Money Creation and Idolatry: How did we let this happen?

It seems that we agree on three points: 1) the financial institutions behaved recklessly (you point out pyramids and Ponzi schemes), 2) we need to rethink our current financial structure, and 3) a crisis of this size prompts us to ask far deeper questions than "How can we financially recover from this global crisis?"

We disagree, however, on a fourth point: the culpability of the U.S. Government as enabler of this crisis, particularly its financial institutions, the Federal Reserve and the Treasury Department. I don't think that this point detracts from the spiritual implications of your post(s)-which in large part I agree with-but it adds to my skepticism of our society's financial structures, shifting blame from casino capitalism (as you call it) to the centralized monetary policy you endorse. The government is not a benign entity. It is subject to the same corrupting factors as financial institutions, especially since government alone can change the rules of the game.

A holistic understanding of human corruption and our uncanny ability to mess things up, be it publicly or privately, prompts deeper questions. How much control do we think we have over the economy? The Keynesian rejection of deflation and recession-that by increasing the money supply we can avoid economic downturns-is especially pertinent. In the current crisis, it was our unwillingness after 9/11 to accept the depth of the imminent recession. The Fed lowered interest rates, which increased lending and inflated the housing bubble. Absent the government's artificial manipulation of the money supply, we would be looking at a much different picture today.

Are we therefore willing to accept that economies naturally ebb and flow, that sometimes it will not feel good, and that we are not in as much control as we think we are? It is not greed that leads to financial bubbles-at least not directly-but rather our unwillingness to accept financial downturns as natural economic events that happen for lots of reasons, many of which are outside of even the largest institution's control. (Greed asks for rules to be changed, but government must capitulate before greed can run its course.)

Herein lays the major critique of both President Bush when he was in office and President Obama now: our country needs to take its medicine, even if it is going to be painful for both our national and global economies. To stabilize the economy means in large part to remove the whims and whines of politicians and financial lobbyists from the money supply equation. It is much harder to be reckless when interest rates are higher and loans are not backed by the government. (Nassim Taleb adds to this the "non-neutrality of representation," which means that risk measures cause a disproportionate increase in risk taking on the part of the unsuspecting user.)

Thus, by lowering interest rates, the government enabled private financial institutions to loan recklessly and create complex financial instruments that eventually broke under the stress of our failing economy. Without artificially low interest rates, much of the current crisis never happens. Had we accepted a necessary (and temporary) recession at any time during our eight year road to financial bust, we would have dramatically reduced the pain we are feeling now.

Thanks for the post and for shining a spotlight on this important issue.

Just to clarify, are you claiming that US money is currently "created" by government? The Fed is not the government. The Fed is not "owned", controlled or accountable to the government (or anyone for that matter). And it was in fact created and funded as a collaboration between very large private banks.

- Visit their FAQ's at: http://www.federalreserve.gov/generalinfo/faq/f... to see for yourself.

While I agree with your point that printing more money is bad, I believe that is a very minor symptom of a much deeper problem. I have to agree with the point that I think glassdarkly is making- as long as ANY group is controlling the "creation" of money we are at the mercy of a group creating policies for their best interests- and not necessarily the interests of their citizens. - Including printing more money to create the illusion of wealth.

As counter-intuitive as it may sound, the quickest, most effective path to a stable economy is to get rid of The Fed. But I don't see that happening any time soon.

This explanation of money and central banking is bogus. The previous post on this was a good start, explaining why money "creation" could become (and has become) a false god for a society with regards to wealth. But this post gets it wrong with regards to money supply, private banks issuing loans, and the central banking system.

The reality is that central banking, and the creation of the Federal Reserve system, is the primary source of the problems of inflation, booms and busts, and "bubbles." They are not a result of natural market behaviors. With regards to banks issuing more money to borrowers than the banks have on reserve, this is not "wealth creation," is is money out of thin air. This is fractional reserve banking, and it bloats the supply of money in an economy. When the Central Bank permits (i.e. "backs the loans") such lending, interest rates (which are prices for borrowing money) are artificial, and unsustainable.

