First of all I want to apologize for the delay in this next installment; I have had some personal affairs to attend to that have been quite time consuming. John tells me that quite a few Minyans have been waiting for the next stage of Elmerville's development. Before we go on with the story, however, I want to take a step back and review the developments so far.
When we last left Elmerville it was a town that had changed significantly. In the beginning, the townspeople were necessarily only concerned with obtaining for themselves the necessities to live; not because that was their nature, but because that was all they had the means to do.
But over the course of a few years everything changed. It wasn't that their personalities changed: the self interest was still there. What changed was the fact that the self interest could be better served by providing goods and services to other people in exchange for income, which is money received through wages or interest, instead of producing goods for themselves. How did this occur?
Their self interest was redirected solely because they were introduced to a more efficient means or medium of exchange, courtesy of a newcomer named Elmer. I contend and will explain later that this was more of a "psychological" phenomenon than a mechanical one. This did, however, lead the people to discover a very important physical concept: through specialization, individuals and consequently society could be more efficient and productive. People as a result were being rewarded with a higher standard of living. They became entrepreneurial, willing to take risks for the sake of profit.
Elmer had brought with him when he came to town the concept of an expansionary currency: paper money called Elmer notes. It was expansionary for one reason only, because of the tenet of debt.
Elmer initially got the economic ball rolling with his purchase of property: the new amount of gold gave the town a one time shot in the arm. But this only liquefied the value of the property that he purchased and had no multiplier effect. It wasn't until people began to borrow Elmer notes and take risk that the expansion really began. The economy was no longer a zero sum game.
Debt creates the ability to transfer wealth from the future to the present: it unlocks the value of resources that are there and would eventually be used. It just allows them to be used sooner and when employed intelligently, more productively. Debt creates the multiplier effect referred to earlier. As we will see, this is not without a cost. The cost is risk.
So it seems the ability to borrow is a good thing. But let's stop here and ask the question: was the creation of Elmer notes or paper money necessary for this expansionary effect of debt to occur? Could not people just borrow and lend gold and accomplish the same thing? My view is that theoretically the answer is yes, but only up to a point. But from a practical point of view, paper money subtly changes the psychology of people. People know that there is only a finite amount of gold. To lend someone something so dear is a difficult thing to do. When paper money is introduced, even though people, at least initially, assign the same value as gold to it, in some nebulous way they view it differently. It seems that it is easier (propensity) to lend.
Elmer actually is just as much psychologist as financier in understanding this fine point. The trick in accomplishing the success of a paper currency is to somehow have people believe that it is just as valuable as gold, but at the same time not. This requires a sort of "weaning" process, because if you really think about it, it isn't logical. But somehow, over time, it happens just the same.
For the first several years Elmer was careful to balance the amount of supply of Elmer notes, which is tantamount to the amount of credit he made available, with the amount of Elmer notes saved by the people of Elmerville. He knew that he could lend out more notes for "business investment" than people deposited back with him as savings because the demand for spending money was much lower than the cumulative currency stock. The chance that savers would demand back their savings all at the same time was very small. This is how the multiplier effect of debt works. Again, used intelligently, debt makes the available capital more productive.
At this stage people still, at least subconsciously, thought of Elmer notes as being backed by gold. If things went wrong they could always exchange all their Elmer notes for gold. You can see that this is not actually the case: if everyone tried to do so they would find that the Elmer notes were not worth nearly the amount of gold they thought they were. But psychologically they still believed it. And that is what counts, until it doesn't.
What people were really doing is putting all their faith in Elmer. This is not necessarily bad, as long as Elmer deserves it. But it can have some unintended consequences if Elmer does not act responsibly, as we shall see.
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