“Pushing on a String” -by Josh

Wednesday, January 14, 2009 – 2:07 PM
“Pushing on a String”
Most people had probably never heard this phrase a year ago. It refers to the monetary phenomenon whereby the financial authorities find themselves powerless to stimulate the economy via the normal expedient of cutting interest rates. Ordinarily, interest-rate policy is a viable tool for speeding up or slowing down the business cycle. If the economy is sluggish, interest rates are lowered, and economic activity picks up. If the economy is too active and inflation looms, interest rates are increased, and the economy slows down.

There are times though where the efficacy of interest-rate policy falters (or disappears entirely). If sentiment is extremely negative, it doesn’t matter that businesses and individuals can borrow money at low interest rates; they will still refrain from spending and investing. This is precisely the situation that our economy is in right now. Regardless of how much money the Fed pumps out, the economy stubbornly refuses to respond.

Interestingly, despite Dick Cheney’s recent assertion that “nobody saw this coming”, Fed Chairman Ben Bernanke gave a now-famous speech in 2002 anticipating precisely this set of circumstances and outlining how the Fed could respond to it. The speech earned him the nickname “Helicopter Ben”, after the most extreme monetary measure he described, which was to literally drop money out of helicopters.

What Bernanke didn’t foresee was that sentiment could get so negative that people won’t spend even if money is dropped from helicopters (which is more or less what the Fed has been doing for the last several months). And – a point which virtually every mainstream economist, government official, and media commentator has failed to note – this is not a failure of monetary policy; it is a failure of money itself.

Banks, corporations and individuals are behaving in a perfectly rational manner when they choose not to spend or invest. After all, if you expect continued economic stagnation, why would you invest? And if you expect prices to fall, why would you spend?

Thus we are faced with a tragic paradox – i.e. just at the time when we most need the people who have money to spend it, they face the strongest disincentive to do so. And the reason why this is so is because money as we currently know it is improperly designed and fundamentally flawed.

If you ask an economist for a definition of money, it will typically be described in one of two ways – i.e. either as a medium of exchange or a store of value. In other words, money is expected to facilitate the exchange of real goods while at the same time serving as a tool for storing and preserving wealth.

Although it may not be apparent at first glance, these two functions are not fully compatible. As the German economist Silvio Gesell observed, it is impossible for money to serve as an effective medium of exchange if it is also designed to serve as a store of value. Money that is designed to serve as a store of value will systematically fail to serve its more important function as a medium of exchange.

To see why this is so, let’s consider an everyday phenomenon with which every human being is familiar – i.e. the fact that things decay. Virtually every type of physical matter deteriorates over time – some more quickly than others. For this reason, every producer of real goods and services is under a natural compulsion to sell their wares. Of course they will try to get the best price they can, but when push comes to shove, they have to sell. Just imagine a dairy farmer who refuses to sell his milk because he thinks the price offered is too low. In a couple weeks his product will be worthless. The compulsion to sell is so strong that he will ultimately have to sell his milk even if he takes a loss by doing so (since the loss would be even larger if he held onto his milk).

Money, on the other hand, is under no such compulsion. Holders of money suffer no penalty if they delay their purchases. As Gesell colorfully describes it, “Demand enters the market proudly confident of an easy victory; supply appears dejected like a beggar… On the one hand compulsion, on the other hand freedom; and the two together, compulsion and freedom, determine price.”

In other words, money enjoys an unfair advantage over real goods and services in the marketplace. And it is precisely because money is intentionally designed to serve as a store of value that this advantage exists. If money was intended to serve solely as a medium of exchange, it would be designed in such a way as to subject it to the same compulsion to circulate that applies to all other goods and services. It is the absence of this compulsion that causes money to systematically withdraw during times of uncertainty, thereby exacerbating financial crises. If money was subject to a “penalty to hoarding” just like all other goods and services, supply and demand would meet on a level playing field, and holders of money would not face an incentive to hoard their wealth just at the time when society needs them to do the opposite.

In order to achieve this result, Gesell suggested designing money so that it deliberately loses value according to a predetermined schedule of depreciation. This would create an incentive for holders of money to “use it or lose it” in both good times and bad. (In his time, Gesell proposed accomplishing this by requiring people to purchase stamps which would need to be affixed to paper currency periodically in order to maintain its full value. Given modern computer technology, a far more efficient and less cumbersome method could be designed.)

Obviously all of this would require a fundamental adjustment in the way we think about money. Up until now, money has been viewed as a form of wealth and has been regulated by the private banks that make up the Federal Reserve system. As Richard C. Cook observes in his book “We Hold These Truths: The Hope of Monetary Reform”, money is a creation of the state and ought to be viewed as a public utility, not as the domain of private interests. Just as we have seen how allowing private corporations to control the distribution of electricity can lead to harmful abuses, the same holds true for money.

And, to bring the discussion back to where we started, we should also note that money designed in such a way would eliminate the problem of “pushing on a string”. With money as it currently exists, there is virtually no way for the financial authorities to compel its circulation, as we now see with the Fed Funds rate near zero and the markets still failing to respond. If money were designed along Gesell’s lines, monetary policy would be far more effective in terms of its ability to compel money to circulate. In a crisis like the one we’re currently in, the government could simply increase the rate of depreciation of money. In that way, unlike our current system in which holders of money are behaving perfectly rationally by hoarding money, they would no longer have an incentive to do so. The ability of the government to adjust the rate of depreciation would allow the “penalty to hoarding” to be set at whatever level was required to compel money to start circulating again. The government would then be pushing on a ramrod rather than a string.

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