Money “Creation”: Let there be money?

by Bob Goudzwaard and Elizabeth Palmberg 05-28-2009

If the financial crisis shows anything, it’s that what’s happening on Wall Street matters to Main Street, and that we should never take “it’s too complicated for you to understand” as an answer. In the new issue of Sojourners, Bob Goudzwaard’s A Paper God breaks down for us how the speculation economy of Wall Street got way out of hand, becoming a false god that warps the real economy.

Here’s another key idea that you can’t afford to not understand: money “creation.” It turns out that this idea – both economic and spiritual – is central to how we got into this mess, so between us, Bob and I hashed out the following plain-English explanation. — Elizabeth Palmberg

Here’s the economic idea of “money creation”: The amount of people working, buying, and selling things in the world is almost always increasing, and the amount of things and services that are produced, bought, and sold is almost always increasing even faster (as we are seeing now, the exception to this principle — a recession — is attention-getting!). To match up with the increase in stuff, the world needs an increasing amount of money, because barter, despite its old-fashioned charm, is a very time-consuming and inefficient way to do business.

If we had an all-cash economy, the necessary money creation would be an all-government show: the federal mint would simply print more bills or stamp out more coins (unless buyers and sellers were willing to use random, non-coined pieces of gold or silver). Many people have an innate suspicion that governments want to “print money” to avoid financial responsibility (which sometimes happens – Zimbabwe is the very extreme case). But money creation for a growing national and world economy does have to happen somehow — unless you want to try to convince the electric company to let you pay your utility bill with your home-grown tomatoes.

Here’s the theological idea – which is also a reality check. God created the world which we can see and touch around us, with all its resources. People can transform those resources, and the human labor which God also created, into an endless array of goods and services — but always based on things created by God. The only responsible and good societal place for money is to serve the good of humans and the environment.

If people or banks “create” money, we may (like Faust in Goethe’s play) think that we have made something entirely new — but this is an illusion. Creatio ex nihilo – creating something out of nothing — is divine. And when humans act and think as if we were gods who can create endless prosperity that is not based in the “real economy” of things and energy created by God, sooner or later that illusion will crash to the ground like Icarus. As described in A Paper God, this is exactly what has just happened to the financial speculation bubble, and it’s taken the world economy down with it.

Coming soon in part II of this blog: Just how did we let this happen?

Bob Goudzwaard, co-author of Hope in Troubled Times: A New Vision for Confronting Global Crises (Baker, 2007), is a former member of the Dutch Parliament and professor emeritus at the Free University of Amsterdam. Recently he chaired a two-year consultation between the World Bank, the IMF, and the World Council of Churches. Elizabeth Palmberg is an assistant editor of Sojourners.

Categories: Economics

Ngchen

I agree completely that overregulation kills business. Underregulation also has negative effects (who'd dare buy any canned food from an unknown brand, if there wasn't safety regulations that ensure the food won't kill you?) And yes, we currently have too much debt, and it needs to be paid off. And yes, trying to inflate our way out of a recession won't work (see Zimbabwe for an example).

Lots of people would argue that the purpose of government in a recession is to reduce the depth of the valley through various measures. Of course, the flip side to that is that the money to pay for the measures should be accumulated when times are flush (which unfortunately wasn't done).

tmal80

As for mass layoffs being bad, I agree. The goal then is for people to
find new jobs in the economy. It is now extremely difficult because
the economy is in such poor shape. But that is what has to happen. We
need to get to what the market (people) really want in order to
recover. It's a tough road, especially because the market has benn
distorted for so long with government intervention. The best way to
get through this is for government to get out of the way, let
businesses fail, stop subsidizing unemployment and let the market sort
this out. Government cannot run the economy. The more government tries
to help by printing money and handing it out the deeper and more
painful the recession will be.
People may be holding out on purchase now. This could be attributed to
the fact that people are on debt. We are in debt as a nation. We don't
need TVS for us. We need to make TVS and sell them abroad. We have
lived beyond our means as a country and now we need to pay back what
we borrowed.
We are overdue for a deep recession because of all of our borrowing
and spending.
Printing money will only lead to an inflationary depression and more
regulation will make it tougher for our economy to find it's way.