Real sustainable lending means some people are saving, therefore other people are borrowing. When more people are saving, those who need to borrow will have lower interest rates. The reverse is true. Supply and demand works with borrowing and lending just as much as it does with any other commodity.

Thomas E. Woods' book Meltdown has a great explanation as to why central banking is fraudulent, debased the value of money, and is detrimental to all, especially the poor.

You write: "In contrast, when money is created by governments, they insert the created money into the system at a different place-i.e., the federal budget, to form a base of the government's spending on real things (salaries, roads, health care, etc.)."

The ambiguous 'etc.' fails to mention that the government uses fiat money to delay entitlement reform and pay for our wars. It was much easier to finance the Iraq War when we decided to print money instead of raising taxes. Had President Bush told the country that he was raising taxes in order to fund our invasion of Iraq (or even told us that he was going to put us trillions of dollars in debt), his support would have vanished.

But this problem precedes the Iraq War. An article in Scientific American (link: http://www.scientificamerican.com/article.cfm?i...) says: "A century ago almost all the world's currencies were linked to gold and most of the rest to silver. Currencies were readily interchangeable, gold anchored exchange rates and the physical supply of gold stabilized the money supply over the long term. The gold standard collapsed in the wake of World War I. Wartime financing with unbacked paper currency led to widespread inflation." The government needed to create money in order to fight a war.

History shows that money creation puts off any sort of accountability for the wars we wage and the bills we need to pay. Government spending would decrease dramatically if we constantly kept in mind that when spending increases, so do taxes. By delaying payment on much of our nation's debt, politicians have passed legislation without confronting the electorate with the bill. While most spending is less controversial than debt financing for a bad war, it is still disingenuous to assert that we as taxpayers are getting something (salaries, roads, health care, etc.) for nothing.

Creatio ex nihilo indeed.

It is subject to the same corrupting factors as financial institutions, especially since government alone can change the rules of the game.

Excellent point, which is ironic since most anti-capitalists (who are largely anti Big Business) put more faith in a single entity-the federal government-to provide security.

Are we therefore willing to accept that economies naturally ebb and flow, that sometimes it will not feel good, and that we are not in as much control as we think we are?

Actually, if we had no central banking system, this "ebb and flow" would be less dramatic and robust. Every example in American history of a boom/bust cycle can be proven to be attributed to an inflation of the money supply, a central bank, or similar scheme.

Without artificially low interest rates, much of the current crisis never happens. Had we accepted a necessary (and temporary) recession at any time during our eight year road to financial bust, we would have dramatically reduced the pain we are feeling now.

This is something most people don't understand. Again, this all stems from the very existence of a central banking system. A free market system, without the FED, would not result in such crises as we have seen. It wouldn't be free of problems, of course, but it wouldn't be the drunken orgy caused by artificially low interest rates. We can blame it all on greed, but that just begs the question, "Why were all these people greedy, and who allowed them to act easily on that desire?" It was the government's involvement in the market, not the market itself. Capitalism is more vindicated by this because it's vomiting out all the toxic assets and reseting all the bad exchanges that took place.

You're half-correct. The Fed is a government-approved monopoly who can print money, and is the federal government's lender of choice. The chairman is chosen by the President (I'm pretty sure), and it is very much in collusion with the government. You're right that it is part of the market, not part of the government, but you can't get off that easy. They do, after all, have a .gov website address.

I'd say it's quasi-governmental. They don't work completely independently of one another. And you're 1 gazillion % correct: the best way to sustainable economy is to end the Fed. Next step go back to a gold standard. We've all (especially the poor) suffered enough at the hands of bureaucrats who've decided what's best for the economy, when the economy works best when the government protects and defends property rights, punished fraud and deceit, and guarantees that it will stay out of private contracts (which is in the Constitution).

