Economic Stability

The AMI‘s Dick Distelhorst wrote a lengthy rebuttal in the comment section of the von Mises blog article: The Dangers of Monetary Reform, which we reprint here:

Note: The first paragraph of each section below is taken from the Misesblog posting, followed by my response. DD
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KG: Many libertarians would favor a return to the gold standard, while others would be content with simply repealing legal-tender laws and allowing competition in currencies. However, even in a great collapse like the one looming now, these reforms may still seem too extreme to the general public. This is especially true if they have an alternative that seems reasonable and gives total control over the monetary system to the state. One such alternative is the 100-percent-reserve solution advocated by Stephen Zarlenga, director of the American Monetary Institute, and author of the book “The Lost Science of Money.”

Response: Zarlenga advocates a system to take back control of our money and use government issued money instead of using bank created interest-bearing debt as a substitute for money. It is not a 100% reserve system, it is a money that benefits the people, not the bankers, system.
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KG: I caught an interview with Mr. Zarlenga on Gnostic Media, in which he discusses his book with host Jan Irwin. The first part of the interview was broadcast on August 30, the second part on December 20, 2009. Neither Zarlenga nor Irwin are economists, but both have strong opinions about economics and economists.
On several occasions, Zarlenga singles out the Austrian School and makes unfounded claims about Austrians, their methodology and their approach to monetary theory in general. In this article, I will attempt to correct Zarlenga on the issues he has with the Austrian School and his ideas on monetary theory in general.
The Definition of Money
Zarlenga claims that Austrians define money as gold, a definition that according to Zarlenga has its roots in the classical economics of Adam Smith. I’m not sure on what he founds this claim, but, obviously, it is not true.
Generally, Austrians define money as a good that is commonly or universally accepted as a medium of exchange. It was the invention of money that allowed the transition from the ineffective barter economy to the dynamic indirect-exchange economy. The Austrian focus on gold is mainly due to the fact that over time the market has selected gold as the primary medium of exchange. This means that while gold can be said to be money, money is not necessarily gold.

Response: If Austrians define money as a good, that means a commodity. And they, as stated, accept gold as money, which is what Zarlena said. Gold is a commodity. Silver is a commodity. Tobacco is a commodity. All have been used as money in the past. Money has been many different commodities. And, unfortunately infrequently, it was simply a creature of law: paper or coin, issued by the government, a token with no intrinsic value that served as money. This is what the American Monetary and Financial Security Act advocates. Money, issued only by the federal government. A fiat money which meets the three main criteria for money (1) a medium of exchange, (2) a measure of value and (3) a store of value. Such money does not require that we, as a people, must go into debt in order to have money, as the present system does. Such money is created out of nothing and must only be created by the peoples’ government on behalf of the people. The present Federal Reserve System “debt-money” meets the first two criteria, but has failed badly on the third – since 1913, when the Federal Reserve Act was passed, the dollar has lost over 95% of it’s value. Go to the link below and check this for yourself. The Fed has totally failed to stabilize the value of the dollar, which was one of its main objectives.

http://www.westegg.com/inflation/infl.cgi

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KG: Zarlenga misses this completely. He also disagrees with the Austrian notion that money is something that arises naturally on the market. The Austrian position is supported by the fact that many things have been used as money throughout history in various parts of the world: commodities such as salt, clamshells, and animal skins. Zarlenga will have none of this.

Response: See my last response, above. Zarlenga even points out the use of various goods for money. The fact that many things have been used for money in the past proves nothing other than many mistakes have been made in the past and we should have learned from those mistakes.
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KG: Instead, he advocates what he calls the Aristotelian view, which is that money doesn’t come about by nature, but by law. In short, the market can’t produce a monetary system; only the state can do so. This view is of course refuted by the very existence of the various money commodities mentioned earlier. Zarlenga does not address this issue, however, nor does the host raise the question.

Response: Zarlenga’s book, The Lost Science of Money, does not say that the market can’t produce a monetary system, it gives many examples of exactly that. He simply points out that these systems have failed and that Aristotle was correct when he said that money is a creature of law. To have a fair system which benefits all, not just some, of the people, money must be created, issued and regulated by the state. This is what Zarlenga advocates and this is what The American Monetary and Financial Security Act proposes. It appears that Mr. Grussner may not have actually read the legislation he criticizes.
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KG: The mistake Zarlenga makes is that he confuses state intervention in the monetary system with state provision of a monetary system. To be sure, the state has injected itself into the monetary system for centuries. But this does not mean that the market is unable to provide a monetary system. On the contrary, when the state injects itself into a monetary system, it in fact injects itself into a system provided by the market.

