Saturday, December 26, 2009

Out Today: Barron's Article by Robert Klein & George Reisman

Our agreement with Barron's prohibits my reproducing the article here, but the link below will take you to it on Barron's website. - Central Problem: the Central Bank

Sunday, November 22, 2009

A Pro-Free-Market Program for Economic Recovery

The following is a speech delivered by George Reisman at the Ludwig von Mises Institute's Mises Circle in Newport Beach, California on November 14, 2009.

Good Afternoon, Ladies and Gentlemen:

As you all know, we are in a severe economic downturn. The official unemployment rate now exceeds 10 percent and according to many observers is actually substantially higher. Within the last year or so, our financial system has been rocked to its foundations. The collapse of the housing bubble and the numerous defaults and bankruptcies connected with it brought down major financial institutions, such as Bear-Stearns, Lehman Brothers, and Merrill Lynch. It also brought down numerous small and medium-sized banks and threatened to bring down even such banking giants as Citigroup and Bank of America. The Dow Jones stock average fell from a high of 14,000 to about 6,500. Important retailers such as CompUSA, Circuit City, Mervyns, and Linens ‘N Things went under, as did countless small businesses throughout the country. Practically every shopping mall gives testimony to the severity of the downturn in the form of vacant stores.

The collapse of the housing bubble and the massive losses and mounting unemployment that have resulted from it have unleashed a veritable firestorm of hostility against capitalism, in the conviction that it is capitalism and its economic freedom that are responsible. It is now generally taken for granted that any solution for the downturn requires massive new government intervention, to curb, control, or abolish this or that aspect of capitalism and its alleged evil.

Reflecting this view, in an effort to avoid financial collapse, the government’s response was the enactment of an $800 billion “stimulus package” designed to boost spending throughout the economic system, and the pouring of more than $1.1 trillion of new and additional reserves into the banking system, along with the direct investment of capital in the country’s most important banks and in major automobile firms, in order to prevent them from failing.

As a result of its so-called “investments,” the government now owns a majority interest in the common stock of General Motors, once the flagship company of capitalism. There have been important extensions of government control over the economic system in other areas as well. For example, the stimulus package contains substantial funding for new bureaucracies to control health care and energy production.

The new and additional bank reserves, moreover, are not only massive, but almost all of them are excess reserves. Excess reserves are the reserves available to the banks for the making of new and additional loans, i.e., for new and additional credit expansion. They are the difference between the reserves the banks actually hold and the reserves they are required to hold by law or government regulation.

To gauge the significance of today’s excess reserves, one should consider that total bank reserves as recently as July of 2008 were on the order of just $45 billion, and excess reserves were less than $2 billion. Those $45 billion of reserves supported a total of checking deposits in one form or another on the order of $6 trillion (a sum that included traditional checking deposits, so-called “sweep accounts,” money-market mutual-fund accounts, and money-market deposit accounts inasmuch as checks could be written against them). That was a ratio of checking deposits to reserves in excess of 100 to 1, or equivalently, a fractional reserve of less than 1 percent.

Today, of the $1.1 trillion-plus of total reserves, all but approximately $62 billion of required reserves are excess reserves. As of the week of November 4, excess reserves were $1.06 trillion.

Fortunately, for the time being at least, the banks are afraid to lend very much of this sum, but the potential is clearly there for a massive new credit expansion and corresponding increase in the quantity of money. Recognition of this potential is reflected in the current surge in the price of precious metals. Indeed, since $1.06 trillion of new and additional excess reserves are more than 22 times as large as the $45 billion of reserves that were sufficient not so long ago to support $6 trillion of checking deposits, they might potentially support checking deposits in excess of $132 trillion. In effect, what has happened is that our recent brush with massive deflation has turned out to be an occasion for a massive inflationary fueling period in the effort to avoid that deflation.

Inflation and Deflation: Credit Expansion and Malinvestment

The title of my talk, of course, is “A Pro-Free-Market Program for Economic Recovery.” What this entails changes as the government adds new and additional measures that create new and additional problems. If I were giving this talk a year ago, my discussion would have been weighted somewhat more heavily toward deflation and somewhat less heavily toward inflation than is the case today.

A fundamental fact is that our present monetary system is characterized both by irredeemable paper money, i.e., fiat money, and by credit expansion. There is no limit to the quantity of fiat money that can be created. This is the foundation for potentially limitless inflation and the ultimate destruction of the paper money, when the point is reached that it loses value so fast that no one will accept it any longer.

The fact that our monetary system is also characterized by credit expansion is what creates the potential for massive deflation—for deflation to the point of wiping out the far greater part of the money supply, which in the conditions of the last centuries has been brought into existence through the mechanism of credit expansion.

Credit expansion is what underlay the housing bubble, and before that, the stock market bubble, and before that a long series of other booms and busts, running through the Great Depression of 1929 that followed the stock market boom of the 1920s, through the 19th and 18th Centuries all the way back to the Mississippi Bubble of 1719, and perhaps even further back.

Credit expansion is the lending out of money created virtually out of thin air. It is money manufactured by the banking system, always with at least the implicit sanction of the government, which chooses not to outlaw the practice. Since 1913, credit expansion in this country has proceeded not only with the sanction but also with the approval and active encouragement of the Federal Reserve System, which, as I’ve shown, is now desperately trying to reignite the process as the means of recovering from the current downturn.

The new and additional money is created by the banking system through the lending out of funds placed on deposit with it by its customers and still held by those customers in the form checking accounts of one kind or another. The customers can continue to spend those checking deposits themselves, simply by writing checks or using other, similar methods of transferring their balances to others.

But now, at the same time, those to whom the banks have lent in this way also have money. To illustrate the process, imagine that Mr. X deposits $1,000 of currency in his checking account. He retains the ability to spend his $1,000 by means of writing checks. From his point of view, he has not reduced the amount of money in his possession any more than if he had exchanged $1,000 in hundred-dollar bills for $1,000 in fifty-dollar bills, or vice versa. He has merely changed the form in which he continues to hold the exact same quantity of money.

But now imagine that Mr. X’s bank takes, say, $900 of the currency that he has deposited and lends it to Mr. Y. Mr. Y now possess $900 of spendable money in addition to the $1,000 that Mr. X continues to possess. In other words, the quantity of money in the economic system has been increased by $900. Mr. Y’s loan has been financed by the creation of new and additional money virtually out thin air. This is the nature and meaning of credit expansion.

Now nothing of substance is changed, if instead of lending currency to Mr. Y, Mr. X’s bank creates a new and additional checking deposit for Mr. Y in the amount of $900. (This, in fact, is the way credit expansion usually occurs in present-day conditions.) There will once again be $900 of new and additional money. There will be altogether $1,900 of money resting on a foundation merely of the $1,000 of currency deposited by Mr. X.

The $1,000 of currency that Mr. X’s bank holds is its reserve. If Mr. Y deposits his currency or check in another bank, it is the banking system that now has $1,000 of reserves and $1,900 of checking deposits. On the foundation of these reserves, it can create still more money and use it in the further expansion of credit. Indeed, as we have seen, the process of credit expansion is capable of creating checking deposits more than 100 times as large as the reserves that support them.

Credit expansion makes it possible to understand what caused the housing bubble and its collapse. From January of 2001 to December of 2007, credit expansion took place in excess of $2 trillion. This new and additional money made available in the loan market drove down interest rates, including, very prominently, interest rates on home mortgages. Since the interest rate on a mortgage is a major factor determining the cost of homeownership, lower mortgage interest rates greatly encouraged buying houses.

This artificially increased demand for houses, made possible by credit expansion, soon began to raise the prices of houses, and as the new and additional money kept pouring into the housing market, home prices continued to rise. This went on long enough to convince many people that the mere buying and selling of houses was a way to make a good living. On this basis, the demand for houses increased yet further, and finally a point was reached where the median-priced home was no longer affordable by anyone whose income was not far in excess of the median income, i.e., only by a relatively few percent of families.

In the middle of 2004, the Federal Reserve became alarmed about the situation and its implications for rising prices in general, and over the next two years progressively increased its Federal Funds interest rate from 1 percent to 5.25 percent. This rise in the Federal Funds rate signified a reduction in the flow of new and additional excess reserves into the banking system and thus its ability to make new and additional loans. This served to prick the housing bubble.

But before its end, perhaps as much as a trillion and a half dollars or more of credit expansion and its newly created money had been channeled into the housing market. Once the basis of high and rising home prices had been removed, home prices began to fall, leaving large numbers of borrowers with homes worth less than they had paid for them and with mortgages they could not meet.

The investments in housing represented a classic case of what Mises calls “malinvestment,” i.e., the wasteful investment of capital in inherently uneconomic ventures. The malinvestment in housing was on a scale comparable to the credit expansion that had created it, i.e., about $2 trillion or more. That’s about how much was lost in the housing market. When the money capital created by credit expansion was wiped out, the lending, investment spending, employment, and consumer spending that had come to depend on that capital were also wiped out.

And, particularly important, as vast numbers of home buyers defaulted on their mortgages, the mounting losses on mortgage loans increasingly wiped out the capital of banks and other financial institutions, setting the stage for their failure.

The current plight of the economic system is the result of credit expansion and the malinvestment it engenders. Capital in physical terms is the physical assets of business firms. It is their plant and equipment and inventories and work in progress. As Mises never tired of pointing out, capital goods cannot be created by credit expansion. All that credit expansion can do is change their employment and shift them into lines where their employment results in losses. The empty stores and idle factories around the country are very much the result of the loss of the capital squandered in malinvestment in housing.

Other Consequences of Credit Expansion

The plight of the economic system is also the result of other consequences of credit expansion, namely, the encouragement it gives to high debt and dangerous leverage. This is the result of the fact that while credit expansion drives down market interest rates, the spending of the new and additional funds it represents serves to drive up business sales revenues and what the old classical economists called the rate of profit. This combination makes borrowing appear highly profitable and greatly encourages it. Individuals and business firms take on more and more debt relative to their equity. They expect borrowing to multiply their gains.

In addition, credit expansion is responsible for many business firms operating with lower cash holdings relative to the scale of their economic activity, in many cases, dangerously low cash holdings. Many businessmen develop the attitude, why hold cash when credit expansion makes it possible to borrow easily and profitably? Instead, invest the money.

Thus, when credit expansion finally gives way to the recognition of vast malinvestments and the accompanying loss of huge sums of capital, the economic system is also mired in debt and deficient in cash. Thus, it is poised to fall like a house of cards, in a vast cascade of failures and bankruptcies, first and foremost, bank failures.

The Road to Recovery

The road to recovery from our economic downturn can be understood only in the light of knowledge of credit expansion and its consequences. The nature of credit expansion and its consequences imply the nature of the cure.

The prevailing—Keynesian—view on how to recover from our downturn totally ignores credit expansion and its effects. It believes that all that counts is “spending,” practically any kind of spending. Just get the spending going and economic activity will follow, the Keynesians believe.

