Circulation of money

There are many prescriptions for poor economies to grow.  Some are based on creating new industries to generate exports.  But one of the simplest and best paths for development is for a country to eat local food.  That is, buy food from local suppliers such as farmers and fishermen. 

In some poor countries, imported food, such as flour, rice, tin fish and tin meat are kept cheap as a form of social welfare.  But it is not a healthy policy for the economy.  Nor is it healthy for the people.

Such a policy directs money straight out of the country.  Once lost, it requires a country to sell exports to recover the lost money and income.  It is can require more investment to raise exports than expanding the sales of local food.  When people buy local food rather than imported food, they increase the export multiplier; that is the money that is earned from exports goes further, raising incomes and creating employment.       

Income distribution

Buying local food sends money to farmers.  These can be amongst the poorest people in the country.  The spending of farmers on labour redirects money to even poorer people. 

Developing secondary industries

Also, farmers spend money on other goods and services which generate further income and employment opportunities.  For example, they need to move their produce to market.  This generates transport industries that once established can service other industries. 

Skills development

Furthermore, if farmers and the transport industry employ machinery, they need people to maintain and modify the machinery to meet local requirements.  This develops skills in mechanics and metal work that can have wider benefits.  Once machinery can be maintained, other industries that would not be able to support their own maintenance facilities can acquire and use machinery, knowing that there is the infrastructure to support the maintenance of the equipment.

Taxation policy

Government policies are also important.  Taxes on imports are an effective way of redirecting money that would have been totally lost on imports back into the country, particularly if the government uses the money to pay for local services such as for teachers and nurses who in turn spend their money buying local food. 

Foreign intervention

These days, institutions such as the World Trade Organisation (WTO) make it very hard for countries to tax imports, as it is seen not only as a form of protection but as undermining the competitiveness of other countries (beggaring thy neighbour).  This is based upon the misguided view that exchange rates cause current account deficits.  That is not the case, as is evident on other pages of this website.   

The money that a country has in circulation will eventually be spent on imports.  But the more times it turns over in the domestic economy, the better it is for the income and welfare of that economy.

Social trade

In a traditional economy, people trade by giving goods to each other.  They keep a mental record of their entitlements and obligations.  People in less traditional economies do similar things.  For example, if someone takes a person to dinner, the person receiving the benefit is put under an obligation to reciprocate.  That is not a written obligation; it is a social obligation, and the person providing the dinner has earned an entitlement.  The reality of this situation is captured in the saying, “there is no such thing as a free lunch.” 

Such social systems have clear benefits over money as a means of establishing an entitlement and a reciprocal obligation.  The entitlement was created without the need for a third party, such as a bank.  That is, the person who received the dinner did not have to borrow money from a bank to be put under the obligation.  Nor did they need to earn the money to pay for the dinner.  The person who provided the dinner created the entitlement and the obligation.  If they chose badly, and the recipient does not reciprocate, then only they have lost.  If the recipient does reciprocate, then the obligation is honoured and with it the debt.  The entitlement and obligation disappear. 

Money and trade

But the money that we use not only buys local products; it can be used to buy imports.  Such money is not so readily created as social currency.  The creation of money must be managed wisely as money can be used to purchase foreign goods.  Poorly managed money can generate more imports than the country has earned from exports and thereby raise foreign debt.

Abuse of money

Even advanced wealthy economies have been devastated by inadequate monetary policies.  For example, many western economies have seen their domestic manufacturing industries collapse because they have been made uncompetitive.  They have seen their foreign debt rise because money has been created in a manner that has caused the country to buy more than it has produced.

There are now many western countries that cannot effectively manage their own economies.  Yet the economists from these countries are advising poorer economies to adopt similar policies to those that have been failing the west.  Such advice is unlikely to improve the prosperity of poorer economies.

Monetary management

Money can be restricted to certain markets, such as domestic markets or to even one store, such as Disneyland Dollar.  The currency managed by Disneyland is better managed than a US dollar.  If it were not, Disneyland would be deeply in debt.

The usual way a currency in an economy with fixed exchange rates was managed was to regulate the growth of bank credit according to the level of foreign reserves.  If there were plenty of foreign reserves, banks could be allowed to increase lending.  If foreign reserves were to fall to undesirable levels, bank credit was restricted.  This was an effective mechanism.

Money is essential for the alleviation of poverty in poor economies. It is better for an economy to have conservative financial systems that ensure external stability than to have advanced financial systems that lead to rising foreign debt and instability.  That only leads to the foreign imposition of austerity measures that mean the foreign imposition of poverty.

This website suggests two financial systems that would provide a sound and stable monetary system to facilitate economic growth.  These are the optimum exchange rate system and the guided exchange rate system.  For countries without a competitive financial market, the guided exchange rate system is likely to be the more suitable starting point.  

A stable monetary system facilitating domestic trade is a sound foundation for the building of a sustainable and prosperous economy.

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The great injustice

 

Last update: 22 June 2010