The Socialist Myth of the Greedy Banker and the Creation of Money

***You can obtain a free copy of this essay in pdf, kindle and epub format at Smashwords

https://www.smashwords.com/books/view/418385

or you can download it for free for Apple devices at

https://itunes.apple.com/us/artist/iakovos-alhadeff/id840901147?mt=11

or you can download it for free Barnes and Noble for nook devises

http://www.barnesandnoble.com/s/iakovos-alhadeff?store=allproducts&keyword=iakovos+alhadeff

or you can buy the kindle edition at Amazon

http://www.amazon.com/s/ref=nb_sb_ss_i_0_7?url=search-alias%3Daps&field-keywords=iakovos%20alhadeff&sprefix=iakovos%2Caps%2C605&rh=i%3Aaps%2Ck%3Aiakovos%20alhadeff

 

Why Private Banks Cannot Create Money

Iakovos Alhadeff


Most people are convinced that private banks are responsible, or at least mostly responsible, for the current economic crisis. The truth is that the crisis is the outcome of the policies followed by the political systems of the U.S.A., the E.U. and China. But I describe the major causes of the crisis in my essay “The causes of the economic crisis”, and therefore the purpose of this document is not to explore them, but rather to explain in very simple words, why private banks are not at all responsible for the crisis, since they cannot “create” money. Even though I have postgraduate studies in economics I am not a specialist, and this document is the knowledge I gathered in an attempt to answer my own questions. Moreover English is not my first language and you will have to excuse my syntax.

To show that private banks cannot “create” money, is very important since excessive money creation in the U.S.A., the E.U. and China, was one of the main causes of the current crisis. Equally important is to explain why excessive money creation is always and everywhere a government act. What happened in reality is that excessive money creation was simply used to accommodate the unsustainable fiscal policies followed for years by many countries. Unfortunately it is much easier to notice the private banks credit expansion with the abundance of cheap credit, and the resulting bubbles, and much harder to realize that it was state policies and laws that dictated such expansions and led to bubble creation.

Since the average person is well aware of the credit expansion and the inflationary money of the pre-crisis era, it is not unreasonable for him to assume that the cause of the crisis is the “uncontrollable” and “unstable” private banking sector. But if a person is mistakenly convinced that the private banking sector is responsible for the crisis, a very reasonable response would be to ask for more government regulation. Wouldn’t that be the most natural response? I therefore believe that it is of great importance for the general public to realize that private banks cannot create inflationary money. Only governments can do so by introducing relevant laws as I explain below.

In order to do so, I use various economic examples to show that private banks cannot “create” money. First I use an example where private banks issue their own bank notes and there is no central bank. In the second example private banks still issue their own bank notes, but there is also central bank that only keeps the private banks’ gold at its vault, and clears their transaction. In the final example which is very realistic, there is a central bank that issues bank notes, which keeps at its vault all the gold, and that clears the transactions between private banks. But the bank notes it creates are still backed by gold. I show that in all cases private banks cannot create money. Then I explain why it is only the government that can create money, and I show how and why it does so. At the final part of the document I explain why conspiracy theories about central banks are not true.

But first of all, what do we mean by “inflationary money”? What do we mean by “excessive money creation”? The best description in my opinion is the following: “Inflationary money refers to an increase in the supply of money that is not matched by an increase of equal value in production”. For example there is an economy with 2 tomatoes and 2 dollars, and each tomato costs 1 dollar. A third dollar is now created, that is not matched by the production of a third tomato. Therefore the price of each tomato increases to 1.5 dollars, which means that the new dollar was inflationary. This is actually a way for the issuer of the third dollar to tax the 2 existing tomatoes.

In my document “Central Banks for non-Economists Part 1: Inflation and Taxation”, I explain the relationship between money creation and taxation, and therefore in this document I will not elaborate on the relationship of inflation and taxation. I will only say what is necessary for the purpose of this essay. I will therefore show with this document that in a free market system, private bankers cannot create money and tax the current wealth. A free market banking system is exactly the opposite from the banking system we know. And I am not saying that when the state follows an aggressive monetary policy, private bankers do not make big profits. They do make big profits at such times. But this has nothing to do with the evil private banking sector. When there is lots of money around, they make big profits because their job is to buy and sell money. In the same way that someone who sells nails makes lots of money if huge amounts of nails are bought and sold. This does not change the fact, that paper money is the most important state monopoly. But before I explain why private banks can not create inflationary money in a free market economy, I would like to say a few words about why it is good for an economic system to have a form of “money” (a medium of exchange), and a banking sector. After all, this document is written for non economists.

In a barter economy without any generally accepted medium of exchange, that is without a good that everybody accepts as a means of payment, a person wishing to sell his tomatoes and buy oranges, would have to find someone who sells oranges and wants tomatoes. This can be a very difficult and time consuming task. On the other hand if everybody accepts a good as a means of payment, i.e. gold, olive oil, paper money etc, this problem ceases to exist. If I want to sell tomatoes I simply have to find someone looking for tomatoes, and with the medium of exchange that I will receive, I will buy the oranges I want. This is a much more efficient way to trade, and it leads to much higher levels of productivity and welfare.

Moreover, the orange producer needs a way to store the value of his production surpluses. If he needs 100 oranges per year but he produces 200 oranges, he must somehow store the value of his surplus i.e. the 100 oranges. He therefore needs a non perishable good, that everybody accepts as a medium of exchange, in order to store his surplus of 100 oranges. This can be a good that can last for a long time i.e. olive oil, but silver, golden and other metal coins, or paper money, are much more suited to serve as mediums of exchange. There are more reasons why an economy needs a medium of exchange, but the above will suffice for my purposes.

Now I want to say why an economy needs a banking system. The farmer of the previous example had a surplus of 100 oranges. There is another farmer that is willing to pay 110 oranges in a year’s time if he borrows these 100 oranges today. But the other farmer is reluctant. He does not know if the borrower is capable of repaying the 100 oranges, and he does not want to risk his surplus. But if there is a specialist who can evaluate the borrowers’ creditworthiness, this problem ceases to exist. This specialist is called a bank. It could be called a money merchant or anything else. But these experts are called banks. There is no difference between a real estate agent and a money agent. One is an intermediary in transactions involving property and the other is an intermediary in transactions involving money. The above explanations of the usefulness of a common medium of exchange and of a banking system are enough for this document. After all nobody disagrees.

My starting point will be an economy with no money and no banking system. There are only farmers producing oranges. Farmers producing more oranges than they consume, worry about their surpluses. They are afraid that someone might steal them when they are absent. There is therefore demand for places to deposit these surpluses for greater security. New companies are created then, with huge vaults, where farmers can store their oranges. Let’s call these companies banks. Farmers store their surpluses in their vaults, and can go whenever they want to take oranges for personal consumption or commercial purposes. I assume for a minute that oranges do not perish, and therefore they can serve as a store of value.

When farmers deposit oranges at the banks, they receive paper receipts. An orange and the number “1” are stamped on each receipt. All receipts are identical, except that each one carries the name of the issuing bank. Gradually farmers start to use these receipts as money. They find it more convenient to do so, instead of carrying oranges around. We now have a monetary economy with a banking system. People do not exchange oranges but paper representing oranges. However citizens want a medium of exchange that is more convenient than oranges. They therefore start using gold, which is much better suited to serve as a medium of exchange than oranges. Now gold is not only used for jewellery but as a means of payment too. In the same way that some people work to produce oranges, some others work to extract and process gold. One should not confuse gold with paper money. Gold is a good like all other goods. Someone has to work hard to extract and polish it, and it has real value. Paper money on the other hand has no intrinsic value. Its value derives from a governmental law establishing as the legal and only means of payment.

The price of gold is affected by the same factors that affect the prices of all other goods in the economy i.e. its availability, demand and supply for gold, improvements in mining techniques, changes in tastes etc. Gold is a good like all other goods (oranges, wood, wine etc). It is not like paper money that has no intrinsic value. Gold simply possesses some special characteristics that make its use as a medium of exchange ideal. Therefore economic agents trade their goods for gold, and deposit their gold at the bank, which in turn issues and gives them a paper ticket (bank note). Let’s call these bank notes “1 gram of gold” notes. All bank notes are “1 gram of gold” notes, and the issuing bank’s name is written on these notes. Banks are obliged to redeem these notes for 1 gram of gold, if the bearer wishes so.

These papers are exactly the same with 1 dollar notes, except that “1 gram of gold” is written on them instead of “1 dollar”. Actually the main difference is that you cannot redeem dollars or euros for gold, while you can do so for the bank notes of my example. The bank notes of my example have real value. They do not derive their value from a law, but from the gram of gold that backs them (or from the oranges that backed them before I introduced gold into my example). And for simplicity I assume that there are only “1 gram of gold” bank notes, and the economy is only producing oranges and gold, and that oranges exchange for 1 gram of gold, and the price is fixed. All very unrealistic assumptions but they enhance intuition which is my aim.

