Currency as Debt: A New Theory of Money
Inflation and Deflation
 

My Dear Friend,

My friend, as you know, when the demand for goods and services increases, typically the output of goods and services increases. As output increases, the amount of currency in circulation must increase to facilitate those additional exchanges thus maintaining economic balance.

Add too much real grease in a mechanical system and the grease might start foaming, eventually losing its ability to lubricate properly. Insufficient grease also reduces its ability to lubricate properly. The amount of grease in any system must be as designed, no more and no less. The same is true with the volume of currency in a monetary system.

The challenge then is how to control the volume of currency and who controls it? Most importantly, who receives the benefits of controlling the currency volume, a select few or the community at large?

In the classic economic equation of Supply = Demand, Supply refers to goods and services (wealth). Goods and services are continually being created, consumed, and replenished because people need and want those goods and services.

Many people look at this equation and think of Demand as something psychological—a need or a desire. This is partially true for individuals, as Demand is the desire for wealth (goods and services) coupled with the ability to pay. For the society, aggregate Demand varies according to desire for wealth (goods and services) and the quantity of currency in circulation.

Since the Supply side of the equation represents wealth, reason would indicate that the Demand side of the equation, being equal, must also represent wealth. With barter, this is true as all parties directly exchange wealth and are buyers and sellers simultaneously by viewpoint.

This is not true when using currency in commerce or trade because currency represents an unfinished exchange of wealth. One party receives wealth (goods and services) while the other party receives currency. Because the other party receives no wealth, somebody owes a debt to that person. Therefore, all currencies are debt currencies. That is, currency represents debt—negative quantities, as wealth is exchanged for a claim check against the future acquisition of wealth from the community.

The use of negative debt currencies permits the consumption of wealth today with future payment in wealth, the second half of the exchange. This can be accomplished only with negative currencies, never with wealth, which is always a positive quantity. As an example, you can’t eat bread for lunch today that was baked from wheat to be grown next year. However, you can eat bread today and delay paying for the bread with credit, repaying that debt with your labor (wealth) next month; or you pay immediately with currency which the seller accepts as payment, but with the expectation that society will supply an equal amount of wealth in a future exchange.

For society, the equation Supply = Demand may be functionally rewritten from the definitions as:

(Volume of Goods and Services)×(Price) = (Desire)×(Volume of Currency)×(Rate of Circulation)

Society’s desire for wealth (goods and services) is essentially unlimited, and therefore often assumed to be constant. However, what is true for society is not necessarily always true for its individuals. If you have just finished eating a steak dinner, your desire for another steak dinner might be relatively low, even if the steak is of better quality and offered at a lower price. Nor is society’s desire always a constant when looking at a specific item rather than aggregate wealth; fads and fashion, for example.

Demand for goods and services always determines their price. Assuming the quantity of currency in circulation remains fixed (Volume and Rate), and the psychological need for goods and services increases (Desire), Demand increases. As Demand exceeds the pace of creating goods and services, prices tend to rise. This normal and expected reaction of any free market is known as price inflation.

Fortunately, there is a natural limit to price inflation when the quantity of currency in circulation remains constant. Remember that individually, Demand is the desire for wealth coupled with the ability to pay, but for society, aggregate Demand varies according to desire for wealth and the quantity of currency in circulation. Therefore, with both the quantity of currency in circulation and the supply of goods and services remaining constant, serious limits on the ability of desire alone to increase prices are soon encountered. At some upper price limit society refuses to buy; and at that point the equation is balanced.

Price inflation often is experienced regionally or within specific markets. Natural events such as droughts cause temporary reductions in crop harvests, and global affairs can cause shortages in the oil supply. Such events cause an increase in the cost of the final product. Why? The Desire for the product, and the Volume and Rate of currency in circulation all remain constant, but the Supply decreased, thus sellers can and often will raise prices. These effects are often temporary, and regional or product specific in nature.

