Why your savings and pensions are at risk

The fractional reserve way of creating money means a lot of people are at risk of losing all or part of their savings and pensions.

If there is too much money supply in the economy then we have inflation and people with savings or pensions lose some of their purchasing power and those who owe money benefit because they repay their loans with less purchasing power.  Now you know why governments and the people who speak on their behalf promote mild inflation.  This is at least unauthorized taxation if not theft.

pexels-photo-2105902If you have deflation, then people who are owed money win because they are repaid with more purchasing power than they loaned.  The borrowers lose because they have to repay with more purchasing power.

To be fair to everyone we need to manage the economy so that just the right amount of money is available at all times.  At a time when the economy is on a down trend, this is very important as too much money puts us in danger of hyperinflation.

Getting this amount right has long been a challenge to central banks although the common sense answer is fairly simple.  The money supply should vary with the quantity of goods and services we want to exchange and it should be flexible up and down.

The wrench in the simplicity is the fractional reserve way of creating money.  When banks make loans they must (or should) keep a fraction of the amount on reserve for when the depositor wants his/her money returned.  As the amount is only a fraction banks are at risk of a “run” if depositors lose faith.  And because of the fractional reserve there is a multiplier effect involved.  Does not this sound like a set up for a crisis?  The mechanics of this process are a little complex although I have always found it easy to understand. To figure it out I suggest you Google “fractional reserve” or look at my free e book Funny Money: Adapting to a Down Economy or look at the essay Going to Market on this weblog.

The other end of the wrench is  that interest is charged on the loans made by the banks.  Mainstream economists have given little or no thought to the consequences of this. Because all of our money is created by the making of loans, if all the outstanding debt were to be paid off at one time there would not be enough money to repay it all because of the interest.  The charging of interest on the debt/money means there is never enough money available to repay all outstanding debt. Inflation is built into the fractional reserve way of creating money.

The system works only so long as the economy and the money supply continues to grow.  An upset in either means crisis of which we have had many.

The relationship between money supply and economic output is expressed in a formula, MV=PQ, some times known as the quantity theory of money.  Money times the velocity at which it circulates in the economy is equal to a price index times the quantity of goods and services produced.

I get ticked off because this is frequently taken to mean there is a direct, proportional relationship between the money supply and the inflation rate or price level.   Can’t people see there are four variables in this formula?  Total output is an important part of this formula.  If it should happen to go down something needs to happen to another variable.

Our society has a strong commitment to economic growth and a need to keep it growing so that people will not suffer from unemployment.   Some desperate people are trying to stimulate growth by increasing the money supply. This may increase inflation but it will not lead to growth unless we can find inexpensive energy and mineral resources to support it.  I suspect the new American president has  his eye on parks and reserve lands to encourage more economic activity.  He will probably succeed in the short term to be followed by a major economic collapse.

This blogger thinks we need some major economic reforms, not only in our financial system but in our commitment to economic growth.  We need to minimize our production and exchange of goods and services so we are using fewer energy and mineral resources.

A lot  of people operate on faith in our financial system and ignore suggestions we need reform.  I think the risk is so great that prudent people will at least give some thought to these issues.  It is your savings and your pensions and your future that is at risk.



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Hiding from the economic crisis

Why are interest rates so low?  It’s a question which has apparently been occupying a couple of North America’s top economists but this blogger sees the discussion as a screen hiding some very important economic issues.such as the root cause of the economic crisis and values which will guide us in trying to  find a solution.

On the surface the answer is simple.  Interest rates are the price of money and are determined by supply and demand.  They are low  because that is where the two balance.  They appear low because we are used to high returns on our investments and are reluctant to give them up.  There is no reason why interest rates could not be zero and maybe they should be.

To understand the root cause of the economic crisis we need to go into a macro economics classroom and watch the lecturer draw his basic diagram on the blackboard.  It is in the shape of an”x” with one side representing the financial side of the economy and the other the real or physical side.   This is important.  As we measure the physical part of the economy in financial terms it is easy to forget the distinction and analyze economic problems only in financial terms.  We need to ask what is happening to the physical side of the economy because it could be that is where the problem is.

This blogger figures the problem is with the resource base.  There are lots of energy and mineral resources left on this planet but we have exploited the most easily accessible.   Those that are left take a lot of time and energy to extract and this is causing a lot of economic problems.  It could even force us into negative growth.  This is a much more serious problem than why interest rates are low.  It is also an extremely difficult problem because it challenges some deeply held beliefs and values.  It’s a lot easier to talk about why interest rates are low.