Response: When you understand that the only fair and just monetary system is when money is created, issued and regulated by the state for the benefit of the people, you also understand that the market has never created a fair and just monetary system. It always produces a system which benefits those that create and run the system. In our representative democracy, those who represent the people should develop and run the system so that the benefits inherent in the power to create money out of nothing accrue to the people in general, not to the select few who run and benefit from the present debt-based system.
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KG The American Monetary Act
What is the 100-percent-reserve solution Zarlenga advocates? It is set out in a bill sponsored by Democratic representative Dennis Kucinich called the American Monetary Act. It has three key elements:
The Federal Reserve must be nationalized and brought into the US Treasury, making it part of the government.
Private banks must be stopped from creating money through fractional-reserve banking. Only the government should create money.
Government would then print money and spend it into circulation on various programs, such as infrastructure.

Response: The above statements are correct, but incomplete.
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KG: The aim of the bill is to transfer the money power, as Zarlenga puts it, from the private Federal Reserve System directly to the government. It would be government who creates all the money, not the banks. Instead of the government issuing bonds and paying interest, it would be receiving interest from anyone it lent money to.

Response: The last sentence above is incorrect. It should say “instead of the government issuing bonds and paying interest, it would pay off the National Debt represented by these bonds by simply exchanging them, as they come due, for non-interest bearing U. S. money.”
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KG: This would also reduce taxes, as the government could print the money it needed to fund various programs instead of taxing it away from the public. For instance, universal healthcare and education could and should be funded by government-printed money, according to Zarlenga. In addition, the government would spend money on infrastructure.

Response: Obviously taxes could be reduced when the government does not have to borrow its own money from privately owned banks and then pay them interest for the use of its own money. The author of this article seems unaware of the fact that, under the present fractional reserve system, all our money (except coins) is in the form of interest-bearing debt. No one can have even one dollar unless someone, somewhere, has borrowed that dollar from a bank and is paying interest on it. This debt- based, interest-bearing ‘money’ is inherently inflationary. The cost of the interest is built into everything. It is ironic that the Federal Reserve is thought of as our “inflation fighter” when the Federal Reserve’s debt-based money is the primary cause of inflation. This system has led to a National Debt of $12.3 trillion and a Total Credit Market Debt of over $52 trillion – all of it paying interest, primarily to those who own, run and benefit from this debt based system. Click the two links below to see the current National Debt and Total Credit Market Debt.

http://www.treasurydirect.gov/NP/BPDLogin?application=np

http://www.federalreserve.gov/RELEASES/z1/current/accessible/L1.htm

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KG: This solution is, as Zarlenga also points out, not a new one. The idea of having the government print money directly has been tried several times in history. Zarlenga claims that these experiments have by and large been successful — certainly more successful than private issuing of money (by which both Zarlenga and I mean private banks creating money out of thin air).
Even though I very much agree with Zarlenga that such private issuance of money has caused disaster after disaster, I challenge his thesis that government-printed money would be better.

Response: Government printed money would be better because, under the American Monetary and Financial Security Act, the President and the Congress would be held directly responsible for either inflation or deflation. No one is held responsible now. Under this legislation, both the monetary and the fiscal power will be under the supervision and control of Congress and the President, which is what the Constitution of the United States already mandates.
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KG: Nationalizing the “Private” Central Bank
The natural first step in implementing the 100-percent-reserve solution would be to nationalize the formally private Federal Reserve. Like many other critics of the Fed, Zarlenga is diligent to point out that the Fed is in fact private and not a government agency. I’m not sure whether it was Dennis Kucinich himself who invented the phrase “The Federal Reserve is no more federal than the Federal Express,” but he certainly has made it his own.
The private member banks formally own the Fed. Many libertarians point this out too, and it is sometimes difficult to judge whether they actually agree with Kucinich’s slogan or not. Because the private ownership of the Fed is often used as an argument against free-market solutions to the problems of the financial sector, I feel compelled to discuss the nature of the Fed.

Response: The nature of the Fed is that the only part of the Federal Reserve System that belongs to the federal government is the 7 member Board of Governors and their staff. The 12 Federal Reserve Banks are a privately-owned banking cartel, authorized by the Federal Reserve Act, to create and issue money in direct violation of Article I, Section 8, Clause 5 of the United States Constitution.
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KG: While it is undoubtedly true that the Fed is owned by private banks, the notion that it is a private company, as private as Federal Express, is wrong.
First, the Fed was created through an act of Congress. Not only that, a separate constitutional amendment was added in order to create the central bank. What other private company can claim the same? Certainly not Federal Express.

