Archives for February 2013

A Plan to Restore Sound Money and Prosperity, Part 2

The Basis of Sound Money

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Brazil’s currency happens to be called the real. (Wikimedia Commons)

What is sound money, really?

In today’s world, we have no choice but to accept paper money and electronic digits as forms of money. The first thing we need to know is, on what basis can we say that a currency has value?

Most gold and silver “bugs” erroneously think that a currency has value only if it’s firmly linked with an underlying commodity. As I’ve explained, however, commodity prices not only fluctuate on their own, they’re subject to manipulation. Therefore, it wouldn’t be wise to fully link any given currency with hard assets.

The gold bugs often claim that fiat currency has no value, but in this they are mistaken. By the way, fiat money is money that a government declares to have value, but which comes with no guarantees.

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1899 silver certificate dollar bill

I once found a “silver certificate” dollar bill, similar to the one depicted above. This bill contained a written promise that it could be exchanged for one silver dollar. Obviously, this was not a “fiat” dollar.

It’s true that fiat paper money has no intrinsic or material value. The paper and the ink are worthless. The government won’t give you gold in exchange for it. Nonetheless, fiat money can still have a great deal of value for defensible reasons.

If there is value to a fiat paper bill, that value is derived from what it represents, and from the limited supply. Currencies have been, and always will be supported by intangibles. Every U.S. dollar, for example, represents a small portion of the labor and property of the American people. The value comes from factors that I explained earlier, such as the strength of the economy and the stability of our government.

This value is real, not imaginary. The U.S. government accepts or requires dollars for payment of taxes and fees, and American companies and individuals accept them in exchange for goods and services. Our dollar is also accepted in many places outside the United States. Even gold bugs who claim that paper money is worthless are happy to provide goods and services in exchange for your fiat dollars.

Every convenient form of currency requires trust. Even if we had a gold-backed currency, we’d have to trust that the government would honor its promise to exchange a set amount of gold for the currency. Either that, or we’d have to trust that we wouldn’t be one of the last people holding dollar bills when the government revoked this promise.

There’s nothing wrong with a government using one or more hard assets such as gold to partially back a nation’s currency. However, for the reasons explained above, any currency that is too closely connected to precious metals is vulnerable to large fluctuations in value, typically due to fraud and manipulation. This danger must be avoided. Therefore, good money must be mostly backed by trust, not by tangible assets.

Proverbs 22:1 says a good name is more desirable than great wealth. If the government, central bank, and people of a nation have good names, the currency will also have a good name. That currency will be honored everywhere, and it will have a high value.

One goal of a stable monetary system should be to eliminate government debt, or at least make it difficult for governments to take on debt. During World War II, the U.S. government took on what may have been the healthiest form of debt by selling war bonds to American citizens. The kind of debt that governments take on from big banks today is not so healthy.

While I’m on the topic, the only “good” form of debt is the kind that’s necessary, and that can be repaid in a timely manner. The Bible discourages believers from taking on debt and from co-signing on loans.

In order to have honest, non-fraudulent money, we must abolish fractional reserve banking. This means banks must lend out actual money that hard-working people either deposited in the bank or paid to the bank as interest.

In theory, this could make it more difficult for people to get a loan. However, the honest monetary and financial systems that I’m proposing here would make money more readily available to all Americans by contributing to greater wealth equality and overall prosperity.

As things stand now, $16 trillion of the world’s money is tied up in U.S. government debt. Other governments have also taken on enormous debts through central banks similar to our Federal Reserve. Just imagine how much more money would be available to the world’s people under monetary systems that didn’t encourage this kind of excessive borrowing.

Making matters worse, periodic economic crashes and financial “rescue” packages for the failed banks take even more trillions of dollars out of the world economy.

The big banks are also too big to efficiently handle micro-financing. The world needs an explosion in micro-business lending. Most of this is going to come from small lenders loaning out “real” money. These micro-lenders could never hope to obtain legal authorization to engage in fractional reserve lending. Then again, why should anyone be given permission to do something as unethical as that?

