Elements of Monetary Science

The Technology & Economic Forum is a venue to discuss issues pertaining to Technological and Economic developments in India. We request members to kindly stay within the mandate of this forum and keep their exchanges of views, on a civilised level, however vehemently any disagreement may be felt. All feedback regarding forum usage may be sent to the moderators using the Feedback Form or by clicking the Report Post Icon in any objectionable post for proper action. Please note that the views expressed by the Members and Moderators on these discussion boards are that of the individuals only and do not reflect the official policy or view of the Bharat-Rakshak.com Website. Copyright Violation is strictly prohibited and may result in revocation of your posting rights - please read the FAQ for full details. Users must also abide by the Forum Guidelines at all times.
Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 09 Dec 2011 07:26

Satya_anveshi wrote:Pranav saab,

as a special case of FRB, consider CRR of 0%; interest rate=0%;

Does the money supply increase?
more importantly, does it matter whether money supply increased or decreased?
What happens to the perceived value of "currency"?


Loans and deposits will increase as we drop the CRR. We have discussed that case here: viewtopic.php?p=1205397#p1205397

paramu
BRFite
Posts: 669
Joined: 20 May 2008 11:38

Re: Elements of Monetary Science

Postby paramu » 09 Dec 2011 07:46

Pranav wrote:
paramu wrote:So you agree that FRB causes prices to go up, which is similar to causing inflation.

I would say that the equilibrium for wages and prices is at a higher point.

If there is no increase in money supply, how did the price point go up? It is same as printing more money without FRB. Effectively both are same.

You can say that M0 is still the same, but the amount of money in circulation, in the form of debt, has gone up several times.

Another thing that FRB causes is increase in debt. Is that a good thing?

It makes loans available for those who want them.

Loans were available without FRB too and the price points were much lower. FRB just reduced the value of money, and people who thought they were saving just realized that the purchasing power of their money went down.

For now we remark that if you keep the money supply static in a growing economy, you will enter into a deflationary spiral, which will bring the economy to a grinding halt (as happened for example in 1929 in the US).


What is the definition of growth? Increase in currency denominated value, where currency is supplied continuously? Productivity increase will reduce the cost of production and hence increase in profit, when money supply is static. There will be a deflationary spiral only if there was a bubble. Did it create bubble using continuous money supply? The argument of threat of deflationary spiral is to justify continuous money supply. There will be pain, but after that there will be a steady state.

paramu
BRFite
Posts: 669
Joined: 20 May 2008 11:38

Re: Elements of Monetary Science

Postby paramu » 09 Dec 2011 07:47

Pranav wrote:If Dick did not increase the money supply by borrowing 8 coins and lending 5, he will not increase the money supply if he does the same thing n times. n times zero is zero.

Then how did prices go up?

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 09 Dec 2011 08:02

paramu wrote:
Pranav wrote:If Dick did not increase the money supply by borrowing 8 coins and lending 5, he will not increase the money supply if he does the same thing n times. n times zero is zero.

Then how did prices go up?


Wages and prices are at a higher equilibrium because the gold coins are circulating more instead of sitting under mattresses.

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 09 Dec 2011 08:11

paramu wrote:Loans were available without FRB too

Not so efficiently. Much of the currency would be sitting under mattresses.

and the price points were much lower.

price point? interest rates are market driven

FRB just reduced the value of money, and people who thought they were saving just realized that the purchasing power of their money went down.

Another way to put it is that FRB increased people's salaries. It is just a different equilibrium.

For now we remark that if you keep the money supply static in a growing economy, you will enter into a deflationary spiral, which will bring the economy to a grinding halt (as happened for example in 1929 in the US).


What is the definition of growth? Increase in currency denominated value, where currency is supplied continuously? Productivity increase will reduce the cost of production and hence increase in profit, when money supply is static. There will be a deflationary spiral only if there was a bubble. Did it create bubble using continuous money supply? The argument of threat of deflationary spiral is to justify continuous money supply. There will be pain, but after that there will be a steady state.


Growth is increase in volume of goods and services. More goods, more services, and constant money supply means deflating prices. We will have more to say about this later.

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 09 Dec 2011 08:40

Pranav wrote:
paramu wrote:Then how did prices go up?


Wages and prices are at a higher equilibrium because the gold coins are circulating more instead of sitting under mattresses.


There is actually a deep reason why more circulation is a very good thing.

If we had to grow or hunt our own food, stitch our own clothes, make our own shoes etc we would all be living like Robinson Crusoe. [Besides, the planet would not be able to support 7 billion Robinson Crusoes, so there would probably be a Darwinian struggle for survival, waged with stones.]

