Power of Story: Roosevelt and Keynes

Herbert Hoover was president when the stock market crashed in 1929. Franklin Delano Roosevelt, the charismatic governor of the state of New York was elected president in November, 1932, and inaugurated March 4, 1933. For three years the country had been traumatized by the worst economic crisis imaginable. The international scramble over gold supplies and debt repayments had involved and embroiled the economies of most of the world.

Roosevelt was a new face with a voice of hope. He was the only man to ever be elected president of the U.S. for four consecutive four-year terms. The irony of his election campaign in 1932 is worth a short review. Looking back over what transpired in the past seventy years it would almost seem as though Hoover and Roosevelt had somehow switched their campaign speeches and each delivered the lines of the other.

During the campaign it was Roosevelt who reiterated the old line party speeches promising reductions of all public expenditures, doing away with useless commissions and offices, consolidating departments and bureaus, and eliminating extravagances. Roosevelt even promised to balance the budget. Hoover was castigated for running huge deficits, his inability to halt the effects of the depression, or restore any semblance of prosperity. Roosevelt at one point even stated, “Our industrial plant is built; the problem just now is whether under existing conditions it is not overbuilt. Our last frontier has long since been reached.” Strange philosophical words when compared to what was set into motion over the dozen years that followed the election. (1)

Roosevelt spent the time between his election and inauguration at his Governor’s Mansion in Albany, New York with his Brain Trust, a group of intellectuals gathered from the universities, primarily Columbia University. Big change was on its way. The intellectual atmosphere on campuses around the world had changed over recent years. Now, we can look back and measure just how big that change was to become. From 1860 until Roosevelt’s election in 1932 the Republicans had held the presidency fifty-six of the seventy-two years. Democrats held for sixteen years. From 1932 to 1980 it was reversed: Democrats held the presidency for thirty-two years and the Republicans for sixteen.

Running against both the Democrats and Republicans in the 1928 election was the Socialist Party. Following is a listing of planks in their political platform:

• Nationalization of our natural resources beginning with coal mines
• A publicly owned giant power system (Tennessee Valley Authority)
• National ownership and management of railroads and other means of transportation and communication
• An adequate national program for food control, food relief, reforestation, irrigation, and reclamation
• Immediate relief of the unemployed by the extension and program of all public works
• Loans to states and municipalities without interest
• A system of unemployment insurance (part one of Social Security system)
• Nation-wide extension of public employment agencies (U.S. Employment Service)
• A system of health and accident insurance and of old age pensions (Social Security 2)
• Shortening the workday and forty- hour work per week
• Federal anti-child labor amendment
• Abolition of brutal exploitation of convicts
• Increase of taxation on high income levels, corporation taxes, and inheritance taxes
• Appropriation by taxation of all land held for speculation

The economic and cultural pendulum had internationally swung and was nationally swinging from belief in individual responsibility and a decentralized and limited government to a model of social outcome equality and a centralized and powerful government. The model relied on the government to protect the citizens from misfortune and to control the operation of the economy, even if that meant the government’s ownership and operation of the means of production.

Behind those closed doors of the Albany, New York Governor’s Mansion, between Roosevelt’s election and inauguration, a philosophical coalition had formed. TheBrain Trust was ready to view the depression as a failure of capitalism, and to believe that active intervention by centralized government was the appropriate prescription for rapid remedy. Relief, recovery, and reform would be the theme of the game plan.

