Professional Documents
Culture Documents
In this issue:
1. Wealth is Not Money, Money is Not Wealth
2. Gold and Other “Real” Money
3. Fiat (paper) Money
4. What is Money Really For?
5. Money Mismanagement
Economics is a strange science where even some of the most basic and critical tenets are still debated at
the highest level. In this series of newsletters I'm going to build up a comprehensive understanding of
economics. I'll try to present the most prominent theories and humbly offer my own synthesis. The
stronger understanding we gain will be directly useful in navigating the world of investing.
5. Money Mismanagement
When the money supply is mismanaged, there are side effects that inhibit wealth creation. For example,
under severe inflation, banks are reluctant to make loans because the value of the money they lend out
may decrease substantially by the time they get it back. Similarly, businesses are reluctant to borrow at the
extremely high interest rates that are likely to prevail. As a result, there is less investment in future
production.
When the government engages in unproductive spending, they are reducing the efficiency of the
economy by wasting human and physical capital. For example, Ingvar Kamprad runs his stores more
efficiently than any of his competitors, so he can then hire more people and continuously increase
production. Kamprad’s efficiency means that he can sell more furniture than anyone else using the same
number of workers and stores. If the government creates new money and builds new stores (or subsidizes
other stores), the managers of those other companies will not make as good use of the country's
resources. Instead of each worker selling 10 chairs a day, they may only sell 8. As a result, the total
number of chairs produced in the world will decrease and we will be poorer for it.
Another example of a mismanaged money supply is when the money supply is not allowed to grow. For
much of the 19th century, we effectively used precious metals as money. The supply of the metals grew
slower than the production of goods. The result was deflation. Under deflation, consumers expect prices
to continue dropping over time so they delay purchases. Businesses are reluctant to invest in new
production because if the prices of their goods continue to drop, they may not earn a return on the
investment. Deflation frequently causes a cycle of high unemployment and slow wealth creation.
Economists generally agree that to optimize wealth creation, we want a slow and stable growth in the
money supply. This can be a challenge for the Federal Reserve, since as we discussed earlier, money is
also created by banks. During recessions or the bursting of asset bubbles, bank lending may suddenly
drop precipitously requiring strong Federal Reserve intervention to maintain a stable money supply. Finally,
there can also be political pressure on the Federal Reserve to increase the money supply faster to create
higher short-term growth and reduce unemployment.
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