Transformative Power of Money, Wealth and Influence Game-Changing Analysis by Paul Sheard

In “The Power of Money,” Paul Sheard delves into the profound impact of financial resources on individuals and societies. With meticulous research and compelling insights, Sheard uncovers the intricate dynamics of wealth accumulation and its ramifications. This groundbreaking exploration unveils the hidden potentials and perils associated with monetary influence, promising to reshape your perspective on wealth and prosperity.

Discover the profound truths behind the dynamics of wealth and influence by delving deeper into Sheard’s illuminating narrative. Uncover the transformative potential of financial resources and empower yourself to navigate the complexities of modern economics with confidence.

Genres

Finance, Economics, Wealth Management, Personal Finance, Investment, Business, Sociology, Psychology, Self-Help, Non-Fiction

“The Power of Money” by Paul Sheard offers a comprehensive examination of the role money plays in shaping individuals and societies. From its influence on decision-making to its impact on societal structures, Sheard explores the multifaceted nature of wealth and its implications. Drawing on extensive research and real-world examples, the book provides valuable insights into the dynamics of finance and economics, empowering readers to navigate the complexities of wealth with clarity and purpose.

Review

Sheard’s exploration of “The Power of Money” is both enlightening and thought-provoking. Through meticulous analysis and compelling storytelling, he elucidates the profound impact financial resources have on our lives. Whether you’re an economist, investor, or simply curious about the dynamics of wealth, this book offers invaluable insights that will challenge your preconceptions and inspire new perspectives. A must-read for anyone seeking to understand the transformative potential of money in today’s world.

Recommendation

The last few financial crises – and now the battle against inflation – have shown how questions about money and government’s control of it can be important and contentious. Economist Paul Sheard explains how the seemingly outlandish claims of Modern Monetary Theory are true to a degree, while at the same time showing how governments refrain from abusing their extraordinary power over fiat money creation. Along with Sheard’s practical reflections on inequality and taxes, the euro, cryptocurrencies and financial crises, this book contains most of what you need to know about “the power of money” today.

Take-Aways

• Commercial banks create new money when they advance loans.
• Governments do not have to balance their spending through taxes and borrowing.
• The real constraint on government spending lies in the resources and capacity of the economy.
• Quantitative easing (QE) is the obvious tool to use when interest rates can’t get any lower.
• The divide between fiscal policy and monetary policy is artificial.
• Policies that tax the rich without reducing their consumption might not have the hoped-for outcomes.
• Financial panics will occur on a predictable basis.
• The power that governments maintain by managing their own currencies calls into question the euro’s viability.
• Cryptocurrencies can’t perform any of the traditional roles of money.

Summary

Commercial banks create new money when they advance loans.

In a modern economy, all money begins life in one of three ways: via commercial bank lending, government deficits and central bank open-market purchases. In normal times, most of the annual growth in money, which a growing economy requires, comes from commercial banks creating loans. The old-fashioned textbook model is that commercial banks attract people’s savings and then lend these funds to borrowers.

“Commercial banks are joined at the hip with the central bank and with the government in the production and circulation of money. Banks create money and help finance economic activity.”

The reality is that banks don’t need deposits on their balance sheets before they can make a loan. Specific capital adequacy or reserve requirement regulations might constrain their lending, as will the judgment of their management as to their loans’ profitability and risks. Banks make loans based on these and other factors, and then the funds from those loans to individuals and businesses inevitably find their way back into the national banking system. This is because whatever the borrower spends the borrowed money on, someone else gets a payment to put in their bank account. In this way new loans create their own deposits for bank balance sheets. This ability to essentially create new money highlights why commercial banks require special regulation and oversight.

Governments do not have to balance their spending through taxes and borrowing.

A government’s spending beyond what it collects in taxes is the second way that money can be created. The convention for developed-country governments is that, for each year that they spend more than they collect in taxes, they must issue the equivalent value of the deficit in government bonds. Investors pay for the bonds in return for receiving yearly interest paid by the government treasury. This means that what is referred to as the “government debt” represents that country’s cumulative yearly deficits.

“The widespread, large-scale QE [quantitative easing] by central banks in recent years shows that it is within the power of the central bank, itself a part of government, to convert government debt at will into something (reserves or monetary base) that never has to be repaid.”

