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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Regulating those evil payday lenders

Here is a link to an article from the Mises Institute opposing regulations for the American payday lending industry.

This simple proposal to regulate short-term lending raises important questions about how we treat poor people, about the role of money in our economy and how we regulate business activity.

This writer believes we should have a collective responsibility to ensure every one has the opportunity for the same standard of living as most other people.  Probably the best way to meet this responsibility would be a universal basic income scheme.  Such a program would not stop everyone from mismanaging their finances but it should eliminate the need for a lot of short-term credit.

Money can be an instrument of exploitation and is based on the debt created when banks make loans.  Debt is a path to slavery, especially for poor people.

We need a radical revision of the way in which we create money.  We treat money as a commodity which has its own intrinsic  value.  We would be better to treat money as a tool to facilitate the exchange of goods and services.  As a tool rather than a commodity there would be no need for interest.  Also the total amount of money available needs to be flexible up and down as the quantity of goods and services we need to exchange expands or retracts.  This guy has written extensively on this topic on his weblog and in his book.

As much as possibly economic forces, competition, should be used to regulate business activity. The more competition the fewer profits and the less need for regulation.  Regulations tend to restrict competition, allow greater profits and increase the demand for more regulations.

This writer is not enthusiastic about supporting the payday loan industry but does recognize that in our society there is a need for short-term credit.  I also believe there is a need to reform our financial system and the reforms could reduce the need for credit from all of us including the poor.

How can we afford a universal basic income?

How can we possibly afford a universal basic income?

This appears to be the strongest argument against an income scheme. It also illustrates one of the basic problems in economic analysis.

When macroeconomic professors stand at the black board they generally draw an x-shaped graph and label one line to represent the real or physical part the economy and the other to represent the financial side. This is an important distinction because if one analyses economic problems only in financial terms the complexities of the financial system get in the way of clearly seeing problems.  Too often economic problems are analyzed in financial terms.

In the case of the universal basic income the question should be are we capable of producing enough goods and services to provide everyone with the desired standard of living.  The answer should determine the level of the basic income.

There are a number of economic issues with which we need to deal:  we have extracted the most easily accessible energy and mineral resources and those left require a lot of energy to get; there are serious problems resulting from the fractional reserve way of creating money; the work ethic is a problem in a high technology world; and there is a need to recognize our economy, what we call capitalism,  is based on legislation which restricts competition and allows some people to make profits they would otherwise not get.

I believe most of these need to dealt with at the same time.  Certainly a UBI should be introduced at the same time as a reform of the financial system. These are complex emotional issues and will be extremely difficult to resolve.

The book Funny Money: Adapting to a Down Economy, by the author of this post discusses these issues. Please have a look at it.

Answering concerns about an income scheme

A discussion forum on the Canadian Broadcasting Corporation website brought out a number of concerns about proposals for a basic income scheme. There were more than 2,000 comments.  Here are answers to some of the concerns.

How do we pay for a basic income scheme?

There are two answers to this question.  The first is that it would replace a range of existing social welfare payments and would make these payments with more efficiency.  Employing fewer people this would increase the need.  Also I believe subsidies should be given to consumers rather than producers so this would release a lot more money for an income scheme.

For the second answer we have to focus on the agricultural surplus, the excess production by each agricultural worker which allows food for people to do other things. Without the agricultural surplus we would not have civilization as we know it.

Until now the agricultural surplus has been distributed via employment but the current level of technology is making this more difficult.  Thus the interest in a universal basic income scheme.  We should note that the agricultural surplus is based largely on petroleum and could be somewhat precarious.

As most of the technology that has gone into the agricultural surplus has been developed over the last 2,000 years and most if not all of us have ancestors who worked on that, we should consider it a part of our inheritance. We are all entitled to a share.  We should have a collective responsibility to ensure everyone has the opportunity for the same standard of living as most other people.  The amount of payments should depend upon the population and the quantity of goods and services we are able to produce.  If this ratio goes up then the payments should go up and if this ratio goes down then the payments will have to go down.

