FDIC insurance is the only thing giving the CD investor that certainty. Anything above $100K is lost if the bank goes under. Without FDIC nothing is insured at all and his only guarantee is backed by the credit of the bank. But this is still not the whole point. Opportunity cost doesn't disappear because you choose to ignore it. Nor can the risk to any CD above $100K.

The Fed effectively regulates this rate through open market operations, so the rate rises at the Fed's command. It's true that you don't now what the Fed will do, but your uncertainty doesn't imply a free market. No one knew what Mussolini or Stalin would do either.

I think you give too much credit to the Fed to be able to effect rates. Like OPEC, it's pretty successful in regulating short term rates in a small range. But if market opinion varies significantly, the Fed loses that control quickly. Ultimately, the market dictates rates at the short end of the curve. The Fed has long ago admitted defeat at the long end.

Real assets can appreciate, but money is an accounting device rather than a real asset. It accounts for the holder's entitlement to consume. When you hold money, you're playing an entitlement game with monetary authorities, and this game is like the market only insofar as monetary authorities construct the game this way.

I don't disagree with you. Here, I think we have a jargon issue that I think we should clear up. "Real assets" are physical assets like land, houses, gold, oil. But the term "asset" can be applied to shares in a company, which are a claim on the company's residual income as well as credit extended to companies in the form of bonds. When I say "assets may rise or fall in value", I include all types of assets. Real assets are expected to rise with inflation, but bonds will fall in value and stocks may rise or fall depending on many variables as inflation increases. This is why savers, who are often invested in stocks and bonds, lose when inflation rises.

It's a real loss of entitlement to consume, compared with the entitlement that might be earned otherwise.

No. when opportunity cost rises, there is a real loss of value. I think you're going off on a tangent. It may be a worthy tangent, but it's not relevant to this subject.

In principle, individual banks could do the same without a central bank. The central bank is only a regulatory authority presumably preventing individual banks from creating money excessively by setting reserve requirements among other things.

I'm with you through that whole section from which I excerpted the above bit. Maybe we're talking past each other, but whether the bank lends 2 dollars for every 1 dollar in reserves or 100 dollars for every dollar in reserve, it must hold reserves to be able to lend and it must get those reserves somewhere. To maintain the entitlement to lend (as you put it), it must find marginable reserves.

Maybe I made the widget myself. Does it matter?

Yes. Your labour is worth something and you probably had to buy materials to make the widgets. Even if a widget is defined as a poem you wrote, it still has value because I've just parted with $100 for it and you decided it was worth your time to create, so the alternative uses of your time to be less valuable.

This is credit. Credit doesn't require you to borrow money from me or anyone else before the transaction. It only requires me to obtain money after the transaction. I understand your objection to this formulation, but the objection is only semantic.

That's my point, Martin. The difference is certainly NOT merely semantic. I think you're confusing explicit borrowing from, say, my friend Jane to pay for the widget and implicitly borrowing from you because you accepted payment in the future. Although, I'm not sure why you're having such a hard time seeing that the two are the same thing.

The point is that you haven't borrowed money from me or anyone else. Neither one of us must possess $100 before the transaction. We might both have popped into existence along with widget an instant before.

Martin, you're making an elementary mistake here that I'm pretty sure you don't make in your real life decisions. Let me think about how to explain this better and get back to you (it's late and the brain is creaky right now).

Borrowing is cheaper than raising equity, so the margin is much higher.

I don't know why this is true, except that bankruptcy courts order bondholders paid before equity holders. It's just a matter of statutory authority, because the state orders priorities this way. Why else would it be true?

Even if the firm never goes into bankruptcy, bond holders must be paid at regular intervals and before common shareholders. Debt service appears in the expenses portion of an income statement. The income left for common shareholders is whatever is left over after everyone else gets paid – hence, a shareholder is a residual owner of the company. Because they are the last in line, shareholders bear the most risk and require a higher rate of return to compensate for that risk. Thus, a company may float a bond issue with a 6% coupon but the same company will not be able to raise equity capital unless it can convince potential buyers of the equity that the expected return will be 10%. Of course, all of these rules are set by some statutory authority.

Certainly, a reserve requirement is only one possible regulation. Others seem advisable. I'm definitely not an anarchist here.

Regulation isn't going to fix stupidity, greed, and hubris. Only the threat of failure will mitigate those instincts. The regulators are offering a bailout and threatening regulation. Regulation which will be swiftly circumvented or changed to create more rents for lenders. My observation from working for a long time in a highly regulated industry is that regulation favours those being regulated and at the expense of the customers.

You don't borrow money from me to buy the widget. You borrow the widget from me.

No, I'm not borrowing the widget. You don't expect the widget to be returned to you. You expect money to flow to you over time in exchange for the widget. For the time that I have the widget but you have not yet received all the money, I have implicitly borrowed the money from you.

