The Economic Benefits of Ending the Fraud of Fractional Reserve Banking

Fractional reserve banking (FRB) is fraudulent. It should be prosecuted as a crime rather than accepted as normal practice under current banking laws. Any society that respects property rights and the rule of law would not allow it. For those unfamiliar with the term fractional reserve banking or not quite confident of its complete meaning, let’s cover some basics.

What Is Fractional Reserve Banking?

All financial transactions must be settled ultimately by an exchange of standard money, otherwise known as "reserves". Reserves in the US are composed of federal reserve notes (good old paper money in your wallet, piggy bank, retailers' cash register tills, or bank vaults) plus reserve account balances held by banks at their local Federal Reserve Bank that may be exchanged for federal reserve notes on demand. The important point is that reserves are not the same thing as the money supply. The money supply is composed of cash outside bank vaults plus demand (checking) accounts at banks. A financial transaction is not complete until reserves are exchanged. For example, accepting a check from your neighbor for selling him your used car is not final settlement, because reserves have not yet been exchanged. The check might bounce. Or the bank upon which the check is drawn might become insolvent ; i.e., it does not have and cannot raise the reserves with which to pay you, the check's payee, even though the bank balance of the payor, your neighbor, was at least as large as the check.

Most people assume that their money held at banks can always be exchanged for reserves, but such is not the case. Under a fractional reserve banking system banks are not required to keep one hundred percent reserves. Rather, they keep a fraction of their obligation to you in reserve (thus, the name "fractional reserve banking" system), under the assumption that not all depositors will want their money back at the same time.

How can this be? If you deposit a dollar into your account at the bank, isn't the bank required to keep that dollar in its vault or at its own reserve account at its local Federal Reserve Bank? The short answer is NO! The bank is allowed to lend most of that money to someone else and keep only a fraction in reserve in order to satisfy your withdrawal request! This is fraud. Through the lending process the bank has created money out of thin air. It is not backed by one hundred percent by reserves. If too many depositors demand their money at the same time, the bank would not be able to satisfy all withdrawal requests. It would not have sufficient reserves to do so. It's as simple as that. Any other commercial business that accepted your property with the promise to return it to you and then lent that property to someone else would be guilty of fraud. But banks are allowed to do just this! Hard to believe, isn't it!

Some present the argument that FRB should continue, because the depositor should have the freedom to take the risk that, if the bank should fail, his money might not be returned to him upon demand or perhaps not at all. But the ethical issue is not about the depositor's choice but the payee's risk in accepting a check drawn on an FRB bank. The depositor may have sufficient funds in his bank account, but the bank itself might not have sufficient reserves to honor the check. How is the payee to know? It is against the law in most states for a payor to knowingly pass a check that exceeds the funds in his bank account. Why then do we accept as part and parcel of the fractional reserve banking system that the bank itself is not required to hold sufficient reserves to honor all its obligations?

FRB Gives Rise to Regulation and Government Money Printing

Volumes of bank regulation, armies of bank regulators, and government money printing have arisen because banks are allowed the privilege of fractional reserve banking. Bank runs were common occurrences before the federal government forced all banks into its deposit guarantee program (the FDIC), itself a fractional reserve institution in that it has a mere fraction of the reserves to honor the vast deposit balances of American banks. During the so-called subprime lending crisis of 2008, so many banks failed that the FDIC itself ran out of reserves (which it had obtained via mandatory premiums from the banks) and had to be bailed out by the Federal Reserve Bank itself, which resorted to the time honored practiced of all counterfeiters by creating reserves out of thin air.

Bank regulation, enforced by the above mentioned armies of regulators (surely you did not think the government would have just ONE regulatory agency for banks!), attempts to do the impossible, to wit, prevent bank loan losses. FRB expands the money supply, which itself causes disruption to the structure of production, an unsustainable boom, and the inevitable crash. This so-called business cycle is not some sort of inevitable consequence of normal business exuberance or lack thereof, but is caused by FRB credit expansion by banks, a phenomenon well explained by Austrian school economists and labeled by them as the Austrian Business Cycle Theory (ABCT).

In the absence of fractional reserve banking, the banks would not be able to expand credit beyond the funds actually saved by its depositors. (Wouldn't that be something!) There could be no disruption to the structure of production; thus, there would be no need for bank regulations or regulators. All funds placed in demand accounts would be secured one hundred percent by reserves. Depositors who wished to earn interest on excess saved funds would open savings/investment accounts with the banks or some other institution specially formed for profitable investment of the public's savings. These investment accounts would not be insured by anything other than the banker's capital account and his reputation for sound lending. Loan losses would be borne by the banker to the extent of his capital account and then the savings fund itself. Naturally, the depositor's demand funds would be completely secured by the bank's reserves. Only the funds placed in the bank's savings/investment accounts would be at risk. Bankers with poor lending acumen would find themselves quickly out of business rather than receiving bailout money from the government. Such bailout money itself comes from Federal Reserve money printing, which itself exacerbates the boom/bust business cycle!

Conclusion

Ending fractional reserve banking would restore the rule of law to the banking system, end the need for expensive and harmful bank regulation, and eliminate the boom/bust business cycle. Bank demand deposits would be backed one hundred percent by reserves, which any competent local auditor could verify at little expense. Banks found in violation of this law would be seized by state authorities and the officers charged with a crime – the crime of counterfeiting. Unnecessary bank regulatory agencies would be shut down, because they would have nothing to do.

