Two Ways of Conjuring Money Out of the Void
Some time ago, I posted support for a theory of currency creation unfamiliar to many (including, until very recently, myself). I followed that post by explaining what a Greenbacker is. I wasn't really sure where next to go on the topic of currency creation and the forces behind it profiting enormously from it (which are only possible because of the rampant ignorance of it) until I heard a recent podcast about money and growth in China.
What's remarkable about this podcast - and I use the term "remarkable" literally, as in I really should remark upon it - is the blind spot suffered by the reporters because they do not understand, it seems, even the basics of monetary creation and issuance . . . and they work on a podcast called Planet Money!
Enough generalizations; let's get to the meat of their possible misunderstanding. (No transcript seems to be available, so I'm summing up. Feel free, of course, to check my interpretation.)
The podcast starts innocently enough by noting that most of the larger industries - the cell phone carriers, the oil companies, the airlines, tobacco companies, you name it - are owned in whole or in part by the Chinese government. It should come as no surprise then that the banks are included as a part of this system of government ownership, called "state capitalism." The presenters posit that this system is either genius or headed for disaster, hence the podcast's title, "Is China's Economy Genius, Or Bound For Disaster?"
Getting to the banking system, Davidson and Goldstein note that Chinese savers deposit far more in Chinese banks than the average person on earth. The Chinese are, by the examples provided in the 'cast, far more frugal on average, depositing something like 20% to 30% of their income in the bank. Since there are few options for savings, the state banks are pretty well capitalized. Adam Davidson then notes about a third of the way through the 'cast that these banks lend this money out, often to "other Chinese companies that go out and build new stuff."
We then cut to interviews with people who describe the almost indescribable level of construction happening in the country, from airports to apartment blocks to whole cities that sprang up in just the last few years. The first interviewed, Michael Pettis (not sure about the spelling of his name), a finance professor and former employee of banks himself, notes that not all of that construction is going to be economically feasible in the near future, since an expensive airport in an under-utilized small town (for one example) is unlikely to attract enough air traffic to pay for its construction in the long term. Davidson notes that much of China's growth is due to this spate of building, and notes that it is financed through lending "from those state-owned banks." Pettis continues, noting that "They borrowed money, and how do they pay it back? They can't pay it back."
"And remember, that's ordinary people's money," notes Davidson, "that the state-owned banks are lending out."
There it is, the disconnect. I emphasized this last statement for a reason: let's get back to my first cited post and the main lesson to apply here. Banks do not lend out deposited money directly. Banks lend out created money backed by deposits.
I'm pretty sure I've heard every Planet Money episode they've released. Much of their reporting is spot-on and applicable in many ways. But they have never, and I mean never ever, properly made the connection between the role of banks and the creation of money.
That's right, folks, Planet Money reporters do not know how money is created on this planet. The irony writes itself.
So, how else can one interpret China's building spree? It sounds like a classic Greenback move, using the money deposited in the state-owned banks to create money and spend it directly into the economy. Remember, Benjamin Franklin noted that certain colonies did this, and were able to provide local services with no taxation. Abraham Lincoln did this as well, arming the Union without the usurous debt burden offered by traditional financiers. Still other countries have followed suit. Remember Germany?
The German people were in such desperate straits [under the Treaty of Versailles] that they relinquished control of the country to a dictator. . . . But autocratic authority did give Adolf Hitler something the American Greenbackers could only dream about - total control of the economy. He was able to test their theories, and he proved that they worked. Like for Lincoln, Hitler's choices were to either submit to total debt slavery or create his own fiat money; and like Lincoln, he chose the fiat solution. . . .
Within two years, the unemployment problem had been solved and the country was back on its feet. It had a solid, stable currency and no inflation, at a time when millions of people in the United States and other Western countries were still out of work and living on welfare. Germany even managed to restore foreign trade . . . using a barter system: equipment and commodities were exchanged directly with other countries, circumventing the international banks. This system of direct exchange occurred without debt and without trade deficits. Germany's economic experiment, like Lincoln's, was short-lived; but it left some lasting monuments to its success, including the famous Autobahn, the world's first extensive superhighway.
(Ellen Hodgson Brown, Web of Debt, Third Millennium Press, 2008, p. 230.)
