There is a quote going around Left Blogistan by Thomas Jefferson. The quote goes like this:
I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.
Thing is, this quote doesn't mean what folks seem to think it means. Below, I explain.
The phenomenon that Thomas Jefferson noted was common in pre-FDR America, where booms and panics alternated. Banks would loan out money, thereby creating money via the process of fractional reserve lending. This is the inflation process that Jefferson notes. Then something would happen. There would be a bad harvest or an earthquake in San Francisco or whatever, and some people could not pay their loans off. Other people would hear that a particular bank was in trouble, and would make a run on that bank. The bank would collapse. If the bank had $500 million in deposits, and was operating on a fractional reserve of 10%, this means $5 billion would disappear out of the economy.
The end result would be deflation. There is less money in the economy, yet the same amount of goods and services. So people get paid less and people pay less for "stuff". No big deal, right? Well, unless you owe money. You took out loans in pre-deflation dollars. Now you don't make enough money to pay off those loans in the new, deflated dollars.
You try anyhow. Because you're trying, money you previously were spending on consumption is going towards loan payments. That decreases economic activity. People lose their jobs and have to take their money out of the bank to live on. You lose your job and default on the loan payment. More banks collapse.
End game: Deflationary spiral. Paul Krugman has the mathematics of it, but let me describe the end result. The end result is exactly what Thomas Jefferson described above. The assets of the common people get auctioned off at bankruptcy auctions, and are purchased for peanuts by the wealthy elite. In short, a deflationary spiral is the end game in a scheme to transfer wealth from the common people to a wealthy elite.
We haven't experienced a deflationary spiral since 1930-1933, when Herbert Hoover's Treasury Secretary, Andrew Mellon, reveled in the spiral. Mr. Mellon had only one formula: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate". He said: "It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people". In short, Republicans then were happy to see a deflationary spiral happen because it transferred wealth from "less competent" people (i.e. the common people) to "enterprising people" (i.e., the wealthy). However, looking at current economic indicators, it appears we may once again be on the verge of a deflationary spiral similar to Mr. Mellon's wet dream.
So: How do we resolve this, if indeed we are on the verge of a deflationary cycle similar to, say, the 1990's in Japan or the period 1930-1933 in the United States? Mr. Jefferson recognized the problem, but he did not recognize the solution, because the science of economics was not well developed in that era -- heck, they still thought money was gold back then and did not recognize how banking activity could create and destroy money. Mr. Jefferson was talking about gold notes, not about money -- he did not understand money. Nobody understood money. I will discuss that further, and, specifically, why Thomas Jefferson's "solution" doesn't work, in my next diary.