Pros and Cons of a Gold Standard

[MediumTex]

Wouldn't much higher reserve requirements address a lot of the concerns about fractional reserve lending?

[moda0306]

Wouldn't much higher reserve requirements address a lot of the concerns about fractional reserve lending?

I think they would.  Is that even pertinent now though?  Isn't the strong will to save and low demand for new debt giving banks plenty of reserves?

[Tortoise]

Wouldn't much higher reserve requirements address a lot of the concerns about fractional reserve lending?

I think they would.  Is that even pertinent now though?  Isn't the strong will to save and low demand for new debt giving banks plenty of reserves?

That's a good question, Moda. Does anyone know of the simplest way to determine what a given bank's reserve ratio is at any given moment in time? (Not the reserve requirement, but the actual reserve ratio, which will presumably be a bit different for every bank.) Or is that considered "proprietary" information by the bank?

If we can't see what a given bank's reserve ratio is at any moment in time, is there a macroeconomic aggregate measurement that could tell us what the "average" bank's reserve ratio is?

MT, the potential problem I see in attempting simply to use a higher reserve requirement to avoid catastrophic credit bubbles is that when times are good, there will always be business and political pressures to push the the requirement back down to a lower level. Eventually people will forget about the prior credit bubble that made raising the reserve requirement necessary, and all they will know is that by lowering the reserve requirement, they will virtually guarantee banks an X% increase in their immediate profits since they'll be able to make more loans.

I can't help but think that human nature makes a "tinker-friendly" system like fractional-reserve banking much more prone to abuse and manipulation than an immutable, clearly defined system of hard money. I do see the world through Austro-libertarian goggles, though, so I'll admit I might be letting my bias prevent me from seeing how humans and their inherent weaknesses can handle fractional-reserve banking without abusing it.

[Gumby]

That's a good question, Moda. Does anyone know of the simplest way to determine what a given bank's reserve ratio is at any given moment in time? (Not the reserve requirement, but the actual reserve ratio, which will presumably be a bit different for every bank.) Or is that considered "proprietary" information by the bank?

I think you can do it at bankrate.com. Do a search for a local bank and click "financial statement". Worth a shot.

If we can't see what a given bank's reserve ratio is at any moment in time, is there a macroeconomic aggregate measurement that could tell us what the "average" bank's reserve ratio is?

FRED (from the St. Louis Fed) would be the place to look. It lets you create your own custom charts for comparisons on the fly. But, I'm not sure if they've published that exact data set you're looking for. Just do a search and it will pull up relevant data sets and you can combine them however you please.

See: http://research.stlouisfed.org/fred2

MT, the potential problem I see in attempting simply to use a higher reserve requirement to avoid catastrophic credit bubbles is that when times are good, there will always be business and political pressures to push the the requirement back down to a lower level. Eventually people will forget about the prior credit bubble that made raising the reserve requirement necessary, and all they will know is that by lowering the reserve requirement, they will virtually guarantee banks an X% increase in their immediate profits since they'll be able to make more loans.

I can't help but think that human nature makes a "tinker-friendly" system like fractional-reserve banking much more prone to abuse and manipulation than an immutable, clearly defined system of hard money. I do see the world through Austro-libertarian goggles, though, so I'll admit I might be letting my bias prevent me from seeing how humans and their inherent weaknesses can handle fractional-reserve banking without abusing it.

The Fed wishes that banks were lending more. Reserves are high. Lending is low. In practice, the money-multiplier doesn't work the way our text-books taught us. It's actually a pretty big problem for the economy right now.

"These facts imply that the tight link suggested by the multiplier between reserves and money and bank lending does not exist."

http://www.federalreserve.gov/pubs/feds ... 041pap.pdf


And in fact, the M1 Money Multiplier has been dropping for years, and officially tanked in 2008. It is dead in the water right now:

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This is a very long trend of a decreasing money multiplier.

When the Money Multiplier is below 1.0, we are unlikely to see any inflation (i.e. multiply any number by a number less than one and you get a smaller number). Right now, each $1 increase in reserves (monetary base) results in the money supply increasing by $0.729.

The Fed cannot create inflation if our fractional reserve banking system is not willing to lend. There is nothing to multiply!

[stone]

TBV, I totally agree with you that the system I describe is one where everything is on a no-nonsense footing and that that would prevent many of the current problems BUT don't you also see that a destructive deflationary spiral would be an ever present accident waiting to happen (and probably not waiting for long) under such a system? That is why I think fiscal wealth redistribution measures would be constantly needed so as to counteract that great deflation risk/certainty.