So, much of the value that is created comes from specialization and exchange.

This exchange can happen through barter, but that is very inefficient. Having a currency is an improvement. The currency facilitates the exchange.

But without FRB, much of the currency is sitting under mattresses. The increase in the velocity of money facilitated by FRB greatly contributes to prosperity.

There is also the previously mentioned point about efficiently transferring surpluses from one sector of the economy to other sectors where value creation is higher.

Even in old times, when physical metal coins were the only currency, the money lenders used to practice a defacto fractional reserve system. What we need is to make it faster, fairer and safer.

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 10 Dec 2011 09:08

Let us summarize where we are:
Pranav wrote:suppose Tom has 10 gold coins, out which he lends 8 to Dick, out which Dick lends 5 to Harry.

Has the money supply increased?

Neshant wrote:There is no increase in the money supply if there are 10 gold coins in the system at all times.

Pranav wrote:If Dick did not increase the money supply by borrowing 8 coins and lending 5, he will not increase the money supply if he does the same thing n times. n times zero is zero.

paramu wrote:Then how did prices go up?

Pranav wrote:Wages and prices are at a higher equilibrium because the gold coins are circulating more instead of sitting under mattresses.

Pranav wrote:total loans are always less than total deposits. Leverage, if defined as the ratio of loans to deposits, is 0.9x, not 9x.


Our model assumed that the currency was gold coins, loans were zero interest, and borrowers were reliable. These simplifications were necessary in order to isolate the points of controversy. As a Einstein said - make things as simple as possible, but no simpler.

Let us now bring in interest, risk, deposit insurance and fiat currency.

Interest: Even if the bank is giving interest to depositors and charging interest from borrowers, the bank will not be changing the number of gold coins in circulation.

There is a legitimate question about whether there are enough gold coins in the system for all the interest to be paid. We will come to that question. For now we just recognize that money supply has not been affected by the actions of the fractional reserve bank.

Deposit Insurance: Some people have strenuously objected to the concept of deposit insurance. Frankly deposit insurance is not fundamentally different from vehicle insurance. You get a license, follow norms, pay a premium and are protected up to a limit. The same applies to banks.

Risk: Some borrowers will be delinquent, in which case the bank will have to cover the loss out of its profit. In extreme situations the deposit insurance and the Central Bank will come into the picture. As regards the role of the Central Bank in mitigating risk, we have touched on it earlier, and will return to the topic later.

Fiat Currency: Since the bank is not running the printing press, nor is it in the business of mining gold and minting coins, whether we are using paper or gold coins is immaterial as far as the bank's operations are concerned. The backing for the currency does, however, have a major impact on the operations of the Central Bank, as we shall see later.
----------------

The next big issue is to take a closer look at the concept of backing for the currency, and how the central bank affects the money supply and mitigates risk. Risk can be at two levels - at the level of an individual bank, and at the national level, from the actions of global speculators.

Neshant
BRF Oldie
Posts: 4850
Joined: 01 Jan 1970 05:30

Re: Elements of Monetary Science

Postby Neshant » 11 Dec 2011 03:41

Pranav wrote:If Dick did not increase the money supply by borrowing 8 coins and lending 5, he will not increase the money supply if he does the same thing n times. n times zero is zero.



As soon as money is counterfeited 9X over and lent out, it IS counterfeiting. It is no different than me having $100 and printing up an additional $900 on my printer.

No amount of fancy footwork is going to disguise the fact that the money supply has increased through counterfeiting.

Why can't I print up $900 on my printer and lend it out claiming I have not increased the money supply?

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 11 Dec 2011 07:35

Neshant wrote:
Pranav wrote:If Dick did not increase the money supply by borrowing 8 coins and lending 5, he will not increase the money supply if he does the same thing n times. n times zero is zero.


As soon as money is counterfeited 9X over and lent out, it IS counterfeiting. It is no different than me having $100 and printing up an additional $900 on my printer.

I hope you are not disputing the fact that n times zero is zero.

Whatever your definition of counterfeiting is, it does not seem to involve any increase in money supply. Let's leave it at that.

Neshant
BRF Oldie
Posts: 4850
Joined: 01 Jan 1970 05:30

Re: Elements of Monetary Science

Postby Neshant » 11 Dec 2011 07:44

I hope you are not disputing the fact that n times zero is zero.


9 times zero would be zero but zero was not what you lent out.

What you lent out was counterfeited 9X over.

Once again, no amount of fancy footwork will disguise the fact that money has been counterfeited.

Now please answer my question : Why can't I print up $900 on my printer and lend it out claiming I have not increased the money supply?