This reform to the banking system is so simple that it will be opposed by all the parasitic government agencies now promising to prevent something that they themselves cause; i.e., the boom/ bust business cycle and bank losses that harm depositors and cripple the economy. Nevertheless, let us pursue this reform with all the confidence and courage of Ludwig von Mises that we are doing the right thing and will not be deterred.

Recommended reading:

The Mystery of Banking, by Murray N. Rothbard

The Austrian Theory of the Trade Cycle and Other Essays, by Richard M. Ebeling

The Essential von Mises, by Murray N. Rothbard

Disgust at the LBJ Library

Recently my wife and I spent a morning at the Lyndon Baines Johnson Presidential Library in Austin, Texas. The damage done by this big bully is incalculable. His library reminds us of the start of the blizzard of government expansion during Johnson's presidential term, which lasted from the Kennedy assassination in November 1963 to his decision not to run for a full second term in 1968, which usually is attributed to his failure to end the war in Vietnam.

Johnson was an admirer of FDR and was determined to revive and complete what he believed should have been integral parts to FDR's New Deal. Johnson called his program The Great Society. As if ignorance of the consequences of this socialist expansion of domestic control by government was not enough, LBJ expanded the war in Vietnam, promising America both Guns and Butter. Even today we live with this expansion of government domestic programs and seemingly never-ending wars as the modern Welfare/Warfare state.

The Johnson Treatment

I called Johnson a big bully in the paragraph above. I believe my assessment is justified by what actually is celebrated at his presidential library. The displays proudly explain and document "the Johnson touch" in print, photograph, and actual recorded telephone interviews. Johnson was a big man who towered over most people. He had a habit of getting very close to someone, leaning over at the waist, and forcing his partner in conversation to bend over backwards to avoid an uncomfortable encounter with LBJ's face. There is a large picture of Johnson giving Supreme Court Associate Justice Abe Fortas this "Johnson Treatment", literally face-to-face. Fortas, who was a long time LBJ supporter, appears to be taking the "Treatment" in good humor, but it is easy to see how it would be almost impossible to keep one's dignity with the president of the United States performing this obviously uncomfortable act.

Surprisingly the JBJ Library celebrates the Johnson Treatment with recorded phone conversations. One conversation was with powerful US Senator Richard Russell, a long time LBJ colleague. Johnson wanted Russell as his personal eyes and ears on the Warren Commission, tasked with investigating the Kennedy assassination. In the recorded phone conversation we hear Russell politely tell LBJ that he is honored but that he has no respect for Supreme Court Justice Earl Warren and must decline the offer. LBJ then badgers and bullies Russell into accepting the position. He says that he wants Russell to ensure that the commission does not investigate whether the Russians or Cubans had any role in the assassination. Russell's vociferous objection in writing to the Warren Commission's "single bullet" theory seemed to justify his opinion of Warren and the commission. The commission's staffers jumped through rhetorical hoops to claim that the report had the unanimous approval of all members.

That Which Is Seen and That Which Is Unseen

The library is full of typical memorabilia. The entrance has a huge display of pens with which Johnson signed hundreds of pieces of mostly domestic legislation. For example, Johnson authored and signed sixty pieces of legislation that effectively federalized education. Of course, the library is full of specious statistics that attempt to "prove" that all this legislation was effective, citing, for example, that the poverty rate decreased and that the percentage of Americans with college degrees increased. Even if one accepts such "facts" at face value, an Austrian economist would point out that all such so-called advances came at the cost of diverting resources from other, more highly sought preferences. Education is an economic good, as is healthcare, retirement savings, food, etc. If Americans valued higher education so much, they would have applied more of their limited resources to this end. The LBJ library ignores the cost, including the social cost, of all these programs and gives the impression that government supplied goods and services could be provided without any change in the nation's production of other goods and services. Thus, the famous "Guns and Butter" claim that we can have it all...a claim that survives to this day.

Perhaps the most enduring legacy of the LBJ years is that his Guns and Butter policies put the US on a path that ended the gold exchange standard, agreed upon at Bretton Woods in 1944, by which the US pledged to honor central bank dollar convertibility to gold at thirty-five dollars per ounce. In the 1950's Eisenhower's budget deficits were very modest and he actually balanced the budget for a short time. But Johnson's Guns and Butter policy caused huge deficits and prompted unprecedented money printing by the Fed. The Austrian economists in Charles de Gaulle's France understood the consequences--that the US did not actually have enough gold to honor central bank redemptions at thirty-five dollars per ounce--and began a run on the US gold supply that eventually drove the US off the gold standard in 1971. (Let me make it clear...the French did NOT cause the run on the US gold supply. The Fed caused the run by printing dollars to pay for LBJ's Guns and Butter policy.)

Vietnam Exposed the Limits of the Johnson Touch

The LBJ library openly shows us that Johnson never had a method for winning the war in Vietnam or extricating the US from what became known as a quagmire. In another telephone recording from early in his administration library visitors hear LBJ tell a partisan that he doesn't know how to win or how to bring the troops home honorably. That is a very bitter revelation to someone who had comrades in arms who died in Vietnam and others who endured captivity in the infamous "Hanoi Hilton". Repeatedly Johnson tried to get the North Vietnamese to a peace conference. This is pure LBJ hubris, convinced that everything is negotiable and that he can use the famous Johnson Touch on Ho Chi Minh. His pathetic bombing pauses to signal our desire to negotiate merely convinced the North Vietnamese that American involvement eventually would end.

What Have We Learned?

