by economists Benes and Kumhof in their widely quoted, less widely read and apparently even less understood IMF working paper 12/202, which I attempted to dissect here. In the following I will not repeat my criticism of Benes/Kumhof. Neither Benes/Kumhof nor Positive Money provide a single economic argument to support the claim that the state is a superior guardian of the privilege of money creation. This is not surprising because there is no such argument. Yet, we have to be grateful to Positive Money for at least not resorting to the bizarre line of reasoning that Benes and Kumhof came up with, namely that in order to improve upon our modern monetary order we have to first discover the ‘true nature of money’, which is apparently not open to the theoretical investigation of economists but can only be unlocked by anthropologists who tell us how money came about in primitive society thousands of years ago, and by certain monetary historians who re-interpret the historical record to tell us that the privilege of money creation has always been safe – and thus, in a logical jump of breathtaking audacity, is assumed to always be safe in the future – in the hands of government. Such mysticism is an insult to any true historian and to any proper economist. Sometimes it may be better to have no explanation at all than to put forward such rubbish. So thank you, Positive Money, for sparing us this nonsense.

Some thoughts on fractional-reserve banking

Let us start by briefly sketching the key problems with fractional-reserve banking.

Most of what we use as ‘money’ today is deposit-money and thus an item on a balance sheet of a bank. This form of money has come into existence through the banking system’s lending activities, i.e. through fractional-reserve banking.

Banks, for as long as they have been around, have never only just channeled saved funds into investments, such as fund management companies do today. Banks have always also been in the business of creating money derivatives (or fiduciary media), that is, financial instruments that are treated as money proper by the public (usually because they were issued with a promise of instant redemption in money proper), and thus circulate in the economy next to money proper. This process allows banks to fund a portion (and potentially a large one) of their lending through their own issuance of money derivatives, although today hardly anybody even distinguishes any longer between money proper and bank-created money derivatives. In a way, it can be said that the banks extend loans by drawing cheques on themselves and having these cheques circulate in the economy as money (and in the hope that they won’t be cashed!). These ‘cheques’ used to be the banknotes of the olden days, when banks were still allowed to print them, today there are deposit money, items on a bank balance sheet, like your current account balance.

This form of banking has made a considerable expansion of money in the economy possible. Fractional-reserve banking has been conducted in some shape or form for 300 years, and its effects on the economy have been the focus of the attention of economists for about as long (Cantillon, Ricardo, Mises – to name just some of the most outstanding social scientists dealing with it). Economists have long suspected, and over time have become ever more successful in demonstrating, that this activity is the source of economic instability. Fractional-reserve banking – and the elasticity of the supply of money that it creates – helps explain business cycles.

In my book Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary Breakdown – I explain in some detail why elastic money is so undesirable, making use of the seminal work of Ludwig von Mises, in particular. In order to understand the full range of problems with fractional-reserve banking in a modern economy we need some knowledge of the origin and role of interest rates, of the nature of what is called ‘money demand’, of investment and saving, and thus the rudimentary elements of a theory of capital. I cannot provide this in a blog post and I am not going to try. Let it suffice to say that the extra money created by banks lowers interest rates on credit markets and expands the supply of investible funds beyond the volume of available true savings. Thus, investment and saving get out of line, misallocations of capital ensue, and what appears like a solid economic expansion for a while is ultimately revealed as an artificial and unsustainable credit boom that will end in a recession. Sustainable growth requires investment funded by proper saving, i.e. by the voluntary reallocation of real resources from present consumption to future consumption (that is saving). Bank credit expansion creates a dangerous and fleeting illusion of the availability of more savings, which means more resources for investment projects that are in fact not there.

Should fractional-reserve banking be banned?

Do I have some sympathy for the proposal to ban fractional-reserve banking? Well, I do agree that an inelastic monetary system, for example a 100% gold standard, would be the most stable (least disruptive) monetary system. (Interestingly, this is not what Positive Money suggests, but more about that later.) But I do not believe that fractional-reserve banking should be and can realistically be banned. Not only because it has been around for so long but also because the exact definition of what is being used as money by the public in a dynamic monetary economy at any moment in time must remain fluid. Financial intermediaries will always succeed in periodically bringing ‘near-monies’ into circulation and thus become de facto money producers, at least for a while.

Furthermore, there is no legal case for banning fractional-reserve banking. It is, in my view, not fraudulent (as some modern Austrian School writers maintain) and there is no basis for banning it on standard property rights considerations. Moreover, there is also little need to ban it as we can, in my view, rely on market forces and the superior regulators of capitalism – profit and loss – to ultimately keep it in check. (Some economists dispute this but here is not the place to discuss this point in detail. I will argue my case below. However, it is not even essential for a critique of the ideas of Positive Money.)

I think that the most straightforward and most obvious solution to these problems is that we remove the extensive framework – erected and maintained by the state – to actively support and systematically subsidize fractional-reserve banking. This means removing the institutions – implemented through acts of politics and maintained through acts of politics- of unlimited fiat money, which means unlimited bank reserves, and of lender-of-last-resort central banks that have the power to issue such unlimited bank reserves. Unlimited state fiat money and central banks are today the indispensable backstops for large-scale fractional-reserve banking activities of the nominally ‘private’ banks.

If fractional-reserve banking is disruptive – and I agree with Positive Money that it is – should we not – as a first step and before we even consider such authoritarian measures as universal bans – take away the state-run support system for fractional-reserve banking by which the banks and their clients are systematically shielded from the consequences of their activities, and through which the true costs of fractional-reserve banking are persistently being socialized?

Fractional-reserve banking and the state

What the folks at Positive Money fail to appreciate is that in a free market the ability of banks to create money is severely restricted. A deposit at bank X is only considered ‘money’ by the public to the extent that this deposit can be used for transactions with potentially everybody else in the economy, that is, not just with other customers of bank X but also any non-customers of bank X, and this is only the case if the deposit remains instantly redeemable in money proper (let’s say, gold or, in today’s world, state paper money) or can be transferred to any other bank. Thus, bank X runs the constant risk that its customers demand redemption of the type of money it CAN create (the deposit that sits on its own balance sheet) in a form of money that it CANNOT create: gold, state paper money or deposits at the central bank that are required for transfers to other banks. (Hint: these are the ‘reserves’ from which fractional-reserve banking gets its name!)

In an entirely free market, in which the state does not interfere in the economy and in which there is no central bank and no fiat money but in which money proper is necessarily a commodity chosen by the market, one the supply of which is outside political control or anybody else’s control for that matter, such as is the case with gold, in such a system fractional-reserve banking is an inherently risky enterprise. The constant fear of requests for large redemptions will severely restrict the ability of private banks to lower their reserve ratios and fund large parts of their lending by issuing ever more money derivatives. Each additional bank deposit that is created out of thin air will increase the risk of a bank run, which, in a world without central banks, bailouts and state deposit insurance, must lead to the failure of the bank.

Sure, banks may still be tempted to issue more deposit money but it requires a somewhat strange view of human nature to expect that even after a number of bank runs, in which bank shareholders and most depositors were wiped out, financially speaking, fractional-reserve banking would merrily continue and could in total be conducted at anywhere near the scale it is today, when banks do not have to content themselves with strictly limited reserves and do not have to operate under the constant risk of business failure but can safely rely – or, at least rely to a much larger degree than in a free market and a hard currency system -  on an unlimited and constantly expanding pool of fiat reserves provided by lender-of-last resort central banks, and where depositors need to pay no attention to the soundness of the various deposit-taking institutions as they simply rely on the blanket cover provided by the state.

Positive Money’s account of fractional-reserve banking makes it appear as if the state and its agencies were simply innocent and powerless bystanders in the business of money creation, rather than active promoters of and eager and indeed indispensable accomplices in the exercise. Positive Money creates the impression that bloated bank balance sheets, real estate bubbles and excessive debt levels had all been created by scheming and out-of-control private banks, entirely on their own accord and behind the back of an unwitting and clueless state, rather than constitute the inevitable consequences of an institutional framework built on the widespread belief that constant bank credit expansion is a boon to the economy.

The truth is that the state, beholden to the generally accepted fallacy that cheap money – and even artificially cheapened money- is a source of prosperity and that we should never allow credit contraction or deflation, has actively supported the gigantic money creation of recent decades. Without an essentially unlimited and ever cheaper supply of bank reserves from the state central banks, private banks could never have expanded their balance sheets so aggressively and issued such vast amounts of deposit money.

Or, to put this differently, had the state wanted to stop or restrict the creation of deposit money by the banks at any point, the state – in form of the central bank – could have done this at the drop of a hat. Restricting the availability of new bank reserves and/or making bank reserves more expensive would have instantly put the brakes on fractional-reserve banking. Not only did the state not choose to do this (at least not for the past few decades), to the contrary, whenever the banks had maneuvered themselves into a position where they thought it themselves prudent to stop or at least slow down their balance sheet expansion for a while in order to protect limited capital or their limited reserves, the central banks invariably cheapened bank reserves further, specifically to encourage further deposit money creation.

In the present context, any criticism of fractional-reserve banking must include, in order to be consistent and complete, a rebuttal of the false beliefs in the benefits of cheap money and criticism of the state’s systematic support for this activity. Positive Money evidently fails to appreciate the role of state institutions and government policy in the present process of money creation or it would argue much more simply and straightforwardly for the voluntary restriction or abandonment of these policies first, and it would be less eager to hand full control over monetary affairs to the state.

Money injections must result in resource reallocations and mis-allocations

Furthermore, a proper understanding of fractional-reserve banking, one that is based on monetary economics and that does not stop at the most apparent symptoms of bank credit expansion, reveals that its core problem is its disruption of the pricing process that would normally co-ordinate economic activity smoothly (in this case, the co-ordination through market interest rates of voluntary saving with investment activity). The problem with fractional-reserve banking is precisely that it leads to persistent misallocation of resources. Would it not be sensible to ask if money injections through the state bureaucracy would also result in very similar or maybe even larger misallocations of resources or misdirection of economic activity?

This seems indeed very likely. We all know that whenever the market is replaced with administrative decisions by a bureaucracy, the results will be suboptimal as the bureaucrat has to make his decisions without the help of market prices, for if he would allow market prices to guide resource use and economic activity there would be no reason for his intervention in the first place. He might then as well leave everything to the market. It is precisely the political decision that the market should not be allowed to allocate resources through market prices and the profit and loss calculations of private enterprises that is the excuse for state involvement in the economy. According to the proposal by Positive Money, a state agency would determine centrally how much money the economy needs and then give this money to other departments of the state, which would spend it according to how it sees fit.

Positive Money does not provide any mechanism for how the state agency might determine who in the economy experiences a higher demand for money, and how the money would get to where it is needed. This is not surprising because there can be no such process, as I will explain shortly. According to Positive Money, the state agency would simply make a macro-level decision as to the amount of new money supposedly needed and hand the necessary amount over to other departments of the state (without the standard process of double-entry bookkeeping that is used today, I might add, by money-creating central banks. According to Positive Money’s proposal, the money is simply created and handed over to the state bureaucracy as a gift.) By putting this money into the economy the state will, of course, exert a tremendous influence on the pricing and the allocation of resources and the direction of economic activity. This does not bother Positive Money. It is simply assumed that this must be better than having private banks do this via the credit market.

It is clear that Positive Money has not fully understood why fractional-reserve banking is harmful. For a functioning economy an uninhibited pricing process for all resources is required in order to direct the use of these scarce resources in accordance with the preferences and demands of consumers. Fractional-reserve banking systematically distorts the pricing process (it corrupts the coordinating properties of interest-rates) but Positive Money suggests to replace it with a process that does away with market prices altogether, and that consists of the arbitrary and politically motivated allocation of resources through a state bureaucracy (even if the central bank is, as Positive Money naively assumes, ‘politically independent’ the departments of the state that are the first recipients of the new money and that decide how the money gets injected into the economy are certainly not).

