Comparison of a monetary system based on political participation to one based on debt—the current system.

Comparison of a monetary system based on political participation to one based on debt—the current system.

 

The fiat monetary system that we enjoy today monetizes debt. Some debt is monetized into base currency (more or less a permanent addition to the money supply), and some debt is monetized into bank currency (temporary additions to the money supply that “disappear” when the debt is paid off). Given a base quantity of money, bank loans temporarily expand the base as more money is needed for business, personal and governmental reasons up to the limits of reserve requirements. From 1959 in to August, 2008 banks maintained low levels of excess reserves–loaned near the maximum allowable by Fed regulations. That is a half century of expansionist policy by BANKS! Beginning in August, 2008, banks began to maintain larger excess reserves–didn’t loan very much. This amounts to a contraction in the money supply. This contraction was precisely when the economy needed spending (more money in circulation) to support production of goods and services or the employment that puts money into the hands of consumers. Between August, 2008 and this writing, October, 2011, the US economy has had three years of monetary contraction policy by BANKS!

 

While bankers will explain that business (which also have been sitting on large cash reserves) are not expanding because of government policies and not seeking loans, the facts will show that standards of due diligence exercised by banks in screening loan applicants and projects (the collateral for the loan) have significantly stiffened/tightened since July, 2008 in response to their previous over reaching and the resulting near banking collapse of the last quarter in 2008. So, under the fractional reserve system of monetizing debt, BANK policies (standards and procedures for deciding to whom and for what to lend money) absolutely determine the supply of money in the US.

 

Since August, 2008, the Feds have gone to considerable lengths to create base money. The banks simply are not responding to the nudge by the Feds. Indeed, at one point the Feds deposited money in a bank’s account without any collateral or the purchase of securities.

 

In comparison, monetizing votes, would create base money on a regular basis and put it directly in the pockets (accounts) of consumers. Bank contraction policies on lending in such an environment would not have the same dire effect on citizens’ wallets as they presently do–layoffs, jobs exported and the like. Banks would still lend money for the same purposes they do now. But, their actions would not stop the flow of money to where it is needed the most-into the hands of consumers.

 

Under the fractional reserve system of creating money, money tends to flow to where it already exists in large quantities-banks, large corporations, the super-rich and just plain people with money (the rich). To illustrate let us take a simple example.

 

To keep things simple assume a four person population, a base money supply of $400. Assume a reserve requirement of 0% (remember this is to keep things simple). Assume I have $100, the bank has $100 in its capital accounts and the other $200 is in circulation. The bank is offering 1% interest on deposits so I deposit my $100. You apply for and are granted a loan of $100 at 10%. At the end of the year you pay off the loan plus interest, mow I have $101 on deposit, the bank has $109 ($100 in its capital account and $9 in its earnings account) and there is $190 in circulation. Assuming the bank continues to loan someone a new $100 every year at 10% in 5 years, I will have $105.10 in my account, the bank will have a bit more than $161.00 in its accounts leaving slightly less than $139.90 in circulation. Money flows to where it is already aggregated! (Or, it moves out of circulation into bank accounts of those who have money and into the banks’ earnings accounts.) (Note, this is similar to wealth condensation, a theory. The difference is that money flows to where it is already aggregated is empirically demonstrable.)

 

It should be noted that the bank’s share from loaning my money to you took more money out of circulation than I did by depositing my money in the bank and earning interest.

 

Now translate 50 years of aggressive lending policies by banks into that simple $400 base money supply example scenario and one is left with the possible conclusion that the financial crisis in 2008 was, at least in part, precipitated by the massive accumulation of money in financial institutions from lending and creating bank (temporary) money. And then banks contracting the money supply by only making very limited loans.

 

The Fed deals through banks and securities dealers in the fractional reserve banking system to create money. While it is unfair and a gross over simplification, banks already have all the money in their accounts. It is probably puzzlement to them to try to figure out a new way to make money with all their money and any new base money they receive. Recently, before 2008, banks invented junk bond, derivatives, sub-prime loans and bundled mortgages, all of which were designed to make a profit. The problem is those “products” might have worked in moderation, but banks jumped in with massive assets. One has to hope that banks figure out that new ways to make money with money are risky and need to be explored in smaller steps then they have in the past. In the meantime, money is not flowing.

