"We are completely dependent on the commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon."
Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta, 1934
Miners used to keep canaries in coal mines as an early
warning device. If the air was so bad that it killed the canary, the miners
would soon be next. Japan may be the canary for the out-of-control deficit
spending policies now being pursued in the United States and the United Kingdom.
In a November 1 article in the Daily Telegraph called "It Is Japan We
Should Be Worrying About, Not America," international business editor Ambrose
"Japan is drifting helplessly towards a dramatic fiscal crisis. For 20 years the world's second-largest economy has been . . . feeding its addiction to Keynesian deficit spending -- and allowing it to push public debt beyond the point of no return. The rocketing cost of insuring against the bankruptcy of the Japanese state is telling us that the model has smashed into the buffers.
". . . Tokyo's price index fell 2.4% in October, the deepest deflation in modern Japanese history. . . . The government could stop this . . . . It could print money Ã l'outrance to stave off deflation. Yet it sits frozen, like a rabbit in the headlamps.
"Japan's terrible errors are by now well known. . . . QE was too little, too late, and this is the lesson for the West. We must cut borrowing drastically over the next decade, and offset this with ultra-easy monetary policy. Does Downing Street understand this? Does the White House? . . . Clearly not."
In case you too have forgotten your high school French, "a l'outrance" means "to the uttermost." "QE" is "quantitative easing" -- printing money. Evans-Pritchard's proposed solution to the mounting fiscal crisis is that the government needs to quit borrowing money and start printing it.
Your response is liable to be that the government is doing that already, in spades; and it does not seem to be working. The Federal Reserve is madly printing money (or writing it into electronic accounts), increasing the money supply to the point that worried pundits are screaming about hyperinflation. Yet the credit crunch just continues to get worse.
And that is true. Money is being printed; but it is not being printed by the government. The U.S. government has opted to borrow rather than print, just as the Japanese did. The Federal Reserve is a privately-owned central bank, which issues Federal Reserve Notes (or dollars) and lends them to the government and to other banks. Those banks then leverage the money into many times that sum in interest-bearing loans.
The problem today is that bank lending has fallen off dramatically. The Fed has been creating money as fast as it can find federal and bank borrowers to take the money off its hands, yet it can't keep up with the rampant deflation in the real economy. Bank lending has dropped by 17 percent since October 2008, when the credit crisis was already in full swing. "There has been nothing like this in the USA since the 1930s," says Professor Tim Congdon of International Monetary Research. "The rapid destruction of money balances is madness."
The reason the level of bank lending is so important is that virtually all of our money today originates as loans created by private banks. Most people think money is issued by the government, but the only money the government creates are coins, which compose less than one ten-thousandth of the money supply -- about $1 billion out of $13.8 trillion (M3). Coins and dollar bills together make up only about 7% of the money supply. All of the rest is simply written into accounts on computer screens by bankers when they make loans.
And this is the real source of the exponential inflation in the money supply in the last half-century. Contrary to popular belief, banks do not lend their own money or their depositors' money. As the Federal Reserve Bank of Dallas> explains on its website:
"Banks actually create money when they lend it. Here's how it works: Most of a bank's loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank ... holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times."
As Robert Hemphill observed in the 1930s, if we had no banks we would have no money, other than pennies, nickels, dimes and quarters. When old loans are paid off and new ones aren't taken out to replace them, the money supply shrinks; and lately, new loans have fallen off dramatically.
Why? Banks insist that they are lending as much as they are prudently allowed to. The problem is that they have reached the lending limits imposed by the capital requirements set by the Bank for International Settlements. In the years of the credit boom, banks were able to leverage their capital into far more loans than are being created now. This was because loans were taken off the banks' books by investors, allowing the same capital to be used many times over to generate new loans. These investors, called "shadow lenders," have now exited the market, and they are not expected to return any time soon. They left after it became clear that the credit default swaps allegedly protecting their investments were only as good as the solvency of the counterparties (typically AIG or hedge funds), which had a bad habit of going bankrupt rather than paying up. An estimated $10 trillion disappeared from the money supply along with the shadow lenders, and the Fed has managed to get only a few trillion back into the market as replacement money."SHADOW MONEY": ANOTHER BLOW TO THE QUANTITY THEORY OF MONEY
Along with the disappearance of the "shadow lenders," there has been a dramatic decline in something called "shadow money." The concept of shadow money was presented by two economists from Credit Suisse, James Sweeney and Carl Lantz, in a Bloomberg interview in May. As explained on DemandSideBlog, shadow money is money the market itself creates in order to finance a boom -- "money" in the sense of a medium of exchange. In a boom there is not enough cash to go around, so collateral is used as near money or shadow money. Shadow money can include government bonds, private bonds, asset-backed securities, credit card debt (which can be incurred and paid off without drawing on the M1 money stock), and even real estate (when it is highly liquid and easily tradeable).