Apart from the well-established and justified reasons to be suspicious of substantial state control over any part of the economy, there are other reasons to reject this proposal. As I have shown in Paper Money Collapse, EVERY injection of new money into the economy, regardless by whom, has to occur at a specific point from where the new money will disperse through a number of transactions. This process must always – from the point of view of a smoothly functioning, uninhibited market economy – lead to disruptions. It can never be neutral and it can certainly never enhance the functioning of the economy, or lead to a better plan-coordination between economic actors. Money injections always lead to arbitrary changes in relative prices, reallocations of resources and redistribution of wealth and income, without ever enhancing the wealth-generating properties of the economy overall. Money injections never benefit everyone, they always create winners and losers. It does not matter who injects the money.

Is a money producer needed at all?

Given all these problems, is it really necessary that anybody in the economy has the privilege of creating and allocating new money? Once fractional-reserve banking has been banned and money-creation by the banks has ceased (or, in my scenario, once the support for fractional-reserve banking has stopped and money-creation by banks has been much reduced), why not leave the economy to operate with a given and stable quantity of money?

Positive Money:

“But that doesn’t necessarily mean that the economy will run smoothly on a fixed amount of money – we may still need to increase the amount of money in the economy in line with rises in population, productivity or other fundamental changes in the economy.”

Positive Money does not explain why this should be the case, simply because there is no reason why this should be the case. The quote above reflects another widespread fallacy about money, namely that a growing economy somehow needs a growing supply of money. Many people will find intuitively that this makes sense. Yet, on further reflection anybody who thinks for a minute about the purpose of money and about how we all use money every day can see quickly that this statement is without any basis in fact and lacks any economic logic.

A growing economy does not need a growing supply of money and therefore does not need a money producer. On the basis of a stable and given supply of widely accepted money the public can satisfy ANY demand for money it may have.


The person who has demand for money never has demand for a specific quantity of money. Nobody who demands money has demand for a specific number of paper notes or a specific weight in gold coins or a certain quantity of bits on a computer hard drive (or whatever is used as money). We have demand for a certain quantity of money because of what we can buy with it, and this depends not on the quantity of the monetary asset as such but on its exchange ratio versus non-money goods. We always have demand for money’s exchange value, for what we can buy with it, for its REAL purchasing power. The value that money has for us, it has because of its purchasing power in trade. Money does not have direct use value, such as any other good or service.

Whether a certain quantity of cash is sufficient for me to carry with me for a good night out in London, depends on what that quantity of money can buy, that is, its real purchasing power. My demand for money is always a function of its exchange value, but money’s exchange value is necessarily subject to constant change as a result of the constant buying and selling of money versus non-money goods by the trading public.

If the public at large has an additional demand for money (i.e. an additional demand for purchasing power in the form of money) what will the public do? – Answer: the public will do what every individual does who wants to increase his or her holding of money, the public will reduce its present ongoing money-outlays on non-money goods (i.e. spend less and accumulate cash) and/or sell non-money goods for money (i.e. liquidate assets). This process will immediately exert a downward pressure on the money-prices of non-money goods and an upward pressure on the purchasing power of the monetary asset (the result is deflation, if you like, but in contrast to all the excited scaremongering about deflation in the media this is a normal market process and nothing to be scared of). By raising the exchange value of each unit of money this process will satisfy the additional demand for money naturally and automatically. The same physical amount of money is circulating in the economy but now this same amount can satisfy a larger demand for money.

Of course, the reverse will happen if the public lowers its demand for money. The purchasing power of money will drop (inflation) and the same amount of (physical) money will still be held but now at a lower exchange value per unit reflecting the lower demand for money.

These processes do not work for other goods or services. If the public has a higher demand for cars, somebody has to produce more cars. This is because the demand for cars is demand for the use-value that cars provide. Additional demand for cars cannot be satisfied simply by raising the prices of cars. But money is demanded for its exchange value, and additional demand for money can be satisfied (and is in fact satisfied) by a higher exchange value of money, i.e. lower money-prices of non-money goods.

Importantly, the processes described here would not just commence once we converted to a system of inelastic money. These processes are by necessity at work all the time – even now in our economy of constantly expanding fiat money and excessive fractional-reserve banking where they are, of course, usually overshadowed by the inflation from constant monetary expansion.

Money qua money has two characteristics: it is the most fungible good in the economy and it is demanded exclusively for its exchange value. From this follows that every individual can hold exactly the desired portion of his or her wealth in the form of money at any moment in time, and it equally follows that the public at large can hold exactly the desired portion of its wealth in the form of money at any time.

If more economic transactions are to occur in a given period of time money can circulate faster, and in fact, money then IS GOING TO circulate faster. If the demand for money holdings rises, this demand can be satisfied automatically and naturally by a rise in the purchasing power of the monetary unit, and in fact, the purchasing power of the monetary unit IS THEN GOING TO rise.

Via the constant buying and selling of money versus non-money goods the public automatically adjusts the velocity of money and the exchange value of the monetary unit, and thus the public is always in possession of precisely the amount of money purchasing power it needs. It is in the very nature of a medium of exchange that any quantity of it – within reasonable limits – is sufficient (and indeed optimal) to satisfy ANY demand for money.

There is no need to fear that this process would lead to undue volatility in money’s purchasing power, to constant fluctuations between inflation and deflation. If some people have a higher demand for money and start selling non-money goods for money, and this is beginning to lift the purchasing power of the monetary unit, then those who have an unchanged demand for money will readily sell some of their money for non-money goods in order to merely maintain the same real purchasing power in the form of money that they had before. Nobody can say that this process will lead to complete stability of money’s purchasing power. Such stability is unachievable in human affairs. But dramatic swings in money’s purchasing power can reasonably be expected to be rare.

Be that as it may, there is certainly no process available by which even the most dedicated, smartest and impartial monopolist money producer could anticipate the discretionary changes in the public’s desire for money balances and neutralize the resulting changes in money’s purchasing power through pre-emptive money injections or withdrawals. Once the changing demand for money has articulated itself in any statistical variables (and, in particular, in rising or falling prices) the public will already have satisfied its changed money demand through the processes described above. The whole idea of superior monetary stability through a central state monopolist is entirely absurd.

Equally absurd is the idea – this one not being advocated by Positive Money, I shall add – that fractional-reserve banks could play a role in satisfying the public’s demand for money. This is, I fear, another widespread fallacy, and it has its origin in a confusion of demand for loans with demand for money. Banks are not in the business of meeting their customer’s money demand (which they could not do even if they tried) but in the business of meeting their clients’ loan demand. Banks conduct fractional-reserve banking in order to extend more loans (on which they collect interest!), not in order to bring more money into circulation. The deposit money that is also created in the process (the ‘cheques’ the banks write to fund the loans) is simply a by-product of their expanded lending business (and this money is absorbed by the public through inflation).

By the same token, nobody (or at least hardly anybody) who has a higher demand for money will go to a bank, take out a loan and pay interest just to hold a higher money balance. Demand for money is not demand for loans. The people who take out loans do not have a high demand for money. To the contrary, they have a high demand for the goods and services that they quickly spend the borrowed money on. That is why they are willing to incur the extra expense of interest. As explained above, people who have a high demand for money cut back on spending or sell assets.


Positive Money starts with a correct observation, namely that today’s large-scale fractional-reserve banking is unnecessary and destabilizing for the economy. However, their suggestion of a ban on fractional-reserve banking strikes me as overly authoritarian, unnecessary and probably unpractical and unrealistic. Simply removing the state-run support infrastructure for fractional-reserve banking would be sufficient, in my view. Where the ideas of Positive Money become bizarre and dangerous is when they propose to install the state as an all-powerful central money creator. There is absolutely no justification whatsoever for such a function in a market economy. It is entirely unnecessary and would probably entail the same, if not worse, misallocations of capital that we suffer now. We would be guaranteed to stumble from one dysfunctional system into another dysfunctional one. The lessons from a proper understanding of fractional-reserve banking and of money demand are very different from what Positive Money suggests.

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Incredible confusions, Part 2: Of interest and the dangerous habit of suppressing it
The true significance of the $1 trillion coin


  1. Democraatus says

    For everyone who has not already done so: buy Detlev’s book ‘Paper Money Collapse’. A must read if you want to understand the economic mess that we’re in.

    I look forward to the next part of this series.

  2. David Goldstone says

    An excellent critique of a deeply flawed theory. I wholly agree that the real evils of FRB arise because of the State’s involvement in the banking system. Without government support,there would be no means for banks as a whole to change their overall reserve ratios. Reserve ratios would remain constant, thus avoiding the misallocations that arise from increases in the money supply not backed by savings. To put it another way, the problem with fractional reserve banking is not that there is £10 in bank money for every £1 in base money. The problem arises when the £10 becomes £20 (or less likely, £5). But for this to happen, there has to be state intervention or subsidy of some kind. My view is that on a free market, FRB would be inevitable and largely harmless.

  3. Dugan King says

    What a waste of words. This is a misdirection play. The writer obviously doesn’t understand the causes of inflation. The gold standard puts a recessive restriction on the elasticity of the money supply. It didn’t work in the past and it certainly won’t work now. I suggest you study Ben Franklin’s Pennsylvania Scrip System to see how honest credit money can be issued with great success and stability. Private central banks have been a bane on humanity for over 300 years. Fractional reserve banking is just a technical term for counterfeiting. The Federal Reserve Bank is not federal nor does it hold any reserves. The only way to counter inflation is by properly managing the quantity of money to match the quantity of goods and services (real wealth) in the market. Too much money chasing to few products cause inflation. A shortage of money compared to products results in recession or depression. Alternative currencies like the Berkshare and the B-note are innovative strategies that seem to be working. The above writer is too wordy and arrogant. I think he is trying to confuse his readers with smoke and mirrors. He must be a paid agent of the Evil Central Bankers.

    • BrunoT says

      For some of our nation’s most prosperous years, 1865-1900′s, prices fell because productivity and technology improved but the currency held its value. Why are goods and services falling in price a bad thing?
      You don’t object to a 60″ TV that cost $3,000 a few years ago costing $999 today, do you? “deflation” (more accurately prices falling) is only a problem if you like to borrow a lot of money. It encourages saving and discourages wasteful spending. Also, more investment due to more savings being available to lend and lower interest rates(real, not fake like now).

      If the problem today is over-indebtedness, perhaps the solution is “deflation” to cleanse the system of the excess debt.

      So, you think GOVERNMENT central banks are a better idea? What if Government made your cell phone? Think it’d be as cheap or good as an iPhone? The market should set interest rates. Otherwise how do you know the correct price of money? Central planning was a disaster for Soviet farming, why would it be any better for the monetary system? How about NO central banks? They serve as a drug dealer for cheap government borrowing. Market rates would serve as discipline for politicians.

    • James Murray says

      I agree,

      The only explanation for such a long, boring, unsubstantiated, diatribe is that he is somehow connected or paid for by the banks.

      They earn some £40 billion a year from interest and so must be able to afford some paid advocates against those who threaten their ill-gotten gains…

  4. dingo says

    great article…very clearly explained. When closely examined, every theory can be illuminated and put to the test of logic and common sense

    • James Murray says


      You must have been reading a different article to me…

      No figures, practically no authorities quoted in support and mostly assertive.

  5. says

    I am commenting here as a volunteer researcher with Positive Money. I have no personal problems with the view of constant money expounded here, except that I think it takes insufficient account of the deep-seated psychological attachment to money goods as measures of worth and esteem. It would not matter in principle if what used to be six inches long were now to be four inches long because inches now measure half as much again in real length as they used to, but it would be rather disturbing in practice.

