Saturday, November 14, 2009

Thoughts at Three A.M.

Up, up, and away...

It seems to me there are three basic reactions to the apparent shift in Fed policy that can be seen in this graph. First is the view that printing money causes inflation and, basically, we're doomed. This view leaves no room for discussion.

Then there is the view that maybe they're not all idiots at the Fed. As the lender of last resort, the Fed resorted to an unprecedented increase in the quantity of money to deal with an emergency. And when the time is right, the Fed will withdraw that money and defuse the inflationary outcome.

There is plenty of discussion related to this view. How will they know when the time is right? How will they withdraw the money? What is the exit strategy? How successful will it be? Will we avoid some or much of the inflation that we expect?

That discussion spills over to the fiscal side of policy. Is the stimulus working? Is it big enough? Is it too big? Was it even needed in the first place?

And then there is the third view.

How did we get into this mess in the first place? What is the origin of this emergency that the Fed finds itself dealing with? What is the nature of the underlying problem?

The simple answer: We have come to use credit for money.

Joseph Salerno will tell you that "money serves as the final means of payment." And therefore, that credit is not money. But someone forgot to tell the American people, because we use credit for money.

Economics 101 textbooks list three points to define money:
1. Money is "a standard of value" -- like "the dollar" or "the euro."
2. Money is "a store of value" -- which is why inflation is a problem.
3. Money is "a medium of exchange" -- meaning we use it to buy things.

According to item three on that list, credit is money because we use it for money.

But if you like, let's say Salerno is technically correct. Credit is not money. After we buy things on credit, we're left with a record-of-spending called debt. And we still have to come up with the money to pay off that debt. And therein lies the problem.

How did we get into this mess in the first place? We have come to use credit for money. We have pushed back the "final payment" problem, and then pushed it back more, like a plow pushing snow. But when you push snow it just piles up. And sometimes, it piles up so much that the pile gets too big to push. And then -- push all you want -- you just can't make any more headway.


The Arthurian said...

My thought here is, the first graph is a response to the second graph. That is, the Federal Reserve keeps pushing up the quantity of money all during fifty years (as the first graph shows), but it still does not provide enough money to pay for all the debt (as the second graph shows). Thus at the end, the sudden shoot-up in the first graph.

My solution would have been to let the first graph increase maybe a little faster, but also -- and here's the step that's never taken -- see to it that the second graph peaks and starts to fall, or at least levels out, before the economy reaches its breaking point.

The Arthurian said...

And where's the breaking point?

Well, you can see where it was in 1933, and our economy broke four years before that.

We climbed back up to that breaking point by the early 1970s, and our economy has been in trouble since that time.

I'd like to see the Debt-per-Dollar number fall by half. I think we could live with that.