Power of Story: Increase in All Prices

In order for a country to experience a functional economy, it must produce goods and services. Through that production income is created to meet the needs of the people of those countries. In the 150 countries I have traveled I have had the opportunity to observe various economies in action and have watched the choices made by the leaders of those countries. In many cases I have also had the opportunity to later observe the consequences those choices set into motion.

The leaders of those sovereign countries may begin to desire goods, services, military weapons, conveniences, comforts, or inordinate political clout for themselves. Their gross national efforts, however, may not have produced wealth enough for the legitimate purchase of those items. An overwhelming temptation then comes for those leaders to start tinkering with the economy.

One irresistible temptation comes when the leaders discover that they can purchase the right to govern the people by promising and periodically delivering goods and services to the constituents. In nearly every African country where I have had business dealings the leader, in an effort to gain the opportunity to govern the people, promises to deliver free electrical service to the urban and rural areas of the country as well as free medical health care to the constituents. Of course, he has absolutely no way to fulfill those promises until he gets into power and is in control of the economy.

The methods of tinkering with sovereign economies throughout history have been varied and extremely creative. The early kings always saw to it that they possessed the exclusive right to mint coins or print currency. In that position they had access to all the gold and silver coins that circulated through the kingdom’s treasury. The king’s men simply took the coins and artfully filed or clipped off a portion of the precious metal. That was called coin clipping. Sometimes the coins were put into moistened leather bags where they were shaken and beaten until small pieces of the coins would come off and cling to the inside of the bag. That was called coin sweating.

At other times holes would be drilled through the coins in order to retrieve amounts of precious metal. Upon occasion, the sovereigns would make a sandwich by using cheaper metal only clad with gold or silver but still call the coin by the same name. Obviously, that would devalue the coin. The king would then take the clippings he had gleaned and mint new coins. Since he was the first to use the altered coins, he would pass them off at full value. Suddenly there would be more coins and fewer goods in the kingdom.

The merchants were helpless to do anything about the coin tricks but they still had an alternative. Since there was, let’s say, twenty percent less gold in the clipped coin, they were forced to simply compensate by raising their prices by twenty percent to offset the difference. A sustained increase in the general level of all prices was experienced, i.e., inflation.

What the king had cleverly done was to impose a twenty percent tax increase on the people without having to go out and collect it. Now he had funds to go purchase his wants. Of course, it didn’t take long for the king to realize that he now had a new problem. The people began using the debased coins to pay their regular taxes. He felt cheated since he was not collecting as much gold now as he used to. But, no problem, like a dog chasing after his own tail, he would simply repeat the whole operation.

The old economist Adam Smith said that the kings who did this:

           . . . were enabled, in appearance, to pay their debts and fulfill their engagements with a smaller quantity of silver than would otherwise have been requisite. It was indeed in appearance only; for their creditors were really defraudedof part of what was due to them. All other debtors in the state were allowed the same privilege, and might pay with the same nominal sum of the new and debased coin whatever they had borrowed in the old. Such operations have always proved favorable to the debtor, and ruinous to the creditor, and have sometimes produced a greater and more universal revolution in the fortunes of private persons, than could have been occasioned by a very great public calamity.

A confiscation or straight tax by the king would not have been nearly as harmful as inflation. A tax would have only affected the relationship between the king and those taxed. But the tragedy of inflation is that it affects and disrupts the relationship ofeveryone in the country. People who have saved money as a store of value no longer have what they though they possessed. Creditors who loaned money with an anticipated return are repaid with less value, and insurance values are wiped out.

An increase in the supply of money relative to the supply of goods is the cause of inflation. Without the possibility of the sovereign government being able to alter the supply of money in the system, there would be no sustained inflation.
 

Next Week: Tents and Tiger Teeth

(Research ideas from Dr. Jackson’s new writing project on Cultural Economics)

Power of Story: What is the Cause of Inflation?