    I would, however, like to correct what I believe to be a mistaken presentation of Positive Money’s stance and proposals. You claim that “What the folks at Positive Money fail to appreciate is that in a free market the ability of banks to create money is severely restricted.” I can only presume that you have not read the detailed analysis of the operation of the financial system undertaken by staff from Positive Money, new economics foundation and the Centre for Banking, Finance and Sustainable Development and published by nef in 2011 as Where Does Money Come From? which explores in considerable detail the prudential constraints under which banks operate and the processes by which they manage, and minimise, these constraints.

    Your analysis depends on the view that the central bank is primarily a lender of last resort. In reality, in an effectively cashless economy such as rules today, the most significant role of the central bank is the bank through whose books all payments are ultimately settled. It is this essential role of payments clearing institution that the Positive Money proposals seek to protect. A consequence of the specific nature of the reforms proposed is that the systemic necessity for inter-bank lending is eliminated and with it both the need for a lender of last resort and for state guarantees for deposits.

    The second plank for your analysis is the view that states are wedded to the idea of monetary growth, that this is a bad thing and that states must therefore be excluded from involvement in monetary affairs. As you are aware, this is a view not shared by all economists. Whether it is a bad thing is a conclusion based on a particular interpretation of events which are susceptible of differing interpretations. In short, it is a matter of opinion. Which opinion is to prevail lies with the free market in ideas. If your interpretation prevails and the state is turned around to constant money, then the Positive Money system enables that policy 100%. The system proposed is policy neutral.

    You criticise the sentence you quote from Positive Money as “without any basis in fact and lack[ing] economic logic”. Perhaps you missed the words “doesn’t necessarily” and “may”. The statement merely acknowledges the fact that economies do not follow pre-ordained laws of physics, or logic, and their outcomes cannot be predicted with any precision.

    • says

      Graham, to say that what you propose is “policy neutral”, meaning your system could even be used for keeping the money supply stable, is – if factually not incorrect – at least not quite fair. On its website Positive Money clearly recommends that the MPC (Monetary Policy Committee of the Bank of England) creates money centrally and injects it into the economy via the government. Let me quote from your proposal:
      “The Bank of England would then take over the role of creating the new money that the economy requires each year to run smoothly, in line with inflation targets set by the government. In order to meet these targets, the decision on how much or little money needs to be created would be taken by the Monetary Policy Committee. [...] Upon making a decision to increase the money supply, the MPC would authorise the Bank of England’s Issue Department to create the new money by increasing the balance of the government’s ‘Central Government Account’. This newly-created money would be non-repayable and therefore debt-free. [DS: This is clearly a gift to the government of the day! Also, whenever the BoE creates money in the present system, it has to book the money on the liability side of its balance sheet and the things it buys with the money to get it into circulation on the asset side of its balance sheet. How does that work in your system? Does the BoE create a new asset and that's it? Is the BoE still a bank or just a printing press?...] The newly-created money would then be added to tax revenue and distributed according to the elected government’s manifesto and priorities. This could mean that the newly-created money is used to increase spending, pay down the national debt, or replace taxation revenue in order to reduce taxes, although the exact mix of these options would depend entirely on the elected government of the day. Consequently, the decision over how newly-created money is initially spent would be made by the government, but the government would have no control or influence over how much money is created.”
      I do not think that this is quite ‘policy-neutral’, and I don’t think that my characterization of your proposal was unfair (nor my conclusion that this is dangerous and politically naive and based on bad economics). I did provide links to the Positive Money website in my essay – and you did, too, in your comment. So I can only encourage readers to check the proposals in their original and judge for themselves.
      In the last sentence of your comment you say that the “outcomes [of economies] cannot be predicted with any precision”. That is correct. But from this follows precisely that Positive Money’s proposal to empower the MPC even further as a central organ for monetary management – as summarized in the quote above – is very dangerous.
      You are, of course, correct that my view as to the undesirability of elastic money is not shared by all economists, or even the majority of them. That, of course, doesn’t make me wrong and them right, and vice versa. But neither is your view that fractional-reserve banking is necessarily destabilizing (which I agree with) a majority view, or one that meets universal approval in the economics profession. Many economists argue (or would argue if pressed) that the bank’s money-creation allows also more credit-creation, which facilitates investment without saving (hurray! the perpetual motion machine has finally been invented!), and allows for faster growth. But crucially, the fact that economists disagree does not mean that economics is merely an expression of opinion. Economics IS a science. It is the science of human action (Mises), and it is undoubtedly possible to develop clear laws of economics that are generally applicable without reference to a specific time or place. This science is different from physics or other natural sciences (it is, in fact, closer to logic and mathematics). For the simple reason that the subject matter of this science (purposeful human behavior) is different from the subject matter of physics or chemistry (the natural phenomena of the world that are not driven by human action, so to speak), the methodology of this science has to be different, and the types of laws it can detect and articulate will be different, too. But economics is not just a matter of taste and fashion. There is right and wrong like in any other science.
      My frustration with Positive Money is this: Positive Money proposes some very radical changes to the UK’s monetary system, namely to force banks to stop the creation of deposit money. Yet, Positive Money has apparently not asked some very fundamental questions first: What is money for, what is its purpose, and how much money does the economy therefore need? Simply carrying over the government’s present policy of setting inflation targets into your proposal (even if only as a political possibility) and your idea of enhancing the power of the central bank does not look like the result of thorough and ‘radical’ thinking to me. You propose some drastic changes to what banks are allowed to do without incorporating this proposal into a comprehensive and consistent theory of money and banking.

      • says

        Thank you for this considered response. I agree that this is an important debate, but doomed to sterility unless institutional arrangements are in place, or can be put in place, to give effect to its conclusions. That is the thrust and effect of our proposals. The monetary system cannot be managed today. The transmission mechanism is a wish and a prayer. Cause and effect is a mystery. Our reforms will provide tools for management. Those tools will be used initially in line with prevailing beliefs about how economies function, and it is important to their acceptance to demonstrate that this will be possible, but experience in their use will moderate those beliefs.

        The brutal fact is that the world’s economies will collapse unless action is taken to cut out known destabilising influences – the current operation of the banking system. We don’t have the luxury of waiting until our theories (which can’t anyway be tested by controlled experiment) are demonstrably fool-proof.

  6. David Goldstone says

    Dugan, the alternative currencies you mention are a step backwards. Money is more useful the more widely accepted it is. This is one of the great virtues of gold. Local currencies are scarcely better than barter which is grossly inefficient and suboptimal.

  7. Joseph says

    Graham – I will read the paper you posted, but I have to say one thing in relation to your suggestion that we have a ‘free-market’ for ideas that decides which policies are implemented. You must know that this statement is total hogwash, the intelligentsia are wedded to the political elite, that is how the state maintains intellectual credibility for their (harmful) policies. Murray Rothbard spoke at length about this. From ‘Anatomy of the State:’

    “For the masses of men do not create their own ideas, or indeed think through these ideas independently; they follow passively the ideas adopted and disseminated by the body of intellectuals. The intellectuals are, therefore, the “opinion-molders” in society. And since it is precisely a molding of opinion that the State most desperately needs, the basis for age-old alliance between the State and the intellectuals becomes clear.”

    Detlev – these articles are appreciated. I was discussing full reserve vs fractional reserve with my father, but hadn’t thought enough about how the free market would place restraints on banks reserve levels if they wanted to stay in business. I look forward to your next piece.

    • says

      But surely ideas are the one area where there is a truly competitive free market. There are no barriers to entry – anyone can have any ideas they please – and social media have all but eliminated distributional constraints. The drawback, of course, is that the market is totally unregulated and rife with counterfeits, bad faith and dishonorable practices.

      • Joseph says

        Graham, of course – that is why we are all here, to find new ideas. But it is still true that the media ascribe to and actively promote the economic ‘group think’ that has dominated the political debate for recent history. I can say from first hand experience that this is also true when it comes to education, where we didn’t even discuss anything outside of neo-classical economics. Therefore ideas such as yours and Detlev’s are quite hard to get out there to where they need to be.

        Anyway, thank you for your reply. We both recognise a problem, I think we just have different ideas as to the best solutions. I certainly wish ideas like this were debated more often.



  8. says

    Detlev – I’ve started to address these points here:

    I agree that the current system would not have developed to this point if it were not for the state support for the banking system. But the idea of withdrawing that state support, as appealing as it is, is a non-starter politically; no government will take that option when our current banking system is so fundamentally unstable. Our proposals are a way of changing the banking system so that it no longer needs that state support; we think this is only possible if you remove the power of banks to create money.

    • says

      Governments will indeed never admit that they are the problem. They will therefore never do anything that voluntarily reduces their influence on anything. However, they regularly get forced to step out of the way by the market. We are already seeing alternative currencies being introduced on the market. Governments of course fight these currencies, but they won’t succeed in fighting them all. One day one of them will prevail. And that is all we need. We need to get the Government out of the money business. Giving it a different role will just lead to new big problems. Regulating the errors of the past regulation has never worked.

    • says

      Ben, thanks for the response. — Ben and I also exchanged emails on this topic. Below is an excerpt from my email to him, which contains a few points that are maybe a suitable addition to the public debate. Again, this is from my response to Ben:

      I see myself first and foremost as an economist, not a monetary reformer or politician (God forbid!). My work – based on the Austrian School of Economics and particularly on the work of Ludwig von Mises – has led me to the conclusion that elastic monetary systems – systems in which the supply of money can be, and usually is, constantly expanded through the issuance of new money from privileged money producers – are always suboptimal, unstable and most certainly ultimately unsustainable. Why? Firstly, ongoing money production is not needed (for the reasons I provide in the final part of my essay on Positive Money), and secondly, because EVERY injection of new money is disruptive to the market process. I argue both points in much detail in my book.

      In real life, a completely inelastic monetary system is probably unachievable but the type of money commodity that almost all civilizations chose in the course history, namely gold and silver, two commodities whose supply is fairly inelastic, makes a lot of sense in light of this analysis, while our present ‘choice’ of perfectly elastic paper money becomes highly suspect.

      The advance of modern banking techniques – namely, fractional-reserve banking – already increased the elasticity of the money supply even under gold standard conditions. However, market forces would have severely constrained the ability of (truly!) private banks to expand the money supply (this is a point that Positive Money fails to appreciate sufficiently). What made fractional-reserve banking (and thus money elasticity) so dangerous was the state’s substantial support for this practice. Why did the state do it? Because of the false view that constant monetary expansion was a good thing: a) it could be used to fund the state (state borrowing has exploded since we left the gold standard) and b) the economy could be stimulated to stronger growth. Both are dangerous fallacies. These ideas are our true enemies and we won’t have a stable economy unless they are thoroughly and completely refuted. (This has been the focus of my work and is the key message of my book.)

      My frustration with Positive Money is this: You focus almost exclusively on the technique of fractional-reserve banking, which in itself is a minor problem. What people take away from your proposals is this: Unlimited fiat money is, or may be, not a bad thing at all. We just need to take the banks out of the equation and give the money privilege to an ‘independent’ state agency that will then centrally decide how much money is needed. But the central problems with elastic money would, of course, persist in this system. I fear the problems with elastic money would be even worse as the idea of a politically independent state agency is an oxymoron in my view. That is why I also consider your proposals politically naive. If you claim – as you do in chapter 3 of Modernising Money – that today’s central banks would no longer dare to cut off overstretched banks from the flow of new reserves (which is true), can you then realistically expect your independent agency to refuse more money to a government that faces a funding crisis?

      I can see why your proposal may appeal to many people at present: it restricts the maneuver room for banks and gives power to an ‘independent’ state agency. A lot of people like the sound of this. However, as an economist, I have to tell them that they make a big mistake. Fundamentally, this is true: ‘the people’ have most power over the use of resources in an economy when they are consumers and the market is entirely unrestricted. In a free market, the only way to make money is to service the consumer. Profit-seeking enterprises are a good thing: because by buying things or by abstaining from buying things WE – the consumers – decide what gets produced. We direct industry via buying and not-buying and via profit and loss on the part of businesses. Look at the type of service we all get as consumers in such areas as mobile phones and consumer technology, industries that are thankfully still lightly regulated. Now compare this to public transport and the NHS. Or, for that matter, our system of government-sponsored banking. Your proposals will give more power over money and finance to state agencies, not the market and therefore not the consumer. I am well aware that most people do want a free market in mobile phones but not in health services, and I can understand the sentiments behind this, although I do think they are misguided . As an economist I know they make a big mistake, because a market solution in such areas as health would provide better service -yes, even for poor people! – than a centrally planned system ever will. The risk with your proposals is that you move another area of our lives even further away from market-based solutions and closer to central planning.