Thank you,
Thomas Maloney

tmal80

Before I reply I would like to point out the reasons why the goal of
any economy is high productivity, not jobs.
Production initially starts out low in one area, then will build if it
is a successful enterprise.
Let's use the analogy of making sweaters. Initially it would take more
resources to make a sweater and since a lot of production went into
making that sweater, the price would reflect it. As other people
realize the profit in the sweater industry they would jump in to make
profits. They would do this by making better sweaters, cheaper and
faster. The competition between these sweater companies would lead to
higher productivity and better quality at a lower price.
Eventually machine, would help make these sweaters. With less
resources needed in the sweater industry those people would go to
another sector of the economy. The process would begin again. The
economy will eventually become very complex, but it will operate in
this fashion on any sector (TVs, computers, cars, etc) this is how it
works.
Prices are supposed to fall as productivity increases. This enables
more people at lower incomes to enjoy these products.
If a central banks' purposes is price stability it already goes
against the natural order of production.
The only way to achieve the price stability is inflating the money
supply to offset the price drop.
I will continue later as I am at work.

Thank you,
Thomas Maloney

Ngchen

First, I will concede that the TV example is not so great, in that yes, TVs have dropped in price over the years, and people are still buying them. The example is better applied to other items that have not dropped in price, which is most everything else (if you believe that we don't currently have deflation.)

Yes, even in a deflationary environment, people will buy some non-zero level of things, if just to stay alive (food for instance). But it really becomes advantageous to make purchases later rather than now, so people end up holding out. For TVs, I'll say that people are holding out already to some degree, but since it's confined to a single sector the overall effect is not so great.

In terms of savings, in a deflationary environment nobody would choose to borrow from a bank to construct something, (except at a bare bones level) because again, everything's cheaper later. Mass layoffs would not be good, because there'd be no other place this labor can go. What good is labor, if it can't be put to use doing stuff that people would pay for? Foregoing consumption now for future use can be GOOD, if the future use really ends up happening. If it does not, then its not so good.

FWIW, modern central banks are generally charged with two missions. (1) Provide price stability (no inflation or deflation). (2) Make conditions favorable for economic growth. It's of course not easy to achieve both of these missions. Crony capitalism is of course a bad thing. Having honest officials goes a great way toward reducing it.

greego

"If you needed a TV, and TVs are selling for $100, and will sell for $100 next week, you may get it now or later. But if you knew they'd cost $80 next week, you'll probably hold out for the lower price. But if everyone started to hold out for a lower price, then nothing gets sold now, prices continue to fall (merchants trying to lure the nonexistent customer), and people hold out even more."

Electronic goods *are* deflationary in nature yet people still buy them by the truckload. What a stupid example.

tmal80

I replied below under tmal80.
Not sure why it didn't attach it to your comment

tmal80

Your thought experiment is flawed.
1. TVs do drop in price, even in todays economy. Do you not own a tv? Even though they drop in price people still buy them. You know that the tv you own now will be worth less in the coming months and you could have bought it cheaper. But YOU bought it at a price that YOU felt was fair. You valued the tv more than say $1000. You cannot classify all people in one vein saying no one will buy.
Some people will wait, but some will buy. If the tv producer guesses wrong his business will fail because he did not accurately reflect what consumers want.
2. Who decides when you are saving too much money? Government? You? You know your finances better than anyone. You will spend and you will save based on your time preference.
Let's assume what you say is true people save too much to the extreme. If it's in a bank in a cd, the bank can lend it out. If I hide it in a mattress, it is not being circulated. Therefore the value of money in circulation goes up and prices drop. What is bad about that?
Mass layoffs in your argument is a good thing in the long run because it frees up resources for other sectors of the economy. The goal is not employment, it is production. Should we eliminate trains and hire a lot of people to transport goods on their backs?
Right now we are in a crisis that was all based on cheap credit and consumption. People are more hesitant to spend moneybecause they are not sure what will happen next. They are foregoing consumption now for future use.
It is going to be a really really tough road back to a sound economy. The best thing for government to do is get out of the way and let the market work. We have had crony capitalism for far too long.