The traditional textbook reading of the situation says that the government needs the cash from private financial investors in exchange for bonds to finance the shortfall between government spending and tax receipts. But the reality is that, when a modern government runs a deficit, it is capable of spending money it has not received. The convention of issuing bonds comes after the spending and soaks up or reverses this money creation, and it is not a prerequisite for the deficit spending. From this perspective, theoretically the investors paying for the bonds are only giving back to the government the extra money its deficit spending has created.

“In this Modern Monetary Theory (MMT) way of looking at things, the government does not issue bonds to raise money but rather to shackle itself against creating too much of it in the first place.”

In theory, even taxes are not absolutely required by governments to fund their spending. But taxes are still crucial. They take out a major slice of the population’s purchasing power, to free up the resources required for government spending. Without taxes, government spending would constitute hyperinflationary spending of newly created money. Taxes also perform other important roles, such as redistributing income from the rich, and mitigating or discouraging negative externalities, as the taxes on cigarettes, alcohol and gasoline do.

The real constraint on government spending lies in the resources and capacity of the economy.

Creating bonds to match or soak up the deficit in yearly spending, which follows from restrictions on governments not being allowed to run an overdraft with the central bank, are just conventions and not technical constraints. After all, by definition, fiat money depends on trusting the authorities that issue it, and these deeply established conventions and norms help back up that trust with practical limits on behavior.

“When it comes to new or expanding government programs, we need to stop worrying about how we are going to pay for them (that is, where the money is going to come from) and start talking, or at least thinking, in terms of where the resources are going to come from.”

The real, hard constraint on a responsible government is not to create demand that will exceed the productive capacity of the economy and therefore create inflation. The politician’s perpetual basic question of how to “find the money” in taxes or borrowing for spending commitments is therefore slightly off-target. The issue is rather: To prevent the economy from succumbing to inflation, how can the consumption of resources be restricted elsewhere to free up resources for the proposed spending commitment?

Quantitative easing (QE) is the obvious tool to use when interest rates can’t get any lower.

In all instances of recessions since World War II, research shows that the average total cut in interest rates to stimulate a struggling economy is around five percentage points. So it’s obvious that if an economy starts a downturn with rates at around half this level, further stimulative monetary ammunition, like QE, is needed. In normal times, central banks are constantly buying and selling their national government bonds to tweak the amount of reserves available to commercial banks, so that these financial institutions are just hungry enough for reserves to hit the central bank’s interest rate target. But during both the aftermath of the 2008 financial crisis and then during the COVID-19 financial panic, central banks bought large sums of bonds and other financial assets in a policy first experimented with in Japan, known as QE. Because central banks can buy these bonds and assets with money they can electronically create, they effectively increase the amount of money in the national financial system. Debates rage about whether and how QE stimulates the economy, but most economists believe that the “portfolio rebalancing effect” works by leaving banks with a lot of reserves available to invest and fewer safe bonds available to invest in, motivating a “search for yield.” This stimulates more investment, which stimulates growth and also pushes up asset prices, which makes people who own assets feel richer and more likely to spend and borrow.

“Every dollar in a bank account started life in one of three ways: a bank created it when it made a loan; the government created it when it spent and didn’t withdraw it by taxing (i.e., when it ran a budget deficit); or the central bank created it when it bought a government debt security (or other asset) from the public at large.”

QE constitutes the third way money can come into existence. It is therefore easy to see why, if the private sector halts activity during a recession, then the two other government-based mechanisms for creating new money have to take up the slack, to prevent unemployment rising or even a deflationary spiral. In a recession, bank lending to people and businesses can stop growing, and if old loans continue to be paid off faster than new ones are made, the risk arises of a shrinking volume of money in an economy, and that motivates monetary policy action.

The divide between fiscal policy and monetary policy is artificial.

It has become the norm in developed countries for tax-and-spend policies to remain at the heart of democratic government. Monetary policies that aim to optimize employment and target inflation through interest rate management are assigned to semi-independent central banks. History shows that credibility is crucial in achieving inflation goals, and semi-independence from short-term-oriented politics and politicians is an effective way to achieve this.

“Consideration should be given to restructuring the policy framework to clearly make aggregate-demand management a joint responsibility of monetary policy and fiscal policy, and to more explicitly recognize the distributional and sectoral impacts of monetary policy.”

However, in accepting some important insights from Modern Monetary Theory, the divide between fiscal and monetary policy appears to be far more artificial than is traditionally understood. Both the stimulative monetary policy of QE and the stimulative fiscal policy of budget deficits are effectively the same medicine: governments creating new money. There is a growing realization that the fiscal policy way of money creation – running government deficits – is sometimes more effective; leaving monetary policy to do all the heavy lifting has economic side effects.