      I rarely make policy proposals but this would be my counter-proposal to Positive Money:

      • Hector Combe says

        There is also the problem of rent-seeking to add to the mix. If PM’s proposals were enacted, and all new money is given out debt-free by an “independent public body” essentially as a gift to various government departments, then these departments will compete to be awarded the new money, wasting perhaps even more resources en masse across all the departments that are competing (as they spend time and energy making the case for their departments new project or expanded budget), than the capital that would be made available with the money to be gifted.

        Although to be fair, I’m not sure how to analyse the existing monetary setup under with rent-seeking in mind….perhaps the problem would be of roughly the same order of magnitude in both cases.

        Generally, I’d like to believe that the level of the expansion of the money supply would be a lot lower under PMs proposals than it is today under the balloon “tail wagging the dog” setup.

  9. says

    I found this article very thought provoking. I have been struggling to find a proxy for real growth and lighted upon [sustainable] population as the answer. I’m intrigued by the idea of inelastic money that, if I understand correctly, varies only in velocity. Intuitively, it seems strange that true growth would not be followed by an increase in money supply, but I must try to rationalise it and internalise it.

  10. m96 says

    Problem with interest is that it redistributes money. It makes people work to earn the interest back. That would be fair if you lent something you had owned and worked for. But since banks don’t, it becomes extremely unfair and a big problem because it redistributes money to something that is undeserved. All of that money will NOT go back into the real economy either.. for obvious reasons.. like hoarding of money, relendning of money, gambling on the financial markets.. and so on.

  11. Michael says

    Detlev, I am an enthusiastic researcher of the way the world works financially. I’m also an avid futures and derivatives trader (on a personal level, not a fund or employed in the profession). I have been following your work for a year and I have read Mises works. I believe the Austrian school is correct, and therefore I agree with your analysis relating to money quantity and misallocations etc. However, I also admire the work of Positive Money but I have not yet read their latest book, nor yours other than the synopsis – both are on order as I type this. However, if possible could you read and debunk a book called The Grip Of Death by Michael Rowbotham which inspired me (and I think Ben Dyson) or perhaps indicate the flaws in that book. That book seems to indicate that banks and not government take the fruits of money creation, and not in some sense the ‘elected government’ and your synopsis seems to not make the fact clear that the banking system is seemingly private and not part of the state/government – it has a ‘shadow banking’ system in place to usurp the central bank control. That is the crux of the recent outcry that banks kept their profits private but then socialised the losses to the taxpayers (ie the UK elected government decided to do this but they were certainly not happy about the situation). Gordon Browns book also puts the whole sorry state to ‘the first crisis of globalisation’. In this regard I’m not sure that anything makes much sense without understanding global money and how it flows – also with WTO rules allowing leakage of currency by way of those global businesses that use transfer-pricing, how can anyone truly know what currency is circulating. Do you support capital controls?

  12. Andrew Jackson says

    The article is based on the premise that the current banking system, where banks create money, is actually stable, it is only the states involvement that leads to financial instability and its assorted negative effects.

    It’s pretty easy to assess the accuracy of the authors claim: prior to 1844 in the UK private banks were able to print paper money, and although the Bank of England existed, it was a privately owned for profit bank and did not carry out any interventions into the economy or any of the other functions that we have come to associate with central banks today (such as lender of last resort).

    Therefore according to the author this period should have been one of financial stability. However nothing could be further from the truth: in Britain the period 1819 – 1844 was characterised by multiple crises and bank failures that were caused by the rapid expansion of paper credit by the private banking sector. This had such large negative effects on the economy that the conservative government of the day was forced to act by introducing the Bank Charter Act 1844, which restricted bank’s ability to create paper money (but ignored deposits). Much later the Bank of England took on the lender of last resort function after the Overend Gurney crisis of 1866. As a result all the functions of central banks that the article claims cause financial instability were actually introduced as a result of trying to make a system where banks create money safe.

    So, as history has demonstrated, it is not state involvement in banking that causes instability. Now this is not to say that some interventions have not led to more instability, there is a lot to be said for the argument that the forms of insurance central banks and governments offer banks have led to riskier behaviour. However, these forms of insurance are a response to financial instability which came about as a result of allowing private institutions to profit from increasing the money supply. Stripping away these forms of insurance would therefore not stop banking crises.

    The question then is how do you stop financial instability and banking crises are their large negative economic effects? The author also makes the point that “the most straightforward and most obvious solution to these problems is that we remove the extensive framework – erected and maintained by the state – to actively support and systematically subsidize fractional-reserve banking.”

    Well that is exactly what the Positive Money proposals advocate. By removing banks ability to create money (by removing deposits from their balance sheets ) banks could be allowed to fail with no need for the taxpayer to bail them out. There would also be no effect on the money supply of banks failing, or large economic consequences.

    The alternative is that deposits are left on the balance sheets of banks and the government announces that it is removing all subsidies from the current banking system. Would this work? The short answer is no – the failure of a bank would have such large negative economic effects that the government would be incentivised to rescue the banks despite its previous pronouncements (the banks would also know this). This is the time inconsistency problem. As a result you can’t remove state subsidies for the banking sector when the money supply exists largely as deposits on their balance sheets, to do so the deposits must first be removed from their balance sheets – the Positive Money proposal.

    • says

      Andrew, first of all, history does not demonstrate anything. It can direct our inquiry, it can illustrate problems and it can tell us what happened – it cannot tell us what must happen. We do not know how banking would have developed without the 1844 Peel Act and in the absence of state intervention. The instability of banking pre-1844 that you describe – and that I do not even doubt in the slightest -, would it simply have continued if there had been no state intervention? Would generation after generation of depositors have kept putting their savings into unstable banks and waited for the next bank run to see these savings evaporate? Personally, I very much doubt it but reasonable people can disagree on this. The point is simply this: we do not know.

      More importantly, I have never maintained that fractional-reserve banking is stable. If you read my essay carefully – and certainly, if you read my book, Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary Breakdown, which has a whole chapter on fractional-reserve banking – you will see that I explicitly say that fractional-reserve banking is destabilizing. In my essay on Positive Money, I specifically say that I have some sympathy for the, well, ‘impulse’, to ban it but that I think that banning the practice is not needed or should not be our first course of action. I do say explicitly that a 100% gold standard would be the most stable monetary system.

      The present state infrastructure in respect to banking is not designed to constrain and control fractional-reserve banking but to actively promote it. The state LOVES fractional-reserve banking because the present macroeconomic mainstream view holds that ‘low interest rates’ and ‘cheap credit’ are great tools for ‘stimulating’ the economy, that constant monetary debasement of at least 2 percent per year is fantastic, so what’s better than have these banks create loans based on printed deposit money!?! Andrew, have you followed the debate in recent years? Since 2008, the ‘private’ banks are not keen on fractional-reserve banking at all anymore. All the money-printing of recent years and all the generous lending based on this money-printing has almost killed them. They are licking their wounds from the last credit boom. They need to rebuild capital and repair their balance sheets because they want to survive. Fractional-reserve banking and bank credit expansion have stopped. Game over. All of you who want to ban fractional-reserve banking should rejoice (I do in fact rejoice, seriously!) because for all practical purposes fractional-reserve banking has stopped. It is dead. Or it would have stopped if it weren’t for the central banks and politicians, and the mainstream economists who advice them. They all HATE the end of fractional-reserve banking. They want to, what’s the phrase?, ‘unlock the flow of credit’. Get the banks lending again. Not a day goes by without a politician lamenting the fact that private banks are reluctant to lend, which means – as you and I know full well – they are reluctant to create loans that are not backed by savings, they are reluctant to expand their balance sheets and reluctant to conduct fractional-reserve banking. They are reluctant to pile more debt onto the economy.

      The first rounds of quantitative easing in the US and the UK may have been implemented to starve off a bank run. But the more recent rounds have been conducted to encourage the banks to create loans again. In the US, the Fed now conducts QE in order to lower the unemployment rate.

      Fact is that the ‘private’ banks are conduits for economic policy, and that this policy is based on the belief that new money is a great tool for creating growth. I think monetary theory shows us very clearly and indeed conclusively that this belief is mistaken. But if Positive Money gets its way, the practice of using money creation as an economic policy-tool, as a way to ‘stimulate’ the economy, would not stop. The power to create money out of nothing would – under your model – simply end up in its entirety in the hands of the very same central bankers who have – based on erroneous if widespread and popular theories – promoted fractional-reserve banking all these years and who do it to this day. We will not get less monetary expansion, that much is certain for we know full well what the economic and political mainstream thinks about expanding money – they think it is great. What will have changed are simply the channels through which that money is injected into the economy.

      Here is my challenge to you: 1) Can you show that constant monetary expansion is needed? (I do not think you do this in Modernising Money but correct me if I am wrong.); 2) Is there any reason to assume that this monetary expansion, now that it does no longer go through the banks and the credit markets but through state spending, has less disruptive effects on the performance of the economy? Under fractional-reserve banking profit-seeking banks at least placed the money with borrowers who they expected to earn enough money in the market place to be able to repay the loan with interest at a future date. They had at least an incentive to not waste it. Under your model, where the central bank directly credits a government account and thus provides a money-gift to the government whenever the central bank wants to increase the money supply, no such constraints apply. What type of mis-allocations/imbalances/disruptions would we have to assume under such a system?

      If your ONLY objective is to make banks saver, banning fractional-reserve banking will accomplish your objective. On this point we agree. If you want to make the economy more stable, allow it to perform better and to avoid crises, your proposal will fail as we will get a lot of unnecessary and disruptive monetary expansion, now channeled through politically motivated state spending.

      • Andrew Jackson says

        “Would generation after generation of depositors have kept putting their savings into unstable banks and waited for the next bank run to see these savings evaporate?”

        Well generation after generation of depositors had been putting their money in unstable banks up until that point; I see no reason to think that they would have stopped then.

        Anyway, moving on, you state: “what’s better than have these banks create loans based on printed deposit money!?!” and also “which means – as you and I know full well – they are reluctant to create loans that are not backed by savings,” You also talk about “true savings” in your article.

        This idea that there is a certain fixed amount of ‘true savings’, or ‘real money’ which the banks have somehow expanded is a fallacy, and is basically a variant on the money multiplier model of banking. The problem is that this money multiplier theory you are talking about has not applied for over a hundred years, probably more. Banks create credit and money is supplied endogenously by the central bank on demand. The private bank tail wags the central bank dog: all the money in the economy today was created by banks when they make loans. Even notes and coins only enter circulation in exchange for bank deposits – if we paid off all our loans there would be no cash in circulation, indeed there would be no money at all. So this idea that there are some ‘true savings’ or ‘real money’ upon which banks expand credit is completely wrong. This is what Schumpeter spoke of when he talked of requiring a credit theory of money rather than a monetary theory of credit.

        You also state: “Fact is that the ‘private’ banks are conduits for economic policy, and that this policy is based on the belief that new money is a great tool for creating growth. I think monetary theory shows us very clearly and indeed conclusively that this belief is mistaken.”

        Well actually monetary theory has shown us completely the opposite; indeed over 100 years ago Joseph Schumpeter recognised that growth is largely financed out of new money creation. Steve Keen has also recently examined this issue by showing that GDP is (in a closed economy) is C+I+G + the change in debt (which is mainly new money creation).