Some ideas about how to fix the economy are included in the essay “LETS go to market: Dealing with the economic crisis” on this weblog.  A major feature of that essay is a proposal to change the way in which we create  money.

The emotions surrounding money make it a such a difficult subject that few people understand the economics of money and banking. This is unfortunate as money is so essential to how we exchange goods and services.  I encourage you to take a look at the essay.

While I prefer to see low interest rates as a symptom rather than the problem here are  some observations.

Money should be considered a tool to facilitate exchange rather than as a commodity with a value of its own As the quantity of goods and services we want to exchange varies up and down  so does the amount of money supply we need,  If there is too much money there will be inflation and if there is too little money there will be deflation.   Some people believe there should be mild inflation but this reduces the value of savings and should be  considered theft.

Quantitative easing has been an attempt to stimulate economic activity by increasing the money supply.  It has resulted in a rising stock market but has done little for the real economy.  That has to be a sign of a serious problem which has not been identified.

The way in which we create money, known as fractional reserve banking, is a heavy-duty problem because it is based on loans on which interest must be paid.  If all debts had to be repaid at one time there would not be enough money in the economy.  It is a Ponzi scheme on a grand scale and it is no wonder we experience frequent financial crisis.  For more on this topic see these previous posts on this weblog.

I believe we are facing a serious economic problem in that it is not clear there can  be a return to economic growth.  Dealing with this will require some major changes in our way of life.  It is disappointing that two of our most well-known economists are protecting us from having to deal with this with a frivolous argument. It’s as if they are playing in the turkey poo on animal farm and producing gobbledygook.

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Independent contractors and falling living standards

This blogger disagrees with economist Robert Reich when he says the rise of “independent contractors” in the American labor force is a legal trend.  It is an economic trend in which incomes are trending down because of problems in the energy and resource base.

Our economy has recently been through some golden  years of prosperity which have come to an end, probably because we have used up the most easily accessible of the energy and mineral resources.  There are lots left but the difficulty of extracting them is reducing the potential for continued economic growth and maybe even going to force upon us some negative growth. 

One of the consequences is that living standards are falling – at least for some people.  As  wages are sticky and people protest when asked to take a cut in wages employers try to find other ways to accomplish the same thing.  One way is to contract out work and another is to assign the work to independent contractors.  The jobs get done at a lower cost to the employers and some workers have jobs even if at less income.   In some cases the work may be done by different employees. 

This is hardly a trend to make people happy.  If it were up to me everyone would have the same incomes, working conditions and benefits as most government employees.  But economic realities will not allow that.

If there has to be a reduction in living standards then it would be fairer to share it among most people.  One way to do this would be with a universal income scheme.

Pensions and dreams

Many people like to dream about the things they will do in retirement and count on their pensions and savings to make the dreams come true.  For lots of current seniors this has been true but younger people may not get beyond the dream.  All the uncertainties of the economic future come to the fore when one starts thinking about pensions.

One hears two major concerns about pensions:  most  people are not saving enough and too many pensions are based on unfunded liabilities.

The one certainty about retirement futures is that well-being and standard of living will depend upon the quantity of goods and services we are capable of producing and the number of people with whom those goods and services must be shared.  Inflation or bankruptcies could easily wipe out  pensions and savings. In any case an increasing population and people living longer into retirement will put pressure on pensions.

There are two ways we can try to ensure our futures into retirement – we can work our butts off in an attempt to return to economic growth or we can reduce our expectations so that we don’t need so need so many goods and services.  It is possible the second option will be forced upon us.  That may not be all bad.  This blogger knows from experience that canoe camping is a lot cheaper and more enjoyable than the large cruise ships..   I also have to recognize that camping would be a lot less fun if we had to share the lake with 2,000 people at a time.

Most  of us are subject to a lot of media hype about the importance of pensions and saving for retirement.  We should keep in mind that we are in for the long-term while the people selling investments are more interested in their next pay cheque.  What is good for them may not be good for their customers and by the time you find out you may not even remember their name.

Some people are worried about government pensions and see private investments as the answer.  I figure the whole financial system is at risk of either inflation or bankruptcy.

In planning for the future we have to evaluate the potential for a return to economic growth.  If one believes we are going to return to growth then it might  be okay to put a lot of effort into a pension.  .  Personally, I think the best long-term investment at this time is a market garden.


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The future of money: inflation, deflation or disappearance into thin air

The future of money has been getting a little attention lately.  It could go one of three ways – inflation, deflation or part of it could disappear into thin air.  Concerns about money probably reflect concerns and uncertainty about where the economy is going.  Frequently behind these concerns lurk people who want a fixed money supply such as gold or bit coin.