We don't put money to productive use as much as money accounts for things we put to productive use. I put the widget to productive use by lending it to you.

First of all, you're not lending the widget. Second, how are you putting the widget to productive use by selling it to me on credit? Why is selling me the widget on credit more appealing to you than receiving the full price of the widget at the point of sale? If it is not more appealing, then how are you being compensated for choosing the less appealing option to make you indifferent between the two options?

The point is that we don't need money for this purpose. We can imagine money if we like.

Let's assume that money represents our individual production. So, instead of directly exchanging the goods I produce for your widget, assume I give you much more easy to handle paper bills which represent my production. So, we're bartering, but paper currency represents my production, which I'm exchanging for yours (the widget). To make things easier, let's assume that this is what we mean by "money".

No, it does happen routinely. It happens every day. Our inflation rate doesn't rival Zimbabwe's, because we don't create money as rapidly, but we do create it continuously.

I agree with that. I thought you meant that the Fed routinely prints money without regard to actual productivity. That happens, but not routinely.

CD's are FDIC insured like deposits. The reason they earn a slightly higher interest rate is to compensate the lender for the lock-up (deposits have no lock-up, of course). FDIC creates distortions in the risk, but even with FDIC, the CD holder risks the opportunity cost of rising interest rates.

But he doesn't risk loss of the deposit. He suffers no nominal risk at all, i.e. he knows precisely the numeric value of his return with practical certainty. That's the whole point. Only a statutory system can promise this certainty. These nominally riskless investments are not free market capitalism.

If interest rates rise during the lock-up, the CD holder will lose the difference between the current interest rate and the one he is receiving for his CD.

Why would the nominally riskless interest rate for a term less than six month rise? The Fed effectively regulates this rate through open market operations, so the rate rises at the Fed's command. It's true that you don't now what the Fed will do, but your uncertainty doesn't imply a free market. No one knew what Mussolini or Stalin would do either.

Or it's a cry to stop printing money like the Weimar Republic.

It can be that too.

The real value of assets can appreciate or depreciate.

Real assets can appreciate, but money is an accounting device rather than a real asset. It accounts for the holder's entitlement to consume. When you hold money, you're playing an entitlement game with monetary authorities, and this game is like the market only insofar as monetary authorities construct the game this way.

This represents a real loss of value.

It's a real loss of entitlement to consume, compared with the entitlement that might be earned otherwise. All games have rules, but calling this game "free market capitalism" is an Orwellian abuse of the language. In free market capitalism, a player holds real assets for their productive utility, not documentary evidence of some central authority's guarantee of a nominal yield.

Banks do accept deposits to lend them. The fact that banks leverage their loans doesn't change that.

If the reserve ratio is 10-1, a bank with only one dollar on deposit may lend nine dollars. It may not lend ten dollars, only nine. That the bank nominally "borrows" the other nine dollars from the rest of the banking system, including the central bank, hardly matters. The central bank ultimately creates all of these dollars in order to lend them, hopefully secured by real assets and a real demand for credit, and the central bank essentially destroys the dollars as member banks repay its loans.

In principle, individual banks could do the same without a central bank. The central bank is only a regulatory authority presumably preventing individual banks from creating money excessively by setting reserve requirements among other things. If the gold nuts only understood this fact, I'd have less of a problem with a gold standard, but a gold standard does not avoid fractional reserve banking. It only fixes the price of gold.

If I deposit a dollar in a bank, does the bank ever lend my dollar specifically? All dollars are interchangable, so this question is meaningless; however, with a reserve requirement, a bank must hold some dollar in reserve to satisfy depositors including me. We might as well say that the bank never lends my dollar but only holds it to maintain an entitlement to lend other dollars. This formulation of the entitlement is equivalent.

And how did you pay for the widget you're now selling to me on credit?

Maybe I made the widget myself. Does it matter? The point is that I own the widget before I transfer it to you with only an expectation of payment over time. This is credit. Credit doesn't require you to borrow money from me or anyone else before the transaction. It only requires me to obtain money after the transaction. I understand your objection to this formulation, but the objection is only semantic.

Incidentally, are you really going to lend me the $100 for 10 weeks at a zero interest rate or is the interest rate built into the price already?

The interest is not relevant to my point. I'm happy to charge you ten dollars and dime weekly for ten weeks. The dime compensates me for the risk that you'll not pay me.

I have borrowed the $100 from you in a very literal sense and the only thing backing that loan is my future production and the widget.

You have borrowed the widget from me, and the widget is worth ten dollars. I have no problem with this formulation. More precisely, "ten dollars" names the value of the widget in common parlance (the language we agree upon in the market).

The point is that you haven't borrowed money from me or anyone else. Neither one of us must possess $100 before the transaction. We might both have popped into existence along with widget an instant before.

