Saturday, 10 October 2009

Was Abraham Lincoln right about money?

Abraham Lincoln said, “"The government should create, issue and circulate all the currency and credits needed to satisfy the spending power of the government and the buying power of consumers. By adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become the servant of humanity."

Many economists have expressed similar sentiments (see “References” below). The sentiment, to put in economics jargon, is that fractional reserve banking should not be allowed, or at least that the “fraction” should be much more tightly controlled. That is, the monetary base (i.e. central bank created money) should make up a much larger proportion of the money supply, with commercial bank created money playing a smaller role.

The main advantage to this change is that it would ameliorate the extent to which the money supply varies in a pro-cyclical manner. That is, during booms, commercial banks create more money – just what is not needed. And during recessions, they extinguish money - again, just what is not needed.

This is not to say that this change would do away with economic cycles. The velocity of circulation of money can vary dramatically, thus even where one had for the sake of argument, an absolutely constant money supply, cycles could and probably would still occur. But at least the above system would help iron out the cycles.

Would this change do away with bank failures? No. There is nothing to stop a bank making silly loans under this different regime. But this regime would at least reduce the incidence of bank failures. Bank failures occur to a significant extent because of bubbles: i.e. commercial banks make loans, which boosts asset prices, which makes hitherto apparently risky loans look less risky, thus banks make further loans and create even more money, etc.


Henry Simons, Irving Fisher, and Frank Knight in the 1930s: (See p. 9)

Milton Friedman (See 4th para)

American Monetary Institute.

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