Hopefully at least some of you now reading this have read my last 4 posts or so, where I have tried to make the case that our system is broken. Here, I begin to offer solutions. Step one in solving any problem is defining what the desired outcome is. That is the concern of this piece.
Tomorrow I will post the actual proposal, which I now believe has actually been tried and used before, in part. That will be a topic of research for tomorrow before it goes up.
For now, please read this with an open mind.
Free market capitalism has two key components: free markets, and capitalism. This seems simple enough. As things stand today, neither applies fully to our banking system.
To consider this topic more fully, let’s consider the question of what a capitalistic, free market banking system would look like.
Here Capitalism will be defined as the use of profits from business to fund growth through reinvestment.
A free market is one in which no enterprise has a legal monopoly through which the forces of supply and demand can be artificially altered.
To begin with, inflation—which is to say the creation of money from nothing--is inconsistent with capitalism. We need a certain amount of money, but the precise quantity doesn’t matter. If a pencil costs $2 and you make $2 an hour, has anything changed if it costs $4 and you make $4 an hour?
Capitalism works best when prices only change with changes in efficiency. This leads necessarily to deflation, which is to say an increase in the purchasing power of money. Deflation, in turn, provides an incentive to save, which is to say to personally capitalize your purchases as an individual and as a businessman. This is quite obviously the opposite of a reliance on borrowing facilitated by money creation, which as an economic system I have labeled "Monetary Mercantilism".
This fact—that our purchasing power should be much, much greater than it is--is actually quite sad, because once you grasp it fully, you realize the sheer quantity of waste we have seen over the last 100 or more years.
To be clear, if at one moment there is no money, then in the next there is, that money does not thereby become "capital". It is what economists call "fiat money". As I have already stated, those who control that process are positioned over time to own everything in our country, since they can get something for nothing, over and over and over. This is the process of inflation, and a just system would abolish it.
I should demolish a common misconception here, too. We hear, over and over and over, how our economy has to grow every year. If we don’t grow for some reason, economists fret. What is actually happening is they are fretting over the lack of credit expansion. If people don’t borrow, then we might lapse from our current system of Monetary Mercantilism back into genuine Capitalism. The bankers don’t want that, and neither do their spokespeople.
The simple reality, though, is that many human societies have existed in relative stasis for thousands of years. At a certain point, enough is enough. If we had actually been able to keep the fruit of our labor—if our money was worth what it should have been worth, if we had not turned the keys to our lives over to Wall Street and Washington—our economy would likely be contracting, and no one would care. We would have plenty of money to live comfortable lives. We work so hard and so feverishly only because most of the product of our labor goes somewhere other than our pockets.
As far as free markets, the Federal Reserve prevents interest rates from reaching their natural levels. They do this by creating money as needed to keep us all awash in a sea of credit. When they create money, they affect the supply/demand equation by increasing the supply.
If the amount of money in circulation were fixed, then the price of that money—the interest rate charged—would go up as demand went up, and down as demand declined. This would automatically prevent the ups and downs of the business cycle, since it would incent rational investing behavior, and not gambling with other people’s money.
A truly capitalistic bank would make money in three ways. First, they would warehouse people’s money. If you don’t want to keep your cash in a safe or your mattress at home, you would pay them a nominal fee to keep it safe for you. Private companies could come into existence to provide insurance for them in the event they were robbed.
Secondly, they could borrow money from individuals for a specified amount of time and rate of interest, and then loan it out at a higher rate of interest. This arrangement today is called a Certificate of Deposit. I am not in any way calling for an end to business or personal loans. I am calling for an end to loans of money that is already spoken for. Loans could still go into default, in which case the bank absorbs the loss, and will still owe the depositor. Again, private companies could be created to whom dues are paid in exchange for insurance against this. Good banks that make good loans would pay nominal rates, and risk-takers would pay higher rates. This will be a free market in banking.
The third option would be charging for clearing checks and debit card transactions. Currently, that is done through the Federal Reserve System. An argument used for this is that it prevents one bank from not accepting the checks of another. With 100% reserve banking, this would not be a problem, since all banks will have to have the money to clear checks drawn on their accounts. You pay a flat rate per transaction, or a monthly fee, or however your bank structures it in a free market.
What free market, capitalistic banking will not include is fractional reserve banking.
We have covered it directly. Now let’s use an analogy. Think of fractional reserve banking in the following way: a friend asks you to watch his house while he is away. You look at the empty house, and realize you can rent it out for your own profit. He comes back from time to time unexpectedly, so you can only rent it out a certain amount of the time. The luckier you feel, the more time it stays rented. When you do finally get caught, though, he fires you. This is the equivalent of a banking panic. Panics are an inevitable result of lending money you don’t have.
All the Federal Reserve System, the FDIC, and the various Congressional bailouts serve to do is gloss over the fundamentally dishonest, illusory nature of our system, which is unsound in its very basis. It is a deck of cards, propped up by inflation/fiat money creation, which is to say the Federal Reserve.
If there is no variation in the quantity of money, there is no need for monetary policy, because monetary policy can only be the solution to business downturns because it is the cause of business downturns. It is no exaggeration to say that all the Fed does is inflate and deflate our currency—which is a damaging, not a necessary function--fund Federal budget deficits, and protect banks from the consequences of stupid risk taking. Particularly since inflation is wealth transfer, it is inconsistent with a just economic system.