Posts Tagged ‘Economics’

(I apologize upfront for the grammar and typo issues that may exist; this needed to be released at the soonest without its usual polishing due to the situation on the Hill.  Please assist me in sending this far and wide with the spirit of urgency that this subject deserves.)

The war drums for the statist’s campaign continues to beat. This week’s battlefield: minimum wage hikes. The argument: “…tell [your Republican representative(s)] it’s time to give politics a rest for a while and do something to help working Americans.”[i] If we allow these feckless tyrants to have it their way, minimum wage would be indexed to inflation[ii] – at a minimum.

This plan sounds good if only first order consequences are considered – government forces companies to raise the limit on lowest wages, and those workers get paid more… period. It’s simple, elegant, and desirable but it’s also false[iii]. One can understand its appeal to childlike minds when exploring this fantasy with childlike forgiveness of inconvenient facts. If raising wages is the only effect, why not raise it? Is it the only effect over time though?

It’s easy to make arbitrary claims, which seem desirable. Not much more is required than a positive attitude. In addition, an estimable bonus goes to the proclaimer since their opponents are at an immediate disadvantage. Whether their opponents neglect to respond or address the issue, the statists have gained tempo.

If their opponents do not respond, the statists appear justified in claiming (to whoever will listen) that their opponents have no responds, which gives them a façade of being right. Uncritical constituents will be pressured to support the statist cause in the presence of the vacuum created by the nonexistent alternative.

If their opponents choose to respond, however, the opponent’s response would require more time and energy producing a lengthy – and if the statists are lucky, boring – response than what it took the statists to make your arbitrary claim (no thought, effort and hardly any time necessary exerted by the statists). This prevents their opponents from being on the offensive in advocating for their ideas, since they are now wasting time addressing mirages.

For the above reasons, I admit up front that I am at a disadvantage. At this point you and I have spent already 1600% more time/energy than the statists[iv] on this issue (and more to go), and I may have failed to make this paper interesting (hello? Are you still there? This is important to understand.). This disadvantage, however, is short-lived unless the statists pass a law before the truth has its day in the sun – this is precisely their Standard Operating Procedure.[v] Given time, the truth is impossible to conceal when readily available and when honest people like yourselves simply take appropriate steps to acquire it. As we will see, an honest attempt to ground the statists’ fantasy in reality shatters its chimera of good outcomes.

I intend to demonstrate that minimum wage is at best not beneficial, and at worse crippling. [vi] I will show: that minimum wage is a special case of general pricing, and therefore, falls under its economic laws; that minimum wage amounts to price fixing and that price fixing falls between the range of not beneficial and harmful.

To begin, I will assert that wage earners have customers. You might be asking who they might be. Perhaps this perspective is not yet sufficiently fashionable to gain popular support, but it is on all accounts accurate as best as I can judge – their customers are their employers.

Consider the general relationship between customers and businesses. Customers seek out desired services from businesses and exchange money for those services. Is this not what employers do when they post available jobs listings, interview candidates, and ultimately hire them? Also, businesses advertise their service(s) to attract customers and exchange services for money. Is this not what a resume, an interview, and accepting a job offer accomplish?

The many forms of employment share this essential relationship: the employee sells a service to their employer. The customer relationship between employee and employer, though a bit unusual in these terms, means that the price of the service in question falls under the province of the same economic law that determines the price of any service – supply and demand. This is evident in the fact that if the demand for a certain type of doctor is high, yet the supply is low, then their salary will be higher than other types of doctors[vii] – even though the duration of their education/training might be the same. Now consider low skilled minimum wage earners that have no chance to rise above that legal minimum. Might that have something to do with the oversupply of unemployed workers[viii] ready to jump into that job at the legal minimum? Wages, if left alone by the law makers, are controlled by supply and demand.

You might be wondering “what’s the big deal with setting a minimum wage” since wage minimums have existed for so long.[ix] Well, first and foremost, it is a form of price fixing and price fixing is harmful. Since wages are a type of pricing, then fixing it at the lower limit is fixing employee services at a lower price limit, is it not? The harmful results of price fixing is best understood by contrasting the complex chain of judgments, decisions and actions that ultimately determine the price of services within a free market, and the devastation that is created by short circuiting this process via price fixing.

Consider your favorite technological gadget for a moment, be it a computer, a smart phone, a movie-streaming device, or something else. What do you imagine went into its creation? How much effort and thought was necessary? How many trades occurred between the first purchases of raw materials (e.g., paying the workers to mine the metal used in your device) and the assembly of the item[x]; Or how many occurred between the purchase of raw materials and the fabrication the special tools necessary to assemble the item, before it was made available for your purchase?

Our economy is such a complex network of services and trade that I doubt any one person can possess all knowledge essential to the creation of such an intricate item, especially since that knowledge changes every minute of every day as the conditions of the market change. Suppose that a circuit company discontinues a component. Or suppose a new component is created that is cheaper (or costlier) and higher performing. Or suppose that any component changes within the chain of production for any production item. Wouldn’t that necessitate an adjustment down the line that reflects the change “upstream”? Many historical examples exist to show that it does, but for a present example, just watch the Wall Street ticker tape to see the “downstream” effect of “upstream” changes.

These constant changes are a life necessity. Life requires that the actions of a living organism produce more value (to life) than what is consumed during the process. Life requires profit. Any action that yields less value than what is consumed is a deadly process – over time only death (i.e., non-existence) with triumph. This principle applies from the simplest action to the most complex chains of interactions – no one part may operate at a loss (forever). The gives rise to a need to keep one’s ear to the ground and remain aware of changes that may affect profit.

