BY GEORGE BERISH – “Federal Reserve Chairman Ben Bernanke … is prepared to take more unconventional policy steps …’because we don’t want deflation.’ …”
When a partisan Federal Reserve Chair threatens “more unconventional” steps than he’s already taken, people who still have savings and investments should listen. When he also mentions “deflation”, they should listen intently. And when he’s been heard to say the Fed can buy furniture and store it in warehouses to increase economic activity – or at least the illusion of activity until his appointer’s next election – they should listen fearfully.
But first you need to understand what the Federal Reserve System “is”, what it does, and how it does it. And that requires understanding what “Money” “is”. So this multipart-part primer on “Money & Banking” in America begins with “Money”.
Defining “Money” is easy. What’s difficult is persuading virtually everyone that virtually everything they believe to be true about “Money” is false. But here goes.
“Money” is a word. It means a “benchmark” used in Economics to assign a number to the abstract concept of “Value”. A close analogy is “Degree” that is used to assign a number to another abstract word — “Temperature”. “Benchmarks” are needed, because abstract concepts do not have absolute numbers of their own.
For, example, if “someone” picks the temperature of ice as the benchmark for Zero, water boils at 100 “Degrees”. But if they pick the “Temperature” of empty Space as the benchmark, water boils at 373.15 degrees.
Unfortunately, “Value” is even more abstract than “Temperature”. That’s because ice always melts a lower “Temperature” than the “Temperature” at which water boils. However, the “Value” of an item of stuff can be more than the “Value” of some other item today, but less than it tomorrow.
E.g. consider the “Value” of a KFC fried chicken leg. To a woman drowning in the middle of a river, its “Value” is literally Zero. To a mother watching her child die of starvation in an African nation whose food delivery infrastructure was destroyed by the world’s latest ethnic cleansers, its “Value” is likely greater than the “Value” of her life or dignity.
IMPORTANT: That means stuff cannot be used as “Money” – not even gold. That’s because the “Value” of “Money” must be constant, but the “Value” of stuff never is.
For example, the “Value” of gold soars when a madman creates a war or a community organizer foments a strike of Africa’s gold mines. It falls when accelerating economic activity makes other investments more attractive. And it will crash if a scientist ever discovers a cheap way to extract gold from sea water.
E.g. imagine borrowing $300,000 to buy a house 10 years ago. If gold was “Money” back then you would have borrowed 1,000 gold coins, whose “Value” at that time was 16 hours* of work at the average hourly wage ($300 ea.). Today you’d have to repay with coins whose “Value” is 69 hours* of work ($1,600 ea.). Now imagine every contract in America expressed in terms of gold money.
Next it’s necessary to realize that abstract things can’t be seen or touched. Therefore, it is necessary to create visible/tangible “Tokens” to show how much “Money” exists, and who owns it.
Long ago, the people of Yap used giant stone wheels as “Tokens” to show a person had “Money”. Today Americans use two “Tokens” 1) an entry (computer bits) in some bank’s ledger with a person’s name on it, or 2) “Currency” in our pockets.
[Note: The stuff used to make a “Token” cannot have a significant “Value” itself. Otherwise there is endless confusion between the value of that stuff – as stuff – and the value it represents as “Money”. Keeping the “Value” of the stuff in a “Token” trivial compared to the amount of “Value” a “Token” made out of that stuff represents prevents that confusion: Use valuable stuff, like gold, as “Money”, or as “Tokens” to represent “Money”, guarantees that confusion.]
So in ancient Yap the “Value” of the stone in its “Tokens” was virtually worthless compared to the “Value” it represented in a “Token”. And in America computer bits, paper, and junk metal in ingots are virtually worthless compared to the “Value” they represent as “Tokens”.
Next, how much “Money” should exist? Simple. Enough “Money” so that at all times:
The “Value” of all the “Money” = The “Value” of all the stuff available for purchase with it.
For example, when farmers harvest grain in the fall, they increase the stuff available for purchase. As people eat it in the winter, they decrease the amount. Therefore, “someone” must be able to increase and decrease the amount of “Money” to keep things in balance. Otherwise the “Value” of “Money” isn’t constant, which means it’s no longer a “benchmark”, which means it’s not “Money” anymore. More specifically:
— If the amount of “Money” doesn’t increase when the amount of stuff does (or the amount of “Money” decreases when the amount of stuff doesn’t), the result is “Deflation”. More stuff divided by the same amount of “Money” means each “Token” represents more stuff than it previously did. Lenders get a windfall, because they are repaid with “Tokens” that are worth more stuff than the ones they lent. Borrowers suffer. [Hence, Bernanke’s fear of “Deflation”. China is a massive lender. America is a massive borrower].
— If the amount of “Money” doesn’t decrease when the amount of stuff does (or the amount of “Money” increases when the amount of stuff doesn’t), the result is “Inflation”. Less stuff divided by the same amount of “Money” means each “Token” represents less stuff than it previously did. Borrowers get a windfall, because they repay lenders with “Tokens” that are worth less stuff than the ones they borrowed. Lenders suffer. [People ignorant of China’s history dangerously believe China will meekly submit to Americans using inflation to renege on their massive debt to China. That is not likely.]
That’s it. Here’s all you need to know about “Money”:
1) It must have a constant “Value” or it is not really “Money”,
2) “Someone” must be able to keep the amount of “Money” in the economy equal to the amount of unconsumed stuff in the economy, i.e. must be able to create and destroy it as needed,
3) Stuff cannot be used as “Money”.
Future installments will address what that “someone” is; who owns that “someone”; the two ways that “someone” is legally permitted to literally mouse-click “Money” into, and out of, existence; and “Money’s” lack of any “benchmark” as stable as “Temperature’s” melting ice? Preview: America’s laws do not allow the federal government to create “Money”, but citizens can destroy “Money”, and therefore Deflation, by repaying loans. “It’s complicated”. But it’s also vitally important to understand.
George L. Berish for The American Political Party