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Money Against Crises

Creating Money as a Way of Fighting Overproduction Crises

Using the information on how money is created, we can consider how the emission helps to fight overproduction crisis problems. This crisis arises when one part of the population that has monetary resources has no motivation to spend them, while the majority of the population willing to purchase consumer goods or own real estate or run a business has no money to do so. This vicious circle cuts economic demand and causes economic depression.

The fractional-reserve banking system, despite its drawbacks—or, to be more specific, due to them—allows creation of demand, thus stimulating economic growth. It has a surprising way of solving the overproduction crisis problem: it allows savers, who are unwilling to spend, to “save” their money while allowing consumers or investors, who do not have the money, to spend it. Now we can easily show how it works.

Money owners have an opportunity not to spend it, but deposit with a bank and draw interest:

CB Money

100 units

Engaged clients’ funds

100 units

The bank can grant consumption loans:

CB Money

100 units

Engaged clients’ funds

100 units

Loans

100 units

Created money (consumers’ accounts)                           100 units

Upon receipt of the loans, consumers remit the money for the goods and services on sellers’ accounts, while the bank makes a wire transfer:

CB Money

100 units

Engaged clients’ funds

100 units

Loans

100 units

Created money (consumers’ accounts)

0

Created money (sellers’ accounts)100 units

 

As we can see, credit emission leads to the appearance in the economy of both new money stock of one hundred units and a new income (sellers’ revenue) of the same amount. Manufacturers are able to sell their goods, which would be impossible if no new money was available. This availability of money undoubtedly stimulates economic growth, but only at the expense of building a pyramid in which the debt burden of some economic entities continuously grows together with the new money owned by others. The fractional-reserve banking system works by the assumption that borrowers will pay back their debts with interest, based on which the bank will be able to fulfill its obligations to the money owners. But let us think about this: how can it be accomplished?

After the money stock is increased by issuing loans, the economic system will continue working in the previous mode: the newly created cash, after being spent by the borrowers, will partially get back to the savers’ hands, suppressing the demand that will have to be stimulated by granting new loans. This lending will go on and on, until the pyramid grows to a cosmic scale, and the amount of accumulated debt and money becomes incommensurably large compared to the cash flows serving the economy.

It is in this situation that the “crisis” occurs, when banks “find out” that their borrowers owe so much that they are unable to repay the money. The market solution for this problem would be declaring the bank’s bankruptcy. The bank must fail—its clients’ money will be lost and its nonperforming loans written off. The liquidation of bankrupt banks would lead to recovery of the financial system. However, it is not as simple as that. The government comes to rescue the system.

Let us look at how government support of the banks shows on their balance sheets and that of the CB.

Here is what bank books look like before banks acknowledge having loan problems:

Balance sheet of the banking system:

CB Money

25

Client accounts

150

Loans

 

155

Capital base

30

 

Balance sheet of the Central Bank:

Gold

25

Bank accounts

25

 

When it suddenly becomes clear that many of the 155 units of granted loans will not be repaid in due time and 25 units is obviously not enough to serve 140 units of the client accounts, the banks declare a crisis. The banks write off 35 units of clearly nonperforming loans, which results in huge losses exceeding their capital base. The government comes to the rescue.

Here is what the balance sheets would look like after the banks receive help from the government:

The banking system:

CB Money

115

Client accounts 

 

150

Initial Investment

155

Write-offs

(35)

Total

 

120

Deposits from the CB

 

50

Initial capital base

30

Losses

(35)

Government contribution

40

Total

35

 

The government helps by making a forty-unit contribution in the bank’s capital, while the CB grants it a fifty-unit loan. The banking system capital and its liquidity sharply increase. What happens on the CB balance sheet?

The Central Bank

Gold

25

Bank accounts

65

Loans to the banking system

50

Term loans to banks

 

 

50

Government bonds

40

 

The Central Bank has created ninety units of new money, fifty units of which were created by granting the loan to the banking system, and forty units were created by buying bonds from the government that immediately transmitted them to the banks’ accounts to increase the latter’s capitalization.

Therefore, the banks received money on the left-hand side of their books and supported their capital, i.e., obtained termless and irredeemable funds, insuring depositors’ money from future losses.

Such emergency measures protect bank depositors’ interests but change nothing in the system. The system remains the same, i.e., based on a fixed-income loan that enables savers to profit from keeping their money while being directly and indirectly protected by the government. At the same time, neither fixed income nor recoverability of the pool of loans funded by bank deposits is economy-based. Continued banking system operation based on the same old rules will lead to temporary growth in demand, fueled by new loans, but then to the emergence of a new crisis situation and the need for new help from the government.

However, in addition to supporting the banking system, the government may stimulate the economy by increasing government expenditure that creates demand. As you remember, any expenses always mean incomes for other economic players, and the government’s expenditure means revenue for businesses and salaries for public employees. Government expenditure is increased through issuing government bonds; in this case, the government independently (without resorting to the banking system) creates new money that is injected into the economy.