[stone]

Medium Tex, I got the impression that under the current banking rules, the capital requirements were what actually limited bank lending and the reserve requirements had very little practical influence. Am I right in understanding that in Canada they have zero reserve requirement? The "hard money" lending method of a loan company needing to sell bonds and issue shares in order to get every penny it lends amounts I guess to a 100% capital requirement.

[TBV]

TBV, I totally agree with you that the system I describe is one where everything is on a no-nonsense footing and that that would prevent many of the current problems BUT don't you also see that a destructive deflationary spiral would be an ever present accident waiting to happen (and probably not waiting for long) under such a system? That is why I think fiscal wealth redistribution measures would be constantly needed so as to counteract that great deflation risk/certainty.

Correct me if I'm wrong, but do you sense a collective aversion to deflation in the air? Why is it that a bit of inflation is officially seen as the price of doing business, but deflation is intolerable.  I see deflation as more a part of the natural order of things, wherein man's increasing innovation and efficiency results in greater value for money.  If that counts as "hard times", then I prefer one in which people's buying power is going up rather than down.

Wealth redistribution is a brute force approach, IMHO.  By definition, such power would be exercised by those who already have power.  Meaning that those most in need of protection (being powerless) would not control the process.  Exchanges in the marketplace correspond to everyone's real-time voluntary evaluation of what's in their best interest.  Not so with government.  I recall reading about a mugger who would ask the victim for their money.  If they surrendered it, he would take it and leave.  If they refused, he would beat them and take it from them.  No matter which scenario played out, the victim always lost his/her freedom. The state "asking nicely" is no less coercive.  And just as prosperous citizens have better defenses against street crime, they will also be better equipped to avoid the redistributive mechanisms you suggest.

Just as there are foolish buy-high sell-low market participants, there are also bass ackwards governmental actors whose housing policies create housing crises and whose income assistance programs benefit middle class bureaucrats more than the targeted population.  Foolishness should be avoided, but fools with the police and armed forces at their disposal are to be feared.

In a slightly off-center response to your post, let me suggest something else.  During the period of feudalism and later constitutional monarchy, the wealthy were bound by a sense of noblesse oblige.  Their privilege entailed responsibilities, not the least of which was to defend with their lives the system from which they derived so much.  It was shameful for an aristocrat to avoid military service.  Now, considering how government is where most of the mischief gets done in our society, would it be asking too much to require that those who seek public office (maybe even just public employment) do X years of active military service?  In fact, how about expanding that requirement to cover lawyers, bankers, college professors, news reporters, lobbyists and all those who see fit to regulate our lives and public discourse?  At least then, members of the elite would have tangibly demonstrated a personal commitment to the common good.

[stone]

TBV, I think it is vital not to mix up deflation due to efficiency gain from deflation due to panic hoarding and economic paralysis. Imagine a situation where everyone has a stop loss order on their holdings of the bonds and shares from the "loan companies" in our hypothetical hard money world. Some minor shock to the system might cause people to become more cautious and hold more of their wealth as non-interest earning zero risk base money. The consequent drop in value of the bonds and shares would create a panic cascade of falling values. It is true that the yields of the bonds would become ever more attractive BUT the increasing purchasing power of the base money would also increase making it also ever more attractive. The lack of credit would cause loans to go bad and losses to be incurred by investors making the drive to base money even more urgent and the spiral would intensify.

[TBV]

Stone, your question is well posed.  However, is the market ever so uniform in its movement?  Are we to accept that the scenario would occur simultaneously and to the same degree the world over?  That seems unlikely to me.  Investors from countries outside the US might see what you describe as a great investment opportunity.  In addition, when domestic investors sit on the sidelines, the incentives to jump back in tend to grow.  Why should those signals be ignored indefinitely?  Furthermore, all of this talk of panic, death spirals, and cascading values are a very grim specter, much like the oft-discussed but seldom seen hyperinflation.  Are the risks that you describe really so high?


One more thing: isn't it quite natural to buy the dips?  If so, then why should "minor shocks to the system" elicit the herd behavior you initially propose?

[stone]

TBV, I think that deflationary spiral effect is much of the reason why credit creation out of thin air and other financial innovations have displaced "sound money" and attempts to get money on a more sound footing tend to be short lived. My impression is that whilst getting a purely fiat currency to last a long time without hyperinflation has  been a "triumph" of modern central banking; getting "sound money" to actually function would be a "triumph" perhaps not really ever yet achieved?? The late 19th century gold standard time had plenty of fractional reserve banking. People used tally sticks to create credit  "money" in medieval times. Many people were not really able to participate in the money economy for much of history. I'd love to hear of an example where there was a predominantly money based economy (ie not having lots of serfs, slaves or most people living by subsistence agriculture and not using money) that did not have credit creation out of thin air nor much government mediated redistribution and that continued for many years.

