Dear Sirs:
In his June 17th essay titled “Make shadow banks safe and private money sound” Mr. Paul McCulley displays a good understanding of the functional mechanics of commercial bank credit creation, shadow bank credit creation, and the powers of the Fed; however he reveals his lack of systemic knowledge of the underlying causes of bank crises. Time and again in his brief essay, Mr. McCulley simply assumes that bank crises happen; ex., “panic ensues”, the “system seized up”, and, therefore, the need for a “lender of last resort (to) ensure a troubled shadow bank could always find a counterparty”. But what causes these crises, and why must a troubled shadow bank, or commercial bank for that matter, be assured of always finding a counterparty? The answer lies in a deeper understanding of money, banking, and economics. The Fed’s massive expansion of fiat reserves is designed to permit banks to expand credit; there is no other reason for it to do this. But fiat money expansion causes what we Austrian economists call “malinvestment; i. e., the initiation of mostly longer term projects for which there are insufficient resources for their profitable completion. Note that the Fed’s expansion of fiat reserves does not create one real capital resource. If we really believed that this was the case, we would not prosecute counterfeiters. Therefore, it is foolish for Mr. McCulley to believe that Fed regulation of shadow banks will prevent another crisis. At this point the crisis is inevitable.