This conception of things, which underlies the support for “stimulus packages” and anything else that will increase consumer spending is mistaken. It rests on a fundamental misconception. It ignores the fact that the fundamental problem is not insufficient spending, but insufficient capital due to the losses caused by malinvestment. It ignores the further facts that credit expansion has brought about excessive debt and, however counterintuitive this may seem, insufficient cash. Too little capital, too much debt, and not enough cash are the problems that countless business firms are facing today as a result of the credit expansion that generated the housing bubble.

Just as a reminder: the way that credit expansion brings about a situation of too little cash while itself constituting a flood of cash is that it makes it appear profitable to invest every last dollar of cash in the expectation of being able easily and profitably to borrow whatever cash may be needed.

What this discussion implies is that an essential requirement of economic recovery is that the widespread problems in the balance sheets of business firms must be fixed. Business firms need more capital, less debt, and more cash. When they achieve that, business confidence will be restored.

Ironically what could achieve at least less debt and more cash in the hands of business, and thus actually do some significant good is if when people received government “stimulus” money, they did not spend very much of it, or, better still, any of it at all. To the extent that all people did with money coming from the government was pay down debt and hold more cash, they would be engaged in a process of undoing some of the major damage done by credit expansion. They would be reducing their burden of debt and increasing their liquidity, thereby increasing their security against the threat of insolvency. Such behavior, of course, would be regarded by Keynesians as constituting a failure of their policies, because in their eyes, all that counts is consumer spending.

The 100-Percent Reserve

The most important single step on the road to economic recovery is the establishment of a 100-percent reserve system against checking deposits. Ideally, the 100-percent reserve would be in gold. And that’s ultimately what we should aim at, for all of the reasons Rothbard explained.
[1] But even a 100-percent reserve in paper would do the job of totally preventing all future credit expansion and, equally important, all declines in the money supply.

(Because the 100-percent gold reserve standard is the long-run ideal of advocates of sound money, I cannot help but feel a sense of great satisfaction in the fact that a major step toward its achievement is what turns out to be urgently needed as a matter of sound current economic policy.)
In the simplest terms, to establish a 100-percent-reserve system in terms of paper, the government would simply print up enough additional paper currency so that when added to the paper currency the banks already have, every last dollar of their checking deposits would be covered by such currency. (Strictly speaking, a significant part, and for some months now the far greater part, of the reserves of the banks are not in actual currency but in checking deposits with the Federal Reserve. For the sake of simplicity, however, we can think of the checking deposits held by the banks with the Federal Reserve as a denomination of currency, since, for the banks, they are fully as interchangeable with currency as $50 bills are with $100 bills and vice versa.)

To illustrate the process of achieving a 100-percent reserve, imagine that total checking deposits are $3 trillion. In that case, the Fed would give the banks new and additional reserves that when added to their existing reserves would bring them up to $3 trillion. Through various programs, such as purchasing bad assets, the Fed has in fact already brought the total reserves of the banks up to over a trillion dollars, but almost all of those reserves, as we’ve seen, are excess reserves, a ready foundation for a massive new credit expansion, since excess reserves can be lent out.

What my example implies is adding to the $1.1 trillion of reserves the banking system now has, a further $1.9 trillion and making all $3 trillion of reserves required reserves. This would mean that the banks could not engage in any lending of these reserves and thus would be unable to finance credit expansion or any increase in the supply of checking deposits on the strength of them. The money supply in the hands of the public and spendable in the economic system would thus not be increased. That would happen only if and to the extent that the 100-percent reserve principle were breached.

Under a 100-percent reserve, checking depositors could simultaneously all demand their full balances in cash and the banks would be able to pay them all. Depositors’ demand for cash would not create a problem and no amount of losses by the banks on their loans and investments would prevent them from honoring their checking deposits immediately and in full. Thus the checking deposit component of the money supply could not fall and nor, of course could its other component which is the paper money in the hands of the public, usually described as the currency component. Thus, there could simply be no deflation of the money supply. And, as I’ve said, because all reserves would be required reserves, there would simply be no reserves whatever available for lending out, and thus no credit expansion whatever. The expression “killing two birds with one stone” could not have a better application.

In a addition, a significant by-product of a 100-percent reserve system would be that the FDIC would no longer serve any purpose and thus could be abolished.

Now an essential prerequisite of the 100-percent reserve is knowing the size of checking deposits, so that it will be known how much the 100-percent reserve needs to cover. At present, when one allows for such things as “sweep accounts,” money-market mutual funds, and money-market deposit accounts, the magnitude of checking deposits to which the 100-percent reserve would apply can plausibly be argued to range from about $1.5 trillion to $6 trillion. It is very solidly $1.5 trillion, but does in fact range up to $6 trillion in that checks can be written on the additional sums involved, at least from time to time and for some large minimum amount.

To clearly establish the magnitude of checking deposits, bank depositors should be asked if their intention is to hold money in the bank, ready for their immediate use and transfer to others, or to lend money to the bank. In the first case, their funds would be in a checking account, against which the bank would have to hold a 100-percent reserve. In the second case, their funds would be in a savings account, against which the bank could hold whatever lesser reserve it considered necessary. In this case, the bank’s customers could not spend the funds they had deposited until they withdrew them from the bank.

As I’ve said, the long-run goal in connection with the 100-percent reserve would be ultimately to convert it to a 100-percent gold reserve system. At that time, following ideas of Rothbard further, the gold reserve of the Fed would be priced high enough to equal the currency and checking deposits of the country and be physically turned over to the individual citizens and the banks in exchange for all outstanding Federal Reserve money. The Fed would then be abolished. But this is a distinct and much later step in pro-free-market reform.

The 100-Percent Reserve and New Bank Capital

It should be realized that a major consequence of the establishment of a 100-percent-reserve system could be a corresponding enlargement of the capital of the banking system and thus an ability to cover even very great losses and thereby avoid such things as government bank bailouts and takeovers.

Consider the balance sheet of an imaginary bank. It’s got checking-deposit liabilities of $100. Initially, it has assets of $105, which implies that on the liabilities side of its balance sheet it has capital of $5 in addition to its checking-deposit liabilities of $100.

Now unfortunately, malinvestment has resulted in a loss of $20 in the banks’ assets, in the part of its assets consisting of loans and investments. As a result, its total assets are reduced from $105 to $85 and its capital is completely wiped out and becomes negative in the amount of $15.

However, on its asset side the bank still has some cash reserve, say, $10. If $90 of new and additional reserves were added to these $10, to bring the bank’s reserves up to 100-percent equality with its checking deposits, the bank’s asset total would also be increased by $90. This $90 increase on the bank’s asset side would have to be matched by a $90 increase on its liabilities side, specifically by a $90 increase in its capital. Its capital would go from minus $15 to plus $75.

Applying this to the banking system as a whole in transitioning to a 100-percent reserve, we can see that the creation of such a vast amount of new bank capital would be entailed as easily to overcome whatever losses the banks might have suffered in their loans and investments.

As explained, if checking deposits were $3 trillion, the Fed would give the banks new and additional reserves that when added to their existing reserves would bring them up to $3 trillion. If this had been done in September of 2008, bringing reserves up to $3 trillion would have required adding $2.955 trillion of new and additional reserves to the $45 billion or so of reserves the banks already had. This vast addition on the asset side of the banks’ balance sheets would have implied an equivalent addition to the banks’ capital on the liabilities side. No matter how bad the banks’ assets were, I think it’s virtually certain that an additional sum of this size would have been far more than sufficient to cover all the losses that the banks had incurred in their bad loans and investments. Their capital would have ended up being increased to the extent the additional reserves exceeded the losses in assets under the head of loans and investments.
The government’s bailout program of stock purchases in the banks would have been avoided, along with all of its subsequent interference in matters of bank management.

Now, as we’ve seen, in fact the Fed has already supplied a vast amount of reserves, about $1.1 trillion, to the banks through various programs such as purchasing bad assets. If the 100-percent reserve principle were adopted now, many or most of those assets could be taken back and the programs that created them cancelled.

Thus, what I’ve shown here is how transitioning to a 100-percent reserve would guarantee the prevention both of new credit expansion and of deflation of the money supply. It could also provide additional capital to the banking system on a scale almost certainly far more than sufficient to place it on a financially sound footing. To avoid what would otherwise likely be an excessive windfall to the banks, it would be possible to match a more or less considerable part of the increase in their assets provided by the creation of additional reserves, with the creation of a liability of the banks to their depositors, perhaps in the form of some kind of mutual-fund accounts. Thus, the newly created reserves might provide a financial benefit to the banks’ depositors as well as to the banks.

Toward Gold

Of course, a 100-percent reserve system in which the reserves are fiat money does not address the problem of preventing inflation of the fiat money. It would still be possible for the government to inflate the fiat money without restraint. That is why it is necessary to have gold in the monetary system, serving as a restraint on the amount of currency and reserves.

Thus, an important ancillary measure in connection with the transition to a 100-percent paper-reserve system would be for the government to demonstrate a serious intent to move to a gold standard. Obliging the Federal Reserve to carry out a program of regular and substantial gold bullion purchases might accomplish this. In any event, it would be an essential prerequisite for someday achieving gold reserves sufficient to make possible the establishment of a 100-percent-reserve gold system. Along the way, this measure should lead to the day when purchases of gold bullion were the only source of increases in the supply of currency and reserves.

Establishing the Freedom of Wage Rates to Fall

Along with stabilizing the financial system through the adoption of a 100-pecent reserve, it’s absolutely essential to establish the freedom of wage rates and prices to fall. This is what is required to eliminate mass unemployment. Whatever the level of spending in the economic system may be, it is sufficient to buy as much additional labor and products as is required for everyone to be employed and producing as much as he can.

Nothing could be more obvious if one thinks about it. Assume, as is the case today, that there is 10 percent unemployment, with only 9 workers working for every 10 who are able and willing to work. The same total expenditure of money that today employs only 9 workers would be able to employ 10 workers, if the average wage per worker were 10 percent less. At nine-tenths the wage, the same total amount of wages is sufficient to employ ten-ninths the number of workers. It’s a question of simple arithmetic: 1 divided by 9/10 equals 10/9.

(Obviously, this is an overall, average result. In reality, some wage rates would need to fall by less than 10 percent and others by more than 10 percent.)

Of course, total wage payments are not fixed in stone. They can change. And in response to a fall in wage rates to their equilibrium level, to eliminate mass unemployment, they would increase. This is because prior to their fall, investment expenditures have been postponed, awaiting their fall. Once that fall occurs, those investment expenditures take place.

Finally, with debt levels sufficiently reduced and cash holdings sufficiently high, and thus business confidence restored, there is no reason to believe that a fall in wage rates could abort the process of recovery as the result of already employed workers earning less and thus spending less before new and additional workers were hired. The cash reserves and financial strength of business firms would enable them easily to ride out any such situation. And thus mass unemployment would simply be eliminated.

What stops wage rates from falling, what makes it actually illegalfor them to fall, and which thus perpetuates mass unemployment, is the underlying pervasive influence of the Marxian exploitation theory. That doctrine is responsible for the existence of such things as minimum-wage laws and coercive labor unions and their above-market wage scales.

