Money and government

Money: a medium of exchange Evolved spontaneously from trading experience Qualities of gold and silver make them well

suited for use as money Paper receipts for stored gold evolved into

money

Government control of money

Governments have profited from subverting the money business Debasement of coins Issuance of unbacked paper money Legal tender laws – monopoly provision of

money Removal of all links to gold/silver (U.S. 1965,

1971)

Today’s money

Most money is in electronic form (bank deposits) rather than currency

Not redeemable for gold or silver Federal Reserve system can create or

destroy money at will. Commercial banks also create money when

they make new loans

Federal Reserve System

Created in 1913 to provide an “elastic” supply of money to act as a lender of last resort

The Fed is nominally owned by member banks but is actually a government agency of a special kind: Makes profits from its operations. Profits net of

expenses are given to the Treasury Does not need to ask Congress for an annual

budget appropriation

The Fed’s track record

Most economists place part of the blame for the Great Depression of the 1930’s on the Fed for allowing the money supply to fall substantially.

The 1970’s price inflation took place under the Fed’s watch

The crash of 2008-2009 took place under the Fed’s watch

The dollar has lost 95% of its value under the Fed

Larry White on the Fed

What the Fed does Interbank transfers Distribution of paper currency Regulation of commercial banks

capital requirements reserve requirements

Lender of last resort Conduct of monetary policy

interest rates, money supply

White: End the Fed?

Scotland: private banks issued notes, no central bank

Sweden: similar Canada:

no central bank until 1930’s No bank failures in 1930’s No banks in distress in 2008-2009

Ordinary banks can issue paper currency Regulation by private clearinghouses No need for monetary policy

Housing Collapse of 2007-2008

Mortgage lending standards deteriorated dramatically up to 2007 No down payment Negative amortization No qualifications (liar loans)

Banks and other mortgage originators immediately sold their loans

Loans bundled into mortgage-backed securities which which mis-rated

Housing Collapse of 2007-2008

Government culpability: Mortage interest tax-deductible Government agencies: FHA, Fannie Mae,

Freddie Mac, etc. Community Reinvestment Act Fed held interest rates low

Private culpability: Lenders (e.g. Countrywide) and mortgage

brokers should have known better

Fiscal stimulus

Massive federal deficits, more than $1 trillion in each of the last four years

Intended to jump-start the economy Federal debt has skyrocketed Unemployment remains high. Business

people are afraid.

Monetary stimulus

Fed has tripled the monetary base in recent years, supposedly to boost spending

But banks are keeping much of the new money at the Fed in the form of excess reserves

New money is largely not being spent, therefore we have had little price inflation

Interest rates are at record lows. Short rates zero, long rates < 3% Savers are getting killed.

Bank regulation and subsidy

U. S. banks have been more or less heavily regulated and subsidized for many years

Many 19th century banks were weak because Branch banking was prohibited Required to hold state bonds as reserves About 9,000 banks failed in the U.S. during the

Great Depression, none in Canada

Bank regulations

Banks are regulated by competing regulatory institutions: Federal Reserve System Comptroller of the Currency Office of Thrift Supervision (defunct) State bank regulations

Many rules Reserve requirements Capital requirements

Bank failures

Banks loan out most of their deposits. Loans usually can’t be called on short notice. So if too many depositors want their money all at once there is a bank run.

Occasional bank runs are socially beneficial Incentive for bank managers to act prudently Incentive for depositors to seek prudently

managed banks

FDIC insurance

Federal Deposit Insurance now covers most bank deposits Individuals: up to $250,000 Businesses: unlimited through 2012

FDIC now handles failed banks and makes their depositors whole. Some banks are liquidated Most are acquired by other banks

FDIC assets are a tiny fraction of its total insured deposit base

Federal debt and deficits

Federal debt and deficits

Interest on federal debt

Currently about $250 billion per year Could rise to $750 billion per year if interest

rates return to normal levels Potential for a tipping point: borrowing to

cover increased interest payments

Social Security

Promoted as a retirement savings program like buying an annuity

Tax rates and the rate base were raised drastically in 1982. Social Security had annual surplus between then and this year.

Surpluses were “saved” in a Trust Fund which holds government bonds. This “saving” is an illusion.

Social Security is unsustainable

Baby boomers are retiring and starting to draw retirement benefits

People are living much longer: expectancy now 78, was 65 when SS was started

Currently 2.8 workers paying taxes per retiree receiving benefits (16:1 in 1950)

Payouts now exceed tax revenue but interest income will cover the deficit for a few years

$15.1 trillion estimated unfunded liability (present value)

Medicare

Medicare has its own Trust Fund which is now being depleted

Because there are few incentives to economize on medical services, Medicare must ration services

Obamacare relies on reduced Medicare payments to physicians and hospitals

What will happen?

Default on U.S. debt more likely than inflationary solution

Social Security and Medicare will collapse Dollar may lose its position in international

trade