John Médaille wrote:
>The problem I see with a FRS is that it
>privatizes a public power. Why should the banks
>have the power to create money? We bail the
>banks with borrowed money they create. Something
>is not right about that. We will be paying
>interest on the money they (or their Chinese
>counterparts) lend us to give to them. What's wrong with this picture?
I wish John had paid attention to what I wrote
earlier about the advantage of using classical
definitions rather than those of J.M.
Keynes. His apparent confusion stems from ignoring my suggestion.
The modern equivalent of classical money is a
central bank's currency or cash. As F. A. Walker
(1878, 405) well summarizes the classical
definition, " Money is that which passes from
hand to hand in final discharge of debts and full
payment for goods. The bank-deposit system
allows the mutual cancellation of bast bodies of
indebtedness which would, without this agency,
require the intervention of an actual medium of
exchange; but deposits, like every other form of
credit, save the use of money; they do not
perform the functions of money. /Money is what
money does/" (original italicized last sentence).
Alfred Marshall (1923, 13) says pretty much the
same thing: "There is ... a general, though not
universal agreement that, when nothing is implied
to the contrary, 'money' is taken to be
convertible with 'currency,' and therefore to
consist of all those things which are (at any
time and place) generally 'current,' without
doubt or special inquiry, as means of purchasing
commodities and services, and of defraying
commercial obligations. Thus, in an advanced
modern society, it includes all the coin and notes issued by Government."
Thus, by the classical definition, banks don't
create money. They simply enable their
depositors to employ the facility of money
substitutes -- checks and electronic transfer
systems-- to settle their indebtedness. And when
banks lend, it is on the basis of their
customers' deposits that they extend such loans,
keeping some in reserve to meet their customers'
future demands for cash. Keynes (1930), on the
other hand, includes bank deposits in his
definition of money and also insists that it is
bank lending that actively creates deposits (1:
25-26). He dismisses the explanation of
"Practical bankers, like Dr. Walter Leaf" that
banks depend upon their customers' deposits in
order to lend, also claiming that "economists
cannot accept this [explanation of Dr. Leaf's] as
being the commonsense which it pretends to be"
(p. 25). Of course, Keynes was not alone among
the early neoclassicals in including bank
deposits among constituents of "money," although
his constituents are the largest, including "unused overdraft facilities."
In the /General Theory /he "assume[s] that money
is co-extensive with bank deposits" (167n).
Were the Keynesian confusion not in the air, the
notion that we have had a "credit crunch" or
"frozen credit" system and that banks needed some
$700 billion bail out in order to unfreeze the
credit market and get credit "flowing again"
would have seen as the falsehood that it is. The
public's savings with depository institutions
were on the increase, and so was M2, 90% of which
is bank credit, throughout the period that Hank
Paulson, Ben Bernanke, and others were proclaiming a freeze of credit.
All one with a clear understanding of the
distinction between money and credit had to do
was check www.federalreserve.gov to find the
data. It was also to disabuse the public's mind
of the falsehood in the air that Bank of America
took out an advertisement in the second week of
March to point out that they extended $115
billion in new credit in the fourth quarter of
2008 alone, contrary to claims of no lending by the banks.
When one understands that lending or credit
extension is to banks what breathing is to a
living being, it is truly astonishing that
otherwise highly placed personalities would keep
talking about doing such and such so the banks
"will start lending again." What do they think
banks do with the public's deposits, stuff them
in their vaults? And how would they be able to
pay interest to their depositors? Banks never
stop lending. They may be more aggressive
(keeping less in reserves) or less aggressive
(keeping more reserves) in lending, but lend they always do.
True, some incredibly wrong things have been done
lately in the U.S. in the name of monetary
policy. But they are not to be cited as evidence
of what is wrong with a fractional reserve system
of banking. Rather, they derive from the
employment of the wrong economic concepts.
James Ahiakpor
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