An increase in the money supply will ultimately be consumed by an increase in the demand. That increase can take two forms: An increase in investment and production to create more goods, or an increase in the price of goods (inflation.) Too quick of an increase in the money supply will often be followed by inflation, but an increase timed well to a growing economy's need for more investment to foster an increase in production will generally result in just that.
Conversely, a decrease in the money supply will often spark a recession: The demand for produced goods is lowered, causing companies (producers) to lay off workers, decrease their capacity, sell off assets, etc. Once production drops to match the new (lowered) consumption demand, which correlates with the new lower money supply, the economy can begin growing again.
The main producer of our currency (North Korea's counterfeiting notwithstanding) is of course our government. They print all of our money, and move it into circulation via the Federal Reserve banks. The government keeps an accounting of all of that money, as they move new bills into circulation and retire old bills.
So, if the government is increasing the money supply to support a growing economy, shouldn't that increase show up as a permanent government deficit? This question has been nagging me for some time now. It's supported in the fact that the U.S. Government has run a net deficit since the 1930's, and we have had generally robust economic growth (some of the best in the world). If this is the case, too, as long as inflation is low or non-existent, should we even be concerned about the government's deficit?
True, part of the deficit is our current trade imbalance. There is no real imbalance: Manufactured goods move into America, and American money moves out. But if that money is not then used to purchase American made goods, but instead Government Treasury Bills, the accounting shows this as an increase in the Government deficit.
The really fascinating thing about this is that we always talk about it as a debt on government, a debt upon us, but it's really no such thing. I have to balance my household budget because I cannot print money. Our Federal Government is under no such constraint. So, if we are using a deficit to increase the money supply and hence grow our economy, there is no 'debt' that future generations must repay. The only 'debt' that may be incurred by future generations is if we increase the money supply too quickly, generating inflation and reducing our standard of living: Future generations will then have to grow their standard of living out of the hole into which we dug. But if our growth in money matches our growth in production and living standards, there is no repayment required.
True, China (our current largest 'debt' holder) could decide to sell its hoard of T-Bills. But all that would do would be to change the exchange of the yuan with the dollar, increasing the value of the yuan against the dollar, and making Chinese made goods more expensive in America. This would lower the standard of living for some of us as cheaply made Chinese goods would no longer be available, but it would make American production more competitive, and should trigger a growth in our manufacturing sector, and an increase in the standard of living for those employed in that sector.
And yet, even with all this, big name economists and business leaders – often bankers – continually warn us of the dangers of too great a Federal Deficit. Since these are quite often people who have dealt with economics and money all their lives, you have to wonder if maybe I've got it quite wrong. That maybe I've overlooked something – something important – that makes a large deficit not as benign as I make it out to be.
I worry about that too. So, I keep digging, keep reading, keep looking. And yesterday, I found this article by James K. Galbraith, that succinctly explains what I've been missing.
If you are particularly sharp-eyed, perhaps you caught it early in this essay. I moved easily from money creation to currency creation, conflating the two. The Federal Government is the only entity that can legally print our currency. But if you've lived long enough, you know that most transactions never require actual currency to take place. As such, money supply and currency supply are not exactly the same thing, and the Government is not the only entity that can produce money. The others are the banks, through lending.
Lending creates money just the same as government spending. Lending, especially for investment, provides the grease for increases in our economic output – just the same as government deficit spending can provide increases in consumption demand that also generates increases in economic output. And Professor Galbraith says it:
“Bankers don't like budget deficits because they compete with bank loans as a source of growth.”
Wait a minute! You mean to say that the Deficit Hawks aren't telling us something true or necessary about the economy, but are instead captives of a conflict of interest?
“And this, in the simplest terms, explains the deficit phobia of Wall Street, the corporate media and the right-wing economists. “
Ouch!
You really need to read the entire article, however. Professor Galbraith outlines the case for when we would prefer private lending to government spending, how the playoff between the two affects Government programs like Social Security and Medicaid, and hammers home some basic economics surrounding money creation and it's impacts.
Once again, too, we need to reaffirm that bankers and those employed in the Financial Industry are not altruists – they have no one's interests but their own when they tell 'us' what needs to be done. Basic Economics belies any claims they may make to the contrary.
