Elastic Money Supply

On today’s show we are talking about the money supply and whether we would be better off with a fixed money supply such as when the dollar was on the gold standard.

In a fixed money supply the economy cannot grow. In fact it is possible for commerce to be inhibited by a lack of money in the system.

Back in the 1970’s the Italian Lira was dropping in value. That meant that the coins in circulation were worth more than the face value of the coins. You could melt down the coins and sell the metal for more than the coins were worth. Coins virtually disappeared from circulation. In those days if you went to the grocery store and, you could expect to receive change in the form of postage stamps which had a face value. When the postal service could not keep up with the demand for stamps, the shop keeper would go to the shelf and grab a big bag of caramels or hard candies and give you a handful of candies as change. It was not very long before you could go to the store and buy a bunch of bananas and pay for it with postage stamps or caramels instead of paper currency or coins.

If you think about it, you don’t want commerce to be inhibited by a lack of coins in circulation. By extension a fixed money supply can result in an inefficient distribution of monetary resources. If I start hoarding cash and keep that cash out of circulation, I can create the exact same conditions as the coin shortage in its in the 1970’s. You don’t need to melt the coins to create the problem. Just keep the coins in a jar in your kitchen cupboard and you will create the same problem.

We have been programmed to think that government has a monopoly on the money supply. But as we will see, we have always had elasticity in the money supply. Let’s imagine a simple example where you or I can create money out of thin air.

Let’s imagine that you are an artist and you paint a painting using about $20 in materials between the paint and canvas. You put the painting on display at the local gallery and a customer comes in and agrees to buy your painting for $1,000. It’s a lovely painting and $1,000 seems like a fair price. But the customer confesses has they are a bit short on cash so you agree to extend credit to the customer. The customer gives you $100 in cash and you write up a loan agreement for $900.

Did you in fact increase the money supply by $900? That $900 now appears on your balance sheet as an asset and there is $900 as a liability on the customer’s balance sheet.

Government was not a party to the transaction. The central bank had nothing to do with the creation of the $900 that funded the painting.

Ok, so we have established that we don’t need government to print money. Money can be loaned into existence.

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Host: Victor Menasce

email: podcast@victorjm.com