Summary of Problems: Central Banking, Taxation, and Borrowing
A review of the imbalances in our economy.
At this juncture, I want to present a summary of the ideas that I have covered up to this point. In my previous articles, I have tried to present to readers part of my vision of a true free market. In these early articles, I have focused on the idea of viewing the free market from a new perspective, and the resulting insights that we gain in our understanding of currency and taxation. This novel but obvious viewpoint shows that elements of the free market such as currency and the provision of public services, emerge naturally from the interactions between the actors in the economy, and do not have to be artificially imposed on the population. In this article, I want to go over some of the problems with our current system, while in the next article I will look at how we get new solutions by changing our perspective.
Central Banking
There are a number of ways in which the current economic system is unfair and not a true free market. The flaws are in the monetary and fiscal systems which create all kinds of imbalances because they are arbitrarily designed and are not in the spirit of a true free market. In terms of the monetary system, countries all over the world have embraced the idea of central banking. Central banking is central planning of the supply and demand of the most important resource in the economy, which is money. Central banks are responsible for creating the monetary base and setting interest rates in an attempt to regulate the economy. This puts a lot of faith in a few people who believe or claim that they have a pulse on the needs of the public, creating a managed economy instead of a free market. But the free market is about efficiently allocating resources to meet the needs of the individuals in the economy. The information needed to do this comes from the subjective values that each individual assigns to the resources, goods, services, and labour that are available in the economy. It is not possible for central planners to know how all individuals value the myriad of goods that can be created. This is why the idea of the free market is so powerful. The free market integrates the partial information from each of the individual members of society to provide goods and services in the quantities that the society really needs. This information allows the market to set prices that reflect the supply and demand of resources, goods, services, and labour. No central planners can have the full information needed to do this efficiently since they don’t know the preferences of the individuals in the economy.
The fact that we have an arbitrarily designed currency system is a major factor in the creation of a lot of the imbalances we see in the economy. Central banking as a source of currency, and a currency monopoly at that, is the primary cause of the widening wealth gap. There are a couple of issues. The first is that there is no freedom in currency creation and usage, and the second is that currency creation is limited to a subset of society, giving them undue advantage over the rest of the public. Both of these issues run counter to the principles of a true free market. The banking system has been assigned the responsibility of creating currency and loaning it out to the general public. Imagine if you had a printing press in your house and could print money at will. Now imagine further that the government mandates that the rest of society must use the money you print to pay their taxes. Thus everyone must obtain your money somehow, so you loan it out to the public, charging interest of course. If they are not able to pay you back then you can claim their property as compensation. The truth is that the entirety of the public will not be able to pay you back. You have loaned out a certain amount, say X, but expect the public to pay back that amount plus interest, i.e., X + I, but the public only has X amount of money. Some members of the public will definitely default on their loans and you get to claim their property. This is the currency system we have now and it results in a continuous transfer of wealth to the banking sector from the remainder of society.
Inflation
The issue of inflation further compounds the imbalances created by the currency system. Central banks claim to maintain price stability, but they actually don’t, because they deliberately try to create inflation which increases prices over time. In other words, they deliberately try to devalue the currency. This is meant to discourage saving, and encourage spending in a bid to increase GDP. Central bankers generally make the mistake of thinking that growing GDP means growing the economy, but the truth is that while spending increases GDP, it is saving that enables the economy to grow. There are two fundamental reasons why central banks want to create inflation. The first is that our currency system is based on debt, since banks loan the currency into existence, and as mentioned before it is impossible for society to pay back this debt completely. Inflation is a way of reducing the impact of the debt on society since they would otherwise be drowning under the debt owed to the banks. The second is the pursuit of growth, which is also related to the debt issue. In order to be able to stay ahead of the debt, or at least keep it manageable, the economy has to grow by some percentage annually, even if some of that growth is just inflation. The central bank inflation target really serves to provide a floor for the nominal growth in GDP. Inflation adds to the nominal growth of GDP and that additional growth means additional money in the economy to help keep the debt under control. We see here that our current drive for growth in the GDP measure has a lot to do with our debt-fuelled currency system which would collapse without continuous growth. Note that it’s not really the economy that is growing but rather GDP. An economy does not have to grow exponentially when it is not fuelled by debt. A true free market currency system is not fuelled by debt.