        The problem is not new money creation at all, it is where that money enters the economy. If it enters the economy as a loan to an entrepreneur that wants to build a new factory producing goods then this will add to growth (and be non inflationary –the quantity of money may have increased but so has the quantity of goods and services). If it enters as a loan to buy a pre existing asset (such as a house) it will not affect the quantity of houses (or goods and services or anything else) in circulation and therefore will only affect price. This is how house price bubbles and financial crises happen – asset price inflation caused by too much credit creation for unproductive sectors of the economy increases the debt to gdp ratio in the economy, until eventually the debt burden becomes so large people start defaulting on their loans (this is a brutally shortened outline of Minsky’s Financial Instability Hypothesis).

        You also state that under the PM plan: “We will not get less monetary expansion, that much is certain for we know full well what the economic and political mainstream thinks about expanding money – they think it is great.”

        Well the remit would only to create money when inflation is low and stable, if central bankers consistently missed their targets they could all be fired!

        You asked a couple of questions:

        1) Can you show that constant monetary expansion is needed?
        The empirical literature shows that low and stable inflation is conductive to growth. The same literature shows that deflation is always an unmitigated disaster. Irving Fishers famous paper, the debt deflation theory of great depressions is pretty good on why that is the case.

        2) Is there any reason to assume that this monetary expansion, now that it does no longer go through the banks and the credit markets but through state spending, has less disruptive effects on the performance of the economy?

        How about a citizen’s dividend for a way of getting new money into the economy? It is the most democratic way of creating new money, it shouldn’t affect relative prices (not that I can think of off the top of my head anyway) and it avoids the government choosing how it’s spent (which I assume you would not agree with).

        However even if we did grant it directly to the government, the answer to the question of “What type of mis-allocations/imbalances/disruptions would we have to assume under such a system?” is pretty simple. Under the current system the misallocation of credit by the banking sector has resulted in continual financial crises. Under our system the new money comes in debt free, so no risk of a debt crisis or a financial crisis. Governments also perform valuable functions, infrastructure, hospitals, police, schools etc, so hopefully the money would go to improving these. Even if the money was wasted (which I assume you think it would be) it’s not a disaster, as it is only the first use of the money. The money would then be spent somewhere else, creating income for an entrepreneur in the process. Besides the point of the money is not to create a revenue for government, but to get new money into the economy.

        Finally, I would just like to re state the point I made earlier, the only way we can stop governments from rescuing banks when they go bust is to remove our money (in the form of deposits) from their balance sheets (the PM proposal). You cannot ban the current banking system, or remove government support from it. I think (correct me if I am wrong) that you basically support our reforms, only you would not have any new money creation (i.e. a stable money supply)?

        • Hector Combe says

          Hi Andrew Jackson,

          I’m new to this forum, so pleased to meet you, I have enjoyed reading your contributions.

          If you would allow me, I can recommend a truly excellent book, Economics on One Lesson by Henry Hazlitt. It covers a lot of the situations you just mentioned. Basically it’s all about the seen AND the un-seen.


        • David Goldstone says

          “The problem is that this money multiplier theory you are talking about has not applied for over a hundred years, probably more. Banks create credit and money is supplied endogenously by the central bank on demand. The private bank tail wags the central bank dog”

          Factually this is correct. The need for deposits does not significantly constrain credit creation. But the reason for this is precisely because of the existence of central banking which provides the necesary liquidity guarantees explicitly or implicitly. If the support of central banking were to be removed, the situation would change overnight. Commercial banks would become deposit constrained and credit creation would be far more limited than it is now. Without central banks to provide emergency liquidity and without the plethora of deposit insurance guarantees and subsidies that currently exist, the banks would constrained by the discipline imposed by the need to keep their depositers happy and by the fear of bank runs. If this were combined with the removal of limited liablity for the banking sector (also a state-provided privilege), unbacked credit creation and expansion by private banks would rapidly cease to be a problem.

        • says

          Andrew, let me answer your last question first: No, I am not in support of any of your proposals. You want to declare illegal an activity (fractional-reserve banking) that is not fraudulent, not a violation of anybody’s property rights, and in which all involved parties (depositor, banker, borrower) can reasonably be expected to participate for their own perceived interest and without necessarily being systematically deceived about the involved practices and risks. Yes, many people may not fully know (or not really care) how it works, and yes, the practice is destabilizing for the economy overall as it leads to business cycles, although the extent of that effect depends on the scale on which FRB is practiced. But we should not ban or restrict by law the activities of consenting adults just to protect some people from their own ignorance or stupidity, or to give the public some mystical right to ‘stability’.

          I could only ever support a ban on FRB if you could convince me that the activity as such was fraudulent. The great Murray Rothbard failed to do so, although he came close, and I do not think that Positive Money even tries to argue the point. Either FRB is fraudulent, or it has to be legal. Period.

          Other activities of the banks are by themselves equally innocuous: making mortgage-loans for private homes, trading credit derivatives, speculating on asset prices. What is wrong with any of these activities in a market economy? – Do you seriously want to advance a crisis-theory according to which the crisis occurred because the banks made the wrong ‘type’ of loans? There is no respectable economic theory out there that would explain the existence of business cycles on this basis. Failure and mistake are always options in a market economy. Every lender is at liberty to make bad loans or the ‘wrong’ loans, although no lender would intentionally do so. If you want to explain a recession, you have to explain a ‘cluster of errors’, namely why did so many people keep making the same mistake for such a long time. Why did the market’s feedback mechanisms not work? – The answer: Elastic money and easy monetary policy have persistently distorted the pricing of risk.

          Extensive FRB destabilizes an economy because it expands the money supply, which in turn lowers interest rates and increases borrowing and investment, broadly defined, without any of this corresponding to savings in the economy.

          If all the bank lending of the last 12 years had gone to entrepreneurs who had built factories (to use your example) and none had gone into the housing market we would most certainly also have had a crisis, just a slightly different one. The entrepreneurs would have used the new money to buy the various resources they needed for their projects. These resources had not been sitting around idly before; they were employed elsewhere in the economy. The inflow of money would have changed the allocation and the use of society’s resources (this is always the case with inflows of new money!). At lower interest rates the factor ‘time’ becomes less of a constraining factor in production, and more resources get employed in projects that only deliver returns in the long run. That is fine as long as the public in their role as consumers and savers are OK with the changed allocation of resources, but are they? – Well, is a greater chance of that if the investment boom is funded out of an increase in voluntary savings, as savings indicate that consumers, too, have now a lower time preference and are happy to see more resources move into investment project. But instead the investment boom was funded with newly created money.

          The problem with our modern infrastructure – unlimited fiat money, lender-of-last-resort central banks, deposit insurance, extensive bank regulation – is that it encourages (and is designed to encourage) bank credit creation and thus lending and investment on a scale that is entirely unrelated to the propensity of the public to save. Interest rates, which are the essential coordinating element between saving and investment, are systematically corrupted. This explains persistent capital misallocation and thus the occurrence of crises.

          Whether the banks wait for more reserves from the central bank and then create extra money, or whether they go ahead and create extra money, then wait for the central bank to deliver the necessary reserves and thereby validate the extra bank lending later, is a technical detail that is entirely immaterial for the central argument (see David Goldstone’s comment). It still remains a fact that FRB on today’s scale (a hugely disruptive scale) is only feasible with extensive state support. Yes, if you subsidize an industry long enough it becomes ever more difficult to wean it off the fantastic support it has come to rely on (and that has now become an integral part of its very business models). But let’s also not forget that presently the banks are not racing ahead with more FRB and dragging reluctant central banks behind them but that it is now the central banks that are pumping the banks full of new reserves to get them lending again. The dog is again wagging the tail.

          So no, I cannot support a program that sets out to ban a non-fraudulent private-sector activity and then gives full control over money to state agencies. Your excuse for further money-printing and thus ongoing debasement of our unit of exchange – now, under your proposal, by a state agency – is the same excuse that is presently used to justify the ongoing state support for FRB: Inflation is good for the economy. This is without merit. It is simply not true. (I refer you to my book Paper Money Collapse where I discuss this in more detail.)

          We do not need some higher authority constantly pumping new money into the economy to create a specific rate of inflation, as predetermined by a group of economic experts. Giving any institution that type of power is highly dangerous and always destabilizing to the economy. It is also unnecessary.

          The idea that economic growth is dependent on the expansion of the money supply is complete nonsense. It is not backed by any of the major schools of economic thought. (If that was the case, why do poor countries not have their central banks print more money? That should get their economies going, no?)

          Prosperity is the result of an intensification of the division of labor (guided by market prices) and the accumulation of capital (guided by market prices), both of which increase the productivity of human labor. The constant expansion of the money supply (inflation) distorts market prices and disrupts these processes.

          Here is an idea: Why do we not turn the question of what is money and how much of it we need/want over to the public? We should privatize money and credit and give it back to the market, which means the public. I am all in favor of currency competition and free banking. I am confident a free market would go back to gold but I am happy to let the public be the ultimate judge of that.

          Your proposal, however, does not empower the public; it empowers the state.

          • Pejeu says

            It boggles the mind how can you say FRB is not fraudulent. The banking system is completely reliant on the ignorance, apathy and obtuseness of the public at large concerning the issue in order to preserve and perpetuate this fraud.

            Banks wilfully mislead people into believing the numbers on the ATM screen or the account balance printout are really money and not just counterfeit electronic monies. Not just make believe bank bullshit.

            Last I checked commercial banks should not be issuing money. Let alone passing it off to unsuspecting people or businesses as genuine money, issued by the legally authorised source.

            Currently invariably a central bank. Not that I like having any bank exist (and thus issue money) at all.

            But last I checked the Central Bank in each country is mandated to perform this function. Which should be performed by the government. And through payments rather than interest bearing loans.

            It certainly isn’t retail banks, though.

            The only reason retail banks get to exist is because of the corruption or incompetence of the legislators.

            The nerve of you FRB apologists!

            It’s simply astounding.

            What, claim it’s a promise instead of a misleading statement and that makes all right, then?

            No, it’s not all right.

            Because you’re still misleading people as to the promissory nature of the promise.

            You’re misrepresenting the promise as the actual thing it’s promising.

            Furthermore, the ill effects of FRB are not contained to the voluntarily contracting parties.

            FRB is basically a mechanism of inequitable issuance of new money into circulation.

            Which is basically a mechanism for the hidden redistribution of wealth and resources in the economy.

            Who the fuck gave a shithead private fraudster the right to redistribute my wealth, the purchasing power of my savings or my income?

            For his own profit, no less.

            Without informing me, let alone consulting me. And for his own gain.

            And without reimbursing me, let alone affording me participation in the profits derived from his legal counterfeiting of monies.

            FRB socialises the cost of bank lending to specific individuals.

            While the gains are privatised.

            And you and your ilk are ok with it, of course.

            You being a (classical) liberal, right winger.

            You’re down with the fraud.

            You people are simply detestable.

            Trying to defend this form of indentured servitude, basically.

            This abject reinvention of slavery.

            Furthermore, as there is no money in the economy that wasn’t lent into circulation by the banking system first, one could easily claim with confidence that generally, each time the banking system issues a loan to the real economy it’s basically printing up it’s assured future profits.

            As there is no alternative to FRB issued money and the associated principal and interest debt may only be discharged through bankruptcy.

            A teeny weeny conflict of interest there, wouldn’t you say?

            How is that fair?

            How is that honest?

            How is that just?

            What kind of a crappy person do you need to be to an apologist for this indefensible practice?


            A libertardian.

            Libertardians are all for freedom.

            The working man’s freedom to starve or loose their home and the crook’s right to defraud people. To steal from people. To exploit people.

            Libertardians are all for the emancipation of crooks and counterfeiters.

            And that’s why I hate you people’s guts.

