Money and Banking 101

In the near future, I will begin posting on situations in the economy and government that affect my industry, subcontracting. To be taken as a serious source, I need to establish my bona fides. I graduated from Campbell University (then Campbell College) in 1970. I have a Bachelor of Science degree in Business Administration, but my true interest was in economics and I took all the courses I could in the economics area.

For Money and Banking, I was privileged to study under Dr. Charles E. Landon. “Dr. Charlie” was a man of small stature, but a man of large influence. He was one of the 3 founding fathers of the economics department of Duke University in 1926. He studied and taught through the “Roaring Twenties” and the Great Depression. He had great stature in the money and banking area and during his career, he was called on to counsel several presidents. He taught from an old fashioned professor’s desk, a raised desk similar to a judge’s bench in a courtroom. He was held in great respect by the students as he was always willing to take time after class to answer questions and coach us through the hard part. Dr. Charlie had retired from Duke University, but had come out of retirement to teach the course he loved most, Money and Banking.

Dr. Charlie is second from the left on the front row in this picture of the Duke University Economics Department taken in 1948.

Unlike many current economics instructors, Dr. Charlie kept to the facts. We covered all the different economic theories, including the good points and bad points of each. Keynes vs. Friedman. The various theories of money. Strong central bank vs. weak central bank.  Equal emphasis was given to each one and we, the students, were left to question the fine points and decide for ourselves.

Our current government follows the theories of John Maynard Keynes. His belief was that with a strong central bank (The Federal Reserve) the government could manage a consistent economy without the highs and lows of a free market economy. The Fed controls the money supply by changing the interest rates, issuing bonds and printing money. Keynesian theory holds that an increase in the money supply will stimulate the economy. If the theory is correct, then with the very low interest rates, all the government borrowing and spending and the Fed’s quantitative easing (printing more money), then why is our economy so stagnant.

One problem is that the Fed cannot control the Velocity of money. Velocity is the number of times a dollar will be spent over a period of time. For example, if I take $100 out of the bank and buy a painting from an artist, he might then take that money and buy food from a farmer, who might then take that money and buy a part for his tractor and so on. My $100 could conceivably stimulate the economy by many hundreds of dollars. In a slow economy, people tend to hold on to their money; save it or pay down their debts.  This produces zero velocity and has an adverse effect on the economy.

So, in my opinion, the economy will come back when jobs and confidence come back. People who are insecure in their jobs or don’t have jobs do not spend any more than they must and this does not create the money velocity to grow the economy. The fastest way to grow jobs is to stimulate business development. Right now, business confidence is low. There is so much insecurity about the future, including the unknown costs of Obamacare and regulations coming from various government agencies, that businesses are reluctant to expand and hire additional people.  Until the government changes its attitude toward business, this sluggish economy will continue.

Who Will Be the Next Milton Friedman?

I was recently watching a business program on television where several people were debating the wisdom of spending another vast sum of money in another stimulus bill (now called a jobs bill) in order to stimulate the economy. One of the people made the statement, “Anyone who has taken economics knows that in a recession you need to inject money into the economy to stimulate spending and jobs.” That started me thinking, “Where did this guy learn economics?”

This thinking is the product of Keynesian economics, named after John Maynard Keynes (1883-1946). Keynes hypothesized that government can use fiscal and monetary policy to mitigate the adverse effects of business cycles with their periodic recessions. Keynesian theories were the basis of the policies of Franklin D. Roosevelt and the New Deal when massive amounts of government spending and government agencies were set up in an attempt to restart the economy during the Great Depression. If you distill Keynes down into a word, it would be demand. Keynesian economics attempts to create demand to level out a downturn in the economy.

If this guy had a balanced lesson in economics, he would have learned about the theories of Milton Friedman (1912-2006). Friedman, a disciple of Keynes, went to Washington in 1943 to work in Roosevelt’s New Deal. He realized there was a flaw in Keynesian theory in that the “Phillips Curve” which described the consumption function did not work. During the 1950’s, Friedman became the leading advocate opposing Keynesianism and promoted a macroeconomic policy called monetarism. He argued that the government could not micromanage the economy because the people would realize what the government was doing and would change their behavior and neutralize the policies. He predicted that Keynesianism would cause “stagflation,” high interest rates and minimal growth. (Remember Jimmy Carter?). Friedman argued that a small increase in the money supply and relaxing of business regulations were all that were required.

Friedman and his disciple, Arthur Laffer (The Laffer Curve), were the architects of the policies of Ronald Reagan, which took only 18 months to turn around the malaise of the Carter years. If you boil Friedman down to a word, it would be supply. In the Reagan years, this was known as supply side economics. The increase in money supply was provided by tax cuts which resulted in an economic turnaround that also increased the total tax revenue to the government. This also worked for John F. Kennedy who used a tax cut to avoid a recession. George W. Bush also used tax cuts which increased total revenues, but strayed from Friedman in that he allowed spending and the size of government to increase which negated the positive effects.

Keynesian thought came to the forefront again in 2007 and has been the basis for the policies of Barack Obama and former British Prime Minister, Gordon Brown. Gordon Brown has now been removed from office. The Obama administration has pumped trillions of dollars into the economy and has little to show for it except they have doubled the national debt in 18 months. We have had only minimal growth. The Fed is loaning money to banks at zero interest in an effort to hold down inflation, but that is the only thing currently keeping us from a full blown case of stagflation.

The causes of our economic crash are for another time. Read Paul Schiff’s book, "Crash Proof: How to Profit From the Coming Economic Collapse" (2006). Written one year before the economic problems started, he predicted both the stock market and the real estate collapses. There is a third collapse in his prediction, the collapse of the dollar. There is your stagflation. Friedman is dead. Arthur Laffer is seventy years old and retired. Where is the next great economic theorist to get us out of this Keynesian debacle? I wonder.