The Theory of Money, Part 43

Photo by Ylanite Koppens on

This is it! The final post of this series. I promised to share my ideas of how we could shift to a sound monetary policy in a more gradual way. And, by sound monetary policy, I mean only using commodity money and 100% backed receipt money. I have tried to show in the prior 42 posts (Part 42 here, Part 1 here) why this is the only truly sound monetary policy.

Last week, I described the catastrophic method to get there, and I said the gradual method would be more realistic, although I am second guessing myself–I worry that a government will only give up its power to create money if a catastrophe forces it to do so. Regardless, the following is my proposal for how to achieve the gradual method.

Just to provide a little structure to this discussion, there are four tasks we need to achieve to get back to commodity money and 100% backed receipt money:

  1. Get rid of the government debt that the government owns
  2. Get rid of the government debt that the government doesn’t own
  3. Get rid of fractional reserve banking
  4. Trade out the 0% backed fiat dollars for actual commodity money

The first issue is a simple one. Just so you remember what this part is all about, recall that any time the Federal Reserve creates new money for the government to use, the government gives the Federal Reserve an IOU in exchange. Those IOUs can be destroyed without creating any deflation or angry investors. Boom, 40% of the debt is gone. Along with this, there would need to be a new law created that abolishes the Federal Reserve, and a constitutional amendment preventing the country from having any kind of money-creating central bank would also probably be necessary.

There are all sorts of international monetary issues I’m totally skipping over with all this, but the essence of those is that the U.S. government would also have to stop trying to manipulate the price of various things, including the price of the U.S. Dollar (USD).

The second of the four tasks is not so simple. The government has to actually pay back that debt or else repudiate it and have its credit rating be downgraded and a lot of very angry investors on its hands, neither of which be healthy for our country.

Fortunately, paying back this money also does not create any deflation–the money lent to the government was already real money that real people owned–so gradual payback of this $18 trillion will not create any direct pricing turmoil. I think it would be reasonable for the government to give up the idea of deficit spending and start putting 1% of its annual tax revenues into the debt. This percentage could be increased slowly to give the government time to either increase taxes (assuming it can be done in a way that would increase total tax revenues) or phase out programs that are no longer worthwhile now that the government cannot create money or borrow more money. As discussed in Part 41, the exception to the rule about no longer borrowing any money would be if there is an existential emergency.

Some quick basic math for how long this would take to pay off that debt: If the government gets around $5 trillion in tax revenue each year, and it puts 5% of that ($0.25 trillion) into its loans, plus the ramp-up period, it will take around 80 years to pay off this debt. Except that it will probably be shorter than that because the amount of tax revenue going to paying interest on all those loans will be decreasing over time, which could free up increased loan payments if the political will is there. Either way, wow that’s a long time! But at least it spreads the payback burden over multiple generations.

The third of four tasks is to eliminate fractional reserve banking. We don’t want to touch this until the government has paid off its debt; otherwise, deflation will cause the effective loan size to be even bigger.

One option is for the government to wait to make a new law prohibiting all exploitative loans by all financial institutions until its loan is all paid off. Prohibiting exploitative loans would allow fractional reserve banking to be slowly phased out as each exploitative loan matures and a new one to replace it is not issued. So if the total supply of all USD (including cash and demand deposits) in the world is $8 trillion, and if the average reserve ratio is 0.1 (money multiplier 10), then after all the exploitative loans are gone, there would only be $0.8 trillion.

The problem with that plan, though, is that it will cause significant and unpredictable depreciation over several years. I’ve already talked about the detrimental effects of pricing uncertainty, so I won’t re-explain that here, but the goal is to avoid as much pricing uncertainty as possible during this transition.

Unfortunately, there’s no way of getting around the fact that because the introduction of fractional reserve banking caused a bunch of inflation, getting rid of it will cause a bunch of reflex deflation.

My solution, then, will be founded upon the principle that slow, predictable, stable inflation or deflation is much less detrimental to the economy than fast/unpredictable/erratic inflation or deflation. I would have the government slowly increase the required reserve ratio each day, maybe by 0.008% per day, so that it takes exactly 30 years to go from a reserve ratio of 0.1 to a reserve ratio of 1.0. We have to do it this slowly because some loans (like mortgages) are 30 years long.

And once we are back to 100% reserve ratios, fractional reserve banking will be gone for good!

The final of the four steps can only take place after that. We have to trade out our fiat dollars for gold. (Really, we can use whatever commodity we want, but I’ll use gold for this example.)

Unfortunately, this is where the piper gets paid, so to speak. Generations ago, when the government liberated the country’s money from its gold backing, it was free to spend all that gold however it wanted. And I talked about how it appeared that all those Labor Units the government was free to spend appeared to have been created out of nothing. But really the issue was that those apparent new Labor Units would disappear again if the country ever shifts back to commodity money. Well, now is the time for that to happen.

