Financing the navy

PeterZ wrote:That's an excellent analogy. I also agree with your description of the effective money supply. I still disagree that fractional reserve banking is implicitly disallowed by Langhorne's honest measure commandment.

One can view borrowed funds (gold coins) as the present value of the cost of executing a business plan. Once a bank lends an entity those funds, those funds get spent and turned into revenue generating assets. The spent funds find their way back to banks to be lent again. The number of gold coins haven't changed. The borrower doesn't have all the coins he/she borrowed. Instead those coins were traded for revenue generating assets in exchange for a contract that stipulates periodical interest payments and repayment of principal at a later date.
[snip elaboration of the point]

Hi Peter --

Thank you! re analogy.

Consider a coachworks in Chisholm. They used to make vehicles for the well-to-do to sit in and be pulled behind horses. The Queen-Empress has invested tax money in railroads, and the railroads want passenger-equipped rolling stock.

Our hypothetical coachworks, because its owners are ambitious, because they're very pro House of Tait, or because they're low on the swank list and delighted to find another business to move into, sinks its working capital and then some into air tools from Old Charis. That lets them bid on railroad contracts with much shorter completion times than their competition, and away they go; they're doing well, the railroad is happy, people are delighted to travel in a nice warm, wind-tight rail car at much greater speeds, and everyone wins.

Pressures of competition make the coachwork firm worry; more and more former coachmakers are trying to get into the railway business, and it's not like they can't buy air tools, too. So, in an attempt to differentiate themselves in the market, our example coachwork firm (its capital sunk) takes out a 10,000 mark loan to buy a big load of display-grade tropical hardwood from Emerald. Old Charis has lots of the stuff, too, but Emerald's got some unique and splendid trees that haven't been seen in Chisholm before. It's a big success; the railroad, busy differentiating proliferating passenger trains into first and second class (third class, with the implied lack of effective windows, is something Her Majesty isn't willing to stand for considering the Chisholmian winter) wants more first class coaches. So there's another 10,000 mark loan, and another batch of first-class coaches, and iterate for five years.

In a sense, it's the same money in each loan; that ten thousand marks has travelled to Emerald, and, in the Empire's internal trade, travelled back somehow, five times. (If it hadn't, the railroad would be able to pay for its new first class cars and it wouldn't be expanding, either. It's quite possible the gold never left its vault in Chisholm, it just had its ownership labels changed in a ledger as various bits of financial paperwork travelled around. You can make duplicates of the paperwork, while if the gold sinks, it's gone.)

The coachwork firm has prospered; it's trained its workers so they know more, work faster, and produce greater value per unit time than formerly. Those workers can quite reasonably expect their wages to increase.

Only the total amount of money in the Empire hasn't increased; that's set by the rate of gold mining. In the general case, gold mining hasn't got any faster and no one's found any new gold because worker productivity is increasing. (Only RFC knows this and arranged an out with Silverlode Island.) So this one 10,000 mark pile of gold has added, just in the value of the wood, 50,000 marks to the worth of the railroad's rolling stock. (If we count the value of the labour, the fact that all that wood is a passenger coach now, it could as easily be 200,000 or 250,000 marks. That gets into questions of defining value and labour compensation and muddies up the example with sticky prices, including prices for labour.)

The result of that is the money supply being spread over much more value; prices and wages in denominated terms should come down, because there's a fixed stock of money -- vigorous and rapidly circulating money, you'd have trouble getting the velocity of money much higher than a railroad expansion will produce -- having to denominate more and more economy as an industrial revolution takes hold and people can do more stuff, more kinds of stuff, and both happen faster.

The desire for some prices, notably the price of labour, to increase (labour is, after all, being much more productive) and the desire for prices to decrease (there is, after all, only this one fixed amount of money to denominate all the value in the economy, so the real value of gold is trying to go up) gets into conflict and the economy locks up in deflation.

The escape is to let the loans create money; if money is a purely notional unit of account, that's not problem. You create money to cover the increased value in the economy through interest on loans. If you can't do that, and the Writ says you can't because money is gold, not a notional unit of account, you've got a real problem with a fixed money supply. You're going to deflate because your money supply can't keep up with your rate of increase in value once you start to industrialize.

Pre-War and pre-Silverlode, if Charis is dealing with this money-supply problem by being a gold sink with respect to the entire rest of the planet, there's a reason people aren't too fond of them! Charisian manufactures really were hurting everyone else's economies, even if the prices are lower than they can achieve locally.

So, yeah, the Writ really does prevent fractional reserve banking; the essential thing about fractional reserve banking is the creation of money by the extension of credit and the Writ insists money is gold, not a notional unit of account.

Graydon,

I agree wealth is created. I agree money facilitates that transaction. Where I believe we diverge is that there are other means of storing wealth than money.

The faster the velocity of money in an economy, the poorer that money is at storing wealth but the better it is at facilitating wealth to be transferred between parties. Let's consider a laborer in the railroad car manufacturer. He trades his labor for gold. The value of his labor is stored in that gold until he deposits that gold in a bank or spends it. If he spends the gold it facilitates another transaction. If he deposits the gold, his wealth is now stored in the form of a contract the describes the rights and consideration of both depositor and bank.

That contract is a poor vehicle for transferring wealth. It is a good vehicle for storing wealth if as you mentioned earlier the rule of law supporting ownership rights and contracts is upheld. So the need for a fast growing economy is to have laws and markets that secure wealth in many different vehicles and allow currency to be used to circulate and facilitate transactions. Your choke point exists if there is too little money to accommodate the number of transactions a growing economy needs, not the amount of wealth it has created. If there is too little money, its value exceeds the value of its ability to transfer wealth easily. At this point the velocity of money slows as more people keep their gold longer before spending or lending and the size of the economy the money supply can support shrinks as the slower moving currency supports fewer transactions.

That's where the promisorry notes help. They offer a better savings vehicle and allows gold to be circulated rather than saved. Gresham's law describes this quite well so long as you qualify valuable as being better at storing wealth. Absent those notes, if the production of gold is outpaced by economic growth, the deflation you cite begins because the money supply cannot support the growing number of transactions.

So as an economy expands, either the actual supply of currency must expand or the velocity of money must accelerate. Under the former condition money will act both as a wealth storage mechanism and wealth transfer mechanism. In the latter condition money must act primarily as a wealth transfer mechanism because it circulates more and stores wealth less, since each unit of currency changes hands more frequently. If money stores wealth less, then something else must store the created wealth. So long as wealth is stored in other vehicles than money, fractional reserve banking won't run afoul of the Writ.