I believe there are some serious problems with the way in which our economy creates money.  As an income scheme involves money this would be a good time to deal with that problem.

How do we stop people from smoking dope all day?

The simple answer to this question is that we do not. We do not need everyone to work all the time to maintain the agricultural surplus.    We no longer need a work ethic.

A basic income scheme would be a tremendous transfer of decision-making power to individuals (from governments and from bankers who create money via the fractional reserve banking system) and we have to allow people to make their own decisions and to take or benefit from the consequences.  The agricultural surplus should give us all the right to decide what to do with our time.

An income scheme would be communist.

This blogger dislikes the isms because they tend to be mostly meaningless.  As I understand communism it involves treating people humanely and government control of the economy.  It seems to appeal to people who wants to tell others how to live their lives.    I believe we should try to treat people humanely and I do not want others telling me how to live my life. As decision making power goes with money an income scheme would be a transfer of power to individuals.  It is difficult to think many communists would want that.

A guaranteed basic income scheme would help with a lot of social and economic problems but such major changes would go against a lot of vested interests.  Even people who would benefit the most are likely to fear the unknown.  Therefore concerns need to be taken seriously.

This blogger has just published an eBook Funny Money: Adapting to a Down Economy which discusses a lot of these issues. The price is only 99 cents.  I encourage you to have a look at it. Until April 19, 2016 you can get a free copy from Smashwords.  Use the link and code at the top of this weblog.

Some concerns about the Swiss money creation referendum

The Swiss are going to hold a referendum on a proposal to change the way in which money is created by transferring this function from private banks to the central bank.  The more I think about this the more I see it as an attack on banks by people who do not really understand what money is and how the financial system functions, or should I say by people whose understanding of money is different from mine.

I believe there are some serious problems with the current fractional reserve way of creating money and anything which might lead to reform is to be encouraged.  However, I would like to see some debate rather than letting those who would tell the rest of us how to live win by default.  I want to see a libertarian reform in which decision-making is by all individuals rather than a select few.

Here are two links to information about the referendum. One, two.

Money is a tool to facilitate the exchange of goods and services and is backed by the agricultural surplus of which we have a huge amount although its continuation is somewhat precarious.  The fractional reserve way of creating money gives great power to bankers who create money each time they make a loan.  The Swiss critics are right about that. Money represents purchasing power for people who hold it and those who create money can decide to whom they will transfer that purchasing power. Transferring the money creation function to the central banks would be transferring power from one small group to another. I am not certain bureaucrats would be any better at making decisions in the public interest than private bankers.

A more libertarian approach would be to combine monetary reform with a universal income scheme and to call money agricultural surplus credits.  This is explained in my just released ebook Funny Money: Adapting to a Down Economy.  The book also talks about the problems with fractional reserve banking. (You may get a free copy of this book from Smashwords until March 19, 2016. See previous post.)

In reforming the way in which we create money two other factors need to be considered.  The total amount of money available needs to be flexible up and down as the quantity of good and services exchanged varies. If it is not flexible we should expect inflation or deflation, both of which rob people of their savings.  The Swiss proposal says the central bank would use its statistics facilities to help in this.

The other concern is interest.  I believe the charging of interest on loans is a Ponzi scheme which leads to periodic financial crises.  This too is in the book. I did not see anything in the proposal to indicate how interest would be handled.  It could be the people who crafted the proposal do not see that interest is a problem in money creation.

I fear that not too many people truly understand how money works in the economy and how the fractional reserve way of creating money is a serious problem.  Reforms are needed although I can not see that transferring money creation from one small group to another small group will be a satisfactory reform.

Why we have financial crises

I believe the root cause of financial crises is in the fractional reserve system of creating money.  Therefore the way to avoid future crises is to change how we create money.

Dear Reader,  This post requires you to understand how money is created by the banks.  I’m feeling too lazy to write that up now so if you don’t already know I encourage you to figure it out.  Google “fractional reserve money”  or look at my essay “LETS go to market: Dealing with the financial crisis” or these other posts on this weblog.  It may appear complicated and overwhelming but if you think it out it should be easy to understand.  I think very few people understand this process which is unfortunate because we can not reform something people don’t understand.  There is a lot of emotion when dealing with money.