Apparently, not much. Today Johnson's Guns and Butter policy is alive and well. Few, if any, Great Society programs have been repealed. The federal government continues to wage war in faraway places and promises ever more goods and services, funded by fiat money set free from any semblance of a gold standard. There is no talk of eliminating any domestic programs or ending any of our wars. On the contrary our government seems determined to provoke new wars in Korea and possibly with Iran and even Russia. The legacy debt for all the federal government's programs--i.e., the unfunded obligations emanating from the government's entitlement programs--has been calculated to be well over a hundred trillion dollars. It is clear that it can be paid only nominally and not with money of even today's reduced purchasing power. So, was LBJ's presidency a success? Unfortunately for America, LBJ would say yes!

My letter to Trains Magazine re: $10 billion waste of capital

October 3, 2017

Trains Magazine

P.O. Box 1612

Waukesa, WI 5317-1612

Re: "Time Is Up", by Bob Johnston (October 2017 edition)

Dear Sirs:

In response to Mr. Johnston's article about the real impact, if any, of the government's 2009 $10 billion infusion to states and Amtrak for the benefit rail passenger service, it is obvious that this massive spending had no real long term impact. Let's just look at several reasons why:

1. The money was NOT invested by private individuals who expected to reap a decent return. It was simply a political handout with dubious goals (get America working again?...who knows?). No one ever expected that the money would be returned to the treasury with interest. And herein lies the problem. Ten billion dollars was diverted from the real economy to politically connected cronies. That's $10 billion of capital that was wasted instead of $10 billion of capital that would have been invested profitably by the private economy.

2. The states and Amtrak do NOT have a business plan for revitalizing rail service; all they have is a pie-in-the-sky wish list. Wishes are not plans. Business plans can be evaluated according to some criteria; wishes cannot be evaluated by any objective standard. Therefore, spending to satisfy wishes become nothing more than exercises in political power and political log rolling (you vote for my expenditure and I'll vote for yours. Neither of us care one whit about the soundness of these expenditures).

3. Amtrak will NEVER be profitable until it is privatized. The only way to determine whether Amtrak can be profitable is for people to invest their own money with an expectation that it will be returned to them with interest. If no one wishes to purchase Amtrak, then Amtrak should be shut down, pure and simple. To keep it going under the present conditions requires a constant infusion of public money, which represents a diversion of capital from sound investments. Instead of capital accumulation via private investment, America suffers capital consumption. It is akin to spending one's savings on personal consumption instead of investing in productive assets. Instead of a future of independence and dignity, one finds oneself living as a dependent of some sort (relatives, the government, private charity).

Patrick Barron

20 McMullan Farm Lane

West Chester, PA 19382

Phone: 610-793-3605

Email: PatrickBarron@msn.com

Free the Arctic!

From the Sunday, August 27th New York Times:


Russian Tanker Completes Arctic Passage Without Aid of Icebreakers


A new Russian tanker with a reinforced hull has cut shipping time from Europe to Asia by thirty percent. One would think that such an event would be hailed by all who desire the betterment of all mankind, but such is not the case. Canada and other nations object, claiming great swaths of the Arctic as sovereign, territorial waters. How foolish! The nations of the world should unite to grant homesteading rights to any entity that uses the arctic for erecting structures, such as oil derricks, and also to grant free passage for any ships to traverse the area for commercial purposes. For Canada to claim sovereignty over great swaths of the Arctic is akin to Spanish Conquistadors planting the Spanish flag in a square foot of beach and claiming an entire hemisphere as property of the Spanish crown.

The Real Aim of EU Brexit Talks and Why It Will Fail

From today's Open Europe news summary:

German MEP says EU wants to punish UK in Brexit talks

Writing in The Times, German MEP Hans-Olaf Henkel argues that the European Parliament Brexit negotiator, Guy Verhofstadt, and the EU’s chief Brexit negotiator, Michel Barnier, want to “punish” Britain in the Brexit talks. He adds, “The reason is simple. They would seek to make sure that Brexit is such a catastrophe that no country dares to take the step of leaving the EU again.” Henkel stressed that he would like the UK to stay a member of Euratom but warned if it chooses to do so it would “will mean paying in and abiding by the rules, as Britain does now, and accepting the jurisdiction of the European Court of Justice when it comes to overseeing Euratom.” Henkel is a member of Germany’s far-right AfD party.

Source: The Times 

The only tool that the EU can wield is to forbid the importation of British goods. But that is self-defeating. The EU punishes its own citizens by forbidding them from purchasing British goods and services. I doubt that the EU will try to forbid its exporters from selling into the British market, so the European Central Bank will accumulate British Pounds. It's tantamount to selling someone a good or service and telling him that you promise never to cash his check.

                                  

Why Sound Money Does Not Need a Central Bank, Only the Rule of Law

The money that all nations use today is composed either of reserves created by a central bank and/or credit money created by banks via fractional reserve banking. In the first case, a central bank can create reserve money via open market operations, whereby the central bank buys an asset--any asset--with reserves that it creates out of thin air. These reserves land in a bank and allow the banking system to create credit money in multiples of the new reserves via the fractional reserve lending process. Both methods of money creation are fraudulent, if done by any entity other than a central bank, in the case of open market operations, or a bank member of that central bank system, in the case of fractional reserve lending. All nations have thrown the rule of law out the window for these monetary counterfeiters.

 

A sound money system does not sanction counterfeiting money, either via creating reserves out of thin air or via creating credit money via fractional reserve lending. In a sound money system there is only commodity money; i.e., gold, silver, bails of tobacco, etc. Commodity money may be spent, as in using gold or silver coins in everyday transactions, or other receipts may be exchanged which represent commodity money that is stored in a safe and trusted facility. Issuing a coin that does not contain exactly the weight and purity as represented is fraud in a society governed by the rule of law. Issuing certificates or bank receipts in excess of the stored commodity also is fraud in a society governed by the rule of law.

