A Challenge to Much That You Believe About the Fed

Real Clear Markets ^ | June 15, 2016 | Harry Binswanger

[expat_panama]

John Tamny, of Forbes and RealClearMarkets, has penned a highly original and stimulating look at the economics of money and banking: Who Needs the Fed? I sang the praises of his remarkable Popular Economics when that came out, and now this just-published book has me singing them again, in a new key.

Let me note up front that there are substantial parts of this book with which I, so far at least, disagree. I have exchanged some emails with Mr. Tamny on these issues and nothing has been resolved. This is a not A Bad Thing: it can be actually helpful to follow a rational person's thinking when you disagree with the conclusion he reaches.

In this case, the disagreement is about inflation. Mr. Tamny thinks the Austrian theory of what inflation is, and how it works, is flawed (I don't). Surprisingly, he argues that expanding the fiat money supply does not affect things much. It mainly leads people to use a different money (e.g., foreign currency).

The German hyperinflation? He holds that in actual commercial transactions, the hyperinflated Marks were scarce, because no one accepted them. An interesting idea, but I'm not sold on the whole idea of "money-as-yardstick," according to which the making of more yardsticks threatens nothing (and accomplishes nothing).

But, as a whole, the book's viewpoint is true and right. The rare virtue of Who Needs the Fed? is its ability to penetrate to fundamentals. Here's a non-exhaustive list of some of these fundamentals:

Wealth is created. Government does not create, it obstructs.

Growth economics is all about reducing the barriers to production.

True, that. Production must precede consumption. As Ayn Rand said, you can't eat the cake before it's been baked. Keynesians please take note. The fundamental fact of economics is not: "scarcity" - which takes the fantasy of unlimited wealth as the standard, then judges what we have as falling short of the fantasy - the fundamental fact of economics is that wealth has to be produced.

Economics is the science of production for the market, not the science of "things you resort to when manna does not fall from heaven."

Credit is real resources labor, materials, factories, etc. - not money.

Remember, it's not dollars that are borrowed but the real resources that dollars are exchangeable for.

... credit is not money. If it were, the "easy credit" that many-who-should-know-better clamor for would . . . be as simple as printing lots of money. In fact, credit is always and everywhere the actual resources tractors, cars, computers, buildings, labor, and individual credibility created in the real economy.

The pursuit of credit is actually the pursuit of the resources . . . necessary for entrepreneurs and businesses to turn concepts into reality.

The interest rate is a price set by objective factors- not by creditor's greed or the Fed's whim:

. . . the rate of interest [is] a price meant to bring savers together with borrowers. If this rate is distorted by governmental decree, the odds of exchange decrease. For credit to be "easy," the price of credit must reflect both the needs of those who seek to access it and the needs of those who have it. Put more plainly, the price of credit should be set in free markets.

Banking should be totally free.

Free markets should apply to banking just as they do to any other industry sector.

John Tamny is one of the few men who, when they say "free markets" mean free markets.

All government spending, not just deficits, comes at the expense of the private sector

...government spending is the opposite of stimulation. It is a tax on real resource creation.

All government spending should be viewed as deficit spending (even that which is constitutional) simply because governments are consuming from the private sector first. . . . [G]overnment spending is what we suffer in the here and now.

The longer term effects of government spending, Tamny notes, are the never-to-be funded innovations, Bastiat's "that which is not seen":

Government consumes credit that would otherwise flow to cancer cures, transportation innovations like private jets, and technological innovations that would make the Internet seem quaint.

Government intervention in the economy is immoral

The wealth they [the Clintons and other politicos] enjoy is the result of the federal government confiscating it from its actual creators. The Clintons are posh and supercilious, but their grand lifestyle is directly attributable to the ability of the political class to plunder America's truly productive.

When politicians talk up 'stimulus' spending, it is realistically code for a redistribution of the economy's resources by a political leviathan that is being enriched on the backs of the American people.

There is much in this book that will make you question conventional wisdom, even if you are already a staunch advocate of laissez-faire capitalism. For example, take banks' influence on the economy. Did you know that banks supply only 15% of the credit extended in this country?! I didn't. Tamny argues that the central bank-the Fed-has far less impact than people imagine it does, though he's very clear that that impact is all to the bad.

Really eye-opening, is his attack on the idea of "the money-multiplier." That's the belief, held by nearly everyone, that banks lend out a high multiple of the money they take in - a multiple of the leverage inherent in keeping only a portion of deposits on reserve. The "money-multiplier" is supposed to result from the fact that money loaned out goes back into the banking system, where most of it is re-loaned. Then most of that is re-loaned, etc.