There are two aspects to the economy – the physical and the financial.  It’s a distinction which is easily forgotten because we measure the physical side in financial terms.    Both of these can cause economic crises and solutions probably require knowing where the problem originates.  A complication is that a physical problem can and usually does trigger a financial problem.  I believe our current economic problems are largely physical in that we have used up the most easily accessible energy and mineral resources.  There are lots of resources left but they are becoming more and more difficult to extract.

The big problem with fractional reserve money is that  interest is charged on the money created by the banks.  But the process does not create money to cover the interest.  So long as the economy and the money supply continues to grow there is no problem.  However, when growth ceases and the money supply contracts there just isn’t enough money in the economy to repay all the loans with interest.  It’s sort of like a Ponzi scheme.

Fractional reserve banking is about increasing the money supply but to the best of my knowledge not much thought has been given to when the process unfolds.  Just as money can be created out of thin air it can just as easily disappear into thin air.  This is a problem because money is essential in our economy for the exchange of goods and services.  Even a small reduction in our money supply can cause severe economic hardship because losses on bank loans come out of the reserves.  Thus losses are high powered money or leverage in reverse.  A run on the bank would also be a loss of reserves if the money is put under some mattresses.  If the money is transferred to another bank then there would be no loss of money supply to the economy although it would take some time for the adjustments to work through the system.

During the crisis of 2008 I figure the losses to the banks reduced the money supply forcing a slowdown in the physical side of the economy.  During the crisis people talked about a shortage of credit and the need for banks to start lending.  As our money supply is based on loans this is the same as saying we didn’t have enough money to facilitate the exchange of goods and services.

The U.S. officials dealing with the crisis were aware of the danger to the economy. They were also aware that a large part of the economy was sound and that the banks had to be saved so as to not have a complete collapse.  They were in a bind because saving the banks appeared to be saving people who did not deserve to be saved.  To have let the banks fail would have hurt all of us.  That is the power of the banks.  They are too important to fail.

The financial intermediation industry is focused on the double  R – risk and rewards.  The great  profits and bonuses of the industry are based on maximizing the rewards and passing the risk on to others.  As a general rule the higher the risks the greater the rewards.  In an ideal world the rewards would go to the people taking the risks but bankers have ways of grabbing the rewards while leaving the risks with the depositors.

The first thing they do is that their  marketing focuses on expected returns.  The risks involved are seldom mentioned so that customers don’t demand the rewards to go with the risk they are taking.  Governments try to protect savers with deposit insurance schemes although the real reason is to prevent runs on the bank.

The second trick is leverage.  If you did your homework you know that banks are required to keep a fraction of deposits on reserve for people who want to withdraw their deposits.  The smaller this reserve requirement the greater the leverage and the more money they can create and the larger the profits.  Regulated banks are told how much they must keep on reserve.  Unregulated financial institutions can get away with greater leverage – until things go wrong and they cannot repay their depositors.

The third profit-making stunt is to finance long-term loans with short-term deposits.  As short-term interest rates are generally lower than long-term interest rates this increases the spread/margin for the banks.  Some people claim this conversion of short-term deposits into long-term loans is a great accomplished of the financial system.  In fact it is a very dangerous practice and through the centuries many bankers have lost their businesses, if not their shirts. (But the profits were great while they lasted.) This is because when there is a crisis people will refuse to roll over their short-term deposits.  With no way to call in their loans the banks become bankrupt even though most of their outstanding loans are good.

If banks were to match the terms of their deposits with the terms of their loans their business would be financial intermediation rather than speculation and the risk would go to depositors  who are carrying the risk in any case.

I hope you can see from these notes that there are serious problems within the financial industry and the fractional reserve way of creating money.  Money is such an emotional issue and the interests of the financial industry are so strong that I believe it will be impossible to make reforms.  


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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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