Chapter 3 - Stability of the Money Supply

Never forget that money is a freely created commodity. Vast quantities of Cash Currency can be created at no cost on a printing machine. Vast quantities of Credit can be created by writing numbers in a register, all at no cost. It cost nothing to create money. It is not the free creation of money that causes a problem, but that the free creation can cause too much money to be created or insufficient money to be created. Money is simply a token that passes from one person to another enabling a transaction each time it moves. The more it moves, the more wealth that is created. The more it moves, the greater the volume of economic activity. The magnitude of the Money Supply needs to be managed with some skill. It is not a self-correcting system and it is prone to a range of abuses. The management is more of an art than a skill. There is no set of strict rules. Our knowledge is very incomplete and prone to bias created by interested parties.

The first and obvious problem occurs when an excessive quantity of money is created. The creation of money needs to be restricted and controlled. The current experiment in money system management has been to remove the money creation task from government and give the control to a central bank. The central bank is then required to maintain the health of the financial system and maintain the volume of money in the Money Supply. Their draft is incomplete. There is more than the volume of money that needs to be controlled. The volume of money that is active is of greater importance. Money stacked up doing nothing is of no use in the promotion of economic activity. The central banks are remarkably inept at maintaining the Money Supply. They also make no effort to ensure that money actually moves in the economy. It is the level of money that is actually circulating that is important. Most money is sitting idle in bank accounts for extensive lengths of time. Inappropriately, the central bank has been given the mandate to maintain the Money Supply when what really needs to be managed is the volume of Circulating Money. Both the magnitude and the movement of money need to be managed. Thus it is the volume of money that is actually moving that is important. There is no point in having money in society if it is stationary.

One assumption that we are expected to believe is that adjustment of interest rates and modification of the reserve requirements will control the Money Supply. This will supposedly alter the volume of credit issued to the public by private banks. This presupposes that the public be in debt to banks. The Money Supply thus relies on maintaining the level of debt. The methods of adjustment are inadequate. They are mostly negative. They may be capable of causing a decrease in the Money Supply but they have little chance of encouraging an increase in the Money Supply. There is an obvious observation that the Money Supply relies on the lending of credit to the citizens. There is no provision for money created as Cash Currency by the central bank to be a significant portion of the Money Supply. Around 95% of the Money Supply is Bank Credit so the economy is totally reliant on the volume of credit issued by banks. The adjustment of interest rates and reserve requirements tends to fail to adjust the rate of issuance of Bank Credit. When it does not encourage a reluctant citizenry to take on ever greater volumes of debt, the central bank is supposed to move to what it euphemistically calls ‘open market operations’. This involves the buying of government securities (government debt) purchased with money that the central bank creates out of thin air. The activities of the central bank are carried out with great pomp and circumstance but are largely ineffective. The governor will appear on the television talking with great gravitas but the results will be largely ineffective.

The procedure involves the government being in debt whilst the central bank purchases such debt with freshly created credit, which is simply numbers written in a book. This action is interesting. The central bank can create credit out of thin air in any quantity. But the government cannot create credit. For the government to get the credit, it goes into debt for money that was created out of thin air at no cost. The government suffers debt and more debt with no way of obtaining extra money to pay the interest. Yet the credit was created out of thin air at the central bank. We have to tolerate this if we accept a system where the government does not create money. It borrows money that the central bank creates at no cost. Then the nations suffers the indignity of tax to pay the interest on the money that was created out of thin air.

These are some of the issues that occur under a system where the money system relies on credit issued by banks. The mistake with the ‘open market operations’ involving the purchase of government bonds is that the bonds are purchased from institutions that are prone to hoard the freshly created money. Thus, the freshly created money does not move into circulation. It becomes Hoarded Money. The result is that the Money Supply increases but the Circulating Money does not increase. This is an age old economics error, brought about by a lack of understanding of Hoarded Money and Circulating Money. This lack of knowledge is corrected in this book.

The level of debt appears in the graph of debt and money for the UK. Here is the graph of Money and Debt for the UK. At about 2008, the loans ceased to be issued to the private sector. This is shown in the yellow line near the bottom right corner of the graph. Whilst loans ceased to be issued, the bank continued to collect interest and loan repayments. The Money Supply faltered. Government Debt increased. The graph demonstrates the inability of current central bank procedures to maintain Money Supply.