Why private banks cannot create inflationary money

Now I turn my attention to the private banker, to whom all socialists attribute the crisis. As expected, the private banker wants to sell as much of the medium of exchange as he can, whether the medium of exchange is olive oil, whether it is golden coins, or paper money or whatever, because this is his job. This is what he does. In the same way that someone selling nails wants to buy and sell as many nails as he can, the banker wants to buy and sell as much money as he can. The more he buys and sells the more profit he makes, exactly like the nails merchant. If the interest on deposits is 5% and interest on loans is 10%, and the private banker lends 100.000 dollars, he will make 5.000, if he lends 1.000.000 he will make 50.000 dollars, if he lends 10.000.000 dollars he will make 500.000. The same principle applies whether you buy and sell nails or money. The more you buy and sell the more profit you make, assuming of course that each sale carries a profit mark up. Therefore it is very normal and very healthy that the private banker wants to lend as much as he can, given of course his customers are creditworthy.

We now have to think whether a private bank can “create” inflationary money if it wishes to do so. And the answer is of course no.   Let’s imagine a private bank, in which farmers have deposited 1.000 grams of gold, and which has issued 1.000 “1 gram of gold” notes, with its name on them. Therefore the issued bank notes are 100% covered by gold, which means that each bank note issued corresponds to 1 gram of gold in the bank’s vault. This bank now wishes to issue another 9.000 bank notes in order to lend them and make more profit. But the bank does not have another 9.000 grams of gold. Therefore these new notes will be inflationary notes. They will be money creation from thin air. Can the bank do so? No, it cannot as I already said. If X Bank attempts to do so, it will go bankrupt very soon. And here is why.

Imagine that the bank issues another 9.000 bank notes, and lends them to some customers in order to charge interest. The customers that will receive the “fresh” notes will use them to finance their activities, thus giving them to other economic agents, who in turn will deposit them to their domestic or foreign banks. The domestic and foreign banks that will receive the new bank notes will send them to the issuing bank to redeem them for gold, as the issuing bank is obliged to do. And more specifically they will require 1 gram of gold for each bank note. But the issuing bank has only 1.000 grams of gold in its vault, and therefore will not be able to redeem the banknotes. Therefore the issuing bank will go bankrupt shortly after the credit expansion.

In the banking system I just described, banks have to send loads of gold to each other every day, in order to clear their customers’ transactions. This is very inconvenient, and I will therefore introduce a central bank in my example. The private banks will continue to issue their own bank notes, and the central bank will simply hold their gold and clear their transactions. For instance when X Bank receives a bank note from Y Bank, it will send it to the central bank. The central bank will take a gram of gold from Y Bank’s box, and put it in X Bank’s box. Once the transfer of gold has taken place, the central bank will return the bank note to Y Bank, since the debt was fully paid. In a banking system like the one I describe, bank notes resemble bank checks, since the bank’s names are written on them.

The inclusion of a central bank into my example does not change much though. The private banks cannot create money for the reasons I described before. If Y Bank has “created” inflationary money, which means it issued more bank notes than the grams of gold it has at the central bank’s vault, it will go bankrupt. Assume farmers deposited 1.000 grams of gold at Y Bank, and Y Bank issued 1.000 bank notes of 1 gram of gold each. Now the bank issues another 9.000 bank notes not covered by gold i.e. inflationary money, and lends it to a customer. The customer buys something and the new bank notes end at X Bank. X Bank sends these bank notes to the central bank, and the central bank finds in the box of Y Bank only 1.000 grams of gold instead of 9.000 grams. The central bank therefore does not clear the transaction. Therefore the introduction of the central bank did not change anything.

Now let’s examine what happens when the central bank not only holds the private banks gold and clears their transactions, but in addition is the issuer of the economy’s paper money. But each bank note issued by the central bank issues is still covered by 1 gram of gold, as was the case in the previous examples. Can private banks now create inflationary money? No they cannot. For the central bank to issue a new bank note, someone will have to deposit in its vault 1 gram of gold, that someone being the government or a private bank (on its behalf or on behalf of a customer). Each private bank receives a bank note from the central bank, for each gram of gold it sells to the central bank. In other words, for each gram of gold that goes in the state’s box of gold at the central bank. Not for each gram of gold that the private banks deposit in their own box at the central bank’s vault. Bank notes are only issued when a gram of gold goes to the state’s box of gold. Therefore the country’s bank notes are real bank notes. For each one of these notes there is one gram of gold (at least) in the state’s box of gold at the central bank’s vault. They are “golden” paper notes.

I will use a full transaction as an example. I sell 1 orange to a person that extracted 1 gram of gold. Remember that I assumed oranges sell for 1 gram of gold. I then deposit this gram of gold at X Bank. X Bank has two choices. One is to buy the gold for itself and send it to the central bank for the latter to deposit it in X bank’s box of gold. Alternatively X Bank can send the gram to the central bank for sale. The central bank will then issue a “fresh” bank note, and send it to X Bank. The central bank will then put the gold in the state’s box of gold (and not in X Bank’s box). I, the seller of the orange, will take a bank note of 1 gram of gold in both cases. In the first case an existing bank note and in the second case a “fresh” one. I can give this bank note back to X Bank and open a deposit account or take it and leave. I use this example to emphasize that for a “fresh” bank note to be created someone has to put a gram of gold into the state’s box of gold. This is very important. And it is a very reasonable, since each bank note created represents for the country a debt of 1 gram of gold, whether this bank note is held by a local or a foreign citizen. And in order for the country to be able to redeem all the bank notes issued for 1 gram of gold, there must be (at least) 1 gram of gold for each bank note issued, in the state’s box of gold. That is why I call the banknotes “golden” notes. If these bank notes are not backed by gold they are not “golden”, they are simply paper deriving their value from a relevant law. Issuing “golden” bank notes is very healthy, since they represent real production surpluses and savings and not inflationary paper.

So, can a private bank in this environment “create” money if it wishes to do so? The answer is again no. If X Bank issues new loans, and gives let’s say bank checks to some customers (remember that now it is the central bank that issues the paper money), the customers will give these checks to other economic agents, these other economic agents will deposited these checks in foreign and domestic private banks, and eventually they will end up at the local central bank to be cleared. The central bank will not find enough gold in X bank’s box, and it will not clear the transactions.

We therefore see that private banks cannot create inflationary money under any circumstances. I hope it is now clear why the document is titled “the myth of the greedy banker”. Only the state through governmental laws, and through its monopoly as an issuer of paper money, can create inflationary money. Inflationary money is as I already said, money not covered by production surpluses. It is money that does not represent citizens’ savings, but it is rather a new government claim on the citizens’ savings. I must also say that a country does not have to produce gold. It can produce other goods and exchange some of them for gold. Gold is simply a good like all other goods.

Creation of money by the government

I hope that it is clear by now that private banks cannot create inflationary money. The problem for a political system with a banking system as described is that the government cannot create money either. And governments have only 3 ways to finance their deficits. The first one is taxation, the second one is domestic and foreign borrowing, and the third one is by printing new inflationary money. As I explain extensively in my other document, printing money is taxation through inflation. Inflation is a way of taxation that most governments very often prefer to use. Taxation is very unpopular, borrowing requires confidence on behalf of the lender that you will honor your obligations and carries the cost of interest, while printing money does not require a third party’s confidence in the government’s policies, it does not carry interest, and it is not as unpopular as taxation. Of course increasing the money supply increases inflation, but most people do not realize that inflation is taxation. Therefore taxation is more unpopular than inflation. If a government goes too far with the printing press though, it can cause very high levels of inflation, or even hyperinflation, with catastrophic consequences for the economy. But in the short run political parties tend to overlook the long run consequences.

I now want to describe the difficulties that a government faces under the gold standard, in its effort to finance deficits by printing money. To make things simpler, let’s start from day 0. Citizens have no savings in gold or oranges yet. They now start producing oranges and gold. Some of them produce oranges and some produce gold, and it is gold that serves as a medium of exchange and a store of value. Producers of oranges, exchange their surpluses with gold, and deposit gold at the bank. Similarly, gold miners exchange their gold for oranges, and deposit whatever quantity of gold is left at the bank. Note that the deposited gold does not represent only the past surpluses-savings of gold in the economy. It represents the surpluses-savings of all goods and services in an economy. When I exchange my extra orange for 1 gram of gold, and I deposit that gold at the bank, that gold represents a surplus of 1 orange that was stored in gold. I mean that the deposited gold at the banks represents all surpluses, all savings in the economy. Surpluses in oranges, surpluses in haircuts, surpluses in gold, surpluses in cleaning services etc, that are all converted and stored in the common store of value, which in my example happens to be gold. In my example gold is the only way to store value, but in reality this is not the case.

The private banks now deposit the citizens’ gold at the central bank, and the central bank issues new “1 gram of gold” bank notes. These notes could be called something else. They could be called dollar notes, or euro notes or whatever. I prefer to use the name “1 gram of gold” notes to emphasize that these notes are “made” of gold, they are backed by gold. Let’s assume now that there is 1.000.000 grams of gold deposited at the state’s box of gold in the central bank, and 1.000.000 “1 gram of gold” notes circulating in the economy.

