Most people are
convinced that private banks are responsible, or at least mostly responsible,
for the current economic crisis. The truth is that the crisis is the outcome of
the policies followed by the political systems of the U.S.A. , the E.U. and China
To show that
private banks cannot “create” money, is very important since excessive money
creation in the U.S.A. , the
E.U. and China
Since the average person is well aware of the
credit expansion and the inflationary money of the pre-crisis era, it is not
unreasonable for him to assume that the cause of the crisis is the “uncontrollable”
and “unstable” private banking sector. But if a person is mistakenly convinced
that the private banking sector is responsible for the crisis, a very
reasonable response would be to ask for more government regulation. Wouldn’t that
be the most natural response? I therefore believe that it is of great
importance for the general public to realize that private banks cannot create
inflationary money. Only governments can do so by introducing relevant laws as
I explain below.
In order to
do so, I use various economic examples to show that private banks cannot
“create” money. First I use an example where private banks issue their own bank
notes and there is no central bank. In the second example private banks still
issue their own bank notes, but there is also central bank that only keeps the
private banks’ gold at its vault, and clears their transaction. In the final
example which is very realistic, there is a central bank that issues bank
notes, which keeps at its vault all the gold, and that clears the transactions
between private banks. But the bank notes it creates are still backed by gold.
I show that in all cases private banks cannot create money. Then I explain why
it is only the government that can create money, and I show how and why it does
so. At the final part of the document I explain why conspiracy theories about
central banks are not true.
But first of
all, what do we mean by “inflationary money”? What do we mean by “excessive
money creation”? The best description in my opinion is the following:
“Inflationary money refers to an increase in the supply of money that is not
matched by an increase of equal value in production”. For example there is an
economy with 2 tomatoes and 2 dollars, and each tomato costs 1 dollar. A third
dollar is now created, that is not matched by the production of a third tomato.
Therefore the price of each tomato increases to 1.5 dollars, which means that the
new dollar was inflationary. This is actually a way for the issuer of the third
dollar to tax the 2 existing tomatoes.
In my
document “Central Banks for non-Economists Part 1: Inflation and Taxation”, I
explain the relationship between money creation and taxation, and therefore in
this document I will not elaborate on the relationship of inflation and
taxation. I will only say what is necessary for the purpose of this essay. I
will therefore show with this document that in a free market system, private
bankers cannot create money and tax the current wealth. A free market banking
system is exactly the opposite from the banking system we know. And I am not
saying that when the state follows an aggressive monetary policy, private
bankers do not make big profits. They do make big profits at such times. But
this has nothing to do with the evil private banking sector. When there is lots
of money around, they make big profits because their job is to buy and sell
money. In the same way that someone who sells nails makes lots of money if huge
amounts of nails are bought and sold. This does not change the fact, that paper
money is the most important state monopoly. But before I explain why private
banks can not create inflationary money in a free market economy, I would like
to say a few words about why it is good for an economic system to have a form
of “money” (a medium of exchange), and a banking sector. After all, this
document is written for non economists.
In a barter
economy without any generally accepted medium of exchange, that is without a
good that everybody accepts as a means of payment, a person wishing to sell his
tomatoes and buy oranges, would have to find someone who sells oranges and
wants tomatoes. This can be a very difficult and time consuming task. On the
other hand if everybody accepts a good as a means of payment, i.e. gold, olive
oil, paper money etc, this problem ceases to exist. If I want to sell tomatoes
I simply have to find someone looking for tomatoes, and with the medium of
exchange that I will receive, I will buy the oranges I want. This is a much
more efficient way to trade, and it leads to much higher levels of productivity
and welfare.
Moreover, the
orange producer needs a way to store the value of his production surpluses. If
he needs 100 oranges per year but he produces 200 oranges, he must somehow
store the value of his surplus i.e. the 100 oranges. He therefore needs a non
perishable good, that everybody accepts as a medium of exchange, in order to
store his surplus of 100 oranges. This can be a good that can last for a long
time i.e. olive oil, but silver, golden and other metal coins, or paper money,
are much more suited to serve as mediums of exchange. There are more reasons
why an economy needs a medium of exchange, but the above will suffice for my
purposes.
