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→See also: Criticism of debt
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* [[Credit money]] |
* [[Credit money]] |
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* [[Debt]] |
* [[Debt]] |
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* [[Criticism of debt]] |
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* [[Hyman Minsky]] |
* [[Hyman Minsky]] |
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* [[monetary reform]] |
* [[monetary reform]] |
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Some critics of fractional reserve banking and the related fiat paper monetary system may refer to it by the term debt-based monetary system,[1] and may refer to the new money that is created in parallel with new debt as "debt money".[2] Their criticisms are based upon non-mainstream economic theories that are generally regarded as incorrect by mainstream economists.
Critics of fractional reserve banking include a number of mainstream economists such as Irving Fisher[3], Frank Knight[4], Milton Friedman[5] and others; strong non-mainstream critics include the Austrian economists, Murray Rothbard[6] and Ludwig von Mises.
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The conventional analysis of fractional-reserve banking and the "debt-based" approach overlap in areas, although the conclusions drawn and the terminology differ significantly. Critics sometimes choose terms with negative connotations (including "debt-based") and claim that fractional-reserve banking is inherently fraudulent or that it inevitably leads to financial crises or periodic crises brought on by bank runs, while mainstream economists regard fractional reserve banking as a useful and benign system, that does not interfere with monetary policy.
Critics of fractional reserve banking usually note that the banking system "creates money out of nothing", requires someone else to go into debt in order for any new money to be created, and debases the means of exchange. The insight that banks "create money by extending loans" is not new, and the subject is covered in most introductory economics textbooks and many popular reference works.[7]
The differentiation of types of money is also not new; there are money types, from the narrow (such as physical notes and coins) to "broad money" which may include various types of bank deposits, chequing accounts and others.[8]
The capacity that the fractional-reserve banking system has to create money and influence the business cycle (including booms, busts and credit cycles) is widely recognized in economics.[9] However, most mainstream economists do not see this as inherently harmful. In fact, the amount of money that governments or central banks should allow to be created through the issuance of new debt to the general populace and the interest rates the indebted should pay on their debts are frequent topics of academic, economic and political commentary.[10]
While certain monetary reformers claim that a fractional-reserve based banking system is inherently destructive and generates inevitably debasement of the currency, extreme inequalityorperiodic crises, the mainstream analysis is that such events are not certain to happen with fractional reserve banking, but might occur due to exogenous events or poor management of monetary, fiscal and financial policy.[11][12] These "inevitability" predictions regarding financial crises or social or political instability are considered by some to be akin to conspiracy theories.[13][14]
In fact, some economists see reserves and other limits upon the banking sector's ability to "create money" as a mechanism for transmission of monetary policy[15] According to this approach, the central monetary authorities use the pricing mechanism (via various monetary policy instruments) to adjust the quantity of money in circulation and protect depositors and the integrity of the financial system. The use of these tools is adjusted according to the nature of the banking system's propensity to create money by lending.[16]
Another divergence is that some economists generally address the issue of choice of monetary regime (such as the comparison between fiat currency and the gold standard) and banking policy as entirely separate issues; the level of banking reserves and other regulatory measures regarded as instruments of monetary policy that help to fine-tune the central bank's control over the growth in the money supply.[17]
Debt-focused critics on the other hand often link the alleged "negative" effects of fractional reserve banking with a government-enforced "paper" or "fiat currency", which they allege allows the practice of fractional reserve banking to continue without a "natural" limitation on the growth of the money supply, thereby causing inherently unsustainable "bubbles" in asset and capital markets that are vulnerable to speculation by highly leveraged hedge funds and other bank agents.[18][19][20][21][22][23][24]
There is also substantial difference on the recommendations regarding "debt-based" views. "Debt-based" views are often associated with monetary reform movements recommending radical or "revolutionary" changes to the current system, such as: (1) a return to the gold standard (orsilver standardorbimetallism); (2) the issuance of "debt-free" money directly from the Treasury (rather than the sourcing of government spending via interest-bearing bonds from the central bank); (3) the issuance of social credit (interest free loans) from a government-controlled and owned central bank; (4) enforcement of full reserve banking for the privately-owned banking system.
