Money is essential to a successful economy. But it’s money in circulation that’s useful. Money that’s locked up in storage in vaults and savings doesn’t help. The early economists understood this well and often used the analogy of money-is-to-economy as blood-is-to-human-body. Circulating money, money that is used to buy things is as important to the economy as the blood in your arteries and veins. The analogy works. It leads us to realize that money, and more of it, can and usually is a good thing.
The analogy, however, doesn’t work for those economists and policy-makers who want are more interested in enabling the top 1% or so to profit at no risk by earning income on holding money. Theoretically, the rich, the top 1%, could earn income from their large stores of wealth by investing it in production. But the profit-by-investment-in-production method requires risk. It’s hard. It requires work to find and exploit good investment opportunities. From the perspective of the really wealthy, it can be more desirable to make money by simply owning money. To do that, it’s necessary to that there be no inflation. They actually prefer deflation because then their cash wealth gets more valuable without being risked or used productively at all. The other approach to making money without risk by simply owning money is to lend it. Instead of starting, owning, and building a business, investing in equity, you make loans. Ideally you use your wealth and influence to get politicians to guarantee your loans – heads you win and tails somebody else loses. These approaches to making money by simply owning money require that money be scarce and hard to get. It’s directly counter to the money in circulation paradigm. A circulatory system deprived of money is good thing those who make money from money instead of labor.
But to persuade the mass of people, the 99%, the ones earning money from labor, it’s necessary to change the metaphor. That’s been rather effectively in the second half of the 20th century. It’s been done by extending a different metaphor. Economists have long used the word liquidity for the idea of how easy it is to convert an asset into cash and therefore spent. For example, real estate (particularly in this market) is very illiquid. I could own a $1 million house but be unable to buy a Coke from the 7-11 store because I lack any cash. That’s an extreme example of illiquidity. In contrast, a liquid asset is one that is either actually cash or easily turned into cash so it can be spent. There’s a whole range of assets in between with varying degrees of liquidity.
This idea of liquidity and it’s association with cash has been used to push a metaphor that suggests the problem is too much money in the economy. We’re peppered with phrases like “drowning in debt” or a house mortgage that is “underwater”. It makes us feel that the liquid stuff is undesirable. So we get a central bank that’s reluctant to create and inject money into the economy because critics claim that will create too much liquidity and they falsely claim that it’s inflationary. When the central bank does increase inject liquidity into the economy, it does it by getting the money to precisely the people who keep it from circulating. We get a government that refuses to use it’s ability to directly inject money into the economy and get it into circulation.
Government ultimately is the source of all money. Only government can define and create money. It has two ways to do it. It can simply create (“print” or “mint” if you will, but it’s not that way anymore) money and spend it. That puts money immediately into circulation in the circular flow of goods and services. Or, the government could create money reserves for the banks, a riskier strategy. The banks then can lend using a fractional reserve logic. If the banks lend out the reserves, then money is created. If the borrowers from the banks spend the borrowed money, then it’s in circulation. If the borrowers use the money to simply buy other financial assets, then it’s not in circulation and is sterile.
In our modern system, the government (in the U.S. and many other nations) has delegated the responsibility for creating money and putting it into circulation to quasi-private central banks such as The Federal Reserve Bank. In today’s workings of the financial system, these central banks have further delegated the responsibility and decision-making on money-creation to private commercial banks by providing reserves for whatever level of loans they choose. When those banks choose not to create money or choose not to create and provide money in a way that puts it into circulation, the system suffers. We suffer from too little liquidity.
Daniel Becker at Angry Bear made this point very well in a long post there in June 2011. He points out that we should really talk about “dehydrating in debt”, not “drowing in debt”. The dehydration metaphor leads us directly to the solution – more money in circulation. I from the conclusion to his post:
Got that? Let’s summarize: The share of income to the 99% of people declined from 1976 onward. At the same time the means of making money changed from labor production to money manipulation (producer economy to finanicialized economy) adding to the reduction in share of income. We also changed the ideology to one from relying on the vast population (as represented by the individual and We the People) to relying on a small portion of the population to distribute what money was created. We did this for 33 years. By 1996, people were borrowing as a means to sustain their standard of living (not increase it). If the people are not spending to increase their standard of living, then is the economy really growing? By 2006 people were no longer able to make the payments and consumption was declining. Then gas hit $4/gal and winter heating was looking like another $4000 to $6000 would be needed.
To date, nothing has been done to address this. Nothing at all. And, by “this” I mean, the income inequality that has resulted in an an economy where a very small group of people (top 1%) are taking money out of the system (that is money that would fuel the engine) faster than the engine can make it which results in an ever faster declining share to the rest of the people. Instead, we have refined new fuel and dumped it right into the top 1%’s hands and wonder why the engine is still sputtering?
One other issue I have with framing and the words used today: Under water.
People are not under water. They are not drowning in debt. On the contrary, people are dehydrating. They are starving for water. Do you know what the symptoms are of dehydration? You get thirsty and then urinate less to conserve water. (debt spending) Then you stop making tears and stop sweating. (can’t borrow) Eventually your muscles cramp, the heart palpitates and you get dizzy. (close to bankruptcy, voting against your interest) Let it go long enough and you get confused, weak and your coping mechanisms fail. (Tea Party, etc) In the end, your systems fail and you die. (recession)
People are dehydrating and Washington is doing nothing about it because they believe it is drowning. They are throwing out life boats to people in a desert. That is the chart Ken linked to.