does all the money go when stock prices plummet?
question mistakes the
monetary value of stocks for money itself. Stock prices simply
the current market value of the shares. At the end of the day,
more shares and less money, while sellers own fewer shares and more
money. Their aggregate financial wealth may be higher or lower,
total amount of money they own remains unchanged in these
The government causes
inflation when it prints too much money.
literally printed by the government
only to meet the demand for portable currency, i.e. Federal Reserve
notes. The notes are issued to banks in exchange for deposits the
hold at the Fed. The public acquires the notes in exchange for
deposits at banks. The amount of currency issued is no more and
than the public desires to hold as wallet money or rainy day
has no bearing on inflation.
Price inflation is mainly
caused by too much money chasing too few goods.
price level is correlated with the money supply, but correlation should
not be confused with causation. Prices are seldom driven by the
money supply. More commonly, the money supply reacts to changes
in the general price level which can be affected in many ways unrelated
to the money supply. Money growth depends on the demand for bank
loans and the willingness of banks to lend. The Fed can influence
the demand through its control of the interest rate. Only if it
sets the interest rate too low for an extended period would the money
supply grow fast enough to put upward pressure on prices.
Banks lend the money of their
issue loans, they create new
deposits without disturbing existing deposits. That is precisely
causes the money supply to grow, and is what distinguishes bank lending
all other types of lending. A non-bank intermediary like a
company lends what it has on deposit at a bank. It cannot create
deposits as a bank is able to do.
When a bank receives a new deposit, it can issue a new loan for ten times that amount.
bank can loan that much only if its reserves at the Fed, including the
amount received with the new deposit, is sufficient to cover a check
written by the borrower for the full amount of the loan. It will
lose that much in reserves to the payee bank when the check clears.
The money multiplier explains
how much money banks can create.
multiplier has no predictive
power. It is simply an after-the-fact observation of the ratio
aggregate demand deposits and banking system reserves. A bank's
is constrained by its capital adequacy, not its reserves.
Bank reserves ensure that
funds will be available for withdrawals by depositors.
reserve requirements on banks were
once viewed as a protection for depositors. Many countries now
reserve requirement on their banks. Banks must hold sufficient
to cover withdrawals by depositors. But a solvent bank that is
temporarily short of reserves can borrow them from the central bank or
money market. Conversely a bank can hold ample reserves and still be
insolvent. Protection for depositors against default is provided
deposit insurance, not by the reserves of the banks.
The Fed controls the size of
the money supply.
A bank in the U.S.
must hold reserves of base
money in proportion to the amount of its demand deposit
However the amount a bank may lend is limited by its own capital, not
reserves. In order to maintain control of the Fed funds rate,
interbank lending rate, the Fed must provide whatever reserves are
the banking system as a whole. In fact if the Fed withheld
could imperil the liquidity of one or more banks. Thus for all
purposes, the Fed cannot even control the amount of base money it
Government deficit spending
increases the money supply.
spending increases the net financial
wealth of the private sector in the form of Treasury securities, not
money. Every dollar the Treasury spends is money previously
the Fed. The Treasury simply recycles the money it acquires from
and the sale of securities. In the aggregate, the public pays for
Treasury securities out of the funds acquired from the deficit spending
Government borrowing drains
loanable funds needed within the private sector.
does not borrow to accumulate
funds in the Treasury. It borrows only to cover its deficit
thus does not affect the size of the private sector money supply on
While government borrowing could temporarily reduce the supply of
funds within the private sector, that effect is short-lived and
The national debt is a burden on future generations.
This is based on the false premise that the national debt must be paid off by the private sector some day. In reality, the
government itself pays to redeem its debt securities as they mature,
using funds obtained by selling new securities to the public. This
"rolling over" of the national debt can be continued indefinitely,
since the government can pay whatever interest rate the market demands
for its securities.
Interest paid on the debt
reduces the funds available for other government spending.
There is no
basic constraint on government
spending in its own currency. Interest payments and the revenues
support them are part of the balanced reciprocal flow of funds between
Treasury and the private sector. Their only effect is a
financial assets, which of course is true of all government