As Long as the Music is Playing

“As long as the music is playing, you’ve got to get up and dance.”

Chuck Prince, CEO of Citibank, quoted in Financial Times, July 9, 2007

How can the US Government get away with creating trillions of dollars from thin air? And why do they want to do this?

The short answer seems to be that our economy is like a game of musical chairs. Everyone stays in the game as long as the music keeps playing and everyone keeps marching around the chairs.

Now — just as a thought exercise: We Will Stop the Music.

[Warning: don’t try this in real life because the economy will collapse.]

Now — you have to find a chair. But it turns out that you can only sit in a chair that you own. And no one actually owns any chair outright. Everyone borrowed money to buy their chair, and each player owes money to another player — or several other players — and they in turn owe money to still other players. This is a game of indebtedness, and in this game if everyone has to pay off All their debts — All at once — then almost every player will end up on the floor and chairless.

This is where the money comes in. In this metaphor, money is the music. As long as the players keep passing money around the circle, the game goes on. That’s why they call it “circulation.” Boiled down, money goes around in a circle from lender to seller to buyer. Money gets added to the system when people lend more money to more people.

Money magically “multiplies” when a player spends their money by giving it to another player. The same ten dollars can go from me paying for a car wash, to the owner paying her employees, to the employee who spends ten bucks on a haircut, to the stylist having dinner with his friends, to the restaurateur buying eggs, to the farmer paying for seed, to the seed business paying the bank for a recent loan, to the bank lending it to me so that in this round I can buy a Whopper and a giant Pepsi with my credit card. If all of these eight transactions happen within a week, then there has been $80 worth of economic activity based upon my $10. This is called the “multiplier effect.” Eighty dollars in one week times 52 weeks means $4,160 in commerce for the year. From a measly ten bucks.

But if you are slow to spend your ten dollars, and if other players are slow to spend, then the economy goes downhill. Suppose that it takes a month for the eight transactions I described above. Eighty dollars in one month times 12 months means we only have $960 in annual commerce. Our “Economy” has “shrunk!” Why? Because the “velocity” of transactions has slowed dramatically. Velocity simply meaning the speed at which we pass the money along to someone else.

Thus I have explained the concepts of systemic indebtedness, the workings of an active economy, the magic of the multiplier effect, and the importance of high velocity. But the basic thing to know is that you have to keep the music playing.

On March 16, the music almost stopped. According to the Wall Street Journal, it was The Day Coronavirus Nearly Broke the Financial Markets. What happened was that the regular flow of money throughout the financial system began to seize up.

The Dow Jones Industrial Average plunged nearly 13% that day, the second-biggest one-day fall in history. Stock-market volatility spiked to a record high. Investors struggled to unload even safe bonds, like Treasurys. Companies and government officials were losing access to the lending markets on which they rely to make payroll and build schools.

Terrified investors ditched municipal debt at fire-sale prices, underwriters canceled billions of dollars worth of deals and new borrowing stopped.

For those few days in March, investors lost faith in America’s public infrastructure. As schools and universities shut down and airports and public transit systems emptied out, the market began to question what had been previously considered gold-plated bets on the core institutions that make up community life in the country.

But the music didn’t entirely stop. It just slowed down enough to scare the hell out of every player in the financial system. Fortunately for us, two gods then intervened.

In citing small g gods, rather than large G God, I am going back to the ancient Greeks. In some of their public dramas they used a platform device to elevate a character playing a god so that “divine” intervention could save the day. Romans called this trick deus ex machina. Literally, god-via-machine. Cinderella’s Fairy Godmother is a deus ex machina. She appears just when all seems lost, and with a gown and a coach.

Our two gods are Jerome Powell, Chairman of the Federal Reserve Bank; and Stephen Mnuchin, Secretary of the Treasury.

Pooling their magical powers, they are “injecting money” into the game of musical chairs. They are trying to “add liquidity” to the system and hopefully “create demand.” Liquidity means money. If you are “liquid” then you have money you can contribute to the game. If you are illiquid, you can’t help keep the game going. You are frozen in place, unless you can sell some assets. If you have no assets, then you are truly screwed.

So let’s go back to the game of musical chairs. Remember that the “music” is actually money, and as long as we keep passing it along, the game continues and no one actually has to sit down in whatever amount of chairs are actually available. Everyone has money or a valid debit or credit card. Everyone is meeting their payroll. Everyone is marching around with giant Slurpees, or with an iPhone 11, or with a new haircut.

Once we introduce COVID-19, the game changes dramatically. Businesses close, factories halt production, employees are fired, furloughed, or laid off. The “music” is slowing down. We have gone from Disco Dancing to a Funeral Dirge.

As of this writing, somewhere between 20–30 million people are newly unemployed. JC Penneys has declared bankruptcy and permanently closed 240 of its stores. Hertz has declared bankruptcy. There will be more. Many more.

Simply put, a health disaster has turned into an economic disaster. And what the public doesn’t seem to realize is that the economic disaster now has a life of its own. From a macroeconomic (big picture) view, “purchasing power” has gone way down. Our system is experiencing a “Demand Shock.”

Which is why our two small g gods — Powell and Mnuchin — are magically creating money and trying to give it to the players who have been sidelined. Our government wants these players to get back in the game. It wants them to take their “free money” and start handing it around again. They want us to keep staff on our payrolls, to go get a haircut, to buy two dozen eggs, to get our cars washed.