Ngchen

Actually, having a lot of inflation is destructive for everyone, as Zimbabwe showed. It's bad for the government too! Now, in terms of why deflation is bad, let's consider a thought experiment.

If you needed a TV, and TVs are selling for $100, and will sell for $100 next week, you may get it now or later. But if you knew they'd cost $80 next week, you'll probably hold out for the lower price. But if everyone started to hold out for a lower price, then nothing gets sold now, prices continue to fall (merchants trying to lure the nonexistent customer), and people hold out even more. At some point, we'll have layoffs galore, and laid off people of course won't buy, no matter how low the price.

Savings are good, in the sense that they permit future investment and protect against shocks on the proverbial rainy days. But saving money for the sake of saving money's actually a bad thing. In the extreme case, it can even become idolatrous. You're correct in that saved money is lent out by banks for production. So the borrower is actually *spending* the money that was saved. In a deflationary environment, there'd be few borrowers because it would be cheaper to get whatever tomorrow, rather than today.

Inflation doesn't really help pay off debt in the long run, because just as the original poster noted, WE cannot create something from nothing. Lenders, in an inflationary environment, will raise interest rates to compensate for the effects of inflation.

tmal80

Government wants not a tiny amount of inflation, but a lot of it. This is the best way to pay back their debts. It is either to admit you can't, tax it from its citizens, or devalue the currency enough so paying it back is easy.
Any inflation is destruction, small amounts of inflation dont show it as clearly. But the effects are exactly the same. Their is no difference between a paper cut and a machete slash in terms of what happened. One is just more severe.

"Hoarding" money is just saving money. Money that people save is then used by banks to loan out as capital for new entrepeneurs. Capital comes from savings (or is supposed to.) Thats how you get the interest rate. If there are less savings, it becomes more expensive to borrow money to invest, and vice versa. New products can be built for people and people win.

Even if people were hoarding their money by piling it into a mattress somewhere, this would make all of the dollars in circulation worth more since there are not as many dollars in circulation, therefore prices would drop to reflect this. People win.

Inflation is stealing. It is stealing the value of someone's savings. How can God be for that?

brady

You write: “If people or banks ‘create’ money, we may think that we have made something entirely new—but this is an illusion. Creatio ex nihilo—creating something out of nothing—is divine. And when humans act and think as if we were gods who can create endless prosperity that is not based in the ‘real economy’ of things and energy created by God, sooner or later that illusion will crash to the ground like Icarus.”

We agree on the implications of this statement, but I extrapolate them further—to government monetary policy. Because it is politically unacceptable for a politician to preside over a downturn in our economy, it is in their best interests to delay a recession—a natural part of life, we must remember—for as long as possible. Long term planning is forsaken for short-term political gain; often interest rate manipulation, as DITE and xfree9 explained, is the easiest way to go about that. Our society’s unwillingness to go through the undulations of the economy, and thus delude itself from top to bottom with endless prosperity, is the fundamental reason for this crisis.

(More in Part 2.)

xfree9

Right on, DITE!

The current economic downturn can be directed primarily at government involvement in the creation of "easy money" during the so-called "boom" of the past 8 years. Investors and speculators would not have gone into risky investments, interest rates would not have been so low as to encourage borrowing money by those who couldn't afford it, and housing prices wouldn't have spiked so high because of the speculation and risky investment.

When the government tells banks that they'll back risky investments if they fall through, and banks loan money to high-risk borrowers that they would otherwise not have loaned money to, how exactly is that a "free market" at work?

xfree9

To match up with the increase in stuff, the world needs an increasing amount of money, because barter, despite its old-fashioned charm, is a very time-consuming and inefficient way to do business.