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 11 Dec 2011 07:48

Pranav wrote:
Pranav wrote:Wages and prices are at a higher equilibrium because the gold coins are circulating more instead of sitting under mattresses.


There is actually a deep reason why more circulation is a very good thing.

If we had to grow or hunt our own food, stitch our own clothes, make our own shoes etc we would all be living like Robinson Crusoe. [Besides, the planet would not be able to support 7 billion Robinson Crusoes, so there would probably be a Darwinian struggle for survival, waged with stones.]

So, much of the value that is created comes from specialization and exchange.

This exchange can happen through barter, but that is very inefficient. Having a currency is an improvement. The currency facilitates the exchange.

But without FRB, much of the currency is sitting under mattresses. The increase in the velocity of money facilitated by FRB greatly contributes to prosperity.

There is also the previously mentioned point about efficiently transferring surpluses from one sector of the economy to other sectors where value creation is higher.

Even in old times, when physical metal coins were the only currency, the money lenders used to practice a defacto fractional reserve system. What we need is to make it faster, fairer and safer.


Incidentally, this discussion also makes it clear why a transaction tax (proposed for example by Baba Ramdev) is a bad idea.

The basis for human prosperity is specialization and exchange, which means lots of transactions. Advancing communications technology means that it is often more efficient to have smaller organizations or even individuals collaborating with each other rather than having huge companies. That again means more transactions. Transactions are good, and it is bad to put a brake on them with a transaction tax.

Also, as the economy moves closer to the free market ideal, the profit margins are going to drop. If you have a 2% transaction tax when your margin is 3%, it actually amounts to a 66% tax.

I am not so opposed to the idea of a financial transactions tax, but a tax on transactions for exchanging goods or services is an extremely bad idea and will lead to a lot of inefficiency.
Last edited by Pranav on 11 Dec 2011 07:53, edited 1 time in total.

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 11 Dec 2011 07:51

Neshant wrote:What you lent out was counterfeited 9X over.

Once again, no amount of fancy footwork will disguise the fact that money has been counterfeited.

I am just saying that whatever your definition of counterfeiting is, it does not seem to involve any increase in the money supply.

Now please answer my question : Why can't I print up $900 on my printer and lend it out claiming I have not increased the money supply?

Because that will increase the money supply!

Neshant
BRF Oldie
Posts: 4850
Joined: 01 Jan 1970 05:30

Re: Elements of Monetary Science

Postby Neshant » 11 Dec 2011 08:13

Pranav wrote:I am just saying that whatever your definition of counterfeiting is, it does not seem to involve any increase in the money supply.


It does involve increase in the money supply because 9X a given amount of money does not come out of thin air.

The only way it emerges is through counterfeiting which is an increase of the money supply.

Because that will increase the money supply!


How is it different from what the bank is doing? This should be interesting :)

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 11 Dec 2011 08:19

Neshant wrote:
Pranav wrote:I am just saying that whatever your definition of counterfeiting is, it does not seem to involve any increase in the money supply.


It does involve increase in the money supply because 9X a given amount of money does not come out of thin air.

The only way it emerges is through counterfeiting which is an increase of the money supply.

Because that will increase the money supply!

How is it different from what the bank is doing? This should be interesting :)

As you said -
Neshant wrote:There is no increase in the money supply if there are 10 gold coins in the system at all times.

Note that Dick is not minting coins.

Vriksh
BRFite
Posts: 406
Joined: 27 Apr 2003 11:31

Re: Elements of Monetary Science

Postby Vriksh » 11 Dec 2011 09:10

I have learned quite a bit reading Paramu, Pranav, Neshant et al.

Regardless, here are my thoughts

1) GoI prints 30% more rupees every year (M3 or by other means such as reducing CRR in effect increasing money circulation)
2) This excess money is preferentially given to those close to government.
3) It can be posited that unilateral and absolute power over money supply leads to inefficiencies due to miss-allocation of resources in any country be it a democracy or an autocracy.
4) Temptation to pay themselves at the expense of those below the pyramid has been a historical fact in all fiat money cultures.
5) In days of old when all money was in unprintable gold, the monarch's only option was to raise taxes to fund his/her schemes, however today Rulers can pay themselves in non-transparent ways which the general public has little idea of and even littler control.
6) One cannot hope to control a monetary system where the response times are the order of days by controlling a political system where response times are of the order of years.
7) It is this time scale arbitrage that allows those higher in the ladder to enrich themselves (unfairly as someone might say)

Simply put unilateral/cartelized control of money supply is a mistake, this includes gold also since supply is cartelized and real time scaling is difficult. Question is how can we make money supply more democratic? Ideas?