Now
I want to say why an economy needs a banking system. The farmer of the previous
example had a surplus of 100 oranges. There is another farmer that is willing
to pay 110 oranges in a year’s time if he borrows these 100 oranges today. But
the other farmer is reluctant. He does not know if the borrower is capable of
repaying the 100 oranges, and he does not want to risk his surplus. But if
there is a specialist who can evaluate the borrowers’ creditworthiness, this
problem ceases to exist. This specialist is called a bank. It could be called a
money merchant or anything else. But these experts are called banks. There is
no difference between a real estate agent and a money agent. One is an
intermediary in transactions involving property and the other is an
intermediary in transactions involving money. The above explanations of the
usefulness of a common medium of exchange and of a banking system are enough
for this document. After all nobody disagrees.
My
starting point will be an economy with no money and no banking system. There
are only farmers producing oranges. Farmers producing more oranges than they
consume, worry about their surpluses. They are afraid that someone might steal
them when they are absent. There is therefore demand for places to deposit
these surpluses for greater security. New companies are created then, with huge
vaults, where farmers can store their oranges. Let’s call these companies
banks. Farmers store their surpluses in their vaults, and can go whenever they
want to take oranges for personal consumption or commercial purposes. I assume for
a minute that oranges do not perish, and therefore they can serve as a store of
value.
When
farmers deposit oranges at the banks, they receive paper receipts. An orange
and the number “1” are stamped on each receipt. All receipts are identical, except
that each one carries the name of the issuing bank. Gradually farmers start to
use these receipts as money. They find it more convenient to do so, instead of
carrying oranges around. We now have a monetary economy with a banking system.
People do not exchange oranges but paper representing oranges. However citizens
want a medium of exchange that is more convenient than oranges. They therefore
start using gold, which is much better suited to serve as a medium of exchange
than oranges. Now gold is not only used for jewellery but as a means of payment
too. In the same way that some people work to produce oranges, some others work
to extract and process gold. One should not confuse gold with paper money. Gold
is a good like all other goods. Someone has to work hard to extract and polish
it, and it has real value. Paper money on the other hand has no intrinsic
value. Its value derives from a governmental law establishing as the legal and
only means of payment.
The
price of gold is affected by the same factors that affect the prices of all
other goods in the economy i.e. its availability, demand and supply for gold,
improvements in mining techniques, changes in tastes etc. Gold is a good like all other goods (oranges,
wood, wine etc). It is not
like paper money that has no intrinsic value. Gold simply possesses some
special characteristics that make its use as a medium of exchange ideal. Therefore
economic agents trade their goods for gold, and deposit their gold at the bank,
which in turn issues and gives them a paper ticket (bank note). Let’s call
these bank notes “1 gram of gold” notes. All bank notes are “1 gram of gold”
notes, and the issuing bank’s name is written on these notes. Banks are obliged
to redeem these notes for 1 gram of gold, if the bearer wishes so.
These
papers are exactly the same with 1 dollar notes, except that “1 gram of gold”
is written on them instead of “1 dollar”. Actually the main difference is that
you cannot redeem dollars or euros for gold, while you can do so for the bank notes
of my example. The bank notes of my example have real value. They do not derive
their value from a law, but from the gram of gold that backs them (or from the
oranges that backed them before I introduced gold into my example). And for
simplicity I assume that there are only “1 gram of gold” bank notes, and the
economy is only producing oranges and gold, and that oranges exchange for 1
gram of gold, and the price is fixed. All very unrealistic assumptions but they
enhance intuition which is my aim.
Why private banks cannot create inflationary
money
Now I turn my
attention to the private banker, to whom all socialists attribute the crisis.
