Printing Money for Wall Street

March 19, 2008

by Oskari Juurikkala

The global financial system is in a deepening crisis, largely due to greedy gambles with complex financial derivatives. The bailout of Bear Stearns Cos., in which the Fed provided $30 billion loan to J.P. Morgan Chase to acquire the investment bank, is only the latest -- and probably not the last -- rescue mission from the central bank. Overall, the response of the Bernanke-led Federal Reserve to the global financial meltdown has been exceedingly simple: lower interest rates.

It is debatable whether that is an effective solution to the problem. It risks destroying the international demand for dollars, and a declining exchange rate would imply rapid price inflation at home as well as increasing pressure on foreign investors to take their money out. Both effects would exacerbate the crisis.

But that is a technical issue. The Fed strategy raises more fundamental issues.

When a central bank lowers interest rates, it engages in an activity that is loaded with moral meaning. The jargon of the macroeconomist can be misleading. Lower interest rates are achieved by increasing the money supply, which is basically equivalent to “printing money out of thin air,” and selling it cheaply to the banking community (although technically it is now achieved by creating fictitious accounting entries).

The moral dimension becomes plainer if we consider a private person doing that. It is called fraud. Counterfeit money enriches the fraudster at the expense of the rest of the society. Creating more paper slips does not bring about more economic resources (production or consumption goods), but only serves to redistribute them. The counterfeiter immediately acquires additional money at his disposal, whereas the purchasing power of the money balances of the rest is slowly eroded.

Modern central banking claims to serve lofty goals: high employment, price stability, and economic growth. In fact, it only enriches those who run the system. Sometimes it is the national government. Consider, for instance, Robert Mugabe’s Zimbabwe with its well-over 1,000 percent (and rising) inflation rate.

In other instances, the central bank is a private entity serving the interests of the financial elite. This was true of most central banks historically, including the Bank of England (founded in 1694), which was only nationalized in 1946.

Unbeknownst to many, the 1913-founded U.S. Federal Reserve System also comes under this category. It is a private corporation owned by its member banks, about whose owners little is known. As a special privilege, the Fed has never undergone a complete independent audit, and it is claimed that it keeps some of its records secret.

One may also challenge the lofty goals of central banks. Inflation is largely caused by increasing the money supply. In consequence, inflation encourages living on debt and discourages prudence and thrift.

Moreover, by creating artificially low interest rates, central banks foster damaging boom-bust cycles, as economists Ludwig von Mises and F.A. Hayek demonstrated. The dot.com bubble, which collapsed in 2000, and the real estate and overconsumption bubble, which is coming to an end today, are just the most recent examples.

So much for stability, economic growth, or high employment.

The Old Testament provides some principles on sound money. Complaining of the sins of Judah and Jerusalem, the prophet Isaiah denounced monetary debasement: “Your silver is turned to dross, your wine is mixed with water” (Isaiah 1:22). Likewise, the Lord exhorted the Jewish people: "Do not act dishonestly in using measures of length or weight or capacity. You shall have a true scale and true weights…” (Lev. 19:35-36)

Debasement and tampering with weights and measures have been a temptation throughout the history of money and banking. They are the essence of the more complex methods of monetary inflation practiced today.

Then there is fractional-reserve banking, the use of demand deposit money in lending business. Many economists, including Milton Friedman and others at the University of Chicago in earlier decades, have identified it as the source of banking instability throughout modern times. Fractional-reserve banking was censured already by Roman jurists, who found it dishonest and legally unsound. Yet modern scholarship shows that it was precisely this instability that provided the justification for inflationary central banking.

The Founders of the United States grasped this. In his letters, Thomas Jefferson wrote numerous lines on the problem with unsound money. In an 1817 letter to Josephus B. Stuart, he noted the consequences of paper money: "That paper money has some advantages is admitted. But that its abuses also are inevitable and, by breaking up the measure of value, makes a lottery of all private property, cannot be denied.”

Jefferson likewise understood the problem with unsound banking. In a letter to John Taylor he said: "I sincerely believe\... that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity under the name of funding is but swindling futurity on a large scale." (1816)

These courageous words ring remarkably relevant today. The roots of the current crisis lay in the manipulation of the money of American citizens. More of that will not solve the problem. Will we have the courage to go to the heart of the matter?

Trained as an economist and lawyer, Oskari Juurikkala works in research, finance, and mining. His consulting firm, Ansgar Economics, advises on macroeconomics and investment strategies. Mr. Juurikkala is founding editor of Kultainfo.com, the leading precious metals website in Finland, and author of Pensions, Population, and Prosperity (Acton Institute, 2007). Send him mail.

Comments

richard ricardo: fishing4@racsa.co.cr

i would like to know the nationalities of these banking elite whom control the entire us economy and what is their true long term objective ?

Robert Promm: rpromm@pacbell.net

A couple of observations.

Want to see the last audit of the New York Fed? It was completed by Deloitte and the URL is here: http://www.ny.frb.org/aboutthefed/annualreports.html. Each of the 12 member banks of the Federal Reserve has its own separate annual audit and you can get all 12. The NY Fed is offered just as an example.