That is the point I am making.

Thanks for the clarification on the Fed as non-government entity.

Do you ever feel frustrated by the lack of basic economic understanding by those who defend money creation and government control over it? I don't think it ever occurs to them that when you give the government control over the money supply, they are being given the ability to "create," which is up to God. God created material when God created the world, and we've discovered throughout history that some things, such as gold, are scarce, and can serve as a medium of exchange. It's kinda arrogant, really, to believe as humans we can create money out of thin air, and then call it "wealth."

Indeed, money creation is a hidden tax, because it makes the money we earn lose value, in order for the government to pay for things like war and entitlement programs.

Honestly, in the end, as a society we stand before God and explain how we served "the least of these," and the answer is we took on massive amounts of debt, debased the value of money, and printed up money, I'd be really embarrassed. The alternative is to get out of debt, save money, and use the surplus to do the exact same thing. This would not only result in a sustainable and prosperous economy, the governmental effort it would take to accomplish the things we now call "entitlement programs" would be more affordable, if they were even necessary at all.

This post is scary! I suggest (uninformed) readers get some some perspective from an opposite view as well to help form an opinion. http://tinyurl.com/mb274u

I'm siding with xfree9's on this issue.

I agree that the ebb and flow would be less dramatic and robust, but as a society we'd still have to accept that downturns do occur naturally. (After all, it was a downturn that prompted the idea of a Fed in the first place.) This assertion is important because it rejects the notion that recessions are somehow bad. In fact, their function in markets seem morally neutral: to liquidate malinvested capital and prepare it for reinvestment.

Per your last paragraph, I still wonder about the post-9/11 economy. Of course, that is a matter of speculation that is tangential to the greater point, but free market thinkers still need to think of these things. Also tangential, but more important, is the intellectually honest acknowledgment that to deleverage the economy, i.e. abolish the Fed, would hurt the economy in the short run. We should do it, of course, but it must be said.

Finally, your last two sentences strike me as logically and structurally similar to the observation that it is not religion that is bad, per se, but rather human nature that corrupts it. I am not conflating religion with capitalism-those are deep waters-but it struck me as something worth noting.

Of course I do. But I feel frustrated in the sense that we all feel frustrated when we think we understand something that other people are missing. It is clear that we read a lot of the same material (Mises, Rockwell, etc.), and I'm not putting words in your mouth, but I hesitate to birth an 'us vs. them' dynamic over a subject as tough as economics. I do want to draw out the larger point that conservatism (lowercase 'c') is attractive in the long run because it is built on the claim that as human we have a limited understanding of the world in which we live. The rejection of money creation and government control can be part of that.

As for the gold standard, I had never thought of it in terms of something that God provided as a medium of exchange. It is a fascinating idea, to be sure, one worth more thought. As for returning to the gold standard, I rarely assert the need to do so. I agree 100% with its merits, but as someone who wants to take part in the current debates, we should recognize that some of our intellectual framework can be modified while staying true to basic principles. Libertarians can get into trouble when they (we) let their wonderful idealism get in the way of a more pragmatic political program.

It is likely we have forever gone beyond certain milestones of America's past, including, unfortunately, the gold standard. I am not conceding defeat, but I'd be happy enough to see the abolition of the Fed, something that would be wonderful for our country and world, including, as you always mention, the poor. Perhaps it will happen in the backlash against the poor monetary and fiscal policy of the past X years.

Thanks for the discussion.

I agree that an us/them way of looking at things are not very productive, and can be disrespectful at times. And I don't expect everyone to "get" economics. I'm merely an armchair economist at best, and that's probably giving myself way too much credit. I'm still trying to wrap my brain around it. My wife is studying psychology, so her brain is light years away from this stuff, yet she understands a few basic things like business cycle and money creation. I guess I chalk it up to common sense. If we really talk through some of the basics, it isn't that difficult. But then again, when I was in high school being taught Economics 101, supply and demand never made sense to me.

