The Safe Haven piece which describes a growing preference for T Bills and currency over other types of "money supply" aka credit/debt raises interesting ideas . . .
. . . but I would describe it differently.
Credit is merely a mechanism to circulate existing money more quickly. Credit has greatly increased while money has not.
The remarkable rise in asset prices in recent years has been a result of an increase in debt, not money. You can increase asset prices by increasing debt levels, but neither of these actions increase the actual supply of real money. Repay, or fail to reissue, the debt and the asset prices decline.
This is why Ben Bernanke's fatuous hypothesis about the "worldwide savings glut" are so divorced from the underlying facts. I find it hard to believe he actually believes his own comments, and I have always wondered what motivated him to float this idea - or the more frightening idea that he actually does believe this concept straight from the mouth of the original "currency crank", John Law.
Its somewhat analogous to this Fed study.
Meet the typical American family.
It has about $3,800 in the bank. No one has a retirement account, and the neighbors who do only have about $35,000 in theirs. Mutual funds? Stocks? Bonds? Nope. The house is worth $160,000, but the family owes $95,000 on it to the bank. The breadwinners make more than $43,000 a year but can't manage to pay off a $2,200 credit card balance. Very little money, and in the event of a contraction of debt - negative net worth.
washingtonpost.com
The situation of this typical American family is compounded by the shrinking capital reserves of the banking system coupled with the constrained growth of what the Fed calls "Permanent Reserves". Although some Monetarists will claim that all money is now debt, this is not actually how the banking system works, even today.
Perhaps these excerpts from "History of Monetary and Credit Theory from John Law to the Present Day" by Charles Rist [1938] can help some think about the difference between credit and money. While credit and money may seem nearly identical in most situations, during a period where there is a loss of confidence - they are not the same at all.
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Confusion between Credit and Money
The use of the bank-note, as later that of the cheque, increases the credit capacity of banks by weaning the public from the habit of using coin. Thanks to this ingenious social device a large part of the sums deposited with the banker is used by him to grant credits to borrowers, while at the same time it remains at the disposal of its owners for making payments to each other. That is the entire "mystery" of credit.
But in all this there is no increase in money, there is merely a more rapid circulation of existing money. Henry Thornton, whose perceptions were very sharp, saw this quite clearly: "If at any given moment an inventory were made of the wealth of a society, the notes issued by the bank, included among the bearer's assets, are counterbalanced by commercial drafts among the liabilities of the signatory; credit and debit equal each other and cancel each other out." "The case of gold, on the other hand, differs from that of paper inasmuch as the possessor of gold takes credit for that which no man debits himself." 1
1 Henry Thornton: An Enquiry into the Nature and Effects of the Paper Credit of Great Britain (1802) p.21.
But this velocity is not constant. It can increase or diminish, an that in two ways: either the minimum to which I have referred is raised, as the practice of resorting to credit becomes more widespread; here it is the velocity of circulation of the cash deposited with banks that increases - or, the velocity of circulation remaining the same for each unit of money delivered to the banks, the number of these units is increased, as the public resort more and more to the practice of concentrating their monetary resources at the banks. Here there is an increase in the velocity of circulation, not of the money placed in the banks, but of the total stock of money within the country.
The two phenomena may occur simultaneously, may strengthen each other, cancel each other out, or act in different directions. But they do not arise from the same causes. The second phenomenon is slow and steady in its working, the first displays rapid alternations of growth and decline, corresponding to phases of boom and slump, or to a prolonged rise or fall in prices. It is by far the more important. The second is of interest because, up to a certain point, it can compensate for an inadequate supply of precious metals. { More or less what the Fed today calls "Permanent Reserves" - Elroy }
The expression velocity of circulation, a favourite term among English writers, is, it is evident, full of ambiguities in its application to banking phenomena. It would be better to restrict its use to the movement of monetary units deposited at the banks, and to use the expression "concentration of coin in the banks" for what has been called the velocity of circulation of the total stock of money within the country.
It is possible to go still further, and to call the changes in the velocity given by the banks to the cash deposited with them simply an increase or decrease of banking credit.
The failure of John Law's unfortunate attempt to establish a bank of issue in France dominated the ideas of the eighteenth century about credit. His contention that to create money is to create wealth was vigorously rejected by all of his contemporaries. The efforts made in the course of the century by so many writers, including Smith, Hume, and Turgot, to reduce the role of money in the national economy to nothing or to insignificance, were directed against Law rather than against mercantilist ideas about money, which had already worn thin. Had not Law announced that an increase in the quantity of money was the only way of stimulating the national economy?
