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Foundation for Economic Education, January 7,
2019, 4 pgs.
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Reviewer Comment: This is a 'libertarian' and
basically an 'Austrian School' view on 'boom-bust' cycles and money supply. In
addition to mistaken concepts about 'money', banking and credit he claims that
basing 'money' on gold would solve the problems he identifies.
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Introduction:
Dr. Shostak believes that commentators on market conditions in 2018 mostly
expected the market prices to continue to increase, but that NOW, meaning late
DEC. 2018 they are expecting a 'downturn' to arrive soon. They are blaming
President Trump's policies for this reversal. They especially fault his tariff
policy. But they are not considering the 'decline in the annual growth rate of
the money supply'. An exception to this is the monetarists - followers of
Milton Friedman. He describes the monetarist theory, that the changes that
constitute a business 'cycle' are found in the changes in the growth rate of
the money supply. From this idea Friedman proposed that the central bank
bureaucrats should establish a 'fixed rate of growth of money supply'. He
includes a lengthy quotation that states this idea. He writes that If this
fluctuation is the true cause then Friedman's idea might be sound.
Contrast this focus on the volume of the money supply with the popular theory
about the 'velocity' of money and its claimed effect. See Shostak's article.
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Money out of Thin Air
Dr. Shostak writes that it is not 'fluctuations' of the growth rate of the
money supply itself that is responsible but, rather, the growth rate of that
component of the money supply that is "generated out of 'thin air'".
He believes that it is this 'thin air' money that enables 'non-productive
activities' that do not create real wealth. Instead it actually diverts money
from supporting creation of 'real wealth' into creation of 'non-wealth'. He
points to the process whereby the 'early receivers' of the new money are the
first able to employ it to exchange for existing goods and services rather than
create new wealth. By the time the real people who would create new wealth have
access to this money prices have risen.
(This 'thin air' 'money' is credit and the author is correct about its
destructive effect - but because of the way it is used - The American economy
was financed by credit from the first voyages of the Pilgrims and the settlers
in Virginia. JS))
The 'early receivers' (NOW, JS) are precisely the insiders in the finance
industry and they comprise most of the billionaires in the Forbes 400.
He continues: "Note that since non-productive or bubble activities do not
generate any real wealth, they cannot secure the goods they require without the
support from newly created money". He elaborates in the results of this
process which increases investment in bad assets. This is expanded further by
the 'fractional reserve' bank system in providing loans. The expansion of loans
based on 'thin air' money used as 'fractional reserves' expands the economic
'boom' But when the loans are paid off the process reverses and elimination of
one loan also eliminates the others that were generated by 'fractional reserve'
expansion. Hence a bust.
He writes: "A fall in the growth rate of money out of 'thin air' is
thereby going to undermine various non-productive activities that arose from
and were supported by the fractional reserve bank lending. This sets in motion
the economic downturn."
He comments that even an expansion of the money supply at a standard fixed rate
(Friedman's idea) would also be an expansion of 'thin air' money, so would
still cause the same problem.
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The Gold Standard and Boom-Bust Cycles
Now we come to the expected link of 'fractional reserve' banking and business
cycles to a proposal on shifting to a gold standard. He admits that even with a
gold standard - that is a direct congruence of (for instance the dollar) of
gold and 'money' there will be some fluctuations on volume. But he claims that,
since gold is also a commodity, its use in the process of exchange is NOT an
exchange of nothing for something so will not divert wealth from wealth
producers towards non-wealth creating activities.
(But, it is exactly that gold IS a commodity and that gold as a 'money' are not
the same and frequently if not always has different 'value' itself, which
creates financial problems. JS)
(In the process of exchange of goods and services in the market money is NOT
being exchanged anyway. It is only the temporary and intermediate medium in an
exchange that is one of real goods and services being exchanged with other
goods and services. More important, is that currency, be it gold or paper or
silver, is no longer the 97% and more component of the real money supply.
Today's money is credit. So in today's market exchange real, existing goods and
services are being exchanged for 'credit' which is a promise to in future
produce real goods and services to complete the exchange process. JS)
He writes: "A wealth producer (because of the fact that he has produced
something useful) meaning gold -can exchange it for other goods. "
(But we no longer have an economy in which 'wealth producers' exchange real,
existing goods and services with each other. We instead have an economy in
which millions of individual consumers are not producers, but are the recipient
of credit supplied by government. And the people who use gold are not the
people who 'preduced' it. JS)
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Dr. Shostak concludes with this idea.
"We hold that the disappearance of money out of 'thin air' is the major
cause of economic downturns. (The injection of money out of 'thin air'
generates bubble activities, while the disappearance of money out of 'thin air'
destroys these bubble activities). On a gold standard, this cannot occur. On as
pure gold standard without the central bank, money is gold.
(The first sentence is correct, but 'money' is NOT gold. JS)
"Consequently, on the gold standard, money cannot disappear since gold
cannot disappear unless it is physically destroyed".
( But the 'disappearance' of money that he notes is due to a contraction of
credit. And during times when gold was used in exchange it also was used before
there were banks and by banks and other holders before there were central
banks. And economies experienced 'boom-bust' episodes from expansion and
contraction of credit. JS)
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In this statement we see advocacy for much
more than only a gold standard with a currency consisting of gold. During the
18th and 19th century when the British pound and then the U.S. dollar were
fixed in value to a quantity of gold, banks nevertheless did issue fluctuating
quantities of bank notes (either in paper or in bank account ledgers - that is
credit). And there were frequent 'boom-bust' episodes in which investors were
excited to create (for instance canals, railroads, agricultural expansions)
that turned out to be mal-investments which, when they collapsed, generated
bank panics and temporary depressions. Moreover, during that gold standard era,
governments issued through banks sizable quantities of paper notes to finance
their wars. So Dr. Shostak is advocating not only the fixing of a currency such
as the dollar to a fixed weight of gold, but also the limitation of investment
and consumption finance to the quantity of currency in gold. It was the
rebellion of farmers and workers in the last half of the 19th century to their
difficullty in repayment of their debts that this caused that generated the
strong 'free silver' political campaigns.
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The existence or absence of a 'gold standard'
was not directly related to economic 'booms or busts'. And 'easy money' versus
'hard money' was a source of continual political conflict in the U.S. during
the 19th Century despite a gold standard. It is fundamentally caused by the
struggle that has existed since the first civilizations between debtors and
creditors - between producers and non-producing consumers. - between rulers and
ruled.
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Ingham, Geoffrey - The Nature of Money
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Martin, Felix - Money - The Unauthorized
Biography
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Kwarteng, Kwasi - War and Gold: A 500-year
history of Empires, Adventures, and Debt
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Davies, Glyn - History of Money: From
Ancient Times to the Present Day
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Hudson, Michael - ...and forgive them
their debts
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Lewis, Nathan K. - Gold the Final
Standard
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Shostak, Frank - Money Velocity and
Economic Growth
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Doug French - review of Vikram Mansharamani's
book - Boombustology: Can Mises and Minsky Help Investors Spot
Bubbles"
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Vikram Mansharamani - Boombustology: Can
Mises and Minsky help investors Spot Bubbles?
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Gerald P. Dwyer - Quantitative Easing: A
Model for Financing Government Spending?
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Alexander W. Salter - Interest
Rates, Funny Money, and Economic Malaise
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Kai Weiss - Central Banks
Contribute to Inequality
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Justin Murray - How Central-Banks
Interest-Rate Policy is Destabilizing Banks
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Money and Value
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John H. Wood - Monetary Policy in
Democracies
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