 

A society governed by the rule of law does NOT exempt any entity, including the government itself, from the law. Thus, a central bank that creates reserves out of thin air is committing a crime, as recognized by Sir Robert Peel in his famous Bank Charter Act of 1844. A member bank that pyramids these reserves into multiples of credit money via the lending process is committing a crime, as cogently explained by Jesus Huerta de Soto in his Hayek Memorial Lecture at the London School of Economic in 2010.

 

In a free society governed by the rule of law any entity can create money and offer its use to the public. I can offer the public the use of my wife's delicious quart jars of homemade pickles as money, either in direct exchange (for example, a jar of pickles for a box of nails at our local hardware store) or as indirect exchange (a certificate that may be redeemed for a jar of pickles upon demand). However, I have violated the law if I hand over a jar that I claim contains my wife's pickles but instead contains something else. Likewise, I  have violated the law if I issue more certificates for my wife's pickles than jars of pickles in her larder, which fraud would be revealed should too many people try to redeem their certificates at my house.

 

Of course, for transactions among people who do not know one another personally, unlike the local recipients of my wife's pickles, a more generally accepted commodity would be used and certificates and/or book entry receipts would have to be issued by more widely known entities. For example, Citibank or Bank of America might issue gold certificates and maintain book entry gold accounts that would be generally accepted by a wide group of strangers as long as these strangers had confidence that Citibank or Bank of America had not engaged in fraud. Gold in their vaults equaled the certificates plus book entry accounts to the gram.

 

All that is required to convert to the rule of law is the repeal of legal tender laws granting special exemptions from normal commercial law to the central bank and its system of member banks. The reverse of Gresham's Law would prevail. i.e., sound money would drive out bad.

No Nation Can Harm Another Economically

My recent Mises Daily Article titled Two Common Objections to Unilateral Free Trade drew some criticism that I would like to answer.

 

Unilateral free trade rewards the country that adopts it

 

Several commented that my use of the term "unilateral" negated my argument. They resurrected the argument that free trade is beneficial to both parties only if both agree to remove trade barriers to the other's products. Otherwise, the party that removes its trade barriers suffers economically by having its industries destroyed by the party that keeps its trade barriers in place. This argument stands all of economics on its head by asserting that consumers are required to support producers; whereas, the purpose of production is to meet consumer demand. If one producer, whether domestic or foreign, wishes to lower its price, accept a lower return on capital, obtains an agreement from its employees to work for less, and thusly is able to capture more market share, no one is harmed. Even if a government taxes its citizens in order to provide subsidies to some producers, this is no concern of the consumers or producers in another country. It is no business of anyone other than the taxpayers of the subsidizing government. These people have a legitimate gripe, for they are being robbed to pay privileged insiders within their own country. Producers in the country that lowered its trade barriers have the choice to redirect their capital to other uses and employees have the freedom to work in other industries. The country's cost of living drops, and its standard of living rises. Even those workers temporarily unemployed will benefit from this lower cost of living.

 

Concentrate solely on freeing one's own economy

 

Others commented that my use of the term "unhampered market" negated my argument. I pointed out that there is always more work to be done and that there is opportunity for all in an unhampered market. These commentators pointed out that no country has an unhampered market; therefore, unilateral free trade would cause permanent unemployment. This makes two false assumptions. One, that workers can only train for one job in a lifetime and, two, that it is futile to lower barriers to employing capital and labor efficiently in one's own country. The obvious proper response is to insist that one's own government allow its citizens full economic freedom and not waste its time trying to persuade other governments to adopt economically sound policies. If other countries wish to punish their own citizens, that is their business and not ours. In fact we are made richer by their poor policies which provide us with subsidized products.

 

Conclusion

 

The only just policy that any government can take is to free its own economy to allow its citizens to purchase any legal product no matter where produced. This provides investors and workers with the only government help they need; i.e., the freedom to employ their capital and labor wherever it may achieve the greatest return. A nation's citizens will enjoy the highest possible standard of living that adopts low taxes, the few regulations that merely support normal commercial law to protect citizens from fraud, and sound money to allow producers and consumers alike to correctly value their present transactions and expected future returns.

 

A corollary to freeing a market economically is to reduce public expenditures that discourage rational actors from engaging in socially destructive behavior. Welfare payments of all kinds, taxpayer supported public schools, unsound and unfunded government mandatory retirement schemes all reduce socially beneficial behavior. In fact our nation's so-called immigration problem would go a long way to being solved if neither immigrants nor native born citizens had access to welfare, so-called free public schooling, free or subsidized housing, etc. on demand, nor could they trespass on either public or private property. This may not solve the immigration problem to everyone's satisfaction, but it would be a huge step in the right direction.

 

The only economic problems that this country or any country faces come from its own misguided attempts to thwart the free market within its own borders. Stop complaining about what other countries are doing for the simple reason that they cannot harm us. Our economic future lies in our own hands.

Two Unfounded Objections to Unilateral Free Trade

 

Recently I forwarded to my circle of friends what I considered to be a concise and accurate argument in favor of unilateral free trade. The author was Professor Don Boudreaux of George Mason University, writing in his daily blog Cafehayek.com. He responded to Mr. Daniel Dimiccio, former CEO of Nucor Steel, who was defending tariffs on foreign steel. Professor Boudreaux explained that arguments in favor of tariffs place all of economics on its head; i.e., that consumers were required to support producers rather than the other way around.

