Thursday, June 17, 2010

My Letter to the New York Times re: Useless "Crisis-Prevention Manual"

From: Patrick Barron (
Sent: Thu 6/17/10 1:43 PM
To: NY Times (

Re: Fifteen Economists Issue Crisis-Prevention Manual

Dear Sirs:
It is no surprise to Austrian school economists that Fed Chairman Ben Bernanke thinks very highly of "The Squam Lake Report", a list of recommendations by fifteen eminent economists for preventing future banking crises. The report ignores the foundation of the crisis and justifies more regulatory power that Mr. Bernanke hopes to wield. The report's tired laundry list of "fixes" will do nothing to prevent future crises, because they attack the symptoms rather than the disease. This banking crisis, like all previous ones in the last hundred years, was caused by bank credit expansion not funded by real savings. The Fed drove down the interest rate by adding reserves to the banking system. Fractional reserve banking allowed the banks to pyramid new loans onto these new reserves. Each dollar of new lending created a matching dollar of new money. This laid the foundation for the banking crisis, because at no point did the public increase real savings. It was all smoke and mirrors.

Fractional reserve banking is damaging enough when the reserves are sound, such as gold or silver, but the practice becomes most lethal when the reserves themselves are manufactured out of thin air. This is the case with all banking systems today--the banking system is allowed to expand the money supply out of thin air based upon reserves that themselves have been created out of thin air via the Fed's open market operations in which it monetizes government debt. This isn't as difficult to understand as it may sound. The Fed prints money out of thin air to buy government bonds. This money increases the money supply AND becomes reserves of the banks. Then the banks are allowed to expand the money supply, via their lending operations, by many multiples of this increase in reserves.

If the report's recommendations are adopted, the Fed will continue to shower the world with funny money while attempting to ensure that it doesn't create another banking crisis. This is impossible. The money must go somewhere, and, since it is not representative of real savings, it will cause another crisis. Attempting to prevent a crisis through regulation of banking activity will cause what Wilhelm Ropke called "repressed inflation" and what we call "stagflation", falling production and higher prices.

The only way to stop expansion of the money supply, which is the real cause of banking crises and the boom/bust business cycle, is to stop expansion of bank reserves and end fractional reserve banking.

Patrick Barron

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