Austerity-Fiscal Cliff-An Explanation
Money is the life blood of an economy. When the supply of money in circulation is extremely low, you will see recessions and depressions. When the supply of money is too large, you see excess inflation and asset bubbles. When money flows we grow. When money stops, we flop.
The major source of new money in an economy is provided by the commercial banking system i.e. Wells Fargo, Citibank, Bank of America, Chase and the smaller local banks. They just don’t loan out your deposits. They loan out far more. This excess is new money created out of thin air! This is a very important concept to understand. This is called “debt” money.
The financial crisis that started in the last decade was caused by this commercial banking system. It actually shut down causing the Great Recession. When this occurred loaning activity stopped, people got scared and started to pay back their loans. This accelerated loan repayment activity actually reduced the money in circulation! Trillions of dollars of loans were paid off since the crash.
When this commercial banking “debt” money ceases being issued and is reduced at the same time, the lesser system of money creation takes over. The other system is deficit spending by the Federal government. Yes, deficit spending forces the Federal Reserve to create money by monetarizing the debt. (They digitally create money and buy Treasuries and other assets) No, it is not all borrowed fromChina. This process has somewhat substituted for the lack of money in circulation from the banking system. It has kept us out of a severe depression! There was no fiscal spending in 1929 and the Federal Reserve tightened the access to money which caused the Great Depression.
The next question is: When do you stop this substantial deficit spending? If you reduce it too early, as Japandid in 1997 and we did in 1937, the country goes go back into recession. This reduction of spending is labeled “austerity.” The U. K. recently attempted this, bringing about another downturn, leading us to worry about the fiscal cliff, a significant increase in taxes and the cutting of spending, an agreement currently in place with Congress and the President, which will drastically reduce the money in circulation leading us towards another downturn.
Has the banking system turned to its normal lending pace? I don’t think so. Lending is tight and demand is very low. Nobody wants to borrow when times are bad? On top of this, bank loan regulations are very strict. This is the usual case for the commercial banking system. Therefore, it is not an effective monetary system for a 21st century economy.
Now, what with all the money the Federal Reserve has created in order to bail out the banking system and other financial institutions. It sits as reserves in commercial and central banks, insurance companies and sovereign wealth funds. It is not in circulation.
This commercial banking system’s creation of money is too narrow to create a quality economy. It basically issues loans for mortgages, equity lines, businesses, credit cards, auto and student loans. Those have been substantially reduced. The other area is Wall Street borrowing to leverage up their various investments, doing little for the general (Main Street) economy. How are we going to get the needed money into circulation?
The only way is complete monetary (money creation) reform by the elimination of fractional reserve banking. We do have a bill in Congress-HR-2990. You can review this act at www.monetary.org. It is an excellent start! This should be the single biggest economic issue, by far, and it is not even debated!
Remember the Great Recession was caused by the monetary-financial system NOT the fiscal (tax & spend) system. Most of the governments involved in the sub-prime crisis were in surplus not deficits. Then the crash hit causing tax revenues to go down and safety net expenses to go up. Then on top of that, certain governments had to bail out their commercial banks.
Japan’s crash caused by their monetary system was over 20 years ago. They are still mired in recession type conditions. Here we sit with no debate and no action by our leaders. It will have to be up to you and me. Please join the monetary reform movement. I will be happy answer any questions you have on the economy on our site at www.cpe.us.com.