By March 4, 1933, Roosevelt was fired up and ready to lead the charge with his inaugural speech. He began by blaming the crash, depression, and economic crisis on bankers and financiers and their quest for profit, and the greedy self-interest of capitalism, never allowing once that the problem had also been the responsibility of the U.S. government itself and the inaction of the empowered Federal Reserve System:

Primarily this is because rulers of the exchange of mankind's goods have failed through their own stubbornness and their own incompetence, have admitted their failure, and have abdicated. Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men. True they have tried, but their efforts have been cast in the pattern of an outworn tradition. Faced by failure of credit they have proposed only the lending of more money. Stripped of the lure of profit by which to induce our people to follow their false leadership, they have resorted to exhortations, pleading tearfully for restored confidence . . . The money changers have fled from their high seats in the temple of our civilization. We may now restore that temple to the ancient truths. The measure of the restoration lies in the extent to which we apply social values more noble than mere monetary profit. (2)

The new president then called for a Bank Holiday and closed all the banks that still remained open. They would be reopened after the Emergency Banking Act and the Federal Deposit Insurance Corporation (FDIC) bills were passed by Congress. It was understood that successful economic systems must be based on confidence and convenience. There wasn’t a lot of confidence left in the system. The tacit message was that no longer would the depositors have to depend on the reliability of the bank, but could rest on the assurance of the government to protect their deposits. “The only thing we have to fear is fear itself.”

President Roosevelt’s First 100 Days witnessed a record number of bills being sent to Congress for approval during a special emergency session. Soon there were so many Relief, Recovery and Reform bills in existence it was hard to keep track of the action. Any programs that failed to pass or were held up for some reason were re-instituted by the President’s Executive Orders. Congress would then have to override the orders or it would be necessary for the Supreme Court to strike them down as unconstitutional. Especially in Roosevelt’s second term, the conflict with the Supreme Court led to their unanimously ruling that the National Recovery Act (NRA) was an unconstitutional delegation of legislative power to the president.

In response, Roosevelt proposed a shocking law that would allow him to appoint up to six new justices of the Supreme Court so that he could have a “persistent infusion of new blood.” Even his own Vice President Garner led an intense protest, claiming that he was violating the very separation of powers that would give Roosevelt absolute control over the Supreme Court by Court Packing. Eventually, however, Roosevelt appointed eight of the nine justices of the Supreme Court. They began to ratify his policies with ease.

On other issues, it was ranking members of his own Democratic party that began taking issue with Roosevelt’s power and policies. Democrats led by Al Smith organized the American Liberty League and vociferously attacked Roosevelt by equating him with Karl Marx and Vladimir Lenin. But, people were going back to work, and once again businesses were beginning to reopen their doors. No one had expected that the depression would have lasted for ten years.

Next Week: More about Bathtub economics

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

© Dr. James W. Jackson  

Permission granted by Winston-Crown Publishing House

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Power of Story: Is John Maynard Keynes Really a God?

From the ivy-covered cloisters of Harvard, Yale, and Princeton to the T-shirt- clad students of your local junior college, wherever the subject of economics is studied and discussed, one name is preeminent: John Maynard Keynes. A sacred hush falls over the classroom when his name is spoken. All jokes must cease about economists with wire-rimmed glasses holing up in their cubicles trying to see if what they just observed in real life can be massaged around to fit their pet economic theory. It is expected that if a professor or student utters his name they must do so in soft, reverent tones, and then place their fingers to their pursed lips and gently touch the printed name on the page of their classical textbook. Just who is this John Maynard Keynes?

The sacred legend holds that in the hours of deepest distress, when the United States was not just reeling from the bludgeoning blows of the Great Depression, but was down and out for the final count, never to arise again from the smoldering ashes of dissipated wealth and shattered culture, John Maynard Keynes came riding to the rescue. It was Keynesian economic philosophy, emanating like a bright beacon light from the halls of King’s College in Cambridge, England, that saved the culture and probably the universe.

As the legend goes, John Maynard Keynes assembled his exclusive teachings into a printed book, The General Theory of Employment, Interest, and Money, that was printed in 1936. Miraculously, the newly elected president of the United States, Franklin D. Roosevelt, stumbled across the book just in time, read the magic words, arduously and meticulously implemented the teachings, and the floundering nation was transformed into the economic super-power that held sway over the entire world like no other nation in history. How could anyone with half a brain and one eye ever dispute or even question those sacred writings that were passed down to this favored nation so many years ago? Blessed is the name of John Maynard Keynes.

