Tag Archives: Texas Straight Talk

Fractional Reserve Banking, Government, and Moral Hazard

ron paul

Last week my subcommittee held a hearing on fractional reserve banking and the moral hazard created by government (taxpayer) insured deposits.  Fractional reserve banking is the practice by which banks accept deposits but only keep a fraction of those deposits on hand at any time. In practice, nearly 100% of deposits are loaned out, yet depositors believe that they can withdraw the full amount of their deposit at any time. Loaned funds are then redeposited and reloaned up to the limit of the bank’s reserve requirements, compounding the effect.

As Murray Rothbard put it, “Fractional reserve banks … create money out of thin air.  Essentially they do it in the same way as counterfeiters. Counterfeiters, too, create money out of thin air by printing something masquerading as money or as a warehouse receipt for money. In this way, they fraudulently extract resources from the public, from the people who have genuinely earned their money. In the same way, fractional reserve banks counterfeit warehouse receipts for money, which then circulate as equivalent to money among the public. There is one exception to the equivalence: The law fails to treat the receipts as counterfeit.” *

While mainstream economists extol this “money multiplier” as a nearly miraculous process that results in a robust economy, low reserve requirements actually enable banks to create trillions of dollars of credit out of thin air, a process that distorts the structure of production and gives rise to the business cycle. Once the boom phase of the business cycle has run its course and the bust commences, some people will naturally look to hold cash. So they withdraw money from their bank accounts in order to hold physical currency. But bank deposits consist of a huge amount of credit pyramided on top of a small of amount of original cash deposits. Each dollar of cash that is withdrawn unwinds the multiplier, resulting in a contraction in credit. And if depositors en masse attempt to withdraw more funds than are available in reserves, the entire of house of cards comes crashing down. This is the very real threat facing some European banks today.

Since the amount of deposits always exceeds the amount of reserves, it is obvious that fractional reserve banks cannot possibly pay all of their depositors on demand as they promise – thus making these banks functionally insolvent. While the likelihood of all depositors pulling their money out at once is relatively rare, bank runs periodically do occur. The only reason banks are able to survive such occurrences is because of the government subsidy known as deposit insurance, which was intended to backstop the stability of the banking system and prevent bank runs. While deposit insurance arguably has succeeded in reducing the number and severity of bank runs, deposit insurance is still an explicit bailout guarantee. It thereby creates a moral hazard by encouraging bank deposits into fundamentally unsound financial institutions and contributes to instability in the financial system.

The solution to the problem of financial instability is to establish a truly free-market banking system. Banks should no longer have a government backstop of any sort in the event of failure. Banks, like every other business, should have to face the spectre of market regulation. Those banks which engage in sound business practices, keep adequate reserves on hand, and gain the confidence of their customers will survive, while others fall by the wayside.

Banking, like any other financial activity, is not without risk – and the government should not continue its vain and futile pursuit of trying to eliminate risk. Get government out of the way and allow the market to function. This will result in a more stable system that meets the needs of consumers, borrowers, and investors.

* Murray N. Rothbard, The Mystery of Banking, 2nd ed. (Auburn, Alabama: Ludwig von Mises Institute, 2008), p. 98.

Failed Fed Policies Prolong the Agony

ron paul

The Federal Reserve’s interest rate price-setting board, the FOMC, met last week.  They will continue to set the federal funds rate at well below 1%, and plan to keep it low until the end of 2014.  That’s a year and half longer than they planned when they met just last month.  Chairman Bernanke says they are keeping interest rates so low for so long because the economic outlook warrants it.

The fallacies in their reasoning would be amusing if they weren’t so dangerous.  The Fed wants to keep the price of money at essentially zero – in other words “free” – to boost the economy.  But the boost they are attempting won’t get here for another three years.  That’s not a recovery.  And we’ve already tried this tactic.  That’s how we got into this mess in the first place: with interest rates artificially low for a very long time.  Free money doesn’t stimulate growth, as Japan’s two lost decades clearly show.  Artificially low interest rates only serve to punish saving, distort market signals, and cause further malinvestment.  They also do nothing to address the only real solution to our economic woes: liquidation of the bad debt that hangs around the neck of the world’s economy, preventing recovery.  Artificially low interest rates merely ensure that we remain a debt-financed consumer economy guaranteed to end up with a weaker economy and higher prices.