Even though it makes no difference for my analysis, in order to be a bit more accurate, I have to add that the price of orange and gold would not be fixed in reality. The banknotes are indeed backed and redeemable for 1 gram of gold, but that does not mean that they will always buy 1 orange. The relative price of gold and oranges will vary according to weather, demand and supply, changes in tastes etc. In other words bank notes will always be redeemed for 1 gram of gold, but that gold might buy 1 orange, or 2 oranges, or half orange, depending on the prices prevailing at the market. But this should not be confused with a general increase of the price level that arises as a result of inflationary money creation. Relative prices must change when market conditions change.

So, we have 1.000.000 grams of gold in the state’s box at the central bank, and 1.000.000 “1 gram of gold” notes circulating in the economy. Let’s suppose that the government wants to issue some more “1 gram of gold” notes, to finance its deficits and avoid taxing its citizens. Can the government do that? Well for a while it can. I assumed that the total gold of the economy is 1.000.000 grams, and let’s say that 100.000 of these grams belong to the state. But the government decides to host the Olympic Games that cost 200.000 grams of gold. The treasury issues a check of 200.000 grams of gold, and gives it to the contractor. The contractor deposits the check at X Bank, in order for the latter to clear it. X Bank in turn sends the check to the central bank for the latter to clear it. The thing is that in reality, the gold is not kept in separate boxes with a bank name written on each box. It is placed all together at the central bank’s vault, and the central bank holds electronic information about the owners of that gold.

Therefore when the central bank receives the check issued by the treasury, it sees that the state’s gold of 100.000 grams is not enough to cover the expenses. However, contrary to what it would do for a private bank, it credits X Bank’s account with 200.000 grams of gold and says that everything is ok. X Bank then credits the contractor’s account, and the contractor starts preparations for the Olympics. The country now owes 100.000 grams of gold. In accounting terms this appears as a debt of the government to the central bank, but in reality it is a debt of the government to its citizens. Except that the citizens do not know that the just lent their government 100.000 grams of gold. Alternatively, instead of a check by the treasury, the government could have ordered the central bank to create 100.000 new notes. The central bank would create these notes pass them to the treasury, and write in the central bank’s books a government debt of 100.000 “1 gram of gold” notes. The treasury would pay the contractor, who would deposit these notes at X bank. X bank would open a deposit in his name and send the bank notes to the central bank in order for the latter to transfer 100.000 grams of gold in its box. The central bank would credit X bank’s gold account which would match the debt created by the government. I think the case with the check is better for illustration purposes. So you better think of this transaction in terms of the treasury check. But both cases are exactly the same. In both cases what happened is that the central bank owes a private bank 100.000 grams of gold, and the government owes the central bank 100.000 grams of gold. In reality, it is of course the government owing to its citizens 100.000 grams of gold, since the central bank is only a governmental institution.

The government just created money. But it did not created new wealth. It simply used its citizens’ accumulated wealth to finance the Olympics. This will of course appear as a debt of 100.000 grams of gold when the government prepares its financial statements at year end, but who notices? Everybody is happy. Everybody got their money. And the government did not have to tax anybody, and did not have to borrow any money. Only inflation was affected. But who cares when inflation is low? The problem for the government under the gold standard is that this artificial money expansion increases demand, it increases the price level, the country becomes more expensive and starts losing its competitiveness, imports start rising and exports start declining. The economic agents abroad that receive the country’s bank notes as a payment for their sales send these bank notes through their central banks, to the domestic central bank, in order for the latter to redeem it for gold.

Therefore if the government is very active in creating inflationary money, the country’s gold reserves will start declining. People will start doubting that the government will be able to redeem its bank notes for gold, and there will be a confidence crisis. Even domestic citizens might start redeeming their bank notes for gold. But there is not enough gold to pay for all bank notes in circulation, since the government used much of it for its expenditures. At some point the government will have to either abandon the gold standard all together i.e. stop redeeming the bank notes for gold, or change the exchange rate between bank notes and gold i.e. say that it will exchange each bank note for half instead of 1 gram of gold. Thus the gold standard imposes much more discipline on a government’s fiscal policies. On the contrary if the government passes a law, as is the case in all countries, imposing its paper money as the legal means of payment without promising to redeem it in gold, there is no limitation on the creation of inflationary money.

Now the bank notes do not derive their value from gold but from the law, and the government can create as much money as it wants. Well, almost as much, because excessive use of inflationary money as a means of taxation can lead to catastrophic hyperinflation. The point is that the gold standard imposes much more discipline on a government, and it is no surprise that governments do not like such regimes. It is no surprise either, that socialists hate the gold standard and libertarians love it. Because it is socialists that like excessive taxation, and since direct taxation is unpopular, they prefer to use the indirect taxation of monetary expansion. Libertarians do not favor big public sector and excessive taxes and they therefore love the gold standard as a barrier to socialist policies.

To make things simpler, think about it in the following. If society’s savings are a pile of gold, and the government takes some of this gold without taxing, it will have to pay back with gold. But the government does not have gold. But if, as it happens in all countries, the government passes a law that imposes paper money as the legal and only means of payment it is in effect forcing its citizens to save their surpluses in paper money. Now if the government can take some of the savings without taxing the citizens. If the citizens ever ask for their money back, the government can always print new money and pay them. But this paper will buy much less than it used to. Of course it is possible to save in gold but it is not as convenient. And therefore most people will hold their savings in the form of paper money. The honest thing for a government would be to back paper money with gold.


The gold standard and budget surpluses

As I already said, the gold standard is a regime favored by libertarians and of proponents of small public sectors in general. This rule prevents politicians, or at least makes it much harder for them, to follow policies based on budget deficits. There is another way however to prevent governments from creating deficits, and this is by passing a law requiring governments to have on average budget surpluses.  Some political systems in developed countries do so, as a means of self discipline. In Sweden for instance, there is a law imposing budget surpluses of +1% on average. That means that deficits are allowed, but they will soon have to be reversed. But such laws are not welcome at all by socialists, since they are even stricter than the gold standard. Under the gold regime as I described above, at least temporarily, a government could finance a deficit by monetary expansion. The law of budget surpluses makes life for socialists even tougher since they can only use taxation to finance their projects. There is also a softer version of this rule that allows deficits but only if they relate to public investment i.e. road networks, harbors etc, with the hope that such investments will increase the country’s GDP.

Central banks and conspiracy theories

The main idea of this document is that there are no fat greedy bankers, but rather fat greedy governments and politicians. However there is one last issue which is the conspiracy theories about central banks. Such theories claim that central banks print money for themselves and this is the cause of the crises. In other words they claim that it is not that central banks are directly or indirectly at the mercy of their political systems but the other way round. The following link has a lot of information about conspiracy theories concerning the Federal Reserve Bank, which is the central bank of the U.S.A.

http://www.publiceye.org/conspire/flaherty/Federal_Reserve.html

Such conspiracy theories are everywhere and always supported by populists, or by people that are not very educated or intelligent, and they have a tendency to believe populists.  Political systems in developed countries try to make their central banks as independent as possible, in order to protect their monetary policy from political cycles. They do so in order to put a barrier between politicians and the money machines. And they do so with laws that they pass in their own parliaments. For instance the board of the Fed, is appointed by the president of the United States of America and approved by the congress, but the president cannot terminate the chairman’s tenure once he is appointed. They do so because they do not want the chairman of the central bank to be at the mercy of the president and the congress. They want the chairman to have some degree of independence in order to be able to resist pressures on behalf of the congress, to follow more expansionary policies. Because the truth is that politicians tend to focus on short rather than long term consequences.

The problem is that political systems do not provide enough independence to their central banks. For instance by law the Fed’s goals are price stability and low unemployment. The same applied for the central banks of the socialist southern European countries. However this was not the case for Germany. Bundesbank’s goal was set by law to be only price stability, and this partly explains the superiority of the German economy, since the political system had to be much more disciplined. Because when you include low unemployment as a goal of the central bank, the central banker is at the mercy of politicians. Politicians know that if their irresponsible fiscal policies lead to high unemployment, the central bank will have to step in and give them a hand in the form of monetary expansion, since it is required by law to do so. But an increase in paper money can only have short run positive effects and will definitely has very strong long term negative effects. Therefore this commitment of the central bank to intervene in case of rising unemployment gives negative incentives to the political system. If on the other hand the goals of central banks were only price stability and the stability of the financial system, politicians would be much more cautious and disciplined.

But even when low unemployment is one of the central bank’s goals, the economists from the academia that that run them, are a significant obstacle to the political system since they do not have to worry about political cycles. And this is the reason that socialists and statists want central banks to be at the absolute control of the political system. And they circulate conspiracy theories about central banks, in order to convince ignorant people that central banks should be stripped from any form of independence. They want the money machine under their complete control. When politicians have the money machine under their control, they can do the following. Suppose there is a 3 people economy, the president and two citizens. The president wants to take a dollar from John and give it to Nick. He can print 3 dollars give 2 dollars to John, and 1 dollar to Nick. If you take into account inflation, the net effect was to give 1 dollar to Nick. But John is happy too. He got a dollar. He did not realize that 1 dollar was taken from him. He thinks 1 dollar was given to him. He only notices inflation. This is the reason that politicians do not want economists running central banks. In less developed countries the money machines are indeed at the mercy of the political system, in the way that statists and conspiracy theorists want them to be. Only in the developed word central banks enjoy some degree of independence.

