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Gloon of Central Banking

Gloon of Central Banking

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TheGloomofCentralBanking
TuurDemeester,november2012

1
TheGloomofCentralBanking
DoestheCB’stoolboxhavewhatittakestocontainaprivate,decentralisedcryptocurrency?Or:Bitcoinseenthroughtheeyesofacentralbanker.
Onoctober29th,theECBpublisheda55-pagereporttitled
VirtualCurrencySchemes
”.
1
Withthisdysphemistictitle,thecentralbankreferstoprivate,unregulatedinitiativesofvirtualcurrency.With183referencesinthetext,itseemsobviousthatspecificallythefastgrowingpeertopeercurrency
Bitcoin
is
underscrutiny.
2
Inwhatfollows,Isketchanevolutionofhowcentralbanks—themonopolistsofthecurrentfiatmoneyparadigm—havedealtwiththethreatoffreemarketcompetitioncomingfromtheinternet,andhowtheyarenowreactingtothesuddenappearanceofanenigmaticrival.Bewarnedthatthisisasubjectivetakeontheissue.Peoplefromcentralbankandgovernmentcircleswillnodoubtaccusemeofbeingunbalancedandunfairinmyinterpretationsandconclusions.Sobeit.MygoalhereistoscrapeofftheveneerofthesereportsandthuscatchaglimpseofwhatmayactuallybehappeningbehindthecloseddoorsofBaselandBrussels.
“…virtualcurrenciescouldhaveasubstitutioneffectoncentralbankmoneyiftheybecomewidelyaccepted.”
ECBReport,10.29.2012
Understandingcentralbankerpsychology
It’smybeliefthatthemostperceptivecentralbankerstodayareveryworriedaboutwhatishappeningintheworld,ormorespecifically,what’shappening
totheirworld 
.Distrustandangerwiththeirpoliciesissomethingcentralbankershavealwayshadtodealwith.
Butnow,forthefirsttime,theyarefacedwithasolutionwhichposesanexistentialthreattotheirmonopolizedfiatcurrency:thearrivalofdecentralizedprivatecurrencies.
Beforewediveintothecentralbanks’reactionstothisnewdevelopment,letusfocusonwhatmakesthewheelsofcentralbankingspin,andhowtheyhavereactedtodigitalcurrenciesinthepast.
Bitcoin’sfixedmoneysupplyanddecentralizednaturemakesittoughcompetitionforcentralbanksaroundtheworld.
(srcimage:theeconomist)
“Theexpectationofageneralprogressiveupwardmovementofallpricesdoesnotbringaboutintensifiedproductionandimprovementinwell-being.Itresultsintheflighttorealvalues,”inthecrack-upboomandthecompletebreakdownofthemonetarysystem.”
LudwigvonMises,1949
“ButexactlywhichfireistheFedtryingtoputout?WhydoestheFedthinkitsactionscanputouttheseparticularflames?HowdoestheFedknowthatitsbalancesheetwillactaswaterratherthanoxygen?”
PeterR.Fisher,BlackRockmanagementdirectorandexcentralbanker,2009

1
http://www.ecb.europa.eu/pub/pdf/other/virtualcurrencyschemes201210en.pdf .
2
TheonlyothercurrencythatreceivesmorethanasidewaysmentionisthestagnatingLindenDollaroftheonlinegameSecondLife,whichin2011hadamarketcapofsome$29million.Hereiswhatthetekstsays:
“…ofparticularinterestaretheschemesdesignedtocompeteagainstrealcurrenciesasamediumofexchange.Forthetimebeing,themostprominentcaseisBitcoin…”
Src:“Virtualcurrencyschemes”,p.19.
 
TheGloomofCentralBanking
TuurDemeester,november2012

2
Theoriginalfunctionofcentralbanking
Centralbankshavehistoricallybeencreatedtoservethreegoals:1.
 
Defendingthemonopolyoffiatmoney2.
 
Institutionalizingfractionalreservebanking3.
 