Response: Whether the Fed is as private as Federal Express is meaningless. What is meaningful is that the privately owned and contolled Federal Reserve Banks create, issue and regulate our money, almost totally for the benefit of the privately-owned banks, not for the benefit of the people. The legislation Zarlenga proposes would return this power and the benefits to the people, through their government.
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KG: Second, the Fed has been given the governmental authority to control the nation’s money supply and direct monetary policy. As a rule, private companies don’t enact and enforce national policy. That is the function of government. Any entity authorized to enact and enforce policy is a de facto government agency.

Response: The above statement is incorrect. The Board of Governors establish and direct monetary policy at Federal Open Market Committee Meetings. The actual enactment and enforcement of national policy takes place in the New York Federal Reserve Bank primarily. Some call the Federal Reserve Banks ‘quasi-governmental’ – you can call them what you want, but they do not act to benefit the people, they act to benefit the banks. The composure of the Federal Open Market Committee ensures this. The FOMC consists of 19 members, 12 of whom have a vote: the seven members of the Board of Governors, the President of the New York Federal Reserve Bank and four other Federal Reserve Bank Presidents, on a rotating basis. But all 19 present can take part in all policy decisions. The 12 Federal Reserve Bank Presidents are elected by the commercial banks in their district, and the seven Governors are appointed by the President and Confirmed by the Senate. It is well worth noting that almost invariably, every Federal Reserve Governor is either a former banker or an economist who worked for bankers. The conflict of interest in the FOMC is quite apparent. (and the actions of the Fed in response to the 2008 financial crisis made it quite clear the Fed, and Bush and Obama, will do anything to save the “too-big-to-fail” banks – and will do practically nothing to save the American people.)
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KG: Third, one of the Fed’s main functions is to fund government expenditures. The same can be said for almost all other central banks in history. Obviously, the private bankers reap huge profits from this partnership with the state, but that does not negate the fact that the state itself benefits hugely as well.

Response: Except in extreme circumstances, such as the 2008 financial disaster and during WWII, the Fed never directly funds government expenditures by buying Treasury Bonds directly from the Treasury.
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KG: The stated goals of the Federal Reserve System are:
Provide a stable and flexible money supply.
Provide moderate long-term interest rates.
Promote full employment, defined as not more than 4% unemployed.
It is obvious that the Fed has failed to achieve any of its stated goals.
Since the creation of the Fed, all of the United States’ wars and all of its major welfare programs have to a very large extent been funded by the Fed’s printing presses. Ron Paul has been pointing this out for decades. The Fed makes even Halliburton look like a beacon of free-market capitalism.

Response: This is incorrect. It is not the printing presses that created the excess “money.” Every dollar in circulation or on deposit today was created by a private bank creating it out of thin air and loaning it to someone – often than someone was the United States Government. As author Bill Hixon once stated, “For the government to permit banks to issue money, borrow that money, and pay interest on it is idiotic.”
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KG: Of course, the authority given to the Fed by Congress was never Congress’s to give, as the Constitution does not allow Congress to issue paper money, and certainly not to enact legal-tender laws making paper notes the only legal money of the nation. If Congress does not have a certain power, it certainly cannot delegate that power to a private entity. If it does so anyway, the recipient of this unconstitutional monopoly cannot be compared to an ordinary private company.

Response: The Constitution does allow Congress to issue paper money. Article I, Section 8, Clause 5 states: “Congress has the power to coin money and regulate the value thereof.” This obviously includes both paper money and coins, how could Congress regulate the value of money if it only had control of coins? And Article I, Section 10 specifically denies the states the power to issue paper money when it states: “No State Shall….coin Money; emit Bills of Credit (paper money); make any Thing but gold and silver Coin a Tender in Payment of Debts.” This specifically reserves the right to issue money to the Congress. Some misinterpret the gold and silver coin phrase to mean that only gold and silver coin should be money. It actually means that states could use existing gold or silver coins to pay their debts, but could not “emit bills of credit” (print paper money).
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KG: This being the case, the outright nationalization of the Fed would not change much. However, as Zarlenga’s goal is to completely nationalize the “money power,” even the formal ties to private ownership must be severed.

Response: It is true that just nationalizing the Federal Reserve would not change much. For example, in England and Canada their central banks are nationalized, yet they continue to use a privately-owned, debt-based monetary system just as we do. It takes three combined steps to properly “sever even the formal ties to private ownership.”
The American Monetary and Financial Security Act of 2009 takes three simple steps to take back control of our money.

