Buffett and Berkshire Eviscerate the 'Money Multiplier' Myth
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Warren Buffett’s Berkshire Hathaway reported earnings last weekend, including a 40 percent increase in operating earnings. Wise minds can and will debate the good or bad of the report. What makes a market a market is a multitude of opposing views.

What's being commented on here is the report that Berkshire has $157 billion in cash on its books. This is worth thinking about with the mythical “money multiplier” top of mind.

About it, some of the various economic Schools (Austrian most notably) ascribe a sinister aspect to banks and the loans they make. Those who believe in the “money multiplier” believe that banks, for being banks, multiply dollars in circulation when they lend out funds placed in their care.

It goes like this: Bank A lends out $1,000 to Bank B, Bank B turns around and makes a $900 loan to Bank C, Bank C loans out $810…According to neo-Austrian theory, in the scenario described $1,000 rapidly morphs into $2,710, and actually much more as Banks D, E, F and beyond are factored in. Austrians conclude from this that banks participating in the alleged multiplication of dollars are in reality taking on the role of counterfeiter.

Imagine then, the loss of sleep for the neo-Austrians if banks were to properly operate sans reserve requirement. In which case Bank A lends $1,000 to Bank B, Bank B lends $1,000 to Bank C, and Bank C makes a loan of $1,000. Voila! $3,000 created out of thin air. Too much credit, too much money, inflation!

Except that the scenarios imagined by Austrians are not rooted in reality. There’s no such thing as too much credit or money in circulation. Ludwig von Mises knew why. As he made plain in The Theory of Money and Credit, we borrow money for what it can be exchanged for. Basic stuff. No one borrows money, nor does anyone lend, earn, or pay with money per se. Money is merely an agreement about value that allows us to move actual resources around, store resources, lend them, borrow them, etc.

Assuming banks, presumably once again for being banks, could multiply money via loans, it would soon enough be true that the exchange media loaned out by banks would rapidly cease circulating due to a powerful evisceration of value. No one can buy, sell, loan, or borrow in money that’s in freefall as a measure of value. Yet dollars remain the currency of exchange and lending not just in the U.S., but around the world. What’s going on? Are markets and market participants stupid? Not likely.

The problem with the Austrian assumption about the “money multiplier” is that it's once again mythical. If readers doubt this, they need only get together in groups of three (or more, or less) at a table whereby Individual A lends $100 to Individual B, and Individual B lends $100 to Individual C. What participants will find is that in moving $100 around, there’s no multiplication. There’s only $100 at the end of the exercise.

That there’s only $100 is elementary. To lend out $100 is to give up near-term use of the $100. No doubt someone loaning out $100 could get close to $100 back by selling the loan, but even then there’s no multiplication. To sell a loan is to find a buyer, and the buyer would be out roughly $100.

Money doesn’t multiply. Realistically it can’t. If lending multiplied the circulation of the exchange medium it would yet again no longer circulate. The money that circulates is trusted precisely because it’s not being counterfeited as Austrians imagine it is.

Which brings us back to Warren Buffett and Berkshire. Does anyone seriously think an investor as savvy as Buffett would keep $157 billion of cash and cash equivalents on Berkshire’s books if banks were in the process of multiplying away the value of the cash? Hopefully the question answers itself, along with any lingering questions about the so-called “money multiplier.” There isn’t one, period.

John Tamny is editor of RealClearMarkets, President of the Parkview Institute, a senior fellow at the Market Institute, and a senior economic adviser to Applied Finance Advisors (www.appliedfinance.com). His latest book is The Money Confusion: How Illiteracy About Currencies and Inflation Sets the Stage For the Crypto Revolution.

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