How printing money destroys wealth

Last week the IMF said that global inflation targets should be lifted from 2% to 4% to aid the global economic recovery.  Given that annual consumer price increases in the major economies is ‘officially’ well below 4%, an adoption of this policy would see an even greater degree of monetary intervention and stimulus by the world’s major central banks. 

Statements like this from the IMF represent the beginning of the next wave of global monetary stimulus.  We should be even more worried at the reaction of the mainstream media however who will likely offer little more than a perfunctory and meaningless analysis of these ideas.  At the heart of the IMF statements is a belief that creating more inflation will create more jobs, growth and wealth. 

Can printing money and extending artificially cheap credit into the economic system create wealth? 

The answer is no, and below we outline why. 

1. The intuitive 

The first line of defence against the proposition that credit and money creation out of thin air can create real value and economic growth is the purely intuitive one.  Something cannot be created out of nothing.  There is, to be horribly trite, no such thing as a free lunch. 

Take the reductio ad absurdum approach: if printing money could create wealth we could all be wealthy in an instant.  Governments could just print money and poverty and joblessness would disappear.  Common sense tells us this proposition is absurd.  It must surely follow that if it is absurd to think we can print our way to prosperity with lots of money it must be absurd to think we can do this by printing small increments of money. 

2. Money, Value and Exchange 

The second line of defence against the absurd idea that creating money and credit can create real wealth and economic growth is the idea of real value and monetary value.  Economic exchange is the exchange of real value in voluntary transactions.  Money is the medium of exchange and its usefulness is derived from its ability to facilitate complex and varied real value transactions without economic agents having to engage in cumbersome and grossly inefficient barter.  This enables a greater division of labour which helps unlock greater real value in the economy as people begin to specialise and engage in new creative and productive activities to meet better the complex needs of a society. 

But note here, it is not the amount of money that is important but merely having money, i.e having a sound and accepted medium of exchange.  Whether the economy has a trillion rand, a billion rand, a million rand, a thousand rand, or ten rand, provided the means of currency is divisible enough to be used among the population, it really doesn’t matter what the nominal amount of currency in circulation is.  Any nominal amount of money or currency can get the job done.  

The reason why people struggle to get their head around this fact is because they think of money in its nominal note form and what that can buy them in their current monetary reality.  They think, “I have ten rand in my wallet, so if there were just ten rand facilitating exchange in the entire economy then how could people all physically use just this one note to trade with?”  But see in reality what would happen: If there were just R10.00 facilitating trade in real value in the entire economy, then R1.00 would facilitate 1/10^th of the trade in real value in the economy, and 1 cent would facilitate 1/1000^th of the real value trade in the economy.  Below that we would simply create new denominations to facilitate ever more micro real value transactions.  So for example, we would just have 1 Buckeroo which could equal 1/100^th of a cent.  1 Smackeroo could equal 1/100^th of a Buckeroo, and so on.  Eventually the term ‘rand’ would become extinct as it would be worth too much to have any practical business or financial significance.  Any amount of money can get the job done. 

This by the way would be true in a pure fiat paper currency system or in a sound money system where notes in circulation are backed by gold and other precious metals.  Even if there were just one ounce of gold facilitating all real value transactions, the paper currency being backed by the gold would simply adopt the appropriate and convenient denominations and gold’s value in terms of that nominal paper amount would be determined appropriately. 

In every case, real value is not affected by the amount of money in the system. 

3. Wealth Redistribution 

Most sound thinkers do not dispute points 1 and 2 above, understanding the intuitive impossibility and the aspects of real value and nominal monetary value exchange that undermine the notion that creating new money and credit can increase real wealth. 

However, many at this point still argue that new money and credit creation by the central bank via the commercial banking system, while still destructive in the long term, can create real value.  They point to the past century as a time when money printing and artificially cheap credit has allowed for rapid and real value creation, particularly in the Western world.  They say that new loans pushed into the system at interest rates below the market rate of interest creates both cheap credit and inflation, which acts as an incentive to producers to increase production and economic activity. 

There is a subtle and insidious fallacy here but one that must be dealt with.  The logic assumes that money and credit is a main determinant of increased economic activity in the country as a whole.  However, this is wrong:  the real determinant of new wealth creation is real saved capital and real available resources.  Capital and resources are, at any given moment, finite, and therefore no additional amount of money and credit can bring about more production than these constraints will allow.  No banking system can create more real credit than there is real capital and resources available at that time in the economy.  Credit and loans, after all, are not money but real savings.  Money is simply the medium of exchange between saver and borrower. 

Even if every company in the country suddenly had the financial means to double production, believing that they could do so forces one to ignore the reality of finite capital and resources.  Supporting this proposition therefore is to ignore completely that there is economic scarcity.  It is simply a false view of the world.

Real credit, then, is finite at any given moment.  Creating new credit out of thin air therefore redistributes real credit from the owners of real capital and savings (the real wealth generators) to the banks, institutions and governments issuing the new credit and money printed by the central bank. 