What baffles me even more is that two decades after the collapse of Soviet planning and decades more since the U.S. and economists purportedly rejected the idea of price setting, we find nothing wrong with the Fed setting the price of money.  We all agree it is a bad idea to have a board saying the price of wheat should be $250 a ton today, or carpenters wages should be $25 an hour until the end of 2014.  But we are perfectly comfortable with having a board set the price of one half of every transaction in our economy.  And our markets are supposedly free.

The Fed policies of low interest rates, Operation Twist, and rounds of quantitative easing are all attempts to keep the economy alive artificially. But the 12 FOMC participants cannot manage the economy any better than the bureaucrats of the Soviet Union.  The policies haven’t worked. They won’t work. Real economic recovery cannot come until we liquidate the bad debt, until we eradicate the poor decisions we made over the last decade, and start with a sound foundation. It is time we acknowledge the truth of the Fed’s activities: they are merely using fancy words for price setting.

Treasury Secretary Andrew Mellon was correct in the 1920s when he said “liquidate everything.”  That’s what we did in the severe depression of 1920-21, and we recovered so quickly it is never even talked about.  We didn’t take his advice after the 1929 crash, and ended up with the Great Depression.  We are committing the same mistakes, destined to live in this Great Recession for a decade or more—it has already been four years, the Fed says it will be at least three more!  It’s time we start rethinking what the Fed’s policies are really doing to our economy, because obviously, by their own admission, they haven’t helped.

Ron Paul

The Business of Government

ron paul

Amid the din of economic nonsense being bandied about since the collapse of the housing bubble and the steep ramping up of our national debt, there has been the persistent refrain that Washington should be run more like a business. If only more business people were in charge to wield their business acumen, we would have this country in shape in no time. But is that a good solution?

Businesses seek primarily to increase their revenues and profits. Government revenue depends on taxes. Government accumulates taxmoney by squeezing it out of people’s productive earnings with threats of audits, fines and imprisonment. Our government already collects roughly $2.1 trillion annually from the productive taxpayers of America. We hardly need to increase our federal government’s revenues like a private business!

Businesses sell products or services to voluntary buyers, always looking to increase their market share as much as possible. But what is the federal government’s product or service? Rules, regulations, bureaucracy, paperwork, red tape, hoops to jump through, uneven protection and security from people with guns, coercion and compliance through force and confiscation of assets, militarism instead of national defense, and of course a vast welfare state. Do we need more of these government services? Hardly. In fact, we have far too many of these destructive things already.

What we need is more freedom. Freedom is the simple ability of people to live their lives as they see fit without government coercion, provided they do not initiate force or fraud against others. What we really need is a less coercive government, not more revenues.

Washington needs to stop seeing itself as a growth industry, and realize that the true function of government is to protect liberty. Washington certainly has expanded and grown and accumulated a great deal of the people’s capital for itself, but this has been at the expense of our nation’s prosperity. This trend needs to be reversed.

We don’t need yet another “jobs” bill to supposedly put the American people back to work. Politicians need to realize that, aside from outright hiring some 14 million people, government does not create jobs. The only thing government does is hinder job creation by getting in the way and consuming otherwise private resources. Therefore, the most useful thing government can do for unemployment is to “liquidate” much of what government does in the first place.

One plain example is our tax policy that encourages U.S. corporations to accumulate foreign earnings abroad rather than repatriate such earnings. Currently there is over $1 trillion of capital that companies are keeping overseas because of the 35% tax charged for bringing it back to the US. Our government literally is pushing capital and jobs overseas that could be used to hire an estimated 2.5 million people here at home.