How does a sovereign nation assimilate and cope with an acquired debt of seventeen trillion dollars? Just how much is a trillion? Let’s see if we can transform this economic amount into a figure that we can better understand.

If Billy Bank Customer walked into his local bank, approached the teller window and requested the employee to count out to him one million dollars at the rate of one dollar per second, how long do you think it would take that teller to count out the money . . . nonstop . . . no lunch breaks, no potty breaks, no sleeping, no walking around, or talking to anyone, just counting?

        The answer is eleven and one half days and nights nonstop!

How long would it take Billy’s banker to count out one billion dollars at the rate of one dollar per second?

        The answer is thirty-two years, nonstop.

How long would it take Billy’s banker to count out one trillion dollars at the rate of one dollar per second?

        The answer is thirty-two thousand years, nonstop. That is longer than recorded history!

Now, we start losing touch with reality and our brain begins to bounce off the inside of our skull when we attempt to multiply that numerical concept by seventeen, or twenty, or twenty-five!

We are going to be dealing with the subject of inflation. Let’s establish a definition:Inflation is the sustained increase in the general level of all prices.

As long as we are in the question asking mode, let’s try a little quiz. Indicate whether or not you believe the following listed factors to be the cause of the monetary phenomenon called inflation:

                                                 Agree                              Disagree  

  • When companies are allowed to have a monopoly on a product or service, they charge more, thus causing inflation, because everyone else then has to charge more.
  • Greed and profiteering on the part of business operators causes inflation. 
  •  When labor unions demand higher wages, it forces manufactures to raise their prices and that in turn forces new demands for higher wages, etc., thus causing inflation. 
  • Imports, such as automobiles, electronics, and clothes, cause inflation.
  •  Exports, such as wheat or timber to other countries, cause inflation.
  • OPEC and other cartels cause inflation since they can demand a higher price for a product, such as oil, which is depended upon so heavily.
  • When the supply of money is increased into the economic system without the same amount of goods or services being increased, the result is inflation. 
  • When products become scarce because of strikes or poor crops, the price goes up and it causes inflation.

The phenomenon of inflation is nothing new in history. Of all the numerous currencies created throughout the world since the 1700s, few to none exist in their original form. Most changes center around deficits and debt. Next week we will further investigate inflation as it relates to the future of our own nation.

(Research ideas from Dr. Jackson’s new writing project on Cultural Economics)

Power of Story: Methods to Alter the Money Supply

The Federal Reserve Board utilizes three basic methods in its alteration of the money supply:

  • Through Its Control of the Fractional Reserve Requirements. The fractional reserve requirement is    the control that would have kept Gaffney Goldsmith from loaning out too much of his gold, i.e., each lending institution is required to maintain a certain percentage of its deposits in reserve, either in their own vaults or on deposit in one of the Federal Reserve Banks. The Fed has the right to raise or lower the percentage of those reserves within congressional limits. Quite simply, if the Fed requires the bank to retain a larger percentage of the deposits, then there is less money to be loaned out, thus the money supply tends to fall or shrink. If the reserve requirement is lowered, then the money supply tends to expand and it is easier for you to borrow the bank’s money.
  • Through Its Control of the Discount Rate. Banks not only use their customer’s money, but they also borrow money from the Fed. The rate at which banks borrow money from the Federal Reserve is known as the discount rate. As the discount rate is lowered, it becomes more attractive for the banks to borrow. The banks borrow so that they can loan more money out to their customers. When money is loaned out to the borrowers, the money supply expands. When the discount rate is increased by the Fed, there is a tendency for the banks to borrow less. Therefore, there is a tendency for the banks to loan out less to their customers, and the money supply tends to shrink. The prime rate is the rate of interest charged by a bank to its best customers. Prime rate is largely determined by the Fed’s discount rate and the customers’ demand for money. If the prime rate gets too high, it becomes impractical for the customers to borrow.
  • Through Its Activities of Buying or Selling Notes and Securities of the U. S. Treasury. This procedure will be explained in detail in the next section. But let it be simply stated here that the most dramatic method for altering the money supply is through the monetizing of the Government’s deficit spending by the Federal Reserve System!