 

After sending Professor Boudreaux's article, I have been hearing two common objections to his article from friends who consider themselves generally to be in favor of free trade, even unilateral free trade. The first objection I will call the Donald Trump objection; i.e., that imports have cost Americans good paying jobs, from which the nation has never recovered and cannot recover as long as we allow imports to replace American made products. The second I will call the essential industries objection; i.e., that there are some products that America must produce itself, no matter what the cost or inefficiency, in sufficient quantities to ensure access to these products in time of war.

 

Objection number one: Free trade causes unemployment

 

The first objection is easiest to dismiss, for it attempts to refute the "Law of Comparative Advantage", postulated exactly two hundred years ago by the great English economist David Ricardo. Peaceful cooperation among peoples of the earth has no limit. Just as we Pennsylvanians find it advantageous to import pineapples from Hawaii rather than attempt to grow them ourselves, Americans find it advantageous to import many goods from people who just happen to live in foreign countries. Absent government intervention to restricts one's own citizens from entering into peaceful cooperation to produce any legal product or service, all will find employment and all will be wealthier. A simple example will suffice. Let's assume that Michael Jordan, the greatest basketball player of his generation (and perhaps of any generation) desired a new home. Let's also assume that Mr. Jordan was a skilled carpenter, electrician, plumber, etc. Would Mr. Jordan become wealthier by quitting basketball for a year or two at the height of his career in order to build his own home? Of course not. Even if we assume that Mr. Jordan not only was a skilled craftsman but just happened to be the best craftsman in the world, he still would be wealthier paying less skilled workmen to build his new home while he earned much higher wages playing basketball. The corollary is that even those who are less skilled in ALL things can find useful employment in an unhampered market.  This is the "Law of Absolute Advantage", a corollary to the "Law of Comparative Advantage".

 

The Law of Comparative Advantage is also revealed once producers create a surplus. Savings produces capital, which produces more wealth when individuals are allowed to engage in the productivity enhancing division of labor via trade. The resulting products and services cost less than previously, yet employment is not destroyed. It is transferred to better uses, which enrich all. Both sides expect that trade is beneficial and must be allowed to freely trade their surplus product. The political location of individuals engaged in such trade is completely irrelevant to the wealth enhancing benefits of trade.

 

The logical conclusion of restricting international trade for just one or two so-called threatened industries is the demand that all products be protected. Advocating an autarkic society is to argue in favor of the fallacy of composition; i.e., that what might be good for one industry--for example, allowing domestic steel producers to extort higher prices from customers--cannot be extended to all industries.

 

This is akin to standing in a giant circle with everyone picking the pocket of the person in front while having his pocket picked in return.

 

The source of our societal problems, even those correctly identified, such as persistent unemployment, must be found elsewhere. As Ludwig von Mises would advise, one must find the proper means to arrive at the ends desired. If the US really does suffer from collapsing industries, restricting trade is not the solution but will exacerbate the problem. In other words, trade restrictions to cure unemployment are the wrong cure and will cause even more harm to society.

 

Unfortunately in modern day America there are many suspects to which one can assign economic decline. American industry is hampered by a panoply of regulatory red tape and outright restrictions at federal, state, and local levels. One needs only to consider the effects of the Environmental Protection Agency, the Occupational Health and Safety Administration, the Federal Food and Drug Administration, not to mention similar agencies at the state level, plus the disaster that is public education (regulated mostly by the states) and ever increasing regulations on economic life at the local level. (My tiny township government in southeast Pennsylvania recently informed us homeowners that we needed to obtain a township issued permit in order to resurface our driveways. So, now I need government permission to maintain my home in good repair!)

 

Objection number two: Essential industries must be protected

 

This is the national security objection; i.e., that the US must maintain a minimum production level of essential war related products.  This is not an argument in favor of economic efficiency. Quite the opposite. Furthermore, little or no evidence is offered that nations have lost wars due to running out of essential products, although it undoubtedly is true that denying the enemy all kinds of goods and services does reduce a nation's war-making capability. Nevertheless, one can make a good case that this concern is unlikely to be a factor by taking a closer look below the surface of this argument.

 

Stating the "essential industries" case:

Let's assume that China wants to drive US steel manufacturers out of business. It succeeds by offering US steel users--manufacturers of buildings, bridges, autos, etc-- high quality products at low prices for an extended period of time. After US steel production has been reduced to zero, China suddenly refuses to sell steel to us and, as a consequence we cannot build essential war material that requires steel components. We surrender to China, withdraw our military protection to allies, and/or accede to China's demands, whatever those may be.

 

The response:

Note that for a long period of time, perhaps years or even decades, China must subsidize steel production, which drains its public coffers and actually reduces its own war making capacity. (China can't build its own battleships, for example, if it is subsidizing construction of ours.)  In the meantime, the US enjoys an increase in its standard of living. We build up our country in many ways, from new and improved bridges to a revitalized domestic auto industry (remember, cheap, high quality Chinese steel is subsidizing US car makers). Now China embargoes steel shipments to the US and makes threats of some kind. Our modern battle fleet, the product of cheap Chinese steel, is at our immediate disposal.

 

Meanwhile, our modern infrastructure, built with cheap Chinese steel, allows us to rush stockpiled war material, also built with subsidized Chinese steel, to our fleet and onward to our overseas bases and the battle area. We then gear up for the possibility of a protracted war by placing orders for steel with the other thirty-odd nations of the world who are eager to sell us high quality steel but who have been shut out of the American market by subsidized Chinese steel.