This is untrue. A stable money supply, historically a gold standard, means that the increased number of goods and services results in a reduction in the price of those services.

Money is not "created." Money is a medium of exchange agreed-upon by a society. When money is added to the system, in ancient times they called it "debasing the money supply," because what the emperor or caesar had to do was trim off edges of the coins, and add new coins. The economy suffers when it happens.

As said in the article, "creation" is a divine act. If we want to "create money," we are out of bounds with our earthly authority, and it must be stopped. Creating money in our system is a huge factor in our economic state. It's also the cause of our booms and busts, which are artificial. The "free market" had nothing to do with it because a "free market" would not have money creation involved.

xfree9

This article is laughable by any armchair economist, let alone professional ones. "Money" is not created, it is agreed-upon as a medium of exchange. As goods and services increase, prices go down when there is a stable supply of money (i.e. gold, which is a scarce resource). Before the central banking system with the monopoly to print money or create it out of thin air with credit, the average wages of Americans was going up, and prices were decreasing, because of increased production.

The boom-bust cycle is caused by an inflation of the money supply, which is created by a central bank with permission to add money to the system. Prices increase as a result. The poor suffer first and foremost because the producers in the economy (aka "the rich") are the first recipients of the new money, and don't experience the negative effects on the economy; indeed, they benefit. In short, central banking in the United States hurts the poor, and benefits the rich. If you want to look at the biggest reason for income inequality from a political perspective, end the federal reserve system and return to a gold standard. History has proven time and again that a stable money supply does not favor the rich over the poor, does not result in inflation, and that prices fall over time, even while wages are rising.

Ngchen

Actually, government may want a tiny amount of inflation, because it spurs people to do stuff with their money rather than hoard it. Deflation is bad for the same reason. Some level of money circulation is needed for the economy to work. But you're right, in that excessive inflation is destructive, and governments ought to do almost everything possible to avoid a Zimbabwe style hyperinflation. I would rather have government services go to near zero, as bad as that is, than have hyperinflation which wipes everyone out and gets government services to near zero anyway!

DITE

Ridiculous.

Government policies encouraged risky lending and then subsidized the risk for those companies that bought risky mortgages. So when the government takes the natural regulator of risk out of the market, people and companies are encouraged to make bad economic decisions.

"If we had an all-cash economy, the necessary money creation would be an all-government show: the federal mint would simply print more bills or stamp out more coins"

Just not true. Most money is "created" when stuff gets cheaper. If product A originally costs $100 dollars, then due to technology or increased efficiency the cost of making product A goes down, the price will go down. If the cost goes down $50 and the price goes down to $25, the company will have $50 more per product sold and the consumer will have $25 more dollars.

The reality is, all investment is "speculation." And we need investment expenditures to ensure long term economic growth. People living in this economic downturn are still exponentially better than an those living in an economy with no speculation.

jkc1945

Government do, indeed, want some inflation of the money supply. They want it for one reason; it is a tax, and a "non-legislated' one, at that. It is a way governments have of (at least in appearance) adding to the national treasury, and simultaneously taking wealth away from the populace, without the populace paying any attention. Legislatures (national, state, or local) love this little fact. They can tax their constituents without actually standing up and voting for that tax.

Lately, our new administration has indulged heavily in this type of creation of fiat money. We issue treasury bonds, and the Federal Reserve buys those bonds by printing money. We (the people) 'support' the printing of that money - -at least for a period of time - - with our creative labor. However, history has shown that this little series of tricks finally catches up with a society. See the photos of Germans, during the hyperinflation of the 1920's, burning stacks of their Reichsmarks, rather than spending them to buy coal. The heat generated by the burnking of the paper money was actually more valuable than the money itself, and exchanging the money for coal was also self-defeating. If we continue to do what we currently are doing, as a society, we also will experience this hyperinflation. We at least ought to be aware of this as we plunge over the abyss.