Chapter 14 - A Lesson From Canada

A graph of the Money Supply in Canada. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

In the above graph you can see that the Money Supply is composed almost entirely of Bank Credit. (The orange is Cash Currency (M0).) The lending habits of banks greatly influences the magnitude of the Money Supply. If the banks stop lending, the Money Supply falls. If the banks lend, the Money Supply rises. At around 2008, you can see a fall in M3 of 1.6%. You might expect a corresponding fall in the economic activity. The reality is different. The fall in economic activity was far greater. I shall show why. The banks had destroyed 1.6% of the money. They had been collecting repayments whilst issuing very fewer loans. The result was destruction of 1.6% of the Money Supply. The reduction of money did not occur in the Hoarded Money. Money is borrowed by those with no money of their own so interest always comes from Circulating Money. The result was an 8% fall in Circulating Money. Hoarded Money remained hoarded. The GDP fell by 8%.

A 1.6% fall in M3 caused an 8% fall in economic activity.

There is an assumption that when the Money Supply falls, the economy will go into a recession. This is misleadingly simplistic. This simplistic statement leads to utterly incorrect thought processes with dire consequences. It is correct that when the Money Supply falls the economy tends to go into a recession, it is not correct to say that this is the only thing that will cause a recession and it is also not correct to say that an increase in the Money Supply will reverse the recession. There is a layer of logic missing.

It is utterly incorrect to assume that increasing the Money Supply will revitalize an economy. When a Money Supply falls, it is a fall in the Circulating Money component of the Money Supply that causes the economy to enter a recession. Hoarded Money tends to stay hoarded. This phenomenon is observed when the velocity falls when the Money Supply is reduced. On entry to a recession, there is a fall in the Circulating Money. The fall in Circulating Money can be caused by a fall in the Money Supply Or a fall in Velocity. It is most commonly a fall in the Money Supply. Thus the common error by Economists.

When the Money Supply falls, money tends to be removed from the real economy rather than from Hoarded Money. Those with ‘more money than they can spend’ tend not to spend and tend to retain their money. Tax is removed from Circulating Money rather than Hoarded Money. Interest is removed from Circulating Money rather than Hoarded Money. A fall in the velocity of money will also cause a recession. A fall in velocity tends to be small in magnitude and tend to accompany a fall in the Money Supply. To monitor the economic health of a nation it is necessary to monitor the Circulating Money as this is the real measure that influences the buoyancy of the economy. Hoarded Money is dead money as far as the economy is concerned.

Circulating Money is changing hands regularly and is easy to siphon. Most tax is taken from Circulating Money. Interest and loan repayments are taken from Circulating Money. This graph for Canada shows the effect particularly well. Canada had a small fall in the M3 Money Supply (1.6% green inset) but a dramatic fall in the Circulating Money (8% light blue). (Here, I class money that sits idle for more than one month as Hoarded Money. Money that moves within one month is classed as Circulating Money.)

A graph of the Circulating Money in Canada. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

In the graph above, a Money Supply fall of 1.6% caused the Circulating Money (light blue) to fall by about 8%. [2] The Cash Currency (orange below) issued by the central bank did not fall:

A graph of the Money Supply in Canada. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

In this next graph you can see the fall in the GDP for Canada:

A graph of GDP for Canada. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

So a 1.6% fall in the Money Supply has led to an 8% fall in Circulating Money and a corresponding 8% fall in GDP. The fall in the GDP causes a fall in the tax revenue. Amazingly, notice that the fall in tax revenue is greater than the fall in Circulating Money:

Canada Circulating Money and Tax Revenue by Andy Chalkley. Creative Commons Attribute by Andy Chalkley. Creative Commons Attribute. www.andychalkley.com.au

The observant will have noticed that the fall in the tax revenue is larger than the fall in the Circulating Money. (In billions) This hints that a minor expenditure into Circulating Money by the government brings a positive result in tax revenue. Why would a government allow a fall in Circulating Money that causes a greater fall in tax revenue? The lunacy of the situation is that the government loses income greater than the fall in Circulating Money.

