Tuesday, May 31, 2016

Financial Resilience

It’s not often that we come across a new term — meaning a term new to us — that actually makes sense.  Last Friday we got lucky, and were introduced to one: “financial resilience.”  Of course, we might have come across it much sooner if we didn’t have to keep looking up how to spell “resilience.”
Anyway, there does not appear to be a generally accepted definition of the term, but — when we asked — it has to do with the ability of an organization to match financial resources to its needs.  On the macroeconomic scale, it seems to be related to the ability of an economy to provide an adequate and elastic currency.
Running a family takes planning and investment in new capital.
The problem is how to implement a financial system at either the micro level or the macro level.  Fortunately, the answer to both is the same.
The most serious issue facing an individual, a family, or a business (or a country, for that matter) is where to find the financing for new capital formation?
·      For the individual and family, capital ownership is essential as technology advances and displaces human labor from the production process.  This makes it increasingly difficult for an individual or family to subsist on wages alone as the value of labor as an input to production falls relative to that of capital.
·      For a business, new capital investment, whether for replacement or expansion, is essential to the survival of the organization as a viable enterprise.  If it can’t keep up, it will go under.
·      For a country, unless there is production, there will soon be no capacity to pay for consumption.  Charity can take up the slack in individual cases, but not when an entire country fails to produce enough for its own needs.  The most graphic “natural” example of this is a famine.  Temporary relief may come from other countries, but if the country itself cannot become productive, many people will simply starve.  When a country fails to foster productive activity, the same thing happens artificially.
First creating money and then investing is . . . well, you know.
The problem is that most academics and all politicians think that the way to finance growth is to create money and hope something turns up.  Usually it doesn’t, and the only change is in the massive amount of debt that results.  To be blunt, government doesn’t create wealth, despite the nonsense that Adolph Berle spewed out in trying to justify the New Deal.
No, the only way to finance growth is first to locate or develop a project with a reasonable probability of becoming productive and profitable within an acceptable period of time.  In other words, find or come up with something of value.
If a thing has value, it can be turned into money.  This is what banks were invented to do — and which most people misunderstand, thereby demonizing banks and bankers instead of using them to their own advantage.
If you have something of value, you can put it into a contract, and either use the contract directly as money, or “sell” the contract to a bank in exchange for the bank’s money.  If the thing of value already exists (such as an inventory of goods you will be selling), the contract is called a “mortgage.”  If the thing of value doesn’t exist or you don’t own it (such as a piece of machinery to make goods you will be selling), the contract is called a “bill of exchange.”  (And if the thing of value is something you don’t own but have the power to tax, you’re a government, and the contract is called a “bill of credit” . . . and a bill of credit is not something you really want to give your government the power to emit.)
Using your contract either to buy new capital or buy other money with which to buy new capital, you (obviously) buy the new capital, and put it into production.  You sell the product, make money, and either redeem your contract (“pay your bill”), or buy back your contract from the bank.
Either way, you have matched the increase in the money supply directly to the needs of the economy.  You have become “financially resilient” without having to guess how much money will result in how much economic growth.  You have also done it without creating debt that cannot be serviced.


Charles Layne said...

Many economists teach that banks create money but they do not; they create credit which can be used temporarily but when repaid the temporary money is destroyed. All sustainable money comes from the US Treasury, all of it. There is no other legal source of US money. The government must supply money to the economy and does. The process is simple and very old. The government spends into the economy and then, after spending, extracts and destroys a portion of the money that was spent before spending more. The destructive extraction is called taxes and it prevents inflation, maintains price stability and moves money around in the economy by taxing "A" and spending to "B". The notion that money is created in the economy as stated here in this article, is an old and thoroughly discredited idea. The only economic recourse if the government does not establish and support a currency is a barter economy which has a very significant problem in creating its own currency.

Michael D. Greaney said...

Rather than respond here, I'll comment on this in the posting for Thursday, June 2, 2016.