Parable of the dollar

Several people recently have asked me to comment on the circulating horror stories about the unsustainability of fractional reserve banking. The following is a parable (with unavoidable simplifications such as zero interest rates and no reserve requirements) in response to conspiracy theorists who labor to undermine the confidence in our monetary system:

Phase 1: Quantity of money increases

John has $1 in the bank. Jill writes a book. Jane wants to read it and borrows $1 to buy the book. Jill puts $1 in the bank. Abracadabra: John and Jill have $1 each on deposit. Is the economy (and by that, of course, we mean the people) better off because there is more money in the bank? No, it's better off because Jill wrote a book that made Jane smarter (although currently in debt).

Phase 2: Quantity of money decreases

Jane writes a book and sells it to John for $1. Jane pays her debt. John gets to read a book but he no longer has $1 in the bank. There is less money in the economy. Is this bad? No, the economy has grown; more goods give people more satisfaction.

Phase 3: Quantity of money does not change

Now John writes a book and sells it to Jill for $1. Bank records show, as initially, $1 in John's account. But it has done some traveling, facilitating production, exchange, and consumption on its way. And everyone is better off in the end.

The days of the gold standard are gone but don't hold your breath expecting a collapse. There is nothing diabolical about the current system of private actors affecting the quantity of money. The Fed has enough tools to balance the process and provide long-term price stability. "Bernanke & Co." don't need more power from Congress, they need transparency so we can hold them accountable for their actions.

Fractional reserve banking is not the root of our problems. What is flawed much more than any current institutional arrangement is the philosophy of consumerism, the belief that little pieces of plastic can make the world a better place. And the shortsighted Keynesian obsession with aggregate expenditures cannot provide the answer. On the other hand, it would be good to rediscover the virtues of personal responsibility. This will help us to defend our liberties against both foreign enemies and domestic tyrants.