The Fed has indeed shares which are held by all the private banks operating in the U.S.A. But banks are required by law to hold the Fed’s shares. And by the same law they have to keep a part of their funds with the Fed. But private banks do not have a saying on the conduct of monetary policy which is determined by a board appointed by the president and approved by the congress. Moreover all the interest earned by the Fed is returned to the treasury at the end of each year (for more details see the link I provided above).

I will therefore conclude by saying that contrary to what conspiracy theorists suggest, the problem with central banks is that they do not have enough independence and they have to accommodate irresponsible fiscal policies. The most famous case is of the northern and southern European countries. The northern European countries provided much more independence to their central banks and they always outperformed the southern countries in economic terms.

If you liked this essay you might want to have a look at some of the following essays too:

Conspiracy Theories About Israel

https://iakal.wordpress.com/2014/05/06/62/

The Energy War Between U.S.A. and Russia and the Threat for Israel’s Survival

https://iakal.wordpress.com/2014/08/05/the-energy-war-between-u-s-a-and-russia-and-the-threat-for-israels-survival/

The Socialist Myth of Economic Monopoly

https://iakal.wordpress.com/2014/03/12/the-socialist-myth-of-economic-monopoly/

The Socialist Myth of Economic Bubbles

https://iakal.wordpress.com/2014/06/21/the-socialist-myth-of-economic-bubbles/

The Socialist Anti-Semitic Myth of the Creation of Money Out of Thin Air

https://iakal.wordpress.com/2014/07/04/the-socialist-anti-semitic-myth-of-the-creation-of-money-out-of-thin-air/

Introduction to Banking

https://iakal.wordpress.com/2014/05/12/bank-recapitalization/

 

136 thoughts on “The Socialist Myth of the Greedy Banker and the Creation of Money”

  1. The difference between government fiat money and other forms of fiat money is that governments can require that their fiat money be used to pay taxes. In the Christian Bible Jesus criticized the temple money changers. The Law required that the annual Temple Tax be paid in official temple silver coins. In this case the monetary value of the metal was immaterial.

    If money is a “medium of exchange” then banks, like the S&H Green Stamp company could create money. What the bank’s paper money and S&H paper money can’t create is a “store of value.” “Store of value” is only one characteristic of “money.”

    “Money” does not require all the theoretical characteristics claimed for it. For example, a historical Pacific Island group used large stone disks as a store of wealth but they did/do not have the characteristic of portability.

    Electric and paper government fiat money makes sense if considered to function as a government countersigned IOU for goods and services.

    Further, compare government issued fiat money and grocery store coupons. Neither can cause inflation nor generate problems for the store or for the government unless either form of fiat money is spent into circulation. The trillions recently invented by the Fed and the government did not cause a runaway inflation because none of it was spent into the economy.

    Like

    1. Thank you for your reply. My essay’s point is that either you have paper money backed by gold to prevent governement to dilute it, or you impose budget surpluses for the same reason. That’s the argument besides showing that private banks can’t create money.

      I think it did not cause inflation because you had cheap products coming from China. And this is the excuse for the Fed. That there was price stability. And some people say that central bank’s goals should be besides price stability, the stability of the financial system too i.e. to prevent bubbles
      Iakovos

      Like

    2. I think we may yet see some of that Paper money from the Fed enter the economy. The only thing holding it back is that the economy has been so bad that no one has wanted a loan.

      Like

  2. Hello Mr. Alhadeff,
    I appreciate that you visited my blog and want to get the word out about yours, and also your essay looks interesting. It is considered against blogging courtesy, however, to simply leave a link as your comment. If you want to provide something useful in the way of a comment to my readers and then say “I have a related article on my blog, and the link is: HHHH”, that would be fine. As it is, I’m not going to approve your comment. Thanks for understanding,

    Regards,

    SI

    Like

    1. Dear friend,
      I know it is against blogging courtesy, but I do not do something I would mind other doing to me.
      If for example you want to leave a link you are welcome to do so. But you know how hard it is to get some readership. It is just a comment. How much harm can it cause? It will not force anybody to read my essay.
      Thank you for your understanding
      Iakovos

      Like

      1. It’s just that leaving a link is the tactic of low quality sites full of ads that just want to get as many people to click to their site as possible so that they can get ad revenue. Your site is much better than that (and your mastery of English is actually very impressive if it is not your native language). Find articles of interest and leave quaility comments. Then, maybe leave a link back to your site in a signature block, or better yet, reference back to one of your articles that is relevant. You’ll find you’ll get a lot of people who follow the link due to the quality of your comment.

        Like

  3. Thank you for your advise. But you realized by now that there are no adds, no nothing. It is just an opinion. The way I see it, if 100 people come and leave comments under my document, they will make it look more important. I do not mean of course that people should thank me, all I am saying is that I am just leaving my mark, so that someone might come and read my document. I really do not think it is important. I am not asking anyone to read my document. And I do know that most people would agree with you.

    And I leave my comment under relevant articles. I write something about Marx I leave a link under a relevant article. I make that article look like it had greater readership than it actually had. Sorry guys but you will have to excuse me. It is just a comment with a relevant subject. I appreciate that you do not do what I do. It is good for you. But you will have to understand, that I do not mind doing it. I really don’t. Actually I would like to put this conversation somewhere that everybody could see it.

    And you have to remember that I am market proponent, a minority. The web is full of socialists. Come one. We have the right to be a bit…….call it what you want. There is a tsunami of socialists putting trash in people’s minds.

    Like

  4. Can I ask you something? How many people have you heard saying that banks have nothing to do with the crisis? Don’t you think there are too few of us saying that? Doesn’t that give us the right to leave our opinion in the form of harmless comments? We are very few saying the truth in a tsunami of lies. We ought to make people read our opinions.

    Like

    1. Except that the banks had everything to do with this particular crisis, since it was a credit-fuelled bubble which inevitably burst.

      Like

  5. This is not the whole story. Banks can create credit ie temporary money, which is not inflationary. The asset bubble which burst in 2008 was fuelled by credit and if the banks were not being greedy, they were certainly being stupid. And not for the first time, since these periodic credit bubbles are a repeated feature of the history of capitalism. If you look into it, you will find that the assets are invariably land, packaged up in some way such as real estate or securities of some kind. And of course it takes two. Borrowers must also be acting stupidly (or greedily).

    Like

    1. Banks can do so because the government wants them to blow the economy (more taxes for government) and buy government’s bonds. Private banks can create money because the government wants them to do so for its own purposes.

      Like

      1. You said.
        1)In the same way that someone selling nails wants to buy and sell as many nails as he can, the banker wants to buy and sell as much money as he can.
        2)Private banks can create money because the government wants them to do so for its own purposes.
        Which one is the rigth one?
        ……et en français , laquelle est la bonne?

        Like

      2. I mean that banking cannot by its nature create money. But if the government wants to increase the money supply or credit or whatever you call it, it can allow banks to do so with relevant regulation. For example fractional reserve banking is one of the ways. To guarantee deposits is another way. Governments do so in many ways.

        But they don’t do so because they want banks to make money. The banking system is simply a tool. They are using the banking system to boost the economy, or to finance their deficits i.e. by having banks to buy piles of government debt.

        But the above does not change the fact that when so much money is bought and sold, merchants of money will make lots of money. In the same way that home constructors made lots of money in the housing boom. Governments did not cause the housing bubble for the housing counstructors to make money. But with so much housing bought and sold they made lots of money. But look at them now.

        Like

      3. You did not read my document. I did not say that private banks cannot create paper money. I said private banks cannot create inflationary money. Because the paper money they issue has to be backed by something. A person must be stupid to accept private fiat money. Why would I accept your private fiat money? I could accept an IOU held by a third party if you were a very big businessman, but that’s it. You cannot have private fiat money. You need a law by the government making fiat money the legal means of payments. As it happens in all countries. There are many people that will benefit if you believe in conspiracy theories.

        Read this

        Click to access how-an-economy-grows.pdf

        Like

      4. The banks cannot create private fiat money. Paper money issued by private banks is not fiat money. The banks create credit through the fractional reserve system. There is nothing wrong with doing so – in fact is it essential for the smooth functioning of an economy – PROVIDED that the credit is issued only for productive purposes eg to purchase equipmment for manufacturing purposes or to finance a construction project which yields no revenue until it is complete. Credit should absolutely not be used to finance land purchase, since nothing is produced in the process – only the transfer of a land title ie it is payment of a release fee. Nor should the land title be used as security for the credit. Unfortunately this practice is almost universal and gives rise to cyclic land price booms and slumps such as the most recent one which collapsed in 2008.

        Like

      5. Private banks create credit because the government wants them to do so, in order to use them as a tool to boost the economy and buy huge piles of government debt. What I am saying is that there is no greedy private banker. A private bank cannot create neither inflationary money, nor credit, no nothing, unless the government wants them to do so. And all governments want them to do so, for the reasons I mentioned above.

        The purpose of this document is to show that private banks all over the world cannot create anything without the governments’ blessings. Governments create inflationary money, credit and you name it.

        Like

      6. Centuries ago when a business traveler wanted to go to a distant city without carrying a large amount of cash he could deposited it with the Jesuits in his city and get a receipt which could be exchanged for cash in his destination city. This was the invention of paper money.

