Wednesday, March 11, 2009

Paul Monroe Says about Forex

The honest truth is that our banking system and money itself is a complete mystery to most Americans - myself included up until about a year ago. Although I have done a good bit of reading on the monetary issue, it is still a very confusing subject full of overlapping jargon and complex systems.I think that criticism of fractional reserve banking is certainly fair when it is practiced under a central bank on the basis of a purely “paper” currency. If I was to loan out money to others, and charge interest, by writing checks for money that I did not have, I would be charged with fraud. Even if I had $10 in the bank, I would still be committing fraud by writing checks for $100 and exchanging them with you for the promise of repayment plus interest.Yet this is precisely what banks do every day. They make loans to individuals using money they do not have. Well, how do they make the loans? They simply create the new money on the spot by typing on the computer and updating the size of your account.The unfairness is that 1) the government essentially mandates that we can only use Federal Reserve Notes as currency and 2) the government mandates that only institutions which are part of the Federal Reserve banking cartel can create this commodity. Such is not the case with gold. Gold is not valuable because the government says so, and no one has an exclusive legal right (or physical ability) to conjure gold out of nothing. Hence, fractional reserve banking - where only a portion of your liabilities are backed by reserves of currency - is immoral primarily because it rests upon a legal monopoly given to and benefiting the banks of the Federal Reserve system.On the other hand, I’m inclined to believe that fractional reserve banking - in a true free market monetary system (free banking system) - would not be immoral or even necessarily dangerous. In such a system, the currency would most likely be gold, silver, or even potentially shares of a basket of commodities… whatever consumers and producers conclude, in aggregate, is the most stable/flexible/desirable basis for a medium of exchange in trade. Banks, then, would provide the services of 1) storing money 2) providing bank notes (paper or electronic) to facilitate economic transactions and 3) issuing loans.Currently, you can go to a bank and exchange a Federal Reserve note for just another Federal Reserve note. Under a free market system, no one would accept such a currency that had no intrinsic value (unless it is an extremely well-established social norm/tradition - like pacific island cultures that used round stones with holes in the middle as money), instead they would demand something of actual value in return that they could then trade with others. Banks would have vaults of gold (or other commodities perhaps), but to facilitate transactions they would issue private notes which are essential mini-contractual obligations to exchange the note for real currency on demand.These notes, like Federal Reserve notes, would be used in trade. People would only accept them, however, if they believed the bank was sound, and that the probability that the notes would be redeemed on demand was certain. This would provide an incentive for banks to behave more cautiously and to show the public proof of their soundness. This contrasts with our current system in which default FDIC insurance discourages consumers from caring about the financial status of their bank.At the same time, such a system would allow banks to engage in fractional reserve banking. By issuing loans in their own private bank notes, they would be able to create more notes (contracts guaranteeing the exchange of the note for real currency) than actual currency in their reserves. The question is, would this be immoral? I don’t think so.First, under a free market system, anyone would be free to establish such a bank and issue notes. Membership in a central banking cartel would not be enforced by law - the system would be completely voluntary. Banks may exist which use 100% reserve ratios, and if you did not trust using a fractional reserve bank’s notes, you could turn to alternatives. Secondly, the entire system would be on the basis of contract. No one would be living under the pretense that the notes are actual money, as we do today. Although banks would be issuing contracts that they know, under certain conditions, they would not be able to deliver on (assume a huge bank run, or theft of the reserves), such contracts are made every day by businesses who know that, under rare or extreme circumstances, they will not be able to fulfill (hurricane, theft, etc).If a bank issues notes and is aware of a substantial risk that it will be unable to perform the contract, or should have been aware of that fact, or if it issues them knowing for certain that they will not fulfill it - the role of the government is to punish them for fraud. Even still, it would against the bank’s own interest to create too many notes since the danger of insolvency in a free market would not be accompanied by the subtle guarantee of a government bailout as it is today.In conclusion, as supply and demand for money changes (in both actual form and in contractual note form), only a free market monetary system would be able to react appropriately. Like all commodities such as lamps, canned soup, or iron ore, money must be left to the free market.I realize this is quite a lengthy post, but I think that the subject is absolutely fascinating. Thank you B.J. for providing a place for discussion of these important and often-ignored issues.

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