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 11 Dec 2011 10:05

Vriksh wrote:I have learned quite a bit reading Paramu, Pranav, Neshant et al.

Regardless, here are my thoughts

1) GoI prints 30% more rupees every year (M3 or by other means such as reducing CRR in effect increasing money circulation)
2) This excess money is preferentially given to those close to government.
3) It can be posited that unilateral and absolute power over money supply leads to inefficiencies due to miss-allocation of resources in any country be it a democracy or an autocracy.
4) Temptation to pay themselves at the expense of those below the pyramid has been a historical fact in all fiat money cultures.
5) In days of old when all money was in unprintable gold, the monarch's only option was to raise taxes to fund his/her schemes, however today Rulers can pay themselves in non-transparent ways which the general public has little idea of and even littler control.
6) One cannot hope to control a monetary system where the response times are the order of days by controlling a political system where response times are of the order of years.
7) It is this time scale arbitrage that allows those higher in the ladder to enrich themselves (unfairly as someone might say)

Simply put unilateral/cartelized control of money supply is a mistake, this includes gold also since supply is cartelized and real time scaling is difficult. Question is how can we make money supply more democratic? Ideas?


Vriksh ji, printing money amounts to increasing the monetary base aka "M0". This is preferable as the measure of money supply because this is the one independent variable that is controlled by the Central Bank.

You are right that the system can be abused. But going back to the gold standard is a cure that is worse than the disease. As you note, the supply of gold is also cartelized. The gold standard makes it easier for international speculators to create Great Depression like conditions.

There is a lot that can be done to make the present system more fair and transparent. We will try to discuss that in due course.

ArmenT
BR Mainsite Crew
Posts: 4239
Joined: 10 Sep 2007 05:57
Location: Loud, Proud, Ugly American

Re: Elements of Monetary Science

Postby ArmenT » 11 Dec 2011 10:30

Pranav wrote:Incidentally, this discussion also makes it clear why a transaction tax (proposed for example by Baba Ramdev) is a bad idea.

The basis for human prosperity is specialization and exchange, which means lots of transactions. Advancing communications technology means that it is often more efficient to have smaller organizations or even individuals collaborating with each other rather than having huge companies. That again means more transactions. Transactions are good, and it is bad to put a brake on them with a transaction tax.

Also, as the economy moves closer to the free market ideal, the profit margins are going to drop. If you have a 2% transaction tax when your margin is 3%, it actually amounts to a 66% tax.

I am not so opposed to the idea of a financial transactions tax, but a tax on transactions for exchanging goods or services is an extremely bad idea and will lead to a lot of inefficiency.

Maybe I'm not understanding something here, but how is a transaction tax different from sales tax, which is already being charged?

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 11 Dec 2011 10:37

ArmenT wrote:
Pranav wrote:Incidentally, this discussion also makes it clear why a transaction tax (proposed for example by Baba Ramdev) is a bad idea.

The basis for human prosperity is specialization and exchange, which means lots of transactions. Advancing communications technology means that it is often more efficient to have smaller organizations or even individuals collaborating with each other rather than having huge companies. That again means more transactions. Transactions are good, and it is bad to put a brake on them with a transaction tax.

Also, as the economy moves closer to the free market ideal, the profit margins are going to drop. If you have a 2% transaction tax when your margin is 3%, it actually amounts to a 66% tax.

I am not so opposed to the idea of a financial transactions tax, but a tax on transactions for exchanging goods or services is an extremely bad idea and will lead to a lot of inefficiency.

Maybe I'm not understanding something here, but how is a transaction tax different from sales tax, which is already being charged?


A transaction tax would apply at each step in the supply chain. Such a tax would make Robinson Crusoe very tax efficient. As far as I know sales tax applies only when the goods reach the end consumer.

It would be more rational to move to a value added tax, I suppose.

Neshant
BRF Oldie
Posts: 4850
Joined: 01 Jan 1970 05:30

Re: Elements of Monetary Science

Postby Neshant » 12 Dec 2011 04:27

Pranav wrote:
Neshant wrote:How is it different from what the bank is doing? This should be interesting :)

Pranav wrote:Note that Dick is not minting coins.


Then how did he lend out 9X what he orignially had?

You can't create a merry-go-round with the logic where you lend out 9X what you had and still claim you didn't counterfeit anything.

There is no increase in the money supply if you have 1 coin and lend out 1 coin. You cannot have 1 coin and lend out 9 coins unless those 9 coins have been counterfeited.

You are trying to bury the issue through confusion and gobbly goop but its plain as day.

