As proof that few people understand how money works in society, I offer an article that explains — in a major media outlet, in broad daylight — that China’s central bank will increase the money supply by 17% in 2009.
The article’s author promotes the positive impact of the new money:
The People’s Bank of China is taking measures to boost liquidity and bank lending that the economy needs to sustain growth amid a global recession.
But the author fails to point out the downside: prices will increase by 17%. Anyone holding yuan will be poorer.
Imagine if there are 10 computers in china and 100 yuan. Each computer’s price will be 10 yuan. If there are suddenly 117 yuan, then each computer’s price will be 11.7 yuan. Those people who did not receive some of the 17 new yuan, will no longer be able to buy a computer! It is those people who should be a bit upset by the increase in the money supply. And the article’s author should speak up for them.
The economy does not need this new money “to sustain growth.” Any business that needs to borrow money is welcome to offer a high interest rate to convince savers to lend their money. We don’t need the central bank to remove the value of these savers’ money by creating new money that is lent to businesses at interest rates lower than free market rates.
Each year, the yuan is worth less. According to the author, the money supply rose 15% last year as well. If we use a baseline of 100, it’s worth declined to 85 during the past year, and will decline to 70.55 in 2009. Eventually, a yuan that was earned in 2006 will be worth nothing. In America, a dollar earned in 1913 is now worth four cents.
The article also brings up two other outrageous aspects of the monetary system: interest rates and reserve requirements.
China cut interest rates by the most in 11 years last month and has lowered the proportion of deposits that lenders must set aside as reserves.
The bank lowered interest rates to benefit borrowers. But what about the savers?!? The lower loan interest rate drives down the savings account interest rate. Borrowers benefit, savers suffer. This is the opposite of what is supposed to happen. In a natural, free market, when banks run out of money to lend, they raise their savings account interest rates to attract deposits and then lend out the deposits at higher loan rates.
The reserve requirement is the percentage of money a bank is supposed to keep on hand. What it really means is the amount of money the bank is allowed to create and lend out. Lowering the reserve requirement allows banks to increase the money supply. If a person deposits $10 into a checking account and the reserve requirement is 20%, the bank can lend out $8, even while the checking account holder writes checks for the $10. This means $18 are circulating, or the money supply rose by $8. If you had this power, you could say, “I have $10 and I’m going to lend myself $8.” Then you would have $18. Banks love this policy because they can create eight new dollars to lend.