Chapter 15 - A Lesson From The U.S.A.

USA 2008

In April 2007, the M2 Money Supply fell by less than one percent. In January 2008, the M2 fell by a small fraction of a percent. In May 2008, M2 fell by less than 1%. In the few months up to July 2007, M1 fell by 2.5%. Cash Currency did not fall. The velocity also fell during this time. The next graph shows a fall of about 3.4% in Circulating Money for U.S.A. at around 2008. (Circulating Money is money that moves within one month.)

A graph of the Circulating Money in the USA. Creative Commons Attribute - Andy Chalkley.

The USA fall matches a fall in the Money Supply in the following graph. A small fall in the Money Supply has caused a larger fall in the Circulating Money. What occurs is that the fall in the Money Supply removes money from Circulating Money whilst Hoarded Money remains hoarded. You will remember that tax is taken from Circulating Money whilst Hoarded Money remains untaxed. You will also remember that repayments are taken from Circulating Money because people with Hoarded Money do not need to borrow money. Thus a small fall in the Money Supply tends to cause a large fall in Circulating Money:

A graph of the USA Money Supply showing Hoarded Money and Circulating Money. Creative Commons Attribute - Andy Chalkley.

In the following graph, you can see that the Cash Currency (orange) did not falter. At no time did the Cash Currency fall. This phenomenon is not influenced by any control that the government may have over the Federal Reserve. This fall in Circulating Money is not caused by the Federal Reserve issuance of Cash Currency:

A graph of the USA Money Supply showing Cash Currency. Creative Commons Attribute - Andy Chalkley.

Following the fall in the Money Supply at about 2008, the Money Supply increased but most of it became hoarded as is demonstrated by a look at the velocity during this time. Money pushed into the economy did not boost Circulating Money. The hoarders got their hands on it. Most of the increase in the Money Supply ended up becoming Hoarded Money held by persons with ‘more money than they could spend’.

A graph of the USA velocity of money from 2000 showing a dip in Circulating Money. Creative Commons Attribute - Andy Chalkley.

This is the same thing but over a longer period of time:

A graph of the USA velocity of money. Creative Commons Attribute - Andy Chalkley.

There was talk that the “people were hoarding money”. However, the ‘people’ were mostly short of money and were spending it within a week of receiving wages. It was persons ‘more money than they could spend’ that were hoarding. The working people were in no position to hoard money. This was the hoarders appropriating the increase in the Money Supply.

In this next graph, you can see that almost all the increase in the Money Supply was appropriated by the hoarders. Almost none of the money released during Quantitative Easing entered the Circulating Money:

A graph of the USA Money Supply showing Hoarded Money and Circulating Money. Creative Commons Attribute - Andy Chalkley.

Why the Money Supply Fell

Let us work out why the Money Supply fell. In the USA, 7% of the Money Supply is created as Cash Currency by the Federal Reserve. This did not fall. This situation was not caused by the Federal Reserve with its Cash Currency creation. Since a series of machinations around one hundred years ago took the money creation facility away from government and put it in the hands of private corporations, the government no longer creates money. If the government needs money, it borrows money. They are separate procedures. The operation of government and the creation of money are separate procedures. The government needs money to operate as a government. Society needs money to conduct business. Money must be created delicately in quantities to suit the economy. If there is too much creation, inflation occurs. If there is no creation, a recession occurs. Excessive creation is likely to cause collapse through hyperinflation. (Hyperinflation occurs when Hoarded Money comes out to play.) Without the ability to create money, the government collects tax and any shortfall is borrowed through a process of issuing bonds. Taxation is collected and spent back into society. No Money Supply increase occurs. When the government issues bonds, it is exchanging the bonds for existing money, so there is no increase in the Money Supply. There is a quirk here. When bonds are sold they are exchanged primarily for Hoarded Money. The government spends the money into circulation. Thus the act of selling bonds tends to move Hoarded Money into Circulating Money. The action of selling bonds does not cause an increase in the Money Supply. So the government has no influence over the magnitude of the Money Supply. The magnitude of the Money Supply is solely influenced by the rate at which banks issue credit. If the banks issue credit faster than they collect repayments and interest, the Money Supply increases. If the banks collect repayments and interest faster than they issue new credit, the Money Supply falls.