So, just what were those original teachings? My major professor in economics, Dr. Paul Ballantyne of the University of Colorado, one day told me, “Jim, if you want to easily remember the economic philosophy of Professor Keynes, just visualize in your mind a bathtub. It is about one-third full of water. Above the bath tub is a spigot with a handle to regulate the inflow of water. Above the spigot are the letters “G” and “I.” Those letters stand for Government and Investment.

As with all bathtubs, there is a drain at the bottom of the tub. Over the drain are the letters “T” and “S.” They stand for Taxes and Savings.

If you want to fill up and regulate the economy you turn on the “G” and “I” spigot and plug the “T” and “S” drain pipe. By increasing the Government Spending and Investment faster than the leakage of Taxes and Savings out of the economy, you can increase the level of income and reduce unemployment.

“But,” I protested to Dr. Ballantyne, “what’s so brilliant and new about that? Explicit provisions were made for that clear back in 1913 when the U.S. passed the Federal Reserve Act. The Federal Reserve was given certain rights:

• The Feds were given the right to raise or lower the percentage of reserves that the banks must keep on hand. If they lowered the amount of required reserves, then the banks would have more money to lend out to customers to invest in their projects. The higher the reserves imposed on the banks, the less money could go into the system.
• The Feds have the right to raise or lower the Discount Rate of the money they can lend to the banks to lend to their customers. The higher the discount interest rate, the less the banks will borrow from the Feds, and the less will be available to the customers, and the less money will be introduced into the system. The lower the discount rate, the more likely the banks will borrow from them and lend the money out to their customers, and more money will find its way into the system, and there will be an increase in employment.
• The Feds have the right to sell and buy back notes and securities to citizens and foreigners to cover the debts the government creates because of their desire to spend more than they have in their account.

How much more could they want? What’s new about Keynes?”

John Maynard Keynes had the advantage of watching Great Britain go through an earlier depression of its own. He was in England and only twenty-nine years old when the U.S. passed the Federal Reserve Act. He was also able to watch what had happened during the recessions of the U.S. and the early years (1929 – 1935) of the Great Depression before he wrote his book. He was convinced that the severe bumps of the boom and bust economic cycles could be flattened out with his aggregate expenditures model. He declared that Say’s Law was not dependable, and if the economy were left to correct itself it would not happen. He pointed to the Great Depression as his needed proof.

But why the God-like treatment for Keynesian economics? All of the tinkering with aggregate expenditures did not lift the U.S. out of the Great Depression. Successful economies are built on production. They have to produce something, and it was not until the U.S. began production for the buildup for World War II that employment and incomes began to rise. Indeed, World War II was a horrible price to pay to end the Great Depression.

John Maynard Keynes did not leave any question as to government’s economic involvement. He felt it was the government’s responsibility to be in control of the stability of the national economy and play an active role in the policies and procedures. He also was a strong advocate of the government’s control of housing and ownership of utilities and transportation. Recent polls indicate that 70% to 80% of today’s economists subscribe to the ideas associated with the Keynesian approach that business cycles should be managed by the Fed. That comes close to divinity. 

Next week we will look at Franklin D. Roosevelt.

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

© Dr. James W. Jackson  

Permission granted by Winston-Crown Publishing House

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Power of Story: Depressions and Panic

Once upon a time to a fabled piece of real estate came individuals and small clusters of sincere, hard working people. Their intentions were to carve out a place of peaceful and prosperous existence on the prized piece of land that miraculously stretched all the way from the Atlantic Ocean to the Pacific Ocean. They dreamed of their desires and opportunities one day materializing into feelings of security, satisfaction, and happiness. Their economic endeavors eventually found them building thousands of individual businesses and employing tens of thousands of their neighbors as laborers.

Their simple economy included the practice of barter and a currency of metal coins and commodities such as tobacco. By the late 1700s, their economy had begun to mature and even show signs of sophistication. A business observer by the name of J. B. Say wrote that it appeared the very act of producing goods seemed to generate income equal to the value of the goods produced. That idea became known as Say’s Law, where supply creates its own demand. In other words, there will be sufficient spending to purchase all that is produced.