This blogger figures money should be defined as a tool to facilitate the exchange of goods and services.  I do not like definitions that make it a store of wealth or a measure of value because these give money an intrinsic value which it does or should not have.  Money should only have value as a tool. 

One of the most important features of money should be the amount available  in the economy needs to be flexible.  It should be able go to up or down  with changes in the quantity of goods and services we want to exchange.  If the money supply is not flexible then as we change the quantity of goods and services then either prices must go up or down or the velocity, the rate at which money changes hands will change.  It is dangerous to assume there will be only growth.

Inflation happens when the money supply increases faster than the rate of economic growth and deflation happens when the money supply goes not keep up with the rate of growth.    Inflation is good for borrowers as the can repay their loans with money which has less real value.  This is one reason governments and their agents want to see mild inflation.  Deflation is good for lenders as they will be repaid with money which has more value.  The ideal should be price stability so nobody loses.

Our understanding of inflation and deflation has been distorted by the long period of economic growth we have just experienced. Most inflation has happened along with growth and most deflation has resulted from banking authorities trying to restrict the amount of money available.  This happened in the 1930s and todays central bankers have sworn to never again let that happen.

There is some evidence that our time of economic growth has terminated.  It is unclear how this will affect prices.  Quantitative easing which is an attempt to increase the money supply has not led to high inflation.  Past hyperinflations have occurred when governments have increased to money supply faster than the economy was capable of growing.  It appears the money created by quantitative easing has led to inflation in the financial markets rather than consumer markets.

Economists generally understand how fractional reserve banking works to increase the money supply but I am not aware of anyone who has thought out the opposite process.  Money that can be created out of thin air can just as easily disappear into thin air.

In fractional reserve banking banks are required to keep a portion of their deposits as reserves for protection against runs. The rest is loaned out and redeposited with the new deposits subject to the same fractional reserve.  The result is that a large proportion of our money supply is  somewhat precarious.  This blogger and many other people on the internet have explained the process.  Just search “fractional reserve banking.”

Central banks can add money to the system by purchasing financial instruments or by changing the reserve requirements.  The could also reduce the money supply by selling financial instruments or by changing the money supply although it is unlikely they will do either under current conditions.

Another way the money supply could be reduced is if the banks suffer large losses.  Any loans the banks have to write off will directly decrease their available reserves.  (The technical term is high powered money.)  This means they will have to decrease their outstanding loans with the same multiplier effect as the money supply was increased.  We will hear about it as a contraction of credit.

So if the banks experience unusually large losses there could be a drastic decrease in the money supply which could have dire consequences.  ( I have read that a number of Canadian and British banks are highly exposed to the energy industry with unsecured loans.)

If a large part of the money supply were to disappear into thin air in the short term a lot of economic activity would come to a screeching halt.  People have in the past used playing cards or candies as a substitute for money.  In the long term the level of activity would depend upon the physical resources available.

People who talk up monetary reform often want a return to a gold standard or facsimile (bit coin).  It is not clear that either of these would correct the problems inherent in the fractional reserve way of creating money.  Nor would they provide the flexibility that is needed in the total amount of money available.

We all think we know everything there is to know about money.  That is a part of what our parents teach us. However, it is a complex subject which few people understand and there are a lot of unknowns, especially if we have to deal with an extended period of low or negative growth.

Compassionate austerity to deal with the economic crisis

To cope with the economic crisis we need austerity with compassion.  Stimulus as a policy will likely make things worse more quickly and austerity as currently practiced is mean and hurting victims.  Those people voting for politicians urging austerity may regret their votes when they too get caught in the crisis.

Compassionate austerity would recognize we are dealing with events beyond our control and would therefore not blame the victims.  It would include some sort of income support for people caught in the crisis

How one wants to deal with the economic crisis depends upon how strongly one believes in economic growth.  If one believes this is just a temporary setback, then one probably wants either stimulus to keep things going or some austerity until the economy corrects itself and growth returns.  This blogger figures the crisis results from problems in the resource base and it is unlikely we will again see the golden  years of prosperity which we have experienced in recent decades.

If this is the case, then austerity is something which will be forced upon us and we should try to cope with it with as little human suffering as possible.

I figure the basic economic problem is that while we have lots of energy and mineral resources left in and on the surface of the planet we have used up the most easily accessible.  Those that are left take so much energy to extract it is becoming less feasible to do so.  Suppose that during the age of prosperity we were able to build an automobile with 1,000 units of energy and labour and suppose it now takes 2,000 units to build the same car.  Not only is this going to double the real cost of building a car it will probably limit the number of cars that can be built.  It will certainly limit the number of people who will be able to afford them.

