[jmherbener]

Power over monetary policy was not centralized in the Board of Governors until the Banking Act of 1935. Benjamin Strong headed the group of Federal Reserve District Bank presidents who, with Board approval, determined rates of discount for commercial paper and open market operations during the 1920s. They engineered a significant monetary inflation and credit expansion in part to re-establish the gold standard, at the pre-War parities and in part to stimulate domestic economic activity.

After the War, the exchange rate of the pound had fallen to $3.20. Britain tried to restore the gold standard at a rate of $4.76. Speculation had driven the rate near $4.70 after 1925, but the fundamentals of underlying purchasing power would not justify it without significant manipulation. That is what the speculators were betting on.

Strong reported to the Board that for the three years 1925-1927, the Fed’s portfolio increased $200 million, the gold stock $18 million, but bank credit had soared by $5 billion. The discount rate was lowered from 6 percent to 4 percent.

The idea was that the pound would appreciate against the dollar if the dollar’s purchasing power was lowered by monetary inflation. The scheme failed because, Britain refused to moderate its own monetary inflation and rising international demand for the dollar prevented the purchasing power of dollar from falling.

The eminent monetary economist, Alan Meltzer, chronicles this story in his landmark book, A History of the Federal Reserve System, Vol. 1.

[jmherbener]

There are two burdens from debt financing of the state. The primary burden is born by the present generation. Bondholders give up command over resources by lending to the state and society in general suffers lower standards of living than it could have enjoyed when the state directs the use of resources instead of entrepreneurs. The latter is the burden born by society at large.

The secondary burden from debt financing is independent of the primary burden. It occurs only if the state taxes some people in the future to pay bondholders. If so, taxpayers bear a burden and bondholders receive a benefit. Control of resources are not transferred to state and so, there is no burden on society at large.

In your case, then, the primary burden is suffered by the Chinese holders of U.S. bonds and by people around the world whose standard of living is lowered by having resources used inefficiently by the U.S. state instead of efficiently by U.S. entrepreneurs. The secondary burden occurs if and when the U.S. state taxes Americans and uses the tax revenue to pay Chinese bondholders. But this is not a burden on society at large.

It doesn’t matter whether or not the taxpayers and bondholders are in the same political boundary. The secondary burden will be suffered by taxpayers and offset by the benefit to the bondholders. So it’s misleading to say that future generations bear either the primary or secondary burdens. The secondary burden is born by the taxpayers (not Americans in general), wherever they reside, and offset by the benefit to the bondholders (not the Chinese in general), wherever they reside.

[jmherbener]

But the bondholder has born the burden in the present, not the future. The bondholder has given up buying consumer goods or making investments in the present when he lent to the state. So future generations do not bear the burden of the debt. If the state coerces taxpayers to pay bondholders in the future that is an additional burden on the taxpayers that is independent of the primary burden of the debt, which is born in the present. This secondary burden on future taxpayers is exactly offset by the secondary benefit to future bondholders. So future generations do not bear the burden of the debt.

[jmherbener]

What if the state borrowed today and then in the future it defaulted on the debt and no taxes were extracted and no bondholders were paid. Wouldn’t the burden of the debt be the same today as in the case where the state taxes some people in the future to pay other people? And isn’t this present burden the main answer to the claim that the debt doesn’t matter because “we owe it to ourselves”?

[jmherbener]

There are two different issues that we should not conflate. The first is the transfer of control over resources from private hands to the state. The happens whenever the state spends funds, from whatever source it acquires them: taxes, borrowing, and monetary inflation. This transfer of control takes resources out of the realm of efficient decision making by entrepreneurs using economic calculation and puts them into the realm of inefficient decision making by politicians and bureaucrats. The burden of the loss of efficiency is born in the present by society at large.

The second issue is the transfer of wealth between taxpayers and bondholders in the future as the state pays the bondholders. This does not transfer resources from private hands to the state. It transfers wealth between two private parties, taxpayers lose and bondholders gain. Of course, this has inefficiencies too since it’s coerced, but it does not transfer resources to the decision making control of the state.

This distinct is helpful in disabusing one of the fallacy that if the state borrows today the burden falls entirely on future generations. Actually, the burden falls on the present generation as resources in the present are wasted by the state. Then, in the future, the state adds the additional inefficiency of coercively transferring wealth from one private group, taxpayers, to another private group, bondholders.

[jmherbener]

When the state borrows today to pay for its expenditures, resources are transferred from private hands to the state today. The burden of the loss of resources from taking them away from their efficient use in the hands of entrepreneurs and putting them into the hands of politicians and bureaucrats occurs now. When the debt is paid in the future by taxes, there is a transfer of wealth between private parties, from taxpayers to bondholders. Resources stay in private hands. Future generations do not pay for state borrowing, the present generation does.

