When real money is short, why not just use funny money?

From The New York Times:

Stocks Surge After Central Banks’ Action on Debt Crisis

Published: November 30, 2011

A move announced by central bankers on Wednesday to contain the European debt crisis resulted in euphoria in global stock markets, but it also prompted skeptics to wonder: will this time be different?

As the crisis has worsened over the last 18 months, pronouncements of plans to fix the euro zone debt problems have led to more than a half-dozen rallies that just as quickly withered as the proposals fell short of hopes.

Wednesday’s rally was among the biggest yet, with the three main indexes on Wall Street rising 4 percent or more, and the Dow Jones industrial average rising 490.05 points, its largest gain since March 23, 2009. Still, some analysts warned that the central banks’ action addressed only some symptoms of the euro financial crisis, so this rally, too, could evaporate.

“It helps to prop up the banks for a while which is going to buy time for Europe to fix the problem,” Burt White, the chief investment officer for LPL Financial, said. “This is basically a Band-Aid.”

Much more at the link. THE WALL STREET JOURNAL also has plenty of coverage: Central Banks Take Coordinated Action, Close Ties Facilitated Coordinated Moves, and Dow Surges 490 Points.

It’s pretty simple: we can “print money,” or engage in “quantitative easing” all we want, as long as people are willing to accept the newly-created-out-of-thin-air dollars as real money. Given the shakiness of the euro, why wouldn’t they?

It’s just a new way of creating money. Remember the lessons from Econ 101,¹ about banks lending money, it getting deposited, and then the bank has the original demand deposit and the new deposit on account, creating money? Think of it as a financial covalent bond

If someone writes a check on an account that he doesn’t have sufficient money to cover, but the bank says, “Yes, you do have the money,” as long as everyone in the financial transaction chain accepts that, hasn’t money been created? That’s pretty much what the Fed is doing, and it’ll work right up to the point where people start to not accept that money as existing. China has been the primary financier of our deficit, and in a supposedly independent move designed to stimulate their own economy, China has also let us know that they are accepting the US and European financial moves for now.

Using that theory, I don’t know why we need to tax or borrow money at all. As long as the government sends out checks on its own account, and the Fed doesn’t say that those checks have bounced, they we ought to be able to pay for government completely, without taxation and without borrowing, and it’ll work just fine, right up to the point that it doesn’t.

Now, it would be illegal for PNC Bank to simply keep honoring my checks, if I start to write them for more money than I have in my account, if I don’t have some sort of overdraft protection or a linked savings account from which my checking account can be supplemented. Banks have to keep good records and banks get audited, but, right up to the point at which PNC is audited, and their generosity to me discovered, wouldn’t money have been created, just as in the method we all learned in Econ 101 in college, concerning bank loans, demand deposits and reserve requirements?

Well, not quite: as soon as the auditors discovered what happened, it would turn out that PNC Bank didn’t have the funds it said, and all sorts of bad things would happen, fines, perhaps the bank going bankrupt, possibly including people going to jail. However, there is no one who audits the Federal Reserve System with the authority to declare their transactions illegal or fraudulent. While it would be illegal for a private bank to be that nice to me, what is to stop the federal government from writing all of the checks it wants, drawn on the United States Treasury, as long as the Fed says those checks are good? Doesn’t that create money, just as surely as the Econ 101 method, and, with nobody having the authority to stop it and send Ben Bernanke to jail for it, how is the money not created? It ought to be perfectly acceptable, right up until people stop accepting it.

The Times original noted that such moves as the central banks³ took on Wednesday have been made before, and the initial enthusiasm didn’t last long. Further, interest rates increased: the Treasury’s benchmark 10-year note fell 24/32, to 9912/32, and the yield rose 0.08% to 2.07% late Tuesday. Decreases in bond prices, which mean higher interest rates, are a quick indication that investors are wary that the moves by the central banks will lead to higher inflation, requiring higher interest rates to make money. Gold futures also increased, another hedge some investors use when they anticipate the value of currencies to decline.

Your editor will be the first to admit that he does not know what will happen. December is traditionally a time when stock prices rally:

Since World War II, the S&P 500 has had the best average monthly performance during December, with an average increase of 1.8%. That’s two times better than the average for all months.

Given the record Black Friday Christmas sales this year, followed by a record Cyber Monday, we could well see strong December/Christmas sales this year . . . or we could discover that people took advantage of bargains and got a larger percentage of their Christmas shopping done early. A strong November jobs report may also indicate that Christmas sales could be higher. Given those things, it may not be until mid January until we see if the central banks’ actions are going to be seen as lastingly strong, or just a quick blip.

¹ – It’s been over thirty years, but, if memory serves, it was actually labeled Eco 161 at the University of Kentucky in the 1970s.
² – When I had trouble with the initial description of how money was created, it was the covalent bond concept, from chemistry, that helped me to understand it.
³ – The Federal Reserve, the Bank of England, the European Central Bank, the Bank of Japan, the Bank of Canada and the Swiss National Bank.

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