Saving, Investment and Prosperity

In a recent article for Free Life, I noted that, for me, the urge to pen a rebuttal to the work of others come not from trawling through the drivel of a statist, leftist or mainstream pundit. Rather, it comes in response to a libertarian who has spouted some piece of nonsense in spite of being in a position to know better. Today, we will address something similar of this ilk in the realm of economics from Alistair MacLeod, Head of Research at Goldmoney.

MacLeod produces detailed, well informed articles concerning the state of the global financial system, tracing its problems back to the existence of freely floating, paper currencies issued unilaterally by governments. While it often helps to have something of a technical understanding of finance and banking in order to comprehend some of the details, he is a clear advocate of a “sound” money standard based upon gold and silver, going at lengths to explain why he believes such standards lie in our future. For those fond of cryptocurrency, MacLeod may prove to be something of a disappointment – he is not a fan, nor, needless to say, does he have any faith in central bank digital currencies. However, this stance is probably to be expected from an analyst working for an investment firm specialising in precious metals.

He is also clearly familiar with the Austrian School of Economics, offering, in one of his recent articles, this brief summary of the Austrian attitude towards fractional reserve banking:

Since bank credit is reflected in customer deposits, a cycle of excessive bank credit expansion and contraction renders a currency fundamentally unsound. The solution advocated by economists of the Austrian school is to ban bank credit entirely, replacing mutuum deposits, whereby the money or currency becomes the bank’s property and the depositor the creditor, with commodatum deposits where ownership remains with the depositor. Separately, under these proposals banks act as arrangers of finance for savers wishing to make their savings available to borrowers for a return.

We might note that, strictly speaking, Austrian economists do not advocate the banning of anything. Economics is a value free science; its practitioners can tell you what the effects of a certain policy will be, but whether that policy should be either embraced or rejected requires a value judgment. This is not pedantry on my part; the mis-categorisation of economic and monetary policies as mere scientific or technical matters which should be in the hands of “experts” has played an enormous role in sheltering them from public scrutiny. Indeed, it is merely another version of the “follow the science” mantra that was used to justify lockdowns and social distancing during COVID-19. Apart from that, however, MacLeod makes a reasonable summary of what most Austro-libertarians believe should be the case. Depositors of money in a bank for safekeeping should retain 100% title to their money and pay a fee to that bank for custodian services. They can withdraw their money for spending at any time. However, those wishing to lend their funds to borrowers in order to earn an interest return would deposit their money under different arrangements. The depositor would transfer title over the money to the bank (thus becoming a creditor of the bank) for an agreed period of time. The bank would then use that money to make loans to borrowers, paying back the funds (together with the interest credit) to the depositor on the date the agreed duration of the loan comes to an end (usually referred to as the “maturity date”). Critically, during the period of the loan, the depositor would not be able to access the funds, at least not without incurring a penalty. Under this set of circumstances, there would be no unfunded expansion of bank credit.

Unfortunately, MacLeod follows this up with this strange paragraph:

The problem with this solution is that of the chicken and the egg. Production requires an advance of capital to provide products at a profit in due course. The real world of free markets therefore requires credit to function. And savings for capital reinvestment are also initially funded out of credit. So, whether the Austrians like it or not we are stuck with mutuum deposits and banks which function as dealers in credit.

MacLeod seems to be of the opinion that the entirety of investment, production and economic progress would grind to a halt if banks were not able to advance loans to borrowers through unfunded credit expansion. In other words, for him, such expansion is a positive thing, becoming a problem only if it is done to excess. This attitude is reflected in his proposed “solution”, which we will address later.

MacLeod does not explain the theoretical basis for this view, so I won’t speculate on where this might lie (and there are many possible options). It is, however, utterly erroneous. In fact, as we shall see, not only can economic progress proceed without unfunded credit expansion, but it is vital that all such expansion is eliminated if we ever wish to have a stable currency and long term prosperity devoid of boom and bust. The remainder of this article will be devoted to demonstrating why this is so.

Read the Whole Article

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