        Like

      7. That is not fiat money. The depositor gave credit to the Jesuits in his city and received a bill of exchange in return, as a receipt for the deposit. The Jesuits repaid the credit at the destination city. But because the Jesuits were trusted, the bill of exchange could have been regarded as good as gold. If the Jesuits had started issuing bills of exchange against no deposited gold, they could have got away with it for a while but the time would quickly have come when their trick was revealed and that would have been the end of their paper bills since nobody would have trusted them again. Credit=trust.

        Like

  6. Probably he was depositing gold to get the paper you are talking about. But when we talk about fiat money we don’t talk about small companies providing some banking facilities. We talk about the governments’ worthless papers, that are accepted everywhere, they are used as a store of value, and they derive their value from the law. A law, as simple as that.

    Like

      1. I don’t disagree. The law is that the state accepts the fiat money for the payment of taxes. That in itself does not make it ineffective as a means of exchange. Gold is also subject to changes in value. There was inflation in Spain throughout the period when gold was being shipped into the country from South America. Nor does reliance on gold prevent damaging property-based, credit-fuelled booms and slumps. These were a feature of economies throughout the nineteenth century.

        Like

      2. Can we look at a practical example. Suppose you want to buy a fishing boat. You go to the bank and obtain credit. The bank needs only to be satisfied that you can repay the loan. In practice, under a gold system, the banker would be able to extend about eight times the value of the gold held in deposits. This factor of 8 was found by experience to be a safe maximum against the change that sometimes loans were not repaid or depositors would want to withdraw their funds.

        A significant factor is that the credit gives rise in this case to a real increase in the stock of wealth ie a boat is taking shape as the credit is taken up. So there is an actual and direct link between the credit and the wealth. To that extent, whilst the credit is APPARENTLY created out of thin air, it is associated with real production. However, when credit is given for land purchase, it does not bring about any increase in the stock of wealth, as land is not produced but existed from time immemorial. In this latter case, the credit has been created out of thin air with no resulting production.

        Like

      3. Changes in the value of gold have nothing to do with a rise in the price level that takes place due to the printing of fiat money. The relative price of gold changes for real reasons, as is the case for the price of all other goods. One year 1 gram of gold buys 1 orange, the next 2 etc. This is not inflation. This is a change in relative prices.

        Like

    1. Credit is trust. If I give you credit, I give you something in the belief that you will pay me later on, because I trust you. The depositor trusted the Jesuits with his bag of gold, knowing that some other Jesuits would give him back the same amount of gold at his destination. But if Jesuits were more widely trusted then their pieces of paper would circulate as money, as good as gold. But it is not inflationary. Is that a clear enough explanation?

      Like

    1. “someone who issues paper for gold cannot create inflationary money or inflationary credit. This is what my document is about.”

      Yes but that was not the problem. Banks, unlike the Jesuits, can create money out of nothing. It is not inflationary in the long run because the created money is wiped out when the credit is repaid, but if used for land purchase will drive boom-bust cycles. It is also not inflationary if it is used to finance the purchase of real wealth, since the credit results in an addition to the total stock of wealth. Land purchase is not an addition to the total stock of wealth and credit used for that purpose fuels the bubble.

      Like

      1. “It is not possible for a private bank that issues paper (tickets) for gold, to create money or credit.”
        Banks do it all the time. It is their standard mode of operation.

        “In our current system, money is created from nothing with a simple accounting entry when a bank issues a loan. As economist John Kenneth Galbraith famously observed, the process by which money is created is “so simple it repels the mind.”

        When you take out a loan from a bank, the bank opens an account in your name and enters the amount of the loan in its ledger. That becomes a liability on the bank’s accounts, offset by the corresponding asset of your promise to repay with interest. Two simple accounting entries and money magically appears from nowhere. This makes banking a very profitable business and is the key to the ability of the institutions of global finance to rule the world.”

        Liked by 1 person

  7. You have to read my document carefully. You haven’t understood what I am saying. Pay attention to the part that I describe the banking system when there is no government intervention. What you describe, is banks under government regulation that allows governments to use banks as a tool for selling government debt and stimulating the economy.

    If the government did not gurantee deposits, and if it did not allow banks to expand credit all together, banks could not create inflationary money or credit. Banks simply respond to the governments’ wants, because the more they lend the more interest they earn. Until they go bust.

    I repeat, you need to read the part of my document about banking, when the government does not intervene in the banking sector.

    And Galbraith was as socialist as it gets. You will never hear a socialist say what I say. You will hear what I am saying only from libertarian economists, and they are a minority. Central banks are socialists’ most important tool in their effort to redistribute wealth and finance governments’ deficits. Therefore they will never admit what I say, even though they are fully aware of it.

    Stop writting comments and read my document. You haven’t understood what I am saying. Or read “The case against the Fed” by Murray Rothbard. It is free http://mises.org/books/fed.pdf .
    .

    Like

    1. Banks have been doing what I am referring to for centuries. The practice began with the Florentines. There is nothing wrong in principle with giving credit on the right terms. It is essential for the smooth functioning of the economy. How otherwise would one build, say, a ship, without a line of credit which enables the ship to be built, materials to be purchased and workers to be paid, when there is no return on the investment until the ship has made a trading voyage and the goods have been transported and sold? That is what credit is for.

      It would be legitimate for government to use credit in the same way for the construction of infrastructure which then led to increased tax revenue. Unfortunately governments do not apply taxes in such a way that improved infrastructure leads automatically to increased revenue. It is certainly not sound practice for governments to use credit to pay current expenses. Nor is it sound practice for bankers to land for land purchase, as this drives the boom-bust cycle. I will have another look at your original piece.

      I would not regard Rothbard as a reliable authority on any matter as his fundamental anarcho-capitalist stance is grounded in a fallacy relating to the nature of land ownership, and an ignoring of the Lockean proviso in his understanding of how property rights arise.

      Like

      1. In the old days many banks were more honest than the government.

        During the savings and loan crisis I knew the top two guys of the United Savings And Loan in Seattle. (they sold out)
        The president had his desk in the middle of the main floor. He would sit there with his shoes on the desk, smoking cigars and reading the racing form. This guy, you could trust.

        Like

    2. The above article you have written runs to 6000 words. You are partly correct in relation to inflationary money created by governments. However, with fundamental misconceptions evident in the first half-dozen paragraphs, it does not appear to be worth whole printing off the document and studying it, which would take the best part of a day. I would be surprised if anyone at all has read the piece. If you can condense your argument into a couple of thousand words there is a chance that it might be studied.

      Land price bubbles are not caused by inflationary money; as you appear to be claiming. They are a result of the use of credit for land purchase, usually house purchase or asset purchase. These bubble/busts are indirectly a consequence of government policy, not because of lack of intervention but because governments leave the rental value of land in private hands and so land titles become the subject of speculation.

      Like

      1. I was sure that you had not understood my document, but with this comment I am 1.000% sure. To answer to you comments is like repeating parts of my document over and over again. You haven’t read the document as you admit. But you are making lots of comments. I have no problem with that. But don’t you think it would be more wise to first read the document and then make contributions? For the housing bubble I wrote another document called “the causes of the economic crisis”. I might post it here in the future. And you will be able to write comments without reading it once more. 🙂

        Like

      2. Blog entries are unlikely to be read if they are not concise, clear, and appropriately titled. If they are more than 2000 words they are also unlikely to be read all the way through – unless they are pdf documents designed to be read on a device designed for the purpose. And particular statements in the first few paragraphs are going to act as a deterrent to reading through to the end if they indicate certain agendas. The title of your piece is a defence of banking practice. Agreed, banking operates within the framework set by government and could have been prevented if different policies had been in place, but what went wrong in 2008 had nothing much to do with government fiat money.

        Like

  8. There is nothing wrong with credit. As a matter of fact, credit is the bread and butter of an economy. But credit has to be based on savings and preferences, and not be credit made from thin air (as is the case).

    I have to insist that you need to read the document more carefully. And there is also a chance that you do not want to understand and you do not realize it. First of all you have to decide whether you want to understand or disagree. If you simply want to disagree, you already did that. There is no point in writting thousands of comments.

    Like

    1. If you want to be read then you need to consider your potential audience. If there are fallacies early on, then they will not read the whole piece.

      Credit IS created out of thin air. The biggest class of creditors are employees. People give their labour for a week or a month, thereby extending credit to their employers. You give credit to someone whenever you do something for someone else, in the vague expectation that the favour may be returned in the future. Or not. Human society is founded on credit given out of thin air. It always has been.

      Like

  9. Of course I want my documents to be read. And I am flattered that you make comments. The thing is that you write comments like you haven’t read my document. Anyway.

    No, real credit is not created out of thin air. It is created by savings, preferences etc, all real factors. Like the case you are describing. You have an employee who is willing to give credit (his work) to his employee. Or the employer might decide to prepay for the month a good employee. This is healthy credit, people know exactly what they are doing. It is not the air credit that I am talking about.

    But let me put it in another way. Go to my example of free banking, that is before the central bank and the government’s laws, and describe to me the way a private bank could create inflationary money and credit.

    Like

    1. >No, real credit is not created out of thin air. It is created by savings, preferences etc, all real factors.