Policies that tax the rich without reducing their consumption might not have the hoped-for outcomes.

If you take on board the previous points made, the way you think about redistributive taxes changes. It is the actual capacity to produce and meet aggregate demand without triggering inflation that matters, not the government finding the money to pay for its spending. So thinking about taxing money away from the rich and spending it on the poor is only feasible if you can reduce the resources that the rich consume.

“Let’s concentrate on the uber-rich…Politicians are tempted to think that if they could just get their hands on a chunk of that money, they could fund such-and-such a program. But it’s real economic resources – labor, capital, and ingenuity – that programs need, not money per se.”

If wealthy individuals have billions of dollars, then taking away some of their wealth is unlikely to change their consuming habits – it merely reduces their assets and investments. If their consumption of resources is not cut, then the progressive policy has reduced asset wealth on one side but kept the spending on consumption on the other side of the equation the same, therefore increasing aggregate demand. In normal times, aggregate demand should already be bumping up against an economy’s maximum capacity.

“The real economic ‘damage’ that the uber-rich do is depriving others of resources through their extravagant consumption.”

So unless the rich are consuming less, the extra consumption given to nonrich people by redistributive policies risks being canceled out by the mechanical triggering of policies such as raising interest rates to bring inflation down.

Financial panics will occur on a predictable basis.

The financial sector manages the capital markets, where less liquid assets like buildings, structures, plants and houses are transformed into more liquid assets, such as shares, mortgage-backed securities and corporate bonds. On an organizational level, banks run on a fractional reserves model, and they hold deposits that can be easily withdrawn. Assets like long-term loans are harder to liquidate. On top of this, it is human nature to want to pile into investments in good times and then panic-sell in a crisis.

“The solution is not for policymakers to take the moral hazard high ground in the middle of a financial crisis. The fire brigade doesn’t let houses burn down, let alone entire neighborhoods, to teach careless homeowners a lesson.”

During a crisis, the line between an existential solvency problem and a theoretically temporary liquidity problem is blurred by downward-spiraling asset values. Given these destabilizing factors, as long as the top management of an institution or business is removed and shareholders’ ownership is diluted – thus addressing the moral hazard concern – rescuing organizations during a panic is usually the right thing to do.

The power that governments maintain by managing their own currencies calls into question the euro’s viability.

For a country with its own currency, moving interest rates up and down is a tool to optimize the temperature of an economy, steering it away from the extremes of either high unemployment or high inflation. But the euro has to set its rate for a group of countries that can be in different economic places. Foreign exchange rates for a currency appreciate and depreciate, based on patterns of trade and investment flows. The market value of the euro reflects the net trading position of all the member nations, from super-exporter Germany to less prolific exporters that could tolerate a devaluation.

“It is not clear what the final resting place of the EU and the euro area will be. What is clear is that the current configuration is not sustainable. Either the economic and monetary union will be bolstered and completed by also making it a fiscal union, or pressures on the euro to break up will eventually become overwhelming.”

This lack of tailoring of interest rates and foreign exchange rates to individual-country needs happens without the tax-and-spend equalization forces that reduce imbalances within nations, as occurs in the United States. If the euro-area member states are not willing to move further toward political and fiscal union, then sharing a currency is similar to living in a “half-built house.”

Cryptocurrencies can’t perform any of the traditional roles of money.

The blockchain and distributed ledger technology contained within the design of bitcoin and other cryptocurrencies are great advances that are finding alternative uses. But cryptocurrencies themselves fail on all three of the traditional qualities that money must have: Cryptocurrencies fluctuate too much to use as a unit of account or a store of value. And they have not taken off as a widespread medium of exchange, beyond the niche tech or antigovernment, libertarian communities, or where the motive is to hide from the law.

“A good prism through which to evaluate cryptocurrencies is the workhorse three-aspect model of money: unit of account, medium of exchange and store of value. On none of these do cryptocurrencies measure up as a formidable challenger to sovereign-based money.”

Their selling point of having no central authority also means there is nothing anchoring their value, such as a government that demands taxes in its currency, or a central bank’s monetary policy targeting an inflation rate. This just leaves the animal spirits of speculation to run amok.

About the Author

Paul Sheard is the former vice chairman of S&P Global and a former senior fellow at the Harvard Kennedy School.