When I say that there appears to be something in the air, I don’t mean just here. For example, it’s affecting the Germans, too, as Lucian Kim notes at Reuters:
“We have reached a tipping point,†the Organization for Economic Cooperation and Development warned last year. Income inequality in the 34 member countries is at its highest level in the past half century, the OECD said in a report. The average income of the richest 10 percent of the population is nine times that of the poorest 10 percent across the OECD, up from seven times 25 years earlier.
There is a time-tested European tradition of sneering at the crassness of American capitalism and the blowhards it produces. But Germans in particular are discovering that their society is not as equitable as they once believed, nor immune to the blather of populists.
In the decades following World War Two, West Germany built up its fabled social welfare system in part to compete with communist East Germany and in part to form a bulwark against the type of extremism that had given rise to Adolf Hitler. Consensus became a byword for the German way of doing politics.
After the collapse of communism in Eastern Europe and German reunification in 1990, the assumption was that the successful West German model would simply be transferred to the eastern half of the country. But as Germany struggled in an increasingly global economy, Merkel’s predecessor, Gerhard Schroeder, slashed social benefits as part of a sweeping reform to make the country more competitive.
Unemployment dropped, and the working poor emerged. Large parts of the former East Germany failed to catch up with the West, and an angry underclass that felt cheated by the promises of democracy was created.
Research shows that Germany is far more similar to the United States in economic terms than most people might imagine. Germany’s so-called Gini coefficient, a measure of income disparity, is 76 — closer to the 80 in the United States than the 69 across the euro zone. In a Morgan Stanley ranking of 20 industrialized countries, Germany came in as the sixth most unequal, right after the United States, preceded by Spain, Greece, Italy and Portugal.
Marcel Fratzscher, head of the German Institute for Economic Research, isn’t only concerned about income inequality in Germany; he also worries about systemic barriers to social mobility. “I don’t have a problem with the top 10 percent,†Fratzscher told Die Zeit. “I have a problem that the bottom 40 percent are being left behind.â€
Contrary to the prevailing wisdom I don’t believe that this is a natural and inescapable outcome. I think what has happened in the United States and in Germany is the result of policy and what can be caused by policy can be remediated or reversed by policy.
The problem with a policy approach is that the policies would need to be to the right of the Republican positions, and you would still need to account for the rest of the world.
The problem is a monetary system built upon a government backed fractional reserve lending system. One part is real, and the remainder is fiction or an entry in an accounting ledger. For the economy to grow,the fiction is assumed or pretended to be real, and more fiction is built upon it. In essence, lead is transmuted into gold.
Whomever owns the original fiction will benefit from the transmutation, and newly transformed fiction (now a pseudo-reality) will create new fictions. These new fictions will be transformed into pseudo-reality, and the process will continue.
If the process is stopped , slowed, or reversed, the economy is stopped, slowed, or reversed. Money is created by borrowing, and any attempts to alleviate a reversing or slowing economy will accrue to those who own the “money” which is really just credit instruments.
It is a compounding issue, and you can never escape it. Time and the numbers will always overwhelm you. There is no policy that will keep the rich from getting richer and at an increasingly faster rate. Or, the only way to stop or slow them is to stop or slow the economy. The only other options are for the government to just send checks or fill bank accounts without any corresponding asset to balance the books or to become socialist in the Marxist concept.
Digging holes and refilling them will not solve your problem. You either borrow the money into existence with an offsetting “asset”, or you just print cash or checks on non-existent accounts. The latter leads to a monetary crisis, and the former leads to the compounding problem.
A hard money solution will eliminate the compounding problem, but it has other drawbacks. It is my natural choice, but I realize it is probably not the most realistic choice. I have chosen a semi-sound money solution as a compromise, but there is always the danger of slipping back into today’s system.
Europe is more than likely a lot worse than the US because their financial industry is a lot worse. It would not be surprising to find a lot of Europeans hiding their money all over the world. China is a horror story. There is no telling what they have buried in the backyard, under the house, or stuffed in the closets, and when they implode, the impact is unknowable. They may be able to just continue as if nothing has changed.
A few notes: Digging a hole differs from manufacturing a hat because the hat has a value and the hole does not. Even the progressive who was thrilled with the government program to employ unemployed hole diggers could not find any value in even one hole. The money that was wasted in the hole digging operation can never be recovered. Energy was spent with no value being created. It can be used as a short term bridge in a safety net program, but it is always a waste of money.
Classical economic theories cannot be applied to a credit backed economic system, or they can with bizarre results. In a semi-sound economic system, they could be applied within bounds.
In a hard money economy, tracking the path of a gold coin or the flow of gold coins has some meaning because as they change hands they represent an individual value for value transaction. In a credit backed monetary system, tracing a fiat dollar is not analogous. The dollar can be used in one value for value transaction, and then, it can be stored in a financial institution. The financial institution can use it to manufacture nine new dollars, and these dollars will begin to be used in value for value transactions.
In tracking the flow of the original dollar, which dollar is the corresponding dollar you track, or do you still consider the dollar in the financial institution to be the original dollar? If the latter, that flow must have abruptly, but most likely temporarily, ceased, and nine new flows appeared out of thin air. What mechanism accounts for this abrupt appearance?
It is similar to applying Newtonian Physics to Quantum Mechanics. Once you understand how things work, it is meaningless. It would be no different than trying to use the Second Law of Thermodynamics as a precedent for the Supreme Court ruling on a Voting Rights case.