This effect is most pronounced in nations with low velocity. In Canada, like most countries, almost all money is hoarded. This means that almost all money sits idle in bank accounts and is owned by persons that have ‘more money than they can spend’. This is shown in the next graph:

Circulating Money and Hoarded Money in Canada. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

In the above graph, you can see that almost all the increase in the Money Supply after 2009 became hoarded. Almost none of the increase became Circulating Money.

The next diagram represents a velocity of two which corresponds to a Hoarded Money rate of 83%. Almost all taxation and almost all interest are taken from Circulating Money:

How tax affects a Velocity of two. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

The next diagram shows the influence of removing interest from the economy. Almost all interest is taken from Circulating Money:

How Velocity is influenced by interest repayments. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

The next diagram shows the influence of removing interest at different rates:

A graph of Interest Removal. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

In the next diagram, I reduce the Money Supply by about 9%. This is very easy to do as we punish Circulating Money and worship Hoarded Money. The only way to reduce the quantity of Circulating Money is for the banks to cease money lending whilst taking repayments and interest from Circulating Money. The banks pull this stunt on a regular basis. Vast quantities of money are removed from Circulating Money each year, which in most years is replaced by fresh loans. Whenever the banks decide to stop lending or the citizens decide to cease borrowing, the Circulating Money falls and a recession is created. Our society and the controllers of our politicians have completely overlooked the crucial role that private banks play as creators of the Money Supply and the total disregard these banks display towards the maintenance of the Money Supply. This also makes it difficult to predict the onset of a recession. It is not easy to predict the behavior of banks and their lending practices. This graph shows a reduction of the Money Supply by 9%. Interest is taken from Circulating Money and so it is Circulating Money that falls. Thus a minor fall in the Money Supply can create a massive fall in the Circulating Money.

The 9% fall in the Money Supply caused a 50% fall in Circulating Money which equates to a 50% fall in business activity. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

The 9% fall in the Money Supply caused a 50% fall in Circulating Money which equates to a 50% fall in business activity. So I present the Canada graph again to demonstrate that very small falls in the Money Supply create drastic reductions in Circulating Money. The effect is far more pronounced in nations with low velocity.

A graph of the Circulating Money in Canada. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

A consideration of Circulating Money reveals that businesses simply pass money through their hands and do not decrease Circulating Money. Governments also remove tax from Circulating Money and spend it back into circulation. Thus, governments do not affect the volume of Circulating Money. The various revolutions and wars prevented sovereigns and sovereign governments from creating debt-free money for their nations. The government also borrows money. It generally does not borrow from banks but issues bonds. In this situation, they are borrowing existing Bank Credit, which tends to be Hoarded Money. This may increase Circulating Money. The only strong influence over Circulating Money is tied to the lending habits of banks. If loans exceed repayments and interest, the Circulating Money increases. If the sum of repayments and interest exceeds fresh loans, Circulating Money falls. Hoarded Money tends not to be affected because hoarders do not need to borrow as they already have ‘more money than they can spend’.

Reverse Logic

Although it is correct that a fall in the Money Supply will tend to cause a recession, it is utterly incorrect to assume that the opposite is true. There is a missing stage of the logic. When the Money Supply falls, it is usually the Circulating Money that falls. Circulating Money is easier to remove from the economy than hibernating money. However, when the Money Supply is increased, the fresh money is more likely to become Hoarded Money. It tends to go to those who have ‘more than they can spend’. This is demonstrated by a drop in the velocity. Pushing new money into the economy is one thing, but getting it to circulate is a more difficult task. The procedure needed to increase the Circulating Money is quite tricky. Circulating Money is, by its very nature, moving from transaction to transaction, which means it is partaking in business transactions. To increase Circulating Money is not just a matter of throwing money into the money pool. It is the rate of business transactions that needs to be increased. In a downturn businesses have been hurt. Businesses have gone to the wall. Factories have closed their doors. It is difficult to persuade the business fraternity to crank up business simply by throwing money at them or making credit available. The best approach is to avoid a fall in Circulating Money in the first place. This is the subject of a later chapter.

It is utterly incorrect to assume that an increase in the Money Supply will cause an increase in economic activity.

Forceful increases in the Money Supply tend to get hoarded as witnessed by a fall in velocity.

