Re: Backing

["Perry E. Metzger" <pmetzger@lehman.com>]

This has nothing to do with crypto. Hit your delete button now...

Matthew J Miszewski says:
> The problem with using a concrete anfd finite source to back
> ypour currency is that it is just that...finite.  This causes
> many economic problems for the social/economic system founded
> on it.  I was barely a pup when the world first discovered this..

It causes no problems whatsoever, other than preventing unrestrained
printing of currency, which governments always detest.

The money supply in a fractional reserve banking system with note
issue is not limited, because this is a fractional reserve, and not
100% reserve, system.

In fact, this system functions far better than a central bank, because
of a planning problem that should be familiar to free market
economists.

The problem is this: central planning of the money supply leads to
shortages and surpluses of money, which produces giant artificial
swings in the economy. I can most easily explain this by analogy to
the problem of production in a socialist vs. a capitalist society. In
a centrally planned economy, virtually all goods exist in large
surpluses or shortages because they are produced by a plan that lacks
market information and priced without regard to market information. In
a capitalist economy, the law of supply and demand keep the market in
line, efficiently allocating the goods within the economy.

The Fed has to try to control the money supply with very poor
measurements of economic activity and blunt instruments like open
market purchases of treasury instruments. This is very much like the
problem of socialist production planning. On the other hand, in a free
banking system, there are none of the problems of the business cycle
artificially induced by central banking because the money supply will
always be controlled in a distributed manner by the market, and will
rise and fall naturally with the demand the market produces. Increased
economic activity will produce natural rises in interest rates
precisely tuned to the needs of the economy by the invisible hand --
similarly, decreases in economic activity will lower rates in the same
manner. The money supply itself will self regulate because of the
excess clearing rule that free banks issuing notes must follow. Its
all very elegant, very simple, and its remarkable that people didn't
realize how important an idea this was until fairly recently.

If you want to read up on this, I suggest George Selgin's "The Theory
of Free Banking". It was his PhD thesis at NYU.

> Remember the Gold Standard?

Yes. Fondly. However, the Gold Standard I fondly remember was the one
from the days when bank notes weren't taxed and banks were free to
issue them at will.

Perry