 

If, however, the Fed were to deal with voters who did not have the power to directly multiply base dollars, individual consumers’ wants, needs and desires would keep the economy moving even when banks can’t or won’t. Individual savings decisions along with Fed reserve requirements will determine how much bank money is creatable. Business receipts in a stable (recall, economic stability was one of the goals of both monetary policy and fiscal policy) and growing economy will create employment opportunities and borrowing needs that are backed by solid business proposals and solid predictions of demand for products.

 

Notice if we were to redo the $400 money supply example we used to demonstrate how money flows to where it is already aggregated under the fractional reserve banking system of creating money, with $100 in base money allocated per person for voting with monetized votes; at the end of the first year I would have $101, the bank $109 but now there would be potentially $590 in circulation (the same 4 people, and $100/year each for voting). Compare that to the relative accumulation of wealth under the more static creation of base money by monetizing debt. So while money will still attract money, the relative amount of wealth captured by the rich and banks will be much smaller and at a slower rate proportionally to money in circulation at any given time. However, if you are rich, you will get absolutely richer at roughly the same rate under both systems of creating base money. Relatively richer is a whole new ball game under a monetizing votes system for creating money.

 

At present 10% of the population control 70% of the wealth (money, liquid assets and property). So if the Fed simply doubled the base money supply, that would be the equivalent of putting roughly 130% of the money supply in circulation (I am assuming that 70% of the money supply is not actually in circulation. This assumption is probably an underestimation of the money supply not in circulation). This is the case as the 70% currently owned by the wealthiest 10% of the population is not actually in circulation, but is “invested” where it can at least earn interest if not grow dramatically. So doubling the money supply, as say a benchmark, would not be inflationary as it is only initially putting 30% more money into circulation than is “theoretically” in circulation now. As argued elsewhere in this work, the initial deposits in voters’ accounts might shift the aggregate demand curve slightly to the right. A dramatic shift or inflation would be highly unlikely as the new base money would be spread out over a year and the initial deposits would amount to less than 2.5% of the “theoretical” money supply. When the second year’s deposits into voter’s accounts begin those deposits will amount to less than 1% of the then existing money supply in circulation. So the incremental effect of monthly new base money will become smaller and smaller the longer the system of monetizing voter participation is in place. What this means is that base money will grow at a predictable and steady rate. The money supply will grow to accommodate new voters. Everyone will have a sufficient income to minimally participate in the economy. That financial institution crises (contractions) need not cause the same severity of suffering among the 90% of the population that, at present, owns 30% of the wealth (and 30% may be an over estimate).

 

What will be role of financial institutions when votes are monetized?

 

Financial institutions will play the same roles that they presently play with one exception. Their accounts will not be the primary placement of base dollars from the Fed. Banks will have to rely on voters depositing their base money into demand deposits and time deposits and other kinds of accounts banks presently maintain. Banks will still create bank money (temporary money) as individuals, firms and units of government need loans for legitimate purposes. So debt will still be monetized on an as need and temporary basis within reserve requirement, but, because banks are no longer the primary engine for putting money into circulation, when banks contract bank money it will not create the same kind of wide-spread cuts in consumer demand or the severe and harmful injuries to average citizens as they have under the system that only monetizes debt.

 

 

 

 

 

 

 

 

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2 thoughts on “Comparison of a monetary system based on political participation to one based on debt—the current system.

  1. Reading this carefully, it continues to make good sense as a plan, or theory. Obviously, the issue is getting those holding the purse strings to see the simplicity of your argument. The top elite controlling that 70% of the money (it is even higher here) are unlikely to want to abandon their position of prestige, and will have to be forced to.
    Best wishes, Pete.

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    1. While I haven’t written about it yet, I am glad you picked up on that a few hundred people who currently make a living by buying and selling securities in the new money creation process may find their occupation altered beyond recognition (when that happens to us, the common folks, we call it losing a job). Yes Pete, I am sure they will kick up a fuss.

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