It is very important for you to take the time to understand the concept of Money and to learn the functions of the Banking System. Without that knowledge it will be impossible for you to understand and appreciate the origin and effect of perhaps the most serious threat to any economy . . . inflation!

Next Week: What do you believe to be the cause of inflation? 

(Research ideas from Dr. Jackson’s new writing project on Cultural economics) 

Power of Story: Who Controls our Money System?

Your agreement with your bank when you make a deposit is that they will return your money to you whenever you demand it if it is in a checking account, or within a period of a few months if it is in some form of a savings account.

This is a promise that the banker only presumes he can keep. Your money is then taken, and the majority of it is loaned to someone who may not be required to repay the money for perhaps twenty or thirty years. Obviously, the bank cannot technically keep both agreements. History has proven, however, that if the element ofconfidence is present, new depositors will put more money into the bank, and out of that new deposit you can receive your money if you so demand.

In the late 1700s, the young government of the United States quickly realized the need for some type of control over banking. Independence and freedom, however, were the key items in the development of early America, and the fear of federal control and “money monopoly” frustrated any successful attempt by the government to bridle banking. “Wildcat banking” was prevalent, and since all banks were scrambling to make a profit, many banks failed due to undisciplined management. The bank panics of 1819, 1837, and 1857 brought about the National Banking Act of 1864.

In 1900, the United States went on the gold standard that was intended to stabilize the economy by making all forms of U.S. currency redeemable with gold. But following the panic of 1907, Congress was persuaded that the reason for all the country’s economic “ups and downs” was that there was no central banking system.They claimed that with such a system there

  • Would be control over the nation’s total money supply.
  • The central bank could step in and protect the depositors of any bank that had become overextended.

It was argued that this would guarantee once and for all the confidence in the banking system. Thus, two days before Christmas, 1913, (after most Congressmen had left Washington D.C. and returned to their homes for Christmas holidays), President Woodrow Wilson signed the Federal Reserve Act.

There was strong reluctance on the part of the individual banks to create a strong central system in Washington D.C. or New York, so the Federal Reserve Act became somewhat of a compromise. It divided the country into twelve districts with each district containing a Federal Reserve Bank and additional branch banks. All banks with “National Bank” designation were required to join, but the state banks only joined if they so desired.

The Federal Reserve Bank is a separate organization, not under the direct control of Congress or the President of the United States. The stated intent was to establish an impartial “referee” to oversee the banking system. The current President, however, does appoint any vacancy on the Board of Governors. The Board consists of seven members. Each member is appointed for a fourteen year term and they completely supervise the Federal Reserve System.

You could not walk into a Federal Reserve Bank and make a deposit or negotiate a loan. A Federal Reserve Bank is a “banker’s bank” that receives deposits, holds reserves, issues notes and currency, and clears checks . . . just for banks. You are affected, however, by an agency known as the Federal Depositors Insurance Corporation (FDIC) that serves to bolster your confidence in the Federal Reserve System by claiming that every bank account is guaranteed up to $250,000, and that since 1934 no depositor has lost any insured funds as a result of bank failure. That guarantee is supposed to alleviate your fears of making deposits in your local bank, even though you subconsciously know that the institution could ultimately only cover a fraction of a penny for every dollar on deposit.

The U.S. Treasury prints paper money and mints coins, but the Federal Reserve System alone is authorized to place them into circulation. The U.S. Treasury also maintains its deposits from taxation, fees, etc., in the “Fed,” as it is often called.

The Board of Governors is assisted by a Federal Advisory Council and the Federal Open Market Committee that is in charge of buying and selling government securities (we will see the importance of this committee later, in the role of inflation)

Of course, the old established banks had no desire to be controlled, but, they had lobbied Congress for government regulations to make it more difficult for additional banks to enter into the competition and to keep the other established banks from initiating competitive practices that would have affected their profits. Perhaps it was due to these ulterior motives that the Federal Reserve System failed so miserably in helping ward off the Great Depression and the bank crashes of 1929.