As expected, the private banker wants to sell as much of the medium of exchange
as he can, whether the medium of exchange is olive oil, whether it is golden
coins, or paper money or whatever, because this is his job. This is what he
does. In the same way that someone selling nails wants to buy and sell as many
nails as he can, the banker wants to buy and sell as much money as he can. The
more he buys and sells the more profit he makes, exactly like the nails
merchant. If the interest on deposits is 5% and interest on loans is 10%, and
the private banker lends 100.000 dollars, he will make 5.000, if he lends
1.000.000 he will make 50.000 dollars, if he lends 10.000.000 dollars he will
make 500.000. The same principle applies whether you buy and sell nails or
money. The more you buy and sell the more profit you make, assuming of course
that each sale carries a profit mark up. Therefore it is very normal and very
healthy that the private banker wants to lend as much as he can, given of course
his customers are creditworthy.
We now have
to think whether a private bank can “create” inflationary money if it wishes to
do so. And the answer is of course no. Let’s imagine
a private bank, in which farmers have deposited 1.000 grams of gold, and which
has issued 1.000 “1 gram of gold” notes, with its name on them. Therefore the
issued bank notes are 100% covered by gold, which means that each bank note
issued corresponds to 1 gram of gold in the bank’s vault. This bank now wishes
to issue another 9.000 bank notes in order to lend them and make more profit.
But the bank does not have another 9.000 grams of gold. Therefore these new notes
will be inflationary notes. They will be money creation from thin air. Can the bank do so? No, it cannot as I already said. If X Bank attempts
to do so, it will go bankrupt very soon. And here is why.
Imagine that the bank issues another 9.000
bank notes, and lends them to some customers in order to charge interest. The
customers that will receive the “fresh” notes will use them to finance their
activities, thus giving them to other economic agents, who in turn will deposit
them to their domestic or foreign banks. The domestic and foreign banks that
will receive the new bank notes will send them to the issuing bank to redeem
them for gold, as the issuing bank is obliged to do. And more specifically they
will require 1 gram of gold for each bank note. But the issuing bank has only
1.000 grams of gold in its vault, and therefore will not be able to redeem the
banknotes. Therefore the issuing bank will go bankrupt shortly after the credit
expansion.
In the
banking system I just described, banks have to send loads of gold to each other
every day, in order to clear their customers’ transactions. This is very
inconvenient, and I will therefore introduce a central bank in my example. The
private banks will continue to issue their own bank notes, and the central bank
will simply hold their gold and clear their transactions. For instance when X
Bank receives a bank note from Y Bank, it will send it to the central bank. The
central bank will take a gram of gold from Y Bank’s box, and put it in X Bank’s
box. Once the transfer of gold has taken place, the central bank will return
the bank note to Y Bank, since the debt was fully paid. In a banking system
like the one I describe, bank notes resemble bank checks, since the bank’s names
are written on them.
The inclusion
of a central bank into my example does not change much though. The private
banks cannot create money for the reasons I described before. If Y Bank has
“created” inflationary money, which means it issued more bank notes than the
grams of gold it has at the central bank’s vault, it will go bankrupt. Assume
farmers deposited 1.000 grams of gold at Y Bank, and Y Bank issued 1.000 bank
notes of 1 gram of gold each. Now the bank issues another
9.000 bank notes not covered by gold i.e. inflationary money, and lends it to a customer.
The customer buys something and the new bank notes end at X Bank. X Bank sends
these bank notes to the central bank, and the central bank finds in the box of Y
Bank only 1.000 grams of gold instead of 9.000 grams. The central bank therefore
does not clear the transaction. Therefore the introduction of the central bank
did not change anything.
