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The Myth of Money Shortage

Inspired by a discussion over at the libertyhq forum, Smiling Dave has decided to explain why there cannot be a shortage of money, that the whole idea is born of ignorance, as J. B. Say rightly wrote in Chapter 15 of his classic work.

To make sure there is no foul play, Dave has invited his friendly adversary, Devil’s Advocate, to debate the topic. What follows is a verbatim transcript of their epic meeting.

DA: Up to your shenanigans again, hey Dave?

SD: If you mean am I about to debunk yet another economic fallacy with rapier sharp insight, why yes.

DA: Rumor has it you are about to take on not only Keynes and all his merry men, but a group of scholars who call themselves Austrian Economists, who purport to march under the banner of the mighty Nobel Prize winner, Friedrich August von Hayek.

SD: If I’m gonna hang myself, may as well be from a big tree. Besides, Ludwig von Mises is on my side, who wrote in Human Action that “The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do”.

DA: And what topic is it this time, Smiling Dave?

SD: Cast thine eyes up to the title of this article, DA, and you’ll see it’s about the myth of money shortage.

DA: I don’t think it’s a myth at all. I personally could use a few more bucks, and I know plenty of other people who feel the same way.

SD: Hey, I could use more money, too. But we are not talking about individuals here. The question under discussion is whether there can be such a thing as not enough money in the economy as a whole. That the whole country would be helped if instead of, say, ten trillion dollars in existence, we have fifteen trillion dollars in existence.

DA: Why would I be better off, if I don’t get any of that extra five trillion?

SD: Exactly. And yet, you can fill a library as big as the one in ancient Alexandria with books and scholarly articles claiming that if only there was more money in the economy when the need arose, there would be no recessions, no unemployment, in short a Biblical Paradise.

DA: And you are going to take on this mighty array of scholars singlehanded, hey? Dave, they wrote whole books. You have one article, and we’re getting close to its end. So yours better be as powerful and decisive an argument as one of Einstein’s thought experiments.

SD: It is a thought experiment, actually. Let’s say our fearless leader, Barack Hussein, issued one of his famous executive orders that from now on the Dollar is to be called the Obama, in honor of his father. Would that end the recession and guarantee full employment?

DA: Dave, Dave, thou slippest. Of course such an executive order would not change anything about the economy. Nothing would be improved at all. A dollar by any other name is the same old dollar.

SD: Ah, DA, you have yet to hear the brilliant stroke fearless leader has in mind. About a month or two after everyone got used to buying and selling with Obamas instead of dollars, he would issue a second, executive order, one that will lead us to the Promised Land, economics-wise.

DA: And that would be?

SD: That every Obama is now to be renamed “Ten Dollars”.

DA: And that helps why?

SD: Don’t you see, DA? He has increased the money supply tenfold. Before the first executive order, you had, say a dollar in your wallet. After the smoke clears from the two exec. orders, you have ten dollars in your wallet. And not just you, everyone in the whole world who had any dollars now has ten times as many.

DA: Don’t be silly, Dave. Just renaming things doesn’t change anything at all.

SD: Exactly. And an increase in the money supply that is arguably fair, in that it gives everyone some of that new money in proportion to what they had before, is really just doing the exact same thing. It is just renaming the existing money.

How right ole von Mises was when he wrote “The monetary crank suggests a method for making everybody prosperous by monetary measures.”

DA: OK, you’ve convinced me. Changing the money supply does nothing. Fine. But now you will have to erase 90% of your blog, where you go on and on about the horrors of printing money. You’ve just proved a claim of those you scorn, who wrote that printing more money will not damage the economy at all.

SD: Printing new money would not damage the economy at all if it was done the way Barack did in those executive orders, making sure everyone got some. But in practice, when new money is printed, you don’t get any of it, do you? Nor does anyone else, except for a very small handful of Barack Hussein’s pals. That’s where the problem is. The ones who get the new money get to spend it, raising prices for everyone who didn’t get any. Inflation. Do a search for Cantillon effects; he’s the one who first explained it.

DA: Wait a minute, now, Dave. You’ve confused the issue. First you said that adding more money into the system does nothing. Now you say it’s harmful. What gives?

SD: Those who talk about a money shortage never spell out who will get the new money, do they? There are only two possibilities. Either everyone will get a proportional amount, or else some folks will get all the new money and others will get none. In the first case, we’ve shown that the new money is just the old money, renamed. In the second case, we know for sure there are big losers from this scheme, the vast majority of folks who don’t get any of the new money. So how can these people argue that it’s a good thing to print more money, that everyone will be better off? Especially since we know full well that nobody will get the new money but the govt and its pals.