When times were good the business owners would invest in purchasing goods and materials to build their enterprises. They would also buy raw materials in order to produce the items they were going to sell. If they did not have enough money of their own, they would invite investors to share in their business venture. Their hard work and diligence ended up with successful production of goods. Many times their successful endeavors resulted in producing more of the items than the present market could purchase.

Once a businessman’s warehouses were full and he had saturated the marketplace with his goods, he would have to put a bookmark in his production until the customers’ purchases would catch up to his production. He would have to lay off his workers until the demand for his products emptied out his warehouse. That allowed him to start up his business again. The lack of continued investment in production resulted in a temporary recession of business and the occurrence of unemployment. The reoccurring cycle gave the appearance of a boom and bust economic pattern.

Observers, also in the late 1700s, like David Ricardo and John Stuart Mill recognized these bumps in the business experience, along with other interruptions like wars, gold rushes, and droughts, and concluded that over the long haul of time all the bumps would tend to even out, and full employment and production would work out just fine, and that eventually demand must equal supply. There would eventually be sufficient spending to purchase all the supply.

But some of the recessions were worse than others. During the seventy-five years in the U.S. prior to 1929, there had been nineteen business recessions with some gaps that even lasted as long as two years. Then came the Great Depression! TheRoaring 1920s had produced a period of easy money, abuse of credit, speculation in risky ventures, and high expectations driven by greed and lack of discipline.

The 1929 crash of the stock market opened the door to panic, and the people waited in lines at their banks to withdraw their money. But, as we learned earlier, when people deposit their funds in a bank it is unjustifiable to think that everyone can demand their money back all at once. Their money that was deposited was not in the banks at all, but had been loaned out to someone else. The new borrowers were not expected to repay those loans for another ten, perhaps twenty years.

All economic systems depend upon the factors of confidence and convenience. When depositors cannot withdraw the money at will that was deposited, they get quite nervous. When, after standing in lines for a long time, they still cannot withdraw their money, they panic. That panic spreads like a wildfire to all other depositors.

It takes such a tiny pin to prick the balloon of confidence. Early in the Great Depression over one third of all the banks in the U.S. failed and closed their doors. The depositors’ funds evaporated into thin air. The confidence in the system was likewise gone.

More than twelve million people lost their jobs. Production dropped 30% and per capita income shrank 40%. Unemployment jumped to 25%, 85,000 businesses failed, hundreds of thousands of families lost their homes, and over half of home mortgages were in default. The financial constriction did not just solve itself. The Great Depression lasted over ten miserable years with no apparent hope in sight.

The local, county, state, and federal governments likewise panicked. They embarked on harsh plans to quickly increase taxes to cover their losses. But there was no money to pay the taxes. The Federal Reserve Bank failed miserably. It had been empowered to move cash early on to the first banks experiencing runs on their accounts in order to stave off such panics. That probably would have stopped the panic, as the people realized that others were getting their money back. Instead, however, the Fed officials applauded in some cases, saying it was all working to weed out the weak banks and those with bad management practices.

What had gone wrong? Was it possible that Say’s Law was wrong? Why were the safeguards of the Federal Reserve System never implemented? What would pull the economy and the people up and out of the Great Depression?

Next week we will look at Franklin D. Roosevelt and John Maynard Keynes.

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

© Dr. James W. Jackson  

Permission granted by Winston-Crown Publishing House

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Power of Story: Monetizing the Federal Debt

So, just how does the U.S government magically turn the federal debt into an asset of spendable money?

As we discussed earlier, the U.S. Treasury Department keeps most of its money in the Federal Reserve Bank. Checks are written for every government expenditure from this account. Upon occasion, however, those in the government have a very interesting problem: they spend more than they have in their account.

If your personal bank account were overdrawn, you basically would have two ways of covering the deficit. Either you would hurry around and earn enough to cover the amount, or you would find someone who would make you a quick loan. The federal government does not earn money, so it is left with the choice of either quickly levying a new tax to raise the money, or going to the marketplace to get a loan. Taxing is part of the government’s fiscal policy, while adjusting the money supply is part of the Federal Reserve’s Monetary Policy.