The most important fundamental requirement for achieving a free market in labor is the total refutation of the exploitation theory and its complete discrediting in public opinion. Such a refutation will show that it is not government and labor unions that raise real wages but businessmen and capitalists, and that essentially, all that unions do is cause unemployment and a lower productivity of labor and thus prices that are higher relative to wage rates. This knowledge is what is required to make possible the repeal of minimum-wage and pro-union legislation and thus achieve the fall in wage rates that will eliminate mass unemployment.


In summation, my pro-free-market program for economic recovery is a provisional 100-percent-paper-money-reserve system applied to checking deposits, accompanied by a demonstrable commitment to ultimately achieving a 100-percent-gold-reserve system. The 100-percent reserve in paper would put an end to all further credit expansion and at the same time make the money supply incapable of being deflated. Its establishment would also greatly increase the capital of the banking system. It would do so by more than enough to cover all the losses on loans and investments incurred in the aftermath of the collapse of the housing bubble and thus make possible the elimination of government ownership of common stock in banks and its interference in bank management. What it would not do is control the increase in paper currency and paper-currency reserves. That will require a 100-percent gold reserve system.

Finally, the freedom of wage rates and prices to fall must be established through the repeal of pro-union and minimum-wage legislation, and more fundamentally, the education of the public concerning the errors of the Marxian exploitation theory and their replacement with actual knowledge of what determines wages and the general standard of living. To say the least, this will certainly not be an easy agenda to follow, inasmuch as it must begin in the midst of a Marxist occupation of our nation’s capital.

Thank you.

[1] Rothbard deserves credit for his ideas on money, especially for his views on the subject of the 100-percent-gold-reserve system. This acknowledgement, however, should not be construed in any way as an endorsement of Rothbard’s belief in a system of “competing governments” or his belief that the United States was the aggressor against Soviet Russia in the cold war.

Copyright © 2009 by George Reisman. George Reisman, Ph.D. is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. He is also a Senior Fellow at the Goldwater Institute. His web site is and his blog is A pdf replica of his book can be downloaded to the reader’s hard drive simply by clicking on the book’s title, above, and then saving the file when it appears on the screen.

Friday, November 06, 2009

University Course Using Reisman and Rand as Texts

National University of La Jolla, CA has a limited number of scholarships available for three online courses that focus on free-market economics and the philosophical foundations of capitalism. These scholarships are being funded by a grant from the Charles G. Koch Charitable Foundation. The scholarships cover the full tuition for the courses. These courses use Capitalism: A Treatise on Economics by George Reisman, and Ayn Rand’s The Virtue of Selfishness and Capitalism: The Unknown Ideal as the required textbooks. These courses can be taken from anywhere in the world, as long as one has access to the internet. The courses incorporate live chat sessions in which the professor and students interact in a virtual classroom, much as they would in a traditional classroom. To obtain more information on these scholarships, please contact Dr. Brian Simpson at or 858-642-8431.

Sunday, October 18, 2009

Maoist in the White House

Anita Dunn, is described by the online encyclopedia Wikipedia as “one of the major decision makers of the Obama campaign” and as one of Obama’s “four top advisers (along with David Axelrod, David Plouffe, and Robert Gibbs).” She currently holds the position of “White House Communications Director.” She is married to the President's personal lawyer, Robert Bauer. In 2008, Newsweek named Dunn and Bauer the new "power couple" in Washington, D.C.

This last June, at a high-school commencement exercise, Dunn had this to say:

“… the third lesson and tip actually comes from two of my favorite political philosophers Mao Tse Tung and Mother Teresa, not often coupled with each other, but the two people that I turn to most to basically deliver a simple point which is you’re going to have make choices, you’re going to challenge, you’re going to say why not…. In 1947, when Mao Tse Tung was being challenged within his own party on his plan to basically take China over, Chiang Kai-Shek and the nationalist Chinese held the cities, they had the army, they had the air force, they had everything on their side and people said how can you win, how can you do this, how can you do this, how can you do this against all of the odds against you, and Mao Tze Tung said, you fight your war and I’ll fight mine.” (Dunn’s remarks appear in an online video at

Back in late 2002, on the occasion of retiring Senator’s Strom Thurmond’s 100th birthday, Trent Lott, then the Majority Leader of the US Senate, said, "I want to say this about my state: When Strom Thurmond ran for president, we voted for him. We're proud of it. And if the rest of the country had followed our lead, we wouldn't have had all these problems over all these years, either." (See

Because Thurmond had campaigned in 1948 on a platform advocating racial segregation and Lott’s statement was—correctly—taken as an implicit endorsement of segregation, the result of his statement was an outcry from the media, various public figures, and other Senators, of such dimensions that he was soon forced to resign as Senate Majority Leader.

This was despite his protestation and apology that “A poor choice of words conveyed to some the impression that I embraced the discarded policies of the past. Nothing could be further from the truth, and I apologize to anyone who was offended by my statement." Thurmond had subsequently abandoned his segregationist position and, consistent with this, Lott said, "My comments were not an endorsement of his positions of over 50 years ago, but of the man and his life."

Nevertheless, perhaps there simply was no valid explanation or justification for Lott’s comment, and his resignation, therefore, was appropriate. But at least Lott was greatly embarrassed by what he had said and did offer a public apology of some kind.

My question is, where is the outcry against Anita Dunn? Her remarks were not limited to a casual comment that had vicious implications. Rather they constituted a prolonged, blatantly explicit, and far more fundamental endorsement of an incalculably worse person and program than did those of Trent Lott. She has dared to say that one of her “favorite political philosophers” is one of the greatest mass murderers in the history of the world, a man whose takeover of China was responsible for as many as 70 million deaths during his reign. She has dared to present the words of this monster as a source of inspiration to youth!

Perhaps she would like to rephrase her remarks. Perhaps she would like to substitute Adolf Hitler for Mao Tse Tung. Perhaps she would like to say something like this:

“In the days when the Führer was being challenged even within his own party on his plan to exterminate the Jews of Europe, the Jews and their allies controlled many major businesses, they controlled many major banks, they owned many major newspapers and magazines. They were protected by the rule of law, by trial by jury, and by laws against robbery, kidnapping, and murder. They had everything on their side and people said to Hitler how can you win, how can you do this, how can you do this, how can you do this against all of the odds against you, and Hitler said, you fight your war and do your destruction and I’ll fight mine and do my destruction.”

If the United States had an honest press and media, one committed to the principle of individual rights, their outrage would drive Anita Dunn out of Washington, D.C. just by hurling her words back at her. They would make her such a “hot potato” that no one would dare to defend her in her infamy.

Copyright © 2009 by George Reisman. George Reisman, Ph.D. is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. He is also a Senior Fellow at the Goldwater Institute. His web site is and his blog is A pdf replica of his book can be downloaded to the reader’s hard drive simply by clicking on the book’s title, above, and then saving the file when it appears on the screen.

Tuesday, September 29, 2009

Ludwig von Mises's Birthday

Today is the 128th birthday of Ludwig von Mises. Please see the tribute to him that appeared on this blog three years ago.

Saturday, August 08, 2009

Replies to Readers of My Article on the Real Right to Medical Care

From a reader in Cambridge, ON, Canada:
RE:The Real Right To Medical Care....

[T]hanks for the fantastic article on real medical care vs. socialized
medicine. I am writing this email because I am a young Canadian who has a socialized medical system. While I cannot argue your logic for a true free market medical care system, I did finish your piece feeling like there is one hole. Not to say the idea is flawed, by no means, but if individuals have a right to life, and had an illness that was fatal if not treated but could not afford said treatment, where does that leave doctors? You mention charity, and I'm sure to a degree that would exist, but if you were a practicing medical doctor, and knew you could save a life with a simple procedure, how many could you turn away based on cost? While I wholeheartedly agree with the principles you outline in your piece, I found it fascinating, I did get the sense that the issue was not broached for that reason. Now I realize this may only be a small percentage of the population in a truly free market, but a life is a life at the end of the day. I hope you find the time for at least a modest response, if I somehow missed you stating said circumstance in your piece, please simply direct me to said section.

Dear Reader:

Thank you for your note. The right to life is not a right to be kept alive by other people, against their will. If there were such a right, then you and I and everyone else not in poverty would have to be devoting our lives to keeping alive countless numbers of impoverished people all over the world. To the contrary, paraphrasing Ayn Rand, the right to life is the right of an individual to take all of the [peaceful, non-coercive] actions that sustain and promote his life. This understanding of the right to life is incompatible with the notion of people having a right to be kept alive at others’ expense.

Of course, people may wish to give to charity within the limit of their perceiving that doing so enhances their own lives. The funds raised through charity together with the time doctors were willing to provide to charity patients would undoubtedly be concentrated on cases in which all that was necessary were relatively simple, inexpensive procedures that would save life or limb. But this cannot be a solution for all those medical problems requiring more complex and costly treatments that are beyond the means of patients and of the willingness and ability of people to provide charity.

What the solution for these medical problems is, is economic progress, which continuously improves medical care and makes it less and less expensive, while at the same times making practically all other goods and services better and less expensive as well, thereby freeing up more income to be spent on medical care if necessary. The foundation of economic progress, of course, is individual freedom and capitalism.

Always, however, there will be some people who will die because still more and better care, that others might have provided, was beyond their reach. There is simply no way to avoid this. It’s an aspect of the fact that man is mortal.

Trying to avoid it by compelling everyone to devote his life to keeping other people alive, beyond his perception of the personal, value to his own life of doing so, destroys the incentives to produce and advance, and thus ultimately does no good to anyone.

Because of this destruction, attempts to enforce such an obligation always stop short after a time. In fact, this is what we are seeing right now in the United States in the proposed roll backs in Medicare and denial of treatment to the elderly. It’s what already has taken place in Great Britain, and, I believe, in Canada and everywhere else that medical care has been collectivized long enough.

The government simply lacks the means to provide everyone with unlimited medical care. Eventually, it has to impose limits. But its limits entail depriving people of medical care who could have afforded it, if left free to use their own resources for that purpose. Its limits entail aborting further progress in medical in order to hold down the cost of operating its collectivized system.

There are two sorts of limits to medical care. One is reality, which encompasses the state of scientific and technological knowledge, the state of capital accumulation, the resulting productivity of labor, and the relative performance of different individuals cooperating together under economic competition and the pursuit of individual self-interest. Under capitalism, as the result of the pursuit of self-interest and competition, this limit is continually pushed outward and the level of care for everyone continually improves. (See my book Capitalism, chap. 9, for further discussion of this.)

The other kind of limit to medical care is arbitrary government fiat. The government takes over medical care and it decides who is to receive care and to what extent. Under government control, the limit to medical care tends to be frozen, indeed, declining. Progress in medical care is largely prohibited as a threat to the government’s budget and decline accompanies the coming to the fore of doctors who are content to be mere tools of government policy; it also accompanies the general economic decline that results from related government policies that are hostile to capital accumulation and economic efficiency.

There’s undoubted more to be said. But I hope that these remarks serve to address the matters you raised.

George Reisman

From a reader in Perth, Western Australia
Subject: stupid Samaritan patsy

"It should be obvious that such an arrangement entails the utter perversion of the right to medical care."

