Re-thinking Monetary Policy: The Benefits of a Deflationary Money System
Why Inflationary Economies Lead to More Debt and Banking Instability
I recently watched the old 1948 cartoon “Make Mine Freedom.” There is a scene that shows Joe Doakes invent an automobile in his garage, and then get a loan to start a business. This is supposed to illustrate how “capitalism” works, but what stood out to me was who he got the loan from.
Instead of going to a bank and presenting his business plan to get a business loan, the cartoon shows Joe Doakes collecting money from his Aunt, an Uncle, his Grandfather, and a wealthy friend.
Since the Grandfather is shown lifting up his mattress to retrieve the money, and the family friend is shown digging the money up out of the backyard, it is fairly clear that these friends and family are making an investment from their savings.
The cartoon then states that by using their savings to help Joe Doakes buy property and tools, that they are being “capitalists.” But this is a very different picture of “capitalists” than is common today.
Today we don’t thinks of aunts and uncles using their savings to invest in an idea that they believe in. Instead, we think of bankers in top hats, like the monopoly man, inspired by J.P. Morgan.
Today we don’t get loans or investments from family and friends. Instead, we get loans exclusively from banks. And indeed, most of the investment that takes place comes from Investment Banks.
But we don’t just get loans for starting businesses. Now we get loans for pretty much everything. Houses, cars, and furniture even. Increasingly mundane things require loans. I was offered a loan to pay for my cat’s veterinary bill recently. People often take out loans for items that cost only a few hundred dollars.
Our aunts, uncles, and grandparents aren’t saving money that they can use to invest. Instead, they’re living paycheck to paycheck. Their monthly income is just enough to make the payments on all of their loans and have a little left over for everyday expenses. The average American doesn’t have enough in savings to cover a mere $500 unexpected expense.
Whatever savings we do have is in a 401k or a house. We gamble that the stock market and the real estate market will keep going up indefinitely. We don’t have money stuffed under our mattress or buried in the backyard.
But maybe we should.
True market capitalism would almost certainly be deflationary rather than inflationary. The inflationary economic system we have today is not the result of market forces, but the result of the bankocrats and the bankocracy. (terms borrowed from Karl Marx, believe it or not)
In a true market economy, the money would emerge as selected by market actors. This would almost certainly be a deflationary money because money that goes up in money increases its salability. Everyone wants as much of it as possible, because it is very likely to increase in value, and is easy to exchange for other things.
This is precisely how gold emerged as the market’s money. It was not the case that gold was selected arbitrarily by some king and decreed money. No, it was selected by market forces over long spans of time and across the whole world. (this is also occurring with Bitcoin, and for the same reasons.)
In an economy with a deflationary money there are few aspects that are very different from our current inflationary economy. First and foremost, borrowing is disincentivized, and saving is encouraged.
It is in a deflationary economy where you would find aunts and uncles and grandparents with a large personal savings, such that they would be capable of investing in a family member’s invention.
And perhaps this is why we see innovation booms and art renaissances in periods and places where deflationary money is in use. There is an increase in leisure for private individuals for one, and for second investment is decentralized into the hands of everyday individuals.
But even as the market has selected a deflationary money, this all becomes corrupted by fractional reserve banks. Historically governments charter banks, such that they are a special entity, rather than a normal private business. And governments charter only fractional reserve banks, and therefore do no allow full reserve banks to exist.
But fractional reserve banks are essentially institutions of legalized embezzlement. Whereas market actors are in want of a service for the safe storage and perhaps safe transport of their money, market actors unknowingly become involved in a sort of ponzi scheme by utilizing the bankers’ services.
That is, by depositing money in a bank depositors unknowingly expose themselves to the risk of losing their money, because the bank is not actually storing the money deposited, but risking it in loans to others. Thus we have two destabilizing effects of legalizing this embezzlement:
First, the effective supply of money in circulation is increased for period of time as the scheme grows. For every depositor acts as if he has access to his funds deposited, and every borrower acts as if he has access to funds borrowed, but in reality, this cannot be the case. For the bank cannot both give out all the loans and allow all the depositors to withdrawal their funds. So the amount of money the market thinks exists is incorrect. Yet, nevertheless, this devalues the money as if the amount of money in circulation is actually accessible.
Second, there is an eventual banking crisis. A rash of bank runs occurs because people realize suddenly that the banks are not able to give people their deposits. Banks fail because people are not able to repay their loans. Depositors lose their money. And there is a rash of deflation as the true amount of money in circulation is realized by the market, which of course is much less than what was assumed while the banking scheme was growing.
All of this occurs because banks are legalized embezzlement institutions. The vast majority of depositors just need a place to store their money, and perhaps also a place to trade their money. They have no interest in taking part in a lending scheme which puts their money at risk. Yet, they don’t have the option not to take part. Either they bury their money in the backyard, hide it under the mattress, or they are forced into the lending scheme.
Second, there are some people who are interested in taking part in a lending scheme. These people want a higher return on hoarding their money than deflation alone would provide them. These people should have the option of finding an institution that specializes in lending other people’s money. These people should be able to hand over their money and earn interest on it, as a percentage of what the institution earns by lending it out.
The problem is the marriage of the two completely separate institutions. One which just stores and transfers money. The other which lends people’s money to others and gives a percentage of the interest. A simple regulation of the banking industry, similar to Glass-Steigal, that separates these two very different functions of banking, would be sufficient to stop the problem.
Yet, instead of this simple regulation, the bankocrats and the bankocracy doubled down on the scheme. Instead of putting an end to the legalized embezzlement, they simply replaced it with legalized counterfeiting. To do this, by government decree, gold was replaced by a government approved currency.
Keep the scheme running, but ensure that the bank runs will never happen because the banks can create money out of thin air to give to depositors who want to withdrawal. Never again will there be a great depression with its deflation and the masses of people who lost their money to failed banks.
But, of course, the inflation and the out of control borrowing and lending will have no backstop. The result is the mess we are in today. Soaring prices, homelessness everywhere, people have no savings and have to borrow money to pay for their cat’s veterinary bills. Inflation up over 10%. Hyperinflation possible within the next 30-50 years. Wars and conflict heating up. Recessions ever looming. Leisure almost non-existent. Innovation slowing. Etc.
But the banks are doing great in this environment.
Some say Bitcoin might be the solution, but not if we still allow legalized embezzlement. The recent scandal involving a Bitcoin exchange that was using its customer’s deposits to invest, etc. and suddenly was incapable of giving its depositors back their money is a sign of things to come.
For one, people should not keep their Bitcoin on exchanges in the first place. But second, if we need any regulation, we need the regulation that separates the storage and transfer services of exchanges/banks, from the lending and investment of depositor funds services.
People should have to opt in to any lending or investment scheme, they should not be forced in simply because they need a place to store their money for a while. Only then can we get to the deflationary utopia we seek. Where inventors get loans from aunts and uncles who have giant savings, and where people retire early to live off their savings and devote the rest of their lives to art and inventions.
Chad Ashton Brown