Fractional reserve banking is here to stay. It won’t be gotten rid of.
As long as that’s the case it doesn’t make much difference whether we have a hard currency or a fiat currency. Banks and other financial institutions create most money and I don’t see that changing for the foreseeable future.
Then, you are trapped by compounding. The best you can do is return to something pre-Nixonian, and even that might not do it. Fractional reserve lending is not the issue. It is the government backing private financial institutions’ accounting ledgers that is the problem. Sen. Glass and Rep. Steagall learned this was the problem, and they sought a way to eliminate it.
Something will change. The world is piling on debt like mad. Negative interest rates are insanity, but to the central bankers and their backers, they seem perfectly reasonable. It is only a matter of time. It is late 2006 all over. What the outcome will be, I have no idea. If I knew how to make some money off of it, I would.
There I agree with you. During the crisis years of 2007-2008 I thought that the banks should be nationalized, recapitalized, and then re-privatized as Sweden had done. Their fully capitalized value was so low that takings wouldn’t have been an issue. Any bank that thought it was an issue should just have been allowed to fail on its own.
Having the Fed (and federal government) backstop the banks produces too much moral hazard. IMO Tim Geithner should have been jailed rather than making him Secretary of the Treasury.
GS’s primary purpose was to separate the investment activities of passthrough underwriting and securities distribution, and trading for the institutions own account, from commercial banking activities of using it’s balance sheet to originate and underwrite loans. Those are fundamentally different risk profile activities. Later, commercial banks began to syndicate loans, upping the risk. Finally the wall broke completely.
Fractional reserve banking is here to stay, as noted. I have a question for Tasty. Given that there is insufficient gold available (by a wide margin) to support the monetary base, how would you transition?
I have a dumb question. If the entire money supply is a trillion (random number) and there’s only a pound of gold, doesn’t the price of gold with a gold-backed currency rise to a trillion dollars a pound? And doesn’t that have rather dramatic effects on the value of my wife’s jewelry?
Purchasing wife 14K gold tennis bracelet: $500
Forgetting to purchase wife 14K gold tennis bracelet: very, very expensive
Heh. Or the monetary base shrinks. The point is that the horse has left the barn. The world is awash in liquidity and look where we are. Imagine shrinking the base precipitously.
Not a dumb question. We haven’t been on the gold standard for 45 years or, said another way, the number of dollars in circulation and the amount of gold available are disconnected.
However and to add to the confusion, the price of a good man’s suit in gold has remained about the same since Shakespeare’s time. Same with the price of a house.
@Drew
I break with most of the Austrians and similar gold standard backers in this regard, but you would have to do a buyback. There would probably need to be some form of nationalization, but it would need to be called something else. I do not support a strict fully gold backed dollar, hence semi-sound.
For me, reinstate and upgrade the wall. Once that is done, flog the central bankers. As soon as the investor banks are as separated as possible, begin removing as many regulations on Wall Street as possible. Hell, I might remove so many even you would cry, “uncle”.
For the money market (?) used as retirement accounts, I would look at doing something similar to the FDIC, but they would not be allowed to stay on Wall Street, be backed by the US government, but subject to Congressional regulations. The FDIC is self funded (money borrowed from the government is paid back by the participating banks).
The money supply should be driven by economic conditions not the other way. You still get inexpensive money. Liberals get the increases they do not realize they need, and for the most part the system works. The Austrians will still scream bloody murder, but too bad, so sad.
At any rate, negative interest rates do not portend anything good. These are strange times, and the calls for a gold standard might come from an unexpected direction. You might realize that all your assets are marked-to-market in a paper dollar value, and if the dollar goes to sh*t for any reason, you have a problem. Most people do not, and some of those reasons are outside of US control.
The United States does not have a fractional reserve banking system. There are no loanable funds limitations and the central bank sets price, not quantity.
Banks have capital requirements, but if I am not mistaken, they are required to have reserves for demand deposits.
I suspect you mean banks do not lend the deposits, and you are getting at that they lend money they do not have.
It’s been 50 years since I took my banking class so I may have the terminology wrong. Here’s how I remember it. In a “full reserve banking system” banks are required to hold 100% of their deposits so that they’re available to be withdrawn. In a “fractional reserve banking system” they aren’t. They’re at liberty to lend not only up to but beyond their deposits. A multiple of their deposits although I believe they’re still required to hold some reserves. IIRC company co-ops (are there such things any more?) could only lend up to the amount of their deposits.
That’s all correct, Dave. The problem is the real meat of fractional or full reserve banking is that it supposedly grants the central bank control over the money supply. In this model if the CB wants more money creation it relaxes the requirement or tightens it if it wants less.
Ignoring for the moment that banks don’t loan out reserves (as textbooks teach), the requirement that the Fed set and maintain a target interest rate forces it to supply whatever quantities of reserves are demanded, otherwise it loses control of the rate. This renders the reserve requirement a nominal-only condition: Australia and Canada have no reserve requirements and yet their monetary operations are identical to ours. They’ve simply abandoned the fiction upon which fractional reserve banking is based.
There are different types of lending institutions with varying sets of requirements, and the regulations have changed over time.
In full reserve lending, you only lend money you actually have. In fractional reserve lending, you lend money you do not have. The idea is that not everybody is withdrawing funds at the same time, but this leads to just capitalising a bank. Starting with the reserve and lending the multiple.
In a private system, banknotes and checks are used, but they are not legal tender. Merchants and others can take them as they like, but the government cannot. No matter how large it gets, a bank can always fail.