But, think about it for a minute: who could lend the government several trillion dollars just to cover the extravagant spending desires of the administration and Congress? Lots of people . . . together, that is! The government does not go to just one source and borrow the money; they make thousands and thousands of little loans in the form of U.S. Treasury bills (T-bills), notes, and security bonds. They are essentially government I.O.U.s given in return for the borrowed money.

In order to assimilate the debt into our system we use a function called monetizing. Many less sophisticated countries simply print the money to pay for the cost of overspending by their governments, finding that form of taxation to be a simpler method. But, as you will recall, increasing the supply of money in the system causes inflation.

We sell the security bonds and treasury notes to our citizens, and also to foreign countries. But that transaction does not inject new money into the system. It would be as if there were 10 dollars and 10 cherry pies in the system. The government wanted one of the cherry pies, but did not have 10 dollars to pay for it. So, it would offer a bond, presuming that there would be one person in the system who would rather have an interest-bearing bond than a cherry pie. So now you have 10 dollars, 10 cherry pies, and 1 bond in the system.

When it comes time to pay back the borrowed money plus the agreed interest on the secured bond or T-bill, the Federal Open Market Committee of the Federal Reserve Bank calls in the note and pays it off. How do they do that? You guessed it . . . with newly created money!

The monetizing process is accomplished by the Federal Reserve Bank issuing a check to the bond dealer, who in turn deposits that check into his bank account. The check, when it is deposited, is credited by the Federal Reserve Bank to that bank’s reserves, and that bank is then entitled to make loans against that new reserve or exchange it for cash.

Why did the Federal Reserve Bank have the right to issue the check? Because it was backed up by the U.S. Treasury I.O.U. that it had just purchased! In essence, what happens in the transaction is that the federal debt—a liability—is transformed into an asset of spendable cash by the U.S. Treasury’s signing of a note! The note is an asset of the Federal Reserve Bank. In other words, the debt of the government has been miraculously turned into spendable money. That’s called Monetizing the Federal Debt!

Monetizing the national debt, by using the intermediate step of issuing bonds, stalls the impact on the economy for at least a year . . . perhaps much longer. But it has exactly the same ultimate effect as if the government did not issue the bonds in the first place, but simply paid its debt with printing-press money or entering strange numbers into a computer. Instead of having 10 dollars and 10 cherry pies and 1 bond in the system, there would now be 11 dollars, 10 cherry pies, and no bond. The outcome is the same as the irresponsible actions of Germany in paying off the war reparations. There is new money injected into the monetary supply that lowers the value of the rest of the money and causes a sustained increase in the general level of all prices . . . Inflation!

When a government overspends, goes into debt, sells bonds and T-bills, it is not a slick process of smoke and mirrors whereby that government creates free money. That government has just set into motion the devaluing of their money and economic system through inflation. The people do not vote on having the value of their money taken away from them, their earnings and equities stripped from them, and their savings stolen from them. The Congress doesn’t even have to vote to raise a tax to accomplish such results. But the silent consequences of extreme and rapid inflation (hyperinflation) are set into motion, as sure as the sunset.

So, just what gave rise to the notion that the federal government could manufacture debt and new money to satisfy the lust of over spending? Next week we will take a look at the interesting paper trail. 

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

© Dr. James W. Jackson

Permission granted by Winston-Crown Publishing House

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Power of Story: Intuition

Why have we taken the past several sessions discussing such concepts as enterprise, production, the history of money, the Federal Reserve System, fractional reserve banking, and inflation? Is all this discussion necessary? Is it important at all? Yes, it is! Oh, yes, it certainly is.

Most people living in our present culture have never been given the basic rudiments of simple economics. We don’t understand what is happening or the rapid changes we are experiencing. We can’t see why the big fuss is made about balanced budgets, debt limits, or deficit spending. Just this week I had a young lady say to me, “I live by one simple motto: go with whatever is free and opt out of participating in the consequences.” I had to have her repeat her motto to me!

Our discussions over the past several weeks regarding some of the basic concepts of our economic system have been very important because intuitively we feel and know that something strange is happening in our economy, but we can’t put our finger on it or articulate what we feel. We all seem to be waiting for the other shoe to fall.

When we go shopping at the supermarket and experience the prices doubling or tripling, and then are reassured that our inflation rate is successfully running at a meager 2.1 percent, we are confused. When we pay $60 thousand for a like-kind automobile that just a couple of years ago we bought for $20 thousand, and the same house that our uncle bought in the ‘80s for $19 thousand just sold for $321 thousand, with three backup contracts waiting in the wings to purchase it, we are confused. But we are shown facts that the Consumer Price Index guarantees that inflation has not increased in any given year over 3.4 percent since 1992.

Born before the U.S. entered into World War II, and living during the latter years of the Great Depression, I grew up with the memories of international economic experiments and their consequences. Following World War I, Germany was demanded to pay for the damages they had caused while blowing up the countries they had invaded. They refused to pay for the war reparations until the pressure of the rest of the world forced them to pay. They paid the debts by simply going to theirFiat printing presses and rolling out newly printed German marks. That seemed to take care of the situation. The world was happy, the individually damaged countries were satisfied, and Germany was off the hook.

They were off the hook and unaffected until the other damaged countries decided tospend the newly created money. They began buying German goods and services with the phony German marks. Suddenly, there were all the new marks buying up all the German goods and services. Since there was nothing to back up the newly created money, all the prices began to double and quadruple because the value of the real marks plummeted.

In the end there were four quintillion marks in existence, and it was not unusual for a German shopper to pay as much as 750,000 marks for a few groceries. That is where we get the stories of the shoppers needing to take a wheelbarrow to the store to transport the necessary marks for the purchase of a few goods . . . and where someone along the route would accost the shopper, dump the currency, and steal the wheelbarrow.

In the very recent past, the U.S. has tallied upward of $17 trillion in debt (refer to our recent article on the amount of a trillion). When I wrote the book, What’cha Gonna Do with What’cha Got?, following the Carter administration we had just topped the incredible amount of $1 trillion dollars in debt. It had taken us well over 200 years to accumulate that amount. Now the debt number is in excess of $17 trillion. Our method of acquiring and assimilating that debt is far more sophisticated than the German’s method that was used after World War I.

Next week we will discuss how the Federal Reserve monetizes the federal debt and transforms it into spendable money.

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

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Power of Story: Tends and Tiger Teeth

Earlier we had an opportunity to agree or disagree regarding certain economic factors that we felt were the cause of inflation. We will begin our investigation by considering the fact that inflation is not caused by individual producers raising their prices. This is true whether we are talking about oil cartels, individual merchants, labor unions, or particular industries. I think the power of story can help us see this more clearly. Let's return again to our primitive friends: Two-Toes Tom, Scarface-Salesman Sam, Wanda[P1] Wonder-Weaver, and Healthy-Hunter Harold.

                                                           *Remember*

INFLATION is a sustained increase in the general level of ALL prices.

One evening all of our friends were sitting by the campfire discussing an interesting new idea. Scarface-Salesman Sam had just returned from visiting a faraway tribe. He said that everybody there was involved in a new concept called inflation. It appeared that it was benefiting everyone in the tribe. The idea was that if they all raised their prices by twice, then they would all have twice as much. Who wouldn't like that? Why hadn't they thought of that sooner? Just think of all the wealth they could have accumulated by now!

Our friends decided that it was high time they adopt this concept for their own tribe. They all rushed back to their tents to get some of their products to trade; there was no sense letting any more time get by.