Most mainstream economists do not consider these measures as either feasible or desirable.
The recommendation of a "full reserve" banking system is considered hypothetical by many economists and virtually all banking systems worldwide operate on some form of fractional reserve banking (although the level of required bank reserves and the degree of regulatory constraints on banking differ greatly, with Iceland, Britain and the U.S. being examples of countries with low reserve requirements imposed by government).[25][26] In response to the criticism that full reserve is needed to avoid liquidity shortages and bank runs, some would point out that banks usually hold reserves as other liquid assets (rather than money) so that they can meet the demands of depositors on their own, thus avoiding liquidity shortages.[27] Reserves, in this sense, represent a form of protection against withdrawals of currency.[28]
The subject of debt-based money (as distinct from traditional monetary policy) is absent from most reputable established mainstream academic economic publications.[29][30]
It should be noted that various other non-mainstream schools of monetary thought do not necessarily subscribe to, for example, the conclusion that fractional reserve banking is inherently destabilizing or that full reserve banking is the appropriate solution; some explicitly advocate "free banking" with no required reserves at all. Some have referred to the concept of monetary policy with full-reserve banking as "nonsense" (that is, a contradiction in terms). More detailed analyses argue that full-reserve banking would impose similar costs of price adjustments in reaction to growth (through a reduction in the overall price level) as would inflation, and hence offer no inherent advantages over fiat currencies and fractional reserve banking.[31]
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In stark contrast to conventional economic analysis, some commentators focus on the combined use of fiat currency, fractional reserve banking and central banking as a negative feature of modern monetary systems. These commentators use the term debt-based monetary system to refer to an economic system where money is created primarily through fractional reserve banking techniques, using the banking system.[32] This form of money is called "debt-based" because as a condition of its creation it must be paid back plus interest at some time in the future.
To some commentators, this implies that as the money supply and the economy grows, the general populace becomes increasingly indebted at the same time as debt grows in parallel with money supply growth, and increasing interest payments (from either taxpayers or indebted consumers) are needed to pay bondholders as the money supply grows.[33][34][35]
Some argue that since debt and the interest on the debt can only be paid in the same form of money, the total debt (principal plus interest) can never be paid in a debt-based monetary system unless more money is created through the same process. For example: if 100 credits are created and loaned into the economy at 10% per year, at the end of the year 110 credits will be needed to pay the loan and extinguish the debt. However, since the additional 10 credits does not yet exist, it too must be borrowed. To some, this implies that debt must grow exponentially in order for the monetary system to remain solvent.[33][34]
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The economic, environmental and social effects arising from money creation through fractional reserve banking has been subject to much heated political debate for well over two centuries.[36][33][37][34]
Critics claim that, in contrast to "debt money" (which is money created in parallel with the issuance of debt or credit), "true" fiat currency is issued by the Treasury of a central government debt-free, as no requirement for its eventual return is made as a condition of its creation.[38][39] Government-issued debt-free fiat currency (such as debt-free notes and coins) can circulate perpetually in the economy as "stable" or even sound money (if backed by goldorsilver) and although not as stable as hard currency, government-issued debt-free notes and coins (such as United States Notes and silver certificates) do not have the same effects of debt-based money described below.[40] It should be noted however that fiat currency can be a source of hyperinflation if its production is not controlled, as the government has the potential to issue unlimited amounts of fiat currency - provided it is accepted as "money" by the private banking system. Notes and coins in circulation (being defined as M0) now account for a tiny fraction of the total M3 money supply in all developed, debt-based capitalist economies (M0 generally being less than 10% of the total M2 money supply in most developed economies).[41][42]
Similarly, gold, silver and other precious metals have in the past been used as money. Because of the difficulty in increasing the supply of precious metals quickly, some monetary reformers believe a return to the gold standard, or a similar system of "hard" or "real" asset-backed currency, is the only way to stabilize the growth of the money supply. These monetary reformers often refer to the gold standard and silver standard as "sound money" or "honest money".
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