The pernicious distortions of cheap money...
Let us go back for a moment to construct a simplified version of what it is we are considering, with the aim of better understanding it. Imagine that along the chain from seed merchant to farmer to grain shipper to miller to baker to wholesaler to retailer to Mrs. Jones, out for her weekly quota of patisseries, there is a flow of goods from the higher orders (i.e., starting with the seed merchant) through the lower and on into our dear housewife's shopping basket.
While this segmented process of production takes place, time inevitably passes as an incomestible, raw material is sequentially transformed into a sought-after item of everyday consumption, with value being incrementally added as the metamorphosis takes place.
Initially, the farmer may lack the means to pay the seed merchant so he asks for, and is granted credit by his vendor – the one generates an entry for accounts receivable, the other for accounts payable. The farmer, in turn, may well have to do the same to the man who comes to collect his grain and so on, all the way down to Mrs. Jones.
Such credit as is granted here is implicitly connected to a decision on the part of the grantor to forego an equal amount of current, monetary recompense and hence, makes him automatically him into a saver. Not in the least inflationary, such a process of credit creation is thus an entirely benign aid to industry and commerce, if practiced in due proportion and with a due degree of diligence.
As our Mrs. Jones dips into her purse and passes over her pennies to the shop assistant, MONEY now moves back up the chain, and extinguishes each debit in turn as the promissory notes, invoices, or bills of exchange come due and are settled. By way of avoiding an infinite regression, Mrs. Jones, we may assume, gets her cash from her husband's job at one of the firms involved, this first amount coming into being when someone saved the money to provide the firm with its start-up capital, long before it was generating any saleable output. Thus, Mr. Jones' effort provides the household with its daily bread, both literally and metaphorically.
Note here that each member of this division of labor has to await his own fulfillment until after the final good has been sold. Once that has been accomplished, each receives a portion of this selling price to the extent of his individual contribution to the value attached to it by Mrs. Jones' decisive exercise of consumer sovereignty. To the degree that each member has correctly judged the management of his affairs, he will receive a little more than he himself laid out – whether this expense took the form of his purchase of the products of those passing firstly the raw, then the several intermediate, and lastly the finished good onto him, or as part of his direct outlay to his workers, his landlord, and his equipment suppliers.
At that point, his entrepreneurial judgment having been fully validated in the marketplace, he and his capital backers can enjoy a well-merited reward. However, it is also the case that, having received both his revenue and the endorsement of the firm's owners, each of our captains of industry has the choice to buy more or less of what he bought before, to put the difference to use in improving the firm's chance of future success, or to quit the business entirely, extracting what capital he can along the way.
This means that, far from being something which we can take for granted once Mrs. Jones steps into the store – as the traditional, GDP-type, consumption-fixated methodology insists is the case – each of these steps is highly discretionary. Each is, moreover, subject to the continuing practice of good management and unwavering entrepreneurship to maintain an unbroken flow of goods. At any point, changes in any of the constellation of conditions influencing each business, or in the motivation of and possibilities of compensation for those running it and investing in it, may mean it becomes either not possible or simply not desirable, to carry on with it– an eventuality which cannot fail to have significant ramifications for both customers downstream and suppliers upstream of that business.
Contrary to the way they are normally dismissed from contemplation, as being mere residuals to be cancelled out in our measurement of that misleading aggregate of aggregates we call 'the economy', all these activities are therefore vital to its functioning and should be treated as such in our every analysis. Importantly, we should bear in mind that while net new investment may be what is needed to improve the capital stock and to increase the division of labor (to add 'roundaboutness', to use Boehm-Bawerk's formulation), it is gross investment – i.e., spending with a view to creating, not exhausting, value – which is a sine qua non for the very maintenance of the extant stock of productive machinery. Anything which serves to reduce it, therefore, ultimately reduces both our wealth and our income, even if its temporary substitution with more end-good spending gives a speciously attractive boost to the guiding calculus of the GDP numbers.
Thus, by way of analogy, we can imagine the step-by-step generation of income as being akin to a relay in which each participant passes a baton on to the next to signify both the movement and further working of the goods-in-process all the way to their final destination in our good lady's larder (perhaps the baton should be marked with notches as a tally to record the credit being extended at each stage as well).
Once the finishing line has been crossed – and the palm awarded by the end-consumers gathered there – the prize money is passed back up among the runners, with each subtracting his cut as the pot reaches him in his turn. For each, that cut constitutes his own spendable portion, i.e., that part beyond the requirements of his continued involvement in the scheme of production. Further ensuring economic harmony – what we Austrians call 'plan co-ordination' – their sum matches exactly with that quantity of final consumption goods which all those involved have helped put on the shelves and which have been duly selected for purchase from among all the competing merchandise ranged alongside them there.
Now consider what happens when each man can take his evidence of a credit claim on another and have it turned into money at the bank. Effectively, each of our relay runners now has his own baton and he can choose to leave his lane, dash across the infield to the finishing line, and there compete with all his fellows in pre-empting the goods piled up there by others, well before they have collectively ensured that their own have been successfully delivered to be offered in exchange.
More money chasing fewer goods – i.e., the potential for giving rise to what Charles Holt Carroll called 'price without value' – is the first result. The second is the temptation to start 'check kiting'; i.e., to divert the monetized claims in their entirety – not just the expected net income component of them – to non-essential or even ultra vires purposes, such as, stock market or real estate speculation, hoping then to meet each bill as it comes due, not out of cash flow, but by cashing in speculative gains or raising further inflationary finance. The third is the disconnection of effective demand from profitable supply with the risk that, in one's own hunger to spend earlier than one has earned the means, one ends up earning less than one had thought to, as prices and quantities become adversely affected by the consequences of one's own impatience.
In Holt Carroll's own words of 1855:-
'The immense variations in the quantity of this delusive currency that we call money, the greater part of which is but a mere "promise to pay" money that has no existence, produce corresponding variations in the money value of property and debts, so that no reliable estimate can be made of property for any considerable period of time. There can be no reasonable reliance that the quantity of money which measures an obligation for six months will be anywhere at its maturity to discharge the debt; and this baffling uncertainty renders the trade of the country but little better than licensed gambling.'
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