Now
let’s examine what happens when the central bank not only holds the private
banks gold and clears their transactions, but in addition is the issuer of the
economy’s paper money. But each bank note issued by the central bank issues is
still covered by 1 gram of gold, as was the case in the previous examples. Can
private banks now create inflationary money? No they cannot. For the central
bank to issue a new bank note, someone will have to deposit in its vault 1 gram
of gold, that someone being the government or a private bank (on its behalf or
on behalf of a customer). Each private bank receives a bank note from the
central bank, for each gram of gold it sells to the central bank. In other
words, for each gram of gold that goes in the state’s box of gold at the
central bank. Not for each gram of gold that the private banks deposit in their
own box at the central bank’s vault. Bank notes are only issued when a gram of
gold goes to the state’s box of gold. Therefore the country’s bank notes are
real bank notes. For each one of these notes there is one gram of gold (at
least) in the state’s box of gold at the central bank’s vault. They are
“golden” paper notes.
I
will use a full transaction as an example. I sell 1 orange to a person that
extracted 1 gram of gold. Remember that I assumed oranges sell for 1 gram of
gold. I then deposit this gram of gold at X Bank. X Bank has two choices. One
is to buy the gold for itself and send it to the central bank for the latter to
deposit it in X bank’s box of gold. Alternatively X Bank can send the gram to
the central bank for sale. The central bank will then issue a “fresh” bank
note, and send it to X Bank. The central bank will then put the gold in the
state’s box of gold (and not in X Bank’s box). I, the seller of the orange,
will take a bank note of 1 gram of gold in both cases. In the first case an
existing bank note and in the second case a “fresh” one. I can give this bank
note back to X Bank and open a deposit account or take it and leave. I use this
example to emphasize that for a “fresh” bank note to be created someone has to
put a gram of gold into the state’s box of gold. This is very important. And it
is a very reasonable, since each bank note created represents for the country a
debt of 1 gram of gold, whether this bank note is held by a local or a foreign
citizen. And in order for the country to be able to redeem all the bank notes
issued for 1 gram of gold, there must be (at least) 1 gram of gold for each
bank note issued, in the state’s box of gold. That is why I call the banknotes “golden”
notes. If these bank notes are not backed by gold they are not “golden”, they
are simply paper deriving their value from a relevant law. Issuing “golden”
bank notes is very healthy, since they represent real production surpluses and
savings and not inflationary paper.
So, can a
private bank in this environment “create” money if it wishes to do so? The
answer is again no. If X Bank issues new loans, and gives let’s say bank checks
to some customers (remember that now it is the central bank that issues the
paper money), the customers will give these checks to other economic agents,
these other economic agents will deposited these checks in foreign and domestic
private banks, and eventually they will end up at the local central bank to be
cleared. The central bank will not find enough gold in X bank’s box, and it will
not clear the transactions.
We therefore
see that private banks cannot create inflationary money under any
circumstances. I hope it is now clear why the document is titled “the myth of
the greedy banker”. Only the state through governmental laws, and through its
monopoly as an issuer of paper money, can create inflationary money.
Inflationary money is as I already said, money not covered by production
surpluses. It is money that does not represent citizens’ savings, but it is
rather a new government claim on the citizens’ savings. I must also say that a
country does not have to produce gold. It can produce other goods and exchange
some of them for gold. Gold is simply a good like all other goods.
Creation of money by the government
I
hope that it is clear by now that private banks cannot create inflationary
money. The problem for a political system with a banking system as described is
that the government cannot create money either. And governments have only 3
ways to finance their deficits. The first one is taxation, the second one is
domestic and foreign borrowing, and the third one is by printing new
inflationary money. As I explain extensively in my other document, printing
money is taxation through inflation. Inflation is a way of taxation that most
governments very often prefer to use. Taxation is very unpopular, borrowing
requires confidence on behalf of the lender that you will honor your
obligations and carries the cost of interest, while printing money does not
require a third party’s confidence in the government’s policies, it does not
carry interest, and it is not as unpopular as taxation. Of course increasing
the money supply increases inflation, but most people do not realize that
inflation is taxation. Therefore taxation is more unpopular than inflation. If
a government goes too far with the printing press though, it can cause very
high levels of inflation, or even hyperinflation, with catastrophic
consequences for the economy. But in the short run political parties tend to
overlook the long run consequences.