Businesses create jobs. Government is not a business. We don’t need more stimulus or phony jobs bills. We don’t need more revenue – $2 trillion is plenty to fund the federal government annually. What we do need is a wholesale rejection of government as a central economic planner.

Ron Paul

Ron Paul – The Fed Twists, The Market Shouts

ron paul

Last week the Federal Reserve began the second incarnation of “Operation Twist”, an attempt to drive down interest rates by purchasing long-term Treasury debt and selling short-term debt. This is just the latest instance of the central bank desperately flailing around doing something merely for the sake of doing something. Fed officials still do not understand– or admit– that the Fed itself caused the financial crisis by driving interest rates too low and relentlessly expanding the money supply. Thus, this latest action will just exacerbate the problem.

Markets, however, understand that the Fed has failed and has no clue what it is doing. This is why markets went into a tailspin after the Fed’s new strategy was announced. Stock, bonds, and commodities dropped in price while the financial press wondered whether this worldwide sell-off meant that the entire system was collapsing. Not since 2008 had there been such a dramatic drop across so many different sectors of the market.

Because of continued rising inflation and the Federal Reserve’s suppression of interest rates, investing in traditional safe havens such as savings accounts, mutual funds, and Treasury bonds has become unprofitable. Lots of money is moving through the system seeking a return on investments or at least some measure of safety, as increasingly desperate investors move their funds around in search of long-term profits and stability. Until the Fed stops its monetary intervention and allows interest rates to be set by the free market, investors will move their money in a volatile manner. They will invest in commodities and stocks while prices swing upwards, but will flee to bonds and cash at the first sign of a downturn.

The uncertainty caused by the Fed does help some people – professional traders on Wall Street for example. Increased volatility and huge price swings mean more opportunities for profit, as sophisticated electronic trading programs can buy and sell huge positions within a fraction of a second of a major market movement. But small businessmen are misled by the artificially low interest rates into making unwise investments, and those whose jobs vanish when the Federal Reserve’s latest bubble pops suffer. Without the knowledge or ability to move with the markets or diversify overseas, average Americans see their savings stagnate or depreciate– along with their hopes and dreams for a better tomorrow.

The only way to return to a sound economy is for the Federal Reserve to cease and desist its monetary manipulation and allow interest rates to be determined by markets, just as the price of goods, services, and labor should be determined by markets. Everything the Fed is doing by pumping money into the economy benefits only the insolvent, too-big-to-fail banks. Low interest rates encourage consumers to take on more debt, meaning more profits for the banks issuing those loans. Purchasing mortgage-backed securities, as the Fed has done, keeps housing prices inflated, helping the banks who have non-performing mortgages on their books. However, it hurts consumers who continue to be priced out of the housing market. In order to maintain a decent standard of living for the American people and to restore the vibrancy of the U.S. economy, it is time to end the Fed.

Ron Paul

Ron Paul – Super Congress A Gift to K Street

ron paul

The Super Congress created by the recent debt ceiling increase deal is a typical example of something nefarious attached to a bigger bill that is rushed through Congress without giving Members ample opportunity to consider the full ramifications. This commission may turn into an early Christmas present for the well-heeled lobbyists of K Street. This is because the commission presents a huge opportunity for lobbying firms to sneak their client’s pet projects and issues into whatever legislation is created by the commission. The fact that automatic cuts to defense are named if the committee deadlocks simply signals to the military industrial complex to bring their A game to the lobbying effort.

One red flag I am constantly aware of in my position as a Congressman is that highly complex and convoluted legislation frequently has dangerous provisions hidden in the fine print. Elaborate legislative packages force lawmakers to take the bad with the good, and often if they refuse, they are accused of voting against the positive provision – never mind the blatant Constitutional violations in the bill, the spending, the waste, and the unchecked expansion of government. I don’t usually have to read too much of a bill like that before encountering something unconstitutional, or simply unwise. Then I have to vote no.

