Lessons from the Japanese: Time to Stop Borrowing Money and Start Printing It

In a fuller explanation on Zero Hedge, Tyler Durden (a pen name) quotes from Friedrich Hayek's Prices and Production (1935). Hayek said:

"There can be no doubt that besides the regular types of the circulating medium, such as coin, notes and bank deposits, which are generally recognized to be money or currency, and the quantity of which is regulated by some central authority or can at least be imagined to be so regulated, there exist still other forms of media of exchange which occasionally or permanently do the service of money.

". . . [I]t is clear that, other things equal, any increase or decrease of these money substitutes will have exactly the same effects as an increase or decrease of the quantity of money proper, and should therefore, for the purposes of theoretical analysis, be counted as money."

Lantz and Sweeney calculate that at the peak of the boom there were six trillion dollars in the traditionally-defined money stock (or money supply). The private shadow stock accounted for $9.5 trillion, and government-based shadow money accounted for another $11 trillion. Thus the shadow money stock dwarfed the traditionally-defined money stock. This can be seen in the chart below provided by Tyler Durden. The blue strips at the bottom, called "outside money," are dollars printed by the Federal Reserve. The red sections, called "inside money," are money created as loans by the banks themselves. The green sections, called "public shadow money," are money created by the government and the Fed as debt (or loans). The purple sections, called "private shadow money," are the money created as private debt securities by the shadow lenders.

shadow money

Lantz and Sweeney estimate the total drop in private shadow money (the purple blocks) during the current credit crisis at $3.6 trillion. This has been offset by an increase in public shadow money, both from the massive borrowing needed to finance the federal deficit and from the aggressive liquidity measures taken by the Fed in converting private securities into loans. Those measures helped prevent an even worse drop in the commercial money supply than actually occurred, but they were not sufficient to eliminate the credit squeeze from lowered commercial lending, which continues to act as a tourniquet on the productive economy.

Moreover, the lending situation is slated to get worse. At the G20 meeting in Pittsburgh in September, deadlines were set for increasing the amount of capital that financial institutions must set aside to cover their loans. That means that credit could get even tighter, further shrinking the global money supply and precipitating an even deeper depression.

Although the Federal Reserve cannot create money and simply spend it into the economy, Congress can. The Constitution authorizes Congress "to coin money [and] regulate the value thereof." A former chairman of the House Coinage Subcommittee once observed that Congress could solve its debt problems just by minting some very large-denomination coins. This solution is invariably rejected as dangerously inflationary; but when the "shadow money" is factored in, we can see that it wouldn't be. Government bonds already serve as money in the sense of a medium of exchange. They trade in massive quantities around the world just as if they were money. Paying off government bonds with newly-printed dollars and then ripping up the bonds (or voiding them out on a computer screen) would not significantly affect the size of the overall money supply, since "shadow money" would just be replaced with dollar bills (paper or electronic). In the chart above, green money (public shadow money) would become blue money (dollar bills and checkbook money), leaving the total money stock unchanged.

It might be argued that the money borrowed by the government has already been spent into the economy, and that if the bonds are now turned into dollars, the money will be out there twice. That is true; but on the shadow-money model, the inflation has already occurred and cannot now be reversed. It occurred when the government printed the bonds. The bonds are already out there serving as money. Whether the money stock takes the form of dollars or bonds, it will be used as a medium of exchange in the real economy.

Another argument often raised is that the money created as government securities and Federal Reserve loans has been "sterilized" by lodging it with central banks and commercial banks. When this money hits Main Street as dollars competing for goods and services, the floodgates will open and hyperinflation will be upon us. That is the alleged justification for keeping the stimulus money in the banks instead of in the marketplace. But then what was the point of the stimulus? If the money is only stimulating the banks, it is not doing anything for the real economy. We want money out there in the marketplace generating demand for products, which generates jobs. Price inflation results only when "demand" (money) exceeds "supply" (goods and services). If the money is used to create goods and services, prices will remain stable. We have workers out of work and factories sitting idle. They need some "demand" (money) stimulating them to create supply, in order to make the economy productive again.

Other critics point to gold's recent rise as an indicator of dangerous inflation already being upon us. The more likely explanation for gold's rise, however, is that foreign central banks are looking for something besides U.S. government bonds in which to park their money. They no longer want our bonds, so fine. Let's tell them no more are for sale. We will in the future sell our bonds to our own central bank, which will rebate the interest to the government after deducting its costs . And we will use the money, not to feed a parasitic private banking empire by building up bank reserves, but for direct expenditures on infrastructure and other public projects that will put people back to work, add to the productive economy, and increase the collective well-being of the people.

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