It may seem overwhelming that so many lives rely on profit to be generated across the board throughout the economy. Not to worry though, no one person needs to perform the impossible and acquire all knowledge of the on goings. It is sufficient that at every stage, two living persons (at a minimum) are free to exchange money for services to mutual benefit, or walk. The potential for competitors prevents businesses from arbitrarily pricing services too high, and the potential for other customers prevent customers from arbitrarily setting prices too low. One simply needs, for any particular transaction, to be aware of their options (which always include no transaction).

If the price of a service would consistently cause one party on either end of the transaction to function at a loss, then the nature of existence does not permit the price to remain this way long term – either the service eventually stops or customers eventually disappear. Each member of a transaction is charged (by the nature of their being requiring profit) to protect themselves and at the same time to meet the other’s interest (by the nature of the other’s being requiring profit).

With this understanding of the complex chain of judgments and decisions that go into transactions, with each member performing a service for profit, one can appreciate the precariousness introduced when non-interested parties establishes laws not subject to (and contrary to) the laws of economics (and nature). The result is a short-circuiting of the living judgments, decisions and actions that existed prior to such a decree. Regardless of the reality of the situation, price fixing established by law ignores all living considerations related to what that price should be.[xi] The price is set even if it is contrary to the needs of life – i.e., contrary to profit.

The consequence of this short circuit depends on where the arbitrary price falls in relation to the price established by supply and demand – i.e., where it is in reference to the market price. If the arbitrary price of any service is lower than the market price, the service tends to disappear. If the arbitrary price is higher than the market price, the customer tend to thin out. If the arbitrary price is equivalent to the market price, there is no harm (for now), but there is also no benefit.

If people less likely to perform a service in producing an item due to price fixing too low, the observable effect is empty shelves within a store.[xii] Does this not make sense as the only logical outcome to low prices? It means someone (or some group) in the chain of production would have to function at a loss. Picture the extreme – forced to give away a service – to grasp that anywhere on this continuum tends toward empty shelves. It is difficult to say exactly who will bear the burden of this loss, but the burden will likely rest with the most desperate and/or unaware party. It is fairly easy, however, to determine who would benefit from paying less for an item – the customer. This combination between some party absorbing a loss and another receiving a greater value causes these items to be scarce.

If the number of customers diminishes due to price fixing too high, the observable effect would be fuller shelves within a store.10 Does this not make sense? The combination of benefiting and cost absorbing is different from price fixing too low, so the result is different. The customers avoid paying more than they would have otherwise and tend to buy other items, while businesses prefer to receive a higher than market value for their item, so they stock their shelves with items that customers are less willing to buy.

If the arbitrary price is somehow just right, the result will not differ from the results of market prices. The items on the shelves will be sufficient for regular commerce with no party assuming an undue loss or unnatural benefit. The result will be good, but not better than letting the market set the price. Since current market conditions are constantly a fleeting moment, price fixing has a major drawback. A stationary arbitrary price, which is correct today, will be wrong tomorrow (or eventually) due to the changes in market conditions, resulting in one of the above undesirable outcomes. The market reacts faster than law makers.

Minimum wage is slightly different in effect than ordinary price fixing, in the sense that it applies a fixed price within a limit and not the whole range.[xiii] In this sense, the minimum could be set to zero and essentially there would not be any fixed prices. If the minimum wage was too low, therefore, we would expect that the market would dictate the price of services that fall between that minimum and the maximum.[xiv] The only harm minimum wage could do, would be to be set higher than the lowest paid worker, which would cause those low skilled workers to tend remain on the “shelves,” which is essentially what we have today, is it not?

When statists determine the minimum wage, they are essentially claiming to know better than the millions of people that judge, decide and act in a free market. We see that this is a form of price fixing, and we see that price fixing can only be harmful in the long run and only not beneficial in the short run. Why maintain a minimum wage? Why not abolish it, and any other form of price fixing statists choose to establish? How much more harm are we each willing to take and remain blind to? Isn’t time past due for us to break their drum sticks and send them home?

—————————–

[i] President Barak Hussein Obama, Quoted in Monday April 28, 2014 WSJ article, Wage Boost Seen as Wedge Issue in November

[ii] Plan expected to be voted on in the Senate Wednesday April 30, 2014, set up by Senate Majority Leader Harry Reid (D., Nev)

[iii] Fallacy of context dropping

[iv] We are at sentence 16 and Statists use one sentence to say “raising minimum wage puts more money in American’s pockets”

[v] Remember Obamacare (AKA Unaffordable Care Act)

 

[vii] Assuming a law doesn’t exist barring the free exchange in this regard

[viii] The Congressional Budget Office (CBO) projects that the unemployment rate will remain above 8 percent until 2014 (cbo.gov). Estimating 230.4 million working age Americans (census.gov) in 2010, that makes 18.4 million competitors throughout the US.

