Monetary Theory, Or Something There Abouts

I am not stranger to various economic theories since I have taken a few courses on the subject.  I am not by any stretch of the imagination an economist.  In the formal sense as economist is an individual who has completed a PhD program in Economics from an accredited university or college.  Actually, a psychologist is in that same category while an engineer is someone who has completed a bachelors degree in the course work.  I mention this is passing purely for comparative purposes.  If one seeks the academic accolades of the titles then one must put in the studies in the graduate schools.  Of course the basic problem remains and that is that the simple possession of a degree doe not mean one actually knows anything.  It only signifies that you attended all the proper classes, did the required work, and obtains the required grades in order to obtain that piece of paper.  That piece of paper say nothing about the practical qualifications for the work you think your are suited for.  Pardon the preposition at the end.

Monetary theory is somewhat somewhat of the same vein.  We believe that there must be a theory.  We believe that there is some critical mass of science or at least observations that show us what this thing calle monetary theory is, and how it is measured and what it is suppose to do.  Well, so much for fantasy land.  But wait, didn’t the Chicago school of economics determine what monetary theory was all about?  Maybe, and maybe not.  Let us think for a minute about money, after all, that is what this theory is about.  One of the reasons why the Federal Reserve System was created was due to the problem of money.  No, not so much about monetary theory but money.  The Panic of 1907 showed that there was a problem with the money supply.  Ok, what is the money supply?  Let us back up a bit.  The bank of England was chartered with the creation of coinage and with the issuance of letters of credit.  Ah, what is the difference in a country where coin of the realm buys what is needed?  Just that, a letter is a promise of creditworthiness or the ability to pay a debt in the coinage or currency of a particular country.  Understand that coinage and the printing of paper currency is about coinage.  That’s right,, gold and silver coins, the real stuff.  Paper is merely a promise of the real stuff.  Why is this concept important?  Because if I have x quantity of gold bars of known purity and t is verified that I have such bars in my safe or vault or repository, then I can issues paper promises that represent those gold or silver bars as repatriation.  I, the King, promise to pay you, the merchant, a gold or silver bar worth x-amount of paper currency.  If I am dealing in tons of gold bars, paper promises is a lot easier to lug around.  Are you with me so far?

So we now have something to measure, money supply.  What is money supply?  Back in the old days it was the amount of coinage and paper currency that was circulating in the economy.  But today, with the issuance of credit, we increase the supply of money, except i is not recognized quite that way.  We have all kinds of measurements of money.  But regardless of the number of coins and pieces of paper currency in supply, it is wise to include that amount of credit issued.  Why?  because credit spends just as well and coins and paper currency.  And what we are talking about is aggregates of money.  Remember, money is that exchange medium we use to pay for goods and services we want.  It is that third party of barter.  Money also has a velocity, that is how much it is turned over or spent.  Assume a finite supply and if all individuals are paid for their services and it all individuals spend all on their money of goods and services, the the velocity must always equal one.  Money eared equals money spent equals one.  A very simple concept.  But let us now assume that e do not spend all of our income.  Let us assume we save or do not spend ten percent of our income.  Let us assume that what we save is then invested into assets that produce a return.  The the money spend less that which is saved plus the return on investment gives us a proper velocity of money.  Where we get a bit disjointed is when we issue credit.  That is, money that is neither earned nor spent.  Of course it is not money spent, it is credit.  Once it is spent that credit becomes debt and enters into the money cycle.  It bought goods and services, it was accepted as money.  Credit then accelerates the speed or velocity of money.  Do you see what has happened?  No coins changed hands, only a promise to repay that was accepted as money.  Are you with me so far?

So now we have a central bank that supposedly keeps track of all the money flows through the economy, all the credit created, and the velocities of various forms of money.  But they look at all this in its aggregate form.  If i look at the aggregate forms of fuel that includes diesel, gasoline, natural gas, ethanol, and every other form of energy and there is one that is very low and one that is extremely high and the rest are merely moderate, that what am I seeing?  If the highest priced energy is really high then the price of all energy is skewed towards the high side.  If the opposite is true then the price for all forms of energy is skewed to the low side.  Average energy cost tells me nothing.  A skewed energy source puts too much weight on one form of energy over another.  Do you see the problem.  No true picture emerges when you aggregate prices simply for the convenience of doing so.  The same is with money supply and credit supply.  So when the central bank decides that interest rates need to lowered or raised, what do they believe they are doing.  Well, by lowering interest rates we may be encouraging economic growth.  Yeah, prove it.  Oh, but there is no real proof.  Why?  because we tend to confuse the international economic reality as though it didn’t really exist.  Decrease interest rates and we stimulate growth.  Well, how has rate decreases and quantitative easing worked out?  No real job growth.  Yes we have more people obtaining jobs but these jabs are more the minimum wage type.  Did we bother to look at the population that is of the age where one must work?  This is often called the population participation rate.  Why has it declined to the lowest point in 38 years?  If the unemployment rate had been reduced why are there fewer people working relative to the population of adults of working age?  Something not right.  But monetary theory says that a decrease in interest rates and an increase in the creation of the money supply coupled with an increase in credit is suppose to increase jobs and decrease unemployment.  what has happened?  Perhaps our measure does not measure what it purports to measure.  Could that be the problem.  The theory or measurement says that a measure must measure what it purports to measure else it is not a valid measurement.  Ok, so the present monetary theory is not a valid measurement.

Well, I will pick these thoughts up tomorrow and we will take a deeper look at monetary theory.  We have far more ground to cover in this area.  What does an increase in debt do the monetary supply?  And if electronic funds make physical currency obsolete what are the consequences?  What is the difference in monetary policy between fiat and precious metal back currency?  Does national or government debt make a difference and why?  We have a lot to discuss.


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