The Money Supply Deception

June 28, 2010

Don't worry about inflation

Will Hutton has a piece in the Guardian (or was it the Observer?) discussing the G20 summit in Canada this week, which I broadly agree with. While Hutton attacks the varied nations that have tramped to Canada seeking rapid deficit reductions (such as our very own), he suggests that any global agreement on continuing anti-recession measures will be illusory.

He also notes, quite probably correctly, that deficit reduction is a smokescreen for banker-protection, writing that the huge cutbacks envisaged by George Osborne in his emergency budget last week, may conveniently allow another round of hand-outs for needy bankers, should the City capsize once more. In such an event, he writes, “the national debt needs to be shrinking as a share of GDP if the UK is to sell the hundreds of billions of pounds of debt necessary to prop up the banks.”

And he correctly notes the duplicity with which this insurance package for bankers’ bonuses has been sold, quipping that “Imposing austerity to save bankers and their bonuses in the future is even less attractive politically than doing it to rescue them from past sins.” And he laments the fairly savage way in which weaker nations are being left to suffer as the bond markets demand immediate cuts (Greece and Spain step forwards, or crawl if that’s all you can do by now).

All of this is fine, but I don’t agree with his conclusion, when he suggests that in the event that austerity fails to right the ships of the global economy, “a recourse to inflation as the only way to reduce the vast debt overhang.”

…All that will be achieved is inflation. Countries in desperation will turn to printing money, keeping interest rates rock bottom and trying to devalue to ease the pressure. Some orderly inflation, as an IMF working paper has proposed, would actually be welcome, but that won’t happen. It will be disorderly.”

So what are the alternatives here? As Hutton puts it, to “manage the economy proactively by using every lever of monetary and fiscal policy to create the employment and activity to allow people to pay their debts down.”

Fine. But what does that mean? There obviously aren’t any physical levers to pull (and in any case, you’d need a government credit to manufacture any new ones, so let’s make it a digital affair). But there are tools available.  Perhaps Hutton envisages tax breaks for R&D, subsidies for green industries, more training programs, that kind of thing. Long term solutions, but laudable.

The problem is, by disavowing “printing money” Hutton leaves his hypothetical policy maker with nowhere to go. If they want to stimulate green industries and overhaul the skills of the British people, or if they want a new transport infrastructure, school buildings, renovated seaside resorts, a vibrant arts sector – all money spinners in some way – tax breaks aren’t going to cut it.

I think that Hutton needs to go back to inflation 101. After all, printing money alone does not cause inflation. Disastrous inflation probably occurs (remember, economists don’t really know a great deal about anything) when a variety of factors intersect: exchange rates, money supply, political stability, wages and raw material considerations.

Adding money to an economy does not inflate prices. This only happens, in theory, if output (things that money can buy) does not increase in step. If the government spends newly created money on projects that will demonstrably generate output, the inflationary effects will be minimal, and moderate inflation would not be a problem. Far from it, it would be a boon to millions of debtors and investors in new firms.

Another problem is that there is money supply and there is money supply. How is money created? Not usually in a mint, with a press and a conveyor belt and a stamping machine. Nowadays, most money is generated via financial mechanisms, by banks making loans to customers with money that they do not hold. According to economist Michael Rowbotham, government-issued cash represented around 3 percent of the UK  money supply in 1998, and the vast majority of the stuff existed “simply as figures flowing between bank and building society accounts.”

You very rarely see in the press a commentator warning of the inflationary risk from such lending, but it is the operations of a financial system (which over time has absolutely monopolised money creation) that have generated record corporate and private debt levels and a rapidly increasing public debt. Truly, this is a money spewing monster of Weimar proportions, or at least it was before its mouth was sewn up by its seizure in 2006.

Now I think that it’s important to realise that the creation of money through a privatised financial system has nothing at all to do with synchronising the supply of money and economic output. It is purely about profit for the lenders concerned. Can such an irrational means of creating credit be allowed to regenerate itself, as it is doing right now, through such enormous public support?

I’d argue not. Hopefully Nobel prize winning economist Joseph Stiglitz would too, for he is one of the most prominent people to be propounding one measure that may begin to establish a better way of stimulating national economies. As he told the the Independent yesterday,”If the banks aren’t lending, let’s create a new lending facility to do that job…In the US, we gave $700bn to the banks; if we had used a fraction of that to create a new bank, we could have financed all the lending that was needed.”

So printing money per se, is not the problem. Targeting the distribution of publicly created money at socially necessary tasks is a priority, and if it generates a little inflation, then it will be even more of a blessing. Indeed, by allowing democratically elected adminstrators to take control (or delegate it) of where credit is directed, it may be the best hope we have of promoting environmentally sustainable economies.

Aside from the ideological minefield which lies between the reality of now and the implementation of such ideas, public money creation implies a deeper problem: it would make politicians accountable for the economy in a truly novel way. While they can currently hide behind the sins of bankers and business cycles, they would then have to justify their decisions – whether to grant or lend, who to delegate authority to, how much (or whether) private lending on the old model is allowed.

That kind of responsibility is what men like George Osborne or Tony Blair spend lifetimes training themselves to avoid. The only ones who can make them face up to it, are us.


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