Although price inflation contains natural market limits, those same factors do not affect the quantity of currency in circulation. If the quantity of currency in circulation increases without an offsetting increase in the output of goods and services, the entire economy does not suffer price inflation but currency inflation. Currency inflation causes price inflation. The reason is that currency is grease to facilitate exchanges of wealth—goods and services. Increasing the quantity of currency without an offsetting increase in the output of goods and services will force prices higher, in this case without limit so long as the volume of currency continues to increase.

The difference between price and currency inflation might seem subtle. However, the two types of inflation are not the same. The market can experience price inflation without currency inflation, but the market cannot experience currency inflation without price inflation. Price inflation is often a natural after-effect of market conditions; currency inflation often is not.

Without outside influence or intervention, the market itself is quite capable of ensuring the Supply = Demand equation remains balanced. However, when a fiat currency is used, and specifically when a select few people become involved in managing the quantity of currency in circulation, those few people artificially manipulate the quantity of currency in circulation. This manipulation is not necessarily evil, immoral, or corrupt, but without proper control mechanisms, the distinction is often immaterial. This is one challenge facing today’s currency systems.

In an honest money system, a mechanism must exist to ensure the quantity of currency in circulation matches the total need for currency. Without an honest control mechanism in place, when the quantity of currency in circulation exceeds the output of goods and services, the entire system suffers currency inflation.

However, the converse of what I just explained has the potential to be more devastating. If the Supply of available goods and services exceeds the Demand for those goods and services, without any change in the quantity of currency in circulation, the entire system suffers price deflation. This forces sellers to reduce prices to match the reduced Demand for those goods and services. Without compensating factors in production and output, reducing prices will reduce profits.

If the quantity of currency in circulation decreases without a corresponding reduction in the output of goods and services, the entire economy suffers currency deflation. Currency deflation is often worse than currency inflation because continued deflation will cause an economic recession or depression. The Great Depression is a classic example. During that period goods and services were available, jobs were initially plentiful, and Demand was normal. Nevertheless, in an attempt to slow credit expansion, the Fed caused a credit contraction, and that contraction removed currency from circulation. Demand decreased. Prices then responded by decreasing. To match demand, producers and manufacturers slowed the output of goods and service. The Fed, unfortunately, continued the credit contraction. The cycle continued downward. Eventually manufacturers and producers could no longer keep pace and began job layoffs. We need only browse through the history books to recall the affects of that devastating period of history.

One must distinguish between price and currency inflation and deflation. Furthermore, currency inflation and deflation must be observed and discussed in the aggregate and not locally.

Managing a nation’s currency is a serious matter. However, with what I have just described, and with an understanding of the cumbersome control mechanisms used by the Fed to control the quantity of currency in circulation, one can easily see why the economy experiences so many miniature “booms and busts.” People often refer to this crazy cycle as the “business cycle,” but sadly, this injustice is self induced.

Without proper honest controls, society suffers continual currency inflation and deflation. This is one of the problems upsetting people—continual change in the currency’s purchasing power. The bill we have been discussing, The National Economic Stabilization and Recovery Act, or NESARA, provides honest and moral mechanisms necessary to maintain a stable currency. Under NESARA, large scale currency inflation and deflation will become footnotes in the chapters of history.

With all due regard and affection,

Your friend
 

Editor’s Note:

To understand how NESARA restores the national currency to being a true public utility, please read the following portions of the bill:

• Part I. Banking and Monetary Reform, Section 2 Findings
• Part I. Banking and Monetary Reform, Section 3 Congressional Control Of The United States Monetary System

To understand how NESARA establishes honest and moral characteristics for the national currency, please read Part I. Banking and Monetary Reform, Section 4 Provisions For United States Currency (Note: Section 4B, the characteristics necessary for Congress to lawfully define United States Treasury credit-notes).

To understand how NESARA maintains stable purchasing power and maintains a stable exchange value of all currencies in circulation, please read Part I. Banking and Monetary Reform, Section 9 Regulation Of The Exchange Value Of Treasury Credit-Notes.

To understand the implications of restoring the national currency to being a public utility, please visit the What’s In It For Me? section.
 

John Maynard Keynes, The Economic Consequences of the Peace