Unlike the banking system, the government debt pyramid is based on claims on general funds, rather than loans to private and legal entities. The asset recognized by Treasury as “Due from general funds” does not assume any liable party who can default. The words like “debt of taxpayers” or “burden of future generations” represent more ideological cliché than names of real obligors. The governments issue fiat money nowadays, and technically the pyramid of the national debt can grow indefinitely with the help of the CB.

Here is what stimulating the economy through issuing government bonds looks like on the Treasury, CB, and banking system’s balance sheets:

The Treasury issues government debts:

Due from general funds

100 units

Government debt

100 units

 

Government bonds are bought out by the CB that remits the money to the Treasury’s account:

Government debt

100 units

Funds in  the Treasurys accounts

100 units

The money received by the Treasury is then remitted to recipients of government expenditures, which looks as follows on the CB’s balance sheet:

Government debt

100 units

Funds on the Treasurys accounts

0 units

  Funds on banks’ accounts

100 units

 

On the bank’s balance sheets, it looks as follows:

Accounts with the CB

100 units

Accounts of bank clients who receive government expenditures

100 units

 

This way, the government increases incomes of physical and legal entities that receive the money issued by the government. Such a system replenishes demand missing in the economy and can be very stable since it is based on the power of the state and the society in general. But although governments have to continue funding a part of their expenses with new debentures, injecting new money in the economy, they should not become the main economic entities – this is the role of the private investors.

The real solution of the excessive savings problem that robs the economy of demand can only be related to stimulating the savers’ consumption and investment. Such stimulation must be a systemic part of the new financial architecture. By reason of the financial system’s internal rules, consumption and investment must become more beneficial than saving, so that physical and legal entities are economically motivated to invest their money in the economy.

The existing financial system de-stimulates economic activity. Governments impose taxes on both incomes and consumption, i.e., punish those who create economic products and those who generate demand so badly needed by the market. Money owners do not pay taxes exactly until they start being helpful to the economy, i.e. working, consuming, and investing. Moreover, the existing system allows those who remove money from the economy (thus causing crises) to earn interest on removing the money! Still further, it charges decreased tax rates on such interest income! There is little surprise that under such circumstances, we live in the conditions of a continuous crisis.

The existence of income on money (including government debts) as well as preferential taxation of unearned income stimulates money hoarding, freezes entrepreneurial initiative, hence suppressing demand and economic growth. The ideology justifies the interest rates and low taxes on interest income by stating that these measures help to stimulate savings and de-stimulate needless money spending. Consumer spending, which is in fact business income, is declared evil, and savings are quite unjustly equated to investments. Simply put, the system encouraging rent-seekers (i.e. persons or entities which receive rent i.e. eligible to collect money without a need to make any efforts) and do-nothings at the expense of entrepreneurs and hired workers is guised under a system that encourages the prudence and providence.

Bearing in mind the rootedness of this preconception and the importance of the issue, let us illustrate it by a simple example.

Suppose some primitive economy has a stock of assets totalling one hundred units of grain. In any underdeveloped economic system, there is always a deficit of goods and continuous underconsumption. For this reason, economic entities always have two options: either to eat up the grain or to save it for the future crop. Those who improvidently consume their entire stock will be left with nothing next year. Those who are prudent to save it and sow more than they did last year will get a larger crop next year. The grain can either be consumed or invested in a new crop. In this simplified model, there is no third option because there is no grain surplus, so anybody who saves simultaneously invests, helping its entire society with his reasonability and prudence. When they talk about the goodness of saving versus consuming, it is this primitive situation that they mean. From the obvious statement that prudence is better than carelessness, as well as from the very unobvious assumption that spending and saving money is equivalent to spending and investing tangible assets, they draw a conclusion about the advantage of money-saving and the admissibility of paying for it. It is not hard to notice that applying this logic to cash expenses does not work even in such a primitive society, since cash expenses do not disappear, unlike eaten grain, but become somebody’s income. Owning money means having power in the society, an opportunity to make economic decisions; if a money owner decides to consume, he or she will spend the money, or if he or she decides to produce a new crop, he or she will also spend money to organize this process. The money-saving act carried out by a wealthy person is not only nonidentical to investment but is opposite to it; a person saving money is like a person hiding his grain in a grain depot where it lies, unneeded by its owner and unavailable to others, until it spoils.

Financial crises serve to restore the health of the economy: passive savers would have to lose their money, and their actual economic expenditures would be much higher than any interest gained, thus turning the artificial money profitability into the natural payment for saving the liquidity. However, direct interference of the government restricting bank depositors’ losses shifts this economic burden to taxpayers, i.e., again on businesses and consumers. In this situation, the middle class and entrepreneurs suffer the most, having to pay this social rent. There is no wonder that the situation forces the class of entrepreneurs to shrink in favor of rent-seekers, and investors leave business projects, investing their funds in deposits and government bonds. This is the so-called flight to money. Why create new ideas, work hard, and spend sleepless nights in pursuit of success if a risk-free bank deposit makes it possible to generate higher profits than any return on one’s own investment?

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