Most experts are of the view that massive monetary pumping by the US central bank, the Fed, during the 2008 financial crisis saved the US and the World from another Great Depression.
If increases in money supply is an important catalyst for economic growth then the World poverty should have been eliminated a long time ago! Most countries have central banks that know how to print money – why then the World poverty still exists?
We suggest that at no stage increases in money supply can be an important driving factor of economic growth.
Some experts do not agree with this. Following the logic that monetary spending by one individual becomes an income of another individual and the spending of another individual becomes an income of the first individual, they hold that this raises the economy’s overall income and in turn overall economic growth.
Note that in this way of thinking, money stimulates consumer outlays, which in turn strengthens overall income and overall economic activity i.e. demand creates supply.
In this way of thinking what funds i.e. provides support to economic growth is the increase in money supply.
We suggest that individuals, which are engaged in the various stages of production, in order to support their lives and wellbeing, require an access to final consumer goods and not money as such.
At any point in time, there is a finite pool of final consumer goods. Hence, the early recipients of a newly created money are going to benefit from the increase in money supply at the expense of the late recipients or no recipients at all of the newly created money.
By exchanging the newly received money for goods, the first recipients in fact divert some goods in the pool of funding to themselves thus leaving less goods to the late recipients or no recipients of money. Hence, the early recipients of money benefit at the expense of late recipients or no recipients of money. It follows also that an increase in money supply cannot generate an overall increase in economic activity whilst the pool of consumer goods remains unchanged.
In short, to fund a greater number of activities requires an increase in the pool of consumer goods i.e. an increase in the pool of funding and not an increase in money supply, which can only fulfill an important role of the medium of exchange. Note that money can facilitate transactions it however cannot produce goods that are required to support people’s life and wellbeing.
According to Rothbard,
Money, per se, cannot be consumed and cannot be used directly as a producers’ good in the productive process. Money per se is therefore unproductive; it is dead stock and produces nothing.
The essence of the pool of funding
We have seen that to fund a greater number of economic activities requires an expansion in the pool of consumer goods i.e. the pool of funding. The key for the increase in this pool is the improvement in the productive structure i.e. tools and machinery.
With the help of better tools and machinery one can secure a larger quantity of better quality consumer goods.
Printing money however, not going to be of much help here what is required is to allocate some of the consumer goods towards individuals that are going to be engaged in the improvement of tools and machinery i.e. the improvement of the infrastructure.
Note that the improved infrastructure permits not only the increase in consumer goods but also the introduction of various services that were not available before.
In short, with a greater output of consumer goods, it is possible to allocate now some consumer goods not only to fund the enhancement of the infrastructure, but also to fund the production of services.
The size of the pool of funding determines the quality and the quantity of various tools and machinery. If the pool of funding is only sufficient to support one month of work, then the making of a sophisticated tool that requires two months of work cannot be undertaken.
We have seen that the enhanced infrastructure permits the expansion of the pool of consumer goods i.e. the pool of funding. All other things being equal this permits a greater allocation of funding towards a further improvement of the infrastructure and consequently permits a higher living standard. Note that the pool of funding supports both productive and non-productive activities.
We label the part of the pool of funding allocated towards the maintenance and the expansion of the infrastructure as real savings.
When consumer goods are employed in the expansion of an economy’s ability to generate a greater production of consumer goods this is called productive consumption. When real savings are employed non – productively this results in non – productive consumption.
The pool of funding and money
The introduction of money does not alter the essence of what the pool of funding is. Money could be seen as a permit to access the pool of funding, or we can also say that money is a claim on consumer goods within a given pool of funding so to speak.
Various producers who have exchanged their produce for money can now access the pool of funding whenever they deem to be necessary. Furthermore, when an individual exchanges his money for goods, all that we have here is an act of an exchange and not an act of payment – money is just the medium of exchange.
Payment always done by means of various goods and services. As long as the flow of production is maintained, one can always exchange his money for the final consumer goods he deems necessary (i.e. he can always exercise his claim on final goods). Obviously, if for some reason the flow of production is disrupted, the holder of money will not be able to fully exercise his claim.
Monetary expansion and the pool of funding
When money is created out of “thin air”, it leads to a weakening of the pool of funding. What is the reason for this? The newly created money does not have any back up behind it as far as the production of goods is concerned – it sprang into existence out of “thin air” so to speak.