 

The Role of the Central Bank

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The Moneylender and His Wife (detail) by Quinten Metsys (1466-1530)

My proposal calls for the establishment of a central bank. This bank would lend money. One purpose of the lending would be to provide reliable financing for citizens at a reasonable rate of interest. Another would be to help stabilize the exchange rate, to keep it within a targeted range.

There would have to be a targeted range in order to maintain currency stability. As has been explained, a stable currency should be the primary objective. Whereas wildly fluctuating exchange rates benefit speculators and financial insiders, stable rates would help the honest workers and businesses that are the lifeblood of every economy.

In theory, the United States Congress would only need to set the targeted exchange rate one time. Let’s assume a worst-case scenario in which the U.S. dollar becomes hyperinflated, and needs to be replaced with a new currency. The Constitution gives Congress the power to coin money and to “regulate the value thereof.” When issuing the new currency, the Congress would decide on its value. This value would become the target value of the currency, probably for the duration of its existence. A stable currency could last for however long a nation may endure.

All goods and services are valued according to a nation’s currency, but how can the currency itself be valued? One way would be to assign the currency a value based on a currency index consisting of floating currencies. This wouldn’t be a stable value for any currency because the other currencies wouldn’t be stable. Currencies today are like helium balloons, always floating upward in the sky due to inflation.

The only way to assign a fixed value to a currency would be to value it in relation to fixed amounts of various commodities. This would include basic necessities such as gasoline, electricity, lumber, cotton, grains, meats, fruits and vegetables, base metals, and precious metals. The commodities could be adjusted over time to reflect actual consumption in the real economy. For example, if vegetarianism caught on with a lot of people, the index could be adjusted to give less weight to meat, and more to other foods.

You might wonder who would be responsible for maintaining and monitoring the currency index. It should probably be a government agency that responds directly to the Congress since the latter has responsibility for overseeing the currency’s value. Better yet, it could be an independent agency established by Congress, that would be made up of trustworthy citizens.

Economic forecasting would be needed to anticipate the future value of the currency. This job will probably never be easy, but no system is perfect.

The central bank must work to keep the currency within the assigned target range by controlling the interest rate and lending money at that rate. The bank would have to remain independent, neither owned nor managed by any other banks or financial institutions, nor by their representatives.

The big banks might insist that no plan of this magnitude can work without their financing and financial expertise. I can already tell you why this would be a lie…

As for the expertise, we would neither need, nor want Wall Street wizards or their “magic.” We’d want to keep the financing honest and simple, without getting into things like complex derivatives.

We wouldn’t even need the big banks’ money. Here are four reasons why:

  1. First, America could finance a government-owned central bank by taxing super-rich people to ease the present state of extreme wealth inequality. I’m not talking about imposing stringent taxes on high-salaried working people such as doctors and airplane pilots. People need incentives to train and qualify for those jobs! Rather, I’m talking about imposing a meaningful tax on people who have more money than they could possibly need. This money wouldn’t go directly to the poor, but to a central bank that can put the money to good use. We could also simplify the tax code to eliminate loopholes that wealthy people and corporations use to game the system.
  2. Another way of financing the central bank would be to open it up to deposits by American citizens, if nobody else. The depositors would receive their share of the interest earnings. In order to maintain American sovereignty over the bank, there would have to be restrictions on the size of deposit accounts, and on the amount (if any) that foreigners can deposit.
  3. A third way would be for the Congress to provide significant funding for the central bank. This shouldn’t be a hard sell since it would be an income-earning investment, not an ordinary expenditure.
  4. The fourth and final reason why we wouldn’t need big bank financing is because the central bank could start out modestly by lending money to creditworthy people in the lower income ranges. The bank could expand its lending operations as it obtained additional capital.
    The central bank wouldn’t need money to open a lot of branches. As I envision it, people would be able to walk into their local bank and apply for a central bank loan.

For all these reasons, America would have no problem financing a central bank with clean, no-strings-attached money. The central bank would make credit available to Americans without shenanigans such as big interest rate hikes, fractional reserve lending, and risky investments that might lead to a bank collapse.