Ms. Brown confirms what the Planet Money team has failed to recognize, that China is indeed growing through applied finance.
By 2004, China was leading the world in economic productivity, growing at 9 percent annually. In the first quarter of 2007, its economic growth was up to a remarkable 11.1 percent, with retail sales climbing 15.3 percent. The commonly-held explanation for this impressive growth is that the Chinese are willing to work for what amounts to slave wages; but the starving poor of Africa, Indonesia, and Latin America are equally wiling, yet their economies are languishing. Something else distinguishes China, and one key difference is its banking system. China has a government-issued currency and a system of national banks that are actually owned by the nation. . . . The notion of "national banking," as opposed to private "central banking," goes back to Lincoln, Carey and the American nationalists. Henry C. K. Liu distinguishes the two systems like this: a national bank serves the interests of the nation and its people. A central bank serves the interests of private international finance.
(Brown, ibid., pp. 258-259.)
This is the distinction the Planet Money team have been remiss in not learning, this difference between central and national banking. No matter how much they stare at the answer, as long as they consult traditionally educated economists for answers, they will always get only the view of banking from the traditional point of view, and will therefore miss the main difference between countries like China and the United States. China spends its created money into its economy directly; the United States also creates money, but most of it is locked up in vaults and will probably not see any appreciable circulation.
I should clarify that last sentence, because it more than anything sums up our national missed opportunity. China has its main state banks lending money into existence and building things, employing people in the process. The US Federal Reserve creates money in lots of different ways. One of the most well-known were the recent rounds of Quantitative Easing where over a trillion dollars here in the US was created and injected "into" the economy. I put "into" in scare quotes for a very good reason: far from entering the actual economy, that money likely languished in a bank vault. I'll let the Planet Money team attempt to explain, and will correct them where necessary. In this round of reporting, Davidson is joined by Chana Joffe-Walt and Alex Blumberg in pieces they did for Ira Glass's This American Life. Thankfully, there's a transcript this time, though it's full of typos. Bear that in mind if you decide to read through the whole thing.
Right off the bat, we see the blindness to bank money creation:
Ira Glass When the United States was on a real gold standard, it was clear what money was and how much money there was. Each dollar corresponded to a dollar of gold that in a vault somewhere. But when we went off the gold standard, somebody had to decide how much money there would be.
This is actually incorrect, but I'm going to let it go for now, except to say that gold in the past backed credit money in the same way that assets back it today. Let's move on. Getting back to Ira:
Some entity had to be entrusted with that power. In our country and just about every modern country today, we give that power to something called a central bank. Our central bank is named the Federal Reserve. You've heard that name, probably. And like all central banks, it has one magical power. The Federal Reserve can create money any time it wants. It's the one institution in America that can decide, OK, the economy would run better, interest rates would drop, whatever, if there was more money out there. Or it can decide there should be less money. It controls the amount of money in our economy, including in a very literal way.
Did you see what Ira did there? The central bank "has one magical power. The Federal Reserve can create money any time it wants." This is true. However, continuing, he notes that the Fed is "the one institution in America that can decide, OK, the economy would run better, interest rates would drop, whatever, if there was more money out there. Or it can decide there should be less money." He mentions that the Fed can create money and that the Fed is the only entity that can set interest rates - which somehow relates to the amount of money in our economy - without explaining how interest rates set by the Fed determine monetary supply.
Without knowing this crucial link between commercial banks and their authorized power to lend money into existence, Ira is reduced to taking a string of facts he does not understand and simply stating them without explanation . . . (wait for it) . . . in an episode titled, again, The Invention of Money.
It gets worse. Throughout the episode, the reporters sound agog at the fact that the Fed created the trillion-plus dollars during the various Quantitative Easing rounds, buying assets at full price with money created with the click of a mouse. An example:
Alex Blumberg Up until recently when the Federal Reserve did this dangerous and magical thing of creating money out of nothing, conjuring money out of the void, it happened in a kind of solemn ritual.
Here and there, we see the disconnect between their understanding of what happened and, well, what happened:
Alex Blumberg They can't just create a whole bunch of money and then walk out to the street corner and start handing it out to people. That would be awkward for one, and it also would take too long. They need to get large amounts of money into the economy fast. And so they need someone who can handle a few billion dollars in one quick transaction, which means the banking system. Banks.