[TBV]

A general question:  If there is systemic deflation, then those who flee to safety are rewarded.  If there is systemic inflation, they are punished.  One would think that hard-working, thrifty citizens of modest means are more likely to be risk averse than those whose fortunes are greater.  Shouldn't risk avoidance be made more secure?  Sound money seems to do that.

[TBV]

Stone:

Aside from any other consideration, wouldn't it be an improvement if citizens could be made whole for the debilitating inflationary effects of liberalized credit expansion? Governments have little incentive to restrict this because tax revenues increase as nominal asset prices and income rise.  Income indexed for inflation would help short-circuit that loop.  So would calculating capital gains based on real values instead of nominal values.

[moda0306]

I think a lot of the deflation debate, as well as the Austrian vs Keynesian arguments, come down to, is how much society is motivated by fundamentals vs the "greater fool" theory.

I think so much of our daily interactions that we choose to make are really, in the end, based upon some form of "greater fool" theory.  Even so, one has to ask whether that means government should take over when our "groupthink" gets us into trouble.  We do things, often, because of the benefit we think they'll realize us based on what others value... not on what we, ourselves, value.

Would we really buy gold at $1,600 an ounce if we didn't think someone else would pay us that much or more in the future?

Would we really put $250k worth of value on a house if we didn't think someone else would eventually pay us about that much after a month of marketing it?

Would we really buy a new car with leather seats, a nice stereo, and German characteristics if we didn't think that'd buy us some status in the society we're in worth the annual depreciation?

We live in a world of everyone constantly trying to guess what will be value of something to everyone else who's also trying to do the same thing... this can create the "bird flock" effect, IMO.

Is this something government should try to work to counteract to create stability?  In my opinion, in some ways, yes.  But maybe that just serves to set us up all of us birds flying too far up into the atmosphere where we can't breathe anymore and we just all fall down dead.

I liken that effect to the idea that we should put out forest fires, which in the past has lead to small fires being put out, much more dead brush developing than otherwise would have, and all of a sudden when a fire finally takes hold past what's controllable, it burns down MUCH more than what would ever have burned down from all the small fires before.  What do we do once we're in this trap?

[stone]

TBV and moda, To me the ideal monetary system would be one where doing what made sense if money was ignored also made sense from a financial perspective. To my mind, in order to prevent transfer of control over to those who are out to "game the system", prices (including asset prices) need to be stable over the medium and long term. Monetary expansion creates the distorting waste of asset bubbles BUT a non-expanding money system could lead to a deflationary spiral where those who held large amounts of base money were able to gather a greater and greater proportion of the monetary base and so gain control.  Our current system aims for a 2% inflation target BUT has been subverted to also give 8% asset price inflation with a froth of volatility. It basically transfers control over to those who own the most assets and manage them from a financial perspective leaving aside what would make sense from a fundamental perspective. I think thriftiness is important if it means us wasting less BUT it can also be wasteful to not do things that make sense in the long term. Building an electricity grid rather than everyone using generators is one example. Building sewers and a safe water supply is another. If deflation led to hoarding of all the base money then waste could come from missed investment and that could be as bad as the current waste from malinvestment induced by asset bubbles. People recoil from the idea of an asset tax (applied equally to all assets including base money) BUT if looked at purely from an economic perspective it seems to me to be a way to avoid deflationary spirals without needing to resort to monetary expansion.

MBV, I think they tried to use indexing to compensate for inflation in Brazil in the 1990s. The problem was that the inflation accelerated more and more. They ended up abandoning their currency and starting a new one. MMTers go on about the Zimbabwe and Weimer hyperinflations being instigated by supply shocks. I guess that Brazilian hyperinflation was a quite different mechanism where the indexing created a positive feedback loop.

About "buying the dips". There was a very sobering back-test of that strategy see:
http://seekingalpha.com/article/265087- ... h-is-right

I guess, come to think of it, Clive's stop loss strategy only works because of the same momentum phenomenon that prevents the "buying the dips" strategy from working??

[TBV]

Stone:

I didn't mean that everyone's income should be increased to compensate for inflation.  I suggested that everyone's taxable income should be adjusted for inflation (i.e. lowered) before taxes were calculated. Ditto for calculating gains from the sale of assets. Thus no tax would ever be due on illusory "gains" unless the proceeds in real terms were more than the price you originally paid.  This way the state would suffer as much by inflation as everyone else, and hopefully learn a lesson.

[Gumby]

Avoiding losses is (almost) as good as a gain.

I completely understand the benefits of avoiding a loss. I mean, everyone wants to avoid losses. But, if an investor allowed their individual PP assets to take losses, wouldn't that give them the ability to offset their PP capital gains with prudent tax-loss harvesting?