As I had explained, the Old Testament prohibited the charging of interest, except in some cases to foreigners. The New Testament gives us an even higher standard. The early Christians gave freely to one another based on the needs. This may lead you to question why I think the central bank should charge interest on its loans. This would be necessary for the following reasons:

  • Interest income would be needed to make up for bad loans, and to pay for the bank’s operations.
  • The profits wouldn’t all be going to a few big, impersonal corporations and their executives. Instead, it would be broadly distributed to American depositors, and/or to Congress’ spending budget.
  • Although the Bible warns against charging interest, that doesn’t change the fact that money today (e.g., for a house purchase) has more value than the same amount of money in the future. Interest-free lending or, for that matter, free money, may perhaps be offered to needy people. However, it would lead to pandemonium and excessive borrowing if nearly everyone were given access to it.
    A further point is that even though the Bible generally discourages the charging of interest, God ordained governments to do some things that ordinary citizens, businesses, or the Church aren’t allowed to do. For example, governments can forcibly collect taxes; catch and imprison criminals; and can even kill people in some instances. In other words, we rightly entrust governments with certain privileges and duties that we don’t grant to anyone else. For this reason, governments are, or should be subject to constitutional law, democratic control, and judicial oversight.

Even private banks and lending institutions should be subject to regulatory oversight. If left unchecked, the charging of compound interest can become a sure means of transferring immense wealth from the many to the few.

As you can imagine, the central bank that I’ve described would be quite different from the current system, which is like a Ponzi scheme designed for the benefit of big banks. Currently, American taxpayers are compelled to pay over $250 billion per year on the national debt. By contrast, the central bank described in this proposal would fund its own operations and return any earnings to the Congress and the American people.

Both systems are similar in one respect. That is, in both cases a central bank lends money, receives it back with interest, and lends it out again. By their nature, banks take back with one hand what they’d given with the other. They don’t take back only what they lent out, but also take interest charges.

The only way banks can put additional money or liquidity into an economy is by increasing their lending. However, once again, excluding write offs for bad loans, all the money must be returned to the banks with interest. If the people do the right thing and pay off a lot of debt, they find themselves in need of more money which, in aggregate, they can only obtain through more borrowing. Thus, under a debt-based monetary system, debt levels must continually increase to keep the economy going.

If you understand how this works, you can see that lending is terrible way of increasing the amount of money in circulation. The primary purpose of the central bank would not be to increase the money supply, but to:

  • Provide for a more stable and trustworthy financial system by replacing big, corporate banks at the national level;
  • Provide fair and reliable financing for most Americans, and;
  • Help stabilize the currency’s value through interest rate adjustments.

Since central bank lending isn’t the best way to increase the nation’s money supply, we must have a method that is not dependent on debt. As I will explain, that would have to be through government spending.

 

The Role of Government Spending

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Money tunnel by RambergMediaImages

I’ve just explained that since new money appears in the form of debt in a central bank system, that same money vanishes when debt is repaid. This makes the Federal Reserve system not only a money-lending machine, but also a money-sucking machine. Our government is being forced to spend more and more money every year on interest payments alone. The Fed and other institutions loans our government the principal, but never prints the trillions of dollars that we need to repay the interest!

The system I’m proposing is vastly different because it would provide the Congress with extra spending money. It would even allow the government to spend money that it didn’t collect in taxes, without borrowing!

You might be thinking that the Congress shouldn’t spend money that it never received through borrowing or taxation. You may wonder how a monetary system that allows Congress to create money out of thin air can be ethical.

The truth is, someone has to coin, print, or digitize new money into the economy. Again, the U.S. Constitution gives the right to issue currency only to our Congress. No outside institution has the right to create dollars and lend them to the government.

It’s unthinkable that the Congress wouldn’t be able to authorize the issuance and circulation of additional money in response to increased demand for the currency. If this were not the case, we’d have no more money in circulation than that which existed in 1776!

The U.S. Congress has the sovereign right to spend newly created currency on behalf of the American people because it represents us. This additional funds would obviously help our tax dollars go further.

You may ask, “How much money would Congress have the right to issue?”

Of course, there are economic, ethical, and rational limits to the amount of money that should be created. This brings us back to our primary goal, which is to have sound money in the form of a stable currency. The Congress should only issue as much money as is needed to meet estimated demand for the currency at the target value. Excessive money issuance would result in inflation, but our goal must be to make inflation a relic of the past.