Now let's remember China's example above. Chinese banks are lending money at a prodigious rate. Things are getting built with this money. The economy is moving much better than ours in the US. Why?
Because in the US the created QE money bought assets. These assets already backed loans on the bank books. These assets were also going bad. If the bank didn't get the Fed to buy these assets at the Discount Window (see story), the bad assets would have to be devalued, or marked to their current market value as opposed to their listed purchase value. This would remove backing for existing loans. Losings enough loan-backing assets means insolvency for the bank.
Bankruptcy.
To avoid bankruptcy, the bank has to hold the money the Fed gave them for that toxic crap. Funny thing, though; the intrepid Planet Money team notes that the reason for opening the Discount Window was, once again, "to get large amounts of money into the economy fast."
Getting "large amounts of money into the economy fast" means spending it, not holding it in a vault. Because they did not understand commercial banking well enough, Planet Money bought the Fed rationale for QE hook, line and sinker, further layering the irony on their chosen moniker.
I can't fully fault Planet Money for brewing their rich irony stew. When they get advice, they generally go to economists. From my years of listening, I'm comfortable saying that most of the economists they consult are of the neo-classical persuasion. It turns out that the neo-classical camp has an enormous blind side when it comes to debt-backed monetary systems.
I'm currently in the middle of Steve Keen's Debunking Economics, where he is taking apart tenet by tenet the neo-classical or traditional view of economics. It is so fraught with shortcuts that don't scale, assumptions proven but the proofs discounted and dismissed, and outright laughable flaws (that lead, of course, to laughable conclusions) that I'm having trouble keeping them in order of importance. Keen notes, however, that one of if not the biggest blind spot in neo-classism is the misunderstanding of the role of debt. From this article:
“Traditional economists do not take any account of debt in their modelling,” he says. “In their world, debt simply doesn’t matter.”
Keen quotes Nobel Prize winning economist Paul Krugman to illustrate the point. In his 2010 paper entitled Debt, Deleveraging and the Liquidity Trap, Krugman said: “. . . looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth - one person’s liability is another person’s asset.”
Yet Keen argues that, while this is empirically true, it is also irrelevant.
“That view is fine if you have money being lent from one person to another, because the lender has less money and the borrower has more and everything ends up equal,” he says. “But this completely ignores the role of banks.
“If somebody goes to a bank and wants to borrow money, the bank effectively creates that money out of nothing. It doesn’t have to take cash out of somebody’s savings to get it. And by doing so it injects extra cash and potential demand into the economy without subtracting spending power from anywhere else. In that way, overall demand is boosted and things can get out of kilter.”
Keen says things are made worse when that money is invested in speculative assets such as property or shares because it raises both the level of debt and the level of asset prices without adding anything to the economy or boosting economic growth: it just results in higher asset prices and higher debt, which inevitably ends up reducing demand.
“This is how bubbles grow and burst and ignoring debt in this way is one of the great fallacies of modern economics,” says Keen.
(I emphasized)
There is more irony to Keen's observation, one that should be emphasized. From the TAL show once again:
David Kestenbaum And the Chairman of the Federal Reserve, Ben Bernanke, says that because of the Fed's [QE] actions, quote, "The world was spared a cataclysm that could have rivaled or surpassed the Great Depression." And Bernanke is actually one of the leading scholars on the economics of the Great Depression. And he says, in fact, that the Great Depression happened in large part because the Fed back then wasn't crazy enough. Or as he put it, they were quote, "Insufficiently willing to challenge the orthodoxies of their day."
(I did it again with the emboldened words.)
Wait. Did you catch that? The "Great Depression happened in large part because the Fed back then" failed to "challenge the orthodoxies of their day." His actions, therefore, avoided prolonged calamity. Which may be true.
But. . . .
Shouldn't someone who "is actually one of the leading scholars on the economics of the Great Depression" have known not just how to avoid prolonging a depression, but maybe, just maybe, how to avoid such a collapse in the first place?!?
Seriously. This most recent collapse took Bernanke and other in his neo-classical camp completely by surprise. His predecessor Alan Greenspan was no exception. In testimony before the House Committee on Oversight and Government Reform, Greenspan revealed the depths of his shock. "I found a flaw in the model that I perceived as the critical functioning structure that defines how the world works, so to speak," he said. (John Cassidy, How Markets Fail: The Logic of Economic Calamaties, Princeton University Press, 2009, p. 6.)