In this following graph, you can see a huge cutback in the lending of banks to the private sector. Repayments continue to be collected. This causes a big fall in the Money Supply.

A graph of the USA Commercial and Industrial Loans. Creative Commons Attribute - Andy Chalkley.

This causes a change in the Circulating Money. Changes in the level of lending cause fluctuations in the volume of Circulating Money:

Circulating Money Annual Change USA by Andy Chalkley data from Fred. Creative Commons Attribute - Andy Chalkley.

Tax Collection

Changes in the Circulating Money causes sympathetic changes in the government tax collection. In the next graph, Tax Revenue is shown in red. As the banks cut lending, the Circulating Money falls (blue) and the tax revenue (red) falls as the economic activity falls. The percentage fall in tax revenue is greater than the fall in Circulating Money:

GDP v Government Revenue. Creative Commons Attribute - Andy Chalkley.
Corporate Income Tax and Circulating Money. Creative Commons Attribute - Andy Chalkley.

State Sales Tax almost exactly mirrors the Circulating Money:

State Government Sales Tax and Circulating Money. Creative Commons Attribute - Andy Chalkley.
State Government Income Tax and Circulating Money. Creative Commons Attribute - Andy Chalkley.
State and Local Government Total Tax and Circulating Money. Creative Commons Attribute - Andy Chalkley.

This next graph shows a dramatic relationship between Circulating Money and Unemployment. This graph shows the supreme importance of maintaining Circulating Money.

Unemployment and Circulating Money. Creative Commons Attribute - Andy Chalkley.

A consideration of Circulating Money reveals that businesses simply pass money through their hands and do not decrease Circulating Money. Since the days when revolutions removed the practice where sovereigns created the debt-free money of the nation, governments remove tax from Circulating Money but spend it straight back into circulation, thus not affecting the volume of Circulating Money. When governments borrow money through bond issues, they are borrowing existing money, which is quite likely to be Hoarded Money. This does not increase the Money Supply but it tends to increase Circulating Money. (When the government borrows by issuing bonds, it tends to borrow Hoarded Money which it subsequently spends into Circulating Money.) The only strong influence over Circulating Money is tied into 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’. It is a rare event for Hoarded Money to be removed from the hands of hoarders. Hoarded Money tends to stay hoarded. Hoarders tend to manipulate the taxation system to their advantage such that their hoards remain tax-free and their income and their speculative spending remain untaxed.

Reverse Logic

A fall in the Money Supply tends to cause a recession. But this is not the only thing that can cause a recession. An increase in hoarding will cause a recession. A fall in velocity will cause a recession. It is utterly incorrect to assume that the opposite is true. It is not reasonable to assume that an increase in the Money Supply will cause an increase in the economy. These factors are related mathematically in the equation Velocity times Money Supply equals GDP. GDP is the annual turnover. Monthly turnover is GDP divided by 12. Monthly turnover is equivalent to Circulating Money. There is misplaced 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’. The procedure needed to increase the Circulating Money is not straight forward. 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. A fall in the Money Supply has damaged businesses. Some have closed their doors permanently and others have laid off staff. These businesses are not going to increase output simply because the opportunity exists. Business is not going to crank up simply because credit is available. Business owners that have been psychologically damaged by situations not of their making are going to be very reticent to increase business. It becomes very attractive to downsize and lead an easier life free from the pressure of employing persons who are not very thankful for the opportunity. Very business friendly conditions need to be created. Employment is effectively the organized organizing the disorganized. Laws that support employees rights and ignore employee obligations are not conducive to strong business. Tax regimes that hammer employees and employers but are soft on non-productive hoarders and speculators are not helpful.

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.

USA graph of debt and money. Creative Commons Attribute - Andy Chalkley.

In the above graph, you can see many features. Notice what happens about 2008. You can see M3 falters. You can see that Cash Currency does not fall which gives a hint that this is not a government created issue. You can see that the Private Debt falls quite dramatically. You can see a dramatic expansion of Government Debt. The government has the authority to create the money for the nation, but is sinking into debt. This is an interesting situation where the government is in debt to private entities. The government has the authority to create the money of the nation, but is in debt to private entities that do not have the authority to create money. It is a nonsense that we should be required to pay interest on our own currency.

