Monday, September 13, 2021

Money Destruction

 “Can money be destroyed?” This was the question I was asked many years ago by George P., a brilliant young man who two years later became the youngest ever Managing Director at one of the largest and most prestigious US investment banks. I was taken aback by his question, because although it appeared simple, it was not.

We quickly established that he did not mean “value”, eg the price of a stock or any other asset going down in price, or the self-evident physical destruction of paper currency. He was after something else, something much more fundamental. I was stumped, so he just said “never mind” and we left it at that. I was busy with day to day work, so I didn’t revisit his question until much later.

Segue to yesterday post’s opening statement: “Money is debt and debt is money”, and the answer to George’s question becomes obvious: the ONLY way to destroy money is to destroy debt, ie to fail to repay the principal amount of a loan or bond. In other words, to go bankrupt and/or write off all or some of the debt. Money expansion being the primary raw material of “growth”, its destruction leads to a contraction, anathema in our Permagrowth society.

Which is precisely why the Treasury/Fed stepped in during the Great Debt Crisis of 2007-09 with unprecedented QE to replace the money being destroyed by massive defaults, particularly in the real estate sector. As new money piled in, “growth” naturally resumed.

And segue to today… the pandemic, a very real natural phenomenon (as opposed to, say, artificial debt crises and market bubbles) is being “treated” in great part by printing even more money. More than ever before. But, the global “real” economy cannot possibly utilize all this money as fast as it is created. It cannot mine iron ore, it cannot produce steel, cars, widgets, anywhere near as fast as the expansion of money. So, duh!!, instead of real growth we get price inflation. 

In the 18 months from January 2020 to June 2021 the net change in US GDP is $1.04 trillion, but the increase in M2 is a whopping $5.74 trillion, see below. Money supply rose more than 5 times faster than nominal GDP!

Lots and lots of money combined with a constriction of growth… guess what you get? Stagflation. Add a touch of climate change obstacles (eg soaring pollution permit prices) and stagflation gets more entrenched. Until, that is, money (debt) starts to get destroyed (without replacement) and money supply goes down. IF this is allowed to happen, that is. And, right now, it is certainly not allowed - at least in the US and EU, which continue to print with abandon. 

1 comment:

  1. I somehow feel that train has left the station... as well as the climate train...

    Assuming run away inflation and run away climate change for the next 50 years, what should we do? Guns and canned food?