Thomas Jefferson was not a paragon of fiscal virtue. He did go bankrupt. Did he mess up or was he a "victim" as many would claim for their own circumstances today??

What about the Scriptural principle "...for to every one that has shall be given, and he shall be in abundance; but from him that has not, that even which he has shall be taken from him." Is that only spiritual or does it apply to everything? The parable was about money ;-)

Clare Krishan: Clare.krishan@comcast.net

CNN reports "Federal Reserve cuts to interest rates benefit banks, not consumers"
http://money.cnn.com/news/newsfeeds/articles/newstex/AFX-0013-23897509.htm

Corporatism? Power corrupts?

Clare Krishan: Clare.krishan@comcast.net

Thanks for the focus on the philosophy (search for Truth) of the market. Perhaps on this Good Friday we people of faith ought remind ourselves, what is the 'marginal utility cost' of the factor "labor" **after** the Incarnation, where the Son of Man died on the Cross. What cost Discipleship, how cheap Grace?

I would welcome a discussion of the lapse in publishing the M3 money supply numbers - in the US does capital really just mean "faith" in fractional reserve credit leveraged on State-owned collateral? How does the market know what the "marginal utility cost" of the much vaulted theoretical "prime" (below which sub-prime is a bad risk) is in a recession where the State bails out negative positions held - when does the "science" of economics become mathematical alchemy?

Thanks, wishing a reflective and Holy Triduum...

P.S. I posted your article to the blog thread here:
http://blog.acton.org/archives/2245-Can-Any-Good-Come-from-a-Recession.html

and more discussion on Left-Right "dirigisme" under Mr Bradley's article. And if "atheistic" global capital markets can be considered just so much mathematical alchemy, I think Rev. Sirico may have misidentified which political economy is plagued by "Liberation Theology"___ ;-) ___ it could be closer to home than states south of the border... try Pennsylvania Avenue, Washington DC !

David Hodge:

Frankopan raises precisely the point that Juurikkala misses: growth in the money supply is a two sided coin. On the one side is Juurikkala's argument against the Fed and the feudalistic view of the lords boosting the value of their fiefdom at the expense of the serfs. On the opposite side, given a non-feudal society, liquidity is the oil of commerce, without which growth and ingenuity starve. For a more practical, historical view of this subject, see The Autobiography of Benjamin Franklin, in which the owners of the private money supply (unsurpisingly, the lords) were petitioned by small businesses to print more money in order that their commerce might more easily be accomplished, because money became scant.

The argument of money must reflect the appropriate condition of the underlying world, which is dynamic and therefore not zero-sum as many gold standard bearers seem to assume. Thus, the supply of money must at once support the growth of the economy while also avoiding outright debasement of the money supply. Note that the Fed action, consistent with its TOMO operations, are lending operations. As in repaid, with interest. When you pay the Fed interest, isn't that taking money out of the system? Then there is also the matter of liquidity in the CDO market, which has induced the failure of BSC. Why not pass the hand to the strong until the market recovers something resembling an appetite for risk? In case you think I'm mistaken about risk appetites check the 90-day TBill yield relative to a 50-year chart. Now is not the time to go radical on the banks - let cooler heads prevail and chart a course to recovery from that point. The worst is not yet behind us, and clamoring about only heightens the tendency toward anarchy.

Chris Manes: lokicsm@aol.com

This is all the result of deregulating the financial markets, which always implode in a fit of greed if left to their own devices. At the very least this argues for the need for a US national bank that loans funds for real production and services and not "side bets" of the kind that hedge funds represent.

But all this is just a side show. The real event under the surface here is the decoupling of capital and production, as the rich seek ever greater rates of returns using nonproductive investment channels like hedge funds. The result is, capital is no long involved in raising wages and standard of living. And once this happens, it's time to reform the entire financial system from the top down to make sure capital is invested in production of services and goods that raise standards of living, not just the income of the superwealthy.

Nicholas Frankopan: nfrankopan@hotmail.com

I agree wholeheartedly that rampant inflation (or debasement) is wrong.

But, for example, if the money supply does not match the growth of the economy this creates a dearth of liquidity. This in turn might make it hard for good business ideas to be translated into reality. At a macro-economic level and in a fully industrialized (and monetized) society managing this balance is more of an art than anything else. If we accept this basic function (of a central body setting interest rates) then we can move to this particular period in question.

The latest spate of lowering interest rates may one day create inflationary pressures. But evidently that is not the case now. We are battling deflation in the economy, mistrust between the banking institutions and a brittle outlook for investors. I believe it is fully justified morally and economically to take these emergency measures. Once we are through this extraordinary period and systemic risk has been seen off ... then we can deal with the risks emanating from low interest rates.

Paul Nollen: paul.nollen@skynet.be

Hello Mr Juurikkala,

other proposals for monetary reform :

the AMI http://www.monetary.org , www.socialcurrency.be and their links pages

Kind Regards
Paul

Acton Commentary