Let's all remember that Greenspan used his flawed model to run the largest economy on earth today. From all I'm reading now, this very flaw caused the money supply to inflate into a bubble, which in turn directly led to the inevitable collapse.
So, where are we now? That is an excellent question.
Before I'm accused of ignoring it, the United States government has spent money into the economy. The so-called shovel ready projects funded by emergency measures have noticeably reduced the level of unemployment and spurred economic activity. Ah, but unlike China, the power to conjure money out of the void is reserved for the Federal Reserve, not for the Federal Government. The Federal Government has to use funds it collects from taxpayer revenues, or, if these are insufficient, borrow from bond buyers at interest. Let's remember what this massive borrowing has done to the purchase power of our money.
Remember, folks, the Federal Reserve is decidedly not a branch of the government. It is, rather, a government-recognized monopoly of privately-owned and operated banks that is legally empowered to "manage" the economy as it will. As I noted above, it manages not the economy, but the banks in the economy, leading to outcomes as drastically different as ours and China's. Like the Planet Money team, you deny this fact at your cognitive peril.
Don't worry, though. You are not alone in this cognitive wasteland of misunderstood monetary policy. Go back to TAL and find the passage that starts with Ira saying "Hey fellas." What follows confirms everything I've noted above . . . and so much less. They seem to take pains to sort through the QE Fed money and the borrowed money of the TARP program, as if separating the two were of vital importance.
It is, actually. Let's get back to the title of this post. If the Federal government never borrowed against the TARP program and instead had the power to instruct the Federal Reserve to spend the trillions of QE and Discount Window money into shovel ready projects . . . the dollar would be stronger, the taxpayers not on the hook for that borrowing, and we would, like China, have people working to build things of value instead of running through their unemployment benefits. A few banks would bite the Big One, but so what. It's called "moral hazard." Look it up. It should be a defining aspect of capitalism, not the rarity it's become. The bankers scattered to the winds can flip burgers at McDonald's for a change.
But that is a conclusion one cannot explain to a traditional economist. They don't see money and debt as it really is, only as it should be in theory. And if all goes according to plan, I'll address the importance of accurate theory next time.
What's remarkable about this podcast - and I use the term "remarkable" literally, as in I really should remark upon it - is the blind spot suffered by the reporters because they do not understand, it seems, even the basics of monetary creation and issuance . . . and they work on a podcast called Planet Money!
Enough generalizations; let's get to the meat of their possible misunderstanding. (No transcript seems to be available, so I'm summing up. Feel free, of course, to check my interpretation.)
The podcast starts innocently enough by noting that most of the larger industries - the cell phone carriers, the oil companies, the airlines, tobacco companies, you name it - are owned in whole or in part by the Chinese government. It should come as no surprise then that the banks are included as a part of this system of government ownership, called "state capitalism." The presenters posit that this system is either genius or headed for disaster, hence the podcast's title, "Is China's Economy Genius, Or Bound For Disaster?"
Getting to the banking system, Davidson and Goldstein note that Chinese savers deposit far more in Chinese banks than the average person on earth. The Chinese are, by the examples provided in the 'cast, far more frugal on average, depositing something like 20% to 30% of their income in the bank. Since there are few options for savings, the state banks are pretty well capitalized. Adam Davidson then notes about a third of the way through the 'cast that these banks lend this money out, often to "other Chinese companies that go out and build new stuff."
We then cut to interviews with people who describe the almost indescribable level of construction happening in the country, from airports to apartment blocks to whole cities that sprang up in just the last few years. The first interviewed, Michael Pettis (not sure about the spelling of his name), a finance professor and former employee of banks himself, notes that not all of that construction is going to be economically feasible in the near future, since an expensive airport in an under-utilized small town (for one example) is unlikely to attract enough air traffic to pay for its construction in the long term. Davidson notes that much of China's growth is due to this spate of building, and notes that it is financed through lending "from those state-owned banks." Pettis continues, noting that "They borrowed money, and how do they pay it back? They can't pay it back."
"And remember, that's ordinary people's money," notes Davidson, "that the state-owned banks are lending out."