DA: You think you’re so smart, Dave, but you haven’t really proven anything. You made up one artificial case, which is basically everyone taking a Sharpie and adding a zero to the denomination of their bills, and shown that in that one case an increase in the money supply is meaningless. But what about all the many other, much more realistic ways of increasing the money supply? Take, for example, Ben Bernanke’s brilliant Quantitative Easing, where he gave all the new money to the banks. You haven’t shown anything about that case, have you?

SD: What you are saying is that increasing the money supply per se is not the answer. It’s increasing the money supply and giving the new money to the right people.

DA: Exactly.

SD: So how come that huge array of economists never go into that? They don’t say “Print new money and give it all to the banks.” They just say “There is a shortage of money. Print some more and save the world”. As if any way you divvy up the new money will solve the problem.

What’s more, their theories all talk about a shortage of money in the aggregate, not a shortage of money in the banks’ coffers, or the govt’s wallet, or Smiling Dave’s checking account. Their theory is that the mere existence of more money will help. And I’ve clearly shown that just having more money in the aggregate doesn’t do anything.

DA: Dave, don’t be naive. When the masses of unemployed read that the reason they are broke is because the banks need more money, or the govt needs more money, that won’t go down very well. They are sure to say, “What about me? I certainly need more money.”

SD: So instead of the unpleasant truth, that giving a bank more money will make Smiling Dave richer, they waffle and talk about creating more money, not spelling out who gets it.

DA: Yup.

SD: Sorry, that makes no sense. We already wrote about how giving all the money to one small group hurts everyone else; it doesn’t help them. Have you done the search for Cantillon effects yet?

DA: So what you’re saying, basically, is that printing new money is just a renaming of the existing money. And whatever economic effects that happen are just the result of giving some people free money by depriving others of purchasing power. And those economic effects are just enriching a small group at the expense of the masses.

SD: Exactly. Too bad that array of scholars in love with printing money don’t come out and say, “We want to give free gifts to some people to be paid for by everyone else.” Put that way, they would have a hard time claiming they are ending a recession or curing unemployment.

And the Devil can but nod his head abashedly, stricken by the simple logic of Smiling Dave.


7 Comments

  1. merennulli says:

    This points out the obvious (to anyone who paid attention in macro economics 1 in college), that total monetary value in an economy is a zero sum game. The underlying point that most everyone paying attention already realizes is that these magic bullet fixes are an effective tax on everyone but those who the person advocating them feels can fix everything by having more spending power.

    The usual case is that the money goes to pay off debt, freeing the government balance sheets up for government programs to work in an unfettered fashion. Of course, that isn’t how it works out, since the spending power of the deflated currency would shift towards those holding those debts, and I don’t think anyone is all that eager to create this new shift in economic valuation just to hand the vast majority of the shifted economic power to China.

    The second case is to use it as a placeholder for taxes. No one is taxed to acquire the new money, but everyone takes a hit to the value of their wallet, meanwhile the proceeds are distributed in a manner that the Right would call “Robin Hood taxation”. This system of bottom-up economic stimulus is what is most eloquently argued as fixing everything, since increased consumer spending increases demand, and increases jobs to fill that demand, meaning “everyone wins”. Assuming the variables this ignores can be ignored, this devalues your self-debate here.

    Of course, those living off retirement savings in an inflating market, low MPC among the poor, and select companies poised to exploit it are variables that mean it won’t fix everything for everyone. This view of the economy looks at it like an artificial waterfall, where you have to pump water out of the basin to the source or it will just be dry plastic rocks after a while. There is certainly an argument to be made for it too. With so many major companies clinging to 80% profit margins as if that were a minimum requirement of doing business, most of us realize something needs to change. Many are pushing for that shift of power from the wealthy to the poor, and “new money” is just one of several attempts at sneaking it past those who oppose it.

    The problem is we’ve gotten so fed up with whichever “the other party” we hate and so contemptuous of the people in “the other party” that we are caught up in massive deception campaigns to get poorly considered workarounds like this “new money” approach in order to accomplish what we assume everyone else should want too.

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  2. sdavesblog says:

    Very insightful comment, merennuli. There are some things I’m not sure about, though.

    “…the spending power of the deflated currency would shift towards those holding those debts…”
    Isn’t the currency inflated, meaning has less purchasing power? Before the Chinese lent us their money, they could buy, say, 10 small countries. We repay them with money that can only buy them 5.

    “… increased consumer spending increases demand, and increases jobs to fill that demand, meaning “everyone wins”.