Dear Dr Reisman,

I find it astounding that a man who can write some many thousands of words on a topic, in apparently grammatically good English, can have the whole concept so wrong.
Altruism, empathy - those are the core concepts of society, not the market place. Health care is part of the altruistic nature of society, and it arose not out of purely commercial needs, it arose because most people on this planet have empathy for those who are sick, those who are unwell. People form collective societies for exactly that reason, to share the common burdens and chance misfortunes in life equally and fairly between those can and those who can't afford it.

I assume you are basically an anarchist with your attitude. All people are free from obligations to any other person, no matter what their circumstances. Hence the idea of Government to provide common services is unnecessary. I guess you probably believe that education should also be a purely commercial domain as well.

It scares me that you may have been teaching these attitudes to your economics students, the world is a poorer place if you have done so. Did you ever lecture or write on the economics of altruism or is it so far away from your moral centre that you can't understand the concept?

You are one of the people who left the man in the ditch for the stupid Samaritan patsy to come along and waste his good economic resources of food, water and labour on the man who for no reason of his own was in dire needs.

Your attitude may seem intellectually clever, put it is morally poor.

As a contrast, here in Australia we have fine collective system of medical care that works extremely well for the citizens of Australia. It is affordable, and we have better health care than the USA.

So, Dr Reisman, I think you need to look at the poor, the unemployed, those born with impediments such as lower intelligence, mental or physical disabilities and try to apply your huge mind to putting yourself into their position. It is probably difficult for you to do so, but should you be successful, you will hopefully feel remorse for your shockingly selfish position on health care.

Dear Reader:

Altruism is a philosophy of misery, suffering, poverty, and the hatred of man for man. It is the philosophy that ruled the Dark Ages and underlay such accompaniments as the Iron Maiden, the rack, and burning people alive at the stake.

Civilization is founded on the philosophy of egoism and recognition of the individual's right to the pursuit of his own, selfish happiness and the corollary recognition that the means of accomplishing this is voluntary, peaceful social cooperation under the division of labor. The gains from the division of labor give to each individual a rational self-interest in the existence of other people and in their individual freedom and right to the pursuit of their own happiness. This is the arrangement that progressively increases the supply of goods and services and improves life for everyone. (For elaboration, see Ludwig von Mises's
Socialism and my Capitalism.)

Under this arrangement—i.e., capitalism—the individual comes to regard other people with benevolence, because their existence improves his existence. In such conditions, people are prepared, within limits, to help others who suffer through no fault of their own. Thus, they help victims of earthquakes, floods, and all other natural disasters. They help people who cannot help themselves, including those who are stuck in a ditch. But that is not their primary goal or, as a rule, a major goal. It is secondary and rests upon their pursuit of their own happiness.

In contrast, when altruism prevails, each individual must regard all other individuals as a source of loss and misery. Their existence is a constant claim against his wealth and time and thus against his ability to enjoy his life. In such circumstances, the individual easily reaches the conclusion that he would be better off if those others did not exist. He would then be free of the burdens they impose.

Historically, the United States was characterized by the individual’s freedom to pursue his own happiness (a basic right enumerated in our Declaration of Independence). Thus, not surprisingly, it was also known for the goodwill and benevolence of its citizens. In contrast, the Dark Ages and the Soviet Union, two leading exemplars of altruism, were known for their hatred and barbaric treatment of human beings. What results from the prevalence of altruism is conveyed in a widely told story in the Soviet Union. It was the story of the Russian who is asked by God to wish for something that he would like God to do for him, on the understanding that whatever God does for him, he will do twice as much for his neighbor. After hearing this offer, the Russian asks that God pluck out one of his eyes, so that his neighbor can lose both eyes. (The story was reported by Hedrick Smith, in his book The New Russians, New York: Random House, 1990, p. 204.)

So much for altruism.

George Reisman

P. S. For elaboration on the contrasting natures of egoism and altruism, see the writings of Ayn Rand, in particular, Atlas Shrugged and The Virtue of Selfishness.

P.P.S. Concerning education, I believe that it should be stricly private. Schools would be legally free to operate on a commercial or non-commercial basis, as they chose. Individual would be free to support non-commercial schools and to provide scholarships for students attending for-profit schools. The main thing is that the government should not be allowed to attempt to improve students' minds on a foundation of pointing a gun at anyone's head, such as unwilling taxpayers, unwilling parents, and unwilling students.

Finally, I am not an anarchist but a supporter of government that is limited to the defense of the rights of the individual against the initiation of physical force, including fraud.

*George Reisman's replies to readers are copyright © 2009, by George Reisman. George Reisman, Ph.D. is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. He is also a Senior Fellow at the Goldwater Institute. His web site is and his blog is A pdf replica of his book can be downloaded to the reader’s hard drive simply by clicking on the book’s title Capitalism: A Treatise on Economics and then saving the file when it appears on the screen. The book provides an in-depth, comprehensive treatment of the material discussed in this post and of practically all related aspects of economics.

Sunday, August 02, 2009

The Real Right to Medical Care Versus Socialized Medicine

I've just posted on the TJS web site a reprint of my 1994 essay THE REAL RIGHT TO MEDICAL CARE VERSUS SOCIALIZED MEDICINE. I wrote this essay to help defeat the Clinton plan for socialized medicine. In all essentials it’s as valid today as it was then. It’s a demonstration that government intervention inspired by the philosophy of collectivism is the cause of America's medical crisis and that a free market in medical care is the solution for the crisis. I urge everyone who wants to help defeat the essentially similar Obama scheme to read it.

Saturday, July 04, 2009

Credit Expansion, Crisis, and the Myth of the Saving Glut



Credit Expansion, Standard Money, and Fiduciary Media

The Stock Market and Real Estate Bubbles

Evasion of Responsibility for the Bubbles

The Saving Glut Argument

The Non-Existence of a Saving Glut

Current Account Deficits as a By-Product of the Increase in the Quantity of Money

Net Saving as a By-Product of the Increase in the Quantity of Money

Summary and Conclusion

Readers who are already familiar with the nature of credit expansion and the concepts of standard money and fiduciary media should skip the first section. Readers who are also already familiar with the role of credit expansion and fiduciary media in generating the stock market and real estate bubbles should skip the second section as well and proceed directly to the third section “
Evasion of Responsibility for the Bubbles.”

Credit Expansion, Standard Money, and Fiduciary Media
Since the mid-1990s, the United States has experienced two major financial bubbles: a stock market bubble and a housing bubble. In both instances, the bubble was inaugurated and sustained by a process of massive credit expansion, i.e., the lending out of newly created money by the banking system, operating with the sanction and support of the country’s central bank, the Federal Reserve System.

The concept of credit expansion rests on two further concepts: standard money and fiduciary media. Standard money is money that is not a claim to anything beyond itself. It is that which, when received, constitutes payment. Under a gold standard, standard money is gold coin or bullion. Under a gold standard, paper notes, which were claims to gold, payable on demand, were not standard money. They were merely a claim to standard money, which was physical gold. The dollar was defined as a physical quantity of gold of a definite fineness, i.e., approximately one-twentieth of an ounce of gold nine-tenths fine.

Today in the United States, standard money is the irredeemable paper currency issued by the United States government. That money is not a claim to anything beyond itself. Receipt of such money today constitutes final payment.

The total of standard money today is the sum of the outstanding quantity of paper currency plus the checking deposit liabilities of the Federal Reserve System. Since the Federal Reserve has the power to print as much currency as it likes, and thus is always in a position to redeem its outstanding checking deposits in currency, these checking deposit liabilities can properly be viewed as a kind of different denomination of the paper currency, much like hundred dollar bills that are to be redeemed for notes of smaller denomination, or one-dollar bills that are to be redeemed for notes of larger denomination. Thus the total supply of standard money is to be understood as the sum of the supply of paper currency in the narrower sense plus the checking deposit liabilities of the central bank.

These two magnitudes, currency plus checking deposit liabilities of the central bank, when taken together, are known as the “monetary base.”

In December of 1994, the monetary base was $427.3 billion. In December of 1999, it was $608 billion. In December of 2007, it was $836.4 billion. In all years prior to 2008, the overwhelming portion of the monetary base consisted of currency. For example, in December of 2007, currency was $763.8 billion, while, as just noted, the monetary base as a whole was $836.4 billion.

A portion of the currency outstanding and a portion of the checking deposit liabilities of the Federal Reserve constitute the reserves of the banking system. These reserves are the standard money that the banks possess and can use to meet the withdrawals of depositors requesting currency. The reserves are also used to meet the demand of other banks seeking to redeem net balances accruing in their favor in the process of the clearing of checks.

In December of 1994 such reserves were $61.36 billion; in 1999, they $41.7 billion; in December of 2007, they were $42.7 billion.

Normally, as the overall quantity of money in the economic system increases, bank reserves increase more or less in proportion. The fact that reserves were almost one-third lower in December of 1999 than in December of 1994, and then barely higher in December of 2007 than they were in December of 1999, despite major increases in the quantity of money over these years, is a major anomaly. It reflects the long-standing, deliberate policy of the Federal Reserve System of reducing and even altogether eliminating reserve requirements.

As a recent scholarly paper noted,

The Depository Institutions Deregulation and Monetary Control Act of 1980 had begun phasing out interest-rate ceilings on deposits and
modified reserve requirements in complex ways. Combined with subsequent administrative deregulation under Greenspan through January 1994, these changes left all the financial liabilities that M2 adds to M1—savings deposits, small time deposits, money market deposit accounts, and retail money market mutual fund shares—utterly free of reserve requirements and allowed banks to reclassify many M1 checking accounts as M2 savings deposits. M2 and the broader measures became quasi-deregulated aggregates with no legal link to the size of the monetary base.
The concept of standard money underlies the concepts of fiduciary media and credit expansion. As I wrote in Capitalism, “Fiduciary media are transferable claims to standard money, payable by the issuer on demand, and accepted in commerce as the equivalent of standard money, but for which no standard money actually exists.”[2]

The overwhelmingly greater part of our money supply today consists of fiduciary media in the form of checking deposits of one kind or another. For example, as of December 2007, the total money supply of the United States, i.e., currency plus bank deposits of all kinds that are subject to the writing of checks, including the making of payments by debit card, was $6901.9 billion;
[3] at the same time, the monetary base was $836.4 billion. Accordingly, the amount of fiduciary media in the United States was equal to the difference, which was $6065.5 billion. This was the sum of money representing transferable claims to standard money, payable on demand by the various banks that issued them, accepted in commerce as the equivalent of standard money, but for which no standard money actually existed.

The only standard money that the banks had available with which to redeem their checking deposits was $42.7 billion in standard money reserves. These $42.7 billion of reserves were the standard-money backing for a total of $6108.2 billion checking deposits, i.e., deposits equal to the sum of $42.7 billion + $6065.5 billion. To say the same thing in different words, there was full, 100 percent standard-money backing for $42.7 billion of deposits, and no standard-money backing whatever for $6065.5 billion of deposits, which latter constituted fiduciary media.

The quantity of fiduciary media in existence at any time represents the cumulative total of all of the credit expansion that has taken place in the country’s money supply up to that time. It represents the sum of all of the loans and investments that the banking system has made based on the foundation of the creation of money out of thin air. The difference between the amount of outstanding fiduciary media at two points in time represents the credit expansion that has taken place in the interval.