There it is, the disconnect. I emphasized this last statement for a reason: let's get back to my first cited post and the main lesson to apply here. Banks do not lend out deposited money directly. Banks lend out created money backed by deposits.
I'm pretty sure I've heard every Planet Money episode they've released. Much of their reporting is spot-on and applicable in many ways. But they have never, and I mean never ever, properly made the connection between the role of banks and the creation of money.
That's right, folks, Planet Money reporters do not know how money is created on this planet. The irony writes itself.
So, how else can one interpret China's building spree? It sounds like a classic Greenback move, using the money deposited in the state-owned banks to create money and spend it directly into the economy. Remember, Benjamin Franklin noted that certain colonies did this, and were able to provide local services with no taxation. Abraham Lincoln did this as well, arming the Union without the usurous debt burden offered by traditional financiers. Still other countries have followed suit. Remember Germany?
The German people were in such desperate straits [under the Treaty of Versailles] that they relinquished control of the country to a dictator. . . . But autocratic authority did give Adolf Hitler something the American Greenbackers could only dream about - total control of the economy. He was able to test their theories, and he proved that they worked. Like for Lincoln, Hitler's choices were to either submit to total debt slavery or create his own fiat money; and like Lincoln, he chose the fiat solution. . . .
Within two years, the unemployment problem had been solved and the country was back on its feet. It had a solid, stable currency and no inflation, at a time when millions of people in the United States and other Western countries were still out of work and living on welfare. Germany even managed to restore foreign trade . . . using a barter system: equipment and commodities were exchanged directly with other countries, circumventing the international banks. This system of direct exchange occurred without debt and without trade deficits. Germany's economic experiment, like Lincoln's, was short-lived; but it left some lasting monuments to its success, including the famous Autobahn, the world's first extensive superhighway.
(Ellen Hodgson Brown, Web of Debt, Third Millennium Press, 2008, p. 230.)
Ms. Brown confirms what the Planet Money team has failed to recognize, that China is indeed growing through applied finance.
By 2004, China was leading the world in economic productivity, growing at 9 percent annually. In the first quarter of 2007, its economic growth was up to a remarkable 11.1 percent, with retail sales climbing 15.3 percent. The commonly-held explanation for this impressive growth is that the Chinese are willing to work for what amounts to slave wages; but the starving poor of Africa, Indonesia, and Latin America are equally wiling, yet their economies are languishing. Something else distinguishes China, and one key difference is its banking system. China has a government-issued currency and a system of national banks that are actually owned by the nation. . . . The notion of "national banking," as opposed to private "central banking," goes back to Lincoln, Carey and the American nationalists. Henry C. K. Liu distinguishes the two systems like this: a national bank serves the interests of the nation and its people. A central bank serves the interests of private international finance.
(Brown, ibid., pp. 258-259.)
This is the distinction the Planet Money team have been remiss in not learning, this difference between central and national banking. No matter how much they stare at the answer, as long as they consult traditionally educated economists for answers, they will always get only the view of banking from the traditional point of view, and will therefore miss the main difference between countries like China and the United States. China spends its created money into its economy directly; the United States also creates money, but most of it is locked up in vaults and will probably not see any appreciable circulation.
I should clarify that last sentence, because it more than anything sums up our national missed opportunity. China has its main state banks lending money into existence and building things, employing people in the process. The US Federal Reserve creates money in lots of different ways. One of the most well-known were the recent rounds of Quantitative Easing where over a trillion dollars here in the US was created and injected "into" the economy. I put "into" in scare quotes for a very good reason: far from entering the actual economy, that money likely languished in a bank vault. I'll let the Planet Money team attempt to explain, and will correct them where necessary. In this round of reporting, Davidson is joined by Chana Joffe-Walt and Alex Blumberg in pieces they did for Ira Glass's This American Life. Thankfully, there's a transcript this time, though it's full of typos. Bear that in mind if you decide to read through the whole thing.
Right off the bat, we see the blindness to bank money creation:
Ira Glass When the United States was on a real gold standard, it was clear what money was and how much money there was. Each dollar corresponded to a dollar of gold that in a vault somewhere. But when we went off the gold standard, somebody had to decide how much money there would be.