[jmherbener]

Thomas Malthus advanced underconsumption against Say’s law. Malthus accepted that production (supply) of all goods generates income sufficient to buy all the goods produced, but he denied that people must spend all of their income. Effective demand depends on both the income and the will to spend it. Keynes would later incorporate Mathlus’s concept of “effective demand” into his own system and Keynesians, like Paul Krugman, would use it to claim that increasing income inequality leads to inadequate aggregate demand since the middle class must spend their income just to sustain themselves but the rich have discretion. For example, if entrepreneurs have produced under the expectation that everyone is spending 95% of his income and then some people grow wealthier and spend only 75% of their income, overproduction will result. Malthus and Keynes, at least in some places, admitted that savings represents potential demand through investment. But, the uncertainty involved in the process of S-I producing future consumer goods could not guarantee enough effective demand to buy all the goods produced. Finally, even if the process of S-I operates properly, there could be hoarding which would bring aggregate demand up short of buying all the goods produced. In any case, the result is a cut back of production. Underconsumption is an explanation for depression.

Underconsumption cannot cause a depression on the unhampered market economy. Entrepreneurial production decisions are guided by profit and loss. Hoarding increases the purchasing power of money. The lower prices allow all the goods produced to be purchased. As prices of consumer goods fall, entrepreneurs lower their demands for producer goods and their prices fall. Profit is maintained and production continues. Shifts from consumption to saving-investing raise the prices of capital goods relative to consumer goods leading entrepreneurs to shift production accordingly. The built up capital structure renders more consumer goods in the future, which satisfies the shift from consumption to saving-investing in the present.

A depression is the correction of the malinvestment and overconsumption of a previous boom. Credit expansion through monetary inflation suppresses interest rates leading to an unsustainable build up of the capital structure and overconsumption. The correction of the bust appears to be underconsumption as people shift toward saving-investing. The over-expanded areas of consumer goods production, e.g., housing, autos, etc. suffer decline.

[jmherbener]

The problem economically with fractional reserve banking is similar to the problem of fiat money. Neither the production of fiduciary media, i.e. fractionally backed money substitutes, nor the production of fiat money can be regulated by profit. Without profit and loss as a guide, production will be inefficient. A bank can issue fiduciary media out of thin air by making a loan to a customer and writing the funds into his checking account. The bank is not intermediating credit from a saver by doing this but creating it with the issue of fiduciary media. It is always profitable to issue more fiduciary media. The interest a bank earns on the loan is always greater than the nominal cost of writing funds into a checking account.
In like fashion, a central bank prints fiat paper money. It is always profitable to print more. Without special privileges in law, like legal tender laws, fiat money would not arise on the market. Fiat money would not develop a wide clientele as a medium of exchange in free competition with commodity money.
In like fashion, fiduciary media is supported by legal privilege. Money certificates came into existence as warehouse receipts for money. The “bank” did not own the gold money placed by the customer in its vault for safe keeping. In order to legally loan the funds warehoused by a customer, the state had to supplant bailment contracts with “deposit” contracts. But, legislation cannot bring about conditions contrary to economic reality. It merely creates inconsistencies in private property claims. Fractional reserves mean that more than one party holds mutually exclusive claims to the same money.
In a “deposit” contract, the customer transfers ownership of money to the bank who then issues a claim to pay the customer money in the future. Such contracts are suitable for intermediating credit. Without special privileges in law, deposits would not develop a wide clientele as a medium of exchange in free competition with money certificates.
Take a look at Murray Rothbard’s What Has Government Done to Our Money?

[jmherbener]

This classification of money arose in the attempts to explain the value of money. The value of a consumer good comes from the aid it gives in directly satisfying a person’s end. Money does not directly satisfy a person’s end. The value of money is in facilitating exchange. The value of a producer good comes from the aid it gives in producing consumer goods that directly satisfy a person’s end. Producer goods are used up in production. Steel becomes a fender for a car, labor services are used up in assembling the car and so on. Money is not used up when rendering its services. It trades from one person to another to another with its physical integrity intact.

The other issue you raise is the item used as money. Let’s start with fiat paper money. In that case, it should be clear that its value cannot come from it being either a consumer or a producer good.

In the case of silver or some market commodity, people will arbitrage the stock of silver across all the different uses that have sufficient value so that the value of a unit of silver is the same in each use. Even so, the value of a silver coin is determined by the value people place on it as a medium of exchange. Just as the value of silver spoons is determined by the value people place on silver spoons as a consumer good.

This does not create an overlap of categories of goods, but a diversity of classification of a single object (silver) according to its uses (consumer good, producer good, medium of exchange).

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