The simplest way in which to understand the process of the creation of fiduciary media and credit expansion is to imagine a deposit of standard money in the form of currency into a checking account. After making the deposit, the depositor has just as much spendable money in his possession as he did before making it. Instead of a roll of currency, he has a checking balance of equal amount. Either way, he can spend the same amount of money. Before making his deposit, he would have had to peel off bills from his roll in order to make payments. Now, instead, he writes checks and makes payment by check. Instead of his roll of currency diminishing each time he peels off a bill, his checking balance diminishes each time he writes a check. In the one case, the spendable money in his possession is his roll of currency; in the other it is his checking balance.

Up to this point in our imaginary scenario, there has been no creation of fiduciary media and no credit expansion. The money supply does not exceed the quantity of standard money. In the one case, before making his deposit, the standard money is in the possession of an individual. After the individual makes his deposit and holds money in the form of a checking balance, the same quantity of standard money is in the possession of his bank. Under such conditions, the quantity of money in the economic system is equal to the quantity of standard money held either by individuals as holdings of currency, or by banks as reserves against the checking deposits of those individuals and equal in amount to the size of those checking deposits.

Fiduciary media and credit expansion enter the picture insofar as the banks in which standard money has been deposited proceed to lend out the standard money that has been deposited with them. To the extent they do this, borrowers from the banks now have spendable money in their possession which is in addition to the spendable money in the hands of the banks’ checking depositors. There has been a creation of new and additional money, which new and additional money represents fiduciary media and an equivalent expansion of credit.

The currency which the banks lend out can easily, and almost certainly will, be deposited. When it is deposited, the same process of the creation of fiduciary media and credit expansion can be repeated. Indeed, under the conditions largely created by Greenspan, checking deposits came to stand in a multiple of more than 160 times the standard money reserves of the banks. In December of 2007, there were $6901.9 billion of checking deposits backed by a mere $42.7 billion of standard money reserves.

In modern conditions, of course, banks do not lend currency. Rather, they simply create new and additional checking deposits for their borrowers. When the borrowers spend those checking deposits by writing checks of their own, the people who receive the checks in turn deposit them in their banks. Those banks then call upon the banks that have created the deposits, for payment. This entails a shifting of standard money reserves from the one set of banks to the other.

To the extent that all banks have engaged in the process of checking deposit creation, the reserve balances due from any bank may be more or less closely matched by the reserve balances due it from other banks. This is because the checks written by its customers to the customers of other banks will be more or less closely matched by checks written by the customers of other banks to customers of this bank. In such a case the only movement of reserves will be the net amount due in the clearing.

From December of 1994, prior to the start of the stock market bubble, to December of 2005, shortly before the end of the housing bubble, the quantity of fiduciary media increased from $1.91 trillion to $4.93 trillion. This represented a compound annual rate of increase in excess of 9 percent over the eleven-year period. From December of 1999, shortly before the start of the housing bubble, to December of 2005, the amount of fiduciary media increased from $3.25 trillion to $4.93 trillion, which represented a compound annual rate of increase of 7.21 percent.

The increase in the quantity of fiduciary media over the period as a whole is significant, not just the increase that took place over the period of the housing bubble itself. This is because fiduciary media created in the years prior to the housing bubble played an important role in financing that bubble. And the same was true of the role of fiduciary media created in the years prior to the stock market bubble in financing that bubble.

As interest rates rose in the latter parts of these two bubbles, vast checking balances created earlier, that had been held as though they were savings accounts, and on which a modest rate of interest was being earned, were drawn into the financing of stock market purchases in the one case and housing loans in the other. The transformation of these deposits from de facto savings accounts into de facto checking accounts was based on the combination of their having had the potential for check writing all along, together with a rise in the rates of return that could be earned by switching their use from a vehicle for savings into a vehicle for buying investments. The rise in rates of return in the one case was in the gains to be had from stock market investment; in the other, in rates of interest on various vehicles for financing housing and real estate purchases.

It might be thought that what I have said of the transformation of deposits on which checks could be written would largely apply also to genuine savings deposits, on which checks could not be written. For the rise in rates of return would provide the same incentive to move funds from them into more lucrative investments. This is true. But nevertheless, there is a crucial difference.

Before the savings deposits can be spent, they must first be converted into checking deposits. All of the checking deposits that come under the heading of M1, most notably those held at commercial banks, require that those banks hold significant reserves, typically in an amount equal to 10 percent of a bank’s total deposits in excess of $44 million. Savings deposits in contrast have not required the holding of any reserves whatever for many years, and even when they did require the holding of reserves, it was at a far lower percentage than applied to checking deposits.

As a result, any movement of funds from savings into checking accounts entails an increase in required reserves. To obtain these additional reserves, banks must sell various assets, the effect of which would be to reduce their prices and to raise their effective yields to the new buyers. Unless the Federal Reserve intervened to provide new and additional reserves equal to the increase in the need for reserves, the effect would be not only a rise in interest rates but a general tendency toward a contraction of credit. This last would result from the loss of reserves by banks whose reserves were already at the bare minimum necessary to conduct operations.

In contrast, the use of savings held in accounts with already existing check-writing privileges to make purchases does not require any additional reserves. The problem of a need for additional reserves arises only insofar as a net movement of funds might occur, through the clearing, from checking accounts of a kind requiring no reserves to checking deposits of a kind that do require reserves. Checking deposits with no legal reserve requirements are money-market deposit accounts and retail and institutional money market funds. Checks drawn on such accounts and then deposited in other such accounts do not require any additional reserves. Additional reserves are required only when and to the extent that checks drawn on such accounts and deposited in conventional checking accounts exceed the volume of checks coming from conventional checking accounts and deposited in such accounts.

To the extent that the Federal Reserve is willing to supply the necessary additional reserves to meet the greater need for reserves arising from such a movement of funds, all checking deposits come to stand on an equal footing as sources of spendable money. And so too do savings deposits that end up being convertible into checking deposits with no net increase in the scarcity of reserves because the Fed has enlarged the supply of reserves to the same or even greater extent than the increase in the amount of reserves required as the result of such conversion.

Consistent with the fact cited earlier that total reserves were substantially lower in December of 1999 than they had been in December of 1994 and grew only slightly from December of 1999 to December of 2007, it must be pointed out that additional reserves can be supplied by the Fed by means of its reducing or eliminating reserve requirements at various points in the banking system. Thus, for example, when the Fed eliminated the requirement that once existed that a 3 percent reserve be held against savings deposits, all of the reserves previously held to meet that requirement became equivalent to a supply of new and additional reserves of that same amount.

The same was true when the Fed allowed commercial banks on weekends and holidays to “sweep” substantial parts of their outstanding checking deposits into types of accounts that did not require reserves. This too made a substantial portion of already existing reserves the equivalent of new and additional reserves. Indeed, the amount of such new and additional reserves constituted such an excess of reserves above the now diminished reserve requirements, that the Fed was obliged to reduce the outstanding amount of reserves by means of resorting to “open-market operations” in which it sold some of its holdings of government securities in exchange for newly excess reserves.

The Stock Market and Real Estate Bubbles
Credit expansion was the source of the funds that fueled both the stock market and the real estate bubbles. In the case of the stock market bubble, credit expansion provided funds for the purchase of stocks. The sellers of the stocks then used the far greater part of their proceeds to purchase other stocks, whose sellers did likewise. In this way, the new and additional money created by credit expansion traveled from one set of stocks to another, raising the prices of the great majority of them. It continued to do this so long as the credit expansion went on at a sufficient rate.

Ultimately, a sufficient rate would have had to be an accelerating rate. This is because rising share prices resulted in people feeling richer and thus believing themselves able to afford more luxury goods. It also led to a stepped up demand for physical capital goods by firms coming into possession of the new and additional money by virtue of sales of stock of their own. The issuance of such stock and use of the proceeds to finance the purchase of physical capital goods was encouraged by the fact that the rise in stock prices made it more and more attractive in comparison with acquiring capital goods through the purchase of stocks in other companies.

Thus, an important later effect of the credit expansion was a tendency for funds to be withdrawn from the stock market, for the purchase of luxury consumers’ goods and also of physical capital goods. To offset this withdrawal of funds, more rapid credit expansion would have been necessary.

When, instead of an acceleration of the credit expansion, there was a diminution in its rate, the basis of the market’s rise was doubly undercut. Since the funds provided by credit expansion had come to represent an important part of the demand for stocks, the reduction in credit expansion constituted a reduction in that demand. Coupled with the outflows of funds just described, the result was that share prices began to plummet. Their fall was compounded by the unloading of shares by people who had purchased them for no other reason than their expectation of a continuing rise in stock prices.

The more recent, real estate bubble originated in the Fed’s panic-response to the collapse of the stock market bubble it had caused earlier. To overcome the effects of that collapse, it progressively reduced its target federal-funds rate, i.e., the rate of interest banks pay one another on the lending and borrowing of funds that qualify as reserves against commercial-bank checking deposits. In this way, it launched a new and more momentous credit expansion.

For the three years 2001-2004, the Federal Reserve created as much new and additional money in the form of additional bank reserves as was necessary to drive and then keep the federal-funds rate below 2 percent. And from July of 2003 to June of 2004, it drove and kept it even further down, at approximately 1 percent.

The new and additional money created by the banking system on the foundation of these new and additional reserves appeared in the loan market as a new and additional supply of loanable funds. The effect was a reduction in interest rates across the board.

Because interest is a major determinant of monthly mortgage payments, the fall in interest rates made home ownership appear substantially less expensive. As a result, a great surge in the demand for mortgage loans and the in the purchase of homes took place. Instead of pouring into the stock market as in the previous bubble, the funds created by credit expansion now poured into the real estate market and drove up the prices of homes and commercial real estate rather than the prices of common stocks.

In the stock market bubble and even more so in the real estate bubble there was both large scale overconsumption and malinvestment. These are the two leading features of booms as explained by the monetary theory of the trade cycle developed by Ludwig von Mises. In both cases, the rise in the price of major assets—most notably, stocks and homes respectively—led people to believe that they were richer and could thus afford to consume more. In both cases, particular branches of industry were greatly overexpanded relative to the rest of the economic system, resulting in a subsequent major loss of capital. In the stock market bubble, the malinvestment was mainly in such things as the “” enterprises that later went broke. In the real estate bubble, it was in housing and commercial real estate.

Evasion of Responsibility for the Bubbles
Credit expansion is what was responsible for both the stock market and the real estate bubbles. Since its establishment in 1913 and certainly since the expansion of its powers in World War I, responsibility for credit expansion itself has rested with the Federal Reserve System. The Fed is the source of new and additional reserves for the banking system and determines how much in checking deposits the reserves can support. It has the power to inaugurate and sustain booms and to cut them short. It launched and sustained the stock market and real estate bubbles. It had the power to avoid both of these bubbles and then to stop them at any time. It chose to launch and sustain them rather than to avoid or stop them.

To be responsible for a bubble and its aftermath is to be responsible for a mass illusion of wealth, accompanied by the misdirection of investment, overconsumption, and loss of capital, and the poverty and suffering of millions that follows. This is what can be traced to the doorstep of the Federal Reserve System and those in charge of it. It is destruction on a scale many times greater than that wrought by Bernard Madoff, the swindler who first made his clients believe they were growing rich, only to cause them ultimately a loss of more than $50 billion. Madoff is one of the most justly hated individuals in the United States.