This is actually incorrect, but I'm going to let it go for now, except to say that gold in the past backed credit money in the same way that assets back it today. Let's move on. Getting back to Ira:
Some entity had to be entrusted with that power. In our country and just about every modern country today, we give that power to something called a central bank. Our central bank is named the Federal Reserve. You've heard that name, probably. And like all central banks, it has one magical power. The Federal Reserve can create money any time it wants. It's the one institution in America that can decide, OK, the economy would run better, interest rates would drop, whatever, if there was more money out there. Or it can decide there should be less money. It controls the amount of money in our economy, including in a very literal way.
Did you see what Ira did there? The central bank "has one magical power. The Federal Reserve can create money any time it wants." This is true. However, continuing, he notes that the Fed is "the one institution in America that can decide, OK, the economy would run better, interest rates would drop, whatever, if there was more money out there. Or it can decide there should be less money." He mentions that the Fed can create money and that the Fed is the only entity that can set interest rates - which somehow relates to the amount of money in our economy - without explaining how interest rates set by the Fed determine monetary supply.
Without knowing this crucial link between commercial banks and their authorized power to lend money into existence, Ira is reduced to taking a string of facts he does not understand and simply stating them without explanation . . . (wait for it) . . . in an episode titled, again, The Invention of Money.
It gets worse. Throughout the episode, the reporters sound agog at the fact that the Fed created the trillion-plus dollars during the various Quantitative Easing rounds, buying assets at full price with money created with the click of a mouse. An example:
Alex Blumberg Up until recently when the Federal Reserve did this dangerous and magical thing of creating money out of nothing, conjuring money out of the void, it happened in a kind of solemn ritual.
Here and there, we see the disconnect between their understanding of what happened and, well, what happened:
Alex Blumberg They can't just create a whole bunch of money and then walk out to the street corner and start handing it out to people. That would be awkward for one, and it also would take too long. They need to get large amounts of money into the economy fast. And so they need someone who can handle a few billion dollars in one quick transaction, which means the banking system. Banks.
Now let's remember China's example above. Chinese banks are lending money at a prodigious rate. Things are getting built with this money. The economy is moving much better than ours in the US. Why?
Because in the US the created QE money bought assets. These assets already backed loans on the bank books. These assets were also going bad. If the bank didn't get the Fed to buy these assets at the Discount Window (see story), the bad assets would have to be devalued, or marked to their current market value as opposed to their listed purchase value. This would remove backing for existing loans. Losings enough loan-backing assets means insolvency for the bank.
Bankruptcy.
To avoid bankruptcy, the bank has to hold the money the Fed gave them for that toxic crap. Funny thing, though; the intrepid Planet Money team notes that the reason for opening the Discount Window was, once again, "to get large amounts of money into the economy fast."
Getting "large amounts of money into the economy fast" means spending it, not holding it in a vault. Because they did not understand commercial banking well enough, Planet Money bought the Fed rationale for QE hook, line and sinker, further layering the irony on their chosen moniker.
I can't fully fault Planet Money for brewing their rich irony stew. When they get advice, they generally go to economists. From my years of listening, I'm comfortable saying that most of the economists they consult are of the neo-classical persuasion. It turns out that the neo-classical camp has an enormous blind side when it comes to debt-backed monetary systems.
I'm currently in the middle of Steve Keen's Debunking Economics, where he is taking apart tenet by tenet the neo-classical or traditional view of economics. It is so fraught with shortcuts that don't scale, assumptions proven but the proofs discounted and dismissed, and outright laughable flaws (that lead, of course, to laughable conclusions) that I'm having trouble keeping them in order of importance. Keen notes, however, that one of if not the biggest blind spot in neo-classism is the misunderstanding of the role of debt. From this article:
“Traditional economists do not take any account of debt in their modelling,” he says. “In their world, debt simply doesn’t matter.”
Keen quotes Nobel Prize winning economist Paul Krugman to illustrate the point. In his 2010 paper entitled Debt, Deleveraging and the Liquidity Trap, Krugman said: “. . . looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth - one person’s liability is another person’s asset.”
Yet Keen argues that, while this is empirically true, it is also irrelevant.
“That view is fine if you have money being lent from one person to another, because the lender has less money and the borrower has more and everything ends up equal,” he says. “But this completely ignores the role of banks.
