November 2016 Brief: Volume 23, Number 32
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Can Rules Prevent Money Printing?
By Patrick Barron
Two Ways to Increase Money
Today’s fiat dollar is created by two methods. One, the central bank (the Fed) creates new money when it purchases an asset. This money is credited to someone’s bank account, a liability on some bank’s books, and is matched on the bank’s asset side by new reserves held at the Fed. Two, these new reserves can be pyramided by the banking system's fractional reserve rules into many multiples of new money. When the bank loans money, it creates a demand deposit on the liability side of its balance sheet, offset by the loan on the bank’s asset side. Historically, banks have been the biggest money manufacturers due to the leverage effect of fractional reserve rules.
The Moment of Money Creation
Notice that the banks’ ability to create new money depends upon the central bank’s power to create reserves. Therefore, we may consider that bank money creation is a secondary and dependent power, even though its impact on the money supply has been great. The moment of money creation is the central bank’s ability to print reserves. Even if the banks demurred in making new loans — which creates new money — the central bank can still increase the money supply by injecting reserves into the system. This power is no different than that recommended by the so-called “Greenbackers” who call for the Department of the Treasury to issue currency itself, as the Lincoln administration did during America’s Civil War. In fact, when the Fed buys an asset, it is acting exactly the same as a “greenback” issuer. The money with which it buys the asset was created out of thin air.
Keynesians Support Fiat Money Creation
An implicit justification for continued support of a central bank or a treasury that can print money is that money is different — i.e., it is not part of the market, like wheat and automobiles — and that special situations can arise in which money printing is warranted. It is a tenant of Keynesian orthodoxy that there must be a lender of last resort to stop a death spiral of deflation — i.e., falling prices. All those who desire that fiat money printing power be given to any agency, whether government treasury office or central bank, may be considered a Keynesian of some stripe, for they are convinced that there are special circumstances that require fiat money creation. They differ only in what they consider to be such special circumstances.
Even Fed Icons Printed Money
Many of us “old timers” revere Paul Volcker, Fed Chairman from 1979 to 1987, who refused to print money, thereby driving a stake through the heart of runaway inflation. Some even older “old timers,” such as David Stockman, revere William McChesney Martin, Fed Chairman from 1951 to 1970. But let me point out that neither of these courageous gentlemen kept complete control over reserves, the building blocks of fiat money. Both were subject to political pressure to inflate reserves. Martin was fortunate to serve during the presidency of Dwight Eisenhower, a fiscal conservative and inflation hawk. But when Ike left office in 1960, Martin succumbed to political pressure to inflate, first by President Kennedy and then most ominously by President Johnson. By the end of Martin’s long reign, the run on the Fed’s gold reserves had begun, and only one year later President Nixon threw in the towel and took the U.S. off what little was left of the gold standard.
The lesson that may be drawn is that no one is exempt from the pressure to print money. No human can withstand the political pressure to inflate reserves. Thus, the relatively small increase in reserves during the Martin and Volcker eras have morphed into outright helicopter money by subsequent Fed chairmen who were convinced that circumstances almost always require the creation of more reserves. I contend, furthermore, that no one can withstand the political and social pressure to print fiat reserves. Inflating the money supply is just a matter of degree.
Even the “Right” People Have No Need of Money Printing Power
Fortunately, there is no need for concern that no human can withstand the political pressure to inflate reserves. Austrian economic science explains that money is a product of the market. Markets are conceptual devices, a sort of shorthand to describe millions and perhaps billions of individual, discreet exchanges. Money is that commodity or commodities that are most marketable and, therefore, are chosen by the market as mediums of indirect exchange. There is no room and no need for anyone to control or direct markets of any kind, and this applies to money, too. Therefore, if there is no need for anyone to control money production, why tolerate an institution that promises to behave itself and honor rules? Even if we thought that the right people could be found to occupy positions of such power, why create the positions in the first place?
No Logical Justification for Unsound Money
The Austrian position that money printing is never warranted is an a priori, deductive conclusion that requires no evidence to be proven correct and that no evidence can prove to be incorrect. It is based upon the irrefutable axiom that “man acts.” Therefore, it is both illogical and a violation of justice to create an institution that is not subject to the normal commercial law of the market.
A complete abandonment of legal tender laws — i.e., laws that allow citizens to use only one money in a monopolized political zone — would allow the inverse of Gresham’s Law to prevail. Good money would drive out bad. Return money production to the market process, where money is that commodity or commodities which are most widely desired by the market as media of indirect exchange. There is no praxeological reason to grant any institution monopolized power to produce money; therefore, there is no reason to create an institution that can do so, and there is no reason to draw up rules that would prevent such an institution from doing so. This is a logical absurdity. The market itself and normal commercial law will ensure that the best money alternatives will prevail.
Patrick Barron is a consultant in the banking industry. He currently teaches Bank Management Simulation at the University of Wisconsin Madison and has taught Austrian Economics at the University of Iowa. He also contributes to the Ludwig Von Mises Institute.
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