The late Paul Samuelson once quoted the late Irving Fisher regarding the monetary policies of the late John Maynard Keynes to the effect that what developed into Keynesian “Modern Monetary Theory” is, in reality, nothing more than “legal counterfeiting.” While it is unusual to find so many defunct economists in agreement on this point, there is another that is even more remarkable:
|"Hi, I'm Irving Fisher, and I advocate legal counterfeiting."|
They all thought it was a good thing. Of course, it seems that all three had somewhat interested motives for advocating “legal counterfeiting.” Fisher, for example, lost a ton of money in the 1929 Crash, and had to be bailed out by Yale University. By “reflating” the currency, Fisher figured the stock market would go up, and he would recoup all his losses, gaining back all that lovely money.
Keynes realized that his monetary theories could not be implemented without the government having total control of the economy, and total control of the economy could not be achieved except by allowing the government to control all economic life through the creation of money and credit, thereby permanently attaching Academia and most of the people in the world to the government spigot that was now the source of all that lovely money for him and his academic buddies.
|"Hi, I'm Paul Samuelson, and I advocate legal counterfeiting."|
Samuelson built his reputation and won a Nobel Prize for supporting Keynesian economics. He wrote what was the most widely used and bestselling economics textbook ever. Had he not backed Keynesian monetary theory to the hilt, he would have lost his Great Reputation and, worse, all that lovely money.
Fisher, Keynes, and Samuelson all have something else in common, too, something they share with virtually every major economist since David Ricardo. It’s acceptance of something called “the Currency Principle.”
And what is “the Currency Principle” you ask?
Most simply put, the Currency Principle is that the money supply determines the rate at which money is spent (the “velocity” of money, a concept developed by Sir William Petty in the seventeenth century), the number of transactions, and the price level. As Irving Fisher expressed it when he put it into an equation,
M x V = P x Q
where M is the quantity of money, V is the velocity of money, P is the price level, and Q is the number of transactions (some people use “T” instead of “Q”).
|"Hi, I'm John M. Keynes, and I invented legal counterfeiting!"|
In mathematical terms, the Currency Principle is that M (construed ONLY as currency and, sometimes, "currency substitutes") is the independent variable in the equation, and V, P, and Q are the dependent variables. That means that as you change M (the amount of currency), the other variables, V, P, and Q, change in response.
There are two basic problems here. One, within the “Currency School,” M is limited to currency or its substitutes (hence “the Currency Principle,” obviously). It does not take into consideration any other form of money . . . and other forms of money in many economies far outweigh currency. This means that, within the Currency Principle framework, the basic assumption is already wrong because it simply ignores the bulk of the money supply! “Money” is not a medium of exchange as the Currency Principle people would have it, it is the medium of exchange.
|"Adam Smith here. I'm opposed to counterfeiting, legal or otherwise."|
Two (and you math majors probably spotted this already), you can’t have more than one dependent variable in an equation. Period. As interpreted by Fisher and every other Currency Principle economist who ever lived, the Quantity Theory of Money equation is utter nonsense. It doesn’t work because it can’t work. All you get is mathematical gibberish.
To understand this, let’s contrast the Currency Principle with the “Banking Principle.” The Banking Principle uses exactly the same equation as the Currency Principle, but instead of starting with the gyrations of David Ricardo, it goes back to the beginning of time and the first principle of economics.
As Adam Smith (whom Ricardo claimed to be correcting) put it, the first principle of economics is —
Consumption is the sole end and purpose of all production.
|Give the Romans a hand: they used real money.|
There are two ways to have something to consume, aside from theft or gift. One, you produce what you want to consume. Two, you produce something to trade to someone else in exchange for something someone else produced that you want to consume.
“Money” is what the medium of exchange is called, the making and keeping of a contract, a promise. “Money” is therefore anything that can be used to settle a debt; “All things transferred in commerce.”
Most simply put, “money” is how I exchange what I produce for what you produce. Money is therefore not “A” medium of exchange, it is “THE” medium of exchange.
The key to understanding the Banking Principle is that, just as there can be no exchanges without something having been produced, there can be no money (at least, legitimate money) without something having been produced (take that, crypto currencies!). Thus, starting again with the Quantity Theory of Money Equation,
M x V = P x Q
we see that V, P, and Q do not depend on M as in the Currency Principle. Instead, M depends on V, P, and Q!
|"Lobachevsky here. I approve of the Banking Principle."|
In mathematical terms, what we see is that there are now three independent variables instead of one, and one dependent variable instead of three. Our math majors can now relax, because that makes sense! You don’t have to guess what is going to happen to V, P, and Q by changing M, you know what is going to happen to M by changing V, P, or Q.
And how do you do that?
In a properly run economy (meaning one in which actual people run things with the government limited to setting standards, enforcing contracts, and keeping people from killing each other when contracts aren’t kept), the amount of money will adjust automatically to the needs of the economy. That is, it will do so as long as everyone has the right to produce marketable goods and services and enter into contracts with each other to exchange those goods and services . . . which means, as long as everyone has the ability to, well, “create money.”
What happens, however, when not everyone can create money? That’s what we’ll look at tomorrow.#30#