There is a quote going around these here Internets:
I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.— Thomas Jefferson, Letter to the Secretary of the Treasury Albert Gallatin (1802), 3rd president of US (1743 – 1826)
Thing is, while Thomas Jefferson did recognize one thing -- that repeated inflation-deflation cycles are a recipe from stripping wealth from the common people (see my note on deflationary spirals below, and how they benefit the wealthy by allowing them to pick up the assets of the common people for cheap) -- he did not understand why they happened, or how. He thought that if he simply disallowed banks from issuing gold notes (bank-issued currency backed by the gold in their vaults), this would suffice to solve the problem.
Like most folks of his era, Thomas Jefferson had no understanding of economics. The then-extant theory of economics was that gold was wealth, and that the purpose of commerce was to amass gold. The prevalent economic theory was mercantilism, which held that the goal of national policy was to amass gold (wealth) in the nation's vaults by exporting a lot and importing little. This theory, BTW, was responsible for the Boston Tea Party -- the goal of British policy was to force their colonies to buy their tea from British India rather than from cheaper Dutch or French sources, in order to prevent British gold from leaving British hands, and the American colonies simply did not get the point.
n any event, Thomas Jefferson was right, but wrong. All private banks create money via the power of fractional reserve lending. Whether private banks issue gold notes or a government-controlled central bank issues gold notes or fiat currency is irrelevant to the fact that fractional reserve lending creates money. The only way to achieve Thomas Jefferson's goal of complete government control over the money supply is either complete government control over all money -- which is not possible, money is, fundamentally, anything which can be used as a medium of exchange, if I can give you 1,000 shares of Cisco stock in exchange for 100 acres of land, this makes Cisco stock money -- or government intervention to inflate or deflate the money supply as various measures show is necessary. Which BTW is why stock market crashes have effects beyond the stock market, but I diverge from my lecture.
The other way to do it is to ban fractional reserve lending. The Muslim world did this, which is why the Muslim world is a fetid backwater, because without bank lending, economic activity slows to the crawl of what is doable with current resources rather than what is doable with the resources created by loaned money. Thomas Jefferson never suggested this, as far as I know. Fractional reserve lending had simply proven too useful over the past 100 years prior to this statement by Jefferson, after it had been invented (or reinvented) by British goldsmiths to make use of the gold on deposit with them. Given that, and given the lack of understanding of then-extant economic theory as to what constituted wealth and money, Jefferson's task was doomed to failure.
So: a) Jefferson did recognize a valid issue (i.e., that repeated inflation-deflation cycles strip wealth from the people -- and we're entering in the deflation part of that, feel good now?), but b) his solution simply will not work even if you do nationalize banks. Money isn't pieces of green toilet paper with pictures of dead people on it. Money is anything that can be traded for anything else of value. Short of a complete totalitarian police state, complete government control of the creation of money simply cannot be done -- a fact that Jefferson, who thought money was gold, would have had no chance of understanding.
-- Badtux the Economics Penguin
And um... gee, I remember reading somewhere that you can't eat gold, right?
ReplyDelete:)
*Yawn* with the gold discussion. The Penguin seems to have shifted his position a bit. But I'm to tired to analyze it all now.
ReplyDeleteBesides, you can eat gold.
Hey Badtux, I was wondering if you would care to comment on a couple of things:
First, what are the additional consequences of a deflationary spiral in an economy that no longer has much manufacturing? Things may be getting cheaper here in dollar values, but if the dollar is tanking on the currency markets, imported stuff will be growing more expensive. Which means *labor* will be cheap but *stuff* will be expensive. Does that mean manufacturing returns to here, where the labor is cheap again? Does it mean China's economy collapses worse than our own?
Second, do any special complications arise because the US is now a net importer of food? If import prices rise, we're screwed, we can't grow our own food without oil and we won't be able to buy oil or food if the prices soar.
To a certain extent we've been exporting the inflationary spiral of the prior six years caused by inflating the backing basis of mortgage-backed securities to China. China has been selling us lots of cheap crap for printed money, then sinking that money into mortgage-backed securities and U.S. treasuries and other such "safe" investments. China pegs their yuan to the dollar, so when there is a trade surplus with the US (i.e. export more to US than gets back from them), China gets a lot of dollars and "drains" the freshly-printed dollars from the U.S. economy.