I now want to
describe the difficulties that a government faces under the gold standard, in
its effort to finance deficits by printing money. To make things simpler, let’s
start from day 0. Citizens have no savings in gold or oranges yet. They now
start producing oranges and gold. Some of them produce oranges and some produce
gold, and it is gold that serves as a medium of exchange and a store of value.
Producers of oranges, exchange their surpluses with gold, and deposit gold at
the bank. Similarly, gold miners exchange their gold for oranges, and deposit
whatever quantity of gold is left at the bank. Note that the deposited gold
does not represent only the past surpluses-savings of gold in the economy. It
represents the surpluses-savings of all goods and services in an economy. When
I exchange my extra orange for 1 gram of gold, and I deposit that gold at the
bank, that gold represents a surplus of 1 orange that was stored in gold. I
mean that the deposited gold at the banks represents all surpluses, all savings
in the economy. Surpluses in oranges, surpluses in haircuts, surpluses in gold,
surpluses in cleaning services etc, that are all converted and stored in the
common store of value, which in my example happens to be gold. In my example
gold is the only way to store value, but in reality this is not the case.
The
private banks now deposit the citizens’ gold at the central bank, and the
central bank issues new “1 gram of gold” bank notes. These notes could be
called something else. They could be called dollar notes, or euro notes or whatever.
I prefer to use the name “1 gram of gold” notes to emphasize that these notes
are “made” of gold, they are backed by gold. Let’s assume now that there is
1.000.000 grams of gold deposited at the state’s box of gold in the central
bank, and 1.000.000 “1 gram of gold” notes circulating in the economy.
Even
though it makes no difference for my analysis, in order to be a bit more
accurate, I have to add that the price of orange and gold would not be fixed in
reality. The banknotes are indeed backed and redeemable for 1 gram of gold, but
that does not mean that they will always buy 1 orange. The relative price of
gold and oranges will vary according to weather, demand and supply, changes in
tastes etc. In other words bank notes will always be redeemed for 1 gram of
gold, but that gold might buy 1 orange, or 2 oranges, or half orange, depending
on the prices prevailing at the market. But this should not be confused with a
general increase of the price level that arises as a result of inflationary
money creation. Relative prices must change when market conditions change.
So, we have
1.000.000 grams of gold in the state’s box at the central bank, and 1.000.000
“1 gram of gold” notes circulating in the economy. Let’s suppose that the government
wants to issue some more “1 gram of gold” notes, to finance its deficits and
avoid taxing its citizens. Can the government do that? Well for a while it can.
I assumed that the total gold of the economy is 1.000.000 grams, and let’s say
that 100.000 of these grams belong to the state. But the government decides to
host the Olympic Games that cost 200.000 grams of gold. The treasury issues a
check of 200.000 grams of gold, and gives it to the contractor. The contractor
deposits the check at X Bank, in order for the latter to clear it. X Bank in
turn sends the check to the central bank for the latter to clear it. The thing
is that in reality, the gold is not kept in separate boxes with a bank name written
on each box. It is placed all together at the central bank’s vault, and the
central bank holds electronic information about the owners of that gold.
Therefore when
the central bank receives the check issued by the treasury, it sees that the
state’s gold of 100.000 grams is not enough to cover the expenses. However,
contrary to what it would do for a private bank, it credits X Bank’s account
with 200.000 grams of gold and says that everything is ok. X Bank then credits
the contractor’s account, and the contractor starts preparations for the
Olympics. The country now owes 100.000 grams of gold. In accounting terms this
appears as a debt of the government to the central bank, but in reality it is a
debt of the government to its citizens. Except that the citizens do not know
that the just lent their government 100.000 grams of gold. Alternatively,
instead of a check by the treasury, the government could have ordered the
central bank to create 100.000 new notes. The central bank would create these
notes pass them to the treasury, and write in the central bank’s books a
government debt of 100.000 “1 gram of gold” notes. The treasury would pay the
contractor, who would deposit these notes at X bank. X bank would open a
deposit in his name and send the bank notes to the central bank in order for
the latter to transfer 100.000 grams of gold in its box. The central bank would
credit X bank’s gold account which would match the debt created by the
government. I think the case with the check is better for illustration
purposes. So you better think of this transaction in terms of the treasury
check. But both cases are exactly the same. In both cases what happened is that
the central bank owes a private bank 100.000 grams of gold, and the government
owes the central bank 100.000 grams of gold. In reality, it is of course the
government owing to its citizens 100.000 grams of gold, since the central bank
is only a governmental institution.
