Guy says money creates production out of thin air.

tcostel posted on Fri, May 27 2011 12:33 AM

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I honestly could not believe my eyes when I read his post. I started to challenge him, and the converstation grew even more ridiculous. I have no idea how to respond anymore. I know what I want to say, I just can't say it right. Here is the conversation, with me and a poster who I will called "Keynes."

Keynes:

Money does create production out of thin air. When money is given to someone it A) means they produced something to get it. B) Spent it on someone else producing.

Me:

If money creates production out of thin air, why is counterfeiting illegal? It should be encouraged! If counterfeiters create more money, they have more money to spend, therefore increasing employment. In a recession, we could all just abandon our own jobs to counterfeit money if it is true the creation of money magically creates production.

If I created some money electronically or with a printer, I have produced absolutely nothing except money. If by creating more money you would create production, the solution to all the world's problems would be to have an infinite supply of money (and therefore infinite production). Our fiat dollar has no worth other than providing a medium of exchange. Creating more of it will increase the supply of dollars used to exchange for things, but the supply of things you want to exchange money does not increase simply because there is more money. That is the problem. Think of it this way. Say a currency is backed by gold. 1 dollar represents an ounce of gold. There are 10 ounces of gold, therefore 10 dollars in the economy. If you create 10 more dollars, you are not creating more gold, only more receipts to it. Therefore, you would have 2 dollars for every ounce of gold. The money is devalued, production does not increase, but if a family only had 1 dollar and did not receive the newly created dollars, they have half the wealth they had before. If a family had 1 dollar and was then given 3 of the newly created dollars, it has double the wealth. Basically, wealth was redistributed, not created.

The same is true for a fiat currency which represents an array of all goods and services in an economy (you redeem dollars for services and goods, etc.). If you print more money, you are not creating more services and goods. Prior to the great depression, the money supply was increasing by large amounts. Yet what was the result? A huge loss of production.

A). Not necessarily. When I give to charity, those receiving the money have not done anything productive. The same is true of loaning money. Money is loaned with the hopes that the recipient will be productive in the future. They have not yet produced anything. In the case of the Federal Reserve, it creates money and then gives it to the banks to loan out, so most new money enters circulation in the form of loans. Money is given to people who have not yet been productive, and the money they are given does not come from production itself, it comes from thin air. So what you have is money circulating in the economy that has never been backed by actual production. The money supply increases, but production does not necessarily at all.

B). When money is given to someone it means they spent it on someone else producing? Sorry, I don't understand that. Do you mean to say when money is given to someone, the person doing the giving is spending on production? If that is what you meant the above applies the same.

Keynes:

Because there is a capacity to production. So printing past that capacity would cause inflation.

Me:

That doesn't prove that money creates production. What I said earlier still stands unchallenged. Before I respond to this, respond to the rest of what I said.

Keynes:  

  Actually my one sentence completely challenged your entire post. Here is a hint:

Wordy posts usually equals circular logic.

A). Not necessarily. When I give to charity, those receiving the money have not done anything productive.
On the point of charity I agree.

The same is true of loaning money.Completely false and ludicrous. I guess this means we should stop commercial bank lending?


Money is loaned with the hopes that the recipient will be productive in the future.
Bingo! And they usually are! Why? Because if they aren't productive they don't eat tomorrow.

In the case of the Federal Reserve, it creates money and then gives it to the banks to loan out, so most new money enters circulation in the form of loans.
Incorrect again. Fractional reserve lending is actual lending first and then the commercial banks borrow to meet reserve requirements, Look at my thread on the money multiplier.

Keynes again:

Here are some facts on fractional reserve lending:

The money multiplier theory relies on the bank having a limit on what they could lend in relative to their reserves. Unfortunately banks are not constrained in lending by their reserves. Read below to understand what banks do:

The way banks actually operate is to seek to attract credit-worthy customers to which they can loan funds to and thereby make profit. What constitutes credit-worthiness varies over the business cycle and so lending standards become more lax at boom times as banks chase market share.

These loans are made independent of their reserve positions. Depending on the way the central bank accounts for commercial bank reserves, the latter will then seek funds to ensure they have the required reserves in the relevant accounting period. They can borrow from each other in the interbank market but if the system overall is short of reserves these “horizontal” transactions will not add the required reserves. In these cases, the bank will sell bonds back to the central bank or borrow outright through the device called the “discount window”. There is typically a penalty for using this source of funds.

In laymen terms the banks lend first then borrow or sell bonds to get the reserves after the fact.

http://bilbo.economicoutlook.net/blog/?p=1623

What this means to us is that banks really have a large capacity to create money, moreso than the federal government does. In the year of 2008, the last boom year, fractional reserve lending created 6 trillion in the money supply in one year.
I tried to find the best explanation on reserve lending there is and hope people will understand what actually happens in the process