[ix] “…a long habit of not thinking a thing wrong, gives it a superficial appearance of being right…” – Thomas Paine

[x] To include hiring employees throughout the production chain, the agreements between subcontractors to perform special tasks, and everything in-between

[xi] Refer back to the number of judgments and decisions going into the production of an item, and at every stage, the life of the members are taken into account (so the life of all its members are taken into account), so just imagine what would happen if one member acted towards loss and death

[xii] https://www.youtube.com/watch?v=jWTGsUyv8IE, Observe the comparison on how some shelves are empty while others have a castle of boxes in stock

[xiii] Not considering progressive taxes for a mement

[xiv] All else being equal, but the effects are known to propagate and not to anyone’s benefit – as the cost of the simplest services rise with the minimum wage, so does the cost of the simplest items, which just changed the condition of the market and affects every “downstream” service

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The Statists (on both sides of the aisle) have unintentionally awakened a sleeping Hero.  For quite some time, this dormant Hero has misidentified Statists as the caretakers of society (self proclaimed of course).  Statists, after all, claim to be the providers of jobs, health insurance, and general prosperity.  But Statists have recently allowed their proper identification to once again be exposed and discovered by part of the population that was formerly in the deep slumber of their busy, productive lives.

This sect of the population has become aware of an essential fact pertaining to any Statists’ “good” deeds: their deeds, good or otherwise, cannot be accomplished without yoking productive Americans — i.e., without yoking themselves.  For what products can statists redistribute if productive Americans do not produce them?  Yet even in the face of this question Statists are keeping to their mode of existence: throttling the goose to continue to lay golden eggs so they can dolled them out in exchange for gratitude, which may translate into votes come the next election cycle.

While productive Americans, these Heroes, are becoming aware of the game they are involved in, they simply wish to act to secure their right to life, liberty, and property, and live their precious lives.  Statists reject such notions as the existence of any rights (except for those they grant or allow) and proceed to violate them in order to carry out their “good” deeds, and proceed to assume all of the credit.

Let’s give credit where credit is due.  Deed after deed has required more effort from productive Americans in the form of taxes (or debt to eventually be paid for later by taxes) — good job Statists, that credit is rightfully yours.  Way to fleece productive Americans and redistribute it (inefficiently I might add).  The source of the wealth you are dolling out, however, comes from productive Americans and they are becoming tired of their role.

What we have here is a clash of worldviews.  While Statists need to resort to force in order to carry out their political vision, productive Americans simply need to refuse to be their victims to carry our their vision.

The foundation of the Statists worldview depends on it being an injustice for the needs of the needy to go unsatisfied.  They insist and continue to remind us that someone has to fill that void.  It has to be either those who cannot carry anyone’s extra weight let alone their own (the needy) or those who can (the productive).

The Statists’ vision is clear: it is analogous to an expansive world that we are all born into and it is completely flooded.  This world is populated with those who swim and those who drown without help — i.e., producers and moochers/looters.  Their solution to what they see is to chain everyone together in the attempt to force the swimmers to keep everyone else afloat.  (The flood represents obstacles to the existence of life and swimming representing the actions necessary to overcome them).  An observant man would rarely fail to notice that those, who are struggling to barely tread water, would be dragged under by the chains connected to less able.  They then put more pressure on the next ablest who is now dragged under by even more weight from the same chains, who then puts more pressure on the next ablest and so on to the end of the chain.  Anyone with sense realizes that if all are chained, all will drown — the necessary result of egalitarianism.

The foundation of the productive Americans’ world view is that their life is precious to them and the needs of some (or many) does not justify the chains they are forced to bear — those chains are the injustice not the needs of the needy.

Productive Americans have a similar vision and it may also be described as analogous to a flooded expanse populated with those who swim and those who drown without help, except they have a different solution: allow them to be free and productive for the sake of their own lives.  The flood is not their fault; it is the default and nature of life.

Who is right?  Statists offer chain gangs on a course certain to lead towards destruction.  What is it that productive Americans offer?   Not much; only voluntary trade of services to mutual benefit.  This process, however, allows productive Americans to continue to innovate and compete to bring the best products at the best prices to the market place, and consequently continuously raise everyone’s standard of living in the process.  Raising the standard of living reduces the obstacles to life.  This in a sense will allow those who were barely drowning in our previous analogy to now be able to tread water, does it not?  If this process continues, over time more people, who would have drowned otherwise, will be able to tread water.

So, in either case, need, will always exist — that obstacle to life is always present.  However, in the first case you have mutual and equal demise as that obstacle becomes increasingly overbearing even for the ablest, and in the other you have progress that continues to raise everyone up and over that obstacle over time.  You be the judge for which sounds better for your own existence.

Productive Americans’ are beginning to realize their solution to life’s obstacle requires the security of individual rights first and foremost regardless of need.  The moralists within the Statists’ ranks attempt to keep them in check by reminding productive Americans that they should love their fellow man and should be thy brother’s keeper.  The proper response to these moralists is to ask, “What respect or love can men have for one another when their lives are chained and meeting one man’s need necessarily means another must suffer?  How can they not come to hate one another in this environment? Indeed, doesn’t this environment necessarily breed hatred?”

What Statists conveniently overlook time and again is that the cognizance of the need of others has not and will never disappear; it simply must take a back seat to securing individual rights in every corner of the political arena.  What they have not failed to overlooked, however, is that the act of asserting individual rights in this arena threatens their mode of existence and succeeding to secure them will unravel their whole rotten racket of rusted chains; and that is a large source of their fear.  That is the motivation for some of them to continue to rationalize their continued actions.

Of course Statists are not this honest with us, or even necessarily with themselves about the nature of their fears and their mode of existence.  Observe that when one’s mode of existence relies on productive Americans acting against their self-interest, or on them passively accepting others who act to throttle them, deceit becomes an important ally while clarity and transparency become a liability.  Statists don’t necessarily want their victims to become aware of what’s going on.

If you get a chance, ask them, “What right does the needy give you to throttle my life”?  Then observe the sorts of contorted pretzels they twist themselves into to evade this crucial connection: their methods require you to wear chains.