If I put a sign on my house saying "Bank" and start lending out what I don't have, how is it different than what the bank is doing?

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 12 Dec 2011 07:08

Neshant wrote:
Pranav wrote:
Note that Dick is not minting coins.


Then how did he lend out 9X what he orignially had?


He kept getting more deposits and lending out a fraction thereof. All without minting any coins. The total loans he made were always less than the total deposits he had received.


We have discussed all this before - viewtopic.php?p=1202800#p1202800, for example.

hariks
BRFite -Trainee
Posts: 26
Joined: 29 Jan 2009 04:11

Re: Elements of Monetary Science

Postby hariks » 12 Dec 2011 12:03

Let us stretch this scenario of lending out 9 gold coins against an actual gold coin (or a real money supply of 1 coin) a little bit. The borrow + deposit cycle repeats a few times, and then we can have a few guys like A, B, C etc owing 1 coin to the bank and couple of guys X and Y having deposits of 4 coins each in the bank. Now X feels rich since he sees 4 coins in his account. He does ask for the money back (that scenario will leave the bank insolvent, prompting RBI printing etc - let us leave that out). X issues a "check" and makes a purchase from Z, something which is worth 3 gold coins. The check is supposedly against real money (as X sees it) so there is no loan involved. Z does not cash the check, and deposits it back in the bank (just like the other guys) to complete the scenario. Now a transaction occured which was greater than the total actual money (without any credit as far as X and Z are concerned).

I don't know what definition of "money supply" is used here: This is what I got from Wiki
"There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits (depositors' easily accessed assets on the books of financial institutions)."

In common sense terms, the "demand deposits" mentioned in the earlier definition seems to have clearly increased, and the leverage seems to have the effect of increasing the money supply since transactions whose value is greater than the existing real money in the system seems to be possible, and we have people who feel richer and can buy things which are worth more than the entire real money supply.

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 12 Dec 2011 12:25

hariks wrote:I don't know what definition of "money supply" is used here: This is what I got from Wiki
"There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits (depositors' easily accessed assets on the books of financial institutions)."

I prefer using the actual number of gold coins as the measure of money supply. In economics this would be called "M0". (In modern times M0 doesn't only mean coins and notes ... money can also be electronic.)

There are definitions which count the deposits, without counting the balancing loans. The money supply by those measures would be larger than the currency in circulation.

But M0 is the one independent variable that is controlled by RBI. If we want to examine the actions of the RBI, we should focus on M0.

we have people who feel richer and can buy things which are worth more than the entire real money supply.

That is possible, in theory.
Last edited by Pranav on 12 Dec 2011 14:33, edited 1 time in total.

ArmenT
BR Mainsite Crew
Posts: 4239
Joined: 10 Sep 2007 05:57
Location: Loud, Proud, Ugly American

Re: Elements of Monetary Science

Postby ArmenT » 12 Dec 2011 13:15

Pranav wrote:
ArmenT wrote:Now say the bank is a multinational shady type and really has $1000 on deposit. Say, Joe American applies to this bank for $5000. Now if the bank was following FRB rules and could not loan more than 90% of deposits, it could not possibly cover this loan application because it can only loan our $900 max. However, shady bank grants this loan and for the federal auditors benefit, claims that Sheik Bin Cheatin' had just deposited $20,000 worth of gold bars the previous day in their middle-eastern branch, therefore they can easily loan out $5000. So, they grant a loan at 5% interest rate and transfer $5000 to Joe American's bank account electronically. Federal official has no way to check if Sheik Bin Cheatin' even exists or not, as he's outside their jurisdiction. However, Joe American eventually has to pay back $5000 + $250 if he wants to fully repay his loan.


Hmm ... suppose Joe has an account with BofA. The money is not credited to Joe's account until BofA's reserve account (with the Fed) is credited $5000 from the reserve account of the bank on which the check is drawn.

So it's not clear how the scam works ... maybe BofA was also a part of the scam?

Sorry, I didn't see this post earlier. To answer your question, it sure is a coincidence that you should mention BofA. As it turns out, when BCCI was first founded, BofA contributed quite a bit of the initial capital of BCCI (25% share)[1] and later went up to 30% share[2]. However, they started to see some funny business and reduced their share to 24% by 1976 and started to get rid their remaining shares rapidly after 1978 because they had some reports of financial irregularities going on in BCCI and owning shares in it would have been inconvenient. However, even after this, they still did maintain a good working relationship with BCCI and continued doing business with them (and made some large profits in the process) until BCCI was forced to close for fraud.

Incidentally, the BCCI fraud forced some changes to banking practices and public interest laws as well.