In the "Wealth of Nations" Adam Smith calls John Law's System "the most extravagant project both of banking and stock jobbing that, perhaps the world ever saw." (Adam Smith, Wealth of Nations, Bk, II, Chapter II. Cannan edition, Vol. I, p. 301) The nineteenth and twentieth centuries have at times been less critical of Law. Certain passages written in restrained and reasonable manner are quoted as expressing the real essence of Law's thought. Actually, they are tactical concessions to the necessities of the moment.
It has also been said that he was an unrecognized forerunner, because certain bankers today have taken up some of his most debatable formulas. It would be more correct to regard these belated disciples as backsliders. The eighteenth century was not mistaken in its attitude. It saw through the fundamental confusion between credit and money that Law deliberately and persistently maintained throughout all of the vicissitudes of his tormented career. I would go further: credit had no interest for him except as a means of making the public familiar with paper money.
He was, it is true, influenced by banking experiences which are today completely forgotten, but to which he constantly refers, and which were bound to maintain that confusion. This has not been sufficiently stressed; but unless these experiences are borne in mind, there is a danger of not understanding his real thoughts.
The idea of a more economic use of the precious metals as the chief effect of the introduction of the bank-note ended by entirely dominating Adam Smith’s thought, and it did so because, in fact, he shared John Law's ideas as to the nature of money, and he believed that money is only "a voucher to purchase": "A guinea may be considered as a bill for a certain quantity of necessaries and conveniences upon all the tradesmen in the neighborhood" (Smith, Vol. I, p. 274) Is this not the equivalent of the quotation from Law given below?
"Money is not the value for which goods are exchanged, but the value by which they are exchanged. The use of money is to buy goods and precious metals while money is of no other use." --
"I consider an écu itself merely as a note drawn up in these terms: Any seller whatsoever will give to the bearer the goods or merchandise which he needs up to the value of three livres, as for other goods or merchandise, and bearing as signature the portrait of the prince or another public mark."
John Law "Lettre sur le Nouveau Système des Finances, 1720"
The identity of thought between John Law and Adam Smith has not been sufficiently noted. It is however, fundamental, and explains many of the errors in English currency theory in the following century.
Like Law, Smith does not regard money as a durable good whose chief function is to store up for the future the value of goods and services sold; he completely forgets its function of saving, as Walras was to call it (which becomes more important as commercial activity increases); he ignores its function of providing a bridge between the present and the future, which is the part it plays at all times, and the most important part; he can see in it only a voucher to purchase in the present, an instrument for distributing goods, not a means of conservation. Hence that long and tedious chapter (Smith, Vol. I, p. 275) in which he tries painfully to explain that money is part of the capital and not the income of society, and which ends in the characteristic passage:
"Money, therefore, the great wheel of circulation, the great instrument of commerce, like all other instruments of trade, though it makes a part and a very valuable part of the capital, makes no part of the revenue of the society to which it belongs; and though the metal pieces of which it is composed, in the course of their annual circulation, distributes to every man the revenue which properly belongs to him, they make themselves no part of that revenue." (Smith, Vol. I, p.275)
If, indeed, metallic money is not income, if it is only a costly "instrument," then obviously any economy in its use is of advantage. But it is precisely here where the mistake lies.
Nevertheless, this idea was seized upon by with extraordinary alacrity and found high favour. Taken up by Ricardo and adopted by Count Mollien and J.-B. Say, it dominated the thought of English writers in the nineteenth century. The belief that the use of metallic money is a retrograde and costly system, to be discouraged by all possible means, is firmly fixed in British thought on currency and banking.
This is in harmony with the remarkable qualities displayed by the English as bankers. The art if utilising to the maximum the coin deposited with them, and of developing all methods of credit, has nowhere been carried so far as at London. But, in admitting their ability in this, the application of Smith's idea, held by so many after him, led the English to under-estimate the importance of a large stock of money to support a vast edifice of credit. The same conception was responsible for serious mistakes in English monetary policy, mistakes which were pointed out by such far-sighted writers Thornton and Tooke, and later Hartley Withers.
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Unfortunately these same flawed concepts inform much of our banking system today, and we are beginning to experience the inevitable problems these concepts create.
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