You have definitely hit that nail on the head.

People confuse money with cash. A dollar is not the same things as a dollar bill. Cash is the actual paper that is circulating. It can only be destroyed by, well, destroying it. Like burning, or shredding.

Money, on the other hand, is more of a virtual concept. There can be more dollars than dollar bills circulating in an economy. A dollar represents, not the value of something, but the value of the *rights and obligations* attached to that something.

Any time, therefore, that we enter into a contract that involves a span of time extending into the future (eg a mortgage), money can be created because new obligations are created.

If those obligations aren’t met, mind you, that money is just as quickly destroyed.

I was going over all of this with my husband and I kept saying, “If everyone is short of money, where did all the money go?” Then it hit me like a ton of bricks – we didn’t have the money in the first place – we had credit. We have been operating on future earnings. Buy now – pay later. Much of that credit – future money – was based on the equity of homes. Equity is based on what a house *could* sell for. When the prices of houses dropped, the equity dropped, the credit dropped… which made credit even less possible.. and so the cycle. IOW, one part of all this is that we loss what we didn’t really have in the first place. Do you think that’s right? Thank you for writing about this. In Christ, Mary
http://www.brokenalabaster.com

Actually, the value of the greenbacks is not just backed by present actual goods. It is backed by present actual goods along with the promise of future actual goods. If I gave you a choice between $100 now and $1000 next week, which would you choose? I will assume the latter, because you recognize that the promise of a future good ($1000) is actually worth more than the present actual good on the table (only $100).

Unless, of course, you don’t have confidence in me, and have no way to enforce my handing over the $1000 next week (e.g. by sueing me). In such a case, you’d take the $100 now.

See? The sum value of goods in an economy is not simply dependent on what we actually make. It is actually dependent on a whole invisible web of property rights and relationships, many of which are more related to future goods than present goods. The system is held up by a combination of confidence and enforcement, and much more by the former than the latter.

If confidence is lost, future goods lose value. And since the greenback is valued based on the total value of goods in an economy – including the future goods – the loss of confidence causes a collapse in value. That collapse, however, brings an even greater loss of confidence, and the collapse continues.

The first cycle of collapse, due to the initial loss of value of the goods, in a necessary medicine within an economy. The second cycle of collapse, however, has no real medicinal value, and if it can be mitigated by confidence-building action that pays for itself, so much the better.

1. Yes, the amount was picked from the air. In some ways it has to be, because we won’t know the total cost until it is all over (or too late). But a proper bailout package does not act like a long-term mortgage, but more like a short-term line of credit. In a line of credit, the lender grants the borrower a certain degree of flexibility because the borrower himself may not know what his needs will be exactly – but that’s understood, and its ok. Given that this crisis is a liquidity crisis, once the panic subsides and the hump is passed the money should be paid back entirely, and likely even with a profit to the US Treasury.

2. RE: the deficit and debt, not much. As I said, this money is targeted to a specific need – the liquidity crisis. The deficit/debt are like cholesterol clogging the arteries. This crisis is like a heart attack. The bailout is the paddles to shock the heart back to life. Obviously the patient will have to address his diet and exercise regimen to get his health under control, but if he doesn’t get the shock now he may suffer so much damage that recovery will be that much longer and harder.

Now medium- and long-term, the USA will need to get the deficit/debt under control. We in Canada were on the edge of a debt spiral ourselves, and we managed to turn it around, so I am sure the USA can do it too.

3. Your point about disincentive is well taken. In a pure market system, the core disincentive is the potential for loss. Those who favour pure markets therefore tend to oppose things like regulation, because (they argue) the market itself is able to mete our the necessary “punishment” to keep things clean and simple.

Still, history has shown a minimal amount of regulation is good for financial institutions. Pure market theory always assumes that human beings are purely rational and have access to all available information. We aren’t, and we don’t. We need intermediaries, like consumer protection groups and regulatory watchdogs, to keep the playing field level for everyone. Its a bit like driving a car: we don’t need people from the government sitting next to us telling us how to drive, but I personally don’t mind having some government regulation that requires us to do things like stop at red lights. It keeps the traffic flowing.

I am personally opposed to excessive regulation in most areas of the economy, except where safety standards require otherwise, or where the system itself is necessarily based on confidence and trust. In these areas, regulation really is the lesser of two evils. The Canadian financial system is very robust thanks (in part) to the right kind of regulation – it might be worth studying.

To use the life-blood analogy that many apply to the “credit” liquidity argument on what ails us, what the good Father claims is money from the Fed is merely plasma – the volume of the fiduciary media in circulation increases, but its efficacy does not – the patient is still life-threateningly anaemic since the money is diminishing in value.

The red blood corpuscles of an economy are not the greenbacks called Federal Reserve Notes – no – its the value of the goods being priced in them. The problem with supply-side Keysians is they truely believe that a nation can flourish being addicted to consumption, that rising house prices create wealth out of thin air (that some how an aggregate of tar-paper shingles, aluminum siding and vinyl windoes appreciates value just by being baked in the sun)

Laisser faire is the opposite: our wealth is not what we’re capable of spending on credit at whatever fixed price set by the “authorities” but what we are capable of saving as capital from our creativity and thrift, after letting folks produce things of value at a just price (laisser=allow faire=make)

What makes the politicians very nervous is not what faces ordinary Americans, its what faces ordinary Chinese, Saudi, European lenders who see their “blood transfusion” being diluted via “plasma” adulteration. The consequences to our international standing are immense, the dollar as currency is losing attractiveness to the outside world since its value is tied to a falling GDP in a recessionary economy. No bailout can undo the irrevocable damage of the past seven years of “management” of the money supply. The patient needs to be fed an iron-rich diet of industry and entrepreneurship, sadly this is not Father’s conclusion, since he’s not an entrepreneur but a shepherd!

Here’s my response to your post (from my blog):
Kudos to Fr. Dowd for weighing in, and it’s well worth noting that we share a common faith and mission. He does a good job of explaining that our problem is a constricted money supply. He’s right. But WHY do we have a restricted money supply? Giving more blood to a patient with clogged arteries won’t increase the blood flow. What’s needed here is angioplasty.

Assuming we were to pass this or another bailout proposal, my questions for you would be:

1) The Treasury has basically admitted that the 700 billion figure was pulled more or less out of thin air – I think the exact quote was “It’s not based on any particular data point”? As such, why should we agree to it? It sounds like either a massively inflated check or a massively understated tip of the iceberg. If it’s the former, where does the extra money go? If it’s the latter, how do we know this isn’t a massive waste of money?

2) I’m sure you’re aware of the states of both our deficit and our debt. How would a bailout of this magnitude affect those?

3) If we agree to this bailout, how do these banks that made the bad loans (and while yes, to an extent all loans are gambles, surely you would agree that there were appalling lending standards in place that contributed to this) have any disincentive to turn around and do the same thing again?

Those would be my first questions, anyway…any insights?

I have a rather different perspective, which can be seen in the various posts here:
http://husbandfatherdeaconman.blogspot.com/search/label/Catholic%20Social%20Teaching

I’m a theologian rather than an economist (and rather a poser theologian at that). Short version: As a primary tenet of Catholic Social Teaching (subsidiarity) reminds us, we should be extremely leery of government taking anything more than it’s basic role, responsibility and power.

Is there a problem? Absolutely. Does the government need to do something to fix it? Absolutely. What does government need to do? Get out of the way.