Supply, Demand: Two Sides of the Same Coin
The Federal Open Market Committee, as a strategy in its "war on inflation," voted last year to raise the Federal Funds Rate and the Discount Rate, saying:
Increases in demand have remained in excess of even the rapid pace of productivity-driven gains in potential supply, exerting continued pressure on resources. The Committee is concerned that this disparity in the growth of demand and potential supply will continue, which could foster inflationary imbalances that would undermine the economy's outstanding performance.
Whenever I hear someone talk about "supply and demand," I am reminded of the late Merrill Jenkins, the original Monetary Realist, who delighted in pointing out that they are the same thing.
One might reasonably presume that the term "demand" refers to things the public wants to buy. A new automobile, for example, would be "demand." Of course, to the automobile dealer, an automobile is not "demand." He's loaded with them. To him, they are "supply;" he supplies them. From his perspective, "demand" is the customer's money. That's what he demands; the customer supplies it, so money is the "supply." The customer supplies the FRNs and demands the Ford; the dealer supplies the Ford and demands the FRNs. So which is supply and which is demand? Well, from whose point of view? And, ultimately, does it matter? Overall, supply and demand are the same thing; different sides of the same coin.
Like so much in our modern world, and especially the world of economics, the terms "supply and demand" are phrases to divert and befuddle, not enlighten. Like the term "inflation," which is mis-used to signify rising prices, "supply and demand" obfuscates rather than clarifies. Of course, clarification may not be in the best interest of the banking fraternity and its sycophants.
A much better phrase to use to facilitate understanding of "inflation" would be "something for nothing." It is certainly true that the public wants things, from food and shelter, to swimming pools and fur coats. And what the manufacturers of these goods receive for them is nothing, which is equally undeniable. The numbers on checks written by customers entitle the merchant to nothing from the bank which has the customer's account. The numbers engraved on FRNs, similarly, entitle the holder to nothing whatever from the source of the "notes."
The question may be posed: "Why would anyone work for nothing?" There are several reasons. One is that the worker doesn't realize that he is working for nothing. It is surprising how few people realize that modern money is not a thing. Another reason is that he is forced to do it. Legal tender laws allow one to pass a non-redeemable "note" without penalty, and nothing else is going to be tendered. So the worker takes the fiat, or does without. Either way he gets nothing, but the "nothing" with the numbers engraved on it can be passed without violating the law, and he has to eat. Finally, there may be those who fully realize the inherent inequity of the system, but favor it anyway. These are probably its beneficiaries.
It takes a certain amount of work to produce goods for the marketplace. Techniques of mass production can reduce the amount of effort required to manufacture, say, an automobile, but no matter how efficient the manufacturing process, the "manufacturers" of modern money can turn out their product faster. It may take hours to produce a car; it takes a second to create enough money to buy it. Now if the supply of money increased at the same rate as the increase of goods, all would be well. There would be a balance between "supply" and "demand." Presumably this was what the Committee referred to when they spoke of "increases in demand have remained in excess of even the rapid pace of productivity-driven gains in potential supply---." Here the Committee regards its "hey-presto" money as "demand," and is concerned that this "demand" will outstrip the "supply" of goods and services, thus "exerting pressure on resources," which could "foster inflationary imbalances." Raising interest rates will discourage borrowing, i.e., money-creation, and thus remedy the imbalance which so worries the Committee. Except that, in the long run, it won't work.
What the bankers would have us believe—although they certainly can't believe it themselves—is that if the supply of goods and services increases by 5% over a period of time, and the money supply increases by the same amount in the same time, things will remain in balance, and "inflation" will be checked. But it cannot happen. A five percent increase in the money supply means that new money will be created in that amount. At some point in the future, that will have to be repaid, with interest. Thus, the money supply will be reduced, eventually, by the amount borrowed, plus the interest. In fact, is the money supply decreasing? Hardly! To merely maintain the money supply, new money must be created to replace that which is repaid (and thereby annihilated), but still more money must be created to pay the interest. And that increase will, itself, be a loan, at interest. An official of the St. Louis Federal Reserve Bank of St. Louis told me over a quarter-century ago that accumulated interest charges were probably about 20% of the amount on the price tag. It could hardly be less today.
This means that the ultimate "continued pressure" exerted by the use of a fiat money is upon the manufacturers, not the bankers! To prevent the prices of their products from leaping sky-high, the producers must necessarily find ways to produce more efficiently, and substitute lower-quality materials for once higher quality ones. Those providing services learn to cut corners and eliminate "frills." Those providing certain luxury services simply go out of business, leading to the common situation of having a broken product which no one today knows how to fix, or which would be cheaper to replace than repair.
Increases in the money supply cannot match increases in productivity. The money supply must increase, even in the absence of any productivity gains, just to provide funds for the payment of interest on previously borrowed money. And that increase will, itself, have to be repaid with interest.
The problem with modern money becomes obvious if you compare the way manufacturers provide their goods with the borrow-into-existence method of the bankers. If Shell didn't sell you gasoline, but only loaned it, so that for every ten gallons you obtained, you had to return eleven, the demand for gasoline would almost immediately explode to such a level that the industry failed. You couldn't produce gasoline rapidly enough to sustain that demand for gas, or supply of it. Money, on the other hand, is created with the flick of a pen. And being an object of thought only, the "supply" will never run out. The only danger to the banker is that the public's confidence in his "product" will dwindle even as the numbers in his account grow. Historically, that has never failed to happen. It is naïve to think it won't happen again; indeed, is not happening now. Accepting the comfortable but fuzzy concept of "supply and demand" instead of the bitter reality of "something for nothing" merely delays the day of reckoning.
Dr. Paul Hein
5 March 2001
Also by Dr. Hein