The best way to introduce new money into the economy would be for the government to determine how much new money is needed, and for the Congress to add that amount to its budget. The budget would consist of not only taxes collected, but also new money needed to support the economy and maintain the currency’s value.

Let’s consider how this might work in practice. Suppose that it is determined, using objective criteria, that Congress should be allowed to spend a specified dollar amount above taxes collected in order to satisfy expected U.S. and world demand for dollars at the target value. For this illustration, “A” will be the amount of taxes collected in the preceding tax year, and “B” will represent the additional money needed in the economy. The Congressional budget would be equal to A + B.

Obviously, the trick would be to determine the value of “B.” If the government were to get this amount wrong, it would need to adjust for it in the budget for the next fiscal year.

This plan could result in a substantial reduction in federal taxes for most citizens.  Although I’m not an economist, I’ll offer a hypothetical example. Real economists would have to account not only for domestic demand, but also for international demand for U.S. dollars, stock market gains or losses, and other factors.

For the sake of illustration, suppose the U.S. economy grows at a rate of two percent per year. The money supply might need to increase at a rate of approximately two percent annually to meet the additional demand. The U.S. GDP is currently $15 trillion. Two percent of that amounts to $300 billion. You can see how this would result in an increase of $300 billion to the Congressional budget with no additional taxes. Americans may want to throw parties because we’ll have done it by making our economy grow!

If the currency becomes inflated beyond the target range, the Congress will need to reduce its spending, especially if economic growth slows at the same time. For this reason, there should be flexibility to adjust the congressional budget from year to year as the situation demands. Incidentally, one of the biggest fixed expenses in the Congressional budget is the $250 billion interest payment on the federal debt, which would eventually be eliminated under this plan.

The one thing that can and must keep the system honest is the requirement to stabilize the currency within the target range. A stable currency contributes greatly toward stabilizing the economy itself. Economic instability is nearly always associated with large shifts in the value of the currency, either through inflation or deflation.

Politicians will always want to spend more money, but this should be prohibited by law. As households, businesses, and local governments must adjust their spending based on income and economic conditions, so too should the federal government.

If the country gets into a war and needs money for that reason, it can raise the central bank interest rate and once again sell bonds to American citizens.

Under any currency regime, bond buyers will want governments to borrow money by issuing debt instruments in both peace time and war. We shouldn’t be surprised that wealthy investors greatly covet this lucrative source of safe income, which they extract from the pockets of taxpayers. However, history shows that debt issuance is a back door route to out-of-control government spending. With it would come the return of inflation, the boom and bust cycle, government expansion, the loss of vital freedoms, military adventurism, and other evils.

 

Summary

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A government of the people, by the people, for the people (1896) by Elihu Vedder (Wikimedia)

The existing monetary system in the United States is inflationary; caters to the big banks; and lacks any effective means of avoiding broad currency fluctuations and devastating financial bubbles. Therefore, I’ve set forth my ideas for a new monetary and financial system. My plan offers two different ways to maintain a stable currency value, i.e., through the central bank interest rate adjustments, and through the congressional budget.

A stable currency will allow people and businesses to plan far into the future. This proposal would allow for a phasing out of the enormous government bond market, which transfers money from honest taxpayers of all income levels into the hands of a relatively small number of wealthy bond holders. My plan would allow the American people to directly benefit from our economic growth by reducing the tax burden. Most Americans will find it easier to obtain loans at a reasonable, and relatively stable rate of interest. Finally, wealthy investors will have less opportunity to finance ever-expanding governments and their wars, but will instead be able to invest more in people, whether it be through charitable giving or through investments in real businesses that create jobs, drive innovation, and contribute to economic prosperity.

I hope I’ve presented this in such a simple way that it all makes sense to you. If not, please ask questions in the comments section below. If you’re in basic agreement with what I’ve written here, please share it with others so that word of this will spread.

Perhaps you have a background in finance or economics, or have further insight from the Bible. Since the ideas I’ve presented here are still “under construction,” feedback is welcome!