Well, productive Americans are now getting wise to the Statists’ ways and are becoming less interested in the “goods” they’re peddling — their inner Hero has awaken.  A group of people, and productive American’s especially, can only be duped for so long by the same warn out gimmick.

Statists, your game is up!  The era of Heroes, who act to secure their rights, has returned!

(Note from author: I have recently been convinced that fractional-reserve banking, though it’s a bad idea, should not be outlawed.  The government should not outlaw bad ideas unless fraud or another for a violating rights is involved.)

 

In order to understand the Federal Reserve (FED), you need to understand credit expansion and the banking systems, which is full reserve and fractional reserve banking.  In order to understand the banking systems, you need to understand the nature of wealth and money, and their differences.

Money does not equate to wealth, or put slightly differently, money is not wealth .  If money was wealth, then why does printing money not increase the total amount of wealth in our society?  Sure, money can be traded for items that satisfy our needs or wants of utility, but as is, the paper is not useful — it’s only potentially useful.  What money represents — e.g., things that satisfy our needs and wants of utility — is useful, which is money’s source of value.

Money is simply a tool of exchange and a means of saving — i.e., the postponement of consumption.   Wealth is the goods you have at your disposal, which will satisfy your needs or wants of utility — i.e., wealth is your standard of living.  The wealthier you are the more you have at your disposal.

The implications behind the meaning of money — as a tool of exchange and a means of saving — are that to possess money you must have produced something of value and passed on your disposal of it to someone else in exchange for an IOU on society — the trade isn’t complete until you trade that IOU for something you need or want.  In essence, you’re bartering and exchanging what you produced for something you haven’t produced — money is simply the median or the “middle-man.”  Money has value but it doesn’t represent a static standard of wealth.

Think of the errors that one might conclude if one equates wealth to money consistently to that end:

1.  Wealth can be produced by reproducing money

2.  Wealth is only as static as the amount of money that exists, which leads some to assume wealth is static

3.  Since wealth is static, then it’s only fair to redistribute it evenly (a common argument)

4.  Profit is exploitation and wealthy people must have exploited the poor (another common argument)

5.  The exchange of money means one benefits at another’s expense

6.  Exporting is good because it brings in money, and therefore, wealth (another common argument)

7.  Importing is bad because it sends money out, and therefore, it drains our wealth (another common argument)

8.  Money just sitting on a table does not multiply; therefore, lending money cannot multiply wealth; therefore, lending money at interest is charging for something money has no ability to produce — more money; therefore, money should be lent at no interest, otherwise it’s exploitation (not an uncommon argument)

People in our society also tend to equate the dollar value of an item as its worth — another error.  Let’s say an item produced was originally $8 per unit.  Now let’s say that half of the items were destroyed — the unit may now be closer to $16.  Instead, let’s say that the money supply reduces by half — the item may now be closer to $4.  In the first case the item’s value relative to demand went up, and in the second case the value stayed the same relative to demand, but the price went down — the value of money fluctuated.  (We are assuming of course that the effects of inflation were instantaneous).

There are many reasons for the value of money to fluctuate.  For example, we could create more money, it can be destroyed, people’s interest in it could change, more things are produced, fewer things are produced, and probably more variables have a play (like foreign currency) than what I have listed.  (A speculator’s sole purpose is to predict these fluctuations and act on those predictions).  People’s desire is hard to predict, which means desire would be hard to predict for any kind of currency whatever; therefore, let’s limit the scope of our study to the aspects that cause fluctuations that can be predicted — like production and the creation of money.

Let’s first analyze what different effects that fluctuating currencies has on wealth.  Gold is a great place to begin our study because, compared to fiat money, gold has a relatively static quantity.  We’ll then shift our focus to fiat money because it contains a lot of the same principles as gold, but in addition to those, fiat money can rapidly multiply.

Given our study, the only real means for gold’s value to fluctuate is a change in the production of goods.  If production increases, then deflation takes hold, which means the value of gold goes up (relative to goods) because you can buy more with the same amount of gold.  If goods and production are destroyed, then inflation takes hold, which means the value of gold goes down (relative to goods) because you are able to buy less than before.

What happens to the treatment of gold as its value decreases? People tend to exchange more of it for goods because a certain amount of gold does not go as far as it used to; therefore, people pay more to receive the same about of goods.  The less gold is worth, the more people prefer goods over gold.  One can anticipate a threshold for the use of money — i.e., men in society have to reach a certain level of production, which isn’t much, to warrant the use of money over barter.

Who are the winners and losers if the devaluation of gold occurs?  The wealth in savings decreases along with gold — savers lose.  The total amount of goods decreases, and therefore, so does the standard of living  — everyone loses.  Because the standard of living decreases, people are less able to store their money in banks — the banks lose.  Does anyone win in this case?  I don’t think so; I can’t think of anyone who benefits.  Maybe those who take out loans benefit by paying back the loan with less valuable money than they borrowed, but that’s isolating a particular situation of the borrowers whole life; his standard of living will decrease with everyone else’s.  Even if someone ends up better off than before, they would be even better off if devaluation did not occur.

What happens to the treatment of gold as its value increases?  People tend to exchange less of it for goods because a certain amount of gold goes farther than it used to; therefore, people can buy the same things with less gold leaving them with change in their pocket.  The more gold is worth, the more people prefer gold over goods.

Who are the winners and losers if the value of gold increases?  The wealth in savings increases along with gold — savers win.  The total amount of goods increases, and therefore, so does the standard of living — everyone wins.   People are able to save more money and borrowers pay back loans with more valuable money — the banks win.  (Sure, borrowers need to work harder to pay back the loan, but that’s no different than paying interest).  Some people will lose, but only on their own efforts and risk to capital.

