Economic Accounting

I often write about monetary policy because its abuse is behind the current woes of the world economy. It may create an impression that I recognise no fiscal implication so it is perhaps overdue to take a look at some economic accounting. We’ll keep it simple.

How does the “bailout with money from thin air” work?

In five simple steps:
1. Central Government raises a debt in the form of a government security (a bond, Treasury bill, etc.)
2. The Central Bank (FED) buys the security from the Central Government.
3. The Central Bank (FED) pays for the Central Government security with money that it does not have.
4. The Central Bank raises a monetary debt as a liability against the economy. (To be repaid with interest from taxes to be collected by Government.)
5. Central government uses the cash for “bailout” purposes.


Here is the accounting:

A) Central Government: - Credit bank account (Asset), debit loans (Liability).
B) Central Bank: - Credit Government Securities (Asset), debit money stock (Liability).


Here is a graphic representation:





The graphic representation shows the interaction between monetary policy and fiscal policy. The newly created “cash” is menacingly not neutral for the economy. It most certainly is not a reshuffling of resources or a redistribution of existing resources. It is an outright new FISCAL DEBT in the hands of Central Government to be repaid by taxpayers or future generations of taxpayers. It is a monetary dilution of economic value (pure monetary inflation) in the hands of the Monetary Authorities until it has been repaid from taxpayers’ money and then neutralised form monetarised debt. Meantime the Monetary Authorities can swap the new Government Securities for toxic banking assets.

The summarised logic behind the bailout is that the Stock Exchange losses of the Great Depression of 1929 resulted in a loss of money supply and to prevent the depression the Monetary Authorities have to “create cash out of thin air” to replace the loss of money from the system. The problem with this theory is that it ignores the pre-existence of a Babelian Tower of Debt built on reckless debt expansion supported by loose monetary policy. The pre-existence and collapse of the Babelian Tower of Debt is the true problem not the fact that the collapse of the Babelian Tower had left a gaping bad debt hole behind. How can the solution be to fill the hole with Government debt to be repaid by taxpayers, most of whom are already overextended in debt? The world had mercy on geese being force fed to produce enlarged livers, perhaps some mercy for debt force fed taxpayers would also be in order.

The solution to the debt problem cannot be found in adding Fiscal irresponsibility to Monetary irresponsibility. Nor is it wise to doom future generations to debt enslavement or endemic inflation in an irrational effort to sustain a collapsing Babelian Tower of Debt.

The expectation that “some inflation” will be good and will prevent a downturn is a fallacy. The very foundation for a depression is built upon the bailout activities. It spreads an ill in the financial sector, via irresponsible Government borrowing aimed at replacing a market proven unsustainable private debt load, to the healthy sectors of the economy. The banking bailout method even surpasses the debt enslavement of Keynesian infrastructure spending. At least the Keynesian method buys infrastructure with the debt and leaves future generations with the inherent infrastructural capital. The banking bailouts only buys bad debts, bad securities, loss making entities, exit strategies for stock exchange speculators, exit strategies for reckless executives and many more similarly dubious assets. What kind of a legacy does this leave behind for future generations who must repay the debt?

The markets must be allowed to clear and rebalance. Intervention should be restricted to policies that will allow the process of clearing and rebalancing to proceed in an orderly manner. Authorities should not reach for oppressive regulation to sustain the Babelian Tower of Debt nor should they be tempted to discount the labour of our children and grandchildren to save the reckless of yesterday.

Beware the danger should the “bailout cash from thin air” escape from the financial economy into the “real” economy. Why would it not, as there are no actual barriers between the “financial” economy and the “real” economy? The competing new money created from thin air will usurp the production surplus of the economy and drive us into depression. (1.)

Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
October 2008



Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .

Please feel free to comment on this blog but let's be polite.


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1. From “bailout” to Depression.


I have previously explained the process whereby the production surplus is removed through monetary excess from the economy in my essay “Praxeology of Commodity Pricing” published at this link http://sareloberholster.blogspot.com/2008_08_01_archive.html .


I reproduce an extract hereunder explaining the process whereby competitive new money skims the production surplus from the economy. Use the “bailout cash” as an input of competitive new money in Exhibit 3 to see how such an escape into the “real” economy could result in a depression where the participants to the “real” economy literally starve.



© Sarel Oberholster

Here is a simple static construct of a ten unit economy with ten units of money available to buy the oil. Thus one unit of money will buy one barrel of oil (price formation). The next step is to introduce motion into the static construct.

Farmer buys the ten barrels of oil, adds his labour and produces 20 units of grain. Farmer use 10 units of grain to feed himself and his family and sells 10 units of grain to Oil producer for 10 units money. Oil producer feeds himself and his family and uses his labour to produce another 10 barrels of Oil. This is now a perpetual and stable economic construct.


© Sarel Oberholster

Next we introduce a State as another economic participant. We do not give State the power to tax but we grant the power to create money. State uses this power and openly creates ten more units of money. State enters the economy with the new money and competes with the old money for the available ten barrels of oil.

The entry of State as an economic participant with new money has very significant consequences for the stable economic construct. First look at what happens to the static construct of Exhibit 1. We add the new money and observe the effect. We also make the assumption that State consumes the Oil for its own purposes (for example to make war or consuming it as a source of energy). The result is shown in Exhibit 3 [and Exhibit 4].


© Sarel Oberholster

The equilibrium in the economy has been disturbed. The presence of twenty units of money competing for the same ten barrels of oil has the effect of changing the price of oil from 1 unit of money to two units of money (100% inflation). State now receives 5 barrels of Oil for its 10 units of money while Farmer receives the other 5 units of Oil.

Who has won and who has lost? State has gained 5 barrels of Oil and walks away an outright winner. Oil producer still received all the money in the economy so perhaps Oil producer is no worse off, but we shall see. Farmer has clearly lost 5 barrels of Oil as Farmer held all the money when half the purchasing power of the total money in the economy was transferred to State through its action of creating 10 units of money. It is only when we assess the impact of State's money creation behaviour on the dynamic but stable economic construct that we see the extent of damage done to this very simple economy. State has managed to acquire the total production surplus in the economic construct through its money creation action.

The construct must remain constant but for the behaviour of State and the consequences thereof. State has created money and vested half the economic product on itself. The new money had competed on an equal footing with the existing money in the economy and has reduced the purchasing power of Farmer by half. Farmer can now only purchase half the production inputs (5 barrels of Oil) needed for his farming production. Farmer can only produce half the grain on half the production inputs. However, Farmer uses this half of his farm product to feed himself and his family and no longer has a surplus product (sellable grain) to sell to Oil producer. Pity Oil producer, holding all the money in the economy yet cannot buy any food. Oil producer will starve. Yet Farmer earns no money to purchase any Oil (production inputs) from Oil producer for the next production cycle and will therefore starve when the next production cycle arrives. See Exhibit 4 hereunder.


© Sarel Oberholster