    It’s a long conversation to challenge the many assumptions in that line. I agree with Austrian Economics, that claims to prove that increasing demand doesn’t create more productive jobs, only parasitic jobs, and that when everyone takes a hit to the wallet that does not mean they can demand more, but less. For starters, if you are not familiar with this viewpoint, you might search this humble blog for Keynes or Say.

    “… you have to pump water out of the basin to the source or it will just be dry plastic rocks after a while.”

    A nice analogy, but a false one, I think. I like the other analogy, of trying to raise the water level of a swimming pool by pouring water from the deep end into the shallow end, a useless endeavor.

    “With so many major companies clinging to 80% profit margins as if that were a minimum requirement of doing business, most of us realize something needs to change.”

    AE argues that there is a huge difference between taxes and profits. If a company makes an 80% profit, that means they are selling something so coveted, that makes people so happy, they are willing to pay the company an 80% profit in exchange for the product. Meaning more power to the company for providing something so important to people. Of course, we are talking about a market where there is free entry, with no legal barriers to someone opening up shop and competing.

    “Many are pushing for that shift of power from the wealthy to the poor, and “new money” is just one of several attempts at sneaking it past those who oppose it.”

    I don’t follow. Nobody gains more from new money than the govt and its pals, who are all very rich people. Sure, the poor might get a crumb or two, but they have already paid dearly for that crumb by having their purchasing power reduced, and the economy as a whole impoverished, meaning a generally lower standard of living.

    “The problem is we’ve gotten so fed up with whichever “the other party” we hate and so contemptuous of the people in “the other party”…”

    Actually, I think everyone wants the same thing, increased general prosperity, meaning that we keep living in the rich USA and not a clone of some impoverished third world country. There is a big intellectual battle about how best to do that. The money printers think they are helping everyone, or claim they think that, and the point of the article is to expose that they are at best wrong and worst terribly wrong.

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  3. merennulli says:

    “Before the Chinese lent us their money, they could buy, say, 10 small countries. We repay them with money that can only buy them 5.”
    As the reserve currency, the issue of buying other countries is muddled, but staying strictly with relative buying power within the US context, China in this scenario gains the power to buy 30% of our GDP instead of the 20% they invested or the 20.5% they expected back. Their buying power compared to uninvolved nations may have decreased, but their buying power in the US market increased – which is critically important with us being the reserve currency and in the top two largest consumer nations.

    “It’s a long conversation to challenge the many assumptions in that line.”
    There’s a reason I put “everybody wins” in quotes. I detailed other flaws in it in the next paragraph, but the flaws you mention are valid as well.

    “A nice analogy, but a false one, I think.”
    And it was intended as a false analogy, explaining why the thought process that leads to redistribution is attractive on the surface. I think we’re in agreement here and not realizing it.

    “If a company makes an 80% profit, that means they are selling something so coveted, that makes people so happy, they are willing to pay the company an 80% profit in exchange for the product. Meaning more power to the company for providing something so important to people. Of course, we are talking about a market where there is free entry, with no legal barriers to someone opening up shop and competing.”
    I would agree that in a fully free market environment, whatever profit is made demonstrates a consumer’s perception of a need being met. That said, we are not talking about a free market. The US has long been a mixed economy, loathe as we are to admit it. There are legal barriers to competition, government incentives, loopholes for larger companies, and a system that lets a ludicrous legal challenge never quite go to court, but cost a smaller company it’s entire business. We also have businesses that bypass the free market with price matching and effective monopolies that bypass our laws against price fixing and anti-competitive practices. It also stands to reason that a company making 80% profit is getting more value from it’s employees than a company making 20% profit, yet pay rates do not correlate. I don’t advocate a specific solution, though, because I don’t have one. That said, I feel it’s important to have the actual problem spelled out, rather than the agenda-laced spin we usually hear – which I took to be what you were trying to accomplish as well with this blog post.

    “Nobody gains more from new money than the govt and its pals, who are all very rich people.”
    If the money is spent on reducing debt, it goes to the creditors (China being the largest). If the money is spent on new government spending, it goes as you say. If the money is spent on an assisted living program, or other bottom-up program, it injects money at the lowest level. The cynic in me sees this as buying votes, but it does follow the model of increasing consumption through the poorest sector. That said, like I mentioned earlier, the MPC is low among the poor. The smart ones pay off debts first, then stash money out of experience that tells them the new money is a one time deal and then they’re on their own. The dumb ones are, despite agenda-laden opinions to the contrary, the exception rather than the rule. It is the quintessential government “give a man a fish” mistake, but it is the viewpoint behind the more eloquent arguments in favor of creating new money to “fix everything”.

