Criticism of fractional-reserve banking
Some critics of economies where new money is primarily produced by private banks via fractional reserve banking may refer to it by the political term debt-based monetary system.[1] Their criticisms are based upon non-mainstream economic theories.
The term, "debt-based monetary system," and related terms, such as "debt money"[2] are not used by conventional economists or academic neoclassical economists. Mainstream economists often refer to "debt money" simply as credit (or, less frequently, credit money) and make no material distinction between hard currency, fiat currency, representative money, sound money and "debt money".[3]
Critics of fractional reserve banking include a number of mainstream economists such as Irving Fisher[4], Frank Knight[5], Milton Friedman[6], Hyman Minsky and others; strong non-mainstream critics include the Austrian economists, Murray Rothbard[7] and Ludwig von Mises.
Conventional economic analysis
Conventional economic analysis essentially characterizes fractional reserve banking as a benign feature of modern monetary systems, which exists independently from the currency regime and is a tool of monetary policy.
Traditional mainstream economics sees fractional reserve banking as a mechanism for transmission of monetary policy: reserves and other limits upon the banking sector's ability to "create money" are to some degree controlled by the government or central bank.[8] According to this approach, the monetary authorities use the pricing mechanism (via various monetary policy instruments) to adjust the quantity of money in circulation and protect depositors and the integrity of the financial system. The use of these tools is adjusted according to the nature of the banking system's propensity to create money by lending.[9]
The weaknesses of the nature of fiat currency (and the capacity of the banking system to create money) and the relationship to the business cycle (including booms, busts and credit cycles) are widely recognized.[10] In particular, the possibility that governments or central banks will create too much money (either directly or through the banking system) is a frequent topic of academic, economic and political commentary.[11]
It should be noted that various other schools of monetary thought, such as the Austrian School, do not necessarily support full-reserve banking; some explicitly advocate "free banking" with no required reserves at all.
Non-professional economic commentators such as Antal E. Fekete, Michael Rowbotham, Stephen Zarlenga (director of the American Monetary Institute) and Ellen Hodgson Brown are often dismissed by professional mainstream economists as "fringe" monetary reformers, not worthy of serious academic or institutional study.
Basic debate
In stark contrast to conventional economic analysis, some commentators focus on the combined use of fiat currency, fractional reserve banking and central banking as a powerful - some would argue destructive - feature of modern monetary systems. These commentators use the term debt-based monetary system to refer to an economic system where money is created primarily through fractional reserve banking techniques, using the private banking system.[12] This form of money is called "debt-based" because as a condition of its creation it must be paid back plus interest at some time in the future.
This also implies that as the money supply and the economy grows, the nation becomes increasingly indebted at the same time, and increasing interest payments are needed to pay bondholders as the money supply grows.[13][14][15]
Although money created through fractional reserve banking techniques is a form of fiat currency (because it is not backed by a real asset such as gold or silver), it can be distinguished from "true" fiat currency in that it is intrinsically "temporary" money, requiring its eventual repayment as a condition of its creation.
The debt-based monetary system is a departure from traditional monetary systems, which were backed by gold deposits or the gold standard, or other precious metals. Because of this departure, it is the subject of continuing political and economic debate. Some critics of fractional reserve banking consider it to be a recent, transitory and unsustainable aberration from traditional, slower-growing, asset-based monetary systems, with potentially destructive economic effects.[16][17]
Some argue that since debt and the interest on the debt can only be paid in the same form of money, the total debt (principal plus interest) can never be paid in a debt-based monetary system unless more money is created through the same process. For example: if 100 credits are created and loaned into the economy at 10% per year, at the end of the year 110 credits will be needed to pay the loan and extinguish the debt. However, since the additional 10 credits does not yet exist, it too must be borrowed. This implies that debt must grow exponentially in order for the monetary system to remain solvent.[18][19]
Basic nature of system
The economic, environmental and social effects arising from a central government's concessional granting of the legal power to create money through fractional reserve banking techniques to the private banks of the world has been subject to much heated political debate for well over two centuries.[20][21][22][23][24]
In contrast to "debt money" (which is money created through the issuance of debt or credit), "true" fiat currency is issued by the Treasury of a central government debt-free, as no requirement for its eventual return is made as a condition of its creation.[25][26] Government-issued debt-free fiat currency (such as debt-free notes and coins) can circulate perpetually in the economy as "stable" or even sound money (if backed by gold or silver) and although not as stable as hard currency, government-issued debt-free notes and coins (such as United States Notes, silver certificates and debt-free Treasury Certificates issued in Germany during the inter-war period) do not have the same effects of debt-based money described below.[27][28] It should be noted however that fiat currency can be a source of hyperinflation if its production is not controlled, as the government has the potential to issue unlimited amounts of fiat currency - provided it is accepted as "money" by the private banking system. Notes and coins in circulation (being defined as M0) now account for a tiny fraction of the total M3 money supply in all developed, debt-based capitalist economies (M0 generally being less than 10% of the total M2 money supply in most developed economies).[29][30]
Similarly, gold, silver and other precious metals have in the past been used as debt-free money. Because of the difficulty in increasing the supply of precious metals quickly, some monetary reformers believe a return to the gold standard, or a similar system of "hard" or "real" asset-backed currency, is the only way to stabilize the growth of the money supply. These monetary reformers often refer to the gold standard and silver standard as "sound money" or "honest money".