 

Now, I ask you...is this not the more likely scenario?

 

Importing subsidized products--perhaps especially products essential for war--increase a nation's war making capacity rather than diminish it. We build up all aspects of our nation's economy, including the defense sector, by using products with the best combination of quality and price, whether imported or not. Doing so allows us either to spend less for the same level of defense or increase our defense by spending the same amount of money but getting more war material in return. Our theoretical potential enemy has actually helped us defend ourselves and our vital interests abroad.

 

Conclusion

 

In conclusion, these two common objections to unilateral free trade do not stand up to closer scrutiny. For two hundred years David Ricardo's Law of Comparative Advantage has informed us that in an unhampered market economy all will be employed to the limit of their capabilities. Furthermore, rather than reduce a nation's security, imports of what we might consider to be "essential materials" actually enhance our security. We need to tax our own citizens less for the same level of security while building up our nation at the expense of potential enemies.

 

Let us end such nonsensical worries and trade freely with the world, especially with those whom we might currently fear, such as China. It wasn't that long ago our nation feared Germany, Japan, and even Great Britain. It's good to remember that peaceful cooperation provides its own momentum for everyone.

 

The true goal for the EU's call to beef up financial regulation

From today's Open Europe news summary:

European Commission considers beefing-up powers of pan-EU financial supervisors

The Financial Times reports that the European Commission is considering plans to beef-up the powers of the three pan-EU financial supervisors, in a bid to address potential supervisory loopholes ahead of Brexit. Valdis Dombrovskis, a vice-president of the Commission, is quoted as saying, “Already you hear there are some disagreements among [EU] member states whether or not some kind of regulatory arbitrage is taking place, so indeed it strengthens the need of the case for regulatory convergence.” The article notes that one of the options under consideration would see the European Securities and Markets Authority (ESMA) been given powers to directly supervise clearing houses, as well as greater oversight over cross-border investment funds.

Source: The Financial Times 

                                           

Let's all consider the true meaning of the Commission's goals by examining these phrases:

"potential supervisory loopholes"

"regulatory arbitrage"

"the need for regulatory convergence"

The EU is terrified that Brexit will mean that it is losing its stranglehold on ever increasing financial regulation.

 

End Banks' Exemption from Normal Commercial Law

Mr. Burke asked me to respond to the article below about how banks engage in money creation. Like many such articles, the one by Mr. Werner seems almost designed to be confusing and obtuse. My short explanation attempts to inform the layman of what is actually happening; i.e., that banks are exempt from normal commercial law and we all suffer.

Pat Barron

---

From: Patrick Barron
Sent: Tuesday, March 21, 2017 10:33 AM
To: Dan Burke
Subject: Re: Richard Werner

 

Banks are exempt from normal commercial law; i.e., they are allowed to engage in fractional reserve banking. In other words, a new dollar of reserves can be pyramided into approximately ten dollars of new bank deposits. Austrian economists call such money created out of thin air as fiduciary media in order to differentiate it from deposits backed by actual reserves. A loss of confidence in a bank can cause a bank run in which there are more claims for deposit withdrawals in the form of actual reserves (Federal Reserve Notes) than the bank actually owns. The bank's bankruptcy is exposed. Bank runs are rare today, because the Federal Reserve promises, via Federal Deposit Insurance, to lend the bank as many reserves as necessary. Nevertheless, this does not fix the fundamental error, which is legal tolerance for fractional reserve banking, and merely causes an expansion of base money (cash and bank reserve balances at local Federal Reserve offices) and sets the stage for another round of money expansion via banks' fractional reserve lending capability. Furthermore, the expansion of base money leads to malinvestment of capital and a rising price level, commonly and mistakenly called inflation. (The real inflation is inflation of the money supply via fractional reserve banking.)


The solution is to withdraw the banks' exemption from normal commercial law and prosecute fractional reserve banking as the fraud that it is. Banking would divide itself naturally into deposit banking, with one hundred percent reserve backing, and loan banking, in which the depositor gives up access to his money for a certain period of time so that the loan banker can find credit worthy customers.


Such a system would lead to the immediate end of federal deposit insurance and government bank examiners. Deposits would become bailments. Loans would be subject to full loss, just as today there is full risk of loss of one's investment in corporate bonds, corporate stock, real estate, etc.


Patrick Barron

---

From: Dan Burke
Sent: Tuesday, March 21, 2017 9:08 AM
To: PatrickBarron@msn.com
Subject: Richard Werner

 

Would you please react to Mr. Werner's article? http://www.sciencedirect.com/science/article/pii/S1057521914001434

How do banks create money, and why can other firms not do ... www.sciencedirect.com How do banks create money, and why can other firms not do the same? An explanation for the coexistence of lending and deposit-taking ☆ Richard A. Werner

A Sensible Economic and Foreign Polciy: Part II

A Sensible Foreign Policy: Mind Your Own Business and Set a Good Example

 

For the sake of peace and prosperity in the world, the US should take the true leadership role in proving to the world that free trade and non-interventionism are all that is required. In other words, all nations should simply mind their own business and set good examples. Just as laissez faire policies work within a nation's boundaries, free cooperation between individuals of different nations will quickly reveal which policies work and which do not. It is important to remember that there is nothing that a nation can do internally to force other nations to subsidize its economy. All subsidies, currency manipulations, etc. are self-defeating. Therefore, the US should take the following actions to remove government interference with peaceful, cooperative trade between its citizens and the citizens of other nations.