To sum up, a gold currency will tend to guide self-interest people towards production and savings making everyone a winner.

Shifting our attention towards fiat money; it has all the fluctuations of gold (as mentioned above) except in addition to those fluctuations, its value can fluctuate easily by reproducing or destroying it.  Since the destroyer of fiat money is the sole loser, however, we can assume no one is that self destructive; therefore, we can limit our focus solely on situations covering the production of fiat currency.  In order to isolate the effects of printing money, we need to consider a scenario with static production, meaning the same products are produced every year.

To begin, as one spends freshly printed money, he removes from society the product of their labor without reciprocating.  This causes more money to exist than what goods have been produced; therefore, the more money you print and spend, the lower its value will become due to inflation.

Inflation is not instantaneous because it takes awhile for its effects to propagate.  The information only propagates as the money exchanges hands.  For example, one can print a pile of money in their basement, but until they spend it the effects will be contained in his basement. Why is this?  Because the printer of money hasn’t made a claim on society by spending that money; it’s not until he removes goods from society without producing goods that society finally begins to realizes there are less goods than before (relative to money).  T he first recipient of freshly printed money may not know the money he’s receiving is printed, but after several exchanges people will adjust their prices when more demand for goods (relative to money) increases.  On the other side of the exchange, the first user of freshly printed money extracts its full value before inflation, but as the exchanges continue, the value extracted decreases as inflation increases.

Who are the winners and losers when money is printed?  The printer of money obviously benefits by being able to consume goods without producing them; however, this causes a strain on everyone who does produce equal to or more than they consume because the printer of money consumes what they have produced — everyone else loses.  The individuals who save money lose wealth in their savings as the value of their money is redistributed into the new total of money — they lose.   Those who take out loans benefit more than savers in the short run because the money they use to pay off the loan is worth less than the money they borrowed; however, in the long run their standard of living decreases with everyone else’s.   There is a point where the standard of living suffers so much that one is unable to pay off a loan and buy sustenance — i.e., their life is no longer self-sustaining. These borrowers go bankrupt, thus consuming the goods of society (spending the loaned money) without producing (not paying off the loan) — they join a similar status as printers on money.  So those who benefit the most are the printers of money and the borrowers of money  (for the short term) — neither of which produced anything for the privilege of spending money– while everyone else suffers.

We now know the different causes of fluctuations in the value of money that can be controlled, which means we discovered enough context to continue onto the banking process; and after that, the Federal Reserve.

Given a static value for currency, let’s see what purposes or value a bank provides.  If men had the ability to keep all their money on their person, then the necessity of banks goes down.  If men could secure their money better than banks, then the value in using a bank goes down.  Since men have trouble keeping all of their money on them securely, banks have value.  This is why men uses banks; for security and ease of use.

The first banks that were used kept money in a vault, and they never lent any of that money out; that type of system is called full reserve banking where 100% of the deposits are kept in their reserves (AKA their vault).  Banks were able to stay in business because they earned money for securing its members’ money — people would pay the banks to secure their money.  The banks would also lend out money that they owned at interest.  At times, they even acted as middlemen between one of their depositors and a borrower and earned some sort of commission on that money.  Full reserve banking does not cause the value of money to fluctuate because it doesn’t reproduce money nor does banking in and of itself produce enough goods to change the value of money — it just secures the principle of property rights ensuring property owners keep their property.

A second system of banking is called fractional reserve banking, and, as the name sounds, the bank is able keep less than 100% of their deposits in reserve, which means the banks can lend out depositors’ money at interest without their knowledge.  The depositors no longer have to pay banks to secure their money because the cost is paid by the interest earned on the lent money; in fact the bank earns so much money that they pay the members for storing their money in their bank.  This banking system causes the value of money to fluctuate, so this warrants further analysis.

The essential difference between the two systems that causes the value of money to fluctuate under fractional reserve banking, but not under full reserve banking, is that for full reserve banking the lender losses access to their money when a loan is created.  For fractional reserve banking, however, loans are made without any lender losing access to their money .  It is important to understand this difference and its full implication because without doing so would mean increasing your risk of making bad evaluations in your conclusions based on this information — like people often do after they equate money to wealth.  First let’s further understand the difference before we get into its implications.

For full reserve banking, when a loan is made the lender sees the money leave his account along with a place holder (or an IOU) for that money; the person taking out the loan has the money along with a negative place holder.  Each place holder and money, or lack of money, counter balances each other — i.e., money with a negative place holder, and lack of money with a place holder cancel each other out.

For fractional reserve banking, however, the bank sees the lack of money along with a place holder, while the person borrowing the money sees the money along with a negative place holder — seems equivalent to full reserve, doesn’t it?  Well, not quite.  Where does the bank get the money to lend?  Is that their money?  It can be, but more than likely that money comes from a depositor.  (It doesn’t matter if the bank uses $100 from one depositor or 10,000 pennies from 10,000 depositors — the essentials are the same regardless of the break down).  What place holders or money transfers do the depositors see?  The answer is none — they see 100% of their money in their account.  Is this a problem?  You bet it is — it’s the root contradiction which causes secondary and tertiary effects down the road.

