THE Global Justice Movement Website

THE Global Justice Movement Website
This is the "Global Justice Movement" (dot org) we refer to in the title of this blog.

Monday, April 6, 2009

Depression, Recession, and Bubbles, Part I: Money Creation Madness

Today's Wall Street Journal carries an interesting analysis of the parallels between the Great Depression and today's financial meltdown, and why the superficially similar "Dot Bomb" collapse did not have the same effect. To summarize the argument of Steven Gjerstad and Vernon L. Smith who co-authored "From Bubble to Depression?" (WSJ, 04/06/09, A15), the Great Depression and the current mess were fueled by consumer debt, in which category we would include the mountain of non-productive government debt.

In the 1920s money was created to purchase homes, to which we would add speculative share issues that couldn't pay for themselves out of their own earnings. The recently-collapsed housing bubble was similarly fueled by massive money creation to finance the purchase of assets that couldn't pay for themselves out of their own earnings. This was magnified by the practice of "securitizing" mortgages, creating money to purchase securities based not on capital goods, but consumer goods, with each new buyer bidding up the price even further with no change in the real value of the underlying asset — or in the ability of the home buyer to pay for the original mortgage.

Worse — as Dr. Harold Moulton pointed out in The Formation of Capital (1935) when refuting Major C. H. Douglas' "social credit" theories, creating money to clear existing inventories of consumer goods inflates the currency to that degree. This is because, consistent with Say's Law of Markets, the income to purchase all consumer goods that have been produced already exists in aggregate in the economy, having been used to finance the production of the consumer good.

In contrast, the "Dot Bomb" collapse involved only a small number of financial institutions, because, while Glass-Steagall had been taken off the books, investment banks had not yet consolidated with commercial banking and mortgage banking. Consequently, the "Dot Bombs" did not involve appreciable amounts of money creation, putting at risk only accumulated savings. Existing accumulations could "safely" be lost, and the removal of which from the economy would actually increase the value of the currency and thus consumer buying power through deflation.

The current financial crisis is, in a very real sense, much worse than that of 1929. Government debt was very low in 1929, while it is at such a level today that many experts are predicting imminent collapse. The "social surplus" of the country and the creditworthiness of the federal government that helped generate the illusion in the 1930s that the Keynesian "New Deal" was bringing about the recovery no longer exists.

If that were not enough, in the 1930s the productive capacity of the United States was fully intact, to such a degree that Keynes yammered on about "over-capacity" at a time when there were people in dire want. In contrast today, U.S. productive capacity has been shipped out of the country for decades, and in ways that have left the American consumer without either a job or ownership of the means of production to generate an adequate and secure income.

Thus, massive money creation is exactly the wrong thing to do to solve the current problem. It would be like pouring gasoline on an already raging inferno. The problem is that other factors complicate the situation, such as how people understand money, credit, and banking and, of course, investment and the process of money creation. We will look at that in tomorrow's posting.