    “Actually, I think everyone wants the same thing, increased general prosperity.”
    True, and worth underscoring and pointing arrows at to emphasize. 99.999% of the population shares the same goal on nearly every issue. Unfortunately, we get caught up in our answers to the problem so much so that we vilify the people with other answers. Our society has categorized everything into two answers for every problem, and one answer is given to each of the two big political parties. You see this very quickly on any news comment page. Proposed solutions get shot down as being “more (expletive) from the (expletive) party”…and then you read 65 replies later that they were wrong about which party the person was from, and the new, well-intended proposal gets shoved aside. The offline world isn’t so transparent about it, but the same process occurs. We shout down ideas that are not what we’ve emotionally invested in, and latch onto any excuse, including things we know are dishonest, to promote our adopted plan. As long as we think less of the people we disagree with, though, we’ll never have the dialogue we need to find the real solutions.

    The current Congress sort of typifies my point with the budget issues. Everyone (as much as that term can ever apply to 350 million people) agrees we shouldn’t default on our debts. Almost everyone agrees we need to reduce spending. A huge majority agrees the lower income tax cuts needed to be preserved. But because the two sides took opposing approaches and became attached to those approaches, they endangered or damaged the parts they openly agreed on to then fail to get what either wanted.

    It’s pretty clear that everyone feels their is something wrong with how we as a nation handle the economy. Whether it’s allowing companies to make enormous profits, or whether it’s allowing laws to favor certain business practices, most people generally realize economic power is being taken away from them and their peers, and we don’t like it. I personally prefer a solution that leaves the market freer than it is today, but I remember the last time we turned a recession into a boom by taking drastic government action against competition-strangling business practices, it was followed by the great depression.

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  4. michele says:

    hi sd, i have a question for you.

    i’m italian and a friend of mine claims that in order to solve all our economic problems we should exit the euro and devalue the currency.
    he than claims that devaluating a currency doesn’t bring inflation and to proove it he brings the 1992 example.
    back then we had the lira and we were in the sme: a system in which currency were not free to float. in september ’92 speculators stroke and we were forced to leave the sme and devalue the currency a good 20%
    after the devaluation both the interest rate on our national debt and inflation got lower.

    note that i just want to refute the claim that devaluations don’t bring inflation, not his entire claim.
    this is my counter argument.

    it’s not devaluation that brings inflation, it’s a different level of inflation that cause a devaluation of the more inflated currency.
    first of all if you want to artificially devalue your central bank needs to print money otherwise free marcket forces just trump the devaluation and bring back the old parity

    if you look at inflation in both italy and germany prior to 1992 you’ll se that italy inflated much more than germany and thus we were forced to devaluate the currency when central bank run out of foreign reserves.

    as for why yields and inflation sunk after the devaluation there were no more expectations for devaluation in the future and italy was supposed to join the euro.
    the inflation imbalances were no more and foreign capitals flowed back with confidence and bought italian sovereign debt bringing down interst rates.
    this allowed the central bank to print less money and thus we got less inflation.

    but what will happen if we exit the euro now? certainly there are many price imbalancies right now between italy and germany so in the short run we can devalue without printing money.
    nonetheless we are in a very different condition compared to the one we had in 1992. back then we were going to join the euro and this set a mood of confidence in investors.
    now we are leaving it to devalue our currency with no real prospectives of an hawkish inflationary policy.

    as we saw clearly in greece when a country is supposed to devalue in the future capitals flee the country and with no prospectives to rejoin the eurozone this will happen to us too.
    this process will cause interest rates to skyrocket.

    now we face the horrible dilemma to let the whole hyper indebted italian economy fail or print some money to bring down yields.
    obv we’ll print. no doubt.
    money printing will scare even more foreign and domestic capitals and they wont come anytime soon back to our shores and we’ll need even more money printing to keep up. this will cause inflation in the long run.

    sadly i don’t have a competent guy in economics at hand and i really need a check on the whole thing.
    i’d really like to read your take on this account.

    thanks

    p.s. sorry for my bad english and feel free to delete my post if it doesn’t belong in your blog

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  5. sdavesblog says:

    My next article will be a response to your excellent comment.

    Should Italy Leave the Euro?

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  6. […] readers of Smiling Dave’s blog have already enjoyed my article proving there can be no money shortage. Someone replied with a blog to explain how there can be a […]

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  7. lio67 says:

    Excellent!

    Like

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