We know that mainstream economists think so.
Let’s talk first about Fractional Reserve Banking. Nowadays, it is legal for a bank to lend Mr A money by writing him a check. For every single dollar they have in their vaults, they can write a check for ten whole dollars. Thus, when they lend Mr A money, they are increasing the amount of money out there. Mr A now has ten dollars to buy a new lamp. The lamp maker has ten new dollars to buy food. The grocer has ten new dollars…you get the idea. That ten new dollars is a great blessing, says the mainstream, because there is more money to spend, meaning more income for people selling, meaning prosperity.
And then Mr A has to go ahead and ruin the economy by paying back the loan! He gives the bank ten dollars. Nobody wants to borrow it, because everyone is trying to get out of debt, not to borrow more. Ten dollars less spending by Mr A on lamps, ten dollars less spending by the lamp maker on eggs, ten dollars less spending by the grocer…add up all those ten dollars, and Mr A has single handedly created a nice little recession. Add up a lot of Mr A’s, and you have the current sad state of our economy, that is nobody’s fault but Mr Average Person’s, who foolishly decided to pay his bills.
Austrian Economics laughs at this depiction of what is happening.
Devil’s Advocate: What’s to laugh? Every step of that argument is rock solid.
Smiling Dave: Elementary my dear Devil. Because Mr A, when he returns that money, is not only not hurting the economy, he is getting rid of parasite that was destroying it.
DA: What are you talking about? What parasite?
SD: It’s very simple. Every person in the economy wears two hats. On the one hand, he works for a living, in other words, he is a Producer of Wealth. On the other hand, he also eats up what is out there, he is a consumer, he is a Destroyer of Wealth.
DA: Those are harsh descriptions, Dave. Destroyer of wealth. Parasite.
SD: We live in a harsh world.
DA: So is everyone a Parasite, because they destroy wealth?
SD: No. In a thriving economy, for every dollars worth of goods and services Mr A destroys by consuming it, he contributes a dollar or more of production.
That’s why you have to work for a living before you can go to the store and destroy. First you Produce, then you get your money, which is basically a License to Consume, then you Consume. This way of doing things ensures nobody is Destroying more than he is Producing.
DA: Because if your paycheck is nine dollars, that means you only produced nine dollars worth of stuff. That’s why you can’t destroy ten dollar’s worth, because it means you have created Net Destruction if you do that.
SD: Exactly. Now when Mr A gets that check from the bank, he is getting a License to Consume ten dollars.
DA: Wait a minute. He just got a license to Destroy, but he hasn’t Produced anything first. So that check for ten dollars is a parasite on the economy. The more checks like that, the more spending, yes, but that spending is Destruction that has no previous Production to balance it out. How can the mainstream say we need more of that?
SD: I know, right?
DA: But what about spending being the motor and the lubricant and the driver and the car that runs the whole economy? If nobody spends, everyone will lose their jobs! The mainstream is right!
SD: Devil, my son, as you get older and wiser you will see that some things are not good or bad per se, but good or bad depending on their relation to something else.
DA: What do you mean? That philosophy stuff is way over my head. I’m talking everyone losing their jobs, and you start in with per se this and per se that.
SD: I’ll give you a simple example. Is eating good or bad?
DA: It’s great. if you don’t eat, you die.
SD: If it’s so great, then I guess a person should eat 50,000 calories a day, right?
DA: Well, no. Eating has to be balanced by energy expenditure. If someone eats more than the energy he expends, he gets fatter and fatter, until he gets obese, meaning he’ll die from that.
SD: So you get the concept of balance, then.
DA: Yes. Eating has to be balanced by energy expenditure, or it’s bad.
SD: Same thing with spending in an economy. It has to be balanced by production, or it turns from a good thing into a bad thing.
DA; It turns from healthy trading into parasitic destruction of the wealth of the nation.
SD: Yeppers. Now, when the money supply is kept constant, that balance happens automatically. You can’t consume unless you have money, and you can’t have money unless you produced first. Balance preserved.
DA: But when new money is created, like that check, more destruction happens because of it, but it’s not balanced by more production.
SD: Right again. And all the people who sell Mr A stuff based on that phony check, they are just enabling the parasite to chomp away at the economy. Have a lamp to destroy, Mr A, and feel free not to create anything in return.
DA: But what about if there are idle resources? What about if the lamp maker is unemployed, and all those ten dollar checks are what are letting him have his job?
SD: So he has a job now as enabler of destruction of the economy.
DA: What do you mean? He’s working now, making lamps.
SD: And giving those lamps to Mr A, who is going to consume them without having produce in return.
DA: But what about the labor that would have sat idle? That’s not being destroyed without someone producing for it, because the lamp maker would have sat idle anyway.
SD: But the lamp maker is using resources that are going to be consumed. The materials of the lamp. The energy required to heat and run the factory that is making this lamp. Mr A is using up all that, besides the labor, and all he gives in return is nothing.
DA: I still think we are better off having the lamp maker be an enabler than have no job at all.
SD: He is better off, sure. But the economy as a whole? Imagine if his job was to set fire to all the oil fields in the US. Nice job, but is it good for the country? That’s the exact same thing he’s doing now. At the end of the day, we are all poorer because of those people, the bank that writes the phony check, the person who spends it, and the guy who sells him something in return for that check.
And we are all poorer means not only are we all poorer, but that there will be even more unemployment down the road if we keep this up. Jobs come from accumulated resources, and the less the are, the less jobs. How many well paying jobs are there on a desert island?
DA: So what should we do, let the unemployed die?
SD: Of course not. Followers of this humble blog and of mises.org know that unemployment has a curable cause. See https://smilingdavesblog.wordpress.com/2013/05/30/does-technology-destroy-jobs/
DA: OK, I get that when this new money is first created, it’s a parasite. But what about when the lamp maker uses it? He did produce before he is going to spend that check, so his consumption is not parasitic.
SD: Yes, that’s true. As George Selgin is fond of pointing out, the damage is only done once.
DA: Then maybe returning the check to the bank is a bad thing.
SD: How can it be? When the check was not in existence everything was fine. Why should things get worse if it melts away again?
DA: So you’re saying it’s unimportant, neither good nor bad, if that check disappears.
DA: But maybe the demand for money has increased, and you are withdrawing money from the economy, and now people cannot get what they want, meaning warm piles of checks to put under their pillow?
SD: We talked about this before, Devil People don’t want money. They want purchasing power. When that check disappears, nobody has lost purchasing power.
DA: But when there is only a million dollars circulating in the economy, you can only buy a million dollars worth of stuff. But when there is two million, you can buy two million dollars worth of stuff. So of course destroying that check destroys purchasing power.
SD: Devil, seriously? The amount of goods and services out there does not change. When there is a million dollars and 100 cars for sale, and then the bank cuts a check for another million, are there suddenly 200 cars? The total purchasing power in the economy at any given moment depends not on how much money is out there, but on how many goods and services are out there on sale.
You cannot have more purchasing power than there is stuff out there to purchase. Which is why all the people trying to figure out a way to improve the economy should be trying to figure out how to increase production, not how to increase the money supply.
And that’s exactly why Mises wrote that anyone who thinks the economy can be improved by changing the money supply is a crank [=nut job].
DA: You’ve talked here about money disappearing because people repay loans. What about if they hoard cash? Save too much?
SD: We’ve talked about that many times. Just do a search for hoarding or for “decisive one liner” here, oh seeker of knowledge.