The government just created money.
But it did not created new wealth. It simply used its citizens’ accumulated
wealth to finance the Olympics. This will of course appear as a debt of 100.000
grams of gold when the government prepares its financial statements at year
end, but who notices? Everybody is happy. Everybody got their money. And the
government did not have to tax anybody, and did not have to borrow any money.
Only inflation was affected. But who cares when inflation is low? The problem
for the government under the gold standard is that this artificial money
expansion increases demand, it increases the price level, the country becomes
more expensive and starts losing its competitiveness, imports start rising and
exports start declining. The economic agents abroad that receive the country’s
bank notes as a payment for their sales send these bank notes through their
central banks, to the domestic central bank, in order for the latter to redeem
it for gold.
Therefore if
the government is very active in creating inflationary money, the country’s
gold reserves will start declining. People will start doubting that the
government will be able to redeem its bank notes for gold, and there will be a
confidence crisis. Even domestic citizens might start redeeming their bank
notes for gold. But there is not enough gold to pay for all bank notes in
circulation, since the government used much of it for its expenditures. At some
point the government will have to either abandon the gold standard all together
i.e. stop redeeming the bank notes for gold, or change the exchange rate
between bank notes and gold i.e. say that it will exchange each bank note for
half instead of 1 gram of gold. Thus the gold standard imposes much more
discipline on a government’s fiscal policies. On the contrary if the government
passes a law, as is the case in all countries, imposing its paper money as the
legal means of payment without promising to redeem it in gold, there is no
limitation on the creation of inflationary money.
Now the bank
notes do not derive their value from gold but from the law, and the government
can create as much money as it wants. Well, almost as much, because excessive
use of inflationary money as a means of taxation can lead to catastrophic
hyperinflation. The point is that the gold standard imposes much more
discipline on a government, and it is no surprise that governments do not like
such regimes. It is no surprise either, that socialists hate the gold standard
and libertarians love it. Because it is socialists that like excessive
taxation, and since direct taxation is unpopular, they prefer to use the
indirect taxation of monetary expansion. Libertarians do not favor big public
sector and excessive taxes and they therefore love the gold standard as a
barrier to socialist policies.
To make things simpler, think about it in the
following. If society’s savings are a pile of gold, and the government takes
some of this gold without taxing, it will have to pay back with gold. But the
government does not have gold. But if, as it happens in all countries, the
government passes a law that imposes paper money as the legal and only means of
payment it is in effect forcing its citizens to save their surpluses in paper
money. Now if the government can take some of the savings without taxing the
citizens. If the citizens ever ask for their money back, the government can
always print new money and pay them. But this paper will buy much less than it
used to. Of course it is possible to save in gold but it is not as convenient.
And therefore most people will hold their savings in the form of paper money.
The honest thing for a government would be to back paper money with gold.
The gold standard and budget surpluses
As I already
said, the gold standard is a regime favored by libertarians and of proponents
of small public sectors in general. This rule prevents politicians, or at least
makes it much harder for them, to follow policies based on budget deficits.