A most important fact to remember is that the Federal Reserve Board has ultimate control over the money supply of the United States of America. They have the power to either increase or decrease the total amount of money, including the ethereal numbers of computer money digits in the monetary system.

Next Week: The three basic methods the Federal Reserve uses in its alteration of the money supply.

(Research ideas from Dr. Jackson’s new writing project on Cultural Economics)

Power of Story: Banking

The last half dozen articles I have written have dealt with the question: What is Money? The conclusion was that over the past two hundred years our concept of money has slowly changed. Cash has become a concept and not a commodity. No longer do we think of money as a bar of gold or silver from which we peel off enough shavings to fulfill the requirement of the balance scale. We instead, fancy money as simply a credit or debit stored in the memory chip of a computer and backed up solely by confidence.

The money system has morphed into what it is because of our demand for convenience, and it is based strictly on the confidence that someone else will accept our ethereal numbers from the computer to satisfy what we owe. There is now no such thing as gold or silver to back up the value.

Here is a confession: I actually went back and read again what I had written about money. My question was: Why did I write that material as if I were an economics professor delivering a lecture in front of a classroom?

I am one of the diehards who still wholeheartedly believe in the power of story. We usually understand best through story. If we are to understand:

  • our fractional reserve system of banking,
  • how and why the Federal Reserve System exists without control of the US government or the banks,
  • how the phenomenon of inflation takes wealth away from you like a thief in the night without the necessity of even one vote of congress,

it will be absolutely necessary to understand some very simple and basic facts that will probably not be gleaned from an economic lecture.

So, please indulge me to try to utilize the power of story to explain in the next set of writings how all of this works together in the real world of money and finance:

The story of banking begins with the ancient goldsmiths. When “Barney Businessman” was fortunate enough to accumulate a sizeable amount of gold or silver as a result of his business dealings, he was then confronted with the problem of keeping it safe from those who had intention of forced wealth redistribution, i.e., thieves and robbers.

Because “Gaffney Goldsmith’s” business was that of dealing in precious metals, he had been forced to construct a thief-proof vault. It was only natural then that Barney Businessman would go to Gaffney and request of him space in his vault to store his accumulated gold. In fact, Barney was willing to pay Gaffney a fee for the “safekeeping” of his gold.

Of course, when Barney deposited his gold into Gaffney’s vault, he requested and received a receipt of deposit which he had to present whenever he wished to reclaim his gold. Other people in the community began to realize that Gaffney Goldsmith’s vault was an extremely safe and convenient place to keep their gold. In fact, Gaffney’s vault became somewhat of a warehouse for gold.

Gaffney was pretty intelligent and he had taken mostly honors classes in school, so it didn’t take him long to realize that on any given day, eighty to ninety percent of the gold in his vault simply sat there collecting dust. He became convinced that there would never be a day when everyone would come to his vault and want to withdraw all their gold at the same time. Any daily withdrawals of gold would be offset by that day’s receipts of gold. And since gold is gold and gold is gold, no one seemed to care whose gold he received when he wanted to make a withdrawal.

Therefore, Gaffney usually made all of his transactions out of the few bags of gold in the front of his vault while all the bags in the back sat there collecting dust and taking up a lot of valuable vault space. Gaffney realized that he had a good thing going. And his books always balanced!

GAFFNEY GOLDSMITH

*        LIABILITIES &

ASSETS          *            NET WORTH

  --------------------------------*---------------------------------

GOLD             $2000       *        RECEIPTS      $2000

The gold was an asset to Gaffney, because it was under his control. The receipts were a liability to him, because they represented the owner’s claim on the gold, and sooner or later, he would be called upon to return the gold.

Question for next week: How was it possible for Gaffney to keep his books balanced and at the same time create more money in the community? 