But Tamny argues that the idea of such money-multiplying confuses dollars with real wealth - the machinery, equipment and labor that credit gives one access to. The same tractor, for instance, can't be used by many individuals at once. So, while the re-loaning may expand nominal bank balances, it does not and cannot expand actual credit. Credit is the resources. The amount of resources available is what it is; it cannot be multiplied by acts of the banking system.

What can be expanded is the use of these resources, by, in effect, borrowers time-sharing them, each borrower having the resources available when he needs them (which is not all of them right away). He draws an analogy to the business model of NetJets, a company that "sells fractional ownership of the jets in its fleet of seven hundred planes." Many thousands of fractional owners can have the use of a jet when they need it, even though NetJet has only 700 planes.

He uses the NetJets example to demolish the opponents of fractional reserve banking, notably the anarchist Murray Rothbard:

As the late Murray Rothbard, a true-blue Austrian, long ago put it, "Fractional reserve banks . . . create money out of thin air. Essentially they do it in the same way as counterfeiters." Underlying Rothbard's assertion is a fanciful belief that the alleged "money multiplier" is a fact. It's fiction.

The essential here is an oft-ignored reciprocity of the market:

Someone can borrow only if someone else is willing to cease using money in the near term. . . . For someone to lend, that someone or business must give up, at least in the near term, the resource access that those dollars represent.

I would add that the re-loans come from the borrower's deposit balance-i.e., the part of the first loan that would otherwise be sitting idle in the bank, not yet being called upon to pay for tractors, labor, etc. So, what is re-loaned is what is not being spent, and what is being spent is not being re-loaned.

Those who are opposed to fractional-reserve banking must be able to answer the challenges raised in Tamny's chapter "Banks Don't Multiply Money and Credit."

Also likely to cause controversy are Tamny's arguments that a) the Fed isn't that influential in the economy, and b) the housing crisis was not caused by credit expansion. I lean against his views here, but I have to admit his arguments give me pause.

In short, this is a book that is will make you think. Even if you end up disagreeing with the "heretical" positions he takes, John Tamny's first-handed challenge to familiar ideas, his new observations, and the fresh perspective he offers from within the pro-capitalist camp will provide you with inestimable value.

Harry Binswanger is an Objectivist philosopher, and was a close associate of Ayn Rand. He blogs at www.hbletter.com.

[expat_panama]

imho a lot of good stuff there, tho I do take issue w/ say, "banking should be totally free". It was the inability of totally free banking to perform it's function in the beginning of the last century that made the 1913 Fed law necessary. We have to have a bank lender of last resort. The constitution requires that the value of the dollar be regulated. Talk about your inconvenient truths....

[Buckeye McFrog]

An excellent primer in ideal free-market economics.

Without a doubt the most ethical and productive way to run an economy.

And utterly unsellable to all but a small minority of voters.

[expat_panama]

A very good morning to all and HAPPY FOMC DAY!!!  Stocks took a bit of a hit yesterday in mixed volume and this morning things are 'iffy'.  We'll see how it makes it thru all this:

7:00 AM MBA Mortgage Index
8:30 AM PPI
8:30 AM Core PPI
8:30 AM Empire Manufacturing
9:15 AM Capacity Utilization
9:15 AM Industrial Production
9:15 AM Capacity Utilization
10:30 AM Crude Inventories
2:00 PM FOMC Rate Decision
4:00 PM Net Long-Term TIC Flows
 

OK, so we can always run to gold but just look where it's going: nowhere.  Then again these days there's a lot to be said for not going any where...

Elsewhere:

Adam Smith Has the Solutions to Our Stagnation - James R. Otteson, RCM
How Breaking Up Banks Could Cause a Recession - Lucinda Shen, Fortune
Overspending Is Holding Back Growth - Richard Rahn, Washington Times
What 'Lower Longer' Means for Investments - Simon Constable, U.S. News
For Clinton, a Risk of Excessive Economic Caution - Eduardo Porter, NYT
Trump's Smoot-Hawley Redux Is About Special Interests - Jay Cost, TWS
Corporate Spending Flows to the Politicians - Walter Williams, Investor's
Is the Brexit Camp Soon to Triumph? - Robert Samuelson, Washington Post
The Really Dirty Part of Clean Energy - Richard Finger, The Huffington Post

[expat_panama]

...all but a small minority...

My hope is that it will continue to be the minority that are running things...

[tbpiper]

Good article.

[expat_panama]

Tx. Sometimes it seems like all freepers are just ‘bad-the-fed’ types, but my thinking is that we’re just hearing from the noisy ones. Reality is that there’s a lot to it and the fed’s actual role is minimal.

[JAKraig]

A sad truth is that government spending for re-distribution wastes a lot of money and destroys resources.

People that don't work for their money hurt overall production. Normally money is earned and then spent to either raise more money or to increase standard of living. In a re-distribution society that money does neither.

