Can Solving the Financial Crisis Be This Simple?

Since my earlier blog poston the current crisis, I have been digging into the analysis and solution proposed by a group whom I call the “Fiat Money/Full Reservists”, or FM/FR people. These are critics of the present money and banking system who are NOT gold bugs insisting on “solid money, backed by gold”.  (The gold bugs are the most numerous and vociferous critics of our present money and banking system; their position has been well countered by many mainstream economists.)

Instead, the FM/FR folks propose a disarmingly simple solution to our financial crisis: buy back our national debt with Treasury-issued "fiat" money AND simultaneously increase required banking reserves from 10% to 100%.

 

In 1 or 2 years, we would:

1. Have no National Debt. It would be extinguished, without inflation (the inflationary effects of issuing fiat money would be offset by the money CONTRACTION caused by raising reserve limits for banks;

2. Accrue no more interest on that debt, thereby eliminating the annual deficit (now about equal to interest on the Debt).

3. Have installed a SUSTAINABLE full reserve banking system– as championed by Ben Franklin and which prospered for many years, until Hamilton and the fractional reservists won out and sent us in the wrong direction.  Fiat money (Greenbacks) issued by the government, not banks, is how Lincoln successfully financed much of the Civil War.

4. Escape the current economic mess, which may well be the final collapse of the ultimately unsustainable 300-year old private fractional reserve banking system.  Fractional banking can prevail only with ever increasing levels of debt. It is doomed to collapse when creditable borrowers can no longer be found, as now.  (I thought unqualified subprime borrowers were the final dregs, but Paulsen on November 14th called for increased consumer credit card debt.)

Here's the best of what I have found on all this so far on the Web:

 

An eye-opening video expositionof our money and banking system. Watch this first.

 

Ellen Brown’s Web site around her fascinating book, “The Web of Debt”. Read the Introduction and Chapter One on her site.  “The Wizard of Oz” was all about money and banking?  Who knew?  In her book, available on line, Ellen advocates the FM/FR solution, and even argues for socializing much of banking.  Were that to be done, she argues, the government, rather than banks, could collect interest for lending activities, and that income would enable elimination of the income tax.  In all: no national debt, and no income tax.

 

A very informative mini-series video is available free, and is also purchasable as a DVD. This video and the money masters Web site http://themoneymasters.com reveal US history through the lens of money and banking conflicts once at the forefront of US politics and now almost unknown.  They then prescribe the "cure" for our ills: fiat money and full reserve banking---FM/FR. 

 

Stephen Zarlenga's American Monetary Institute is the foremost institutional advocate of Fiat Money/Full Reserve. Note Kucinich's Nov. 4 victory speech excerpt on this site. (Dennis first met his wife Elizabeth when she accompanied Zarlenga to his Congressional office in support of FM/FR).

 

Also see the Wikipedia articles on Full Reserve Banking, Fractional Reserve Banking (less good), and Monetary Reform.

 

I am troubled that the Fiat Money/Full Reserve advocates are almost all "amateurs", not front line academic economists (except Milton Friedman(!)), and some veer off into conspiracy theories. But I have not been able to find a cogent refutation of their analysis or of their proposed solution, which sounds too good to be true. 

 

Is it? I need help understanding why it WON'T work.

 

Please let me have your thoughts and findings about all this.

Comments

[Peter T]

I wanted to add something to my previous comments:
While I think that a Fiat Money / Full Reserve system looks promising (except for the bankers), I don't see it as a miracle drug, as some other people seem to do. We still have to work for our fruits of labor. I agree only with the last point of that list, the others seem to violate the fundamental principle (there is no free lunch):
1. Have no National Debt.
2. Accrue no more interest on that debt, thereby eliminating the annual deficit
3. that would enable elimination of the income tax
4. Escape the current economic mess, which may well be the final collapse of the ultimately unsustainable 300-year old private fractional reserve banking system.

Even in a FM/FR system, some people have to work to deliver the government services, and those people need to get a share (tax) from the other peoples income. Even if the government profits alone more from seignorage, it will need taxes to function. Some bonding activity is also justified for investment projects that will bring benefits in the future.

Interesting is point 4: While the introduction of FM/FR system is difficult and will be heavily opposed by the banks, the current situation seem to go already in a direction of FM/FR - the banks are weakened, and the government is supposed to compensate for the loss of private spending. If the Federal Reserve buys US-treasuires and transfers the profit (interest) back to the Treasury, this essentially creates money by government spending instead of by private debt. To avoid a later inflation from all this created money, the government could rack up reserve requirements to over 50%.

Some economic studies would be needed, before going down such a path, but who would want to pay for them?

[OleFogey]

One more great resource to those you posted. What got me thinking about all this in a new way was Paul Gringon's (sp?) "Money as Debt" video found on the web. Our current system creates the principal but not the interest of loans, thus creating an automated cue of losers.

[Peter T]

> I need help understanding why it WON'T work.

A Fiat Money - Full Reserve might work, because:
- a full reserve system gave stable money for decades in the form of notes of the Bank of Amsterdam (but it wasn't fiat)
- fiat money has worked since Kublai Khan when the governments sets the right boundaries (I know that is asking for a lot).

Beside Milton Friedman, there were other proponents of FM/FR, notably Irving Fisher who formulated the debt/deflation theory of the Great Depression. Of all, he saw first the danger of money as debt and advocated debt-free money.

I see other reasons than impossibility of FM/FR that debt-free money has never been realized so far: It reduces the banks to safe-guarding depositories and clearing houses (for demand deposits and transactions) and to credit match-makers who try to find for a credit need the saving with a similar time horizon. That would be much less profitable than creating money by lending it out. Especially the US financial industry made a lot of profit, compared wiht other US industries, over 30% of all profits in 2002-2006. Now those profits are shown to be accounting hallucinations, but don't expect the bonuses to be paid back that were calculated based on the bogus profits. The donations to politicians from those "profits" won't be paid back either, of course.

[OleFogey]

I just posted what is below on the Huffinton Post Blog to back up your point.

We have a lot of educating to do. Once there were political parties that could discuss this stuff. Now it is difficult to get this understood at all.

Here is the post:

Naming the Problem. Agreed that the Obama Finance team is the same-old boys. No politician can be existential, and no one yet has named the problem. If households, businesses, banks and government are deep in untenable debt, could there be a problem with the debt (i.e. banking) system? Does it make sense to hire a banker to get us out of the hole bankers got us into? Think outside the Loan! ThomH below is correct is asking that Ellen Hodgson Brown (Web of Debt author) and Stephen Zarlenga (American Monetary Institute) be invited to blog here. Know some History! It makes no sense to bail ourselves out with borrowed money. (!) Either we sell ourselves out to foreign interests, or depend upon ourselves (and Not the bankers) and emulate Abe Lincoln's greenbacks. (with no interest). Obama will not have a forever dole machine, for after a while the world who owns those treasuries will ask for his liver. He had better get better advice. So far people have no idea how inbred the banking scene is, or that the Federal Reserve is not controlled by the government .
If the Huffington Post cannot raise the issue.... then who?