It’s a little like calculus, which may be why people like Ron Paul can’t understand it.
What happens to money that is "lost" in the market? What should happen?
We have run this experiment before. We ran it in the 1930s. Money was lost in the stock market, a lot of it. The U.S. government, and other western governments, refused to replace it. That would be printing new money, they said. It would lead to inflation. Just like Germany in the 1920s.
The result was stagnation, and actual deflation, as fewer dollars were available to chase goods.
The answer was inflation.
The Nazis and the Fascists created inflation by simply demanding
production and printing money to pay for it. Their economies began to
recover. The U.S. recovered far more slowly, in part because John
Maynard Keynes’ seminal book, "The General Theory of Employment, Interest and Money" was
not published until 1936. Facing the threat directly the U.S. finally
accepted inflation, stimulating demand and launching a recovery which
went right through the war into the 1960s.
The simple answer is that money which is lost should be replaced.
Current Fed chair Ben Bernanke was appointed, in part, because he had studied these questions extensively. His Essays on the Great Depression
called that period the "Holy Grail of macroeconomics." He did not know
then that he would be facing an identical problem so soon after his
That’s the current financial crisis. Our lax regulation allowed our
bankers to create trillions of dollars in Confederate Money, money that
was supposedly backed by mortgages, but which in fact was worthless
paper. The terms on many of the mortgages were too steep, the
appraisals were inflated. New forms of money were created "insuring"
this money, and new markets were created where leverage was allowed at
absurd levels. The deals could not be unwound when the markets turned,
and thus trillions of dollars were lost around the world.
The money must be replaced. If you don’t replace the money you get
deflation, too little money chasing too many goods. That’s what we have
now. It is killing us.
The questions are how will the money be distributed, and what will be the cost of that money? I am becoming afraid that Bernanke is living up to his nickname "Helicopter Ben" not because he’s printing money (he should) but because he’s not being careful about where it goes.
The money needs to be put to work. Instead it is being hoarded. Even
when the money is used to buy bank shares, the money is simply used to
restore capital ratios, it isn’t lent out. I wrote here that the $700 billion work-out would be used to take back bad assets and turn them into good ones. That is what we were told would happen. Banks would then be able to make new loans. It appears that the critics of that plan might have been right — it’s just being stolen and locked away.
Money that is not circulated is worthless. Money needs to be put to work.
If banks will not put new money to work, if they won’t invest
new dollars to stimulate the supply of new goods and new demand for
those goods, then government must do that.
The challenge for government, as it was almost 80 years ago, is to
invest that money in production that will pay for itself. Roads,
bridges, ports, broadband, infrastructure. Make business life easier,
put cash into peoples’ pockets, create both real supply and real
Money is trust, but it is also a measure of work. It is energy, both
real and potential. To create real value it must become real energy, it must be used, and so
far banks are just using it as potential energy.
The attitude of bankers toward money today reminds me of the famous Lincoln saying before Antietam. "General McClellan, if you don’t want to use the Army, I should like to borrow it for a while."
Having government create demand directly is not a great idea,
compared to having businesses direct demand.
But if business won’t then