A contradiction follows the formula of something that is and is not at the same time in the same respect.  Well in the fractional reserve bank’s example, the depositor’s money is his (as displayed in his account) and is not his (as displayed in someone else’s account) at the same time (from the initiation of the loan until it’s paid off) in the same respect (as seen in an account) — the very definition of a contradiction.  It is inessential that the banks have not named one depositor they’re taking from when they take from the pool of money in their vault  — that money came from somewhere and doesn’t eliminate the contradiction.  It is inessential that the lender puts collateral up against the loan to counteract the risk of default — it doesn’t eliminate the contradiction.

The contradiction is the single piece of essential information because contradictions cannot exist and every attempt to bring a contradiction into existence has resulted in some sort of annihilation.  For example, think of the results of carrying out polices based on equating money to wealth — e.g., you seek to print more money, you wage war to confiscate money, you eliminate trade as people attempt to sell their products and boycott yours and vice versa, etc.  It eventually results in the annihilation of whatever value you were trying to create — i.e., money and societies lose their value.  In the case of fractional reserve banking, as we will discover, the results are the same — i.e., the retardation of wealth at best and destruction of wealth at worst.

(This particular contradiction within fractional reserve banking is also a violation of property rights, where property is necessarily singular ownership — i.e., one thing one owner.  For fractional reserve banking, multiple owners exist for a single thing — i.e., depositors and borrowers own the same dollar.  Of all the economic reasons I’ll go over in explaining the perils of fractional reserve banking, it is the argument for securing property rights that should be sufficient to a free society, that has any interest in remaining free, in ceasing the act on moral grounds and making it illegal).

In full reserve banking, the amount of claims (potential claims) on society are never greater than (and are actually equal to) the amount produced — i.e., the producer lends his claim on society in exchange for interest, which is paid by the borrower.  In fractional reserve banking, however, you have greater claims on society than what has been produced because you have producers who do not lend their claim on society, and you still have borrowers who acquire a claim; this creates a lag effect, where claims on society increases faster than what is produced.  Where did the increase in claims come from?

So how did the banks succeed in creating a contradiction if they cannot exist?  How is it that the depositor’s money is and is not his at the same time in the same respect?  I’ll I’ve you a hint, a contradiction cannot exist.  When you think you’re facing a contradiction, check your premises; you’ll find that one of them is wrong.

Our essential premises are that the depositor still has access to his money and that the money supply did not multiply.  We know that bank runs can occur, which leads one to suspect the former.  We also know that the depositor can use his money (under normal conditions), which leads me to suspect the later.  The truth is that both premises are false under different contexts, and both are never true at the same time.  The double contradiction only serves to further conceal the contradiction — it allows most to accept the lie that both premises are true, which is only half of the truth when in fact both are never true at the same time.  The reason that two contradictions seem to exist is because the respects (remember “…in the same respect”) change subtly making it hard to track.  In one respect, the money is owned on paper, and in another respect the money is owned physically.  On paper the money supply multiplies and physically it does not .  So when the money is owned in one respect, let’s say physically, then the money supply premise is true, while all depositors having access to their money is false.  If money is owned in the other respect — on paper — then all depositors having access is true, while the non expansion of the money supply is false.  (I suggest rereading the arguments surrounding the different respects of ownership until it sinks in).

A fair number of people see that both premises are false under different conditions, but fail to understand the implications or severity in accepting the contradiction.  They obviously understand from history that bank runs are bad, but think they can be avoided and see no negative repercussions for expanding the money supply.  We understand, from our discussions of inflation, why expanding the money supply is bad.

Who are the winners and losers under fractional reserve banking?  Savers find that the money they saved loses value over time more than the interest they earn on that money — they lose.  More consumers than producers exist at any one time   — everyone loses as the standard of living suffers.  Bankers are able to earn a ton of money from interest on money they didn’t own — they win, but only for the short term because their standard of living suffers more than it would have if the money supply didn’t expand.  (It’s would be difficult for bankers to understand this because they can potentially make 45 cents on the physical dollar every year).  The borrowers win in the short run by paying off the loan with less valuable money, but like the bankers, their standard of living suffers in the long run for the same reasons as bankers.  There is a point where the standard of living suffers so much that one is unable to buy sustenance and pay off their loan — their life is no longer self-sustaining.  Unlike full reserve banking, however, where the lender would lose his money along with the person he lent money to, no depositor “loses” theirs under fractional reserve banking.

A limit exists for how much banks can lend out, under fractional reserve banking, and still function.  If they keep 100% in reserves, then it’s no longer fractional reserve.  If they lend out all of their reserves, then they default on any withdrawals, which results in a bank run.  What number, between 0% and 100%, allows a bank to function and allows depositors to have access?  It really depends on how much people need money.  The ability for people to save increases as the standard of living increases; and vice versa as the standard of living decreases.  In addition, when people borrow money, they use unconsumed goods — i.e., what would become savings — to pay off the principle and the interest.   There is a point, therefore, like there is in the use of money, where the standard of living needs to reach a certain point before fractional reserve banking can exist because people need to save money in order for fractional reserve banking to function and people need to earn enough to save.

Let’s assume that we reached the limit of credit expansion, what happens when we reduce the amount of credit by paying off loans?  Deflation occurs.  Is this a good thing?  We discussed earlier that deflation is good, but in this case, it is good only under a certain context.  The savers benefit because the value of their money increases — they win.  The standard of living increases as more goods are consumed when people start to pay off loans — everyone wins.  The borrowers suffer because they need to pay back the loans with more valuable money than they borrowed — they lose, but they would pay interest anyway.