References:
[1] http://en.wikipedia.org/wiki/Bank_of_Credit_and_Commerce_International
[2] http://www.fas.org/irp/congress/1992_rpt/bcci/03hist.htm

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 13 Dec 2011 08:51

Let's now look at what role a Central Bank should play in controlling the money supply.

Assume we have a growing economy. If the volume of goods and services is increasing, but money supply remains static, it will lead to deflation. So money supply does need to be increased in a controlled way. On the other hand, excessive increase in money supply will lead to inflation.

The money supply, therefore, must be linked to economic trends. It cannot be left to the whims of mine owners. Furthermore, any new money must be introduced into circulation in a fair and transparent way.

It is very instructive to look at what happened during the American Great Depression of 1929. As per economist Milton Friedman, then US money supply was decreased by about 33% from 1929 to 1933. Agricultural prices collapsed by some 60%.

In a deflationary scenario, it makes sense to postpone all purchases - the prices are going to be lower tomorrow. This keeps more money under mattresses, which in turn makes the deflation worse, leading to greater pressure to postpone purchases, and so on. This is what is called a deflationary spiral. A deflationary spiral is particularly bad for those who have borrowed money to expand their businesses. With collapsing prices and a dearth of customers, they will be pushed into bankruptcy, and be forced to sell their businesses.

The way to combat a deflationary spiral is for the Central Bank to increase the money supply. A nation on the gold standard, however, has its hands tied by the need to maintain the link with gold.

Elites who control the money supply in a nation can go on increasing their grip over the whole economy by causing cycles of expansions and contractions, leading to boom-bust cycles on Main Street. The modus operandi is to move cash or bonds at the peak of the expansion, and later, at the peak of the contraction, buy up businesses that have been bankrupted by the deflation, for pennies on the dollar. The United States has been put through this wringer many times.

This is why, having a privately owned Central Bank (such as the US Fed) is undesirable. Yet abolishing the Fed and going back to the gold standard is not a solution - private interests controlling gold mines and large gold reserves can also wreak havoc. Indeed, the US has seen several of these boom-bust cycles even before the establishment of the Fed.

A publicly owned Central Bank, operating with total transparency, and with no arbitrary discretionary powers, is what would be desirable.

Neshant
BRF Oldie
Posts: 4850
Joined: 01 Jan 1970 05:30

Re: Elements of Monetary Science

Postby Neshant » 13 Dec 2011 16:23

Pranav wrote:He kept getting more deposits and lending out a fraction thereof. All without minting any coins. The total loans he made were always less than the total deposits he had received.


This is not a free energy machine where you put in 1 unit of energy and get out 9 units out of nowhere.

Nobody would ever have to work if it were so. We'd all hang "Bank" billboards outside our homes and get in on the action. Why stop at 9X, why not 9000X? Surely if it works for the bank, it should work for everyone else.

The whole example is nonsensical. Anytime more money is lent out than base money supply, it can only have come from counterfeiting.

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 13 Dec 2011 17:54

Neshant wrote:Anytime more money is lent out than base money supply, it can only have come from counterfeiting.

We have two elementary and indisputable facts. Firstly, your own assertion -
There is no increase in the money supply if there are 10 gold coins in the system at all times.

Secondly, we have the fact that Dick does not mint any coins; the number of gold coins in the system remains unchanged.

I leave it to you to figure out what is or is not possible under these elementary constraints. We do not really need to worry about what your definition of "counterfeiting" is.

hariks
BRFite -Trainee
Posts: 26
Joined: 29 Jan 2009 04:11

Re: Elements of Monetary Science

Postby hariks » 14 Dec 2011 01:16

Pranav wrote:
But M0 is the one independent variable that is controlled by RBI. If we want to examine the actions of the RBI, we should focus on M0.

we have people who feel richer and can buy things which are worth more than the entire real money supply.

That is possible, in theory.


I think that is quite practical, since most people deal with electronic money or checks these days. Well, it looks to me that if people can buy and sell goods whose value is more than the entire money supply, and have deposits (which can be used as electronic currency) more than the entire money supply (M0 as you said), then isn't this leverage by the bank having the same effect as increasing the money supply? Just that people are not holding printed cash in hand, but the transactions look the same as they were holding printed cash.

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 14 Dec 2011 06:50

hariks wrote:isn't this leverage by the bank having the same effect as increasing the money supply? Just that people are not holding printed cash in hand, but the transactions look the same as they were holding printed cash.

That was pretty much the question asked by paramu (viewtopic.php?p=1208660#p1208660). The answer is that yes, with fractional reserve, wages and prices are at a higher equilibrium, because money is constantly in circulation instead of sitting under mattresses.