Graph of United Kingdom Money Supply and Debt. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

How Money Enters the Economy

About five percent of the money enters the Money Supply when the central bank prints Cash Currency. [Australia 3.5%, UK 3% and USA 7%] The central bank prints Cash Currency which is purchased by the high street banks using Bank Credit. They don’t buy it with anything real, they use their self-created credit. The Cash Currency is used to top up the ATMs and teller trays. Ninety-five percent [Australia 96.5%, UK 97% and USA 93%] of money enters the economy through the granting of loans by private banks. Banks are constantly creating new loans. At the same time, they are collecting repayments. If they issue more loans than they collect in repayments, the Money Supply increases. If they issue fewer loans than they collect in repayments, the Money Supply decreases. Here is a graph for Spain. You can see the debt ceases to increase and the Money Supply ceases to increase. The government has some vague control over the issue of Cash Currency, but that does not fall. The government does not create Bank Credit. If the government wants money, it borrows it and spends it. You can see that the government debt expanded. However, governments borrow using a borrowing procedure where they issue bonds. The government borrows existing Bank Credit which it spends into society. So the government does not influence the magnitude of the Money Supply:

Graph of Spain Money Supply and Debt. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

The days where the government has influence over the magnitude of the Money Supply have long gone. The modern catchy phrase is “Keep the central bank free from political influence”. Thus we have anti-democracy in the money system. The government sends us to the wars that are promoted by the American sourced media, but has no ability to maintain a steady Money Supply. The Money Supply becomes dependent upon the rate of issue of new loans by private banks. The government obtains money by taxation, borrowing or asset sales. The central bank creates a ‘front’ for the money activities of the private banks. The Central Bank gives an air of officialdom to the usurers.

With taxation, the government taxes and spends back into society. With borrowing, the government borrows by issuing IOUs called bonds. These are paid for using existing money. The government borrows existing money and spends it back into society. When the government sells assets, it manages to clear some of its debts. The assets are purchased using existing credit. And so the government has no obvious way of increasing the volume of the vital circulating medium. I shall give you a few secrets later in the book. There are ways the government can get around this but they are rarely utilized.

In the current world, fresh money is created when banks make loans and the Money Supply is reduced when the banks collect repayments. In the USA, if the gross debt is $66 000 billion, and we guestimate an average interest rate of 5%, the annual interest is of the order of $3300 billion. This has the potential to reduce the $18000 billion Money Supply by 18%. Repayments possibly double this figure. Thus repayments and interest have the potential to reduce the Money Supply by around 36%. A fascinating observation occurs when you compare the total interest to total federal taxation which equals $3299 billion. Interest collected by banks for the use of Bank Credit that was created by accounting entries is of the same order as the Federal Taxation.

The volume of fresh credit created is so huge that it comprehensively influences the economy. It is not just the volume of lending that causes influence. The sectors of the economy that are granted credit, expand and the other languish. Where this fresh money is first spent, heavily influences the economy. If the banks lend for car loans, car sales will go up. If the banks refuse to lend for car loans, car sales will go down. If banks lend for land and house speculation, land and house prices will rise. Speculation in land and property is usually masked as ‘property investment’ which hides its landlordism and speculation nature. It is bubble creating. When the bank lends into a speculative area, the asset values enthusiastically rise. When the lending is curtailed, the reverse occurs and the bubble bursts as people see asset values plummet. We are talking selective inflation of assets influenced by bank lending practices. I highlight the relevant sections of this farewell speech.

President Andrew Jackson 1837: “In the hands of this formidable power, thus organized, was also placed unlimited dominion over the amount of circulating medium, giving it the power to regulate the value of property and the fruits of labor in every quarter of the Union, and to bestow prosperity or bring ruin upon any city or section of the country as might best comport with its own interest or policy…Yet, if you had not conquered, the government would have passed from the hands of the many to the hands of the few, and this organized money power from its secret conclave would have dictated the choice of your highest officers and compelled you to make peace or war, as best suited their wishes. The forms of your government might for a time have remained, but its living spirit would have departed from it.” [2]

You should read this again. Andrew Jackson is saying:

The issuers of credit have formidable power.

They are organized.

They control the amount of circulating medium.

They control the value of houses and land.

They control the fruits of labor.

They have control over business activity in every corner of the land.

They can bestow prosperity or ruin on any individual, business, state or region.

If they are not controlled, this organized money power will operate in a secretive manner to control politicians, governments and officials in high places.

It will compel you to make peace or war, as best suited their wishes.

It will influence every level of government.

I put it here as I wish you to read it again:

President Andrew Jackson 1837: “In the hands of this formidable power, thus organized, was also placed unlimited dominion over the amount of circulating medium, giving it the power to regulate the value of property and the fruits of labor in every quarter of the Union, and to bestow prosperity or bring ruin upon any city or section of the country as might best comport with its own interest or policy…Yet, if you had not conquered, the government would have passed from the hands of the many to the hands of the few, and this organized money power from its secret conclave would have dictated the choice of your highest officers and compelled you to make peace or war, as best suited their wishes. The forms of your government might for a time have remained, but its living spirit would have departed from it.” [2]

By profuse lending in housing, house prices rise. When lending ceases, house prices fall. If one district is starved of loans, that locality experiences recession. Every area of the economy depends upon the lending habits of banks. If a government does not comply with bankers wishes, it has the power to create a recession and also has the power to blame it on the government. The banks can kindly donate to compliant politicians whilst providing ‘education’ on appropriate policy.