Let us have a careful look at another series of graphs that I have created to illustrate the 2008 crisis. Take a long time working through this graph. Notice that Cash Currency did not fall. Notice the fall in the Money Supply and its relation to the fall in Private Debt. Private Debt falls as fresh loans are not created. However, loan repayments and interest continue to be collected. The result is a fall in the Money Supply. The fall in the Money Supply is removed from the Circulating Money. This damages the GDP. The government tried to rectify the 2008 situation by taking on debt itself in a clever obfuscation called ‘Quantitative Easing’. I’ll explain Quantitative Easing in a later chapter. There is some fascinating logic behind it and it would take a genius to design and execute the process. It nearly worked, but the hoarders got hold of the money. The essence was that the fed bought existing bonds, which released freshly-created virtual dollars into the Money Supply. The fed created the fresh bank-credit to purchase existing and perhaps new bonds [in a ratio I have yet to determine]. The credit was created out of thin air. This certainly puts new bank credit into the Money Supply, but you can detect a fall in velocity, which indicates that the money fell into the hands of those with ‘more money than they can spend’. My thinking is that the bonds were purchased from institutions who had no need of money. The better solution would be to ensure money got to persons with little money who would spend it immediately into circulation and into the hands of small business owners. You can download these graphs from the website. The result of the ‘Quantitative Easing’ increase in the Money Supply was that the increase largely finished up in the hands of those with ‘more money than they can spend’ and thus became hoarded. A full understanding of the process is only possible by considering Circulating Money. It took three years before I could compile the following graph. I doubt that you will understand it at the first attempt.

A graph of the USA around 2008 explaining the mechanism of Quantitative Easing. Creative Commons Attribute - Andy Chalkley.

This graph shows the Federal Reserve increasing its holdings of US bonds. This was the major characteristic of the ‘Quantitative Easing’. The Federal Reserve created fresh credit out of thin air and purchased government bonds. One might assume that this fresh credit masquerading as money would increase the Money Supply in a manner to increase business activity. It was a masterful concept by someone with great insight. However, there was one major flaw. A lack of understanding of the relationships between Money Supply, Circulating Money and Hoarded Money led to the oversight that bonds are sold to institutional operations that operate outside the real economy. The bonds were purchased from institutionalized institutions that allowed the money to stagnate in bank accounts. Even if the institutions purchase shares, this does not help. It is only the initial issue of a share by a company that brings money to the company. Subsequent share transactions are simply speculative gains for shareholders. Even the first share sale by the company is a selling of part ownership of the company for expansion, largely due to unfavorable treatment of expanding companies by the tax regime. Any company wishing to expand is forced to auction itself off to ‘investors’ (people that have more money than they can spend, sometimes called ‘rich pricks’). The company then has to work and stress to create profits for totally idle owners. In this next graph, you can see the dramatic increase in the Federal Reserve holdings of government debt. In other words, the citizens, who own the government, owe even greater quantities of unpayable debt to the ultimate private owners of the Federal Reserve. The Federal Reserve bought this debt with money it created by the flick of a pen and the people thanked them for ‘saving’ their economy:

A graph of the Federal Reserve holdings of government bonds during the period of Quantitative Easing. Creative Commons Attribute - Andy Chalkley.

There is almost no obvious action that a government can take to cure a recession. The recession is caused by a heavy cutback in bank lending. This might be a purposeful action by the banks or it might be reluctance by the citizenry to take on more unpayable debt. Spain is a nation in a long term recession. Note that Cash Currency did not fall. Credit available to the private sector dried up as can be seen in the level of private debt. The government took on extra debt to cover a shortfall in tax revenue due to a fall in business activity. It is the usual folly of taxing activity rather than hoardings:

A graph of the Money Supply and Debt for Spain. Creative Commons Attribute - Andy Chalkley.

