An old Coal Miner looks at Money

by Ted Crook

Recently a friend asked me to offer this essay for public consideration.  If there are questions about it, the wikipedia article on money supply will give more information than anyone sane might wish to know.

In 1923, inflation in Germany led to Adolph Hitler being taken seriously in Munich.

In 1932, the world depression led to Adolph Hitler being taken seriously in Germany as a whole.

Government policies ensuring the stability of money in both cases would have prevented world war two.

It is easy to see how the problem occurred in 1923:  a weak government having to print paper money lowered its value to nothing.

It is harder to understand what happened in 1930:  No one took paper money out of the economy, yet the supply of money shrank anyway.

Banks loaned money to stockbrokers to buy stock on margin.  When the market dropped, banks called in the loans, forcing sale of stock into a already diving market.  Eventually the banking system and the market stopped functioning.

Any form of banking system multiplies the amount of money in the economy.  When the system stops working, the multiplied money disappears.

The usual measure of the multiplied money is the M2--essentially the sum of the currency plus most bank deposits.

Here is a popular theme of conspiracy theorists:

“The evil bankers are messing with our money.  They’ve figured out some  magic way to make money out of nothing and charge us interest for it.”

There is, of course, no magic (and no evil conspiracy) in this multiplication.  It arises naturally because a banking system exists. Most of the money deposited in a bank is loaned out to be deposited in another bank...to be deposited in another...and another.  The result is more money on the books of banks than there is currency.

The banking system is a very important part of a free enterprise system.  If all banks were closed (and bankers jailed) tomorrow, a black market banking system would be in business the next day.

An easy way to estimate the amount of money multiplication is to divide the M2 by the currency.

In 1929, the M2 divided by the currency was about 12.  In 1933, the M2 divided by the currency was about 6.  No wonder all the jobs disappeared (and Adolph Hitler, claiming Jewish conspiracy, got political traction). By the way, the source of these numbers is the wonderful Bureau of the Census publication,Historical Statistics of the United States, Colonial times to 1970.

One theme often heard in conservative circles is the need to stabilize the currency by “returning to the gold standard”. Understanding how money multiplies, however, shows this to be a ridiculous step.  There is nothing wrong with the currency in circulation--all shocks to the economy occur with the multiplier.  Backing money with gold, silver, tin, copper, or potatoes doesn’t affect the multiplier at all.

The only way to stabilize the multiplier is to put systems in place to stabilize the banking system.  Currently the systems include the Federal Reserve, insurance, and regulation.

The current systems work well ordinarily.  The Fed can regulate the money supply by setting interest rates on any money they loan to banks.  When the system locks up, as it did in 2007 and 2008, control by interest rates fails, because no one is borrowing anything.

The thing that pulled the world out of the depression of the thirties was massive printing of money after 1940.  The multiplier stayed low, but the influx of currency for the war effort produced jobs and prosperity.

The US Treasury quietly inserted more currency into the economy in the years after 2008 which helped to stabilize the money supply.  If the multiplier can’t be fixed, the next option is to print money. If that fails, then the next option seems to be guns and fixed bayonets.

I am convinced that the American public understands the importance of money multiplication as well now as the Germansdid who voted for Hitler (sarcasm intentional--when were you taught about this in school?).

Since a shock to the money multiplier is the real source of most economic (and political) malaise, stabilizing the multiplier is the most important (and possibly most difficult) government duty.  After all, stabilizing money is alway easier than using guns and fixed bayonets.

Electing people who understand this simple concept of money multiplication should be the duty of every citizen...in every country.