Fortunately, the real-world U.S. government didn’t spend all of the gold it took so long ago! Estimates are that it still owns about 18,000,000 lb of gold. So, for example, if 18,000,000 lb is a quarter of what it originally took, then the shift back to gold would only result in a 75% loss of all Labor Units that are stored in cash. This assumes the value of gold (in Labor Units) is the same as it was back then.

How many people can tolerate losing 75% of their cash overnight? I suspect a large percentage of the population would be in dire straits if this happened. Many loans would go unpaid. It could be enough to trigger a full-blown societal default, which is what we have been trying to avoid with the gradual method I’m describing in this post!

Not to mention the economic havoc that would be wreaked when people know that suddenly their cash will be worth 75% less overnight. Rational people will be doing everything they can to get rid of their cash by buying investments or other assets–anything they can get their hands on that isn’t already sold out by everyone else rushing to do the same thing. So the majority of the cash will probably be in the hands of businesses by the time the switch is made, which would mean that businesses will get a lot of sudden sales and then will suddenly be a quarter as wealthy (in cash) as a result.

None of these things are good. So, again, we’re going to have to do this the super slow way. The government will have to accumulate enough gold to be able to trade in all USD for gold without causing anyone to lose any Labor Units in the process.

The math for how to do this would be fairly simple. First, find out the current market cost of gold in USD. Then, accumulate enough gold to do an equal trade for the total USD in existence. So if there are $1 trillion USD out there, and each pound of gold costs $1,000 at that time, then the U.S. government will have to acquire 1 billion pounds of gold.

If it dedicates 5% of its annual tax revenues to buying gold, then, according to rough guesses of current tax revenues and the price of gold per pound, it could buy another 11 million pounds of gold each year. That means it will be able to acquire the required 1 billion pounds of gold in another 90 years.

Then, on that fateful day when the U.S. government determines that it owns enough gold to trade out for USD without causing anyone to lose any LUs in the process, there can be a giant USD buyback day. Your demand deposits will suddenly change to be quantified in grams of gold (yes, the U.S. will just have to shift to the metric system at the same time). And as for your physical cash, you will take it to some predetermined location (probably a local bank because it will be able to store the gold in a vault) and they will give you the appropriate amount of gold in return. And that will be the day that the U.S. finally officially achieves its goal to get back to a sound monetary policy.

In total, the gradual method would take about 80 years to pay off its debt, 30 years to eliminate fractional reserve banking, and 90 years to get back all the gold it took from us and spent. That’s 200 years! I didn’t plan it that way, but it sure worked out to a nice round number.

Maybe we could be more aggressive and do it faster. Maybe in the meantime some incredible technologies like AI-controlled robots will enable us to glean a lot more wealth from the earth and will decrease the cost of fulfilling many of our other needs, so society will be so wealthy that we will be able to afford to put 10% or 20% or even 50% of annual tax revenues into this effort and condense the timeline. We can hope.

I am struck right now by the extent to which we have been royally screwed by governments and their modern monetary policies. Think about it–to be able to pay back all the wealth they (and banks) have taken from us, plus the wealth that they’ve spent prior to taking from us, it will take them 200 years! This is ludicrous. And that doesn’t even include all the inefficiencies they have cost us along the way, which are impossible for me to quantify right now but probably amount to even more than the measurable wealth they’ve cost us.

And that’s probably an appropriate way to end this entire series. The final conclusion: We’ve gotten screwed. And, even crazier, almost no one in our modern society has the faintest idea that it has happened.

We really can’t even blame the politicians for this. I’ve shown how every decision they made along the way to get us here has been perfectly reasonable.

I guess the default path of some things in this universe tends toward bad outcomes. And the economics of money is one of them.

But I hope that, with the information I have shared in these 43 posts, you not only can understand how modern government monetary policies have cost us so much wealth, but also you can see that a few well-designed constitutional provisions are all we would need to prevent that default path with all its inefficiencies and injustices. Unfortunately, that only applies to new countries. For all those countries that have already traveled that default path and landed at 0% backed fiat money, there is a connecting path that can get them back to the sound monetary policy path, but it is an arduous and long path. Yet, like any other worthwhile major investment, it will be a big short-term cost for a long-term much larger benefit.

Thank you to everyone who has followed along for almost a year of money blogging (on a healthcare policy blog no less!) as I sated my desire to make this information accessible to the world. I dream that it will have some impact on improving monetary policy in this world, sooner or later. Maybe one day I will turn it into an audiobook so that it can be easier to share. But that sounds like a lot of additional work and research for someone who is still trying to devote a lot of time to fixing the healthcare system first. If you know anyone who would want to direct that effort for me, please reach out! But, until then, I will leave this series here on the internet with the hope that the people who need it will find it and share it.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: