Money Supply 101: The U.S. and Your Wallet

I once was told of a new law firm -- the joke goes -- "Duey, Cheetum and Howe," not to be outdone by "Lye, Cheetum and Steele." Sometimes one might feel like something is going on in the U.S. economy which approximates the sentiment conveyed by the joke known by all law students. There are in fact good reasons for this -- three to be precise. By name these are:

1. The Fiat Creation of Money
2. Expensive Regulatory Costs
3. Fractional Reserve Bilking (er, Banking. That was a Freudian slap).

According to the first of these, the U.S. government can create money (print dollars) de novo without any form of collateral -- liquid collateral -- to enable one to possess or redeem his money in specie (as they used to say), meaning, in the form of gold or silver. If you or I do this, it is called "counterfeiting," and it is against the law.

The laws of supply and demand tell us that when one adds more dollars to the pre-existing money supply, without a parallel addition to the money supply reserve of inherent value for which the new dollars stand, each dollar in circulation devalues by a small amount. In effect, the new dollars siphon off economic value from the existing dollar pool, shrinking the purchasing power of pre-existing dollars.

This creates inflation. Inflation represents the total cost of the new dollars to you and me. There is no free lunch, and there are no free dollars to buy it with when you pay for it. Put a little more "historically," the de novo production of money amounts to "taxation without representation." You don't vote for the Fed Chairman, and the other bureaucracies wouldn't let you even if it were legal.

The biblical commentary on this practice is short and decisive: Thou shalt not steal.

Second, Regulation is a form of taxation. Most people do not recognize this, and no one is going to tell you this, especially not the Democrats. Each time a new law is passed which requires businesses, corporations, and/ or individuals to change some form of behavior, it has sweeping effects across the entire economy, since each economic unit involved -- millions potentially -- must spend money to comply with the new law. Some are more expensive than others, but all of them cost. The precise cost to people in the economy depends on where the money goes which is paid for compliance. Often, the money leaves the national economy.

This also can make items purchased commonly in the U.S. more expensive, since businesses must pass this cost onto their customers, or else simply lose money. By regulation then (some of which is necessary), we drive UP the cost of domestic goods and services, making it more likely that customers will buy elsewhere (reducing our gross national and domestic products).

Over-regulation then amounts to theft as well. This implies that we need an objective standard by which to judge just WHICH regulations are warranted and which are not - for the latter are excessive (theft). These create inflation by rendering domestic goods and services more expensive.

When one combines the shrinking dollar with the more expensive goods and services, we have a "double-whammy" inflation producing mechanism in the economy.

Third, what is called "Fractional Reserve Banking," contributes to our overall money supply problems. Wikipedia describes the dubious practice thus:

"Fractional-reserve banking refers to the common banking practice of issuing more credit than the bank holds as reserves. Banks in modern economies typically loan their customers many times the sum of the credit reserves than they hold."

How does the law allow a bank to lend far more than it has on hand in reserve assets? Wiki explains it this way:

"Reserves (silver, gold, and U.S. Bonds in past banking eras and U.S Bonds or Credit in the present banking era) are a special form of money which can be held by the commercial banks either in their vaults or on deposit at the central bank. They are generally described as a "high-powered" form of money and are needed to perform fractional reserve banking. When a bank is in possession of [such] bank reserves this means that it is able to lend more currency to others than it has on deposit."

"If we imagine a bank which has $100 in reserves, with a 20% reserve ratio the bank would be able to lend up to $400 without breaching the ratio."

If this sounds counter-intuitive to your ethical sensibilities -- leaving you saying HUH? -- you are not alone. You have sixty-six biblical books on your side. This practice can put large numbers of investors and bankers at great financial risk.

The net effect of FRB is to create additional capital for investing in the short run at a very high cost in the longer run. This is short-term thinking at odds with the postmillenial teachings of the Bible.

Here is the wikipedia explanation from the Austrian school of just what happens historically with FRB allocated investment resources [God bless the Austrian economists]:

"Fractional Reserve Banking allows an increase in the supply of currency available to make loans to purchase investment capital, without increasing the quantity of investment capital or real savings. The quantity of loans will be higher than the actual supply of saved resources available for investment. Investors will assume that the quantity of loans available represents real savings. This misinformation leads investors to misallocate capital, borrowing and investing too much in long-term projects for which there is insufficient demand and real savings. As investors spend borrowed currency, segments of the economy will boom. Later investors will find the prices of their outputs falling and their costs rising, leading to the failure of new projects and a bust."

Okay, let me try this one on you. First, your goverment creates funny money, shrinking your dollars, then overregulates business to drive up the cost of the stuff you buy. This third insult means that central banks can pretend to loan your bank -- and your business -- money it does not really have. This is a deliberate (self-conscious and systematic) overextension of credit. Now why would anyone do this?

This practice enables banks in effect to "create money" out of the blue -- credit dollars let us call them, by extending their lending power like one extends a telescope. This means that banks ARTIFICIALLY grow and shrink the money supply at will, within the constraints allowed them by Uncle Sam. This allows them to manipulate the cost of money.

What does it mean to say "the COST of money?" When one lends money, he charges interest. Interest is what you pay to rent the money. It shows how much you will have to pay to rent (borrowing is renting at interest rather than at a flat fee like a boat) the money. So money has a COST, if you wish to borrow it.

By increasing or shrinking the money supply, banks can make money more rare or more common. Now supply and demand tells us that more rare items are more expensive, and ones more common are cheaper. One of the reasons a single ounce of gold costs so much is that gold is very hard to find. It is rare.

So if -- I mean when -- fractional reserve bankers cut the money supply, they drive up the cost of money. By reversing this process, they render money cheaper. This gives the central banks a clearly unfair advantage (monopolies are against the law), and their "better customer" banks also an edge others do not have.

Now the government is able to manipulate the money supply this way, but it is - please recall -- artificial. There is not only no money (gold or silver) back these credit extensions; there are not even any promises currently backing them (letters of credit, etc). If anyone else tried this, they would be arrested and charged with several crimes, in the case of the government (since they can impose sanctions) this would include extortion, fraud, and all manner of market manipulation tactics forbidden to companies and individuals.

It also has hidden costs (which are beyond the scope of this post), but suffice it to say that it can and has put the entire economy at risk. By overextending credit, one puts banks in the position (if defaults come hard and fast) of collapsing and defaulting on THEIR own promises in turn to those who entrust their assets to the banks.

For these, and many other reasons, if you live in the U.S., you find it extremely difficult to get ahead, and it seems like your paychecks are always "shrinking." That's because they are. In addition, you must pay myriad taxes which can add up - these are the ones you can see -- to almost one third of your entire earnings. If you add all the hiddens "fees" -- from inflation-generating taxes, practices and unethical maneuvering -- you might pay over half of what you make.

Finally, consider this. Inflation is not a one-time tax. It compounds over time. The dollars printed now have something like 25% at most the purchasing power of 1970 dollars. In other words, your 2005 dollars are worth a 1970 quarter at best.

This is the cost of doing other than what the Bible commands. No wonder the Lord Jesus constantly compared debt to sin, as in "forgive us our debts, as we forgive our debtors." And, also, the Bible teaches, "the tongue of the righteous is choice silver." This is because any nation which puts into effect the Word of God taught by the righteous will find their barns overflowing and vats brimming over with new wine.

In the days of Solomon, whose tongue was choicest silver, silver itself was so common, it became like stones. This is called "abundance in abundance." And the rewards of wisdom are better than rubies. Righteousness exalts a nation, but fractional reserve banking destroys any people. So does counterfeiting. You can't call it something else just because the government does it.

But, "blessed is that nation whose God is the Lord." Your wallet could be much fatter, and it isn't just your own doings (diligence, ingenuity, investing) that make the difference. It is the national -- covenanted -- community in which you live -- for better or for inflation.

So now you know.