ReplyDeleteIn short, China is basically in the same position as the US circa 1929. The U.S. was the manufacturing plant for Europe in much the same way that China is a manufacturing plant for the US now. The US was running constant trade surpluses with Europe. The US had pegged their currency to the de-facto European currency (gold), so was draining off Europe's currency and causing deflation in Europe (since you can't print gold), which is what caused the problem in Germany with repaying their reparations to France and Britain that eventually led to the rise of Hitler. So China is hoping like hell that Helicopter Bernanke gets up there in his chopper and starts tossing out dollars willy nilly, because if it doesn't, China gets hurt *bad*. Not fatally bad because unlike the US in 1929 modern-day China is run by technocrats who have modern economic theory at their fingertips, but their plans to modernize their economy run up on a major shoal at that point.
So anyhow, you are correct, imported stuff gets more expensive if the US is no longer able to trade worthless paper for Chinese goods. Does that mean that manufacturing returns to the United States? Well, the answer to that is, "it depends". There are some parts of the U.S. industrial base that are simply *gone*, and cannot be rebuilt without decades of work. For example, there are only five shipyards in the United States capable of building anything larger than a yacht, and they're all military shipyards. The workforce is gone, the facilities are gone, the expertise is gone, we'd have to start from scratch and it would take a decade or more to rebuild the capability to build non-military ships. On the other hand, there are some things, like automobile manufacturing, that are already cheaper in the United States than in most other nations. The U.S. actually exports Toyotas to Japan. Imagine that. I would say that if the situation continues for an extended amount of time, yes it would encourage foreign manufacturers to set up plants in the US to make "stuff" currently made overseas. This, however, assumes that an isolationist faction does not come into power and slam down tariff barriers and set up a trade war similar to that caused by the Smoot-Hawley Tariff Act of 1930 that was supposed to increase U.S. manufacturing by shutting out foreign goods, but instead ended up killing U.S. manufacturing because if you're a net exporter of manufactured goods and suddenly your foreign markets are closed off by retaliatory tariffs... duh. You lose.
So anyhow. The basic problem with goods becoming expensive and labor becoming cheap is that, well, you're talking about a drastic reduction in the standard of living. As I've mentioned before, my grandmother and great-aunts and great-uncles all survived the Great Depression and I got to talk to them a lot before they died. It was a hard life.
Finally, regarding food: The US is now a net importer of food, but primarily because of cheap dollars. This has driven farmers of many specialty items out of business because foreign competitors can undersell them on the domestic market, e.g., catfish, crawfish, various vegetables. Also, the U.S. imports a lot of specialty foods not available in the US either because it's not the right season for them yet, or because they simply won't grow here. But the US does have the capability to produce all the food that it needs for survival. The grocery store shelves might look a bit bare or some things simply become too expensive for "regular" people to buy, and there's a lot more canned and frozen food and a lot less fresh food (because out-of-season food simply won't be available fresh, instead of being imported from Chile or etc.), but nobody has to go hungry. The big worry is what happens to the oil supply. Because right now we're woefully dependent on oil. And if oil gets so expensive that farmers can't get their crops in... then we see a societal collapse akin to that of Rome in the period 400AD to 600AD, when Rome went from a modern city with over a million people to 40,000 survivors huddled in the ruins, as famine caused by interruption of the food supply led to social disorder and the utter disintegration of Roman civilization in Western Europe.
Anyhow, lots of various thoughts in the above. I'll try to put them together into something a little more cohesive shortly.
Hi BadTux,
ReplyDeleteInteresting and vexatious reading, both you and Tom. After carefully reading Tom's quote, I looked up from my screen and wondered. Did Tom make any distinction between "restored to the people" and government takeover? Damn. Now I'm going to have to read his quote in its full context.
Dave
Well, I suppose there's two interpretations. Either Tom was saying that only gold coins were money and no other money should be printed (which as I've pointed out does not eliminate the problem of fractional reserve lending creating and destroying money), or Tom was saying this power should be reserved to We The People, i.e., the people's democratically elected government. It makes no sense to say that individual people can be allowed to print money at will, because said money would be worthless and even Tom knew that because of the experience of the Continental dollar.
ReplyDeleteMy basic point was to talk about the problem of fractional reserve lending creating and destroying money and thus the need for some countervailing power to create and destroy money as needed to offset this, and about how Tom saw the problem of inflation-deflation cycles but his solution -- take the power to print gold notes away from the banks -- would not solve that problem (regardless of who he gave the power to print gold notes to). The inflation-deflation cycles are inherent in fractional reserve banking unless there's someone else in the system printing money whenever the money supply starts dropping due to people saving up their money rather than borrowing money.
In short, the post was about why Thomas Jefferson did not understand the fundamental problem and thus is not a viable guide for dealing with today's economic problems.
- Badtux the Monetary Penguin