I focus on the monetary base (M0) as the measure of money supply primarily because it exposes the actions of the Central Bank.

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 14 Dec 2011 07:45

Here is another way to view fractional reserve -

Suppose you have a surplus. Now you could keep your surplus sitting under a mattress, but you lend it to a friend to start a business. The friend later returns the amount with interest. You and your friend have cooperated with each other for mutual growth.

Fractional reserve banking facilitates such cooperation, even amongst strangers. A nation with fractional reserve is a nation that is more cooperative. You can expect such a nation to have higher prosperity and higher growth.

Obviously, the intermediary will also try to maximize his profit, so you need many such intermediaries, competing with each other.

paramu
BRFite
Posts: 669
Joined: 20 May 2008 11:38

Re: Elements of Monetary Science

Postby paramu » 14 Dec 2011 09:29

The money that is lent out coming back to the bank for safe keeping, is not really a surplus money. That is just borrowed money.

The asset value effect of FRB lending out 9X original cash is same as lending out 9X money directly without FRB. When asset prices go up in FRB, because of the availability of extra cash, is in fact inflationary. This doesn't really mean that that is a good thing. What if uncle ben tells you that he will add one extra '0' to every dollar that everybody has. Will that really make the economy good? This is same as change in equilibrium mentioned in FRB.

Once the economy reaches the equilibrium, and if the Fed doesn't print additional money, there will be deflation. What this tells you is that there was inflation when FRB started. To avoid the deflation the Fed has to continue to print money. i.e. continue the ponzi scheme.

The advantage FRB gives is that the amount of money that needs to be printed is 1/9 of the required inflated amount. FRB only helps the ponzi.

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 14 Dec 2011 09:39

paramu wrote:The money that is lent out coming back to the bank for safe keeping, is not really a surplus money. That is just borrowed money.


The 8 gold coins which Tom gave to Dick were surplus for Tom. Harry borrowed 5 of them from Dick, and used them to buy some tools for his auto repair business, from Sam. Sam, the tools dealer, doesn't need them right now (i.e. they are surplus for Sam at this point). So he goes and deposits the coins with Dick again. Dick lends 4 of those Mary to buy a sewing machine. And so on.
Last edited by Pranav on 14 Dec 2011 12:25, edited 1 time in total.

shyam
BRFite
Posts: 1453
Joined: 29 Jul 2003 11:31

Re: Elements of Monetary Science

Postby shyam » 14 Dec 2011 12:12

This Max Keiser interview of Detlev Schlichter, author of paper money collapse, is useful for people who follow this thread. Start watching from 12:40


Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 14 Dec 2011 13:11

shyam wrote:This Max Keiser interview of Detlev Schlichter, author of paper money collapse, is useful for people who follow this thread. Start watching from 12:40

Standard Austrian School stuff ... they are believers in the gold standard, which is deeply problematic for reasons I have mentioned earlier.

A little later, I will post some information about the political connections between the Austrian school and the old banking elites.

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 15 Dec 2011 09:07

Pranav wrote:It is very instructive to look at what happened during the American Great Depression of 1929. As per economist Milton Friedman, then US money supply was decreased by about 33% from 1929 to 1933. Agricultural prices collapsed by some 60%. ...

Elites who control the money supply in a nation can go on increasing their grip over the whole economy by causing cycles of expansions and contractions, leading to boom-bust cycles on Main Street. The modus operandi is to move into cash or bonds at the peak of the expansion, and later, at the peak of the contraction, buy up businesses that have been bankrupted by the deflation, for pennies on the dollar.


Controlling the money supply gives elites a hidden but enormous power over a nation. A maxim apocryphally attributed to the "House of Rothschild" is that "Let us control the money of a country and we care not who makes its laws." Whether or not the attribution is correct, it does contain a kernel of truth.

Indians are rightfully outraged at the history of so many millions dying in famines engineered by the British. Less well known is the fact that on occasion, western societies have been made to suffer on an almost comparable scale through monetary policies. During the Great Depression, there were kilometer-long lines in New York for free soup. There were "hunger marches" by people protesting the lack of food. As per a statistical study, during that period, the US suffered a population loss of some 7 million.

Vriksh
BRFite
Posts: 406
Joined: 27 Apr 2003 11:31

Re: Elements of Monetary Science

Postby Vriksh » 15 Dec 2011 14:28

It is obvious that fiat money controlled by the elite is not a good idea. Is there a way to engineer smart money that is more democratic (for lack of a better word).

