A Tale of Two Fools

Walk up to a street kid anywhere in the world, and he'll tell you what money is.

These days walk up to any two economists, and you're likely to get confusing,  contradictory explanations. That's because there's a minor brouhaha going on right now , about whether money is contracting or expanding, inflating or deflating.

Actually they're talking about the same thing. The only difference is that  they're using different words for the same definitions. It's sort of silly and ridiculous. Like medieval scholastic arguments about how many angels could dance on a pin. < Of course  common sense tells us it can only be two angels at two different times. ( Just kidding. Or am I?)  >

But evidently many economists have nothing better to do with taxpayer subsidized salaries, then have these esoteric debates that they probably don't understand themselves.

Basically, one side is saying all this Federal Reserve "money creation " by Bernanke will create inflation: while the other is saying no, we have deflation,  because money is being shrunk faster then it is being made. Actually no one knows right now, because the events they're talking about, haven't happened yet. < I know. This gets more confusing as we continue. >

Very simplified, today money creation in America originates with the Federal Reserve. The Fed decides to make a bookkeeping entry, just a bookkeeping entry, of say a trillion dollars. With this "money", they then purchase securities from the banking system < Before the financial debacle it was Treas obligations. Now it's just any security. > Presto, the banking system just has a trillion in cash it didn't have before. If it does nothing with this trillion, it's considered free reserves. But as any street kid will tell you, just having money doesn't make you any money, and with inflation, your money is actually decreasing in value.

So banks usually want to do something with this money. Classically, they use it as a base to  make loans. These loans are several magnitudes larger then the original trillion dollars. In other words, your private commercial bank is now creating money in the form of debt, just like  the Federal Reserve did. < This all takes place in what is called  "T Accounts", a concept most bankers have trouble understanding. Which should give you some idea how stupid they are. >

And this new bank debt is actually money. For example, if you purchase a car with a bank loan,  do you really think the auto dealer is going to say - "Ah. This is not money. This is only debt. See, Ethel, my wife. We have only this debt. How can I buy you that new frying pan. " Nonsense. The proceeds of the auto loan are deposited in the car dealers bank account as "money". His wife will get the new frying pan and anything else she wants.

This all worked very fine for the past hundred years. Then over the last ten years, again simplified, all the rules that made this system work safely, were thrown away. The reasons were incompetency and corruption.

So today, rather than talking about reenacting Glass-Steagall or otherwise how to really fix the system, some economists are arguing about whether or not the debt created today is actually money. Will the system work as before, and all this new debt cause hyperinflation. Or is it the  "money supply" , not debt,  that is actually money.

Well like most silly arguments, they're both wrong. If the Federal Reserve creates money, but the banks don't lend it, then you basically have no money because there is no debt creation. Like I said before, it's called the liquidity trap. And again like said before, this also occurred in the 1930s. So if no money is created, you're not going to have hyperinflation.

Likewise if debt is being destroyed faster than it is created, you're not going to have deflation either. Why? Because from the debt that existed,  it has already created that money in the car dealers bank account,  and you can be sure his wife Ethel has already spent it. And whoever received the money from Ethel will also spend it. Or at least spend some of it. < This is called the velocity of money. > So this debt contraction really isn't "destroying" the money it created. It may be causing hell for the banks and preventing new debt < money > creation. But it's not "destroying" money.  In other words, it's not deflationary.

Deflation occurs when firms can't sell their goods and they lower prices. Just look at any large retailer for verification.

Inflation occurs when you have only so much to sell, like one melon, and 100 people want to buy it. In other words more demand than goods. Now what merchant would be dumb enough not to raise the price. After all, they're only human.

Money assists or discourages this process, depending on Central Bank policies and goals. But money is not the raison d'tetre for this all happening. That's why Central Banks efforts today are mostly futile and of no use. They may have helped create the mess we have, but that doesn't mean they are the solution. One process is not symmetrical to the other.

What the Central Banks are doing now, with all their crazy  money explosion,  is called "pushing on a string". Again as I previously mentioned. the term originated in the 1930s.

In the future, I'll try elaborate further on this very complex subject, that has only become more complex over the last year. But then that's what fools like Bernanke do, make things more complex than they are.

Just remember, your money is no longer " as safe as if it's in the bank".

"The first thing I did in a new town was look up the local banker. They're usually the most easily fooled and always excited about a crooked deal. The perfect mark for a con." - The Yellow Kid < a notorious swindler at the beginning of the last century. My, oh my, how times haven't changed. >

< As always, this article is for information purposes only. >