      Ultimately credit is caused by trust. If people didn’t trust Safeway to redeem their coupons they would not be issued. Credit ratings exist because statistical analysis of credit is trusted by lenders.

      The US dollar is the reserve currency because the US government is internationally more trusted than other major currencies.

      Like

      1. I agree with that but I do not see the relevance with my document. There is a difference between real credit and inflationary credit. Both require trust. But this is not the issue

        Like

  10. “How an economy grows” is fundamentally flawed. It ignores the role of land in the economy. Any street beggar knows the importance and real financial value of a good location. How could Schiff have missed this? Even his desert island will have a part of its coast where it easy to get into the sea and parts where it would be dangerous and difficult.Given that Able, Baker and Charlie have a relationship where they barely tolerate each other, one of them would in reality claim ownership of the bit of the island where with the safest beach, and charge the other two for using “his” beach.

    Like

  11. Then modify “How an economy grows”, and assume that at time 0, all individuals own an identical piece of land. You are missing the point of the book, which is to show how government intervention in the form of money creation distorts the economy.

    Government intervention in the form of taxation is very different because people know that the state is confiscating their savings. With money creation they do not realize it. They see paper money and they believe that their savings are there. But they are not. They are gone. Modify “how an economy grows” the way I told you to get the point of the book

    Like

    1. All individuals do not own identical pieces of land. They can not. Even in Schiff’s island model, the three sites will be different from the start. One of the sites will include the spot where Tom, Dick and Harry prefer to do their fishing from, so Tom, the owner, can charge Dick and Harry to use it. At that point Dick and Harry will cry “foul”, and it is then that the politics begins, government starts to grow, and with it all the interference that the book condemns. A model of political economy that does not take account of locational advantage ie land value, is close to worthless. Rothbard fudges this issue as well.

      The same ignoring lies behind the assertion that the banks were not largely responsible for the bubble-bust of 2008 and the subsequent recession, which has nothing to do with the general inflation induced by government-sponsored increase in money supply. Bubble-busts were a feature of the economic landscape throughout the nineteenth century, when most governments operated currencies on the gold standard. This alone defeats the argument that the banks were blameless.

      Like

  12. Of course it is not possible for all individuals to have an identical piece of land. But I am asking all socialists to think that way, so that they realize the distorted way they think. I wrote “why karl marx was wrong” to clearly show why the leftists’s way of thinking is far from reality.

    To think about something, you need to hold all other factors constant. You could argue that the person who is using the best spot should pay a fee or tax or something. But you are trying to relate this to the way governments are stealing their citizens by printing money. It is irrelevant. Assume that you have a fair tax and every fisherman in Schiff’s book pays according to how good his spot is. Nothing changes. The government should not steal all fishermen by printing money. Taxation is the honest way for a government to carry out policies.

    The problem for socialists is that taxation is unpopular. And what socialists really are? They are common thieves. And they need a way to steal. And the way they steal is by printing money

    Like

    1. I am not a socialist but would not dismiss it so lightly or vehemently, especially if one has no viable alternative to put in its place. It does not promote your case or your credibility. Socialism arose out of a set of conditions, and a set of consequential problems, which those who oppose are apparently attempting to restore, thereby re-creating the problems which people will will find intolerable and wish to change.

      Nor do I agree with printing money in place of taxation, but this will inevitably happen in the absence of a robust tax system with no deadweight costs. A related issue is the borrowing for state projects, principally infrastructure. Where these give rise to external benefits which lead to an increase in tax revenue, the practice is no different from private investment in physical capital, which also leads to an increase in the overall stock of goods (though not for purchase of land, which does not). And sometimes there are wars which have to be paid for.

      Living in what remains one of the most socialist countries in the world, it is evident that socialism can continue to bring many benefits both for the individual and for society.

      I am not trying to relate Schiff’s model to anything. It is nonsensical. Abel, Baker and Charlie evidently lack the basic human capacity of being able to collaborate. The situation illustrated below is the one that is more likely to have developed. Abel, being the fastest swimmer, would have claimed ownership of the island, on the principle proposed by Rothbard, whereby the right goes to the first claimant. Baker and Charlie would have then had to pay rent to Abel for their right to exist. That is the logic of Rothbard’s position and that is why socialism got a foothold in the first place.

      Like

    1. In many ways Sweden remains socialist. No bad thing. But socialism has left an expensive legacy. And the tax system remains a disaster for the Swedish economy.

      Like

  13. If you ever have time, have a look at this essay. You can read it and ask for a refund. I think you should be more informed about your country. I wrote it because I was tired of listening to my compatriots saying “socialist Sweden this”, and “socialist Sweden that”…

    Like

    1. The political economy of Sweden is too complex to be characterised as socialist or capitalist. There is some very big business, much of it owned by big banking outfits such as the Wallenberg. family. There is an unhealthily close relationship between big business and big unions, with the aim of keeping pressures and conflict below blow-off point. Very high labour-related taxes have led to de-industrialisation and high rates of unemployment. Bureaucracy and the tax system creates a hostile environment for small business.

      Sweden’s good fortunes derive from having a lot of space, a small population and an attidute that prefers collaboration to conflict. A further advantage is a practice which goes far back into Swedish history, the practice of Reduction, that is the Crown taking back land that was held by aristocratic families and redistributing to small farmers. The most important of these is probably that which took place in the 1680s under King Karl XI. This means that Sweden is unlike the UK, where the land ownership, reckoned by value, is concentrated into the hands of a tiny number of aristocratic families who consequently have an important influence on everything that happens. A further advantage is the existence of a land tax at a rate of 1% of capital value, equivalent to about 20% of annual rental value.

      The country is in a state of change due to attempts by recent governments to make the taxation and regulatory environment less hostile to small businesses, but there is a very long way to go in that direction. There is not much of a culture of enterprise amongst native Swedes and it is immigrants who are making much of the running.

      Like

  14. What you say is very interesting, but at the end of the day you have to answer one question. Is the Swedish success due to capitalism or socialism? And I am sorry but the evidence is clear my friend.

    Like

    1. You pose this dichotomy between capitalism and socialism. Capital is an entity so vague that it cannot be defined and in fact is never properly defined neither by its detractors or its proponents. Almost nobody will even give a coherent and consistent definition of the term “Capital”. “Free markets”, on close examination, usually turn out to be nothing of the kind. Much the same criticism, mutatis mutandis, can be levelled at socialism. As for the apparent success of Sweden, I would suggest that there are other reasons altogether than the two possibilities that you postulate. A myriad of reasons, indeed, including natural geography and a series of historical events that goes back to the occupation of the country by Germanic tribes about 1600 years ago, and the traditions those tribespeople brought with them. One of those traditions was co-operation, a notion that the sociopaths in Schiff’s parable seem not to have grasped.

      Like

  15. My friend, go read my document about Sweden (and ask for a refund) and forget about what is capital, what is free market, what is socialism, what is communism, etc. Things are much simpler than you think.

    Like

    1. If you really believe that things are so simple and that fundamental terms in economics do not need to be defined, and that you can make a judgement on a country without having lived there for a while, and without knowing the language, I don’t think it is going to be worth the time and effort of wading through what you have written.

      Like

  16. But we are not here to have a theoretical discussion. There are other people a lot more qualified to do that. We are here to use our common sense. That’s what my document is about. It is not an academic document. It is a common sense document. And you are missing the point. And you are missing the point because you don’t want to get the point. You just do not want to.

    Like

    1. Common sense is insufficient when an analysis of political economy is concerned. It needs to be grounded on a sound theoretical basis. A knowledge of the country’s history and culture is also needed. If the point you are trying to make is that capitalism is good and socialism is bad, or for that matter, that socialism is good and capitalism is bad, then I would not want to get it. Both terms are shorthand for a complex systems of organisation and the world is not so simple as advocates of systems would want to believe.

      Liked by 1 person

  17. No. You are wrong. Economics are common sense and a lot of thinking. I haven’t done a lot of thinking and therefore I do not have answers for everything, but I know that much. Economics is not physics.

    And yes, capitalism (freedom) will eventually lead to more freedom and equality than socialism (equality). The problem is that it is very difficult to establish economic freedom, which will bring freedom in all forms eventually. People who want to socialize wealth, have a great advantage. Because socializing wealth has short term benefits for the average voter, while freedom only has long term benefits.

    And we all tend to focus on short term benefits. Look at Switzerland. She became so rich because she managed to persuade her citizens that it is not right to steal somebody else’s wealth. And it so rare to have a country with such mentality, that everybody is trying to keep his wealth in this country.

    Like

    1. Capitalism cannot be equated with economic freedom. In the island example, where the fastest swimmer would have claimed ownership of the land, there would have been no economic freedom for the others. Economic freedom is impossible unless land is free, and how do you propose to bring about that situation. The entire move towards socialism from the late eighteenth century was a (misguided) response to the loss of freedom that had resulted from land enclosure. In the USA, economic freedom existed because land was freely available, at least until 1889, when there was no more west for the young men to go to.

      What you are advocating, faux-liberalism, would merely re-establish the conditions that existed in the middle of the nineteenth century. This seems to be the direction the world will go in the next fifty years. It will lead to economic and social catastrophe, global disruption and wars. Put your weight behind it if you want, but you will not like what it is going to lead to.