Neshant's idea that everyone should open a bank is a good one, and there are many private banks that operate. As is obvious from this system with banks there is no guarantee that the banks will give your money back since there is a chance that all those who got loans from the bank default . However a government backed bank only has to print more cash and distribute it to all creditors, of course the money would then buy me nothing and in effect is a default.

Is there a way to generate a money standard that fairly measures value generated by a group of entities interacting with each other and is not controlled by a central authority? Can we make this part of the discussion and generate a parameter set that makes this possible

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 16 Dec 2011 07:39

Vriksh wrote:Is there a way to generate a money standard that fairly measures value generated by a group of entities interacting with each other and is not controlled by a central authority? Can we make this part of the discussion and generate a parameter set that makes this possible


An essential feature of any currency is limited supply.

You could use as currency a commodity with intrinsic value such as gold. But that is definitely not immune from manipulation by private interests.

If you are using tokens of some sort (either electronic or paper) then you definitely need a central authority to issue and restrict the supply of tokens.

You could conceivably have multiple competing currencies, each issued by its own authority.

The approach which I prefer is to have one publicly controlled currency, which is administered with 100% transparency and with no room for arbitrary discretion. Such a currency is very much possible, I will try to describe such a set-up.

shyam
BRFite
Posts: 1453
Joined: 29 Jul 2003 11:31

Re: Elements of Monetary Science

Postby shyam » 16 Dec 2011 08:09

All currencies start with noble declarations, but end up being manipulated.

At Brettonwoods, US promised that USD will be backed by gold and asked everybody to use it as reserve. But in the end, they ended up printing more dollars, against the commitment they made, and finally defaulted - negating the promise of gold.

If you suggest something that can be manipulated under certain conditions, it will be manipulated. No exceptions.

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 16 Dec 2011 09:20

shyam wrote:If you suggest something that can be manipulated under certain conditions, it will be manipulated. No exceptions.


That is a statement that can be made about anything, not just currencies. However some systems are more transparent than others. For example in elections, you can have fraud whether you use EVMs or ballot papers. But stuffing of ballot boxes is more visible than an EVM Trojan.

Ultimately, the price of liberty is eternal vigilance.

Pranav
BRF Oldie
Posts: 5280
Joined: 06 Apr 2009 13:23

Re: Elements of Monetary Science

Postby Pranav » 17 Dec 2011 08:13

We saw how, in a growing economy, the money supply has to keep pace to avoid deflation.

Now comes a key question. How do you inject newly created money into the economy, in a fair and transparent way?

One principle is that the money should be deployed where the value creation is maximum. A rational metric for value creation potential is the interest that a user of the money is willing to pay. For example, in a nation short of cement, if somebody who wants to set up a cement plant expects 20% returns, he might be willing to pay 10% interest on funds borrowed.

So let us say we decide to lend the newly created money into the economy, charging as much interest as the market will bear.

Obviously, the newly created money belongs to the people as a whole. We will have to be prudent about who we lend it to. If the borrower goes bankrupt it will be a loss to the public. One way of lending money in a secure way is to buy government bonds in the bond market.

Now, in due course the borrower repays the money with interest. What should the central bank do with the principal and the interest? These amounts belong to the people as a whole. The Central Bank could either lend them out again, or retire them from circulation, depending upon how you want to adjust the money supply. The policy of the US Fed is to transfer the bulk of the interest to the US government for its use.

But if money lent out is to be returned with interest, will there be enough money in the economy to make that possible? Note that the Central Bank is continuously introducing money into circulation (with loans) and removing money from circulation (via repayments of those loans). These activities are calibrated so that the money supply keeps pace with the natural rate of growth of the economy, and price stability is maintained. So there will always be money to repay loans with interest.

An interesting feature of this system is that if the Central Bank stops making new loans all together, and goes on removing from circulation the money it receives, then the money supply will eventually dwindle to zero. Obviously, all hell will break loose well before that.

sumishi
BRFite
Posts: 514
Joined: 30 Oct 2008 00:03
Location: Innerspace

Re: Elements of Monetary Science

Postby sumishi » 17 Dec 2011 14:19

Pranav wrote:...
But if money lent out is to be returned with interest, will there be enough money in the economy to make that possible? Note that the Central Bank is continuously introducing money into circulation (with loans) and removing money from circulation (via repayments of those loans). These activities are calibrated so that the money supply keeps pace with the natural rate of growth of the economy, and price stability is maintained. So there will always be money to repay loans with interest....

Wasn't this the funda behind the Colonial paper money and Lincon's Greenbacks, managed by the government and not a central bank?


Return to “Technology & Economic Forum”

Who is online

Users browsing this forum: No registered users and 10 guests