The commercial banking sector, in alliance with the central bank, has complete control over credit creation in both volume and loan type which gives them complete control over the shape of the economy. Cutbacks to any business sector will stifle the growth of that sector. Strong lending into any asset class will inflate that class of asset creating a ‘get rich quick mentality’ amongst the lemming-like small time investors. This ends in tears as the banks stop inflating that area and sending that sector into recession. Recessions are not just a single national economics statistic. Each sector of an economy can have inflation and deflation. Booms and recessions can occur in any number of sectors. Similar happens regionally within a nation. If lending is weaker in one region, that region will experience a recession. Allowing the commercial banking sector to have full control over the Money Supply creates problems not only with the total magnitude of the Money Supply but also its regional distribution. Regional inconsistencies in economic activity are caused by unhelpful private bank lending practices.

Credit Control

Some countries implement ‘Credit Control’ as a way of controlling the Money Supply. ‘Credit Control’ is the process where government controls the credit creation of banks. ‘Credit Control’ was first implemented in 1912 by the German Reichsbank. The procedure was later copied by the USA Federal Reserve bank in the 1920s and then by other nations. The implementation lasted for many decades. Credit allocations favored productive credit creation. Unproductive credit creation was restricted because it creates asset inflation followed by banking crises. Bank Credit was not available for purely speculative transactions. Consumer loans were restricted. Bank Credit was allowed for productive use. This is an important tool in the government’s arsenal for controlling the economics of the nation. The practice has been removed from the government’s hands by insisting that the central bank be “freed from the influence of politics”. The central bank then avoids using these powers to control the banking industry that it is required to control. When the control of a central bank is removed from government, its control falls to representatives of the banking industry over which it is supposed to exert control. The banks are in charge of the banks. They then make a great show of controlling the banks using procedures that have no hope of controlling the banks nor the Money Supply. When the Money Supply misbehaves, the government is accused of mismanagement, usually resulting in a change of government to another party that supports the debt banking system and any war advertised by those that supply ‘news’ to the media empires. There is a pretense that the lending practices of banks can be controlled by centralized interest rate control. The pretense is given great dignity and allows the mischievous practices to continue.

The banks are in charge of the banks.

Economic Development with Stability

Credit Control is a good way to maintain a stable economy with orderly growth. Fresh credit can be regulated to maintain a mild increase in the Circulating Money and ensuring that the productive areas of the economy have adequate recourse to credit. Speculative and financial areas of the economy can be restricted from credit to prevent asset inflation. Selective asset inflation is a dangerous ‘boom-bust’ activity carried out to make ‘money from money’. This gives no productive gain in the nation and tends to add to business costs. Under poor management, speculators get an excessive share of available credit. This tends to cause financial disturbances. Credit Controls regulate the volume of bank advances which then raises or decreases the volume of bank lending. Selective Credit Controls encourage bank lending into certain sectors and discourage banks from lending for inappropriate purposes. Selective Credit Controls are a great aid in the control of an economy.

Selective Credit Controls are a great aid in the control of an economy.

Currently, government influence over the private banks is handicapped. The banking industry has an army of heavily funded lobbyists that can outnumber the politicians in numbers, incomes, expertise, and financial resources. The best way to a politician’s heart is through his campaign fund. And politicians get well funded when they are supportive. The result is that all major parties are supportive of the debt banking system.

Without Credit Controls, the tools available to the central bank are rather blunt and tend not to achieve their objectives. The central bank can become a puppet of the private banks. The banking industry has successfully removed the use of the best tools available to control the banking industry. Central banks are very successful at creating an illusion that the economy and the Money Supply is being controlled. In reality, central banks are unable to control:

Not even the Bank of England is ignorant of the charade:

Bank of England 2014: “Is it difficult to believe that the Central Bank with the blunt instrument of interest rate control can control private corporation lending habits. As inflation continues to flourish, their control appears to be a carefully controlled myth.” [1]

The consequence for a nation is dire. However, the arrangement is spectacularly successful at diverting the blame for Money Supply and economic woes away from the commercial banks and onto the central bank and government. A change of government usually completes the blame arrangement. A few ineffective regulatory changes are made to give the illusion that all has been fixed. This continues for a few years until the private banks decide to cease lending. This destroys the Money Supply and the economic welfare of the people another time, whence a new blame-game starts all over again.

