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Graphics in text mode : - ( - Edited 1-22-16
Apologies beforehand on my lack of working knowledge and familiarity with html and posting graphics on this site.
Nevertheless, a description is in order if it is only the second or third best means of conveying ideas. We've been through this in the tsunami, but a detailed step-by-step review may be worth the effort for new readers. Much of what is suggested here is common knowledge, but somehow escaping notice until we're deep into another recession or worse.
The contribution of borrowing, credit, debt and stock of and the circulation of money stock changes in the process is NOT a difficult concept, yet it has been and is still ignored by commercial and central bankers - flagrantly!!! Ignoring the details may set their minds at ease or ease their pursuit of career opportunities for the moment but the consequences hang over the global economies with promises worse and much more frustrating than the sword of Damocles.
In sequence, (and in the manner of Irving Fisher's explanation of his debt-deflation theory) this is what happens:
- An economical sector or enterprise needs cash to combat a "temporary" (or more persistent) condition: the larger the sector, the more disastrously multiplied are the results.
- The mechanics are observed through application to a commercial bank;
- The bank sets up a current account in the amount of a loan against which the applicant can draw and dispense funds to limits granted.
- The amount of the current account is listed as a liability in the bank's accounting system.
- That liability is discharged as payments are received.
- In the meantime, the credit is circulated as money or purchasing power.
- The increased circulation has the same effect - though temporary, as we'll see - of increasing the stock of money available.
- Purchases are made: the consumer gets her goods, or buys her new house, tidies up and augments her living quarters to a level not possible with savings or income at the level then present. For a business enterprise, capital equipment or supplies are purchased, an investment is made which would not be possible at current income/reserve/resource levels.
- In the meantime, the currency/credit is released more deeply into circulation in the community to supplement the stock of available currency creating a condition of temporary imbalance. . . meaning inflation-inducing expansion of money supply.
- Graphs depicting this would start with the solid trend line of REAL economic progress - be that an upward or downward slant signifying improvement or deterioration of the basic economy.
- The effect of the additional available currency delivered by the banking activity has immediate consequence; it begins a second line, dotted (to indicate its temporary nature), diverging from the trend line and moving upward at a slightly greater slant than the Trend line.
- This second, dotted line may be insignificant with one or a dozen loans; but, depending on the mood (sic!) of production industries, or the aggregate households community as a whole, may have a tendency to find a less resistant line at a steeper incline, indicating more freely flowing currency path options may be enticing others to do the same: either spruce up the aggregate (meaning total economic entity) neighborhood(s), or globally if this is the consumer sector, or, increasing production facilities if that applies.
- The second line can balloon above the trend line at some suggested angle until it meets the resistance of market satisfaction or capabilities - meaning all consumers have committed to whatever fancies they have generated and there are no more buyers, or all production facilities have finally supplemented their ability to satisfy markets and are now in over-production mode.
- During this time, borrowers have been paying off their loans, banks have been reducing their liabilities with the "income" and the entire economy has been experiencing the effect of the "retired" currency put into circulation, with all expectations adjusted to new levels and this causes a withdrawal of purchasing power without notice on the community.
- Sated consumers cut back on their spending spree, or production facilities now find themselves with declining market interest and begin shutting down their facilities and begin forced layoffs which then alters the amount of normal income to both production and household.
- At the same time, the dotted line above the trend line on our graph, takes a dip toward the original solid trend line and the impact of the aggregate constriction may impel the trend line down into a tailspin decline which would never have been suggested by a normal economic trend, one not augmented by the temporary introduction and subsequent deprivation of credit/loan currency. Very often the weight of the dotted line and the strength of the impact turns the trend line down, and we're into a recession or worse in search of something solid - stability.
- At this point, production/consumption slowly become aware of the effect of the collapse of the trend line but may disbelieve the suggested consequence, either the severity or persistent effect, and, expecting a quick turnaround and recovery, they continue a certain amount of spending on the basis of savings, or small loans they fully intend to repay.
- After a period of adjustment, they discover the savings are not as sound as they believed, or the lenders not as anxious to loan, or the downturn, more persistent than expected, takes on a gloomier outlook, suggesting it will last longer than first believed, or other income is absent - this, then, is the "liquidity" crisis too often described as "lack of demand". But, overall, reality sets in.
- Consumers of both household and production goods are forced to admit the constriction of money supply and the over-capitalization of production facilities has become an unsupportable burden which, coupled with the sudden evaporation of currency supplies, becomes too weighty for the economy or its financial slight-of-hand.