The velocity of Money in the Canada. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

In the next graph, you can see that the percentage of Hoarded Money has increased. (The top horizontal is 100%. Circulating Money is light blue. Hoarded Money is grey.):

The percentage on money that is circulating in Canada. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

In the following graph, you can see that almost all of the increase in the Money Supply around 2009 got into the hands of the hoarders. Almost none of the increase in the Money Supply entered circulation:

Circulating Money and Hoarded Money in Canada. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

So what will cause the Money Supply to fall? The government has no ability to cause a change in the Money Supply even though it is common practice to blame the government. The government collects tax and spends the tax. Any minor shortfall is borrowed from the existing Money Supply through the mechanism of bond issue and immediately spent back into society. There is no change to the magnitude of the Money Supply through any government tax collection or expenditure. (The action of issuing bonds may draw money from hoarders and put it into circulation.)

There is no change to the magnitude of the Money Supply through any government tax collection or expenditure.

Banks, on the other hand, can and do alter the Money Supply. The banks make loans on a daily basis. Banks collect principal and interest repayments on a daily basis. If the loans are being issued at a faster rate than loans are collected, the Money Supply increases. If loans are recalled at a faster rate than loans are issued, the Money Supply falls. Repayments and interest are collected from people that do not have excess money and so are collected from Circulating Money. Thus a very small fall in the Money Supply has a devastating effect on the economy. In this diagram, an 8% fall in the Money Supply has the potential to reduce the Circulating Money by 50%. In practice, it is a bit less, but you can see the potential for economic drama with just a small fall in the Money Supply.

A graph of Hoarded Money. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

To finish the study of Canada, I give you a graph showing the Cash Currency, Money Supply M3, Private Debt, and Public Debt:

Canada. A graph of Money Supply and unpayable Debt.
Some people ask why the Bank of Canada can’t directly increase or decrease the Money Supply at will, since it regulates the supply of paper currency in circulation.
The answer is that the banknotes issued by the Bank represent only a small portion of all the money circulating in the economy at any one time.
http://www.bankofcanada.ca/wp-content/uploads/2010/11/canada_money_supply.pdf. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au
Circulating Money, Hoarded Money, and Debt in Canada. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au

The above graph is fascinating. The only money that is being useful is the pale blue Circulating Money. This is money that changes hands at least monthly. The grey Hoarded Money sits in bank accounts as ‘savings’. It does not contribute to the wealth generation because it is not enabling transactions. It is the Circulating Money that is the vital circulating medium that enables the nation to sustain itself. The hoarding of money stifles the transactions that are vital to an economy. In Canada, only 4% of the Money Supply was created as Cash Currency. [M0 = $C82.7 billion, M3 = $C2193.8 billion gives 3.769%] Thus 96% was created as credit at the time of creating loans. The credit is 96% of the Money Supply. Unfortunately, a strange side effect is that the debt that was created at the time of creating the credit increases due to interest. Interest has bloated the debt to become unpayable. Circulating Money is about 10% of the Money Supply [about $C219billion] against a debt of about $C5000 billion. If we suppose an average interest rate of 5%, the interest comes to $C250 billion. Thus the interest to creditors exceeds the volume of Circulating Money. Total tax revenue for the federal government in 2009 was $C237 billion. Interest to private banks exceeds tax revenue.

Quite clearly the debt is not repayable for a number of obvious reasons. The most obvious is that the volume of debt exceeds the volume of money. The second it that any attempt to pay off the debt would remove the vital circulating medium. All economic transactions would cease. Once we decide that repayment of the debt is impossible, we have no other option but to maintain the debt. I often word it as:

We can live with debt. We can live with unpayable debt. (We are doing so at present.) We cannot live with monetary collapse.

Collapse is worse than debt.

Here you can see a serious drop in the Bank Credit issued by the banks in Canada in about 2007. (I forgot to correct the x-axis shift on this graph. The 2007 figures were recorded as 2007 rather than 2007.99 or 2007.5)

Graph of Domestic credit provided by financial sector (% of GDP) for Canada. Creative Commons Attribute - Andy Chalkley. www.andychalkley.com.au