As for pragmatism, I think I agree with regards to the "public face" of how to engage in dialogue. Sometimes ideology gets in the way of practical steps toward that very same ideology. For instance, I'm very much in favor of the gold standard, but if I were to run for president next election, that wouldn't be my platform. It would be smaller, baby steps toward that. That's why HR 1207-"Audit the Fed"-is a great first step in revealing the secrecy. I think most libertarians get thrown out of a conversation because of their passion for principles with a disregard for practical steps toward a society that embraces those principles.

I blog, if you're interested: www.liveloud.net

The "babysteps" approach doesn't move fast enough to keep up with the seven-league strides of our opponents. Many voters know this. We libertarians are never going to be loved by the mainstream media and politicians, who are mostly bought and paid for; but we've got to speak truth to power nonetheless. There will come a day when enough people cry out against the status quo that it will tumble down, just as the former USSR eventually fell.

Is it me, or is there an odd lack of counterpoint to the arguments we're making here in the comments?

You guys are all pretty far above my ability to keep up, but I can still be pretty sure of one thing: when the U.S. Treasury offers bonds ('debt') for sale on the open market, and the Fed has to buy all or most of it in order for us to have a "successful" auction, something is drastically wrong. i understand the Fed is not 'governmental,' but it will do until something else come along. And it appears to me as if (1) we issue bonds, and (2) we sell them to ourselves. Is this even close to what is going on, in the real world?

Practically speaking, the "babysteps" approach is all there is. Sad but true. But of course I agree that we always need to speak truth to power.

It is all too far beyond me. I do not really grasp the distinction between banks (the Fed) creating money vs the government; nor do I grasp how this relates to money disappearing from the economy.

And I don't grasp how this boils down to me and my ethical choices. It feels as if there are vast segments of our economy that is fundamentally fraudulent--or open to fraud.

Which leads me to my current simple equation for my life. I believe wisdom is the product of a simple morality lived out over time (in obedience and submission). I think we have strayed so far from some matters of simple economic morality that confusion will carry the day. On the one hand we have very sophisticated arguments in which expert opinion ranges all over the map (which to me does not look like, walk like, or talk like wisdom); and on the other hand a confusion that can't even muster a counterpoint. To me, they both look like confusion.

I do not have a spirit of fear--but of power, love and a sound mind. I will attempt to act with responsible stewardship with what is in my hands today--praying for wisdom

An excellent introduction to the way the Fed works, its relationship to the government, and how it affects our daily lives is Thomas E. Woods' Meltdown published earlier this year.

Also try this link: http://video.google.com/videoplay?docid=-466210...

Who in the world can "create' real money? Printing money, then lending it to the government is what the Federal Reserve does. The money is not toed to any commodity, hence the term "money creation."

If money is tied to a commodity it has real value. If it is not, it is a fiction, causing inflation (due to the "money" having no intrinsic value, and thus inflating the cost of the dollar against foreign currencies.)

I can't understand how anyone would think that governments, who murdered around 270 million people last century - are more trustworthy "creating" money than people who actually produce something tangible and actually do create money.

Take an extreme case as an example: Zimbabwe's annual inflation rate is now 516 quintillion per cent.

I've seen photographs of public restrooms in Zimbabwe where signs are posted requesting that people not use Zimbabwe currency as toilet paper.

Zimbabwe has 100 billion dollar notes - all because of its feckless leaders "creating money." Had their money been tied to a commodity - something with real value, this couldn't have happened.

There was a time when global currency was exchanged at about the same rate. Then governments got into the "money creation" business.

It's easy to point fingers at banks, wall street, etc. But corruption is corruption, and the private sector doesn't have a lock on corruption - it's not even in the same league with governments. I suggest that people take a look at GAO reports regarding GAO''s auditing U.S. Government agencies over the past 30 or so years. There are so many billions missing that it's astounding. I don't want any more foxes guarding the hen house...