Deflation is bad under fractional reserve banking, however, if it occurs rapidly.  For example, the faster deflation occurs the harder it will be for borrowers to pay off the loan and buy sustenance, which increases their likelihood of bankruptcy.  Borrowers lose the ability to pay off the loan because they now need to work several times harder (up to 10 times) to pay off loans — they lose.  The more borrowers that go bankrupt, the less money the banks will have to pay depositors their interest.  The less the banks have to pay depositors, then the more likely they will go bankrupt — they lose.  If a bank manages to avoid bankruptcy, they will still be unable to return to full reserve banking; that equates to lost value.  The bigger the gap between what the banks have in reserves and what the depositors have in their accounts, then the more value is lost — savers lose.  The more value that is lost, then the more the standard of living suffers — everyone loses — e.g., the market crash of 1929.  The trend of fractional reserve banking is to resist returning to full reserve for that exact reason — everyone loses.

So at the limit of fractional reserve banking — meaning the reserves are at their lowest and the expansion of the money supply is impossible — is it better than full reserve banking?  Under full reserve banking production matches or surpasses claims to consume, the standard of living matches advances in production, and property rights are protected.  Under fractional reserve banking at its limit, production lags behind claims to consume (remember there are more claims to consume than what people produce due the fractional reserve banking contradiction), the standard of living matches advances in production, and property rights are violated.  All being equal, if my evaluation is correct, a full reserve banking society would improve their standard of living at a similar rate to that of a fractional reserve banking society; however, there would be a period of time, for the fractional reserve banking society, when the standard of living would lag behind until the limit of expanding money is reached.  The icing on the cake (sarcasm), however, is that everyone’s property in banks are constantly at risk because they are relying on others not to make a physical claim on their money.  As our standard of living continues to drop, how much longer to you suppose people can live without making that physical claim?

We talked about the nature of money, the ways in which it can fluctuate, different systems of banking, and the implications of each; now we have a great base of knowledge to discuss the FED.  Every fact you read about the FED is true, but not the evaluations.  For example, they do control the money supply by setting the interest rate for loans, but that is not in the long term interest of anyone, and only serves the short term interests of very few people.  They don’t print money and loan it out, they simply loan money in the form of electrons, and fill their reserves with printed money that the US Treasury Department printed — essentially the same thing as loaning printed money.  They actively strive to cause inflation, between 3% and 5% every year, which continually increases the limit   of fractional reserve banking; thus, avoiding the system’s natural limit.  The FED is able to loan money even if there are no depositors to back it up.  Depositors become an old fashioned notion when the production of every dollar carrying person is backing up the freshly printed bills.  This leads us to our next question: is fractional reserve banking better than full reserve banking if the natural limit placed on fractional reserve banking is removed?  The question reduces to, is steady inflation better than steady deflation?  You have the information; you be the judge.  I suggest starting with the lagging of production behind consumption that we discussed in fractional reserve banking, which would necessarily continue and become greater.  Is that good?  Do you think there is a possibility where the increases in claims to consume would surpass the advances in production?  And finally, do you benefit?

The FED is convinced that their actions are in the best interest of the country, and therefore, in your best interest — that is their evaluation.  What is yours?

In response to The above video advocating consumerism, specifically as it applies to job creation:

I will begin by saying that propagating false principles and ideas that cater to the fashions of the time is easy in that it can be brief; it takes length to root out the error(s) by catering to people’s reason.  The initial advantage goes to the fashionable, but in the end reason is what “sticks” if people are willing to make the effort to discover what is true and why.

Life is a process of self-generating and self-sustaining actions — look at anything that is alive today and you will see this to be a true principle.  This action translates into human action as production — the self-generated action of man to the production of goods that he requires for sustaining his life.  It is self-sustaining if he produces more than what it costs to produce — i.e., his actions are profitable.

If left alone, man must produce for himself, but once he has a neighbor there can be a division of labor and trade — there “CAN be”, meaning it’s an option.  Both traders can now neglect a certain action that they will trade for; they can now focus on producing more of what they will use to exchange for what the other will make.  This is the formation of the most basic job — of neglecting one thing and creating more of another, in order to exchange at a net gain (or profit) than otherwise would be possible.  Both traders increase their activities in one area — creating the option of a certain action in exchange for wages.  This principle applies throughout a free economy: division of labor and production reorganizes as a trade to the profit of all.

It is true that demand creates an incentive for production, and demand creates an incentive for creating jobs to support production, but without rich entrepreneurs and the super rich, most of those demands would go unfulfilled.  Neither a sea of tears nor an army of guns will create any value that is demanded.

When the rich are starting a business, he creates the option of work that wouldn’t otherwise exist in exchange for wages; and he creates an option to buy a product that wouldn’t otherwise exist in exchange for payment.  It is also true that without others to make use those options, then those options would go unfilled or unbought.  It is safely assumed that people choose, to the best of their ability, the best options for themselves; and if they take a job or buy a product, then it is the best option for them according to them.

If entrepreneurs lack the capital to start a company, they CAN look to others who have capital (the super rich) and create an exchange to the profit of both.  The super rich lending their money is providing a service.  They worked or their relative worked and saved — i.e., withheld their consumption — to acquire that capital.  They earned it, and that is their property by right.

Where entrepreneurs and the super rich get the credit for creation is creating the production and job opportunities that would otherwise not exist, and on top of that they do it in a fashion that is consistent with life — in a self-generating and self-sustaining fashion — i.e., at a profit.  Consumers filling the created job opportunity or consuming the resulting production is not and can never be a function of creation; it can only be the consumption of something that has been created.