Taxation is unlikely to help. Tax is collected from Circulating Money and spent back into circulation. Tax revenue falls during a recession because the government is encouraged to tax productive activity rather than the parasitic activities of hoarders and speculators. The government has been separated from its ability to create money. All that is needed is a small percentage increase in the Circulating Money. A one percent increase in Circulating Money would amount to about $16billion increase in Circulating Money [$1600billion/100] This is about 0.1% [16000/16]> of the volume of Hoarded Money. If 0.1% of Hoarded Money was pushed into circulation, the recession would cease. The minimum monthly balance of bank accounts needs to fall by 0.1% to end a recession. The Cash Currency is created at arms length and only comprises 7% of the Money Supply. The demand for Cash Currency is dictated by the public demand for cash which the citizenry purchase with Bank Credit. If the government issues bonds to obtain borrowed Money, the bonds are purchased with pre-existing Bank Credit. When this pre-existing Bank Credit is spent by the government, it is likely to move into Circulating Money. Thus government borrowing by bond issuance will increase the Circulating Money and thus release the nation from the indignity of a bank-induced recession. Here is a graph to illustrate the process where a government purchases bonds to exit a recession:

bond issues and the conversion of Hoarded Money to Circulating Money. Creative Commons Attribute - Andy Chalkley.

There is no obvious action the government can take to directly increase the Money Supply. Even when the Money Supply is increased, there is no certainty that the Circulating Money will increase. There is no way that the government can force banks to issue fresh money and no way of forcing the generated bank money into business. The central bank makes some effort to give the illusion of control by adjusting the interest rates in a collusive manner. Interest rate manipulation has side effects. Some adjustments can be made through the tax system to enable business to expand without the tax burden. The prime target here is depreciation. Delaying tax deductions for money spent forces businesses to scurry to the money lenders. Generally the act of taxing productive effort whilst easing tax on those with ‘more money than they can spend’ puts the affluent in a position of financial power over those that create genuine wealth for the nation. One solution is for the government to create a public bank and counter the destructive cyclical nature of bank lending by partaking in what is commonly called ‘counter-cyclical finance’. This involves the government bank creating loans for public development at exactly the time that the private banking industry decides to restrict lending. In a public bank scenario, the public bank is owned by the government on behalf of the people and is in a position to lend for government projects in a manner that the government owes interest to itself. They tend to be opposed by the establishment beholden on the favors of the private banking industry. Another action is to take business-friendly actions to encourage business. This will include regulatory changes and taxation changes. Particularly hurtful to business expansion is the depreciation of purchased assets. Although little recognized, depreciation is a delay in tax deductions for assets purchased by expanding businesses. Another hurtful tax is Payroll Tax which favors those with unearned income which tends to be the hoarders of money. Sales Tax is hurtful to business and should be reduced or simply delayed. Sales Tax is counter-productive to a vibrant economy. Here follows a graph that demonstrate that Income Tax reduction can lift business activity causing a lift in tax revenue.

A graph demonstrating that a reduction of income tax rate can cause an increase in government revenue. Creative Commons Attribute - Andy Chalkley.

The graph is somewhat controversial. The graph shows two occasions where the tax rate was reduced causing an increase in tax revenue.

A government needs taxation. In times gone by, when the sovereign government created the money, taxation ensured that there was no oversupply of money. In modern times, there is a new experiment in the nature of money creation. Where money is created by other than the government, tax is collected and spent back out into society. Any shortfall is gathered by contracting debt mainly through the issue of bonds. This can create a situation that I call ‘Bond Blackmail’ where bond holders might refuse to rollover (renew) government bonds. The debt is typically blamed on the incumbent government when there is actually no possibility of repaying the debts to the moneylenders. However, the system can work, but it does require that the constant rise in the debt be ignored. However, in general terms, the government collects the tax and spends it back into circulation. This does not alter the Money Supply. The government tends to favor the hoarders and speculators through favorable taxation arrangements. Tax needs to be collected collected in a manner that does minimal harm to the welfare of businesses. Where tax is taken inappropriately, the gap between rich and poor increases. If the tax regime is not carefully crafted, the entire economy is slowed. In some cases, the tax may even become revenue negative such that an increase in tax rate will cause a reduction in government revenue. Some taxation methods may be so difficult to enforce that an army of taxation officers are necessary to enforce compliance. The taxation authority may become like a second police force. In general, it is better to leave the money in the hands of the working people for they spend it quickly which keeps the Circulating Money flowing.