          • says

            I explained all of this in my essay and in my book. FRB is not fraudulent. No bank pretends it keeps 100 percent reserves. Depositors know (should know and can know because nobody hides it) that deposited money does not just sit in the vault but is lent to third parties – at risk (how else can the bank pay interest to the depositor?). Whenever you deposit cash at a bank you exchange ownership of money (which is now transferred – by you!- to the bank) for a claim against the bank on repayment! If you do not like that don’t put your cash in a bank, keep it in a safety box. I know people who do that. — FRB does not socialize anything, it is the government that socializes the risk of FRB. In a free market, in which each bank is at risk of bankruptcy and where core money (bank reserve money) is an inelastic commodity (gold), FRB will be very limited. It only becomes dangerous for the wider economy when the state subsidizes it via easy fiat money (unlimited reserves), a lender-of-last resort central bank, deposit insurance and other measures. Either you are unable or unwilling to grasp this. In any case, many people disagree with me but they have the courtesy to watch their language. If you cannot conduct a civilized debate you should stay off a website like this one. I am sure the internet provides plenty of outlets for half-baked opinions, prejudice and angry tirades. Good luck!

  13. simon says

    Detlev you are starting to become my favorite Austrian economist. Rarely have I seen the theories of the Austrians explained with such clarity. Thank you!

  14. Joseph says

    Hi Andrew, quick question – when you say a citizens dividend, what exactly do you mean and how would it work? Secondly, do you honestly believe you can trust the state to be an independent, unbiased producer and distributor of money, given the history of incompetence and corruption in our government? You say the government performs valuable functions, but when I look at public services I don’t think ‘wow I wish the government was 100% in charge of my money as well!’ As a note I totally understand that private bank credit creation with a taxpayer/central bank ‘backstop’ probably isn’t any better.

  15. Hector Combe says

    I think the key issue here is, is it just and right to lower your aim slightly in the hope that it is something that you can actually achieve in the near future or should you stick to what you ultimately know to be the truth, or the best way of doing something, regardless of how politically unfeasible or unpopular that may be. I think we can all understand that both sides are right in their own ways. I believe Rothbard wrote on this very issue at the end of “The Ethics of Liberty”.

    PM’s proposals, while not the separation of state and economy that is ultimately required, would be a large step in the right direction. If we as a society generated enough grass-roots understanding and knowledge to get the monetary setup changed, surely that would also stimulate enough interest and debate to get people to turn around and take notice of the real economics, Austrian economics, and how it could radically change and turnaround our understanding of what we should expect from our governments…moving in the direction of maximum liberty, a free society, Hayek and spontaneous order and so on and so forth.

    Gentlemen, why don’t you arrange a moderated debate on the issues that have been discussed here, and record it and put it on your websites? It would be fascinating to watch, and you would both generate interest in the academic and political debate, and draw much needed attention to the need for reform.

    Another idea, Mr Schlichter, would you be interested in starting up a “Campaign for Economic Secularism” to actively put forth the ideas you have expressed in your work, to try to educate the public about the damage being done by our current monetary system. The approach of such a group would be to educate the public about the need for reform and change by introducing the idea of “economic secularism”. That is to say, we have an understanding that we do not tolerate government interference in our religious affairs, so it is equally (if not more) important that we should not tolerate government interference in our economic affairs. I think the time is ripe for this idea to spread, the public intuitively senses these problems, without necessarily having the (austrian) framework to understand why.

    I have actually emailed Ben Dyson about this idea as it is something I am interested in doing, but in the new years have been rather busy with my work and have not chased it up. Would be interesting to hear your thoughts.

    Great article by the way
    Hector Combe

  16. says

    I have never met a central banker but I have met quite a few Politicians, and watched them perform their tricks for many a year. The idea that they are somehow more intellectually equipped to manage the money supply is so absurd I cannot fathom how anyone would bother “researching” the possibility!

  17. fazsha says

    I agree with Detlev’s analysis. To extend the analysis, I don’t think it s/b the central bank role to try to prevent banks from extending credit too loosely, if they independently decide to do so and are willing to take the risk. Nor do I think it is their role to bail them out if they fail. I would welcome bank failures as a means to purge excess credit in the system. Rothbard pointed out, however, that one goal of central banks was to get the member banks to expand credit TOGETHER, so there would not be a ripple effect of contraction in other banks to meet their reserve requirements. We can see that today, as global central banks expand TOGETHER in near perfect synchronicity. This is an entirely corrupt feature of central banking, and the one feature I wish we could stop, while still maintaining the clearinghouse features.

  18. says

    Mr. Schlichter,

    A wonderful analysis and I especially appreciate your views on fractional reserve banking.

    Regarding the following: “Well, I do agree that an inelastic monetary system, for example a 100% gold standard, would be the most stable (least disruptive) monetary system.”

    As I assume such a system would not be developed in a free market (and I don’t imagine you do either), would you view this 100% gold standard system as more stable than a fully free-market developed system?

    If so, could you please elaborate (even briefly) as to why?

  19. Robert says

    The introductory critique of too-ready acceptance of whatever nostrums have gained currency is well-directed and elegantly done. But the ” loading” begins immediately: the myths chosen ostensibly to illustrate this thesis are stool-pigeons artfully selected for their utility in setting-off the writer’s own particular sectarian beliefs in the most flattering relief. We are being lined-up to be receptive to the propaganda exercise which is to follow, to be conducted on the writer’s own chosen terms.

    It would have been more honest had he run-up his colours from the start instead of misrepresenting what is in fact a polemic as loftily-disinterested enquiry.

    He defines his own mission as being to dispel what he deems to be the “confusion” which is befogging others’ perceptions – though not of course (by definition) any of his own particular set. So the reader is left in no doubt that he is in the presence of an oracle.

    But an oracle, be it noted, who speaks with an Austrian rather than a Delphic accent – which may engender the suspicion that some smoke and mirrors may be at work. Thus we are hardly into the discussion of Positive Money’s proposals before an Austrian shibboleth duly makes its appearance:- PM’s proposals do not resort (curious phrase!) “to any theories of capital or business formation”. So that automatically invalidates them…? When they are not in fact contingent upon that particular (Hayek-mandated) theoretical framework…?

    We then descend (disappointingly) to villification. Because the findings of modern archaeology and anthropology regarding the origin of money (which – unlike the pseudo-science of economics – are founded, however imperfectly, upon verifiable empirical observation) are in complete disagreement with the beliefs of the founding fathers of the Austrian school – which they show to have been no more than armchair speculation at best, anachronistic into the bargain – those findings are simply trashed. They do not fit with the revealed truth, ergo they must be wrong. In a dazzling display of effrontery, it is the scientists who are portrayed as purveying “mysticism” not – heaven forbid.- the doyens of the Austrian school. To borrow from another Austrian, practising in a rather different discipline, this seems remarkably like subconscious “transference”.

    And no, as a matter of fact, the “‘true nature of money’…” is not “…open to the theoretical investigation of economists”, for the very good reason that they are not equipped with the knowledge or tools necesarry for its elucidation, whereas anthropologists, prehistorians and archaeologists are, so far as anyone is. Sorry, but there it is.

    I could go on this vein except that my post would then become far too long. I think the above already adequately makes my point:- if you’re not already of the Austrian persuasion, don’t take any of Sclichter’s pontifications without a very large pinch of salt. If you are, you’ll already have been preconditioned not to accept anything that doesn’t conform to the teachings of the True Faith. In fact, you will disparage it as being beneath contempt regardless of the scholarly credentials of its author.

    And – in case anybody gives a damn – no, I’m neither an academic nor an economist.

    • says

      Just to clarify a point: Never have I implied that archeologists or anthropologists are mystics. The point is a very different one: Money is a tool. It is a tool for human cooperation, and it is a tool that we all use every day. As money-users all of us have some idea of why and how we use money, and therefore what makes good money. Economists are social scientists that have developed modes of analysis that systematize and conceptualize such thinking (and yes, a lot of that can be done in an armchair but the same is true of mathematics and theoretical physics, I guess). Economists have developed modes of thinking by which we can better understand the workings and full impact of such ‘modern’ social tools as money. We can have a debate about how the science of economics should be organized and conducted but it requires enormous ignorance to disregard economics altogether. Our modern societies deal with issues for which scientists such as archeologists and anthropologists have very little to say. Or, to the extent that they do want to contribute to the debate of current phenomena they have to then also adopt the type of conceptual economic thinking that characterizes the economist. They would have to distill that part of their historical knowledge that is relevant for today’s world, and in order to do this they have to think conceptually, just like a modern economist does (or should). (And I suspect – alert! this is a personal opinion – that such relentlessly self-promoting anthropologists such as ‘Occupy Wall Street’ campaigner, David Graeber, may not be quite representative for their science and may do more harm than good to their science.) —The hammer is also a tool. If we wanted to design a better hammer would our first response be to say, let us find out what the ‘true nature of the hammer’ is? We all use hammers but its true meaning is closed to us. To unlock it we need to consult a group of anthropologists and archeologists to tell us how the hammer came about and what its first uses were. — Sorry, Robert. This approach is nonsense, and it is no better in the field of money. — One last point: You try to discredit me as an “Austrian True Believer”, as a sectarian, but you do not refute a single point I made.

  20. Joseph says

    The first thing I thought off when I read about Cyprus was this article Detlev. This is what the belief that someone will bail you out no matter what happens does to banks, and for some reason I doubt Cyprus will be the last now that people know that the state can’t afford to insure their money.

  21. says

    Schlichter’s article is nonsense for the following reason. He attacks Positive Money because PM adheres to an idea accepted by about 90% of economists (as Schlichter himself points out) namely that a flexible monetary base is desirable.

    He might as well have attacked the economics department at Oxford University on the same grounds. Or in the Adam Smith Institute. Or the Treasury. Or… you name it.

    • says

      To state, as I do, that a flexible monetary base is not needed and is in fact harmful, is “nonsense” because … a majority of today’s mainstream economists holds a different view. Wow. Is it that easy? Is that how we settle academic debates now? Counting heads? — Surely, you can then logically explain why I am wrong and all those other economists are right…. Go ahead. I am interested. By the way, some of the greatest economic minds in history shared my view.

      • says

        I didn’t mean to suggest that PM was right because their flexible monetary base idea is accepted by the large majority of economists. My point was that the flexible monetary base idea is a hundred miles from being an idea peculiar to PM. So it’s a bit odd to criticise PM on that score.

        I.e. you might as well criticise the economics department at Oxford for exactly the same reason, as I pointed out above.

        Put another way, if there is an idea or set of ideas which REALLY IS unique to PM (and I don’t know of one) then OK: criticise PM for that.

        • says

          There is nothing unique or original in PM’s proposals but that should not shield them from criticism. Their theories are half-baked and faulty, and the conclusions they draw are dangerous. Thus, they should be criticized. If the Oxford economics department holds similar views or similarly faulty theories they should be criticized too, and I will happily do it.

  22. says

    Found the comments and to some extent the article useful in putting meat on the bone for the argument that as James Robertson and others have suggested, replacing the private monopoly of money creation with a government monopoly may not have much chance of success or of improving matters if it did. While the narrative of monetary dysfunction is generally quite widely agreed, responses tend to fall into two camps, the Monetary Reformers and the Money Diversifiers. The former think there is no time to allow multiple competing currencies to develop ground-up and out-compete our fiat currencies. The latter think there is no chance of any monopoly currency avoiding capture by TPTB. Lets hope they are not both right.

    I find the authors faith in the market touching. It’s certainly a compelling construct and a model that can stand seemingly endless tinkering on economics’ aspirational and probably fruitless search for elevation from pseudo-science status. Tinkering that seems able to ignore the fact that markets as defined don’t exist. Personally I am entirely happy to trust the market to ‘disclose’ the price of things I don’t really need. But for the stuff-of-life, give me inefficient community, co-operative (or even government) governance any day. There are no markets that can’t be manipulated by insiders or captured.