In contrast to the $50 billion of losses caused by Madoff, the losses caused by the Federal Reserve System and those in charge of it amount to trillions of dollars, probably to more than $10 trillion if the stock and real estate bubbles are taken together. Instead of affecting thousands of people as in the case of Madoff, tens of millions have been made to suffer hardship. Indeed, practically everyone has been harmed to some extent by what the Federal Reserve has done: the owners of stocks that have plunged, pensioners, the unemployed and their families, towns and cities suffering the consequences of business failures and plant closings.

It is difficult to imagine living with the knowledge that one is personally responsible for such massive destruction. Such knowledge might easily drive someone to suicide or at least to some means, such as drink or drugs, of not having to allow it into consciousness.

Alan Greenspan, who was Chairman of the Federal Reserve’s Board of Governors from 1987 to 2006, the period encompassing both bubbles, is clearly the single individual most responsible for the bubbles. The present Chairman, Ben Bernanke, also bears substantial responsibility, though not to the same extent as Greenspan. While Chairman only since January of 2006, Bernanke has been a member of the Federal Reserve Board since 2002. Thus he was present in a major policy making position during most of the housing bubble and crucial years leading up to it.

Neither Greenspan nor Bernanke have resorted to drink or drugs to conceal their responsibility from themselves. Instead they have resorted to specious claims about the cause of the bubbles, the housing bubble in particular.

One can read through their widely disseminated public statements and not find a single explicit reference to credit expansion and fiduciary media, nor to malinvestment and overconsumption. To avoid recognition of any need to discuss these phenomena, Greenspan seems to have wiped his mind clean of all knowledge of how Federal Reserve interest-rate policy affects interest rates in the economic system.

In what appears to be his closest reference to credit expansion, he wrote, in an article in The Wall Street Journal of March 11, 2009:

There are at least two broad and competing explanations of the origins of this crisis. The first is that the "easy money" policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today's financial mess.

The second, and far more credible, explanation agrees that it was indeed lower interest rates that spawned the speculative euphoria. However, the interest rate that mattered was not the federal-funds rate, but the rate on long-term, fixed-rate mortgages. Between 2002 and 2005, home mortgage rates led U.S. home price change by 11 months. This correlation between home prices and mortgage rates was highly significant, and a far better indicator of rising home prices than the fed-funds rate.

This should not come as a surprise.

After all, the prices of long-lived assets have always been determined by discounting the flow of income or imputed services by interest rates of the same maturities as the life of the asset. No one, to my knowledge, employs overnight interest rates—such as the fed-funds rate—to determine the capitalization rate of real estate, whether it be an office building or a single-family residence.

In these passages Greenspan invents a version of the opposition to Federal Reserve sponsored credit expansion that no opponent of credit expansion or “easy money” has ever held. No opponent of credit expansion has ever claimed that reductions in the federal-funds rate need directly affect long-term interest rates. To the contrary, the significance of reductions in the federal-funds rate is that what is required to bring them about in the actual market for those funds is an increase in member-bank reserves. The increase in those reserves is then the foundation of credit expansion to a vast multiple of the additional reserves. That credit expansion is what then serves to lower long-term interest rates, such as mortgage rates.

The way the process works is as follows. To actually achieve the lower federal-funds rate that it announces as its target, the Federal Reserve goes into the market and buys government securities from banks or the customers of banks. It pays for those securities by means of the creation of new and additional standard money. When the Fed purchases securities from banks, the banks directly and immediately have equivalently more reserves in their possession. When it purchases securities from the customers of banks, the banks gain equivalently more reserves as soon as those customers deposit the checks they have received that are drawn by the Fed on the Fed. These checks are then forwarded to the Fed and the reserve accounts of the banks in question are equivalently increased.

Depending on the amount of their increase, the immediate effect of the additional reserves is to reduce or eliminate deficiencies in the required reserves of some, many, or all of the banks that have had such deficiencies, to replace deficiencies of reserves with excesses of reserves, and to increase the excess reserves of some, many, or all of the banks that have had excess reserves. The effect of this in turn is to reduce the demand for federal funds, i.e., funds that qualify as reserves, while increasing their supply. This combination is what brings down the federal-funds rate in the market for federal funds.

What is far more significant is that the creation of new and additional excess reserves by the Fed—reserves beyond the amount legally required to be held—places the banking system in a position in which it can expand the supply of checking deposits and thus fiduciary media to a multiple of the additional reserves. And thanks largely to Mr. Greenspan that multiple came to be enormous. By December of 2005, it exceeded 126 times. Two years later, it exceeded 160 times.

Thus for each dollar of additional excess reserves created, a credit expansion was made possible on the order of a vast multiple. The new and additional fiduciary media corresponding to the credit expansion were the source of the funds for stock purchases in the stock market bubble and for housing and commercial real estate purchases in the housing bubble. Their pouring into the home mortgage market was what drove down mortgage interest rates. Between December of 1999 and December of 2005, almost $1.7 trillion of new and additional fiduciary media were created and lent out.

As market interest rates started rising in the second half of 2004 and then through 2005, increasing amounts of deposits earning a modest rate of interest and on which checks could be written, came to be used more and more as checking accounts rather than savings accounts. They were drawn into the spending stream in response to the higher comparative rates of return that could be earned through investment in securities. This allowed the life of the housing bubble to be extended until 2006.

The Saving Glut Argument
Along with denying the causal role of Federal Reserve expansionary monetary policy in the housing bubble, Greenspan advances the claim, greatly elaborated by Bernanke, that what was actually responsible for the bubble was an excess of global saving. He argues in his Wall Street Journal article that

[T]he presumptive cause of the world-wide decline in long-term rates was the tectonic shift in the early 1990s by much of the developing world from heavy emphasis on central planning to increasingly dynamic, export-led market competition. The result was a surge in growth in China and a large number of other emerging market economies that led to an excess of global intended savings relative to intended capital investment. That ex ante excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005.
In a series of lectures beginning in March of 2005 and continuing into the current year, Bernanke elaborates on this claim. At a lecture given at the Bundesbank in Berlin, Germany, on September 11, 2007, titled “Global Imbalances: Recent Developments and Prospects,” he argued that stepped up saving in developing countries was largely responsible for “the substantial expansion of the current account deficit in the United States, the equally impressive rise in the current account surpluses of many emerging-market economies, and a worldwide decline in long-term real interest rates.” (For the benefit of non-technical readers, the “current account” balance encompasses the difference between exports and imports both of goods and services, the difference between incomes earned abroad and incomes paid to abroad, plus the difference between remittances from and to abroad.)

These developments, he held, “could be explained, in part, by the emergence of a global saving glut, driven by the transformation of many emerging-market economies—notably, rapidly growing East Asian economies and oil-producing countries—from net borrowers to large net lenders on international capital markets.”[4]

In a speech delivered on April 9 of this year at Morehouse College in Atlanta, Bernanke stressed that “the net inflow of foreign saving to the United States, which was about 1-1/2 percent of our national output in 1995, reached about 6 percent of national output in 2006 an amount equal to about $825 billion in today's dollars.” He then proceeded to blame the housing boom on this inflow of foreign savings. “Financial institutions,” he declared, “reacted to the surplus of available funds by competing aggressively for borrowers, and, in the years leading up to the crisis, credit to both households and businesses became relatively cheap and easy to obtain. One important consequence was a housing boom in the United States, a boom that was fueled in large part by a rapid expansion of mortgage lending.”

Thus, according to Bernanke, it was not credit expansion or anything that he and the Federal Reserve System and Mr. Greenspan were responsible for, but the inflow of foreign savings. That inflow, representing a “global saving glut,” was responsible for the bubble and its aftermath.

Bernanke uses the expression “saving glut” repeatedly: 9 times in his lecture at the Bundesbank in September of 2007, 11 times in his lecture at the Virginia Association of Economics in March of 2005, and 10 times in his Homer Jones Lecture in St. Louis in April of 2005. Despite his constant repetition of the claim, it turns out to have absolutely no substance. Nowhere is the existence of anything remotely approaching a saving glut in any way substantiated.

The Non-Existence of a Saving Glut
The very notion of a saving glut is absurd, practically on its face. As I wrote in Capitalism:

Before the scarcity of capital … could be overcome, capital would have to be accumulated sufficient to enable the 85 percent of the world that is not presently industrialized to come up to the degree of capital intensiveness of the 15 percent of the world that is industrialized. Within the industrialized countries, capital would have to be accumulated sufficient to enable every factory, farm, mine, and store to increase its degree of capital intensiveness to the point presently enjoyed only by the most capital-intensive establishments, and, at the same time, to enable all establishments to raise the standard of capital intensiveness still further, to the point where no further
reduction in costs of production or improvement in the quality of products could be achieved by any greater availability of capital….

Long before such a point could ever be reached, time preference would put an end to further increases in the degree of capital intensiveness.

It is doubly absurd to believe that the source of a saving glut would be precisely countries possessing very little capital compared to the United States and other industrialized countries. But that is what Bernanke claims. He claims that countries such as Thailand, China, Russsia, Nigeria, and Venezuela are the source of the alleged saving glut.

There are further theoretical considerations that argue specifically against any form of “saving glut” being responsible for the housing bubble.

First, if saving had been responsible, and not credit expansion and the increase in the quantity of money, then the additional saving taking place in the countries providing it, would have been accompanied by a reduction in consumer spending in those countries. People would have had to spend less for consumption in those countries, in part, in order to make available funds for additional spending on capital goods that were exported to the United States. Such export of capital goods to the US would not have fueled a boom here. To the contrary, it would have resulted in lower prices of capital goods in the US. Only the portion of funds saved that was used to finance purchases within the US could have contributed to any higher prices of capital goods and land in the US. And, of course, whatever rise in the prices of capital goods and land that might have taken place in the US would have tended to be matched by a fall in the prices of consumers’ goods in the countries that had stepped up their saving. The only way that the demand for capital goods and land could rise without the demand for consumers’ goods falling would be on the strength of an increase in the quantity of money and the total, overall volume of spending in the economic system.

Indeed, the fact that in the absence of an increase in the quantity of money and volume of spending in the economic system, shifts in spending serve to reduce prices as much as increase them has a parallel in the further fact that increases in the relative size of some of the countries in the world’s economy imply equivalent decreases in the relative size of other countries in the world’s economy. In the absence of an increase in the quantity of money and volume of spending, growth in the relative size of the economies of many Asian countries would not by itself be sufficient for greater saving in those countries serving to increase global spending for capital goods. For that greater spending would be accompanied by reduced spending for capital goods in other countries, i.e., countries that were already in the category of developed economies and now had to yield some portion of their previous relative size.

In the present instance, what this means is that greater spending for capital goods and land in the US, financed by saving in parts of Asia, would be accompanied by less spending for capital goods in the US (and possibly elsewhere) financed by saving in the US or financed by saving elsewhere in the world. If spending for capital goods financed by saving in Asia is not accompanied by reduced spending for capital goods financed by saving elsewhere, the only ultimate explanation is an increase in the quantity of money and volume of spending in the world’s economy. Of course the source of such an increase in today’s conditions is none other than the Federal Reserve System.

