Eight Arguments Against Debt 4 – Debt and Inflation

There are Biblical grounds for staying out of debt. Any one of these is sufficient reason for people to avoid debt, as much as it is within their power. When put together, they become a formidable array of reasons why debt should be avoided.

4. Debt and Inflation

In chapter six I discussed inflation and its causes. I argued that monetary inflation, an expansion of the money supply, causes price inflation.

Monetary inflation, I also argued, was immoral, since it devalues the purchasing power of money as prices in the community rise. I pointed out that the two primary means of monetary inflation were using the presses to manufacture notes and coin and the creation of money through credit. It is this latter method of monetary inflation that we need to understand in relation to debt as well as in relation to biblical morality.

The modern banking system operates on a system of trust and confidence. No modern bank, at least in Australia, carries all its obligations fully in reserve. The legalization of fractional reserve banking, where the bank is only required to hold a fraction of depositors' money in reserve, has rendered each bank unable to meet its immediate obligations. When you deposit money in a bank it is a liability of the bank and an asset to yourself. Banks, though, have been granted a legal privilege that is denied to most other businesses. It is not obliged by law to hold all its liabilities in reserve. Instead of holding money in its vaults for safe keeping, the bank treats a portion of depositors' money as a liability and holds it in reserve (the purpose of the Reserve Bank of Australia), but considers the remaining and larger portion as an asset that it lends out at interest.

Bankers feel fairly safe in doing this, since they can estimate from previous experience what the cash flow from their vaults will be in terms of people demanding the return of their deposits. If they know that on average only 10% of money is needed to satisfy demands for a return of deposits, the bank can make use of the remaining 90% for itself in the interim.(1)

This is known as fractional reserve banking. But the problem does not stop at this point. It is compounded because the bank further mistreats the loaned-out portion of a deposit when it returns to the bank by again keeping 10% and loaning out the rest. This is how the financial system inflates the money supply, thereby increasing the amount of purchasing power (here in the form of credits). When the ratio is altered between money and goods (money includes credit, since it combines with currency to form purchasing power) by increasing the amount of money, prices tend to rise. Or, to look at it from the other side, the purchasing power of money declines. This is inflation, and you can refer again to chapter six for a fuller explanation of inflation and what effect it has.

If it is accepted, however, that diluting the value of money is morally wrong, then we need to think carefully about the use of bank debt, since it is the primary means whereby the money supply is expanded.

Put this another way: without borrowers, fractional reserve banking methods would fail. If there were no borrowers, there would be no possibility of the bank creating money ex nihilo, out of nothing.

Since lowering the purchasing power of money is defrauding our neighbor of his wealth, we must recognize that each one of us has the means in his power to help prevent this from occurring. Single-handedly we may not be able to stop the practice totally, but we can add our small part to hinder its progress. We can decline to participate in the fractional reserve procedure by refusing to become borrowers. (We could also refuse to participate by insisting that the banks hold our funds in reserve so that their obligations are matched by their reserves. In other words, we need a 100% reserve banking system.)

This argument is an argument against borrowing from banks. Borrowing from friends or relatives does not cause the money supply to rise, so this argument against debt is limited in its scope to only that debt which is used to increase the money supply. Earlier arguments against debt, however, cover non-bank debt, so the limited aspect of this particular argument against debt does not provide any loopholes where a pro-debt position can be taken.

1) See Mark Skousen, Economics of a Pure Gold Standard (2nd ed., Auburn, AL: Praxeology Press, 1988).

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