      Economics is more than common sense. You need to understand the relationship between events, and the chains of cause and event by which it operates, which is not always in accordance with common sense and is in some circumstances counter-intuitive. It is governed by laws, such as the Law of Rent. If it were not, there would be no point in advocating any course of action whatsoever.

      Like

  18. All socialists try to complicated things, because they are lacking arguments. Think of an economy that at day zero all individuals have an identical piece of land. This is not possible, but let’s assume it is. And let’s find in this theoretical economy which economic system is better. That’s how you should think.

    And capitalism, in its original form that is, it is free market in the same way that socialism in its original form is an economy with only social ownership. Don’t get confused by today’s mixed economies. Socialism as an economic system refers to an economy like the economy of the Soviet Union.

    Like

    1. I don’t think anyone is seriously arguing for an economy like that of the Soviet Union. But there have always been mixed economies, from the time of the ancient Babylonians. There are things that are beyond the resources of individuals or private corporations. The recent bout of flooding in England illustrates this nicely. Pure capitalism, whatever that is, cannot of its nature take account of externalities. Socialism attempts to address the issues caused by market failure. It doesn’t do it very well but at least socialists do not try to pretend that capitalist systems could cure all that is wrong with political economy, nor that the state has no legitimate function.

      Now that full-on socialism is discredited, it is time to establish what that legitimate function is. I would suggest that one of the functions is to hold the ring so that the lions don’t gobble up all the smaller animals.

      Like

  19. I did not say that anyone is arguing in favor of a soviet style economy. Some actually do, but not you. I am only saying what socialism actually is. It is not a mixed economy. It is an economy with 100% social ownership of the means of production. In the process of time that changed, and most people use the word socialism to describe a mixed economy. But the original meaning of the word is as I said.

    On the other hand there can’t be a pure capitalist economy, because capitalism needs the state to provide a judicial system, defense etc. Pure capitalism is to have the minimum state possible. That is a state that guarantees everybody’s freedom, and the undisturbed working of the economy.

    Like

  20. Paid by taxes of course. Is there any other way? Direct taxes though and not indirect. So that everybody knows what is left in his pocket from his savings. So that everyone consumes according to his real wealth, and not the wealth he would have hadn’t the state taxed him. And so that everybody realizes that the state is paying with his money and pays attention on what the money is spent.

    What is this link you sent me? Tell me a few words because I have read a lot lately, and I do not think that I can handle more reading in the foreseeable future.

    The real question though, is what you are doing here. The document is obviously alien to your way of thinking. So what attracts you so much to this document?

    Like

    1. You do not know anything about my way of thinking and what is, and is not, alien to it, or you would not have made the comment in your last paragraph. Leon Maclaren who wrote the article to which I sent you the link, was the son of the Scottish Labour MP Andrew Maclaren, 1883-1975. He did a lot of thinking on fundamental issues relating to political economy. If you are not going to read him at least read Plato’s Republic if you have not done so already.

      Are regards taxes, most contemporary means of raising public revenue are nothing more than legalised robbery so presumably you do not support them. The other issue is the matter of tax incidence – the economic impact of the tax is not necessarily on the individual nominally responsible for paying the tax. An example is income tax, the incidence of which falls on the employer. The notion that employees pay tax is a smoke-and-mirror illusion based on the fiction of “gross pay”. As I said earlier, common sense does not take one far when considering economics. Nothing is quite what it seems on the surface.

      So I repeat the question – how should a minimum government be paid for? What taxes would you propose?

      Like

  21. You assume that I consider tax as robbery. Not at all. I believe a society has to set minimum standards of living. On a scale of 1 to 100, if the average citizen is enjoying a welfare of 60 lets say, you must provide a minimum of 20 for everybody (random numbers).

    Where I disagree with socialists is the following. You first need to teach the individual that the most important thing in the world is himself, and then to teach him that he must care for his fellow citizen. We should not feel guilty if we feel that we are the center of the universe. We are the center of the universe. And if we believe so, no wars can occur, because we cannot believe that anything is more important than ourselves. A good person is a person that thinks 75% about himself, and a mean person is a person thinking 95% about himself (approximately).

    Anyway, the answer is direct taxes. If I produce an orange per hour, and I make a profit of 100 dollars per hour, I should pay 20-30% on taxes. Even a bit more I could accept. And nothing else. No VAT no nothing. You know that for every profit you make, you pay 30%. And that’s it. No VAT, no property tax, no inflation tax, no nothing. And a part of that 30% (random number) should be spent on my local community.

    I do not claim that I have a concise economic plan or philosophy. I know nothing my friend. But I can use my common sense. And common sense and a lot of thinking is all it takes. I have common sense and I have done a little bit of thinking.

    I am sure your link is very interesting, and Plato is very interesting, but it really seems I read more than I should have lately.

    Like

    1. If you have produced 10 widgets, surely they are your property to do what you want with them? Why should government have a claim on the product of your labour ie 3 of them? If someone else produces 20 widgets, why should the government have a claim on six of them? People who work the hardest are getting punished, and so is Abel in Schiff’s story, the ingenious one who gave up his food for a day to make a fishing net. A tax on his wages might have made him decide not to bother.

      There is another problem with your income tax which is the busker story here, a more realistic parable than the island with the three fishermen who won’t work together.
      http://www.landvaluetax.org/theory/sounds-from-the-deep.html

      Like

  22. It is good for me to pay income tax, so that you are not hungry, you are educated etc, so that you do not come and kill me, so that I can feel safe etc. I will pay for my own benefit. You can built a welfare state on the notion of self interest.

    I disagree with your article. I haven’t finished it because my disagreement is fundamental. We should all be allowed to bid for each post. The best offer takes the post.. Am I missing something?

    Like

  23. Land tax is contrary to property rights. There is no justification for land tax since land is purchased with money from income, on which income tax is paid. That you can certainly call theft.

    Like

  24. You are missing a lot. Go back to Shiff’s island, or rather, a real version of it. Abel was first ashore and claimed that the island was his. So he collects rent from Baker and Charlie. For ever. That is not the whole of the story either. Please re-read the piece about the buskers. It is a realistic model of the economy. Equal inputs of labour and capital do not result in the creation of equal amounts of wealth. Marxists and liberals both ignore this fundamental and readily observable fact. The busker will pick up more at Victoria will earn more than he will at Roding Valley (the quietest station on the London Underground).

    Charging rent for the pitches is essentially the same as allowing them to bid, provided that the rents are set at a realistic level for each pitch. There are many pitches which buskers would be willing to use as long as they do not have to pay rent, because if rents are charged, the buskers will never earn enough to make it worth the effort. These are the marginal pitches. (you cannot work this out by applying common sense alone). If marginal pitches are free, then the number of productive sites is maximised.

    If, on the other hand, the buskers are asked to pay a proportion of their takings wherever they are, then the buskers at the best pitches are left with more than those working at the quieter places. That is how income tax operates. Under a system of “income tax” the busker is retaining some of the rental value of the location. Worse still, locations where it would just about be worth working at if nothing had to be paid ie the marginal locations, become sub-marginal if some of the earnings are taken. An entire swathe of busking pitches is effectively taken out of use. In reality, it is why the economies of places away from centres of population – Scotland, Cornwall and Northern England, suffer from permanent depression. The system of taxation pushes them below the margin. The government then has to fork out billions of pounds in welfare benefits.

    A further issue with income tax is that wages tend to a level which is the minimum workers will accept. If income tax has to be paid, then they will require higher wages than if there was no income tax. Think about it in your own case.

    The INCIDENCE of income taxes is on the employer, who then has to pass them on to the customer, and it also cuts into the employers’ profits and reduces the rent he can afford to pay, so it is partly passed on to the landlord. This is a relationship that you cannot deduce by common sense.

    Like

  25. How can it be that land tax contrary to property rights but income tax is not contrary to property rights. You made ten widgets with your own bare hands. They are your property, are they not? You exchange them for the things you need, so what you have receive in exchange is also your property. But because it is more convenient to use money, this exchange between widgets and your necessities takes place in two stages. So where is the morality in having a goverment official intervening and taking away, in effect, three of the widgets which are your property.

    As for land taxes being immoral. Nobody made land. Protecting people’s rights to secure occupation of land is, as you say, a fundamental duty of government. Why should people not pay for that protection? Furthermore, if you look at the origin of land rights, they were normally through the exercise of force, or, rarely, on the principle of first-come-takes-all, or at best, first-come-takes. This is Rothbard’s position. Where is the morality?

    Like

  26. First of all a “rent” comes from the government, while a “bid” comes from the market. Very different things, very different economic models.

    As I told you before, let’s forget about real world problems. Let’s talk about a theoretical and easier to grasp environment i.e. where we all have an identical piece of land at day 0. Once we decide which economic system is best for such an environment, we can see what modifications are required.

    I am asking for simplicity and you are asking for complexity. This is always the case with libertarians and non libertarians.

    Like

    1. Rent is payment for a location. It is the perfect expression of the operation of the market. Governments do not set rents.