Bernie Sanders: “It is not Congress which regulates Wall Street, but Wall Street that regulates Congress..”

Lewis vs. United States, 680 F. 2d 1239 9th Circuit 1982 “The regional Federal Reserve banks are not government agencies. ...but are independent, privately owned and locally controlled corporations.”

A large portion of the Money Supply sits idle in bank accounts for years on end. This money does not engage in transactions and is thus useless to the economy. I call this Hoarded Money and I calculate that Hoarded Money makes up ten to twenty percent of the Money Supply of most nations. In most nations, only ten to twenty percent of money changes hands on a regular basis. I use a time of one month in my calculations. Money that changes hands within one month is classed as Circulating Money. Money that is idle for more than one month is classed as Hoarded Money. The time of one month was arrived at by studying the habits of ‘spenders’. A fruit or flower seller turns their money over in a day. Young people spend their weekly wage before their next wage arrives. Those with mortgages often have no money left by the next wage. Only those with ‘more money than they can spend’ keep money for extended periods. Those with borrowed money effectively have no spare money at any time. Here is a diagram showing a velocity of two:

Velocity equals two by Andy Chalkley. Creative Commons Attribute

Here is a diagram showing a velocity of one:

Velocity equals two by Andy Chalkley. Creative Commons Attribute

The 8% changes hands regularly and effectively supports the ‘real economy’. The grey sits idle in bank accounts for extended periods of time adding nothing to wealth generation for the nation.

The following graph shows the Hoarded Money and Circulating Money for the USA:

Circulating Money USA. Andy Chalkley. Creative Commons Attribute

A hiccup in the M3 Money Supply for the USA caused a 3.4% fall in Circulating Money which nearly brought the world money system to its knees.

It turns out that it is the volume of Circulating Money that has the influence over the economy. It is the only money that is changing hands on a regular basis that influences economic activity. Hoarded Money causes no activity in the economy because it is not changing hands. The economy is influenced by changes in the magnitude of the Circulating Money component. In this next graph, I show changes in the Circulating Money and its influence on employment. Blue is the change in Circulating Money. Red is the change in Employment.

USA Unemployment and Circulating Money by Andy Chalkley. Creative Commons Attribute

In recent decades, the private corporation called the IMF, masquerading as an international bank, has started dictating “best practice” to governments. The IMF is a privately owned corporation just like any other corporation except that it has a few advantages. Governments start to follow instructions from the private banking corporations tied in with “neo-liberal” and “neo-con” thinking processes. This approach recommends (demands):

The consequences are not good. The central bank is freed from its originally designed purposes:

On the subject of housing, banks lend copious amounts of money to real-estate speculators. This is conveniently reworded as ‘real-estate investment’. This prices the young out of home ownership. ‘Investors’ charge expenses to their tax but defer their profit indefinitely. ‘Investors’ can outbid the young on any property purchase.

You sometimes hear the popular line put into politicians mouths: “The central bank should be free of government interference.”. One wonders why we put governments in place to govern. Apparently, the central bank believes that it should operate outside of democracy without supervision or regulation. Who ultimately has the authority to create the money of the nation? One might assume that it is the government. The banking system then primes the politicians to have this authority removed from government. It then encourages the government to relinquish all control over credit creation.

Central banks have turned central banking policy on its head. Since the start of central banking, the role of the central bank included the financing of government, the management of exchange rates, and support for all appropriate economic sectors. These ideas were accepted as the very reason for their existence. Central Banks now believe that they should now:

They give the illusion of control of the Money Supply by adjusting the interest rate in a proud manner. This has about as much chance of success as King Canute’s attempts at stopping the tide at the seaside.

To make matters worse:

High-profile personnel tend to have a revolving door arrangement as they walk out of mega-banks into treasury jobs and then back to their mega-banks. Their allegiance is likely to be with their ultimate employer, the banks. Their mind-set is a banking and borrowing mind-set. Similar happened to King Louis before the French Revolution. A man named Necker was put into the King’s treasury and succeeded in getting the king into debt for gold. If gold is of limited supply and is lent, where is one supposed to get the extra gold to pay interest? If gold is lent and gold plus ten percent has to be repaid, where is one supposed to get the extra gold? Although history books try to paint a glowing picture of Jacques Necker, the result of loans contracted during Necker’s incumbency was that the public debt was greatly increased. Necker encouraged increased debt and ‘cooked the books’ to hide the debt. Why would the king be in debt when the king had the authority to create the money? Jacques Necker was encouraging the borrowing from bankers that had created a ‘value’ for gold. Although I am no fan of monarchy, I am neither a fan of any replacement system that is beholden to moneyed interests.

Recap and Further Points