So, any entrepreneur accessing newly created credit is simply using redistributed capital from the existing pool of available capital.  Therefore whatever economic activity he generates from his borrowings is activity that can now no longer be created elsewhere. 

A clever response at this point, although easy to refute, is: what if someone borrowed money created out of thin air and used it to get themselves an education which increased their ability to add real economic value in the future?  This is a straw man argument.  It concerns what people do with existing capital rather than the creation of new capital.  If capital is redistributed then it follows that the people from whom it is taken and the people to whom it goes would very likely use the capital in different ways and with differing degrees of economic success.  Real capital and resources can be squandered or put to very good use depending on who is in possession of them.  In the example above, what is seen is the person using the redistributed credit to get educated, but what is not seen is the person no longer able to access credit and do something potentially even more productive with it. 

Creating money and credit out of thin air actually entails wealth redistribution, not wealth creation. 

However, we need to take it a step further.  Some at this point might argue that if creating new money and credit out of thin air is indeed just wealth redistributive and does not destroy wealth, then it can surely be used as a tool to meet some of government’s redistributive objectives? 

Showing that new credit and money creation cannot create new wealth is not enough.  It is essential to explain why it actually destroys wealth. 

4. Wealth destruction 

As we have seen above, real savings and credit are autonomously redistributed by price distortions in the capital markets created by the central bank.  Artificially cheap credit resulting from new money creation in the system creates a mismatch between real savers and borrowers.  With an artificially low interest rate real savers are no longer being adequately compensated for deferring their consumption, while those who prefer to consume now flock to access the cheaper credit. 

Two simultaneous processes take place with regard to savings here. 

1. Real wealth generators will start consuming more of their real savings
2. At the same time, their existing unconsumed real savings are being redistributed away from them, undermining real wealth creation activities and thereby discouraging such activities.   

Meanwhile entrepreneurs can access credit at a cheaper rate, encouraging them to invest in lower yielding business activities than they otherwise would have had to invest in to make a decent profit.  This gives rise to at least two damaging investment decisions. 

1. The first is that entrepreneurs choose to invest in already heavily invested sectors where marginal returns are quite low and markets already quite mature.  They do this because perceived risk is low compared to the potential return to be made on the cheap credit. 
2. The second damaging investment decision is that entrepreneurs choose to invest in longer term capital projects that tend to only generate returns after a few years time.  They do this because the cheaper funding allows them to carry the debt burden for longer before returns are generated and because projects funded over a longer time horizon are far more sensitive to funding costs (the rate of interest) than those funded over a shorter time horizon. 

To sum up, real wealth creators are consuming more real capital/savings than before and their wealth creation activities are being undermined.  At the same time the capital autonomously distributed to other entrepreneurs is being sunk into lower yielding longer term projects whose success relies on the ability of people to consume in the future. 

The problem is that real savings are diminishing, undermining future consumption – the very consumption their longer term business ventures will rely upon to generate profits! 

Put simply, a mismatch has occurred between expected future demand and current savings.  Entrepreneurs are making more products than people will need in the future, and not enough products that they need now.  The entire economic system’s time-preference structure is distorted.  

Time, effort and talent are flowing wastefully into products no one wants.  Thousands, hundreds of thousands, or even millions of people become employed in jobs producing the wrong goods.  People’s time, effort and talent are being thrust into superfluous endeavours – time, effort and talent that they will never again be able to expend on anything else. 

Meanwhile, in many instances capital is sunk into wasteful and superfluous projects.  Some argue that, eventually, demand will be able to justify these wasteful projects.  This may or may not be the case depending on the extent of the excess capacity created in that particular good and the future growth and demographic prospects of the country.  What is true, however, is that the distorted capital structure fails to meet the needs of people optimally, creates wasteful endeavours, creates an over-consumption of real capital, and erodes real wealth creation activities.  

Each of these consequences is a loss of real wealth. 

Conclusion 

As so this perhaps is the crux of the debate: Money created out of thin air and pumped into the economic system via commercial bank credit distorts the capital structure and therefore causes a failure of the economy to properly meet the needs of people.  This is the greatest economic indictment on the fiat-based credit system – it creates gross economic inefficiencies. 

In addition to that it is immoral, for it unjustly and insidiously takes resources owned by some and gives them to others.  It punishes real wealth creation and rewards opportunistic economic agents positioned in or around the central bank/commercial banking cartel. 

And so, recent claims by the IMF that global central banks need to raise inflation targets and loosen monetary policies even further to aid the global economic recovery are: 

• Intuitively wrong
• Misunderstand completely the role of money and real value
• Ignore/remain ignorant of the immoral distribution of wealth away from real wealth creators
• Ignore/remain ignorant of the destruction of wealth it will create 

The IMF view is therefore:

• Immoral and unjust
• Economically ignorant
• Economically negligent
• Economically disastrous 

The current economic system is already deeply flowed.  Listening to the IMF will only accelerate the collapse of the fiat debt-based system and impoverish more of the world along the way. 

Any takers for that option?