Imagine for just a few moments an economy with no debt. You have no ability to borrow or lend, nor does any other participant in the economy. There is also no mechanism to print money and therefore to create additional nominal paper wealth. The only assets you own were purchased with the fruits of your labour and enterprise. The only money you have is from the proceeds of assets you previously sold or income from labour and enterprise, yet unspent. Also in this fictional land, the nominal supply of money, coins and bank notes, exactly equals the true nominal and economic value of society’s wealth, This wealth consists of ready to use commodities (grown coffee, mined coal, etc.) and real, not paper, assets.
If the rate of saving increases, or the holding period between transactions lengthens, the velocity of money and real economic activity decreases. If through natural disaster or war, assets are destroyed, the nominal value of paper money would be greater than the economic value of real assets. In this environment of fixed money supply with no ability to lend, borrow or print money, society can only theoretically accumulate more assets in future periods, than it did in the past, by improving the efficiency of commodity growth and extraction or by inventing new products of economic value.
But unless money supply is increased, or the circulation of money accelerates, the prices of assets and commodities would have to fall, due to the increased supply of commodities and assets relative to fixed paper money supply. Furthermore, you could not increase your personal real economic wealth by working longer hours unless another participant was willing to work less hours as your increased output would also create excess supply that the fixed monetary base could only purchase through deflation of asset prices.
Let’s build into this zero sum economic model, debt, the ability to lend and borrow. Again money supply is unchanged. The zero sum game is also unchanged. The flow of money is altered but no real economic growth is secured. The only change is the timing of consumption for each party. The borrower enjoys higher consumption now at the expense of future consumption. He is spending future income. The lender forsakes current consumption, preferring to consume later when the debt is repaid. The real economic asset base is unchanged. The borrower can purchase assets, employ more staff, pay higher wages but if the supply of money is unchanged every dollar or pound he spends is directly offset by the decrease in economic activity of the lender.
So debt by itself, within a fixed money supply economy, is a financial transaction that creates no real economic growth. Progressing towards a more realistic scenario, closer to today’s economy, let us introduce the concept of new and additional money supply. Not new economic wealth, just new paper money. The creator of this paper is seeking to stimulate the economy and decides to allocate a third each to Consumption, Lending and Investment. (By investment, I am referring to the creation of new assets of economic value and the improvement of existing production efficiencies, not the purchase of assets already in circulation).
Examining each of the three in isolation, if new money is added to an economy within a fixed asset base, purely to increase consumption, inflation is caused as demand increases whilst supply is constant. Nothing new of economic value has been created. Each unit of paper money is just worth less relative to the unchanged real economic asset base. Borrowing to purely consume creates inflation and has zero sustained economic benefits.
The second scenario relates to the share of printed money that is lent and borrowed. If the borrower uses his additional paper money to consume the economic impact is unchanged, as above. If the paper money is used to buy completed assets, again as discussed above, the only occurrence will be inflation in the price of assets. Debt used to increase consumption or purchase assets has zero sustained economic benefit, only the flow of money changes. There is no new real economic wealth, just inflation, or asset price bubbles, or both.
Therefore, only newly printed money that is invested into the process of building new assets of economic value has a positive impact on growth. Increases in consumption can only be sustained if it is the function of an enlarged asset base of economic value exactly matched by an increase in the supply of nominal paper wealth.
To achieve real economic growth, society must have a mechanism that increases money supply which both facilitates and mirrors real economic growth, (the increase in quantity of real assets). In the absence of this scenario when newly printed money is allocated to the purchase of completed assets, or consumption, rather than applied to investment in the production of new assets or invested to improve current output efficiencies, zero real economic growth occurs and asset price bubbles are created.
Applying this theory to the current stimulus policy and the new paper money printed by the Fed and other monetary authorities, every dollar spent on supporting consumption or used in the purchase of completed assets has zero true economic value and is today’s generation borrowing from the income of future generations. It’s fake growth, here-today-gone-tomorrow paper wealth. Therefore, every dollar allocated to the balance sheets of failed banks, which is then lent to stimulate consumption or used in the acquisition of existing in-circulation assets represent transactions of no true economic value. Supporting financial institutions that profit from building fake wealth probably isn’t a great idea either.
In fact, the stimulus package is quite successfully re-building the same myth of debt-fuelled economic growth and is deepening the embedded structural problems of a debt based society, which incorrectly allocates printed money to consumption and zero-sum financial transactions rather than into real economic investment.
If you persist with the same course of action, is it reasonable to expect a different outcome?