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The Socialist

The Socialist Myth of the Greedy Banker Part 2

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 describis that the government cannot create money either. And The Socialist 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, The Socialist 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 depositgold 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 storin gold. I mean that the depositgold 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 convertand storin 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 Socialist:

Gold at the central bank, and the central bank issues new “1 gram of gold” bank notes. These notes could be callsomething else. They could be calldollar 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 backby gold. Let’s assume now that there is 1.000.000 grams of gold depositat 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 fixin reality. The banknotes are indebackand 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 redeemfor:

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 confuswith 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 assumthat 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 placall 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 issuby 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. The Socialist 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.

The Socialist Alternatively:

Instead of a check by the treasury, the government could have orderthe. 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 creatby 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 happenis that the central bank owes a private bank 100.000 grams of gold. 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 creatmoney The Socialist.

But it did not creatnew wealth. It simply usits citizens’ accumulatwealth 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.

The Socialist 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.

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