Banks do borrow at the short end of the curve and lend at the long end.

But the borrow is not necessary to extend credit. Banks needn't borrow (accept deposits) to extend credit at all, and in some banking systems, they don't. Some banking systems have no reserve requirement. In principle, you could open a bank, fetch some newly created money from the monetary authority and immediately start lending it. The monetary authority avoids creating too much money this way, hopefully, because that's just his job. He's a state regulatory agent.

Borrowing is cheaper than raising equity, so the margin is much higher.

I don't know why this is true, except that bankruptcy courts order bondholders paid before equity holders. It's just a matter of statutory authority, because the state orders priorities this way. Why else would it be true?

Of course, so is the risk of so much leverage – which is why it's particularly unwise to loosen lending standards as much as they were loosened in the past few years.

Certainly, a reserve requirement is only one possible regulation. Others seem advisable. I'm definitely not an anarchist here.

"Borrowing" is something else really. This word suggests that I take possession of something of real value today and exchange it for your widget today.

No, I'm borrowing from you to buy the widget. I'm taking possession of your widget today (which has value) and I'm paying your for the widget over time.

You don't borrow money from me to buy the widget. You borrow the widget from me. I say this myself. You obtain the value of the widget in some other form to compensate me later. You don't borrow the value of the widget to exchange this borrowed value for my valuable widget at the point of sale. You only provide me the value of the widget over time after the exchange. That's credit.

If I had paid you the $100 today, you could have reinvested it in inventory, or put it toward other productive use.

We don't put money to productive use as much as money accounts for things we put to productive use. I put the widget to productive use by lending it to you. Perhaps, I expect you to put the widget to productive use to earn its price. I don't need money for this purpose. I need the widget.

The point is that we don't need money for this purpose. We can imagine money if we like. This imaginary money is like the money that monetary authorities circulate. That's my point.

Your opportunity cost of lending me the $100 has real value to you.

I don't lend you $100. I lend you a widget. You and I agree to name the value of this widget "$100". I enter this name in my accounting ledger.

If you want to agree that my accounting entry is money, that's fine. I'll agree. Money is an accounting device, like so many entries in a ledger. That's my point.

The only difference in your widget scenario and what you describe as "borrowing" is who is doing the lending. Otherwise, they are exactly the same.

That the scenarios are essentially the same is precisely my point. If we agree that I've lent you $100, then I might as well be the author of this money myself. I am the monetary authority. If another monetary authority will then exchange its notes for my accounts receivable (or lend me its money with my accounts receivable as collateral), then I may exchange my money for this other money. Anyone may create money this way.

True enough. There's nothing to stop government from printing money. However, you simply can't say this is what happens routinely. If it did, our inflation rate would start to rival Zimbabwe's. This is starting to smell of the gold standard argument. Is this where you're going?

No, it does happen routinely. It happens every day. Our inflation rate doesn't rival Zimbabwe's, because we don't create money as rapidly, but we do create it continuously. We also destroy it continuously.

This is starting to smell of the gold standard argument. Is this where you're going?

No. Vidyohs will tell you that I'm no champion of what people commonly imagine as "the gold standard". Money is not a commodity. It's an accounting device. A gold standard only fixes the price of gold and requires decentralized monetary authorities to bank gold and trade it at this fixed price. A gold standard does not dictate how much money the authorities may circulate. It implies no one-to-one correspondence between banked gold and bank notes redeemable in gold. It only requires gold bankers to redeem notes for gold at the established price.

Sorry, Martin, but reading that statement one more time doesn't help me understand why the analogy is not valid.

"Not valid" is your description. Mine was "highly debatable" The analogy is debatable, because China's economy is potentially much, much larger than Japan's. I don't know how to make such an obvious point except simply to state it. You think this difference between Japan and China is irrelevant?

China with the same per capita productivity as Japan produces ten times a much. China with the same per acre productivity produces twenty-five times as much. These measures are crude, but I only suppose that, with a similar rule of law, China easily could be a far larger economy than Japan. Ignoring such an obvious distinction is obtuse.

I'll say more later. Be patient. I don't oppose trade with China. If it were up to me, there would be far fewer restraints on trade with China, including fewer restraints the purchase of goods allegedly infringing intellectual property claimed within the U.S. and fewer restraints on Chinese labor within the U.S. (fewer restraints on immigration).

Sorry, Martin, but reading that statement one more time doesn't help me understand why the analogy is not valid.

Adrian Chiew related the 1980's fear of Japan to the current fear of China. You claim that analogy is debatable, but only offer some reference to the differences in size of the populations. Why does the population make any difference?

Some 1980's protectionists were fearful of Japan's economic growth. Some current protectionists are fearful of China's economic growth. What's debatable about that?

Please don't repeat the sentence about China's population being so much larger without some explanation as to why that's relevant to Adrian's point.