Money 101 — part 5

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The Effects of Inequality in the Accumulation of Money

As noted above, John Locke argued that one of the virtues of using durable money was that it did not decay when used as a store of value. But warehousing even a durable money might entail waste. If the money is an ordinary durable commodity, then what can be wasted is time; the commodity might otherwise have been put to productive use while it were stored.

Locke seems to have sensed this problem, because he wrote as if gold had no meaningful value other than by an agreement amongst men. This was not correct in his day — gold had various applications and potential applications, which were the foundation of its value as money — and it is still less true in our own. (For example, gold is used in the production of electronics.).

But, once notes begin to be used as money, literally holding money can correspond to holding slips of paper; and if there is partial-reserve issuance, then the corresponding warehousing of some commodity serving as a base is reduced. And if the money is by fiat, then the warehousing of a commodity is no longer involved at all.

Yet there is a populist view that, somehow, for some party to accumulate a vast amount of money is a drag on economic production, from the money not being used.

The first thing to understand is that, when a person or an association accumulates a large amount of money, it is almost never warehoused à la Scrooge McDuck; instead, it is deposited with a financial intermediary (such as a bank), and that intermediary loans the money to those who will spend it on resources for production or for consumption — fundamentally what would have happened had the accumulation been dispersed amongst a wider range of persons. Indeed, those who accumulate large sums of money do so by using resources in a manner to increase their accumulations,[17] and are therefore typically going to warehouse a smaller proportion of their money than those who are less successful accumulators. So, if warehousing money were a meaningful problem, then thwarting these successful accumulators would tend to worsen that problem!

If some person or group of persons actually warehoused a large sum of money, what they have done is to reduce the supply of money in circulation (M). If a huge proportion of the money supply began to be warehoused, then a general decline in prices would be observed, as this money were withdrawn from markets in which it were previously spent. (A decline in the money supply is not the only thing that might have this effect, but if we don't observe this effect then we know that the share of the money supply being warehoused isn't hugely increasing.) The monetary unit would serve less well as the unit of account than if prices were generally stable, so a decline in prices would creäte misallocations. If a huge share of the money supply were for some reason suddenly warehoused, there would be a huge economic downturn caused by the misallocations resulting from prices being too high for the amount of money remaining in circulation, until price adjustments had been made. If the warehousing (gradual or sudden) plateaued at some new proportion, then once prices had reëquilibrated, it would have no further effect.

But if the money were subsequently put back into circulation (as it might if the state forced people to reduce their warehousing of money), then the effects on prices would be reversed and misallocation would return because, with prices now increasing, again the monetary unit would work less well as the unit of account. If the reduction were relatively rapid, then again there would be an economic downturn.

(As noted in a prior section, when a money is based upon a commodity, the commodity used as money is shifted from other use when the value of money is increasing, and shifted to other use when the value of money is decreasing; and there would of course be some of this reällocation in response to the price-effects of changes in what share of money were warehoused, either as notes or as the commodity itself.)

In sum,

  • accumulating money isn't the same as warehousing money,
  • people who are effective in accumulating money are less likely than other folk to warehouse money,
  • the price effects of an increase in warehousing aren't being observed, and
  • forcing warehoused money back into circulation would be injurious to the economy.

[17] Very simply, a pile of money does not grow if someone simply sits upon it.