This brings to mind a true story about President Dwight D. Eisenhower. A reporter once asked him “how can we get the economy moving again?” He answered, “Buy.” “Buy what?” the reporter asked. “Buy anything” the President answered.

Five months ago we had an abundance of places to “buy anything.” And every time we spent money, we allowed another person to re-spend our money, and so on.

Thus the pressure to “re-open.” Re-opening means having more places to spend your money. Re-opening means that some and perhaps many workers will be rehired. Having a job means having a paycheck means being able to buy and means that you are back in the game. It also may mean catching the virus and dying. Many of us are afraid and don’t want to start Disco Dancing on a crowded floor (or crowded bus, or office, or subway). So there is concern.

One concern — indeed the original concern of this essay — is how the government can produce money. The answer is: by magic. Magic based on Belief. Seriously, the only reason $10 is worth something is that we all believe it is worth something. An American dollar is just a piece of paper. It is a “token of exchange.” So is every other currency.

A good currency has strong “purchasing power.” That means that you can easily use it to acquire something. A good currency is “stable.” This means that if you can buy a cookie for $1.00 today, it is likely that you can buy another cookie tomorrow at the same price.

The US dollar is a strong currency, despite the fact that we have thrown trillions of dollars of made-up money into the world economy. To those of us who are not macro-economists, this may seem odd. Made-up money ought to be as worthless as Monopoly money. Yet, at the moment our U.S. currency is very stable. Indeed, the dollar is worth more against other world currencies.

One would think that if trillions of new dollars appear, the relative value of a dollar should be lessened. We should have buckets of dollars chasing a limited supply of cookies. [Macro-economists don’t use the term “cookie”; they use the term “widget” to stand for something that can be produced and purchased. But I like cookie.]

If I am a sharp Cookie Company CEO, I am going seize this opportunity and raise my price. Now I want $2.00 for my cookies.

But, if the same cookie tomorrow costs us $2.00, then our dollar has lost value. That’s called “devaluation.” One could also call it “price inflation,” and if it is happening across the economy, then this is “general inflation.” INFLATION.

But what if the trillions of new dollars do not make up for the trillions of dollars that have been removed from the economy by layoffs and store closings? What if there is less money in the system? Less money means less demand. Maybe people buy less of my cookies. Maybe I have to reduce my price to fifty cents; two cookies for $1.00. The price has gone down, and if that is happening to cookie vendors and Slurpee sellers across the country then that’s called “Deflation.” Deflation is very nice for those who have money to spend. Deflation is bad for sellers. They are earning less, their profit goes down, and then they lay off workers, and perhaps they go out of business entirely. DEFLATION

Macro-economists, politicians, and business leaders generally agree that both INFLATION and DEFLATION are bad for the economic system. Surprisingly, there is a general agreement that 2% inflation each year is just about right for a humming economy. And that a 4% unemployment rate is also just about right. This is what the US economy had before the pandemic hit. Economic Paradise.

This “paradise” might have looked very different from the micro-economic point of view. That is to say, from the view of an individual or a family. Remember income-inequality? The rich getting richer? The rising cost of health care? Schools where 99% of the children come from families so poor that they qualify for free breakfasts and lunches at government expense? Don’t kid yourself, it wasn’t Paradise.

Things have suddenly gotten worse. And there is every reason to think that the economy will get even “worser.” If things go really wrong, then we could be entering a period of STAGNATION. The last time this happened, it was called The Great Depression.

There is at least one more scenario for our economy and the global economy: STAGFLATION. Stagflation is three-dimensional. It describes an economic situation where there is inflation, unemployment is high, and the general economy is stagnant. So, The Great Depression plus Inflation.

Four scary words. INFLATION, DEFLATION, STAGNATION, and STAGFLATION. Which way are we heading? What will this mean for me, my life, and my children?

That in a sense is what my original question was about. Where is this all headed? Our fairy Godfathers (Powell and Mnuchin) have given us a dress and a coach, but what happens at midnight? Can they keep shoveling dollars into the system? Can they keep thousands of businesses from going bankrupt? Can they get 38 million workers their jobs back?

No, they cannot. As one of my new macro-voices, Danielle DiMartino Booth, has observed: “You can print money, but you can’t print jobs.” If we actually have anything that could be termed a “recovery,” it will be slow and painful — especially at the micro level. Micro means real people. Micro is our family and our friends and our fellow Americans. Micro is the office cleaners and the vegetable pickers and the store clerks at JC Penneys. Micro is the ten million (or more) workers who won’t get their jobs back this year, or even next year.

So let’s be frank. This is a shit-storm.

We are entering a period of economic and social turmoil. Big Ideas are needed. BIG IDEAS.

At this very moment there is no agreement on any Big Idea — other than finding a vaccine. A vaccine will not perform an economic miracle. Our economic system is in a tailspin. The pandemic temporarily stopped the music, and that has triggered an economic crisis that is increasingly independent from the health crisis.

Right now there is no consensus on what to do next. There are some Big Ideas being bruited about — a Green New Deal, A Guaranteed National Income, A Debt Jubilee — but nothing has taken hold.

This is a time very much like 1932. The system is collapsing, people are losing their jobs and perhaps soon will lose their homes. What came out of that time was the New Deal.

So is that what we need? A New New Deal? You bet we do.

Trump Resister, Grandfather, Environmentalist, Feminist, Quaker.

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