My understanding is that PRPFX takes advantage of their losses in this manner, to minimize taxes passed on to shareholders.

Though, I suppose if one were able to avoid losses successfully, they would probably result in a bigger gain overall.

[fnord123]

I suggested that everyone's taxable income should be adjusted for inflation (i.e. lowered) before taxes were calculated. Ditto for calculating gains from the sale of assets. Thus no tax would ever be due on illusory "gains" unless the proceeds in real terms were more than the price you originally paid.  This way the state would suffer as much by inflation as everyone else, and hopefully learn a lesson.

I believe this is already the case, insofar as tax brackets are inflation adjusted each year - e.g. see http://www.irs.gov/newsroom/article/0,, ... 25,00.html.  Note that this doesn't hold true for AMT, which hits upper-middle income and above folks and must be manually adjusted by Congress.

Of course, if the metric for inflation used (CPI-U) misstates inflation, then this doesn't really work.  Some of the (failed) debt ceiling plans had proposed switching from CPI-U to C-CPI, which would result in even lower inflation measurements, thus causing the bracket adjustments to be smaller (so more taxes paid) and also cause cost-of-living-adjustments to be smaller (so less entitlements paid out).  These are strong incentives for government to understate inflation.

[stone]

TBV, I understand what you were meaning now. I think TIPs were also invented so as to show that the government would also feel the pain if inflation got out of hand. As Gumby says, a big problem is how to measure inflation. The basket of goods used "evolves". I see inflation as the price we pay for not stomaching a more effective fiscal approach to wealth redistribution that would make inflation unnecessary.

[TBV]

fnord123:  Thanks for looking that up.  I see that several things get adjusted for inflation, but from what I read there income is not one of them.

[fnord123]

fnord123:  Thanks for looking that up.  I see that several things get adjusted for inflation, but from what I read there income is not one of them.

Hmm - perhaps I am misunderstanding the following (from the same link I provided above):

Tax-bracket thresholds increase for each filing status. For a married couple filing a joint return, for example, the taxable-income threshold separating the 15-percent bracket from the 25-percent bracket is $67,900, up from $65,100 in 2008.

So this means that if a person's salary keeps up with inflation in 2009, their after-tax money, held constant for 2008 dollars, would be the same - they would be no worse (or better) off.

Is your point that inflation is going up, but wages are not keeping up with inflation? That would indeed create a scenario where year-to-year a person would have less purchasing power after adjusting for taxes & inflation.  If that were the case, in years where wages go up faster than inflation, would you advocate for automatic tax rate increases?

[TBV]

Truly adjusting taxable income for inflation would entail lowering your reported income by expressing its value in constant dollars.  As I said, several things do presently get adjusted for (like exemptions, tax bracket threshholds, gift exclusions, etc.) even though they don't reflect the actual rate of inflation (either full inflation or the government's own CPI).  But my point is that there is no inflation adjustment for the actual reportable income amount.  Under the current system, the yearly value-less nominal increases in one's income still get taxed.  My suggestion is to not hold taxpayers liable for anything other than taxes on real wages.

For example, if the base year were 2000, a wage earner with 2011 gross income of $50,000 would have it adjusted (before any other adjustments) to its year 2000 equivalent value, which is $38,144.

[The inflation figures come from the Bureau of Labor Statistics: http://www.bls.gov/data/inflation_calculator.htm]

[fnord123]

I think your proposal is just a different way of arriving at the same result as the current system. The current system has the benefit of being simpler for a taxpayer to calculate.

Assume Joe Taxpayer earns $38,144 in 2000. Let's say the 10% tax bracket applies to anyone earning $38,144 or less.  Joe pays $3,814 in taxes, and has $34,330 in after-tax, year 2000 dollars left that year.

Joe Taxpayer earns $50,000 in 2011 (i.e. his salary goes up commensurate with inflation).  The IRS has adjusted the 10% tax bracket to keep up with inflation (which they do), so anyone earning $50,000 or less is in the 10% bracket.  Joe pays $5,000 in taxes and has $45,000 in year 2011 dollars left.  $45,000 in 2011 dollars is $34,330 in 2000 dollars.

Thus,  Joe does take home the exact same amount of real wages after taxes, as measured in year 2000 dollars, under the current IRS bracket indexing.  This only breaks down when Joe's wages do not keep up with inflation, or if Joe earns enough to pay AMT (which should be inflation indexed, but isn't).

[TBV]

Fnord123:

I did two actual returns for a single wage earner, no dependents, standard deduction.  The real taxes in 2011 would actually be slightly less than 2000, presumably because of shifts in the brackets overt the last 10 years.  I concede your point.  Thanks for the time you took to shed light on this issue.