    When deposit-protection is withdrawn from the banks in an ideological attempt to return banking to the ‘free market’, how can I personally know which banks are more likely to fail. Losing your life savings isn’t like buying a planned-obsolete dishwasher. Perfect information? B****cks.

    Andrew Jackson makes the point about misallocation of capital, and I think PM’s view is probably that a Monetary Allocation Committe couldn’t do any worse. A random number generator probably couldn’t do any worse. Other commentators such as FinanceWatch have pointed up and described the full implications of this lack of strategic guidance in capital allocation. I can’t help thinking that national priorities should guide this activity. It shouldn’t be left to the herd-mentality of a group of risk-dyslexic oligarchs to allocate on sentiment.

    But we’ll probably disagree on that.

  23. Joe Doe says

    Just a heads up, the question I’m about to ask is hypothetical and without much consideration. Here goes. What if whatever created value, created money? If I work for one day, I create x number of dollars for myself. If I buy something with that money, that money gets destroyed. How would the economy work with this modality?

  24. Ernest de Cugnac says

    Thank you for a thoughtful demolition of the Positive Money position. I have been as reassured by you as I have scared by them. Scared by the possibility, not entirely remote, that they could develop some sort of political head of steam. There is also nothing quite so scary as naive views sincerely held by ernest and worthy people.

  25. A says

    You wrote that “A growing economy does not need a growing supply of money and therefore does not need a money producer.” Does not though a growing population need a growing supply of money? If the money supply remained constant but the population continued to grow the amount of available money per person would decline year on year. In other words, the amount of money circulating today (digital and hard currency together) is surely far greater than 100 years ago. Where did this money come from is the supply of money was stagnant and did now grow? What type of a solution is there for this?

    • says

      A, you seem confused. A growing population needs a growing supply of money as little as a growing economy needs a growing supply of money. (And by the way, a growing population usually means a growing economy.) Money is a medium of exchange. Its value IS its purchasing power. If 100 million people use 100 tons of gold as their form of money, what is the problem if the population grows to 110 million people? There is no problem. A) The existing stock of gold may change hands more frequently, thus facilitating more transactions. B) More importantly, money-prices will now be lower. That means each ounce of gold now buys MORE stuff. If you allow prices to be reasonably flexible (which they are in a free market) ANY quantity of money (within reasonable limits) can facilitate any number of transactions! With the SAME stock of money a BIGGER population can trade MORE goods and services. All you have to do is allow prices to drift lower over time, as will happen naturally. As the population grows and the economy grows, prices drift lower if the supply of money is unchanged. There is a smaller quantity of money per person but that money now buys more. Each person may in fact be richer than before even if there is a smaller quantity of money per person. The QUANTITY of money is immaterial. Money is all about purchasing power. Demand for money is never demand for a certain number of banknotes or weights of gold but always demand for the purchasing power of those banknotes or amount of gold. In 2008 almost every citizen of Zimbabwe was a billionaire in local money but a billion could not even buy you an egg.
      Since the introduction of unconstrained fiat money the global money supply exploded with huge adverse effects for society. That happened for political reasons (predominantly) not because of economic necessity.

      • kahuna says

        Hi Mr. Detlev,

        but if the price of gold raise up, in theory, its deflationary. It means, people would prefer to save gold in stead of invest it, since its scarce money, its a kind of money limited in quantity, and everyday its purchasing power increase. If you know that it will get revaluated, why are you going to invest it? you prefer to save it, so you take base money out of circulation, entering a base money deflation situation, less credit creation, less business investment, etc., isn’t it?

        thanks in advance!

        • says

          What you describe is the alleged problem of hoarding, which is not a problem at all.
          1) Over any given time period there is no guarantee that the purchasing power of gold-money will go up, i.e. that there is always deflation. Yes, on trend and over longer periods one should expect secular deflation but whenever the demand for money goes down, whenever the public lowers its demand for cash balances, even temporarily, money’s purchasing power will drop. Additionally, the concept of a price index or price level is problematic. Money’s purchasing power doesn’t change uniformly. Relative prices change considerably, so if you save by holding money (gold), the thing you may want to ultimately buy may still not get cheaper, or only after a very long time.
          2) The trend rise in purchasing power can be expected to be slow, maybe 1 or 2 percent per year. If people are happy to get a 1 percent real return on their savings fairly securely (but not absolutely securely, see 1)), they may save by holding money. If they want a higher return they will have to invest and give the money to an entrepreneur. All this means is that the threshold for (hopefully) productive investments is in excess of the 1-2 percent that people can reasonably expect to get from holding gold, at least on trend. Well, this will hardly mean the end for productive investment.
          3) Even in inflationary fiat money systems, there are usually almost-secure (very low-risk) assets that offer a small real rate of return. These used to be bank deposits (although not anymore because of the crisis and present central bank policy) and certain fairly secure government bonds. If your argument were correct, people would also have saved (and would still save) only in bank deposits or government bonds as these, too, provided – and in some cases still do provide – small real returns at very low risk. Evidently, that is and was not the case.
          4) If gold money replaces bank deposits and government bonds as the preferred savings vehicles for people who do not want to invest in productive enterprise (and this must ultimately always be the backbone of every economy), so much the better. The explosion in bank balance sheets and the growing public debt load are a menace to our economies as I explain in my book.
          5) Hoarding is self-correcting for two reasons: opportunity costs and time preference. As people bid up the price of the money-good (gold) prices of non-money goods fall, and the opportunity costs of sitting on money rather than spending it rise. If many people shift from equities into gold, equities get cheaper until at some point some people move the other way. This is true for consumer goods as well. — You may counter by saying that everybody has an incentive to not spend today because prices will be lower tomorrow but this ignores time preference, which is an essential element of all human action: to want something, all else being equal, means to want it sooner rather than later. Would you not buy a burger at McDonalds because you knew that if you waited a year it would be 2 percent cheaper, and if you didn’t go to McDonalds next year either, you could save another 2 percent? Would you eat all your burgers at the end of your life? — The prices of consumer electronics (TV, VCRs, laptops, mobile phones) have on trend been falling for years but, evidently, time preference in respect to these goods has trumped the sector-specific deflation. A real saving in a year of 1 or 2 percent (or even 5 or 10 percent) was evidently less valued by consumers than the subjective benefit of having a state-of-the-art electronic gadget now.
          6) Historically, this has not been a problem for gold money economies.

          I hope this answers your question. You may also consider this link:

  26. Pejeu says

    Yet another right wing fraud apologist.

    FRB is inherently fraudulent and for that reason alone should be outlawed.

    The only purpose of money issuance is to redistribute wealth and purchasing power (resources basically) in society.

    All banking does is redistribute other people’s wealth. Which is basically the power to tax and spend. Which should be the exclusive purview of government.

    Not private shitheads which have a profit motive to shift as much wealth as possible in society, regardless from whence to where, from whom to whom or for what as they get a cut of every bit of wealth they redistribute.

    Only frauds and thievews and their right wing shithead apologists disagree.

  27. EcoCollectivist says

    The problem with economists is that they all believe in God. Or, put another way, there is only one economic system that “works”. In fact there are many economic systems which “work”; but there is only one system which brings about a particular outcome. Thus, the question shouldn’t be “what economic system works?” But rather “what type of outcomes do we want from our economic system?” The capitalist economic system has the worst outcome of all systems as it has no capacity to equitably distribute wealth, work within environmental limits, or create a positive cooperative social environment.

    • says

      “The capitalist economic system has the worst outcome of all systems as it has no capacity to equitably distribute wealth, work within environmental limits, or create a positive cooperative social environment.”

      Carbon is the very worst material on which to base a life form, as it has no capacity to guarantee immortality, facilitate time-travel or ensure a permanent supply of free pizza and Coke.

  28. kahuna says

    good morning prof. Detlev,

    first at all, thank you very much for this article. Amazing how you explained how demand for money works. One of the best on internet.

    anyway, i still have some doubts i would appreciate so much if you could solve. I dont know if its going to be possible since this article is a little bit old, but here there are:

    1. my first doubt is not a doubt per se, but a detail explanation. If you read the last PositiveMoney book (“Modernizing Money”), you will see that what the book proposes is almost the exact theory Hayek or Mises explains in their work (ok, is no exactly the same, but the same spirit). In “Modernizing Money”, they explain how credit expansions create, thanks to central banks, artificial interest rates, creating at the same time consumption and investing behaviour, and capital distorsion structure. In their proposal, with 100% reserve banking, purchasing power would be 100% transfer from savers to investors, there wouldn’t be central bank lender of last resort, and savings accounts would be out of commercial banks balance sheet, so in case of a bankruptcy, bail ins would be possible without risking peoples savings (like could happen with a Hedge Fund). The book continues with more details like how FDIC creates moral hazard, etc. From my point of view, this Positive Money perspective is almost Austrian! :-)

    2. My first doubt is about how this system would work. If you read the book i link before, and you change debt-free-money issued by the treasury (as the book proposes), by the word ‘gold’, what would be the difference?

    In a gold standar, if gold price increase, miners have the incentive to mine more gold to put it in into circulation. If gold price goes down, miners have less incentive to mine it. If gold price raise up, it means that people demands more gold for transactions because there is a small deflation, so miners put into circulation the quantity needed to balance again the gold price (people demand more value-exchange). If there is a little inflation, it means that there is more gold than necessary, so GDP will have to catch up the quantity into circulation to balance the price. At the end, you need miners putting gold into circulation, because its not operative that, as you explain, if demand for money increase, gold price increase … because at the end it means that the gold supply is fixed (doesn’t grow), so its obvious that the system is deflationary by default. More GDP, more demand for money, exchange-value raises, fixed base money supply … its deflationary. How can we grow in goods and services?

    so, what is the difference with state money issuance? if the goverment decides that inflation rate has to be under 2%, and small deflation occurs (lets say, it falls under 0.5%), it will mean that people demand more money (gold or debt free paper money) for GDP transactions, isn’t it? if we were under gold standar, miners will put gold (and also paper money) into circulation until price returns to previous levels (inflation rate of 2%). If we do not put debt-free paper money into circulation, the same would occour: fixed base money supply, GDP growth, incrase money demand (exchange-value) .. would create deflation.

    Well, in the other side, we can imagine a world with a fixed constant money suply that doesn’t grow, and the cost of a donut is 0.0001 onzs of gold :-).

    3. You claim that state issue money would miss allocate capital resources, but, how? The proposals of how the treasury should inyect the debt-free money are more than one. One of them would be through public infrastructure, like roads or bridges. But there are other ways, like a fix supply to commercial banks, or direct inyection to savings accounts poor people, or lots of different ideas. With BitCoin is electronic mining. There could be lots of ideas.

    Lets imagine that the state inyects money through public infrastructure, and lets say the inflation target has to be 2%. We can calculate the inflation not through CPI, but deflator. So, do you think that an inyection of 2% GDP into economy can create capital missallocation? or if we decide that 1% has to be lend to commercial banks, and 1% to public infrastructures?

    thank you very much for reading my comment and giving the posibility to write in here,


    • says

      1. If Positive Money were worried about Austrian School business cycles they should advocate an end to any active monetary policy, a fixed monetary base, the termination of the “lender-of-last-resort” function of the central bank (and the privatization of the central bank), a complete end to state-involvement in money, and potentially a return to a gold standard. All of these are sensible reform proposals that reflect the views of Mises and (the younger) Hayek. I would back them up on those. If you implemented those, fractional-reserve banking would cease to be a problem in my view. The Austrian business cycle would pretty much have ended. But Positive Money want to ban fractional-reserve banking, which is unnecessary, and give full monetary powers to the state, which is dangerous and certainly not in line with anything Mises and Hayek suggested. Positive Money believe that today the central bank is at the mercy of the banks, which is wrong. They propose the establishment of a Money Creation Committee. This is not a free market solution and not an Austrian concept at all. It is anti-free market and pro-state-controlled money. It is incompatible with capitalism and a free society.