(1) It Incorporates the Federal Reserve Banks into the U. S. Treasury where all money is created by the government as real money, not interest-bearing debt, and spent into circulation to promote the general welfare; monitored to be neither inflationary nor deflationary.
(2) It eliminates Fractional Reserve Banking in a manner that makes the federal government the only entity with the power to create, issue and regulate our money, as Article I, Section 8, Clause 5 of the United States Constitution already mandates.
(3) As the “debt-money” created by the privately owned Federal Reserve and commercial banks disappears when debts are paid, it would be replaced with real money spent into circulation to rebuild our badly decayed public infrastructure which includes roads, bridges, dams, water and sewage plants, mass transit, schools, etc. This would create millions of high paying jobs. Public infrastructure also includes universal health care and education for all. A stimulus check of at least $5,000 should be sent out to immediately start getting out of this recession by putting money back in the hands of the American people.
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KG: Abolishing the Fractional-Reserve Banking System
“If Congress does not have a certain power, it certainly cannot delegate that power to a private entity. If it does so anyway, the recipient of this unconstitutional monopoly cannot be compared to an ordinary private company.”

Response: I agree. The Federal Reserve Act has always been unconstitutional.
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KG: The second key element of the plan is certainly something the Mises Institute and the American Monetary Institute can agree on, albeit with completely different objectives. Zarlenga is correct when he points out that private banks presently create money (or credit) out of thin air through fractional-reserve banking. The 100-percent-reserve solution calls for a government monopoly on creating money, which is why Zarlenga advocates the abolition of such banking. That way, the government won’t have any competition.
Presently, the banks have only a fraction of their deposits in reserves. How does Zarlenga propose to solve the problem of the transition from fractional reserves to full reserves? He proposes to lend government-printed money to the banks, thus increasing their reserves to cover all outstanding claims on them. This solution has a few flaws.

Response: The American Monetary and Financial Security Act DOES NOT propose lending government-printed money to the banks, it proposes converting all bank deposits and all Federal Reserve Notes to U. S. money with a simple accounting procedure. This is all covered in Section III of the legislation.
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KG: First, the government-created paper currency is no more real than the credit issued by the banks, as neither represent actual resources accumulated from real savings. For this purpose, it makes no difference who issues the phony money, the banks themselves or the government.

Response: The paragraph above indicates that the author does not understand the difference between money and credit. Money is a creature of law, created, issues and regulated by the government and the profit inherent in the creation of money accrues to the people for their general welfare. Credit is issued by private businesses in the form of debt due in the future. Credit is not money, credit is debt. Money is not debt, money is just money – a medium of exchange, a measure of value and a store of value. Produced and regulated by the state, not by private organizations or individuals. And money is not wealth, money is a claim on wealth.
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KG: If banks can create credit that is then converted into money lent from the government, they have every incentive to keep creating credit. This situation would also encourage the government to keep lending money to the banks, not only for the interest they can charge, but because the ever-increasing supply of money leads to more and more taxable consumption, not to mention that the government itself can fund its own vote-buying programs so much more easily. Runaway inflation would be nigh on unavoidable.

Response: The American Monetary and Financial Security Act has nothing in it even remotely resembling the above statements.
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KG: Second, the bank’s equity is not enhanced by the government loans. When the bank has lent out 90 percent of its deposits, it has, say, $1,000 in reserves and $9,000 in loan receivables on its asset side, and $10,000 in deposits on its liability side. The infusion of a $9,000 loan would increase its reserves to $10,000, thus covering all of its deposits, but it would also increase its indebtedness by the same amount.

Response: The American Monetary and Financial Security Act has nothing in it even remotely resembling the above statements.
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KG: If every depositor withdrew their money, the bank would be left with $9,000 in debt on the liability side, but with $9,000 in loan receivables it is not allowed to have on the asset side. If the bank were forced to write off the loans because every depositor withdrew his money, the bank would be left with $0 in assets and $9,000 in debt to the government.

Response: The American Monetary and Financial Security Act has nothing in it even remotely resembling the above statements.
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KG: The solution presented is thus no solution at all, only a mechanism by which the same type of continuous inflation of the money supply could be carried on under the guise of full reserves, leaving both the government and the banks to continue to create money out of thin air. This would debase the currency and cause boom-bust cycles, all the while enriching government and the banks.

Response: The American Monetary and Financial Security Act has nothing in it even remotely resembling the above statements.
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KG: So while we can agree on the abolition of fractional-reserve banking, Zarlenga’s solution to the transition problem is deeply flawed.

