Money is both a store of value and a medium of exchange. People want to hold it as part of their wealth and they also need to spend it on food, water, shelter, clothing and things that make life worth living. Unless money supply grows sufficiently to accommodate both the desire to save and the need to spend, saving in the form of money necessarily impoverishes other people.
Why is this? Well, let’s imagine for a minute that the only purpose of money is exchange. People use money to buy the basic goods and services that they need to live, but they don’t buy non-essential items and they don’t save. It should be obvious that if money is evenly distributed across the population, the amount of money in circulation must increase at the rate at which the population grows. If it doesn’t, then someone goes hungry.
Now imagine that people start saving some of their money instead of spending it all. Physically saving money – stuffing your mattress with it, for example – removes it from circulation. It can’t be used to buy food or pay the rent. So if everyone is stuffing their mattresses, more money must be created, otherwise the money in circulation becomes insufficient for everyone to buy what they need, and someone goes hungry.
Why might people stuff mattresses? One reason is insurance. If I have a mattress full of money, then if I need funds in a hurry I can simply raid my mattress. I don’t have to wait for the bank to open and I don’t have to worry about whether it will have enough money to pay me. And I don’t have to try to raise money by selling or pawning the family silver.
For people who lived through the Great Financial Crisis of 2008, the fear of not being able to access money or, worse, losing their savings in failing banks and crashing markets, is intense. Not that many of today’s savers stuff mattresses. But they do demand that their savings are safe.
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In the past, they relied for safety on institutions: deposit insurance on bank accounts, government bonds in pension portfolios. But now they can hold cryptographically secure digital assets that are as liquid as cash: Coins that no one can take and that are available to spend whenever they need them. The rational desire for safe and liquid savings is a major driver of the cryptocurrency revolution.
If stashing money away against a rainy day was all that people wanted to do, then money would not need to gain in value. It could even erode in value if interest rates on savings were high enough to compensate for the inflation loss. But people want more than just rainy day savings. They want to build wealth. And they want that wealth to grow all by itself, whether or not they add to it from their earned incomes. When they hold their wealth in the form of money, that creates a problem.
There is a fundamental tension between those who primarily want to save money and those who primarily need to spend it. Those who want to save money don’t want the supply to increase, because they like their money to appreciate in value, and producing more of it stops it appreciating. But those who need to spend money prefer the supply to increase, because it makes money easier to obtain. Admittedly, if money rises in value then they can buy more with it, but that’s no consolation if they can’t get enough money to buy what they need.
When the value of money itself increases, the prices of everything for sale in that money fall. Such a fall in the general price level (not prices of individual goods) is known as “deflation.” It is typically caused by there being insufficient money in circulation to meet people’s demand for it. Those who have money are happy because they are becoming wealthier. But someone, somewhere, is going hungry.
I often hear people saying deflation is good for the poor because their money goes further. When deflation is caused by technological advancements, this can be true. Technological advancements enable humans to produce more for less, and this can feed through into lower prices, which benefit consumers. But deflation caused by money scarcity can never be good for the poor. Money scarcity always and everywhere means someone goes hungry.
Deflation due to sustained money scarcity destroys the economy and wrecks lives. At the limit, it causes mass starvation. This is not just because saving money takes it out of circulation, leaving less to go round. There’s another reason, too – and it is this one that keeps central bankers awake at night.
When the price of money rises relentlessly, people will spend as little as they can. After all, who is going to spend money if they know it will be worth more tomorrow? In Japan today, expectations that money will continually rise in value (or that consumer prices will continually fall) has kept economic growth low for a very long time despite the best efforts of both the Japanese government and the Bank of Japan to encourage people to spend more.
But without their efforts, things could be much worse. Falling consumer spending can trigger a disastrous deflationary spiral. As consumer spending falls, companies cut production, reduce wages and lay off staff. Falling incomes then force people to cut back spending even more, and prices fall even more, forcing companies out of business at the cost of more jobs resulting in further consumer spending cuts. Sometimes, prices can even fall to zero – but this doesn’t mean the goods aren’t wanted.
In his Depression-era novel “The Grapes of Wrath,” John Steinbeck describes Californian farmers leaving peaches to fall from the trees because it was not worth picking them. This apparent “overproduction” led to calls for farms and businesses to be “liquidated” and people to lose their jobs, because apparently no-one needed these good. But at the same time as Californian farmers were allowing their peaches to rot, unemployed migrants from Oklahoma were starving. The economist Irving Fisher tersely commented that “a cause of the common notion of overproduction was mistaking too little money for too much goods.”
Why was there so little money during the Great Depression that prices crashed to zero and yet people starved? The consensus among economists is the U.S.’ determination to remain on the gold standard after the Wall Street Crash in 1929 forced it to keep the money supply very tight and rein in government spending. After the U.S. left the gold standard in 1933 and President Franklin Roosevelt introduced the New Deal, the economy recovered to some extent, though there was a second recession in 1937 that is generally ascribed to premature tightening of monetary policy. The U.S. economy didn’t really recover from the Depression until World War II, when both the Federal Reserve and the government turned on the money taps. It is a tragedy that the government would ensure there was sufficient money to produce armaments but not enable the entire U.S. population to buy food and shelter.
The battle between savers and spenders is played out not just in Great Depressions, but in every boom and bust cycle. During the prolonged recession after the 2008 financial crisis, there were similar debates about overproduction, though at the time we called it “abundance.” Now, we can see there was no abundance, only insufficient money: the Fed’s quantitative easing didn’t reach Main Street, banks weren’t lending, scared people were paying down debt (which, economically speaking, is a form of saving), and the U.S. government’s spending was constrained by arguments over the debt ceiling.
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Now we are in another recession, and this time it is being played differently. Both the Fed and the U.S. government have turned on the money taps. Those who want to hold money as a store of value are screaming about negative interest rates and the possibility of inflation from all this money creation. But the purpose of all this money creation is to ensure that, unlike previous contractions, we don’t mistake too little money for too much goods and end up with people going hungry.
I believe that ensuring no one goes hungry is much more important than preserving the wealth of people who have money. After all, people don’t have to keep their wealth in the form of money, there are a variety of assets that they can use as hedges against inflation, including – now – bitcoin. But people who are unable to obtain money because there is insufficient in circulation have no other options. Unless more money is created, they will starve.
So I’d rather money wasn’t deliberately kept scarce to placate savers. Let the supply of money respond to demand for it. When everyone wants to save in the form of money, you need to produce more of it so those who need to spend money don’t starve. Obviously, we don’t want to create so much money that it becomes worthless. But it is better to risk waking the demon of inflation than to deny people the means to live.