On the way back to his tent, Healthy-Hunter Harold was just beaming. "Think of it . . . from now on, I'll only have to trade four packages of fresh meat for two stone axes instead of the usual eight. I can put twice as many trades together." Wanda Wonder-Weaver was also excited, since she would now be getting twice as much for her blankets. Two-Toes Tom, who had been tired a lot lately, was glad that now he could finally slow down a little, since he would be getting the same amount, but only having to produce half as many stone plows.

Excitedly, they all returned to the campfire to get started with their trading. Healthy-Hunter Harold wanted to go first with his fresh meat. Instead of the usual eightpackages, he only brought four to trade with Sam for two of his stone axes. But alas! Sam was standing there with only one axe that he intended to trade with Harold for the regular eight packages of meat. Sam argued that since it was his idea, he should be able to go first, i.e., one axe for eight packages of meat. Harold informed him that would be fine, but the eight packages of meat would come off Sam's body!

It began to dawn on Wanda Wonder-Weaver what was happening. Whether Sam raised his prices and Harold paid it, or Harold raised his price and Sam paid it, you still haven't caused inflation. For if one price goes up, then the other price must come down. She realized that it wouldn't make any difference how many people were involved, or how many products were involved, or for what reasons they wanted to raise the price, they could not cause inflation, i.e., a sustained increase in the level of all prices, simply by raising their individual prices. For if one product goes up in price, then one, or a combination of other prices, must fall by precisely the same amount. Even if there is a scarcity of a product due to poor crops, strikes, or exports, the increase in the price paid for the scarce product will only result in your having less money left over with which to make other purchases.

If an oil cartel, e.g., OPEC, raises its price of oil by $50 billion, there should be $50 billion less in the system for consumers to purchase other goods. These other goods would then sit on the shelves and go unpurchased, thus causing a recession in business.

Wanda Wonder-Weaver gathered her blankets together and headed back to her tent. Ol' Two-Toes Tom sadly went to sleep, dreaming of how close they had all come to being wealthy!

You now can see that for whatever reasons prices are raised, e.g., scarcity, monopolies, wage and price fights, you cannot cause inflation . . . a sustained increase in the general level of all prices. You will see later that the raising of prices is a necessary result of inflation, not the cause.

That night Scarface-Salesman Sam went to bed troubled. What had he forgotten? Why didn't inflation work around the campfire that night with his friends? Then he remembered that the other tribe wasn't trying to make it work with the barter system. They were using a medium of exchange-"money." In fact, they were using gold coins. Sam knew that his tribe had used tiger teeth as money before. Why wouldn't inflationwork with tiger teeth just as well as with coins?

The next morning he was up early to explain his new idea to the others. He told them that he had finally figured it out. First of all, they must go off the barter system and exclusively use tiger teeth as money. Secondly, if they would bring together all of their tiger teeth that they had used as money they could then count them. Thirdly, if they would double the number of tiger teeth that they were using as money, it would then be possible to charge twice as much for the same number of products.

At that point Wanda Wonder-Weaver stopped her weaving on her blanket and laughed out loud!

           With that kind of thinking . . . it's no wonder you guys are still primitive! 
           Can't you see? . . . When you double the money supply and the supply of                goodsstays the same,  you cut the purchasing power of the money in half . . .
           that is . . . it takes twice as much to purchase the same product.
 

On the surface it might appear that everything would be going up in value. But it is not. The only way to have a sustained increase in the general level of all prices is to have a sustained decrease in the general value of the money.

Another way of stating that all prices are rising at the same time would be to say that the money system is falling in value.

The reason for Scarface-Salesman Sam's misunderstanding of the concept of inflation was due to his misunderstanding of the motive behind the concept. All he observed was that the merchants were getting higher prices for their products, but failed to see that the real value they were receiving was less. He didn't know that the king of the tribe was extracting from his people a silent tax through inflation to pay off the debt of his last spending spree, knowing full well that if the people understood what he was doing, they would revolt or elect a new tribal chief. You can't ultimately play games with smoke and mirrors or tents and tiger teeth.

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

© Dr. James W. Jackson

Permission granted by Winston-Crown Publishing House

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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)

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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)

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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) 

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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)

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