Nathan Scandella (personal)

The Problem with Our Economy

No, it's not the subprime mortgage crisis. That's just the fire drill du jour. The real problem with the economies of all the world's major nations is one that goes back to the original days of banking. The problem is the way money is created. Money is created by governments sanctioning banks to issue new credit. This credit is now money. But, it wasn't (at least most of it) money before it got lent. The bank didn't lend you the money of one of its other depositors. It injected new money into the system, with the blessing of our government-created central bank (in this country, that's called "The Fed").

What's wrong with this? Well, as a result of this system, the vast majority of money in our economy was not directly created by the central bank. It was created by commercial banks lending money (credit). The banks have an upper limit on how much credit they can issue. When things are working normally, they issue almost exactly that maximum amount of credit. This is how they make money ... by making as many loans as they are allowed to.

Unfortunately, when things go wrong, banks may not want to issue as much new credit as they are legally allowed to. This is where we're at today. In this case, the government has recognized that it needs to inject money into the economy, and is willing to run up the deficit (and inflation) to do so. However, it isn't yet working, because the government only controls a small portion of the money. That money needs to be multiplied in the real economy by the banks, and there's only an upper bound on how much banks can lend, not a lower bound. Thus, we have the credit crisis.

Here lies the first problem. In times of crisis, even if the government wants to do something, it may not be able to. But, how can that be? If the government is allowed to make money, and the economy is the issue people consider most important, how can we have allowed a situation to develop where our government can't fix a money shortage? It's as if we're being attacked by enemy aircraft, and the Air Force has built a bunch of planes, but can't seem to find any pilots to fly them.

The second problem has to do with the fact that banks get to charge us interest on the credit that they've created. Now, an administrative fee for origination of a loan makes perfect sense. The bank has to spend time to validate your collateral, and process the loan. But, why do they get to collect interest on the money they've created? The government allowed them to create the new credit, and thus add new money to the system. But, nobody created a new chunk of money that represents all the interest that will be due over the life of the loan. This money is nonexistent. What does that mean? That we, as an economy, have to keep taking out more and more loans to keep paying off the ones we already have. Just like switching the balance on one credit card to another card, with the total balance continuing to grow because of the interest. Ultimately, all the debts can never be repaid.

The result of this second problem is that we've committed ourselves to a bigger and bigger economy, just to keep a large fraction of the existing loans from collapsing (which then leads to a depression). Therefore, our current system can never be maintained by a stable population, unless somehow that population can continue to produce more and more every year. By the way, experts predict world population growth will stop by about 2050. Now, the madness materializes!

It's bad enough that we're currently struggling to fight natural resource depletion and environmental destruction, by finding greener ways to go about our business. The reality is that none of this can ever keep up with the financial system we've been living under. Ultimately, this system will run out of energy and natural resources to feed it!

So, we have a system that has robbed the government of the power to correct the situation in times of crisis, and also one that fundamentally cannot be satisfied in a world with finite resources. What can be done? Well, first of all, it is possible to maintain life on earth sustainably (if not indefinitely, at least for a very long time). However, we need to look at how much of our planet's resources can be consumed sustainably, and put limits on our consumption that reflect this. Currently, there are no such limits. Carbon cap-and-trade solutions being proposed by both Obama and McCain are one way to accomplish this, for one particular natural "resource". Next, we need to give control of the money supply back to a central authority, such as The Fed (and you thought they already had this, didn't you?). If The Fed is responsible for creating all the money, then we need only let banks lend out what they actually have in deposits and capital, not some multiple of that amount. This new Fed, however, needs to differ from the status quo in the sense that its leaders need to be true public servants. Even if they're not directly elected by the public, a no-confidence mechanism needs to exist whereby a corrupt, or ineffective Fed Chairman can be removed from office promptly.

But, since our population is still growing today, how do we allow our economy to grow? Keeping the sustainable resource limits in mind, we can still allow money to be injected into the system, but it needs to be by the central bank. I propose that the mechanism for injecting new money into the system would be as government spending on infrastructure projects. These are projects that we currently think of as the government's responsibility, such as roads and military equipment. But, they should also include spending for new infrastructure we know we'll need, but that the private sector won't put up the funds for. An example would be the green technology industry that Obama has talked about. Solar array factories. Battery production. Biofuel farming, wind turbines and new nuclear plants. These items will represent new value injected into our system. And they will be items that will have significant long-term leverage in terms of the jobs they create, and the money they save (via energy independence, energy efficiency, and reduced environmental impact).

The public has a general reluctance towards government spending. I suppose some of that is rational. But, this is the way government should be spending money. On infrastructure that enables business to be conducted, and on projects that business could not justify the up-front cost to pay for itself. Currently, new money is injected at the discretion of the banks. Those who get it are the ones the banks deem prudent investments. Some of them no doubt represent new businesses that bring wide-ranging benefits to society-at-large. But, much of that money goes to fund casinos, nail salons, video game arcades, payday loan stores, or OJ's lawyers. We love to think that the private sector knows best how to use money, but elected officials, accountable for their jobs to the general public, should be able to pick a few worthwhile projects to fund with the new money.

We've found a democratic way to inject and control the money, and one that does not preclude sustainable living. It's a win-win situation ... except for the bankers, of course.

Posted at 02:26AM Oct 26, 2008 by Nathan in Economics  |  Comments[1]