Inflation is a major contributor to the transfer of wealth from the poor and working classes to the rich. The reason is simple: the rich keep most of their wealth in assets rather than in currency, while the poor keep whatever wealth they have in currency. The working class is in between, keeping their wealth proportionally in assets and in currency. Assets are generally immune to inflation, while currency is devalued by inflation. Thus when the central bank pursues an inflation target of say 2% like in the US, what happens is that the poor have their wealth devalued over time, while the rich have their assets maintaining their value. The assets may even appreciate in value over time since a lot of the new money created by central banks goes to prop up the value of assets. The poor’s loss in value of their currency, and the rich’s gain in value of their assets results in a widening wealth gap.
Currency Monopoly
Another problem with our currency system is that there is a currency monopoly. Currency is created by the central banks and multiplied by private banks through fractional reserve banking. Currency monopoly means that one sector of the economy gets to create currency while the others don’t, but they have to obtain this currency as mentioned before and use it for their transactions. Currency monopoly also results in wealth transfer to the banking and financial sector. You see it not just in terms of assets owned by the banking and financial sector but even with labour, as some of the best minds are drawn to work in that sector.
The idea that banks should be responsible for creating currency arose from the fact that we initially had commodity currency in the form of gold and silver. Despite their useful properties which make them good as money, gold and silver are also bulky and it is not ideal to carry them around. Thus banks arose to solve that problem. Banks would store gold or silver in their vaults and issue certificates which were easier and safer to carry, and could always be redeemed for the actual metal in the vault. Our banking system evolved from this idea and we still cling to structures that developed from this, such as fractional reserve banking and later central banking. The consequence of this is that banks alone create currency and even the government does not create its own currency but has to tax and borrow. Even though it is possible to create private currencies in some countries, these currencies cannot compete with the monopoly that the banks have.
Taxation and Borrowing
I’m of the opinion that in any country with a reasonably sized economy, the government should never have to borrow money, not even from its own people. A full-scale economy should have all the resources and labour it needs within it. When the government wants to implement a project, all it needs to do is redirect the resources it needs from their current private uses to the public project. When you borrow, you don’t really borrow money. What you borrow is resources you don’t have. The “borrowed” money is just used to obtain those resources. Thus the government of a reasonably sized economy should not have to borrow anything since the country already has all the resources it needs. They just need to redirect those resources.
If the government does not have to borrow, the alternative seems to be taxation. But we have to ask again, does the government need to tax? We understand now that the reason for the government to tax or borrow is to redirect resources from private uses to public ones. This understanding allows us to seek alternatives to taxation and borrowing. The reason governments today have to tax or borrow is that they do not create their own money. The banks do. It takes money to redirect resources from private uses to public uses, since the people who own those resources have to be appropriately compensated. This is a key concept. We have to understand that we don’t need everybody in the society to contribute towards providing public goods and services. What we really need to do is to compensate those among the public who provide the labour and resources to implement public projects. That is enough, and further exchanges in the economy will ensure everyone contributes indirectly. When you understand this, it is clear that the government doesn’t need to raise money from the public through taxation. It only needs to be the creator of its own currency, and to use the money it creates to compensate those who contribute to the public goods and services that the government provides. Those contributors can then use that money to seek compensation from the general public in the form of real goods and services.
The way our economy evolved has led to a separation between monetary policy, implemented by central banks, and fiscal policy, implemented by government. The truth is that they do not have to be separate. A true free market currency system, eliminates the banking sector’s monopoly on currency creation and puts it in the hands of the people in two ways. First, it gives the people the freedom to create their own private currencies and allows these private currencies to compete in the market. Secondly, it gives the government the privilege of creating a public currency on behalf of the general public which can be used to compensate those who provide first-level public services. First-level public services are those provided by the government to the entire society.
These are some of the problems with our current system. The imbalances are caused by the monetary and fiscal systems that we use. These systems arose from a viewpoint of the economy where exchanging products for money is seen as the fundamental interaction, instead of the exchange of products for other products, i.e., barter. In the next article I will review how viewing the economy from the latter perspective addresses the issues raised. The key is to always keep in mind the fundamental problems we are trying to solve. We will see that there are organic solutions within the free market, and if we embrace it we can get rid of these imbalances that have arisen due to the arbitrary systems that we have implemented.