“If somebody goes to a bank and wants to borrow money, the bank effectively creates that money out of nothing. It doesn’t have to take cash out of somebody’s savings to get it. And by doing so it injects extra cash and potential demand into the economy without subtracting spending power from anywhere else. In that way, overall demand is boosted and things can get out of kilter.”
Keen says things are made worse when that money is invested in speculative assets such as property or shares because it raises both the level of debt and the level of asset prices without adding anything to the economy or boosting economic growth: it just results in higher asset prices and higher debt, which inevitably ends up reducing demand.
“This is how bubbles grow and burst and ignoring debt in this way is one of the great fallacies of modern economics,” says Keen.
(I emphasized)
There is more irony to Keen's observation, one that should be emphasized. From the TAL show once again:
David Kestenbaum And the Chairman of the Federal Reserve, Ben Bernanke, says that because of the Fed's [QE] actions, quote, "The world was spared a cataclysm that could have rivaled or surpassed the Great Depression." And Bernanke is actually one of the leading scholars on the economics of the Great Depression. And he says, in fact, that the Great Depression happened in large part because the Fed back then wasn't crazy enough. Or as he put it, they were quote, "Insufficiently willing to challenge the orthodoxies of their day."
(I did it again with the emboldened words.)
Wait. Did you catch that? The "Great Depression happened in large part because the Fed back then" failed to "challenge the orthodoxies of their day." His actions, therefore, avoided prolonged calamity. Which may be true.
But. . . .
Shouldn't someone who "is actually one of the leading scholars on the economics of the Great Depression" have known not just how to avoid prolonging a depression, but maybe, just maybe, how to avoid such a collapse in the first place?!?
Seriously. This most recent collapse took Bernanke and other in his neo-classical camp completely by surprise. His predecessor Alan Greenspan was no exception. In testimony before the House Committee on Oversight and Government Reform, Greenspan revealed the depths of his shock. "I found a flaw in the model that I perceived as the critical functioning structure that defines how the world works, so to speak," he said. (John Cassidy, How Markets Fail: The Logic of Economic Calamaties, Princeton University Press, 2009, p. 6.)
Let's all remember that Greenspan used his flawed model to run the largest economy on earth today. From all I'm reading now, this very flaw caused the money supply to inflate into a bubble, which in turn directly led to the inevitable collapse.
So, where are we now? That is an excellent question.
Before I'm accused of ignoring it, the United States government has spent money into the economy. The so-called shovel ready projects funded by emergency measures have noticeably reduced the level of unemployment and spurred economic activity. Ah, but unlike China, the power to conjure money out of the void is reserved for the Federal Reserve, not for the Federal Government. The Federal Government has to use funds it collects from taxpayer revenues, or, if these are insufficient, borrow from bond buyers at interest. Let's remember what this massive borrowing has done to the purchase power of our money.
Remember, folks, the Federal Reserve is decidedly not a branch of the government. It is, rather, a government-recognized monopoly of privately-owned and operated banks that is legally empowered to "manage" the economy as it will. As I noted above, it manages not the economy, but the banks in the economy, leading to outcomes as drastically different as ours and China's. Like the Planet Money team, you deny this fact at your cognitive peril.
Don't worry, though. You are not alone in this cognitive wasteland of misunderstood monetary policy. Go back to TAL and find the passage that starts with Ira saying "Hey fellas." What follows confirms everything I've noted above . . . and so much less. They seem to take pains to sort through the QE Fed money and the borrowed money of the TARP program, as if separating the two were of vital importance.
It is, actually. Let's get back to the title of this post. If the Federal government never borrowed against the TARP program and instead had the power to instruct the Federal Reserve to spend the trillions of QE and Discount Window money into shovel ready projects . . . the dollar would be stronger, the taxpayers not on the hook for that borrowing, and we would, like China, have people working to build things of value instead of running through their unemployment benefits. A few banks would bite the Big One, but so what. It's called "moral hazard." Look it up. It should be a defining aspect of capitalism, not the rarity it's become. The bankers scattered to the winds can flip burgers at McDonald's for a change.
But that is a conclusion one cannot explain to a traditional economist. They don't see money and debt as it really is, only as it should be in theory. And if all goes according to plan, I'll address the importance of accurate theory next time.