Jul

26

Lydian coin, 610 BC, Bundesbank collectioThe money supply misleads lots of people. If the money supply was cut in half today, it would not cut the economy in half. Why would it? It would simply mean that every dollar is now worth half as much more.

Well, that's in theory.

The reality is that there is a whole class of people (bankers, homebuilders) who have benefited from the illusion that more paper money means more wealth. Those people get wiped out when money stops growing (LEH, C, UBS, et. al.).

Those people thus spend huge amounts of money lobbying the government to make sure that their non-productive economic activity never stops, and obviously they have been successful.

The most basic concept in economics is that markets are necessary because of the signals that prices send.

Well, we overbuilt housing, so now the market sends the signal, through prices, that no more housing needs to be built.

Yet, ~95% of the country thinks that propping up home prices and distorting the signal that the market is sending is somehow good for the economy. It's not.

Stefan Jovanovich comments:

Gordon's polling numbers are unusually pessimistic. Most of the surveys of likely voters indicate that a majority think propping up home prices will not work and is not a good idea. The argument between the people who have benefited from the expansion of credit and those who question its wisdom is not a new one. It is at the heart of the debates of the 19th century over the legal tender status of state bank notes, the monetization of silver and the establishment of a Federal Reserve system that accepted government debt as backing for demand notes. In the 19th century the hard money advocates of both parties (Jackson, Buchanan, Cleveland for the Democrats; Grant, Garfield, McKinley for the Republicans) won the argument. For the last hundred years soft money has called the tune. What is remarkable about the present moment is that, for the first time since the establishment of the Federal Reserve, the debate over what should control the growth of credit - the market or the government - is actually an open question.

P.S. In a world where half the income is paid to or for the benefit of people whose work is never tested by the market, the use of monetary aggregates as a measure of anything other than themselves becomes increasingly suspect. Jean-Marie Eveillard has a wonderful phrase for Dr. Phil's money=size of the economy syllogism — "mechanical monetarism". The wisdom of the gold standard was that it divorced money from credit and left credit free to grow based on the increase in wealth — property, skills, enterprise — and the fluctuations in people's appetites for risk. What even the Paulistas seem unable to understand about the gold standard that was written into the U.S. Constitution was that it defined money by its physical property — so many grains of gold — and not by its exchange value. The money was the gold; the prices were the exchange values. That essential wisdom is one that even Adam Smith had trouble with and that only Thornton and Cantillon, those monetary theorists who actually dealt in trade and banking, understood. It is almost universally ignored now. Any monetary system that defines money by itself is fatally unstable.


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2 Comments so far

  1. jim on July 26, 2009 10:03 am

    There are no free markets left anyway. Bernanke acts as the all-knowing father, manipulating everything according to his will.

  2. reid on July 30, 2009 3:41 pm

    The full faith and credit of the US is what should define the value of the dollar. See Lincoln and Greenbacks, and Jackson’s war against Central Bankers.

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