Money Enters the Economy From the Wrong End

Virtually every day seems to bring news of yet another economic hardship for state and local governments and the citizenry that depends on them (this, in addition to hardships arising from the downsizing, off-shoring, and restructuring occurring in private industry). Here in California, we are in the midst of an especially wrenching state budget crisis, forcing cuts to services basic as education, health care, emergency response, and safety net programs for low-income families.

The irony is, this comes at a time when there is theoretically more cash running around the economy than at any point in history. What's going on here?

After studying our monetary system for several years, the answer became clear: Money enters the economy from the wrong end!

For as ubiquitous a phenomenon as money is - touching virtually every aspect of waking life - few people understand how money is actually created. Only about three percent exists as hard currency (coins and bills). The rest comes into existence as "fiat currency" - a bizarre process whereby money is actually created when banks make loans - and goes away when the loan is repaid. (That's why the recent credit crunch was so threatening to the economy.) Most people have trouble understanding this upon first hearing - money is *not* created by the Federal government. It is created by the private banking system, with the blessing of the Federal government.

This being the case, what do banks most want to make loans for? It is generally large, capital intensive, resource consumptive projects - office buildings, housing developments, power plants, war machinery, factories, production runs - the bigger the better. At the other end of the economy, it is hard-to-impossible to get loans for the things with direct social benefit but lesser return on investment: parks, libraries, museums, public education, art and music programs, child care, basic community health services, emergency response, and the like.

When the Wall Street economy is booming, there is usually enough "trickle-down" from the beneficiaries of the big projects to fund our Main Street social needs. However, in a recession/depression, the trickle-down substantially dries up, and we can all see the effect on Main Street, state and local government, and the economic plight of average citizens.

Accordingly, rather than pump a trillion dollars into the financial sector, hoping some of it will make it past CEO bonuses, then the big lumbering projects, and eventually make its way to average citizens, wouldn't it be far more effective to spend money directly into the economy by funding domestic infrastructure projects, Main Street small business, and other public sector needs? We've proven time and again that "trickle-down" economics doesn't work. Aren't we long overdue to try "trickle-up" instead?

Bill Miller
August 2009

Views expressed on this page are those of the authors and not necessarily those of Campaign for America's Future or Institute for America's Future