See also
- American Monetary Institute
- Antal E. Fekete
- Austrian School
- Credit money
- gold standard
- Michael Rowbotham
- Murray Rothbard
References
- ^ For an example of the public use of the term, see the speech of the Earl of Caithness in the House of Lords on 5 March 1997
- ^ For an example of the use of the term "debt money", see this example from the "Bible Believers" website
- ^ For an example of the mainstream use of the term "credit" instead of "debt-money" see this example from the Financial Times, 1 May 2008
- ^ Fisher, Irving, 100% Money, Pickering & Chatto Ltd;, ISBN 978-1851962365
{{citation}}: CS1 maint: extra punctuation (link) - ^ Daly, Herman E; Farley, Joshua, Ecological Economics: Principles and Applications, Island Press, p. pg 250, ISBN 1-55963-312-3
{{citation}}:|page=has extra text (help) - ^ Friedman, M., A Program for Monetary Stability, New York, Fordham University Press, 1960, pp. 65
- ^ Murray Rothbard, The Mystery of Banking
- ^ http://books.google.com/books?id=Oco-yeAJhaEC&pg=PA63&lpg=PA63&dq=united+states+empirical+money+multiplier&source=web&ots=OramxjOSGb&sig=Hk0lI1jjWTEL3rqRXRIU4e-R0UE#PPA64,M1 Anna Jacobson Schwartz, Money in Historical Perspective, p. 64
- ^ See, for example, Brookings Papers on Economic Activity: 1, Macroeconomics, edited by William C. Brainard, George L. Perry, p. 149 (Christina Romer and David Romer, "New Evidence on the Monetary Transmission Mechanism").
- ^ http://books.google.com/books?id=Oco-yeAJhaEC&pg=PA24&dq=money+and+business+cycles&lr=&sig=UWFFKAlwUeN7gj08L_dMrR5_gvQ Money in Historical Perspective, Anna Jacobson Schwartz, p. 160
- ^ See, for example, [http://books.google.com/books?id=XVCgcHQS_nQC&printsec=frontcover#PPA76,M1 Milton Friedman, The Optimum Quantity of Money, p. 75
- ^ For an example of the public use of the term, see the speech of the Earl of Caithness in the House of Lords on 5 March 1997
- ^ Rowbotham, Michael (1998). The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics. Jon Carpenter Publishing. ISBN 9781897766408.
- ^ Antal E. Fekete, The Twilight of Irredeemable Debt
- ^ The Forgotten War
- ^ Cox, Jim (1997). "The Gold Standard". The Concise Guide to Economics (2nd edition ed.). Savannah-Pikeville Press. ISBN 1-57087-292-9. Retrieved 2007-12-15.
{{cite book}}:|edition=has extra text (help); External link in|chapterurl=|chapterurl=ignored (|chapter-url=suggested) (help); Unknown parameter|origdate=ignored (|orig-date=suggested) (help) - ^ A History of Money from Ancient Times to the Present Day by Glyn Davies, rev. ed. Cardiff: University of Wales Press, 1996. ISBN 0 7083 1351 5
- ^ Rowbotham, Michael (1998). The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics. Jon Carpenter Publishing. ISBN 9781897766408.
- ^ Antal E. Fekete, The Twilight of Irredeemable Debt
- ^ Brown, Ellen H. (2007). Web of Debt. Baton Rouge, Louisiana: Third Millennium Press. ISBN 0979560802. Retrieved 2007-12-15.
- ^ Rowbotham, Michael (1998). The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics. Jon Carpenter Publishing. ISBN 9781897766408.
- ^ The Forgotten War
- ^ Antal E. Fekete, Fractional Reserve Banking Revisited
- ^ Antal E. Fekete, The Twilight of Irredemable Debt
- ^ The Forgotten War
- ^ Stephen A. Zarlenga, The Lost Science of Money AMI (2002)
- ^ Honest Money
- ^ Extract from Ellen H. Brown, Webt of Debt
- ^ Global Money Supply Ratios
- ^ Why the Money Supply Made News