If you read
yesterday’s blog posting, you know that Say’s Law of Markets and money creation
go together. In a very real sense,
production is money, and money is production . . . if the system is arranged
the right way. “Money” — defined as
anything that can be accepted in settlement of a debt (“all things transferred
in commerce”) — is the means by which I exchange what I produce, for what you
produce, so that every producer is a consumer, and every consumer is a producer;
supply and demand are in balance. That
is why money is usually defined as “the medium of exchange.”
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| Jean-Baptiste Say of Say's Law of Markets fame. |
Note that we just
said that money is THE medium of exchange.
Under the “Currency Principle” (that we disagree with; we’re “Banking
Principle”), money is defined as A medium of exchange . . . which changes
everything just by changing a single word.
If money is THE medium of exchange, then anybody can create money simply
by entering into a contract; all contracts (exchanges) become money, just as
all money is a contract.
If, however,
money is A medium of exchange, then a monkey wrench has been thrown into the
system. The automatic link between
production, consumption, and money has been broken.
This is easy to
understand. If money is defined as “all
things transferred in commerce,” and understood as THE medium of exchange, then
there can be no money without production and exchanges of that production. If, however, you ignore the definition of
money as “all things transferred in commerce” and limit the definition of money
to A medium of exchange, i.e., mere purchasing power, you admit the possibility
of a kind of money that is not linked to production. Money not tied to production is mere consumptive
or purchasing power, a kind of money that is simple “fiat” (Latin for “let it
be”), that is a command from some authority that something is money, with or
without being linked to production.
Monetary policy
changes from the problem of, “How do we ensure that the currency, that is, the
unit of measure for money, is stable and uniform?” to “How do we create enough
money to meet the needs of the economy without causing too much damage?”
In the first instance,
monetary policy means ensuring that all producers can turn their production (if
they so desire) into money at a standard rate and value, that the unit of
currency always has the same objective value, regardless when it is issued or
who has it. In the second instance,
monetary policy means ensuring that the value of the currency and the amount can
be manipulated to try and force desired results. The value and the amount of currency become
subject to the demands of whoever has the most power.
Under monetary
policy consistent with Say’s Law of Markets (the Banking Principle), no money
can be created until and unless there is something of value that is owned by
the issuer to back it up. This can be
existing wealth (“past savings”), or it can be future wealth (“future savings”),
but the bottom line is that, one, there must be actual, measurable value, and,
two, the creator or issuer of the money must own that value or have a valid,
legal claim. In this way, the amount of
money in the system is, in the ideal case, always equal to the needs of the
economy, and there is no inflation or deflation.
Under monetary
policy that is not consistent with Say’s Law of Markets (the Currency
Principle), money can be created at will, whether or not there is something of
value owned by the issuer, or even whether value exists at all! In practice, the most common way this happens
is that a government will “emit bills of credit,” i.e., create money backed by future tax collections.
That is why
another term for “bill of credit” is “anticipation note,” as it “anticipates”
that taxes will be collected in the future to cover the bill of credit. The problem, of course, is that a government
doesn’t own the taxes until they have
been voted and collected, unless it’s a socialist government. By emitting bills of credit, the government
is actually issuing funny money: “legal counterfeiting,” as Irving Fisher
called it.
From a systemic
point of view, when a government emits bills of credit, it makes it possible to
consume without producing. It also
causes supply and demand to go out of balance.
When only producers can create money, then it is impossible to create
more money than can be matched by production (obviously). If non-producers — such as the government —
can create money, however, then supply and demand go out of whack. The is more demand than supply, more “money”
than production.
And that means
that the price level will start to adjust to match the excess demand:
inflation.
For example,
suppose that A, B, C, and D from yesterday’s examples produce stuff worth 1,000
Pazoozas. If that’s all, then supply and
demand are equal at 1,000 Pazoozas.
There is neither inflation nor deflation.
Now, however, E,
the government, comes in and emits 1,000 Pazoozas’ worth of bills of credit,
which he spends into the economy. All of
a sudden, instead of 1,000 Pazoozas’ worth of demand in the economy, there is
2,000 Pazoozas’ worth: the 1,000 Pazoozas of demand created by the production
of A, B, C, and D, and the 1,000 Pazoozas of demand E issued with his bills of
credit.
What
happens? Either E purchases everything
in the economy with his 1,000 Pazoozas, or prices double (i.e., the Pazooza loses half its value). In the first instance, A, B, C, and D can buy
nothing, and starve. In the second
instance, they buy only half what they previously consumed, and go hungry. E has effectively stolen purchasing power
from everybody else by using the hidden tax of inflation to finance government
by changing the value of the Pazooza instead of having taxes voted.
Nor is
government-induced deflation any better.
Suppose the government cuts the money supply in half.
Prices fall, yes,
but then people are stuck paying off debt with money that cost them twice as
much, or selling goods for one Pazooza that cost them two Pazoozas. People take a loss on every transaction the
same as with inflation. It’s just that
where inflation benefits debtors, deflation benefits creditors. People who are neither lose either way.
#30#