Second, contrary to popular understanding, when saving is divorced from the increase in the quantity of money and volume of spending, and takes place without such increase, it does not tend to grow larger from year to year. Nor does consumer spending tend to decrease from year to year. And thus more saving would not serve to raise the prices of capital goods or land from one year to the next. Its effect would essentially be limited to a discrete, one-time only increase.
[8] Yet for the prices of capital goods and land to rise from one year to the next on the strength of an increase in the demand for capital goods and land based on an increase in saving, the increase in saving would have to become progressively larger from year to year. And this would mean that the demand for consumers’ goods would have to become progressively smaller from year to year.
For example, imagine that at the expense of an equal fall in the demand for consumers’ goods, the demand for capital goods rose by some given amount, say, 100. This 100 can represent however many billions or hundreds of billions of dollars as may be required to make it realistic in terms of present spending levels. In such circumstances, there would be nothing present that would make the prices of capital goods or land any higher in the second and later years of 100 of additional such spending than in the first year.

Indeed, as the years wore on, the increases in production achieved by a greater supply of capital goods would start reducing prices, including the prices of capital goods themselves, as the supply of capital goods itself was increased on the foundation of a general increase in production. Even land prices would fall to the extent that improvements in the supply of capital goods permitted the adoption of methods of production that allowed the economical use of previously submarginal land or so increased the output per unit of land as to make part of its supply redundant.

In circumstances of an unchanged supply of money and demand for money for holding, each act of greater saving and accompanying greater expenditure on capital goods operates in a manner analogous to the relationship between force and acceleration in the physical world. In the physical world, in the conditions of a friction-free environment, a single application of force to an object imparts continuous motion at a constant velocity. Similarly, in the economic world, in the conditions of an unchanged quantity of money and volume of spending, each act of reduced expenditure for consumers’ goods and increased expenditure for capital goods, causes the economic system to adopt a greater relative concentration on the production of capital goods and a reduced relative concentration on the production of consumers’ goods. This produces an inertial effect on capital accumulation.

The first result of the greater relative concentration on the production of capital goods is a greater production of capital goods, alongside a smaller production of consumers’ goods. These additional capital goods, however, obtained on the foundation of additional saving, are the basis of an increase in the ability to produce both consumers’ goods and further capital goods. That is to say, the additional capital goods make possible a general increase in production, an increase in the production of consumers’ goods and a further increase in the production and supply of capital goods as well. The process of an increasing supply both of consumers’ goods and capital goods, based on the foundation of a single fall in consumption and increase in saving, can go on indefinitely if it is accompanied by further scientific and technological progress. In these circumstances, a further fall in the demand for consumers’ goods and rise in the demand for capital goods would be analogous to a further application of force to an object and would result in an acceleration of the increase in production.

A further point must be mentioned here. And that pertains to the durability of capital goods and its implications for capital accumulation, saving, and spending. Thus, if the average life of the capital goods in our example of 100 of additional spending for capital goods were, say, 10 years, then a diminishing process of saving would go on for 10 years with no further fall in the demand for consumers’ goods nor rise in the demand for capital goods. Net saving and equivalent net investment in the economic system would take place in a pattern 100, 90, 80, …10, as the 100 of additional spending for such capital goods was accompanied by successive increases in annual depreciation charges. The additional depreciation charges would be 10 in the year following the first year’s expenditure of an additional 100 for such capital goods. In the next year, when there were two such batches of capital goods, depreciation would be 20. At the end of the tenth year, the depreciation charges on ten such batches of capital goods would be 100, and net saving and net investment would disappear, unless, of course, there were a further decline in consumption expenditure and increase in demand for capital goods.

What is particularly important to realize here is that the net saving of years 2 through 10 would not serve at all to raise the demand for capital goods and land nor their prices, but would contribute to the supply of capital goods being larger, production in general consequently being greater, and prices in general, including the prices of capital goods, being lower as a result. Such results, and those of the process of saving and capital accumulation in general that were described a moment ago, cannot be reconciled with the conditions of a bubble. They should not be cited as the basis of explaining a bubble.

Third, if somehow saving were responsible for the housing bubble, why did it suddenly collapse? Why did people suddenly stop saving and stop making funds available for the purchase of homes? Obviously, the explanation was that the bubble did not depend on saving but on credit creation and its acceleration and that when the ability to create sufficiently more credit came to an end, the props supporting the bubble were removed and it collapsed.

Fourth, if saving were responsible for the bubble, why have banks and countless other firms found themselves confronting an acute lack of capital? Saving provides new and additional capital. How can it be that an alleged process of saving has resulted in widespread major capital deficiencies? This situation of insufficient capital is the result of malinvestment and overconsumption, which are the consequences of credit expansion, not saving.

Fifth, if saving had been responsible for the increase in spending on capital goods and land, the rate of profit would have modestly fallen from the very beginning, and continued its fall until net saving came to an end. It would not have risen, let alone risen dramatically, as it did during the bubble.

This is the implication of the discussion, above in this section, of the second reason why saving was not responsible for the bubble. In particular it is the implication of the example of 100 more of spending for capital goods financed by 100 of saving derived from 100 less of spending for consumers’ goods. In that example, in which there is no increase in the quantity of money or total volume of spending, the global economic system would have had the same total aggregate business sales revenues, with the sales revenues coming from the sale of consumers’ goods diminished by the amount of saving, and those coming from the sale of capital goods equivalently increased. At the same time, however, it would have had a tendency toward a rise in the aggregate costs of production deducted from those sales revenues.

The rise in costs would have been the result of such things as additional depreciation charges on the new and additional capital goods purchased, or additional cost of goods sold following additional purchases of materials and labor on account of inventory. In the example of 100 more being spent for capital goods each year with an average life of 10 years and accompanying depreciation charges in the respective amounts of 10, 20, …, 100 in the 10 years following the rise in demand for capital goods, aggregate profit in the economic system would have been falling year by year by an amount equal to the increase in depreciation.

A falling aggregate amount of profit together with the increasing amount of capital invested in the economic system, would have progressively reduced the economy-wide average rate of profit. It would have been a case of a falling amount-of-profit numerator divided by a rising-amount-of-capital denominator.

Totally contrary to what one would expect from these effects of a rise in saving, the reality, of course, was a sharply higher average rate of profit in the economic system so long as the bubble lasted. This can be explained only on the foundation of credit expansion and an expanding quantity of money and volume of spending, not on the basis of saving.

If none of these five reasons are sufficient to dispel the notion that a saving glut was responsible for the bubble, then hopefully it will be sufficient to point out that there simply was no saving glut, but rather only a very modest rate of saving, a mere trickle of saving. For it turns out that over the 13 year period 1994-2006, the rate of saving in the US, together with all foreign saving entering the country in connection with deficits in the current account, never exceeded 7 percent, and in 8 of those 13 years was 3 percent or less. In 5 of those years it was a mere, 1 or 2 percent. And what is of special significance is that in the years of the housing bubble, 2002-2006, it was especially low: 2 percent in 2002, 1 percent in both 2003 and 2004, 3 percent in 2005, and 4 percent in 2006.

To see this result, it is necessary to begin by removing all fictional elements in the reported amounts of domestic net saving and GDP. These fictional amounts consist of various “imputations.” The leading imputations that are relevant here are those that arbitrarily convert what is in fact consumption expenditure into investment expenditure. These have the effect of reducing reported consumption and equivalently increasing reported saving.
[10], [11]

The two most important such imputations are these: 1) the treatment of the purchase of single family homes that the buyer intends to occupy and that thus will not be a source of any money revenue of income to him, as though they were nonetheless income producing assets and therefore represented an investment; 2) the treatment of government expenditure for fixed assets such as buildings, as though it were an investment expenditure rather than a consumption expenditure.

When such imputations are removed from the calculation of net saving and from GDP, the very modest extent of saving that has been going on over the last decade or more is clearly shown. Indeed, since 2002, domestic net saving has been negative to the extent of several hundred billion dollars each year.

The following table describes the situation:

The table has 6 columns. Column 1 lists the years 1994 through 2006, the period encompassing both the stock market and the real estate bubbles. Column 2 shows the current account deficit in those years. This deficit is taken as representing the foreign savings coming into the United States. (For this reason it is shown as a positive number.) Column 3 shows net saving in the United States in those years when such savings are calculated free of imputations. Column 4 is the sum of Columns 2 and 3. It shows total saving in the United States as the sum of foreign saving entering the country together with domestic saving. Column 5 is GDP year by year, with all imputations removed. Column 6 is the sum of imputation-free foreign and domestic saving divided by such GDP, presented in decimal format.

The notion that there was a saving glut behind the housing bubble is simply a fiction. Its proponents could manufacture as much of a glut as they like simply by reclassifying such things as expenditure for automobiles, major appliances, furniture, and clothing as investment expenditures, on the grounds that these goods too are durable, like houses. That would equivalently reduce consumption expenditure and increase reported saving in the economic system.

Current Account Deficits as a By-Product of the Increase in the Quantity of Money
Bernanke and Greenspan et al. focus on deficits in the current account as representing the counterpart of foreign saving and investment, which they believe must be present to finance the deficits. There is certainly a very close relationship between foreign saving and investment on the one side and the financing of deficits in the current account on the other. The following example may help to highlight this relationship.

Thus imagine Saudi Arabia back in the days when geologists had determined that the country possessed vast oil reserves but before it had any oil wells, pipelines, refineries, or facilities for the handling of supertankers. Those things had yet to be built.

Now how could those facilities be built? The only way was by means of the arrival of shiploads of equipment and construction materials from Europe and the United States. In addition, large quantities of various consumers’ goods were required for the foreign engineers and other workers who were required to carry out the construction. All these goods coming into Saudi Arabia were imports of foreign goods. But Saudi Arabia had hardly anything to export before its ability to produce oil was developed. Thus, in the interval, there was a massive excess of imports over exports. That excess represented foreign investment in Saudi Arabia. Its physical form was all of the facilities under construction and then, ultimately, the completed facilities for producing oil.

Foreign investment very often, perhaps most of the time, has this kind of close connection to the existence of an excess of imports over exports and, more broadly, an excess of outlays of all kinds on current account over receipts of all kinds on current account. (As previously explained, the balance on current account includes not only the difference between the imports and exports of goods, but also of services. In addition, it includes the difference between incomes paid to abroad and incomes paid from abroad, and finally, the difference between remittances to and from abroad.)

Nevertheless, it should be realized that the essential, core concept of the current account, namely, the so-called balance of trade, which is the difference simply between the import and export of goods, was developed long before the emergence of any significant international investment. It was developed and employed by a school of writers known as the mercantilists, who were current from the 16th to the third quarter of the 18th Century, when the school was laid to rest by Adam Smith.

The main concern of the mercantilists was the accumulation of gold and silver within the borders of their country and the prevention of any loss of gold or silver by their country. Gold and silver were the money of the day everywhere and, it was believed, needed to be accumulated within the country in order to be available if and when the government might need them, in order to finance military operations outside the country or any other activities in which circumstances might operate to draw precious metals away from the country.