Response: Zarlenga’s solution is not deeply flawed, the writer must go to the link below and read the American Monetary and Financial Security Act.

http://www.monetary.org/amacolorpamphlet.pdf

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KG: Spending Money into Circulation
The 100-percent-reserve solution has government running the printing presses itself and spending the newly created money into circulation. By spending the money on “productive” projects and programs, such as infrastructure, healthcare, education and so on, Zarlenga claims that the money won’t lose its value over time. The inevitable rise in prices would be offset, he claims, by the increased production the government spending leads to.
“When this economic crisis evolves into a currency crisis, which it most probably will, reform will become inevitable. The question then is what ideas for reform are lying around for the people and the politicians to choose from.”
I argue that the 100-percent-reserve solution would drive up prices. The government would always find new programs to spend money on. The more money the government spends into circulation, the more it debases the value of the previously printed money, causing the purchasing power of each existing dollar to fall.

Response: Nothing in the American Monetary and Financial Security Act states that everything will be paid for with money just printed for that purpose. New money will only be created as needed. What the writer does not seem to know and what the so-called “too big to fail” banks don’t want you to know is that all of their money was created in the form of debt, and when they can no longer create more “debt-money” it will disappear as the debts are paid or defaulted, which means we will have to replace their debt money by spending real U. S. dollars into circulation. Then we would finally get the benefits we should have received in the first place – and all these benefits come without debt, without taxes, and without inflation. The real money we need to spend into circulation to replace this “debt-money” is literally trillions and trillions of dollars. And it all would appear as a bonus or dividend for the American people. To allow this recession or depression to continue when the way out is well known is inexcusable. The American Monetary and Financial Security Act IS the way out of the present recession.
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KG: This also shows the fallacy in the argument that a dollar’s value can be set by government, which is one of Zarlenga’s key underlying arguments. Money is a function of law, as he claims in good Aristotelian fashion, which means that its value can be set and enforced by the government.

Response: The dollar’s value will be set by the government following the guideline to be neither inflationary nor deflationary. Under this legislation we will finally be able to have the stable dollar the Federal Reserve has never provided.
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KG: However, because the printing of money is so much easier than the production of actual goods and services, the production of new money is likely to far surpass the production of new goods and services. So in order to keep prices from rising, the government would eventually have to impose price controls. This has been done several times before, most recently by Nixon in the 1970s.

Response: With a stable dollar none of the above will happen.
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KG: However, the price controls would simply lead to economic chaos and black markets, where people try to make exchanges at real market prices. Additionally, the chronic price inflation would encourage people to borrow and spend, since the value of their debts would steadily decline. The lenders would have to counter this with increasingly high interest rates, making long-term investing very difficult, which in turn would greatly disrupt economic activity.

Response: With a stable dollar none of the above will happen.
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KG: Since Zarlenga intends to fund such things as healthcare and education with government-printed money, it becomes obvious how catastrophically inflationary the 100-percent solution would be. In the interview, Zarlenga says that one of the first spending projects would be revamping the nation’s infrastructure. According to the calculations of civil engineers, a complete overhaul of roads, bridges, and so on would cost $2.3 trillion. This could, according to Zarlenga, be paid for with the printing press.

Response: All agree that our infrastructure is in disrepair. The $2.3 trillion figure is probably in the ball park. What do we need to have to bring our infrastructure up to date? We need a labor supply, we need the knowledge, we need the equipment, we need the material and we need the money. In the middle of this Great Recession with high unemployment and the need for millions and millions of new jobs, the only thing in the list above that we don’t have enough of is money. It is extremely practical and probably very necessary for the government to create the money to rebuild the public infrastructure over the coming years as fast as possible, probably about $300 or $400 billion a year. For the government to create and issue the money to do so would not only not be inflationary, it would provide millions and millions of good paying jobs right when we need them. The same can be said for universal health care and public education. BUT, when the time comes that creating the money to do this would be inflationary, then the financing will be through taxation, but even that will be at rates lower than the current rates for most Americans.

KG: The Moral Dimension

Response: Since I have addressed most issues in my responses above, I will not address this section or the following section other than to say that of course Morality and Fairness and Equality have a place in our monetary system just as they have a place in my life and your life. And there is no question that the existing, privately-owned and controlled Monetary System is completely immoral, unfair and full of inequality. Just look as what the “too-big-to-fail” banks have done to this country. And our government bailed them out, but not the people. Now the big banks are giving themselves $140 billion in bonuses (using our money). This is their reward for destroying our economy and throwing millions of people out of work and causing millions of people to lose their homes and much of their savings and their retirement funds. The American Monetary and Financial Security Act will return our nation to a government of the people, by the people and for the people. And it wil always consider morality, equality and fairness to be necessary in providing good government.
Dick Distlehorst
Burlington, Iowa
February 2010