 

 

1.  Adopt unilateral free trade.

 

Completely eliminate all restrictions on the importation and export of legal products. For trade purposes treat the rest of the world as if it were part of one's own country; i.e., the freedom to buy and sell all legal products anywhere in the world. It is a mercantilist fallacy that a nation becomes wealthy by selling more than it imports, thereby accumulating gold (now foreign exchange). On the contrary, mercantilist nations deny their citizens the right to become wealthy. They do not allow their citizens to exchange the product of their labor for the most goods and services. Rather they deny their citizens a higher standard of living by forcing them to purchase higher priced and/or lower quality domestic goods. If this were not the case--i.e., if a nation could produce all things that it needed at the lowest worldwide price--trade barriers would  not be needed, since no one would wish to purchase inferior/higher priced foreign goods. Of course, this is not the case at all. The division of labor is a natural, beneficial process that knows no international, political boundaries. If Hawaii were not a state of the union, but rather a foreign nation under its own political system, would Americans be better off by denying themselves Hawaiian grown pineapples and instead grow inferior pineapples at higher prices somewhere in the remaining forty-nine states? Of course not. Free trade allows for the most efficient allocation of worldwide capital to produce the most goods and services for those who participate.

 

 

2. Do not lobby foreign governments to allow one's own citizens' goods into their countries.

 

A nation that restricts imports harms its own citizens. Allow them to correct their own government's errors themselves. A nation that denies its citizens the right to import goods from other countries yet encourages its citizens to sell goods into those same countries, (and may even subsidize these sales in some way), has adopted an illogical and unsustainable policy. It is similar to selling one's wares and never cashing the customers' checks. Foreign exchange accumulates in the protectionist nation's central bank. But to what end? If that government buys the national debt of the same nation, then the fallacy becomes even more clear. It denies its citizens the right to buy that nation's goods and services, yet when the government itself buys that same nation's debt it is funding that nation's spending--infrastructure, defense, etc.--with the fruit of its own citizens' toil. Nothing could be more illogical, and this policy will be abandoned eventually or the protectionist nation will fail economically.

 

 

3. Do not prevent one's own citizens from buying so-called subsidized or "dumped" products.

 

This oft-used policy is a consequence of mercantilism. Nation A prevents its citizens from buying products that it claims nation B subsidizes in some way. The US/Canadian softwood dispute is a good example. The reciprocal tariffs that emanated from this dispute have caused Americans to pay more for softwoods, reducing their standard of living. The "seen" consequence is that American softwood producers get higher prices for their product, but at the "unseen" expense of their fellow countrymen. The US consumer suffers and capital is used in less productive ways than if the tariff were not in place. If Canadians are foolish enough to subsidize exports, the beneficiaries are Americans. Canadians are taxed so that Americans can enjoy cheaper softwoods.

 

 

4. Do not subsidize in any way any good, whether sold domestically or to foreigners.

 

The flip side to number three above is that a nation should not subsidize exports. All the citizens of the exporting nation bear the cost, and the citizens of the importing nation reap the benefit. What could be more illogical?

 

 

5. Scrap all existing trade treaties, agreements, etc. and defund and close down all trade offices and personnel.

 

Free trade is incompatible with managed trade. All trade agreements are "managed" trade. If they aren't managed, then what is the point of the agreement itself? There is nothing to manage. But, if the point of the agreement is that a nation will open its doors to another nation's products only if that nation reciprocates, then each nation is still pursuing the illogical and self-defeating precepts of a mercantilist trade policy.

 

 

6. Do not intervene in any way into the internal affairs of any country.

 

If one's own citizens are disgusted with the governmental policies of another country, they can privately boycott that country's goods and refuse to invest in that country's economy. This is the international equivalence of boycotting some local vendor. (A good domestic example of this policy is the boycott organized by Cesar Chavez. See The 1965-70 Delano Grape Strike and Boycott.) A good international example is the closing over the last decade of most Cities Services (Citgo) gas stations. Venezuela owned Citgo, and Americans were disgusted with Venezuelan policies. No governmental policy was necessary for US citizens to register their disgust. The fact that the Venezuelan government has not changed its policies is no reason for the American government to take action. Americans can simply be reassured that they are not supporting Venezuela by purchasing it most recognizable product--oil.

 

 

7. Do not use military force except to retaliate against attack upon one's own territory or the right of one's own ships, planes, etc. to travel in international waters or airspace.

 

No nation has a right to intervene, especially militarily, in the internal affairs of others. This is the non-aggression principle extended to the behavior of nations. Of course, if no nation intervened in the affairs of another and no nation attacked another's territory, war between nations would end. There are many caveats to this policy--genocide of minorities by majorities, for example--but nations must beware of the slippery slope toward continuous interventions that so-called "special cases" seem to authorize.

 

 

8. Do not enter into unlimited and/or ill-defined collected security agreements.

 

Just as a nation should not intervene militarily into the affairs of others on its own accord, so the speak, it should be even more circumspect about not becoming legally tied to intervene in the affairs of others as a result of a collective security agreement. This would be second hand intervention, whereby the nation itself is not attacked but acts as if it were. Collective security agreements should be written very carefully. Carte blanche agreements remove the incentive of one's allies to resolve agreements peacefully. There are few disputes in which side is completely innocent and the other is completely guilty. There are few disputes in which there are only one of two alternatives. Furthermore, collective security agreements may backfire; i.e., reducing the security of current members and admitting new members with ancient animosities that they now find no reason to attempt to resolve peacefully. Collective security agreements suffer the same adverse consequences of other socialist policies.

