IN HIS book, The Power of Money: How Governments and Banks Create Money and Help Us All Prosper, Paul Sheard, an Australian-American economist and the former vice-chairman of S&P Global, provides novel explanations related to money, including what it is and how governments, commercial banks and central banks create it and influence its creation.
He clears up common misconceptions that many people have about money, including whether the US government is imposing a huge burden on the country’s grandchildren, and mortgaging their future by racking up huge debts.
That particular species of fallacious thinking, termed a “category error”, treats the government as if it were a single household, when in fact, it is analogous to an amalgam of all households in a country. The current generation can borrow only from itself, not from future generations that do not exist yet.
Sheard says that every generation leaves to the next generation a capital stock that is always bigger and better than what it received from the prior generation. There is no reason that governments should always balance their budgets, and generally, they should not. If too much government debt is outstanding at some point, then macroeconomic policy can take care of it.
Sheard explores many important money topics that are relevant today, such as bank runs and financial crises, the euro sovereign debt crisis, wealth inequality, and Bitcoin and other cryptocurrencies.
Money can cause serious problems for an economy and society at large. The risk of bank runs and financial crises arises because of the inherent mismatch between the liquidity of financial claims that the monetary economy generates and the illiquidity of the productive assets that constitute the real economy.
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The central bank’s role as the lender of last resort empowers it to prevent financial crises and quell those that occur. Sheard argues that the US Federal Reserve erred in not acting as lender of last resort to Lehman Brothers in 2008.
The euro sovereign debt crisis of 2009 to 2010 revealed a deep structural flaw in the euro area’s economic architecture. Member states are obligated to pool their monetary sovereignty, but not their fiscal sovereignty. They cede their monetary sovereignty to the European Central Bank, while retaining responsibility for their fiscal affairs. The situation results in member nations having to borrow in a foreign currency, one they cannot produce at will.
For the euro to endure, says Sheard, euro area members must voluntarily accept stringent fiscal restraints and recognise that pooling monetary sovereignty is a political act. The right of a nation state to create and control its own money is a core aspect of sovereignty.
According to Sheard, if the EU political elites cannot explain to their electorates that monetary union is just as deeply political in nature as fiscal union, and garner the necessary consent to complete the economic and monetary union, the euro may one day be finished.
The book also looks at the economic forces behind large wealth disparities, especially in relation to the tiny cohort of the uber-rich. Sheard argues that extreme wealth inequality is a by-product of prosperity-generating market processes, and that the uber-rich do much less harm than is often claimed. If the government deems improving the plight of the poor desirable, it should do so independently of whether and how it “taxes the rich”.
Finally, Sheard believes that Bitcoin and other cryptocurrencies are not as detached from the legacy monetary system as they appear, and are likely to struggle to compete with it when it comes to fulfilling the three canonical roles of money: unit of account, medium of exchange, and store of value.
Cryptocurrencies are likely to find a permanent niche in the monetary ecosystem, but they may at this time be early in their innovation cycle, making definitive predictions tough. Rather than challenging the traditional monetary system, cryptocurrencies and their foundational technologies are more likely to help reshape it by spurring innovation.
In summary, this book is useful reading at a time when innovations such as Bitcoin and other cryptocurrencies, as well as policy experiments such as quantitative easing (QE), have made it critical to understand how money works.
The writer, CFA, is senior vice-president of Basis Investment Group in New York City, and an adjunct associate professor at New York University’s Stern School of Business
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