It is also said that people create the value that is demanded by demanding that value — demand creates value.  True, things are of value because of demand; however, assuming that individuals want to live, then there will always be demand and a need to produce — the nature of reality and life requires this.

To give credit to people for creating demand where the nature of reality and life is responsible is worse than a contradiction; it’s an evasion of reality.  It amounts to saying that consumers created demand where it would otherwise not exist, and they alone hold power over demand and can turn their demand on or off, instead of realizing that the nature of reality and life is the true source of demand.  The former leads to the fallacy of consumerism and the primacy of consumers, and the later leads to a correct framework for analyzing economics and the primacy of reality.  

Prove me wrong consumers by stop demanding, and with your ceasing of demand goes your ceasing of consumption — do it, stop consuming if you can!  Alas!  A false principle never fails to betray itself.

With a false principle, sprouts false and destructive ideas — like the video suggests.  If consumerism is assumed to be a correct framework, then I agree with the video that it logically leads to taxing the rich and giving it to the middle class and those who consume.  They would be the true source of the value given to production after all.

What would taking from the rich and “investing” in consumers do (analyzing it through a correct framework)?  It violates our first principle that life is a process self-generating and self-sustaining action.  Taxing the rich is a forced acquiring of their profit (remember that profit is the result of their self-generating and self-sustaining action), and giving it to consumers will simply allow consumers to consume in exchange for that money.  The result is the feeding off of self-sustaining and self-generating action to support a “sink hole.”  The ratio/percentage of this siphoning has it’s limit before the entire system cannot be self-sustaining!  Why, in the name of life, would we ever want to move in that direction!

The last objection I have of consumerism is the argument that the rich getting richer will result in a lack of consumers because people will have less money to buy things.  What a tragedy that existence has in store for man when he harms himself buy producing and selling more of what other people want!  We are doomed!  We are doomed to do little for our fellow man or to harm them, and we are doomed to harm ourselves in both cases!

Fortunately existence doesn’t have it out for man and has provided a mechanism to avoid destruction.  The solution is simple — the price mechanism.  The nature of pricing dictates that if the production of goods are up and the amount of money in circulation is down, then the prices of products will necessarily drop provided that trade is left alone by the government or those who would like to initiate the use of force.

Do not get fixated on money — it is deceitful when analyzing economics because it is easy to confuse money for wealth.  Money is a medium of exchange only.  An exchange involving trading a product/service for money is incomplete until that money is in turn exchanged for a product/service.  It is products and services that are the ends and it is production and money that is the means to self-generating and self-sustaining processes — i.e., to life.

(Note from author: I have recently been convinced that fractional-reserve banking, though it’s a bad idea, should not be outlawed.  The government should not outlaw bad ideas unless fraud or another for a violating rights is involved.)

The origination of the idea:

Where does the idea of fractional-reserve banking come from? The short answer is goldsmiths implemented the idea to depart from full-reserve banking. Back when gold and silver coins were the primary means of currency, goldsmiths kept deposits of gold in their safe for a small fee. In return the depositor would receive a receipt for the exact amount of their deposits. After a while, the receipts grew in popularity and were circulated just as much as the physical metals were themselves — after all, they were as good as gold. The deposits in the goldsmith’s safe were collecting dust and the smith realized that very few people came back to collect their deposits because they were using their receipts instead. The goldsmith would then lend out the deposited gold at interest while keeping some in reserve just in case someone returned for it. The depositors didn’t mind too much because they received their gold when requested (more or less) and because instead or paying for the storage fee, they would receive interest for their deposits; thus, the birth of the fractional-reserve banking process.

Money To Be Made With Little Risk:

Who is making the money? In short, the bankers are. They are earning interest on money that is not theirs. Getting back to our previous example, let’s say for the sake of argument that the bank makes 8% interest for money on loan and pays 3% interest for deposits. Given our example, there is $9000 loaned out and $10,000 in deposits—or $9000 loaned out, and $9000 + $1000 in deposits. To simplify, that means the bank is making 5% on $9000 (8% on $9000 — 3% on $9000) and paying 3% $1000. $9000 is $1000 times 9; so to simplify even further, that means the bank is making 45% (5% times 9) on $1000 and paying 3% on $1000. And to go the rest of the way, the bank is earning (when all is said and done) 42% (45% — 3%) on that original $1000, which was not originally theirs. There is a ton of money to be made off of money that doesn’t belong to you. Is this process sustainable?

The Sustainability Of This Contradiction:

Continuing with our example, one can see that eventually the bank will own at least $1000 on record—only about two iterations of interest payments is 86% of $1000. There is still $9,000 on record for loans and $10,000 for deposits. Ok let’s assume the bank makes $1000 and withdraws it out of the system (the most extreme scenario) and puts it into an off shore hedge fund leaving everyone else to pay back $9000 in loans with zero money available. This will create an infinite demand for money and no means to quench it. Or in the case of a bank run instead, where everyone pulls out at the same time leaving those last in line with lint in their pockets. The only result of either scenario is deflation (in this case by 10 times), leading to a depression.

Ok, this obviously cannot be sustained given my little example, but what about on the scale of an entire country (or the world)? Macroeconomic effects are made of microeconomic events; therefore, if something cannot work at the micro level, then how can it possibly work at the macro level? The answer is it can’t. The part cannot contradict the whole. The best you can hope for is to patch it up the best you can temporarily, and they do, until the system ultimately fails—like in 1929 or any end to any bubble.

This is an excellent video for those interested in an entertaining break down of the two economic/political ideologies at war in our country today, and has been going on for almost a century. The stakes are high.