The holder of the newly created money can use it to withdraw final consumer goods from the pool of funding with no prior contribution to the pool. Hence, this act of consumption, or non-productive consumption, puts pressure on the pool of funding. (The individual consumes goods without contributing to the pool of consumer goods).
We can infer from this that when money is created out of “thin air” it diverts consumer goods – the means of sustenance – away from producers who have contributed to the pool of funding towards the holders of the newly created money. We label producers who have contributed to the pool of funding wealth generators.
Because of the increase in money supply, wealth producers discover that the purchasing power of their money has fallen since there are now less consumer goods left in the pool – they cannot fully exercise their claim over final goods since these goods are not there.
As the pace of money creation out of “thin air” intensifies, it puts greater pressure on the pool of funding. This in turn makes it much harder to implement various projects as far as the maintenance and the improvement of the infrastructure is concerned. Consequently the flow of production of various final consumer goods weakens, which in turn makes it much harder to make provisions for savings. All this in turn further weakens the infrastructure and so undermines the flow of production of final consumer goods.
We can thus conclude that monetary growth cannot produce a general expansion in economic activity – also labeled economic growth.
On the contrary, by diverting means of sustenance from wealth generating activities towards non-wealth generating activities monetary expansion only weakens economic growth.
The illusion that monetary policy can grow an economy
As long as the pool of funding is expanding the central bank’s monetary policies appear to be working. For instance, by employing so-called counter-cyclical policies the central bank seems to be able to “navigate” the economy. However, all this is just an illusion. By means of loose monetary policies, the central bank can only generate non-wealth-generating activities.
As various unpleasant side effects of this loose monetary policy emerge – such as rising price inflation – the central bank reverses its loose stance. The reversal of the stance undermines various activities that sprang-up on the back of the previous loose monetary stance and this in turn leads to an economic bust.
After a certain “cooling off” period, the central bank reactivates its loose stance. This again revives various “artificial forms of life”, and the so-called economic boom emerges again.
The emerging economic growth that accompanies the boom is because of the fact that the pool of consumer goods is still expanding. The pool of funding still manages to support not only wealth producers but also various non-wealth-generating activities.
If, however, the pool of funding ceases to grow, or it even declines, then the economy falls into a “black hole”. Once this happens, the central bank can print as much money as it likes but finds that it cannot “revive” the economy.
On the contrary, it only weakens the pool of funding further and delays the date for a meaningful economic recovery. A stagnant or a shrinking pool of funding therefore shatters the myth that central bank policies can grow and navigate the economy.
Summary and conclusions
Most individuals in the western world take the ample availability of goods and services for granted. Indeed, the complex structure of production gives the impression that what is required is simply the existence of demand and the rest will follow suit.
It is, however, much less appreciated that the sophisticated structure of production, which generates seemingly unlimited goods and services, does not have a life of its own – it requires a key ingredient, which is the pool of funding. It is the pool of funding which not only maintains, but also enhances the production structure and thereby promotes our lives and wellbeing.
There is, however, a growing threat to this pool and to the high living standards that we have become accustomed to. This threat emanates from the view that there is no need to worry about the supply of goods, and that what matters is only demand.
Given the assumption that goods will always be there, most economists are preoccupied with how the demand for goods and services can be boosted. When asked how demand is going to be funded most modern economists reply: by means of monetary pumping and low interest rate policies of the central bank. For them funding is something that can be created out of “thin air.” Cheap monetary and fiscal policies, which masquerade as policies that aim to grow the economy, are in fact achieving the exact opposite.
The only reason why economies are still growing is not because of central bank and government policies but in spite of these policies. So long as the pool of funding is still growing the central bank and government can give the false impression that it is their policies that made economic growth possible. Once, however, the pool of funding becomes stagnant or begins to shrink, economic growth follows suit and the myth that government and central bank policies can grow the economy is shattered.
According to Mises,
An essential point in the social philosophy of interventionism is the existence of an inexhaustible fund, which can be squeezed forever. The whole system of interventionism collapses when this fountain is drained off: The Santa Claus principle liquidates itself.
 Murray N. Rothbard, Man, Economy and State (Los Angeles: Nash Publishing, 1970), p.670.
 Human Action 3rd edition Contemporary Books p 858.