Thursday, January 15, 2009

Rewording Keynesianism

Let's try to reword Keynes' classic General Theory equation in terms that underlies the "points, not gold" reality behind fiat currency.

The identity reads:

GNP = C + I + G + [CAS]

Gross National Product = Consumer Spending + Private Investment + Government Spending + [Current Account Surplus]

Subtract taxes from both sides and you get:

Gross National Product - Consumer Spending - Private Investment - Taxes = [Government Spending - Taxes] + [Current Account Surplus]

OK, let's put this into words that explicitly track money creation, transfer, and destruction.

(The total sum of all monetary transactions in the economy) - (transfers of money between private parties in exchange for real goods and services) - (transfers of money between private parties in exchange for promises of future money) - (transfer of money out of the private sector and into the Government) = (creation of new money by the Government which it transfers to the private sector) - (destruction of money) + (foreign inflows of money in exchange for outflows of goods)

So, the residual left over after all transfers in the private sector, and taxes, equals the Government deficit, plus foreign inflows of money.

Or, the (net) money the Government creates (out of nothing, because it can; through spending, because it must) equals the private desire to (net) save, plus the foreign desire to (net) save.

The Government creates money and transfers it to the private sector by spending. The private sector transfers the money amongst itself (spending, investment) and puts the rest in the bank. If the private sector wants to put more money in the bank, that money can either come at the expense of transactions, or it can come from the Government simply running a larger deficit, and thus creating additional money for the private sector. So long as the private sector uses this money to save, it's creation is not inflationary and will not show up in the CPI. Inflation is caused by too many dollars chasing too few goods, and dollars under the mattress are not chasing anything.

To be added: the role of Prices, Banks, Taxes, Interest Rates, and the Yield Curve.

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