So did we ever find out who was planning
to make money on the hedge funds that cashed in
when the banks failed?

I'm still waiting and wondering about the wisdom of betting against yourselves.
Did these people not have money in a bank or a house somewhere?
What were their true motivations?

I am still waiting for families to move back
into the homes in our neighborhoods
that were bought by the speculators who
lost their shirts because they got caught
with the hot potato last.

Last I heard the banks were still auctioning
off homes to the speculators.
The people who were paying my bills were
families with children.
I wasn't making more than I needed to get by but it was enough so that
I could do things for others.
I would l like to see family housing declared no speculation zones from now on. Family housing is a national treasure, it does not belong on the gambling table at the Cassio.

This entire discussion presumes a definition and form of money, namely pieces of paper with particular designs and numbers printed on them. The free market would choose gold and silver, not the toy fiat money we use today.

Could private banks create gold and silver coin out of thin air? Of course not. Someone must actually mine and refine the ore first, then it must be coined. And even then the mint must have a reputation for coins of reliable metal content for people to trust it and use it.

The word "dollar" is derived from the name of a silver mine (e.g. "thaler") and designated a coin of one ounce of fine silver. With that, the idea of silver having a value expressed in dollars is bizarre. How much is a one-ounce silver coin worth in dollars?? The answer: One! A one-ounce silver coin *is* (or was) a dollar by definition!

Consider the difference in value of one versus ten actual (silver) dollars compared to one versus ten "dollar" federal reserve notes. How much more difficult would it be to mine and refine enough ore to create ten coins versus one coin compared to changing the printing plate to show "10" versus "1" on a super special piece of paper?

The hinderance that comes with the creation of money must be considered in this discussion. Are we to rely on the restraint of politicians? Of the quasi-government body, the Federal Reserve Bank?

If legal tender were gold and silver, as the US Constitution requires by restricting the States to make only such coin tender in payment of debts, said implied legal tender power belonging to the States exclusively as no such power is given to Congress (the power to coin money is not the same as the power to define legal tender), Congress could create new coins as often as they had refined ore available and it would still be tempered by the fact that it is a precious metal that can not be replicated at will.

Let us use gold and silver coin and just divide it into smaller pieces as needed. Then when economic activity increases thanks to some invention of some new technology, the value of money (real money) will actually increase rather than decrease, as with inflation.

The very concept of fiat money and inflation as a tool of economic stimulus is that of a perpetual motion machine, and should be rejected for that fact alone. You can not get something for nothing, and you can not pick yourself up by your own boot straps. It only has the illusion of "working" temporarily, and only benefits those closest to the source of the new money: the self-privileged bankers.

If it was true that inflation could have any real benefit, why not print up enough notes to make us all millionaires? The answer is simple: a million "dollars" would come to buy only a hamburger dinner for four and we'd take our families to McDonald's with a wheelbarrow full of colored paper adorned with Caesar's portrait.

The destruction of this fiat ("by decree") currency is inevitable as those who believe men are sinners should know. Why on God's earth would you trust a government of man? How could they possibly know how much inflation was "just enough"?

We should have competition in money creation just as we have competition in fast food restaurants and department stores. Free competition will prevent monopolies and will assure purity of content of *precious metal* coin.

Speculation serves a function on the market. Look up Thomas Sowell's Basic Economics, or even browse the chapter on speculation in it. I doubt he would defend the actions and results of what you're describing, but making it "illegal" or partitioning zones would likely have some unintended consequences that neither you nor I would really want after all.

Besides, the biggest reason speculation was "hot" the past few years was because interest rates were artificially low. Had the interest rate been what the market determined, only a very few risk-takers would have been able to afford it, and more often than not they are the ones who speculate for the more beneficial reasons of the market. Again, this all stems back to artificially low interest rates. Only one source for that: federal reserve bank.

"But in the 20th century, a new kind of money creation become common: Private banks themselves were able to create enormous amounts of money. How did they do this? Simple