      If we accept your starting condition where everyone has an identical plot of land at day 0, we can return to Shiff’s island and divide it into three. But even at day 0, the plots will not really be equal. One will get a bit more sun, and be better for growing things, another will have the better beach and the other’s will want to use it for fishing from, and so on. Now let us suppose that some women arrive and the original inhabitants all have families. How will their children and grandchildren divide the space between them. And then the people get more prosperous, build a harbour and some roads, and set up a market place. The differences between the different plots of land become greater every year.

      Simplified models are a good way of understanding complex processes in economics, but not if they are so simplified that they are completely unrealistic. And “systems” cannot be simplified to the point of meaningless either. The Monopoly game is a good example of an economic model that remains true to reality in its essentials. It illustrates, amongst other things, the suck-up effect that occurs when rents remain in private hands.

      Like

  27. I did not say that we have to stay with the example of a very simple economy. I said it is worth thinking in such simple terms first and then continue to the real world.

    The thing with the harbor is very simple. If the market cannot produce it, and if it is really needed, and if if citizens know what they are paying, the government should tax them and build it.

    When rent is paid in a private agent, yes it is a market process. But when it is paid for government it has to take the form of bids.

    This is a great article for the myth of economic monopoly

    Click to access SimpsonWeb.pdf

    Like

    1. Staying with the island for a moment, let us suppose that the inhabitants agree to put it somewhere selected at random. The situation that then arises is that whoever happens to be closest to it can develop his land with warehouses and a market place, and it will then become the hub of the island’s activities. He will become the monopoly owner of the most valuable land on the island, as will all successive owners of that land. The owner of the land at the opposite side of the island cannot compete, since all goods must be carried across the island. Therein lies the core of the fallacy which the article is trying to defend through clever argument and the presentation of half-truths as uncontestable facts. In reality the situation he is arguing for is dog-eat-dog. I was astonished that he defended Microsoft, which in reality is an example of how a firm can become almost overwhelmingly dominant whilst selling a poor product and giving bad service.

      Like

    1. You do not know me yet you came to a conclusion which was absolutely not true. However, if you want to progress your ideas I would strongly urge you to study carefully Chapter 25 of Leviticus. This is, I would suggest, taken with Plato’s Republic, a sounder basis for developing a body of philosophy in the area of political economy than the works of Murray Rothbard, Bruce Benson and the school of von Mises. Certainly they have some useful insights but these have to be sifted from the dross and the downright dangerous.

      Like

  28. But I am not claiming that I have developed a coherent ideology. What I do, is simply saying “this is a white wall and not a black wall” when I see a white wall. I am making some observations. But some are of fundamental importance.For instance to realize that when one’s life is the ultimate value, no wars can take place, is of great importance. Because if self interest is the ultimate value, it is not moral for a country, a religion, a something, to ask you to risk your life. This is a fact.

    But there is a coordination problem. What happens if this takes place in one country and not in another? How do you defend this country? That would be a reasonable argument. But you are not saying that. You are saying that the wall is not white. You say it is black.

    Like

    1. It is impossible to make sound judgements except from a standpoint of coherent ideology. I do not believe that you consider that self-interest is the ultimate value. With a name like Alhadeff you have an illustrious tradition to uphold. Please try to live up to it.

      Like

  29. Hahahaha!!!! I was wondering what you are doing here. I thought it was the name, but then I thought that maybe you simply found the document interesting. So it is the name? The Alhadeffs are moral and individualists my friend. Self interest is moral.

    Like

    1. I was more interested in the document initially, since it articulates a view of political economy that I find both abhorrent and intellectually unsound. But I did wonder about your first name, which is presumably Greek, and the Alhadeff was a mystery so I looked it up.

      All sorts of political doctrines caused pain in the 20th century, as you will be only too aware. What you call “socialism” is usually referred to as Marxist communism. Democratic socialism is a different beast and at its worst it produced societies such as 1950s Britain. Both are spent forces. Fascism ie xenophobic nationalism, is not however, and the body counts of the two twentieth century tyrannies were about the same.

      The individualist sociopaths described by Schiff encapsulate very nicely the libertarian stream of thinking in the tradition of Rand, Rothbard, Benson et al. and they what will goes the great pain in the 21st century. At the same time there will be militant Islam to deal with. We are in for interesting times. I would not fancy being around in the second half of the century. Naked self interest is alien to the tradition to which you belong and you really should know better than to be promoting this kind of thing.

      Liked by 1 person

  30. But you can be an individualist and still think about yourself only 75% of the time. You can still leave a 25% for others. This is what good people do in reality (family excluded). I am not talking about naked self interest. I am talking about self interest with honesty.

    And I am not saying that a person who was not fortunate to go to school should have the same decision power as an academic. I could therefore accept that democracy must have some means of ensuring that the elite decides how things will be done. But that can be justified only when individualism is preached at the same time. And this is not what we see in reality. Look at how many forces ask people to act if they are not the center of the universe. Church, country, socialism of one form or another.

    And when I say the obvious, I am called an individualist psychopath. There is no balance my friend. That’s why I am barking so loudly.

    Like

    1. I am not calling YOU an individualist psychopath. I don’t call people rude names. I referred to Able, Baker and Charlie on Schiff’s island as individual sociopaths ie people who were incapable of co-operating with each other. This is unfortunately an attitude that is widely held up as desirable, especially in the US by advocates of free market individualism modelled on the homesteading era. You should not be supporting this sort of thing. It probably originates with Calvin. If you want to put together your own theory of political economy, you need to start with Plato and Scripture, and take heed of the principles set out in the Catholic Social Teaching documents Rerum Novarum, Quadragesimo Anno, Mater et Magister, Centesimus Anno and Caritas in veritate.These are available in translations in many different languages so you probably should not have to struggle with the English. There is also the work of Henry George and Leon Maclaren.

      The Austrian school is best ignored. They merely want to support unjust privilege under the guise of promoting economic freedom. That is what is known as humbug.

      Like

      1. Thank you for the recommendations. But so many things to read…..But I totally disagree with your opinion about the Austrians. The Austrians represent the pure economic way of thinking. Without considering political and social complications. Not that I know much about the Austrian theory, but for me the Austrian school is what we should call the “how the economy works” school of thought.

        And of course there are political and social considerations to be addressed, but we can not afford to ignore the “how the economy works” school of thought in the public debate. And we often do so. And if we ignore it for a long time we go bankrupt i.e. Greece. And you have to remember that we live in two very different countries. There is a great difference between your Swedish socialism and our Greek socialism. Huge difference.

        Like

      2. The Austrians, like most economists since 1890, ignore the particular role of land in the economic process. So they are fundamentally useless or worse, I can appreciate that as a reaction to the Marxist fallacies they have a certain appeal, but it is a waste of time studying them. Greece’s problems are those of bad government and are, I would assume, part of the inheritance of Ottoman occupation. Swedish socialism has left a mixed legacy but like its British counterpart it was not sustainable and had run its course by the 1970s. It needs to be remembered also that many companies in Sweden did very well out of World War Two by selling stuff to both sides, and came out of the war with undamaged. That is part of the luck of geography. The country is tucked away in a corner of no strategic importance. It has a difficult climate, a lot of space, few people, little in the way of natural resources and nobody else can understand what people are saying.

        Like

  31. The Swedish economy is in many respects more free than the American and British economies. What is very important in the Austrian theory is their explanation of business cycles. Look what happens now. People think that the economic crisis is a market failure and ask for more government. While it is a crisis of government intervention (as the Austrians say) and therefore less regulation is required. But there is so much propaganda that the Austrian view does not exist.

    The fail of the Greek economy is partly due to corruption and partly due to socialism.

    Like

    1. I referred your article to another commentator, Mark Wadsworth and this was his response.
      “Whether it’s Faux Libertarian or not doesn’t matter, the point is he is completely and utterly 100% wrong on the facts.
      Governments, central banks, commercial banks, building societies and anybody who has ever bought on credit creates money in the same way. There is only one way of doing it. What follows from that must also be rubbish.”
      What is referred to the business cycle was first explained by Henry George. It is an effect of the interaction of the banking system with the land market. There is a positive feedback loop in the system. Positive feedback loops give rise to cyclic oscillations. The mathematics of interest rates appear to lead to a periodicity of 18 years. This can be traced all the way back to 1800. The past three cycles, bottoming out in 1974, 1992 and 2010, illlustrate this clearly. Politicians and economists do not like to accept this. The phenomenon has been analysed by, amongst others, Fred Harrison and Philip Anderson, the latter in “The Secret Life of Real Estate”. The Austrians and the Keynesians have had nothing to say on the subject, which makes their work essentially worthless. The Austrians and the neo-libertarians are concerned mostly with defending existing property rights against humanity at large, under the pretence of advocating freedom. And you should not be lending your support to their project.

      Like

  32. Private banks cannot create inflationary money my friend. Actually that’s the point of my document and not business cycles. And for me it is a fact, not merely a view. You do not have to accept it as such of course.

    Like

  33. And I do not find the expression “faux libertarian” negative, since I am just making some observations and I cannot claim to have a complete ideology. I call my self libertarian without having thought about it adequately though.

    Like

  34. I got a lot of publicity from you my friend. Given you disagree with my document I really appreciate it. If I knew I would have written something more in accordance with your tastes, to get even more publicity.

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s