Home Commentary Opinion OPINION: A Flawed Economy and Why It Will Continue

OPINION: A Flawed Economy and Why It Will Continue


by Wavell Cowan, MontpelierTheBreezeKickstarterWeb

The fact of the 2008 financial collapse into the great recession and the subsequent uneven, snail-paced economic recovery are contemporary concerns. Thomas Piketty’s recent book on the growth of wealth and income inequality has become a best seller. Foreign Affairs magazine in recent issues has featured articles on these aspects of the economy. Bernie Sanders in his presidential primary campaign has made much of these concerns. However, in spite of all this attention, nary a mention is to be found anywhere of the reason that best explains why these problems plague our economy, nor a whisper of the reforms such an explanation dictate as necessary.

Consider then the following:

The ups and downs in the economy’s gross national product over the past centuries and up until today, have been exactly mirrored by the ups and downs in the money supply. It is intuitively obvious that this should be so, as recognized by Adam Smith and his fellow 18th century philosopher, David Hume. The logical consequence of this indisputable fact is that any particular level of economic activity requires that a certain money supply be available. Furthermore, an increase in economic activity can never occur without a corresponding increase in the money supply. Properly matching the money supply required to achieve a desired level of economic activity is thus the fundamental technical problem that needs to be addressed. Too little money, and the economy will fail to achieve its growth potential. Too much money will mean the economy is unable to meet the demand created by the money supply and the resulting price inflation will adversely affect the value of the currency.

The technical solution to this problem requires the scientific analysis that will produce a statistically strong mathematical connection between the workings of the economy and the money supply necessary to sustain it at an optimum level. Once this model exists, a robust means to ensure the required money supply is actually available, needs to be put in place.

However no such well-defined mathematical modeling is used in the current approach to managing the economy, and the manner of creating this money supply is far from robust. These serious defects guarantee an economy that will continue to produce the current problems.

An effective modeling procedure requires a careful scientific review of the quality and completeness of the economic statistics required for effective analysis. For instance, data that identify the extent to which price increases in the economy (as currently determined by the consumer price index), are driven by non-market forces (indicating a need to further expand the money supply), or by excessive demand in the economy (indicating a need for a contraction of the money supply) are badly needed, although currently ignored by economists.

The fractional reserve system now in place, by which the private banking sector is largely responsible for providing the money supply is not only far from robust, but incapable of meeting the criteria that any decent scientific analysis would establish for a workable system of money creation. No legitimate scientific inquiry would make the creation of the money supply solely dependent on increasing the total (public plus private) debt in the economy. Yet this is precisely how the money supply is now created. Any such inquiry would further propose a direct and clear connection between the system of money creation and the public good, something currently non-existent.

From this perspective, only a money creation system controlled by Congress, in accordance with their currently ignored constitutional prerogative, can successfully meet the suggested scientific criteria. This would have a government agency undertake the scientific modeling essential to any rational form of money creation. The increase in the money supply dictated by this mathematical modeling would be achieved by government legislation to directly feed this required new money into the economy to support infrastructure and other investment needs based on considerations of the public good. The new money needed to meet the demand in the economy would thus be provided by public sector spending before flowing into the banking system as the deposits that would become the funds available for the activities of the financial system. In effect, the fractional reserve system would disappear. Banks would require their cash reserves to cover 100% of their loan portfolios.

Such a system would free the economy from the undesirable debt driven fluctuations in the money supply currently responsible for recurring recessions and the existence of the so-called business cycle. It would also eliminate the need for government deficit spending as the means to increase the money supply. This would eliminate the financial burden of ever increasing interest payments that currently discourage governments from making sensible investments to help resolve social and other national and global problems.

Money creation, established for historical reasons to facilitate distribution, as a service provided by a private banking sector, ultimately through the fractional reserve system, has become so accepted as the “norm” that it is now immune to rational scientific investigation. This failure to revisit a course of action that technological advances have made obsolete is the flaw which guarantees little will change — at least until a more scientifically aware electorate comes to the rescue.