      2. Deflation is not a problem, certainly not the mild, secular deflation of a hard money system, such as a gold standard. There are no theoretical reasons for why this should be a problem, as I explain at length in my book, and neither is there anything in our historical experience that would indicate that it is a problem. A “hard” commodity, i.e. one with a fairly inelastic supply, such as gold, makes for excellent money on account of theory and history. The switch to paper money was entirely politically motivated. It is true that secular deflation will, over time, make the mining of more gold profitable, and this will counterbalance somewhat the deflation. However, this does not mean that there will be no deflation, or that this will guarantee price stability (a silly concept). Also, I show in my book that even if all mining were to end at some stage (as is the case with Bitcoin) this would not be a problem. Secular deflation would continue.

      Because the mining of gold is expensive and thus regulated by money’s purchasing power, the supply of money is “fairly” inelastic and outside of political control, which is also important. In a paper money system the supply of money is entirely flexible and under the control of the issuing authority. This is destabilizing for the economy and politically dangerous. But Positive Money want to maintain this. They wrongly believe that we need elastic money and therefore a money producer. They only want to change this process and give more control to the state (the Money Creation Committee). This seems to come straight out of George Orwell’s 1984.

      3. “Debt-free” money creation by the state is discretionary and arbitrary money spending by the state and means the new money is unconnected to any economic activity (as is still the case when private banks create money as part of commercial lending). Instead, money comes into circulation in form of a gift from the issuing authority. As a general rule, all injections of new money (whatever the process) must cause economic disruptions, as I explain in detail in my book. But discretionary money-gifts from the state will certainly lead to worse dislocations because of the absence of any considerations of profitability (which still play a big role for private banks – even if they can create money, they cannot create capital and thus run risks, so they will only fund projects that stand a chance of repayment) and the necessarily political nature of the process. This will be much more wasteful for society and disruptive for the economy. The problem with fractional-reserve banking and bank-money creation is that the artificial lowering of interest rates that is part of the process corrupts the risk-reward calculation of the banks and leads to boom and bust. The process that Positive Money suggests does away with any risk-reward analysis and replaces it with political discretion.

      • kahuna says

        Hi Mr. Schlichter,

        first at all, thank you for your answers. Its a privilege :-). By the way, i already put your book in my wishlist on Amazon, so i will wait for the new version on summer, once i read you are planning to update the version :-). SuperB.

        according to the first, i just said that PositiveMoney uses lots of Austrian economic thinking into the book to explain boom&busts (actually they cite Hayek). And to be more precise, they explain very detailed how central bank manipulates interest rate to achieve a certain level of aggregate demand (inflation and employment rate goal), how are commercial banks capabilities to create “money” (credit-money) and allocate it according to their interest (asset inflation for instance), how FDIC provides the wrong incentives for a commercial bank risk race investment, or how the policy of central bank “lender of last resort” do not provide the right incentives to make responsible banks investment, so they propose separate savings check accounts from their balance sheet, so that from now on they could work as an “Hedge Fund” (there is no risk to lose savings accounts, so there is no reason to rescue commercial banks through taxes anymore). They explicity explain that credit expansions are caused by commercial banks in times of ‘prosperity’, following Minsky theory, and how this credit growth is not based on real savings, but interest rate manipulation, so there is no real purchasing power transfer when creating loans.

        You propose not to ban FRB, and maybe you are right. Its totally normal that a solvent institution can provide credit. But, do you think FRB could have evolved like this way if goverment would had stopped accepting this digital credit-money creation as legal tender and for tax payment? who knows. There are austrians, like Huerta de Soto, that advocate for the end of FRB, so about this subject, there is no consensus inside Austrian community. From my point of view, the existence or not of FRB is not crucial to understand credit expansions and capital miss allocation. You can have FRB and responsible credit creation. The key are the incentives, and is obvious that the modern incentives (FDIC,FED) are providing the opposite.

        So if you analize all this details, at least you could agree that they are not that far from the root causes of boom&bust :-). They are not just demanding “state money printing”, ala “Venezuela” or “Argentina”, but explaining the causes and proposals for the situation. They are not argueing like a Keynesian, claiming that the aggregate demand fell because of a “aggregate irrational behaviour”, or denying that bubbles and credit expansion exist: Krugman? :-). If you read their last book “Modernizing Money”, you end up with the feeling that they understood the root causes, and math lots of austrian perspectives, but in stead of proposing inelastic base money, they propose semi-elastic (only elastic in times of debt deflation, but they claim that under the new system, there wouldn’t be huge boom&bust because of the existence of real interest rates, so debt deflations would be less common = less elastic base money supply).

        So at the end, if we read carefully the demands of Positive Money, in general the only BIG difference between Austrian “system” and Positive Money “system”, is that the first advocates for private desnationalization of money creation (gold through miners), while the seconds propose public money creation (paper through a committee). Thats the BIG difference from my perspective.

        Let me ask from another perspective. During all XX century, the average new gold supply through miners has been around a fixed 3% anual supply (i read it somewhere, but i cant find the source anymore). Lets imagine that goverments stablishes a kind of universal rule and law that imposes that there should be a _inelastic_ (as Milton Friedman once proposed) fix anual paper money base money supply of 3%. Lets just try to imagine that situation. In gold standar, miners used to inyect this base money through goods & services purchase, or through bank investment vehicle. Under public paper standar, this money could be inyected through public expenditure in goods & services, or private commercial bank lending procedures (so they would seek for profitability). From an economic perspective, from a scientific theory, do you think there should be a _big_ difference in the behaviour of both systems, once there is no private money creation, or central bank interest rates manipulation?

        You claim that this new money is unconnected to any economic activity, that it doesnt look for economic profitability, so will create miss allocations capital structure and rent seeking. But from my perspective, i dont think so a 3% (GDP) annual fix paper debt free money supply would create a huge capital miss allocation. Its “just” 30.000 billions $ for an economy of 1 trillion GDP. And supposing that all of this 3% is through public expenditure, that is not a must. There are other ideas to try to search for profitability. I mean, expenditure in productivity (public infrastructures for instance, renewable energy production, or enviromental externatilities). Or if you want 100% price lighthouse, we can inyect this money directly into poorest savings account, in stead of tax redistribution. And it doesnt have to be a fixed 3% base money supply, but inflation target (that is what they really support i think), simpler to understand by the public. How much could be for a 2% inflation target? central banks would be just institutions that study the inflation rate, or manage the savings accounts infraestructure, as Positive Money propose, but couldnt manipulate interest rates through repos or fed fund rate. And of course, it wouldnt act as a lender of last resort, since in the new system, banks wouldnt be rescued.

        Another perspective. Lets imagine the absurd (ok, i know its absurd, jut for the sake of the argument), that every year we put the exact amount of paper money inside earth that targeted the previous year a 2% inflation target. And every year “miners” have to extract it. No FRB. No central bank interest rate manipulation. Does it work? :-)

        So at the end, we are not talking about economics or a scientific point of view about if the system, under ideal conditions, could work properly, but a political point of view. Its just about claiming that institutions, politicians and citizens do not have the knowledge and behaviour to use this power responsibly. That the quantity of money will not be spent in productivity growth to increase goods & services, but in lobbism and “digging holes”. Or this 2% anual inflation will not be respected, like in Argentina or Venezuela.

        And about this statement, maybeyou are right :-). But this is not about how the economy could work, how the machine works, but how the society would use this tools by political discretion. Obviously there are countries like Argentina or Venezuela, but there are others also like Sweeden, Germany, Switzland, Canada or Australia, countries with central banks that are the opposite to this previous latinoamerican countries in terms of macroeconomics behaviour, and their situation is the opposite.

        In the past, if we read economic and financial crisis through history, we can see that we had hundred and thousands of crisis and bank runs even before central banks existed, and aggregate demand was even invented. There are only a few cases of free banking, like Scotland, a case that was studied by Lawrence White (i appreciate your link, but i already knew about him :-). Its obvious that it worked during almost 1 century, something excepcional, but apart from this example (there are others, but smaller countries, with less complex economic activity, and during less time), the economic reality shows us that even under austrian political principles (gold, free banking, etc.), the world experienced bank runs, crisis and recessions. All of them were caused by political reasons? politics expanding base money supply because of wars? politics interventions? maybe, or maybe not. Before central banks, we had bubbles like the tulips, and example of irrational behaviour in history. Or when in xv century, Europe discovered new gold mines in “new worlds” that boosted up the base money supply creating high inflation.

        I am not an anti gold. Its obvious that gold provides lots of positive features, i am not denying it. Just saying that under gold standard, world experienced crisis, bank runs and depressions, so advocate for the return of a gold standard is not a guarantee of prosperity and peace.

        again, thank you very much for your attention and time!


      • Jonas Jensen says

        Hi Detlev,

        A very interesting conversation and article. I have just one question. I can’t figure out how the problems inherit in fractional reserve banking will not be an issue in your gold standard system. As I understand both you and PM agrees on the fact that FRB can increase the money supply almost indefinitely. wouldn’t that be the case in a gold standard as well? Especially in the modern economy where paper money is rarely used and all transactions are digital. Why would banks need any kind of gold reserves in such a situation? only digital reserves would be needed in my view. Wouldn’t this lead to an ever-expanding digital money supply and inflation?

        However I do think your stable money supply is a very interesting. Do you have some comments on why this stable supply should/could not be fiat money?

        Thanks for the debate

        Best regards
        Jonas Jensen, presently writer of a master thesis of fractional vs full reserve banking

  29. Allan Jones says

    For an in depth look into state run private banks, there is evidence of such enterprises who function very well in comparison to private banks who need topping up by a state, such banks as Bank of North Dakota, or the history of Australia’s Commonwealth Bank when it was administered by the federal government.
    One outstanding thing about a government run public bank is that any interest paid upon loans can be directed into public works, this is a dividend paid for borrowing that does not exist with private banks, the shareholders of which then put capital to work buying privatized tax payer funded institutions.
    A fractional reserve government run bank would return interest to the borrower this way while the medium of principle is cancelled out back to where it came, thus this type of bank is non profit, non debt,and can monetize the total future & existing wealth of of the whole nation, it is cost less and debt less and is only a means of the exchange of all goods, services,& infrastructure and nothing else!

  30. says

    We have the technology to operate a single global banking system in which money can be loaned directly to an individual with a personal credit/debit card account. All citizens would be allowed to borrow up to a certain amount each month and would be the customers of the entrepreneurs who would obviously be making positive deposits to their cards. A percentage of these deposits would be returned to the central bank (taken out of circulation) so that the amount of curency in circulation can be controlled. The amount loaned out interest free each month to each individual would be decided by public debate. Students would be allowed to borrow more than drunks. There would be no homeless poor. Accounts are balanced at death of the holder or written off as welfare.

    • says

      Why would any entrepreneurs or savers be interested in providing these funds if they are lent out interest-free and if the entrepreneurs/savers have no say in who gets the money? – This is some centrally planned money socialism and thus unworkable. “Public debate” does neither guarantee efficiency nor justice. – Interest free money for all citizens is equivalent some form of “money drop” (helicopter money) and it is only going to lead to rising prices (inflation). The more you spread the new money (I have to assume the money gets printed) the more you get simple price-effects (I explain this in chapter 3 of my book). Society doesn’t get wealthier by having new money dropped on it.

  31. Dom Ferrand says

    In an inelastic monetary system, as proposed by the author, is there not a danger of a deflationary spiral? Would there be an incentive to trade if the purchasing power of money was increasing? How would the balance of trade be effected? Would there need to be import restrictions, etc?


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  2. […] Detlev Schlichter points out that it is the government who encourage fractional reserve banking, and all that really needs to happen is for them to stop doing this and banks will create some money but not nearly as much. Also, having the state create money is no less a recipe for disaster than having the banks do it, and maybe more of a disaster. The same economic distortions will apply. […]

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