There is another way however to prevent governments from creating deficits, and
this is by passing a law requiring governments to have on average budget
surpluses. Some political systems in
developed countries do so, as a means of self discipline. In Sweden
Central banks and conspiracy theories
The main idea
of this document is that there are no fat greedy bankers, but rather fat greedy
governments and politicians. However there is one last issue which is the
conspiracy theories about central banks. Such theories claim that central banks
print money for themselves and this is the cause of the crises. In other words
they claim that it is not that central banks are directly or indirectly at the
mercy of their political systems but the other way round. The following link
has a lot of information about conspiracy theories concerning the Federal
Reserve Bank, which is the central bank of the U.S.A.
Such
conspiracy theories are everywhere and always supported by populists, or by
people that are not very educated or intelligent, and they have a tendency to
believe populists. Political systems in
developed countries try to make their central banks as independent as possible,
in order to protect their monetary policy from political cycles. They do so in
order to put a barrier between politicians and the money machines. And they do
so with laws that they pass in their own parliaments. For instance the board of
the Fed, is appointed by the president of the United States of America and
approved by the congress, but the president cannot terminate the chairman’s
tenure once he is appointed. They do so because they do not want the chairman
of the central bank to be at the mercy of the president and the congress. They
want the chairman to have some degree of independence in order to be able to
resist pressures on behalf of the congress, to follow more expansionary
policies. Because the truth is that politicians tend to focus on short rather
than long term consequences.
The problem
is that political systems do not provide enough independence to their central
banks. For instance by law the Fed’s goals are price stability and low
unemployment. The same applied for the central banks of the socialist southern
European countries. However this was not the case for Germany. Bundesbank’s goal was set by law to be only price stability, and this partly explains the
superiority of the German economy, since the political system had to be much
more disciplined. Because when you include low unemployment as a goal of the
central bank, the central banker is at the mercy of politicians. Politicians
know that if their irresponsible fiscal policies lead to high unemployment, the
central bank will have to step in and give them a hand in the form of monetary
expansion, since it is required by law to do so. But an increase in paper money
can only have short run positive effects and will definitely has very strong
long term negative effects. Therefore this commitment of the central bank to
intervene in case of rising unemployment gives negative incentives to the
political system. If on the other hand the goals of central banks were only
price stability and the stability of the financial system, politicians would be
much more cautious and disciplined.
But even when
low unemployment is one of the central bank’s goals, the economists from the
academia that that run them, are a significant obstacle to the political system
since they do not have to worry about political cycles. And this is the reason
that socialists and statists want central banks to be at the absolute control
of the political system. And they circulate conspiracy theories about central
banks, in order to convince ignorant people that central banks should be
stripped from any form of independence. They want the money machine under their
complete control. When politicians have the money machine under their control,
they can do the following. Suppose there is a 3 people economy, the president
and two citizens. The president wants to take a dollar from John and give it to
Nick. He can print 3 dollars give 2 dollars to John, and 1 dollar to Nick. If
you take into account inflation, the net effect was to give 1 dollar to Nick.
But John is happy too. He got a dollar. He did not realize that 1 dollar was
taken from him. He thinks 1 dollar was given to him. He only notices inflation.
This is the reason that politicians do not want economists running central
banks. In less developed countries the money machines are indeed at the mercy
of the political system, in the way that statists and conspiracy theorists want
them to be. Only in the developed word central banks enjoy some degree of
independence.
The Fed has
indeed shares which are held by all the private banks operating in the U.S.A.
But banks are required by law to hold the Fed’s shares. And by the same law
they have to keep a part of their funds with the Fed. But private banks do not
have a saying on the conduct of monetary policy which is determined by a board
appointed by the president and approved by the congress. Moreover all the
interest earned by the Fed is returned to the treasury at the end of each year
(for more details see the link I provided above).
I will therefore conclude by saying that
contrary to what conspiracy theorists suggest, the problem with central banks
is that they do not have enough independence and they have to accommodate
irresponsible fiscal policies. The most famous case is of the northern and
southern European countries. The northern European countries provided much more
independence to their central banks and they always outperformed the southern
countries in economic terms.
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