We Have to Go Spend Money to Keep From Going Bankrupt

“Well, people when I say that look at me and say, ‘What are you talking about? You’re telling me we have to go spend money to keep from going bankrupt?’” Biden said. “The answer is yes, I’m telling you.”

Vice President Joe Biden said this to people attending an AARP town hall meeting on July 16, 2009 at an event in Alexandria, Virginia (CNSNews.com).

This quote at that time was a butt of many jokes. But I actually agree with him. In order to understand why one has to understand what the idea of “Credit Crunch” really means.

A sustained "Credit Crunch" is a death knell for an economy. Credit Crunch implies that "money supply" is decreasing. Our monetary system of Fractional Reserve Banking is such that decrease in money supply for a prolonged period of time means principal and interest payments on existing debts will become more and more difficult to make and eventually lead to widespread defaults and deflation. Money supply is decreasing even as I write this article due to insufficient new bank lending. The net of all borrowings and paying down of debts to commercial banks HAS to be positive (there has to be more money creation as time goes on due to interest charges). If the net money creation is negative for too long (i.e., severe decrease in money supply) the financial system will simply collapse on itself. It cannot continue functioning.
Remember:

1. When money is borrowed from a commercial bank it is actually created (born) and enters circulation at the time of the funding of the loan.

And the following is even more important:

2. When money is paid back to satisfy principal and interest charges to a commercial bank it is actually DESTROYED (dies) and is removed from circulation.

If you understand (#1 and #2 above) then you will see why the credit crunch is very serious issue. Without a sufficient money supply our economy will collapse (as it did during the great depression).

So, why has Japan avoided a great depression for 20 years (Japan's credit crunch occurred in 1990)? Japan has avoided a great depression because Japan has done what America did to escape the great depression. And that is to spend a lot of (i.e., newly printed and/or borrowed) money on public works projects. Of course America spent a lot of (newly printed and/or borrowed) money on the war effort (WWII).

In fact, after WWII there was another serious economic recession (in 1945 – almost 13% decline in GDP) as war related production was ramped down. The GI Bill, the Marshall Plan, the Space Program and later the highway construction program, the Korean War, the Vietnam war, the cold war defense spending and the star wars defense spending kept us out of a depression. By the same token the Y2K spending, the dot com boom and the housing/real estate boom also kept us out of a depression. Note that it does not matter who prints the money (Banks can print and LEND or the government can print and/or borrow and SPEND). Either way, it works. It keeps the economy out of a depression.

If we cannot get sufficient commercial bank lending going again (Japan has been waiting for 20 years) and if the government does not spend to make up for the insufficient bank lending then we will descend into a depression (due to continued contraction of the money supply).

To properly get around this money supply contraction issue (long term) we have to find a way to create and circulate new money into the economy that is not dependent on lending (that really means getting rid of debt based money creation and doing equity based money creation). For more details please see my earlier article posted here:

Modern Monetary Theory: There Is Another Way (http://aquinums-razor.blogspot.com/2010/11/modern-monetary-theory-there-is-another.html)