Steady-state money

From an exchange with my mate Neil Cameron at One Salient Oversight. For years I’ve been trying to understand why he wasn’t concerned about the peaknik “money creation demands growth” theory, and now I think I finally understand why.
***

Okay, I want to quote Wikipedia at you. Whoever wrote the opening
paragraph to the “Steady State” article got it in one. It’s really
important that you read it:

“The steady state is a condition of the economy in which output per
worker (productivity of labour) and capital per worker (capital
intensity) do not change over time. This is due to the rate of new
capital production from invested savings exactly equaling the rate of
existing capital depreciation. Exogenous growth models show how
economies will naturally tend to a steady-state. The steady-state is
generally associated with the Nobel Prize-winning economist Robert
Solow, who created the Solow Model in 1956.”

Look at this sentence again:

“This is due to the rate of new capital production from invested savings
exactly equaling the rate of existing capital depreciation.”

The phrase “new capital production” refers to businesses borrowing money
to invest in growth-producing economic activity.

But note that this equals “existing capital depreciation” – in other
words, investment in a profit-making enterprise is balanced out by
NON-INVESTMENT.

This seems to be a really hard concept for scientific non-economists to
grasp, but indulge me.

Let’s pretend we are in our steady state economy. Within this economy
there are businesses who are investing in order to profit and grow. Yet
at the same time there are businesses that are decaying and closing
down. The profit of the new businesses ends up being matched by the
losses of the old businesses.

(Steady state doesn’t imply that the economy is static. It’s still
dynamic, but the losses end up balancing out the profits)

So what’s happening to money at this point? With the fractional banking
system in place, the commercial banks are lending out money to the
profitable businesses. Money circulates around.

But at the same time, commercial banks are NOT lending money to the
businesses that are decaying.

Now this might confuse everyone. So let’s add numbers to it.

Let’s say that the amount the commercial banks lend out to the growing,
profitable businesses is $1 million. So what we have is $1 million that
needs to be paid back in interest later on. Let’s say the final figure
ends up being $2 million coming back by the time the debts are paid off.

So. We have to find an extra $1 million in the economy. Where does it
come from? This is the problem that seems to confuse people.

So. Profitable business = needs $1 million added to money supply.

But now let’s go to the decaying and shrinking businesses. What’s up
with them? What are they doing? Actually the important thing is what
they’re NOT doing. They’re NOT borrowing and they’re NOT spending.

And with all this NOT borrowing and NOT spending going on, their capital
deteriorates.

But what about money? If these businesses aren’t doing anything with it,
then they’re not adding to the money supply are they? That’s true, sort of.

And now for the whammy:

Profitable business = needs $1 million added to money supply.
Non-profitable business = adds zero money to money supply.

Therefore we have inflation of $1 million.

Right? No. Wrong. Wrong. Wrong.

The real equation is:

Profitable business = needs $1 million added to money supply.
Non-profitable business = causes $1 million to be subtracted from money
supply.

And that’s how it works.

Money is created by the actions of central banks and commercial banks.
Commercial banks create most of the economy’s money, but whenever a bank
decides to NOT lend it out they are NOT having a neutral effect on the
money supply but a NEGATIVE effect. Holding money and doing nothing with
it CAUSES THE MONEY SUPPLY TO SHRINK.

IN a steady state system, therefore, any lending to businesses at an
interest rate ends up being balanced out by the effects of NOT lending.

Here’s an adage I made up – if money is loaned into existence, then
logically it can be saved out of existence.

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