$1,000 + $800 + $640 + $512 + $410 + $328 + $262 + . . .
At the end of 14 banks in this chain, the grand total is $4,780, and
it is evident that we are rapidly and asymptotically approaching
an increased money supply of $5,000.
In this way, competing banks under
the aegis of a central bank
can increase the money supply by the money multiplier in the
aggregate even though each individual bank expands by only 1
minus the money multiplier. The mystery of the inflation process
in the modern world has finally been unraveled.
2. T
HE
C
ENTRAL
B
ANK AND THE
T
REASURY
We have seen that modern inflation consists in a chronic and
continuing issue of new money by the Central Bank, which in
turn fuels and provides the reserves for a fractional reserve bank-
ing system to pyramid a multiple
of checkbook money on top of
those reserves. But where in all this are government deficits? Are
deficits inflationary, and if so, to what extent? What is the rela-
tionship between the government as Central Bank and the gov-
ernment in its fiscal or budgetary capacity?
First, the process of bank money creation we have been
exploring has no necessary connection to the fiscal operations of
the central government. If the Fed buys $1
million of assets, this
will create $5 million of new money (if the reserve ratio is 20 per-
cent) or $10 million of new money (if the ratio is 10 percent).
The Fed’s purchases have a multiple leverage effect on the money
supply; furthermore, in the United States, Fed operations are off-
budget items and so do not even enter the fiscal data of govern-
ment expenditures. If it is pointed out that almost all the Fed’s
purchases of assets are U.S. government bonds, then it should be
rebutted that these are
old
bonds, the
embodiment of past federal
deficits, and do not require any current deficits for the process to
continue. The Treasury could enjoy a balanced budget (total
annual revenues equal to total annual spending) or even a surplus
(revenues greater than spending), and still the Fed could merrily
170
The Mystery of Banking
Chapter Eleven.qxp 8/4/2008 11:38 AM Page 170
create new reserves and hence a multiple of new bank money.
Monetary inflation does not require a budget deficit.
On the other hand, it is perfectly possible,
theoretically, for
the federal government to have a deficit (total spending greater
than total revenues) which does not lead to any increase in the
money supply and is therefore not inflationary. This bromide was
repeated continually by the Reagan economists in late 1981 in
their vain effort to make the country forget about the enormous
deficits looming ahead. Thus, suppose that Treasury expenditures
are $500 billion and revenues are $400 billion; the deficit is
therefore $100 billion. If the deficit is
financed strictly by selling
new bonds to the public (individuals, corporations, insurance
companies, etc.), then there is no increase in the money supply
and hence no inflation. People’s savings are simply shifted from
the bank accounts of bond buyers to the bank accounts of the
Treasury, which will quickly spend them and thereby return those
deposits to the private sector. There
is movement within the same
money supply, but no increase in that supply itself.
But this does not mean that a large deficit financed by volun-
tary savings has no deleterious economic effects. Inflation is not
the only economic problem. Indeed, the deficit will siphon off or
“crowd out” vast sums of capital from productive private invest-
ment to unproductive and parasitic government spending. This
will cripple productivity and economic growth, and raise interest
rates considerably. Furthermore, the
parasitic tax burden will
increase in the future, due to the forced repayment of the $100
billion deficit plus high interest charges.
There is another form of financing deficits which is now obso-
lete in the modern Western world but which was formerly the
standard method of finance. That was for the central government
to simply print money (Treasury cash) and spend it. This, of
course, was highly inflationary, as—in our assumed $100 billion
deficit—the money supply would increase by $100 billion. This
was the way the U.S.
government, for example, financed much of
the Revolutionary and Civil War deficits.
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