Taxation tends to be taken from the Circulating Money. Although tax is seen as a negative, the government spends the taxed money back into society. Those with ‘more money than they can spend’ will tend to discourage tax on their money hoardings and accumulated assets with the result that almost no tax will be taken from Hoarded Money in the form of Land Tax, Rates, Demurrage Tax, Wealth Tax, Financial Transactions Tax, Death Tax and Inheritance Tax. Unearned Income is taxed at a lower rate than earned income due to Payroll Tax. An army of clever accountants finding procedures that are not available to the wage earner. Bank lending often tends to favor investors rather than small business. Small business will suffer from the lack of available credit whilst land prices will be inflated by excessive lending for real estate speculation. This pushes up business costs and drives business to countries that do not have ‘usury of land’. Speculation on land destroys productivity.

As Circulating Money falls, government revenue falls, government expenses rise and government deficit rises. It is thus crucial the Circulating Money does not fall. In the following graph, at around 2008 to 2010, the tax revenue falls and the government expenditure rises. The difference is given a name to digest that it is a current government fault. In reality, the tax regime has been adjusted in favor of the hoarders by previous governments falling for well-funded lobby groups. The tax regime based on taxation of productive effort causes the tax revenue to fall in sympathy with a fall in Circulating Money. The decline in the Money Supply is caused by cutbacks in lending. Yet the government gets blamed for economic mismanagement for its inability to control a so-called deficit.

A graph of the revenue, expenditure and deficit in the USA. Creative Commons Attribute - Andy Chalkley.
Tax Revenue in the USA. Creative Commons Attribute - Andy Chalkley.
USA Tax Collection. Creative Commons Attribute - Andy Chalkley.

Now to test your comprehension. See if you can understand the logic in this next set of graphs. In the top graph, the Hoarded Money fell at about 2008. This does not hurt the economy because Hoarded Money sits idle in bank accounts. However, Circulating Money fell slightly. Circulating Money changes hands regularly and so the effect is extremely damaging. Economists point to the fall in velocity and make inappropriate claims that “People are hoarding money.” But this is not correct. Even the Fed said this. In the St. Louis Fed paper, Yi Wen and Maria A. Arias asked: “The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it. Such an unprecedented increase in money demand has slowed down the velocity of money.” [3] It was not the working people that hoarded. They were even more broke than previously. It was the hoarders that hoarded the fed’s fresh money. The Fed gave it to the wrong people. Here the authors point to the total inability of the Fed’s ability to handle the Money Supply: “This implies that the unprecedented monetary base increase driven by the Fed’s large money injections through its large-scale asset purchase programs has failed to cause at least a one-for-one proportional increase in nominal GDP. Thus, it is precisely the sharp decline in velocity that has offset the sharp increase in money supply, leading to the almost no change in nominal GDP.” [3] Asset purchases refers to the Fed creating fresh credit by writing numbers in a book and buying government debt. I suggest that the fed purchased the debt from financial institutions that hoarded the money and spent no money into the real economy. The money went to the ‘Rich pricks’.

at 2008, you can see that the volume of Hoarded Money actually fell, although the proportion of Hoarded Money increased. It is the Circulating Money that falls that causes the damage to the economy. Claiming that the people are hoarding is ridiculous. It ignores the fact that ordinary people have no money left at the end of the week. Ordinary people do not hoard. People with ‘more money than they can spend’ hoard money. The monitoring of Circulating Money is far more important than the monitoring of the Money Supply. One group that has demonstrated an inability to maintain neither the Money Supply nor the Circulating Money is the central banks. Another group that has a patent disregard for the Money Supply and the Circulating Money is the private banks. Their disregard extends to the total volume of credit issued and its failure to place the credit in the hands of those that operate in the real economy:

USA Hoarded Money and its relationship to Circulating Money. Creative Commons Attribute - Andy Chalkley.