If this is a correct analysis of the problem, then clearly we need to make some revolutionary changes in the way in which we organize ourselves to produce and exchange goods and services.  I predict there is little likelihood of the revolution starting until the economic crisis hits pensioners.  For the time being it is mostly young people who are hurting.

There is a need to rethink our commitment to economic growth and rearrange our economy so we take advantage of modern technology so that most of us can live comfortably without having a job.

What disturbs me about austerity is that the people who promote it have so little compassion and understanding for those who have been caught by the crisis.  Many of those who vote for politicians pushing austerity need to rethink their votes as it could be only a matter of time before they too will find their comfortable lifestyle being challenged,

Austerity with compassion should include some sort of income support.  This blogger would like to see  a guaranteed annual income scheme combined with changes in the way in which we create money.  However, the need is so great I will say we need anything that will provide everyone with a more or less equal share of the goods and services we are capable of producing.

If you liked this post your are invited to comment, press the like button and/or click  one of the share buttons. If you disagree you are invited to say why in a comment.  While I like the idea of sharing this platform, my personality is such that I don’t reply to many comments.



Some reasons economists don’t get it.

What is wrong with economics?  Through the years a lot of people, including the current group of students have recognized there are problems.  This blogger figures there are two types of problems –  problems with human nature and problems within economic theory and understanding.

Most of us most of the time think and act in our own short-term interests,  Some people won’t listen to things that contradict their interests.  This can be a problem for economists as their paychecks often depend upon telling business people and politicians what they want to hear.  It is likely some of the students demanding changes in the way economic is taught will have to come to terms with this.

The other human nature problem which interferes with economics is that some people like to exploit others – sometimes deliberately and sometimes because they believe it is their right.  Using money as a tool to facilitate the exchange of goods and services allows us to have economic relationships with strangers from many parts of the world..  It also makes it easier for some people to exploit others. I am currently reading The Big Short by Michael Lewis in which he details the people who foresaw the subprime mortgage bust and profited from it.  It’s sort of interesting to see the exploiters being conned although I  believe that for relationships to be satisfactory there needs to be a more or less equal two-way exchange.  Another interesting thing is that most of the players on either side came out of it rich.

Neither of these human nature problems is likely to be resolved by changing the economic curriculum or the way the subject is taught.

It may be that for economists to tell their employers what they want to hear the economists have to be blind to some realities.  Here are four examples.

One of the greatest of economic myths is that growth can continue forever.  Economists occasionally talk about scarce resources then assume that there never will be scarcity.  Yes, we still have lots of mineral and energy resources.  However we have used up the most easily accessible of them.  What’s left is difficult and takes lots of energy to extract. This is a diversion of energy from other uses.  From history we know that all previous civilizations have collapsed.  Some people talk as if we will be the exception.

The second unseen reality relates to free market competition.  The problem with competition is that the more competition the smaller the profits.  In large parts of our economy competition is restricted by government legislation and regulation.  Licenses, patents, copyright, tariffs all allow firms to make profits they wouldn’t get with full competition.  It also means consumers pay more than they would otherwise.  When we talk about a market economy we ignore how governments work to restrict competition.

Sometimes economists distinguish between the real economy and the financial economy.  It’s an important distinction and we lose some understanding when we forget it as we often do.  My favorite example is with pensions.  Most people plan their pensions in money terms.  But there are three things that can happen to one’s pension savings:  inflation, failure of the firms in which savings have been invested and a government mandated haircut.  For most of us our standard of living in retirement will depend upon the ratio of goods and services produced to the number of people making demands on those goods and services.  If we experience a major drop in production, it will not matter how much pension money one has.  It might be prudent to plan for retirement at least partially in terms of the physical economy. How about a large garden?

The complexities of money creation and the deep emotions associated with money make it the most misunderstood and problematic  aspect of economics.  A number of posts on this weblog have dealt with the problems of money.  I believe that in the fractional reserve method of creating money economists have ignored the fact that interest is charged on the money created.  This feature makes the fractional reserve money into a Ponzi scheme. This explains the regular financial crises our economy has experienced.  If more people understood how the banking system creates money and the problems, we would probably be demanding changes which would take away from the profits and powers of bankers. How many economists would even dare to think that?

There appear to be lots of problems within economics.  How we exchange goods and services and the relationships involved in these transactions are an important part of our lives. It may be that some people can  benefit if most of us don’t see these relationships clearly. However, I think we would all be happier if we did.


If you liked this post your are invited to comment, press the like button and/or click  one of the share buttons. If you disagree you are invited to say why in a comment.  While I like the idea of sharing this platform, my personality is such that I don’t reply to many comments.

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