 

 

Conclusion

 

Most of the issues confounding Americans today are the result of government hubris and overreach. Government apologists believe that the economy can be improved by intervening into the free market. But sound economic theory reveals that government intervention is both unnecessary and destructive. It reduces market transactions that participants believe will benefit both parties. Furthermore, it misdirects capital to unsustainable investment, resulting in capital deccumulation. Complete laissez faire is the only rational policy that remains.

 

Internationally, government should follow the maxim "Mind your own business and set a good example." Avoid intervening into the affairs of others and allow your good example to speak for itself. In trade avoid the fallacies of mercantilism. Avoid or strictly limit collective security agreements and follow the non-aggression principle.

A Sensible Economic and Foreign Policy: Part I

 

A Sensible Economic Policy: Laissez Faire

 

The Misesean insight that all economics is based upon methodological individualism plus the no harm principle calls into question the raison d' entre of the regulatory state, including legal tender laws; i.e., the mandatory and exclusive use of state produced and controlled money within the sovereign boundaries of the state.

 

Since every economic transaction is between private parties who believe that they will benefit from the transaction, how can any other individual--much less some remote burreaucrat--even know what these transactions might be or their terms? All that is required for peaceful cooperation among people everywhere is ordinary commercial law to define contracts, fraud, etc. and the law of torts to define harms. These laws arose out of the common law over the centuries and not out of the hubris of self-aggrandizing bureaucrats.

 

There is no harm that can be visited upon the population that the common law has not addressed. It follows, then, that the people should take the following actions to defund and remove from power the expensive and business-stifling regulatory state.

 

 

1. Eliminate all federal cabinet level agencies related to regulating economic life.

 

Of the current cabinet level bureaus, the following should be eliminated immediately, including all departments within these bureaus, such as OSHA (within the Department of Labor) and the EPA (customarily accorded cabinet rank):

 

a. Agriculture

b. Commerce

c. Labor

d. Energy

e. Education

f. Housing and Urban Development

g. Transportation

 

The above seven agencies spent $667 billion in 2010, representing 23% of all federal spending.

 

 

2. Eliminate the central bank--the Fed--and scrap legal tender laws.

 

Of course, a free market must include freedom of its participants to use whatever medium of exchange--money--that it chooses. Money is part and parcel of the market economy. It arises naturally to break the limits of a barter economy, also known as direct exchange. Commodity money becomes indirect exchange, whereby market participants trade for the most widely accepted commodity rather than trade directly to satisfy their ultimate goals. There is no need for the state to dictate what may be used for indirect exchange. Market participants themselves are in the best position to determine which commodity makes the best money.

 

Furthermore, central bank produced and controlled money has allowed government to act like a common counterfeiter, producing money out of thin air to fund its own spending programs and/or reward its supporters, all at the expense of society as a whole. It is much easier to fund wars and welfare out of printed money than taxes, or borrowing from real savings. The steady erosion of money's purchasing power hits retirees the hardest, diminishing their ability to plan for a retirement of comfort and dignity. Furthermore, the Austrian Theory of the Business Cycle places fiat money expansion as the root cause of the Boom/Bust cycle that misallocates and eventually destroys capital.

 

 

3. Eliminate government licensing of occupations and products.

 

The best regulator of occupation quality is the free market. Government agencies protect the status quo, erecting unnecessary barriers to cheaper, affordable alternative services. There is no objective standard for determining service quality. This is a judgment of market participants themselves. In a free market unscrupulous and incompetent practitioners are weeded out by competition and ordinary commercial and tort law.

 

 

4. Eliminate standing in court of third parties.

 

Environmental groups and other anti-business, anti-development groups file suits to stop projects over which they are not parties; i.e., they do not own property, cannot show that they are suffering real, as opposed to hypothetical or psychological harm, such as the loss of scenic views. Such groups are always at liberty to solicit funds from their members to buy and set aside what they consider special, scenic areas. Like licensing of occupations under the banner of consumer protection, there is no objective standard of what is and is not a scenic view or special area. Only the market can decide such things. Environmental groups cannot assume to have a superior, or more insightful position outside the market, because there is no standard for determining such things as beauty. These are subjective evaluations which change constantly. If you think this is not the case, just study the rural cemetery movement of the nineteenth century in which the world's best landscape architects were hired to design cemeteries where families would spend many hours each weekend among their ancestors.

 

 

5. Restrict monetary damages for violations of commercial law, torts, and other harms.

 

Only the parties to a dispute who have standing in court as suffering real damages should be compensated financially for violations of the common law, and these compensations should go entirely to the parties involved, not third party whistleblowers and/or their attorneys. Current friend-of-the-court rules allow meddling by third parties who can delay business projects almost indefinitely or drive up costs until the projects are abandoned.  Those who suffer are the project developers, of course, plus all the unseen employees who never became employees and all the projects' happy customers who never became happy customers.

 

 

6. End all subsidies.

 

If a business cannot produce a profit acceptable to its investors, then the investors should close it down and invest their scarce capital in a business whose product is more highly desired. Businesses that produce losses are prima facie evidence that capital is being consumed rather than accumulated. Private investors will close down such businesses or lose all their capital. Government subsidies plunder existing capital in order to prop up those businesses that are consuming it. But subsidies do not stop capital deccumulation, only those who suffer the loss. Typically high profile businesses, those with large union workforces, or those politically connected are the recipients of capital provided by common, working people. In other words, subsidies are theft.