"But look—there was plenty of money in 1939. That doesn't make sense."
"Haven't you just told me that in 1939 there were millions of people who needed things they couldn't buy? And weren't there merchants who had all these things and wanted to sell them very badly, yet couldn't sell them? Wouldn't all this have been very different and vastly improved if the people in dire want had had that money in their pockets to buy from the merchants who had to sell or go bankrupt? Isn't that a shortage of money?"
"Yes, of course. But where are you leading me?"
"Patience. In 2086 the government gives money to the people to do that necessary buying."
"Yes, I know. Master Cathcart told me that the government got this money off the printing press or out of the inkwell—in other words fiat money. How can it be worth anything?"
"We decided that money was anything which always could be swapped for goods and services. That implies that the person who accepts it believes that he can do likewise. Therefore money is money as long as everybody believes it is money. There is a touchstone which will enable you to determine whether or not people will believe in money: Can you use it to pay taxes? Will the government give you something for it of value, postal service for example? If the people collectively as a state will accept it, then so will the individuals. Our 'fiat' money qualifies. The United States will accept it in exchange for things of value. That is no longer true of your gold. It can't be used for taxes. You may or may not be able to swap it off, it isn't money, and you may be stuck with it. As a matter of fact all United States currency has been 'fiat' currency ever since the United States suspended gold payments in 1933. Since that time the gold standard has been simply a fiction convenient in party politics. However I believe that your principle difficulty is in understanding why it is necessary for the government to create new money and give it away to the consuming public. In order to understand that, it is first necessary to understand the mathematics of the relationship between prices and purchasing power.
"Before we go into the mathematical theory, let me state the fact which we are to explain: In1939, and before, the sum total of the purchasing power of the public was always less than the total price of the goods offered for sale. This is just another way of saying that 'overproduction', with its attendant unemployment, poverty, labor warfare, and so forth, was a chronic condition. As a matter of fact it is not necessary to understand the mathematics behind it as long as you observe the fact, just as it isn't necessary to know how a house caught fire in order to see that a house is on fire and to realize that something must be done about it. I stated that 'over-production' was chronic and that it is identically the same thing as saying that the public as a whole didn't have the money with which to buy the goods offered for sale. You will certainly agree that such was the condition from 1929 to 1939. It was generally recognized and the government even went so far as to partially make up the spread between prices and income by direct relief—giving money away—and wages for made work—giving money away with a moralistic sugar coating. This would have been sensible had the government created the money by fiat. Instead they borrowed it from the banks who created it by fiat. This was silly as it piled up a national debt to be reckoned with in the future and the money wasn't one whit sounder under the fiat of the banks than it would have been by government fiat. For please understand that the money lent the government by the banks to provide relief did not come into existence until it was borrowed. The bankers took it out of an empty vault—they fished it out of the inkwell. This may be hard to believe but it is the literal truth. Every time a bank loaned money in those days it created it. Of course President Holmes would successfully reclaim this practice for the government decades later, but at this time it was entirely imprudent.
"But to return to 'over-production'. Before 1929 in the period after the World War until the market crash, the spread between production and consumption was absorbed in several ways; an enormous increase in private credit or debt especially in the development of installment buying, exploitation of foreign fields particularly in Central and South America—which means to give away goods and get engraved paper in return, which later turns out to be worthless; and in losses suffered by practically all farmers and many businessmen. You see, a large percentage of businesses failed even in boom times in which case their inventories were sold below cost.
"The condition in the World War years is simple to understand. During war, production goes at maximum speed for the war machine and burns up the excess. Of course an enormous load of debt is created which must someday be cancelled in some fashion. Before the World War there were many years in which the pattern was similar either to the boom twenties or to the depression thirties. In either case production always ran ahead of consumption and was disposed of in the usual ways; by the creation of debt, by destruction of price values through bankruptcy, by sending more goods out of the country than were taken in, or by outright destruction of goods as in war, or, as was done in peace time, by crop destruction.
"The case in which more goods are shipped out each year than are imported deserves special mention. For many years this was regarded as the ideal economic condition although any child can see the absurdity of it, but it was called by all sorts of fancy names; 'Favorable Gold Balance', 'Favorable Trade Balance', 'The American Plan', 'Cornerstone of American Prosperity'. It was taught in the public schools as a natural law."
"Yes," mused Perry, "I remember being taught that in grammar school. My geography book devoted a whole section to telling how necessary it was."
"As a matter of fact it was as vicious as it was silly. Each nation tried to sell more than it bought, and this was the basic cause of every war in modern times. The stupidity of the idea should have been obvious, but the nature of the financing system made it inevitable. Since production always exceeded consumption by a wide margin throughout this period,* [*The reader need not accept this without proof. Fortunately the records of the period are available in the Washington Archives. See statistics of the Department of Commerce, et al., for those years. The Author] it was necessary for a nation to get rid of its excess as best it could or suffer severe economic upset at home. Many were the devices to promote this, for example, the 'protective' tariff and the subsidizing of the merchant marine.
"There was only one period in which this peculiar financial fallacy was suited to the needs of the country, and that was in the days of the frontier. The system created bankruptcy and poverty, and the victims moved west and developed the country. It is customary to speak of population pressure as causing the movement west, but that is true only in a limited sense. The east was never too crowded in the pioneer days to support its population insofar as land and raw materials were concerned, but it already had a financial system which automatically created a spread between purchasing power and production, and thereby automatically created an unemployed class, which moved west with the next wagon train to rehabilitate itself in a simpler economy. Oh yes, we had an unemployed class in Andrew Jackson's day, but we called them pioneers!
"So much for the simple fact that in your 1939 economic system over-production or under-consumption or a shortage of purchasing power was a chronic condition. Now let us examine the mathematical nature of purchasing power to discover why this was so. In so doing we shall discover the possible solutions and select the one we like. You see I've done this problem before and can show off how clever I am. You know about Little Jack Horner? I've always suspected that he knew where the plum was before he stuck in his thumb." A grin split Davis' saturnine visage and made him look like a little bald-headed gnome.