That doesn’t seem to be the case with a majority of legislators, unfortunately. In order to ram through one special interest’s favorable treatment or giveaway, a certain amount of horse-trading is done. The end result is mammoth bills with myriads of unrelated provisions that favor those with the best lobbyists at the expense of everyone else.

The creation of a 12 member committee to preside over $1.5 trillion in spending decisions, and the exclusion of the rest of Congress also means lobbying firms can focus their efforts on an anointed few, which is certainly more manageable for them than having to deal with the entire Congress. Every cut considered will, of course, have a recipient on the other end whose livelihood is being threatened. The probable outcome is that any cuts realized will be more a function of lobbying prowess than the merits or demerits of the actual programs on the chopping block.

Make no mistake – I am enthusiastically for cutting government spending. The goal should be to eventually reduce government down to the size and scope of its constitutional limitations. However, the process of getting there must also be constitutional. Concentrating such special authority to fast track legislation affecting so many special interests to a small, select committee is nothing more than an unprecedented power grab. Only fears of an impending catastrophe could have motivated Members to allow this legislation to be rushed through Congress. The founding fathers had strong feelings about taxation without representation and under no circumstances would they have felt excluding 98% of Congress from fiscal decisions was appropriate.

I see nothing good coming out of this Super Congress. I suspect it will be highly vulnerable to corruption and special interests. No benefit can come from such careless disregard of the Founders’ design.

Ron Paul

Ron Paul – When a Cut is Not a Cut

ron paul

By: Dr. Ron Paul, U.S. Congressman

One might think that the recent drama over the debt ceiling involves one side wanting to increase or maintain spending with the other side wanting to drastically cut spending, but that is far from the truth.  In spite of the rhetoric being thrown around, the real debate is over how much government spending will increase.

No plan under serious consideration cuts spending in the way you and I think about it.  Instead, the “cuts” being discussed are illusory, and are not cuts from current amounts being spent, but cuts in projected spending increases.  This is akin to a family “saving” $100,000 in expenses by deciding not to buy a Lamborghini, and instead getting a fully loaded Mercedes, when really their budget dictates that they need to stick with their perfectly serviceable Honda.  But this is the type of math Washington uses to mask the incriminating truth about their unrepentant plundering of the American people.

The truth is that frightening rhetoric about default and full faith and credit of the United States is being carelessly thrown around to ram through a bigger budget than ever, in spite of stagnant revenues.  If your family’s income did not change year over year, would it be wise financial management to accelerate spending so you would feel richer?  That is what our government is doing, with one side merely suggesting a different list of purchases than the other.

In reality, bringing our fiscal house into order is not that complicated or excruciatingly painful at all.  If we simply kept spending at current levels, by their definition of “cuts” that would save nearly $400 billion in the next few years, versus the $25 billion the Budget Control Act claims to “cut”.  It would only take us 5 years to “cut” $1 trillion, in Washington math, just by holding the line on spending.  That is hardly austere or catastrophic.

A balanced budget is similarly simple and within reach if Washington had just a tiny amount of fiscal common sense.  Our revenues currently stand at approximately $2.2 trillion a year and are likely to remain stagnant as the recession continues.  Our outlays are $3.7 trillion and projected to grow every year.  Yet we only have to go back to 2004 for federal outlays of $2.2 trillion, and the government was far from small that year.  If we simply returned to that year’s spending levels, which would hardly be austere, we would have a balanced budget right now.  If we held the line on spending, and the economy actually did grow as estimated, the budget would balance on its own by 2015 with no cuts whatsoever.

We pay 35 percent more for our military today than we did 10 years ago, for the exact same capabilities.  The same could be said for the rest of the government.  Why has our budget doubled in 10 years?  This country doesn’t have double the population, or double the land area, or double anything that would require the federal government to grow by such an obscene amount.

In Washington terms, a simple freeze in spending would be a much bigger “cut” than any plan being discussed.  If politicians simply cannot bear to implement actual cuts to actual spending, just freezing the budget would give the economy the best chance to catch its breath, recover and grow.

Syndicated by Alan’s Money Blog (http://www.alansmoneyblog.com)