(Research ideas from Dr. Jackson’s new writing project on Cultural Economics) 

So, What is Money? Part 5

As we have discussed, the only reason printed paper money has purchasing power today is because people accept it as having value. You accept paper money in payment only because you have confidence in the fact that other people will accept your paper money when you wish to pay for something.

 It is not too difficult to see how check writing came into practice. It, too, was based on convenience and confidence. The practice of check writing was somewhat of a throwback to the old idea of signing over to someone else the receipt that the goldsmith had issued when you gave him your precious metal to hold in his vault for “safe keeping.”

The explicit instruction on that paper check allowed a depositor to tell the holder of the value to transfer the funds from the depositor’s account to the account of another to whom the payment needed to be made. As long as the intended recipient of the funds was convinced he would actually end up with the funds, he would accept the written check as payment.

The plastic credit card was a phenomenon of my lifetime. In the beginning it was not really seen as money, because the credit card required another form of money, either cash or check, to pay off the monthly charges. But the convenience of the plastic credit and debit cards was so alluring and so addictive that the requirements for the factors of confidence were hardly given a second thought.  More and more usage of the plastic credit cards included the direct authorization of transfer of value from holder, through the financial institution, and on to the merchant.

Over time, the tangible aspect of money has come to be seen as a nuisance as well as a nescience. There is so much tacit confidence and presumption in the emerging system of ethereal money that to me it smacks of overwhelming incredulity. The full confidence is placed not in something that is even remotely tangible and protectable, but in the wishful thinking that envisions a failsafe system of convenience and absolute confidence placed in a collection of numbers stored in a computer. Cash has become a concept and not a tangible asset. That is a scary and very vulnerable position for a culture.

(Research ideas from Dr. Jackson's new writing project on Cultural Economics)

So, What is Money? Part 4

The first paper money in America came not from banks but from the governments of the new colonies.  In 1690, Massachusetts issued paper money, but it had no tangible asset to back it up, only a promise to redeem it later. That privilege was soon abused, and the market was flooded with the junk paper money trying to purchase any available goods. Prices soared.

The paper money drove the metal coins out of circulation simply because everyone began hoarding the metal coins.  By 1751, Britain demanded that no more paper money could be issued. The Mint Act of 1792, that has survived almost intact until the present, adopted the dollar as the standard unit of currency and the decimal system of counting. But what has backed up the U.S. dollar and given so many people the confidence in it as a secure store of wealth?

Some folks would tell you that the reason for the confidence is that there is one dollar worth of gold in Ft. Knox, KY for every dollar that is placed into our money system by the Federal Reserve Bank. Sorry, but that hasn’t been the case since the U.S. abandoned the gold standard in 1933. By August, 1971, we had sloughed off over $12 billion of the gold reserve in Fort Knox.

Saying that our currency was backed up by the equivalence of gold in Fort Knox was a sick joke. To make things even worse, it was agreed that if we owed a debt to any sovereign government, they could demand and receive our payment in gold from our reserve. In 1971, President Nixon realized that when the U.S. had trade imbalances with other countries, and we bought more from them than they bought from us in traded goods, they could and were demanding payment from us in gold out of our reserves in Fort Knox.  We possessed less than one penny at that time in reserves for every dollar issued.

On August 15, 1971, President Nixon closed the gold window. That severed the critical link between international currency and real gold. From that time on the U.S. would pay their balance of international payments in dollars. That was the first time that link had been broken in 1,500 years! Since that time the world has accepted the U.S dollar as the international standard of payment.

Other countries are now demanding to know how much real gold the U.S. has stored in Fort Knox to back up our standard of currency. That’s another sick joke. There isn’t enough there to even make a quantifiable difference. There is really only one thing that gives any form of money acceptance and usability: confidence! People will only accept U.S. dollars as long as they believe that someone else will have confidence enough in the currency to take it from them in true form of payment. That national and international confidence is very quickly melting away.

