I harp on quite a lot about the excess debt circulating in the system due to the rapid increase in the money supply. I am sure I am exceptionally boring when I find someone willing to lend me an ear. I was explaining to my wife the other day how the central banks have intervened and essentially flooded the markets with money. In the chart below you can see what effect this has had on the stock market but it has also had similar effect on property and other assets.
My wife a psychology major asked me one question, “what’s so bad aren’t we as a world richer for it?”
Hmmmm, not a bad question I will reluctantly have to concede. However it forced me to think a little bit before answering. As I am typing this I realise I am not going to be able to do justice to this question in the hour I have before this letter gets automatically sent at 5pm on Sunday.
Let us go all the way back to 1650 and hear what William Potter a royal official had to say about increasing the circulation of money. He said it with a little more pomp than I say it with:
Let it be supposed that money (or that which goes for such) doth increase among them; it follows that (they not hoarding it up, but laying it out in commodity, as fast as they receive it) the more their hands are filled with such money, by the increase thereof, so much more doth the sale of Commodity, that is Trading increase; and this increase of Trading doth increase Riches…… Therefore increase of money, or that which goes for such, not hoarded up, is the Key of Wealth.
I don’t think I could have made a stronger case for money printing than any of those wigged gentleman 350 years ago. The truth be told the forerunner to the modern day banking world were the goldsmiths who like any startup founders had managed to solve a logistical problem. The problem for merchants arriving in London on East India ships full of gold and silver from their spice trading was where to store all their gold and silver.
The goldsmiths started writing certificates stating the amount of gold stored with a goldsmith. With these notes merchants were able to move around much more freely and not be so worried about their goods being stolen and yes of course trade with the certificates. Wait for it this is the best part, hello fractional reserve banking, the goldsmiths realised that the all the merchants were highly unlikely to ask for all their gold at once. So they did what any normal (?) person would do, they started to issue more certificates than were backed by the amount of gold. For example if there were 10,000 pounds in safety. They would issue 30,000 pounds worth of certificates. The 10,000 of pounds represented in-specie ownership of the gold and 20,000 of pounds were issued and lent to borrowers backed by nothing. As long as no more than 10,000 pounds was ever asked to be redeemed for gold at one time all was fine, if 10,001 was requested for redemption there would be a potential devastating disaster.
John Law a Scotsman was born into a family of goldsmiths in the year 1671. This guy was quite the character, extremely colourful as are most gamblers who like a bit of booze and the attention of women.
I am now rushing time, fast forward a few decades to 1716 and France was insolvent in desperate need of a way to finance their economy after their recent war of the Spanish Succession.
One of Laws great financial engineering feats came with the Mississippi Company. As with the purchase of most company shares you are required to purchase them outright. Not so with the Mississippi Company. The shares were sold for cash at a 10% premium. The purchaser put up the 10% premium as their down payment and then made 20 monthly “calls” of 5% thus placing 15% down in total. A 15% increase in the share price resulted in a 100% return on investment and so was born what we today call margin trading.
There is so much more technical detail to unpack with the South Sea Bubble as this period become known by. However I am going to match my wife’s short and sweet question with an equally short and sweet answer.
Yes for a period of time, short in the scheme of economic history, printing money resulted in wealth and prosperity for the bulk of society. However, history has shown on more than one occasion that printing money not backed by real money has resulted in financial chaos.
As King Solomon says, “there is nothing new under the sun.”