Economics (minus) 101
Nov. 19th, 2008 11:47 am![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
viverraI think I just got some validation of my common-sense (as opposed to book-learned) economic ideas.
I've mentioned to various economists over the years that credit cards increase the money supply. This is usually part of a conversation about how raising interest rates is actually inflationary, despite the orthodox economic stance that you control inflation by raising interest rates. The economists I've talked to have usually looked a bit uncomfortable, but declined to explain why I'm wrong.
But I recently heard on the radio an economist talking about the recent crisis. He was asked "but where did all the money go?" His answer was money was not actually disappearing, but that since loans were not being made, the money no longer existed in essentially two places and this had the effect of shrinking the money supply. Aha! The flip side of that remark is that loans, including credit card usage, increase the money supply, as I've been saying for years.
Suppose I buy something for $100 and charge it. Now I have the goods worth $100, but the credit card company also has an asset (my loan) worth $100 on their books. That extra $100 has been created, just as surely as if the bank had a printing press in the basement. The money supply has been increased.
So the Fed doesn't really control the money supply; banks and credit card companies do. Increased money supply is both inflationary and results in a higher standard of living; the second is desirable but the first isn't.
Now if I don't pay my bill, the bank adds interest. I might spend as much as $125 for goods worth only $100. This doesn't represent any additional goods. That extra $25 doesn't need to be backed with bills; it's just made up. Once again, that increases the money supply and is therefore inflationary, but it doesn't contribute to a higher standard of living (it doesn't represent either goods or labor). The bad without the good.
Therefore, to control inflation, the interest rate should be lowered, not raised. The traditional theory of raising interest rates to lower inflation is based on the idea that debt is always discretionary. The reality today is that it isn't. Students graduate from college with tens of thousands of dollars of debt. The average credit-card holder has $6000 in debt. Here in New England, an average worker with an average salary has to borrow money to pay the winter heating costs. Debt has become a normal and unavoidable part of the consumer economy.
One way to control the money supply would be to stop lending and wait for all the loan balances to be paid off. To really stop creating money, we would also have to stop charging interest. Ultimately, everything would be on a cash basis, and the Fed would have complete control of the money supply.
Without meaning to, this is what we have fallen into (except the stop charging interest part). But the sudden change has caused economic chaos, so the government is frantically trying to jump-start the lending process again.
An alternative, albeit still cataclysmic solution might be to assess the actual size of the money supply, adjust salaries and prices so that consumers would not find it necessary to borrow money, and then severely limit access to credit. That solution would put us back into the monetary state of the fifties or sixties, when consumers did not routinely use or need credit. This might not be a bad thing, but it would be incredibly hard to transition to from today's state (witness today's economy).
But the real question is, what does the government want the economy to do? Is it really necessary to control the money supply? If not, why not; if so, why? The "free market" favors unrestricted access to credit (ie an unregulated money supply) but it also doesn't "care" about either workers or consumers except as variables in an equation. I would posit that the first responsibility of government is to care for the populace.
I don't mean 'care for' in the sense of 'meet all their needs'. One also cares for the populace by creating a situation in which they can thrive. Politicians can debate the merits of encouraging people to make and keep as much money as possible versus an obligation to provide health care, jobs, or retirement.
But it is people who must thrive, not the abstract concept we call the "economy". We should never lose sight of that.
I've mentioned to various economists over the years that credit cards increase the money supply. This is usually part of a conversation about how raising interest rates is actually inflationary, despite the orthodox economic stance that you control inflation by raising interest rates. The economists I've talked to have usually looked a bit uncomfortable, but declined to explain why I'm wrong.
But I recently heard on the radio an economist talking about the recent crisis. He was asked "but where did all the money go?" His answer was money was not actually disappearing, but that since loans were not being made, the money no longer existed in essentially two places and this had the effect of shrinking the money supply. Aha! The flip side of that remark is that loans, including credit card usage, increase the money supply, as I've been saying for years.
Suppose I buy something for $100 and charge it. Now I have the goods worth $100, but the credit card company also has an asset (my loan) worth $100 on their books. That extra $100 has been created, just as surely as if the bank had a printing press in the basement. The money supply has been increased.
So the Fed doesn't really control the money supply; banks and credit card companies do. Increased money supply is both inflationary and results in a higher standard of living; the second is desirable but the first isn't.
Now if I don't pay my bill, the bank adds interest. I might spend as much as $125 for goods worth only $100. This doesn't represent any additional goods. That extra $25 doesn't need to be backed with bills; it's just made up. Once again, that increases the money supply and is therefore inflationary, but it doesn't contribute to a higher standard of living (it doesn't represent either goods or labor). The bad without the good.
Therefore, to control inflation, the interest rate should be lowered, not raised. The traditional theory of raising interest rates to lower inflation is based on the idea that debt is always discretionary. The reality today is that it isn't. Students graduate from college with tens of thousands of dollars of debt. The average credit-card holder has $6000 in debt. Here in New England, an average worker with an average salary has to borrow money to pay the winter heating costs. Debt has become a normal and unavoidable part of the consumer economy.
One way to control the money supply would be to stop lending and wait for all the loan balances to be paid off. To really stop creating money, we would also have to stop charging interest. Ultimately, everything would be on a cash basis, and the Fed would have complete control of the money supply.
Without meaning to, this is what we have fallen into (except the stop charging interest part). But the sudden change has caused economic chaos, so the government is frantically trying to jump-start the lending process again.
An alternative, albeit still cataclysmic solution might be to assess the actual size of the money supply, adjust salaries and prices so that consumers would not find it necessary to borrow money, and then severely limit access to credit. That solution would put us back into the monetary state of the fifties or sixties, when consumers did not routinely use or need credit. This might not be a bad thing, but it would be incredibly hard to transition to from today's state (witness today's economy).
But the real question is, what does the government want the economy to do? Is it really necessary to control the money supply? If not, why not; if so, why? The "free market" favors unrestricted access to credit (ie an unregulated money supply) but it also doesn't "care" about either workers or consumers except as variables in an equation. I would posit that the first responsibility of government is to care for the populace.
I don't mean 'care for' in the sense of 'meet all their needs'. One also cares for the populace by creating a situation in which they can thrive. Politicians can debate the merits of encouraging people to make and keep as much money as possible versus an obligation to provide health care, jobs, or retirement.
But it is people who must thrive, not the abstract concept we call the "economy". We should never lose sight of that.