In the short term some builder will make money on the building of public housing but nobody will make money on the rent or upkeep of the housing. The money given to the re-distribution recipients will be spent on food, drugs and others that add little to the economy.

Adding to the economy means something produced not something consumed. When most workers consume something they actually produce more than they consume. The “extra” may go into a bank account or some other savings such as the stock market where the money is used to produce “things”. These “things” make life better and earn the investor more money to either invest or consume.

To governments its all about consumption. They figure if people spend money then the economy is good but it takes more than that and when the government prints fake money it simply means that the rest of us will have to spend more of our money to get what we want and that leaves less for investment and therefore less creation of new “things”.

Governments can spend money that helps growth by spending on infrastructure which enhances everyone’s ability to produce more.

Welfare spending hurts an economy in many ways. If people don't get free food and housing then they are willing to work for less, that promotes more production. When people don't get free stuff and they are already working for less than they think they are worth then they try to make themselves more valuable by learning a skill or being good at what they do so they can get a promotion, both raise production.

In our society we are killing our economy by allowing our government to make too many monetary decisions that are adverse to the health of our economy.

I remember that in the 50’s we spent 75% of the budget on defense spending. Now it is only 24% but 65% goes to re-distribution. It is unsustainable.

[reed13k]

Specifically it states: “To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;”

Notice very few talk about the regulation of the value of foreign coins? It also says nothing about establishing a federal bank only that they can coin money and regulate the value.

In my opinion, there is no need for a lender of last choice - if the market will not lend then there is such a risk that reason indicates no lending should occur. This is directly what led to the housing crisis where lending was regulated to the point of mandating loans to those who should not have them.

In the case of government, the federal reserve is making loans to a government that is cash poor and should not be getting it without high interest rates. The only reason those rates aren’t in place is that they are attempting to prop up a currency which has been devalued due to their lack of concern of it’s value because they think they can continue to kick the can down the road forever.

[Boogieman]

"the fed’s actual role is minimal" criminal

FTFY

[expat_panama]

Welfare spending hurts an economy...

We agree that that current welfare spending levels --65% goes to re-distribution-- are destructive and way out of line.  There's most probably some optimum level where allocating recourses to "promote the general welfare" is appropriate, but we'll have to have a lot of spending cuts before we get anywhere near there.

[expat_panama]

...very few talk about the regulation of the value of foreign coins?

My take is that what we're talking there is foreign exchange rates --something lots of folks talk about..

...no need for a lender of last choice...

That's where I disagreed w/ the article.  imho before 1913 congress did a poor job complying w/ its mandate to "coin Money, regulate the Value thereof"  considering we what we ended up w/ was massive price swings of double digit inflation for a year followed by double digit deflation.  It's because most money is created not by government printing presses but by banks loaning money --and that means government regulation of banking becomes the only way congress can comply w/ the constitution.

[reed13k]

Ok - I agree we have exchange rates but they are one of the pretty much free floating and not regulated at least not the value, which is set by the market.

Ok - I can understand the need to regulate the banks - but not to create a central bank or a lender of last resort. The two things are not the same. And the later ends up putting too much power in the hands of a few instead of leaving it for the market or with Congress where it belongs.

To me it’s no different than congress handing law making off to an unelected bureaucratic regulatory agency which is a plan and utter relagation of their powers to the executive branch because they don’t want to be seen voting on things that they secretly want.

[kosciusko51]

“[P]romote the general welfare” is an objective of the Constitution, but it is only achieved through the enumerated powers of the Constitution. Anything else is unconstitutional.

[expat_panama]

...it is only achieved through the enumerated powers of the Constitution. Anything else is unconstitutional.

No matter what you and I think, most folks go along with the idea that Fed's have more powers than those specifically enumerated in Article 1.  The word 'immigration' does not appear anywhere in the constitution, yet we go along with the idea that the power to set limits on immigration is an inherent power of congress for the president to enforce. There are a lot of other things that you and I would take for granted that are like that.

mho is that we need to use some judgment here case by case.

[expat_panama]

...the need to regulate the banks - but not to create a central bank or a lender of last resort. The two things are not the same...

A lot of folks here see it that way, and others might argue that we won't have banks w/o a LOLR because it's something the private sector simply can't provide.  The state cannot exist w/o some kind of financial system, so no matter what you and I say the state will do what ever it has to do to survive.

[kosciusko51]

Not sure what you mean:

Article. I. Section. 8.

The Congress shall have Power ... To establish an uniform Rule of Naturalization, ...

Section. 9.

The Migration or Importation of such Persons as any of the States now existing shall think proper to admit, shall not be prohibited by the Congress prior to the Year one thousand eight hundred and eight, but a Tax or duty may be imposed on such Importation, not exceeding ten dollars for each Person.