- Some obligations are not met due to "cash flow" difficulties in banks and their borrowers, while the trend lines drift lower and lower at a too rapid rate.
- Not satisfied with the lesson of the credit bloat and the impact of the temporary increase of circulating currency, central banks then determine that what is needed is doubling the burden by augmenting stock of currency thereby alleviating cash flow problems by selecting one sector or another as beneficiaries of their largesse and proceed to generate more imbalance by distributing funds beyond the economy's support level.
- The industries are trying to make do in an environment which is over-capitalized for normal activity which means cutting back, and the community of both production and consumer goods are trying to live within the means of a less than normal economic society, another retraction. Into this, central banks pour Quantitative easing. The mismatch aggravates the situation.
- The net effect of the central bank intrusion with additional currency is to tax further the already struggling economy with false stimulation hoping to resuscitate market activity while consumers are not yet prepared to adjust to normal. In a sense, the effort is overkill - as bad or possibly worse than the effects of over-ambitious credit creation which is now meant to force the community into a support mode for capitalization that has no legitimate market to service.
The puzzle of the moment is how can economists pose a process as obvious as this in such complex terms that they confuse themselves? Shouldn't they enter into the financial arena with words of advice well before the predictable critical point of issuing credit-based circulating currency to the degree that threatens stability? The advice would be as simple as rephrasing a borrowed line from a movie
"Couldn't you stop your scribbling for a minute? Put down your pens, stop fiddling with your equations and look at the situation through a normal pair of eyes? Couldn't you do that little?"
No! They're above that. They love "errors of composition". After the errors are generated, they can fill their empty hours searching for solutions.
There was an escape suggested in the tsunami thread which will be repeated here, though some deaf ears may be beyond remedy:
The way out of the Boom/Bust cycles is to determine how much currency augmentation is needed for an acceptable rate of growth. If that rate is established, credit issuance should be limited to its support and not allowed beyond that into the areas of speculation and the accompanying disaster.
Bankers’ objections are specious! We set up reserve limits for every kind of banking activity through BIS. We've heard of Basel I, II, and III; what's wrong with instituting Basel IV which would deal with over-issuance of credit and preventing the destructive false purchasing power? Control credit and loans with a sense of urgency?
At this stage of scientifically developed Economics, we should know and have equations which would detail the needed amount of capital which would safely support growth at a reasonable rate. Capital funds and credit should be retained and/or limits marked for circulation and the limits of credit that can be safely issued. That is to specify a range of needs in those respects, instead of catering to the satisfaction of those who would manipulate finances for their own benefit at a sustainable level of expense for all. This can all be managed on the basis of existing data sets.
There is one danger to the attempt to control development which needs recognition and that is the concentration of effort. It has been demonstrated in controlled societies. When central authorities issue growth or development plans, inadequate attention is directed toward the weight of over-concentration of community effort - a neglect of the advantages of "random walk" concepts. We've used the example of a boatload of passengers rushing to one side of the ship and causing a capsize. As long as there is a equal distribution of passengers on the ships deck, no harm will come to anyone. But, once they all find a reason to rush to one side, danger follows. Imbalance and disaster follow.
The paramount example of this was the concentration of Russia's term plans for development. Longer range capital development became the prime concern and consumer goods were reduced to secondary importance; shortages developed and we know about the long lines and inadequate supplies of food, clothing and almost all consumer necessities. "Random walk" approaches must be preserved. We might point out that the rush to capitalize on trends, the rush to profit before the opportunity passes, even when central authorities are absent, causes the fluctuations of the Boom/Bust cycle and the catastrophes large and small that follow.
We've resisted attempts to control this concentration through regulation to this point to our detriment. Through this neglect, we promote the business cycle, explained away with every conceivable concept as we've mentioned several times over the past seven years. But, then, if we follow Veblen's depiction of the businessman's goals, and concede the high ground to them, the cycles will continue.
It is that simple.
What ratio prevents a solution to such a problem? 80 something against 6 1/2 or seven billion? What in the world is the obstacle here? If the equations are not yet ready for deployment, they could literally be generated - overnight! And, we could smooth out the fluctuations the next day. But, it would appear, only if the 80 would permit it!
The alternative is the eventuality of a self-destructive community proving itself - as Eccles, with a successful banker's insight, suggested some 80 years ago.