Inasmuch as already by that time, most of the European countries had no gold or silver mines within their territory, the only way they could gain gold or silver was by means of the export of goods. The import of goods was seen as constituting a loss of gold or silver by the country. Accordingly, the goal of mercantilist policy was to maximize exports while minimizing imports. That would allegedly ensure the greatest possible accumulation of the precious metals within the country.

Centuries later, in the chapter “On Foreign Trade” in his Principles of Political Economy and Taxation, Ricardo developed the principle that the supply of the precious metals tends to be distributed among the different countries essentially in proportion to the relative size of their respective economies. He wrote: "Gold and silver having been chosen for the general medium of circulation, they are, by the competition of commerce, distributed in such proportions amongst the different countries of the world as to accommodate themselves to the natural traffic which would take place if no such metals existed, and the trade between countries were purely a trade of barter."

The operation of this principle can, of course, be modified by the operation of other principles working alongside it. Thus a country with a relatively small economy, but with an exceptional reputation for the security of property and the enforcement of contracts, might well have a quantity of money within its borders far in excess of what corresponded to the relative size of its economy. By the same token, countries with larger economies but in which property rights and the enforcement of contracts were in retreat, could possess a proportion of the world’s money supply substantially less than what corresponded to the relative size of its economy.

It follows from Ricardo’s principle that countries with gold and silver mines will experience a chronic excess of imports over exports. The gold and silver that they mine cannot all be retained within their borders. If they were retained, the country would have a disproportionately large supply of the precious metals. This would serve to raise prices in that country relative to prices abroad. The effect would be an outflow of the precious metals until their buying power at home did not fall short of their buying power abroad by more than the costs of shipping them abroad.

Today, the US dollar is in a position similar to that of gold under an international gold standard. The dollar is a virtual world money—not completely, but substantially. The United States is the country with the “dollar mines.” When dollars are created in the US, a substantial portion of them will flow abroad. And this applies not just to currency, but also to checking deposits and all other short-term financial instruments easily convertible to currency.

Most of the dollars that “flow abroad” need not actually circulate abroad but to a large extent serve as mere precautionary holdings of money, and, to an important extent, as reserves for financial institutions that create various moneys other than dollars. These other moneys that are created on the foundation of additional dollars circulate abroad.

Now the fact that the United States compared to almost all other countries in the world still has the most reliable protection of property rights and enforcement of contracts, is responsible for the fact that much or most of the money that “flows abroad” does not in fact leave the country. Rather it passes into the ownership of foreign individuals, firms, and governments who continue to hold it within the United States.

The increase in such foreign owned assets within the United States has the appearance of foreign investment. Actually, it is nothing more than the by-product of credit expansion and the increase in the quantity of money within the United States.

There is no genuine surge in foreign saving. There is domestic credit expansion and money supply increase that serves to increase imports and shift ownership of a substantial portion of the additional money supply, and short-term claims to money, to foreigners.

Ironically, Bernanke himself helps to confirm this interpretation of the increase in the current account deficit. He says: “First, the financial crises that hit many Asian economies in the 1990s led to significant declines in investment in those countries in part because of reduced confidence in domestic financial institutions and to changes in policies—including a resistance to currency appreciation, the determined accumulation of foreign exchange reserves, and fiscal consolidation—that had the effect of promoting current account surpluses.” (Bundesbank Lecture, Berlin, Germany, September 11, 2007.)

What Bernanke describes here is not any sudden increase in foreign saving but rather decisions to change the way in which a portion of previously accumulated savings are held, i.e., to hold them to a greater extent in the form of US dollars and short-term claims to dollars.

In the same passage, Bernanke presents a second reason for the alleged growth in foreign savings, namely the sharp increase in the price of oil that had taken place. He says, “sharp increases in crude oil prices boosted oil exporters' incomes by more than those countries were able or willing to increase spending, thereby leading to higher saving and current account surpluses.”

Here, Bernanke overlooks the role of credit expansion and the increase in the quantity of money in bringing about the higher price of oil. He also overlooks the effect of the higher price of oil on the real incomes and ability to save of everyone who had to pay that higher price.

The role of credit expansion and the increase in the quantity of money in causing the rise in oil prices was confirmed by the subsequent plunge in oil prices once credit expansion was brought to an end and appeared to be about to turn into massive credit contraction. It has since been further confirmed by the recent rise in oil prices following the growing belief that the government’s program of renewed credit expansion will be sufficient to eliminate the danger of a financial collapse and will serve to maintain and increase the demand for oil.

Net Saving as a By-Product of the Increase in the Quantity of Money
My discussion of the fallacy of a saving glut as being responsible for the housing bubble and its aftermath would not be complete if I did not point out that the continued existence of net saving is itself a by-product of the increase in the quantity of money and volume of spending in the economic system. In the absence of increases in the quantity of money and volume of spending, economy-wide, aggregate net saving would tend to disappear. It would cease when total accumulated savings came to stand in a ratio to current incomes and consumption that people judged to be sufficiently high that they had no further need to make still greater relative provision for the future.

What keeps net saving in existence is that the increase in the quantity of money and volume of spending tends continually to raise incomes and consumption in terms of money. In order to maintain any given ratio of accumulated savings to a rising level of income and consumption, it is necessary to increase the magnitude of accumulated savings. At the same time, the increasing quantity of money provides the financial means of spending more and more each year for capital goods as well as consumers’ goods and for thus maintaining the desired balance in the face of growing magnitudes of spending.

Thus it is the increase in the quantity of money and the volume of spending that it supports that is responsible for net saving continuing in being. In the absence of the continuing increase in the quantity of money, net saving would disappear, and capital accumulation would take place simply by means of a continually increasing purchasing power of the same capital funds. That growing purchasing power would be created by the increase in the production and supply of capital goods and the fall in prices of capital goods that would result.

Summary and Conclusion
The real estate bubble, like the stock market bubble before it, was caused by credit expansion. The credit expansion was instigated and sustained by the Federal Reserve System, which could have aborted it at any time but chose not to. As a result, the Federal Reserve System and those in charge of it at during the real estate bubble bear responsibility for major harm to tens of millions of Americans.

In order to avoid having to accept this responsibility, a specious doctrine has been advanced by Alan Greenspan and Ben Bernanke, the former and present Chairman of the system, and others. That is the doctrine of a “global saving glut.” Not credit expansion but the saving glut was responsible, they claim.

The truth is that time preference puts an end to further saving long before it could outrun the uses for additional saving. This makes a saving glut impossible. In addition, there are five major reasons why saving could not have been responsible for the real estate bubble in particular. First, if saving had been responsible, rather than credit expansion and the increase in the quantity of money, there would have been a corresponding decline in consumer spending in the countries allegedly doing the saving. The fact is that there was no such decline.

Second, saving implies a growing supply of capital goods, more production, and lower prices, including lower prices of capital goods and even of land. These are results that are incompatible with the widespread increases in prices typically found in a bubble.

Third, if somehow saving had been responsible for the housing bubble, the spending it financed would not suddenly have stopped. Such stoppage is a consequence of the end of credit expansion and the revelation of a lack of capital.

Fourth, if large-scale saving rather than credit expansion had been present, banks and other firms would have possessed more capital, not less. They would not be in their present predicament of having inadequate capital to carry on their normal operations. This situation of insufficient capital is the result of malinvestment and overconsumption, which are the consequences of credit expansion, not saving.

Fifth, in the absence of increases in the quantity of money and overall volume of spending in the economic system, saving also implies an immediate tendency toward a fall in the economy wide average rate of profit. This is another result that is incompatible with what is observed in a bubble or boom of any kind, which is surging profits so long as “the good times” last.

Especially noteworthy is the fact that in the real estate bubble, there simply was no saving glut. In the 13 year period 1994-2006, the rate of saving in the US, together with all foreign saving allegedly entering the country in connection with deficits in the current account, never exceeded 7 percent, and in 8 of those 13 years was 3 percent or less.

What has served to conceal how low the actual rate of saving has been is the fact that major fictional items have been counted in saving, which add hundreds of billions of dollars every year to its reported amount. The most notable instance is that purchases of single family homes that the buyers intend to occupy and that will thus not be a source of any money revenue or income to them, are treated as though they were nonetheless purchases of income producing assets and therefore represented an investment. Similarly, government spending on account of buildings and structures is treated as investment. Such overstatement of investment correspondingly understates consumption expenditure in the economic system. And when the artificially reduced amount of consumption is subtracted from any given amount of national income or GDP, saving appears to be equivalently larger.

The alleged saving entering the American economy via deficits in its current account is in fact largely not saving at all, but the by-product of US credit expansion and money supply increase. Dollars today are a virtual global money. And in conformity with Ricardo’s principle concerning the distribution of the precious metals throughout the world based on the relative size of the economies of the various countries, most of the additions to the supply of dollars and short-term claims to dollars cannot remain in the possession of Americans but must gravitate into the ownership of foreigners. This creates a deficit in the balance of trade and in the whole of the so-called current account. While it may appear that increased foreign holdings of dollars and short-term dollar-denominated securities represent foreign investment, the truth is that much or possibly even all of the alleged foreign saving entering the United States is nothing other than a consequence of US credit expansion and money supply increase.

Finally, net saving itself, as a continuing phenomenon is nothing more than a by-product of the increase in the quantity of money, in that it would come to an end if the money supply were to stop increasing.

The conclusion to be drawn is that the housing bubble was indeed the product of credit expansion, not a “saving glut.”


[1] David R. Henderson and Jeffrey Rogers Hummel, Greenspan’s Monetary Policy in Retrospect, Cato Institute Briefing Paper 109, Cato Institute, Washington, D.C., November 3, 2008, pp. 4f.

[2] George Reisman, Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) p. 512.

[3] This figure is arrived at by taking the sum of M1, sweep accounts, money market mutual fund accounts both retail and institutional, and one half of savings deposits as the measure of money market deposit accounts, the data for which are apparently otherwise unavailable. The same procedure is used as the basis of all other statements of the money supply or changes in the money supply.

[4] Italics in original.

[5] Reisman, Capitalism, p. 57.

[6] “Homer Smith Lecture,” St. Louis, MO, April 14, 2005.

[7] For a comprehensive explanation of the role of the quantity of money in determining the volume of spending in the economic system, see Reisman, Capitalism, chaps. 12 and 19.

[8] For an explanation of the role of saving in capital accumulation, see ibid., pp. 621-642.

[9] For a thoroughgoing discussion of the determinants of the rate of profit and its relationship to saving and capital accumulation, see ibid., chaps. 16 and 17.

[10] For a comprehensive explanation of the distinction between capital goods and consumers’ goods and investment or, better, productive expenditure and consumption expenditure, see ibid., pp. 445-456.

[11] For a detailed critique of the imputed income doctrine, see ibid., pp. 456-459.

Copyright © 2009 by George Reisman. George Reisman, Ph.D. is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. He is also a Senior Fellow at the Goldwater Institute. His web site is and his blog is A pdf replica of his book can be downloaded to the reader’s hard drive simply by clicking on the book’s title, above, and then saving the file when it appears on the screen.