(Research Ideas from Dr. Jackson's new writing project on Cultural Economics)

So, What is Money? Part 3

Money can be any article agreed upon as a store of wealth by any number of people and used as a common medium of commerce to exchange what they have for what they want. Whenever the article fails to maintain people’s confidence in its power to purchase, it fails to remain money.

Whatever is agreed upon and used as money is relied upon because of convenience and accepted because of confidence. If something new comes along that is more convenient, and can still retain the confidence of the people as to its purchasing power, it has the possibility of becoming a new form of money.

The desire for convenience motivated people to begin to use pieces of paper as money instead of lugging around bags of heavy metal bars or clumsy coins. That took a huge leap of confidence until people began to trust in the fact that other people would accept their pieces of paper as payment for goods or to satisfy debts.

In the beginning, paper money looked a whole lot more like a receipt. For safety and convenience, people would take their gold or silver to a business (like a goldsmith) that was equipped to store the metal there for “safe keeping.” Sometimes, they would place the metal in a local bank vault.

The goldsmith or banker would give the owner of the metal a receipt to prove ownership. When that person wanted to make a purchase or pay a debt he would simply sign off the receipt and hand it over to the new recipient. Should the new owner of the receipt want to take physical possession of the metal he would go exchange his receipt for the real metal. Or, for convenience sake, he might simply sign the same receipt over to another person when making a purchase or paying a debt.

Over the years we have moved in the direction of a cashless society, but certainly not a moneyless society. Convenience and confidence will always determine what will be used as money. Is each article used as money always backed up by gold or silver somewhere in a vault? 

(Research ideas from Dr. Jackson’s new writing project on Cultural Economics) 

So, What is Money? Part 2

It might be possible to imagine a cashless society, but not a moneyless society. People will always fabricate some kind of money in order to help them facilitate trading the things they have for the things they want. What’s your preference to use as money?

Historically metal has been used most. It is a whole lot easier to make change with pieces of metal than with raw eggs. Economist Adam Smith said in the mid 1700s: 

    Metals cannot only be kept with as little loss as any other commodity, scarce anything be less perishable than they are, but they can likewise without any loss, be divided into any number of parts,  as by fusion those parts can easily be reunited again; a quality which no other equally durable commodities possess, and which more than any other quality renders them fit to be the instruments of commerce and circulation.

It became inconvenient over the centuries, however, to stand in line at the marketplace and pull out your bar of gold and whack off an amount for your purchase and weigh it with accuracy. So, the usage of coins became more convenient. Minted coins were easily identifiable and had their weight and purity stamped on them.

It was also common for the coins to bear the image and guarantee of some governmental leader. Sooner or later the governments have always taken over the sovereign control of the minting of coins. Even in the US, under the Mint Act of 1792, the debasement of coins by an individual was made illegal and a crime punishable by death. The government likes to have control of the monetary system. Down through history, however, sovereign governments have repeatedly abused their rights of minting coins.

Would some people accept commodities to be used as money? Yes. Would most people accept precious metals to be used as money? Yes.

But why would any reasonable person accept a small printed piece of paper as money?

(Research ideas from Dr. Jackson’s new writing project on Cultural Economics) 

So, What is Money? Part 1

Has there always been money? Where does it come from? Who determines its value? Are credit cards really money? Does the value of money always shrink with age? What happens when money fails to maintain its power to purchase? What would a totally cashless society look like?

In 1758, philosopher/economist David Hume stated: 

Money is not, properly speaking, one of the subjects of commerce, but only the                  instrument which men have agreed upon to facilitate the exchange of one                            commodity for another. It is none of the wheels of trade: It is the oil which renders the motions of the wheels more smooth and easy.

We have come a long way since David Hume’s discussions regarding money in the eighteenth century. In my travels I have observed different cultures using some pretty strange things as money: salt, animal hides, wives, cattle, wheat, and beads.

By the way . . . how is your confidence level these days in having all your store of wealth represented by numbers in your bank’s computer?

(Research ideas from Dr. Jackson’s new writing project on Cultural Economics)