Institutionalizingseigniorage
1.Defendingthemonopolyoffiatmoney
Historically,moneywasmintedbyprivateparties,givingthegeneralpublicthefreedomtochoosethebestmoneyavailableinthemarketplace.Thischangedwiththecomingofcentralbanking,whichimposedamonopolyonmoney,allowingthegovernmenttocontrolavastamountofwealthandmakingitmucheasiertoborrowfromthenextgenerationsbysellingT-bondstothebanks.FiatmoneyasdefinedintherecentECBreport:
“anylegaltenderdesignatedandissuedbyacentralauthority.Peoplearewillingtoacceptitinexchangeforgoodsandservicessimplybecausetheytrustthiscentralauthority.Trustisthereforeacrucialelementofanyfiatmoneysystem.” 
3
2.Institutionalizingfractionalreservebanking
Theroleofcentralbanksasthelenderoflastresortistomakewholethefractionalreservebanks(banksthatonlykeepafractionoftheirreservestrulyavailabletotheircustomers)whenevertheyrunintotrouble—inotherwords,tobailthemoutonasystematicbasis.It’simportanttonotehowthisroleoflenderoflastresortalsoforcescentralbankstosupportmassiveexpansionofgovernmentspending:ifprivatebanksareallowedtoplayaroundwithcustomerdeposits,itbecomesverytemptingforthesebankstoloadupongovernmentbondsattheexpenseofthesaver.
3.Institutionalizingseigniorage
Theeasiestwaytodefinemodernseigniorageis‘moneyprinting’,or‘controlleddebasementofthecurrencyinfavoroftherulers’.Amoresophisticated/convoluteddefinitioncanbyfoundattheBIS:
“Inahistoricalcontextthetermseignioragewasusedtorefertothe
 share, feeortaxwhichtheseignior,orsovereign,tooktocovertheexpensesofcoinageandforprofi
.Withtheintroductionofpapermoney,larger profitscouldbemadebecausebanknotescostmuchlesstoproducethantheirfacevalue.Whencentralbankscametobemonopolysuppliersofbanknotes,seignioragecametobereflectedintheprofitsmadebythemand
Thefirststeptowardsunderstandingthecomplexitiesofmodernfinancialinstitutionsandterminologyistofindoutwheretheycamefrom.Onlyunderstandtheoriginsofaninstitutionorinstrumentandyouwillfinditspresent-dayrolemucheasiertograsp.”
NiallFerguson,2008
“WhenyouorIwriteachecktheremustbesufficientfundsinouraccounttocoverthecheck,butwhentheFederalReservewritesacheckthereisnobankdepositonwhichthatcheckisdrawn.WhentheFederalReservewritesacheck,itiscreatingmoney.”
‘Puttingitsimply’,BostonFederalReserveBank
“…ifonedayinthefuturetheexistentfinancialsystembasedonthemonopolyofapubliccentralbankwereevercompletelyprivatizedandafree-bankingsystemsubjecttogenerallegalprincipleswereestablishedthecurrenttangledwebofadministrativebankingregulationswouldbereplacedbyafewclear,simplerulesincludedintheCivil,CommercialandPenalCodes.”
 JesúsHuertadeSoto,1999
“J.P.Morgan’sfondnessforacentralbankwasheightenedbythememoryofthefactthatthebankofwhichisfatherJuniuswasjuniorpartner…wassavedfrombankruptcyinthePanicof1857byanemergencycreditfromtheBankofEngland.”
MurrayRothbard

3
“VirtualCurrencySchemes”
 
TheGloomofCentralBanking
TuurDemeester,november2012

3
ultimatelyremittedtotheirmajororonlyshareholder,thegovernment.” 
4
Nowthatmostfiatmoneyisdigital,thecostofmoneycreationisalsovirtuallyzero,makingseigniorageallthemoreeasyandprofitable.Seignioragecomesinespeciallyhandyifthegovernmentcannotlongerpayoffits’debtwiththerevenuesoftaxincome.Quotingfroma2011BISpaper:
“Atthelimit,ifgovernmentistoremainsolvent,monetarypolicyhasnoalternativebuttoprintmoneytogeneratetheseignioragerevenuesneededtomeetinterestpaymentsinthedebt.” 
Whatkeepsacentralbankerupatnight
ThereasonwhyItellallofthis,isthatitiscrucialtounderstandhowamoderncentralbank
bydesign
isforcedtoembracebothseigniorage(moneyprinting)anditsroleaslenderoflastresort(sponsoringfractionalreservebanking).Theformeristhesourceofprofitthatkeepsthedaytodaygovernmentwheelsturning,andthelatterisneededtokeepthestate’slongtermdebtmachinespinning.Andtwomechanismsonlyfunctionaslongasthegeneralpopulationispreparedtocooperate.Itisthecitizenswhoholdthepinintheproverbialgrenade,becauseitis
 fromthem
thatthegovernmentbuystheservicesitearnswithseigniorage,anditis
 fromthem
thatthebanksusedepositstolendmoneytothegovernment.Arunonthebanksorarefusaltoacceptthatthemonopolizedmoneyhasactualvaluewillcausethiscentralizedsystemtostopfunctioning,greatlydeminishingtheeconomicprivilegesofgovernments,banks,andcentralbanks.Bycontinuallybeinginvolvedinseigniorageandtheproppingupoffractionalreservebanks,acentralbankoperatesinanenvironmentthatintheblinkofaneyecanturnintoaneconomicwarzone.Soinorderforthecentralbankingsystemtokeepfunctioninginthemediumterm,thetrustofthegeneralpopulationiscrucial.Iquotefromthereporton“VirtualCurrencySchemes”:
“ 
Thereputationofcentralbanksisakeyelementindeterminingtheeffectivenessoftheirvariouspolicies
 ,especiallymonetarypolicy.Areputationishardtoearn,butveryeasytolose.Sincecentralbanksareinstitutionstowhichpeoplelookinordertoestablishhowmuch
trust 
to placeinmoney,theyareveryconcernedabouttheirreputation.”
image:St.LouisFed
“…thecentralbanksbecamemoreandmoresubordinateofficesofthetreasuries,meretoolsfortheperformanceofcreditexpansionandinflation.Itdoesnotmakeanydifferencepracticallywhethertheyareorarenotownedbythegovernmentanddirectlymanagedbygovernmentofficials.Ineffectthebanksgrantingcirculationcreditareineverycountrytodayonlyaffiliatesofthetreasuries.”
LudwigvonMises,1949inHumanAction
“I’mstruckbyaphraseusedbymyfriendAllanMeltzerinarecentphoneconversation.Hesaid,“It’saracebetweentheinflationrate,thetaxrate,andcontrols,andallthreearegoingtowin.”
ex-secretaryofthetreasuryGeorgeP.Shultz,2009

4
“ImplicationsforCentralBanksoftheDevelopmentofElectronicMoney”,october1996,p.15.
5
Source:
“PerceptionsandMisperceptionsofFiscalInflation”,p2.(http://www.bis.org/publ/work364.htm)

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