Note: This article is concerned with a less important issue than my previous post. The question of monetary supply becomes simple if we first recognize the fundamental issue of whether, in the first place, we need banks.

In my previous article, Without banks: A proposal for a prosperous and stable economy, I discussed the role of banks in the money supply. I described how an economy with institutions that lend long and borrow short is inherently volatile and exposed to risk. I proposed that this volatility and risk could be avoided by phasing out the institutions that lend long and borrow short - eventually banning this business model altogether; requiring that all loans be covered by credit explicitly provided for the duration of the loan.

Towards the end of that article, I added a monetary proposal: shifting to a fixed, or predictable, volume of currency.

Central banks, with their ability to print limitless amount of money, currently exist for two purposes. One purpose is reasonable, if we are to have banks at all: central banks create money in times of crisis so that they can bail out depositors at failing banks. The other purpose is the subject of this article: creating money in normal times to 'stimulate' the economy. That is, to poke people with the stick of inflation, 'stimulating' them to deposit their money with banks.

I discussed how banks inflate the supply of money by a factor of about 10, and how the varying moods of the banking sector can lead to economic booms as well as busts. A 'boom' occurs when all the borrow-short/lend-long institutions lend freely, to the maximum amount they can. This increases the effective amount of money in the system vastly, and there's a lot of economic activity going on - much of which later turns out to be waste. A 'bust' occurs when it dawns on people that much of the economic activity during the 'boom' was waste. This means that lots of the loans that were made were bad loans that aren't going to be repaid. This threatens the lenders' capital reserves, which are already low because they've been lending as much as they could. So the only thing that they can do is decrease lending. I showed in my previous article how, if lending is decreased as a proportion of incoming deposits only by 10 percentage points, say from 90% to 80%, this eventually reduces the effective amount of money in the system by 50%.

When the effective amount of money in the system is decreasing, how are even those borrowers, whose loans might have seemed sensible before, going to repay their debt? Many of them aren't; there's insufficient money to go around. So now, as banks lend less, borrowers are increasingly going bankrupt, producing what is called the bust.

I argued that, in an economy with no lending long and borrowing short, and with a fixed supply of currency, there would be no boom and bust cycles, while sturdier bridges between prospective lenders and prospective borrowers would arise.

However, if the supply of currency was fixed, the role of borrowing in such an economy would be less.

The reason is that, in an economy where the supply of currency is constantly being inflated, everyone who holds currency has to lend it in order to just stand still. If you keep your money buried in a jar, its value is eroded over time because the amount of money in the economy is steadily increasing, compared to the amount of services and products. Whatever the economic growth, which would normally cause prices to slowly decrease due to increasing production - the money supply grows more. Holding bare currency is thus not an effective store of value.

In an economy where the monetary supply is fixed, the reverse is true. Holding bare currency does become an effective store of value. On the face of it, this sounds good. It may very well be. Banks, however, would have you believe that it isn't. The reason they would have you believe that is, in an economy where currency is a good store of value, their business would do much worse. If money is losing strength, people are forced to put their money into banks. It's common sense: put the money you don't need in a savings account, or else you're losing value.

Since banks are institutions that lend and borrow on a massive scale - a magnitude larger than even the amount of issued currency in the system - it is important for the health of their business that everyone believes that lending and borrowing is crucial to economic prosperity. Since everyone understands that lending and borrowing is not crucial for their day-to-day life, banks would have everyone believe that lending and borrowing is crucial for economic growth. The classic argument is, entrepreneurs need to be able to borrow money to create new products and services that we all need. But do they?

[Edit: removed an unnecessary argument that was probably defective.]

Does Intel need to borrow money in order to build a factory that will manufacture the next generation of faster processors? They do not. They have cash. Does Microsoft need to borrow money in order to build a new software product? They do not. They have cash.

I do not believe that all businesses can be bootstrapped. However, I do believe that investing is best when done by people who already have money - who have proved that they have the capacity to earn it and keep it; who do not need to borrow it from a bank. And the best way for such investors to be repaid is through an equity stake, i.e. by earning a proportion of future profits. If their investment succeeded, i.e. if it has increased production of a resource that is valuable to the economy, then their dividends will pay it back. This is not a zero-sum game, because everyone can be continuously investing in their businesses to improve production, and if all such investments are smart, then everyone will be paid back - not necessarily in a larger total amount of money, but with larger total purchasing ability, than if they chose not to invest.

I do not believe that bank-like loans are as crucial to economic growth as banks and other borrow-short/lend-long institutions would have us think. There is a case to be made for borrowing on a reasonable scale. However, the rampant lending on which our current economy is based, fuels boom and bust cycles, encourages a gambling culture of investment, and introduces a systemic risk.

In a fixed monetary supply economy, people would still borrow and lend, but more investment would be made by people investing directly into things they think are worth investing, acquiring equity stakes. It would be the reasonable way. It in fact already is; however, we now have short-borrowers/long-lenders who make it easy to 'invest' money with them. But it is not 'safe'; and it is not healthy for the well-being of the economy, because the people who might otherwise invest money directly into plans they think are worthy, instead pass on their money onto agents whose activities have more to do with gambling and where genuine production improvement is just one of the possible side effects.

And if it turns out that people in a fixed monetary supply economy do not invest or lend enough, and that growth suffers as a result - we can always cause the monetary supply to start to steadily increase, thus poking people to consider investing their savings. The economy might benefit if people used their minds and spent more time thinking about where to invest; rather than abdicate responsibility and do the default thing, putting their money into equivalents of banks.