King Midas is the man who can turn anything he touches into gold. He has been used several times to illustrate a few basic principles about money(with the extra assumption being that during his time, gold=money. For this story, we can additionally ignore international trade just to make life easier).
First, he was introduced to explain the basic idea that more gold/money does not equal more wealth if it does not mean more real goods. In such a case, which is the normal one, more gold only drops the value of gold, or in other words, causes inflation. Money is a claim to resources, it is not valuable itself. If America disappeared tomorrow, all the dollars held by the various counties would become worthless as they would no longer have real goods to trade for.
In truth, the Midas situation (the ability to create currency on demand) is the situation almost every modern economy faces. Money is now easily printed and even more easily created digitally. The value of money is based on what that money can buy. In normal circumstances where most people who want to work are already producing (full employment), there is very little increase in goods that can occur. So making money more prevalent in this case primarily just makes it less valuable (inflation).
We saw King Midas at his most foolish when he tried to fix the inflation he created by instituting price controls. If there are roughly as many goods as before(stuff) but more claims to goods (money), it is an unavoidable reality that each claim must become worth less. Price controls don’t ensure that this does not happen. Instead, they merely make goods harder to find at official prices.[1]
So can Midas’s money creating powers ever be used for good?
Yes! One particular scenario serves as the heart of much of what Macro is concerned with. The nominal recession. The 2008 recession, great depression, and Japan’s two-decade stagnation all fall under this category. In general, I have found people try to make everything around these sorts of things overly complicated and convoluted. It is true that the actual conditions indeed can get rather complicated and that the circumstances leading to these crises can, in fact, be convoluted. However, the basic logic of what goes wrong and how to fix it is actually really rather simple and obscured rather than illuminated by getting too deep into details.
Hercules, hero and son of Zeus, robs the national bank of Midas’s kingdom, stealing as much gold as he can carry (which is a lot because of his superhuman strength). He carries all this gold back to the kingdom of Mycenae as part of a task to the king there (the result primarily being a onetime increase in Mycenaen inflation).
At first, when the theft of gold is reported, Midas is enraged, but suddenly he relaxes and laughs. He has learned from his adventures in using his powers that wealth for a kingdom was about real goods and services, not money. He had a hearty meal and slept peacefully. However, the reality Midas awakens to is not the one he expected. There was a long line of complaints. The baker hadn’t paid the flour maker, who in turn hadn’t paid the farmer for more grain. The farmer hadn’t paid the field laborers, and the field laborers hadn’t been able to afford their nightly lodgings. The inn they stayed at hadn’t been able to buy the necessary provisions to make breakfast for their lodgers. The line of complaints snaked all the way out of Midas’s mansion. After some time of seeing his kingdom in such shambles, hearing an endless stream of similar complaints, he sent everyone away. He hoped the problem would resolve itself quickly.
It didn’t. Things, if anything, got worse and worse. It was confusing. Everything real that existed in the country before the theft occurred was still there. Yet, suddenly, much of it had simply stopped working. He knew more gold didn’t make the kingdom richer, so why was it that less gold suddenly made it so much poorer? The problem seemed to be that of payment. Why didn’t the prices just go down? Even more troubling was the fact that his kingdom’s economy seemed to contract by even more than what Hercules had stolen. He thought of how the baker’s refusal to pay had created a chain of events much larger than just the initial purchase of flour from the miller. One person’s lack of payment could mean many people down the line would also be unable to pay. (multiplier effect)
Midas disguised himself as a traveler and journeyed into the market square where people were all bickering. He listened to a conversation between two vendors.
“I’m not coming down on price! We agreed it’ll be half a gold a load for the rest of the year.” Said a thin merchant.
“My customers are all dried up at the currents prices, I gotta lower them, but I can’t when you’re still charging such outrageous prices!” Said a fat one.
“Hey pal, a deal’s a deal, a contract is a contract. If you don’t agree to pay, you can try to find another vendor.”
(contracts)
Midas made a note of this and moved on to a quarreling boss and his employees.
“Look, chaps,” The short bald boss said. “Business ain’t what it used to be had to lower prices, and even then, things aren’t exactly sanguine. Don’t make enough myself to cover your wages.”
“Oy,” one of the workers, a tall man of thirty, said. “Just got my raise last year, I come back to the wife with less money, and I’m liable to be sleeping outside.”
“Yeah!” the other workers said.
“Look, I know if I try to reduce your wages, I’m liable to have a mutiny on my hands, but I just don’t have the cash flow to pay you all. I’ll have to fire someone. Since Al was the last one hired, the only fair thing I could think of was to fire him, sorry Al.” (money illusion)
One of the workers, a young man, began sobbing. Midas had seen enough and returned to his manor. He sat on his throne thinking. He could just wait. Eventually, all the prices and wages would adjust to the now smaller amount of gold circulating. (classic solution) Though this was theoretically true, those workers seemed very set that their wages denominated in gold wouldn’t fall. The longer this problem lasted the larger its damage would be. Young men like Al who were out of a job might soon turn to crime, and at the very least, they were likely to lose what skills they possessed(Hysteresis). Why should his people be forced to endure their current hardships if there was a faster way of solving the situation?
He could, of course, just make a lot of gold and hand it to the people or the banks, or he could even use it to buy things. All of these would directly increase the gold circulating, and quickly, but Midas had worked hard in the last few years to build a reputation as someone who wouldn’t abuse his powers. Using them like that might cause a panic.
He could also stimulate things without using his powers. He could borrow money that is currently just sitting around and spend them. So long as he spent the money faster than it would have otherwise been spent, that should also increase the money circulating. Since the crisis began, people had started saving more, not less, trying to protect themselves for the uncertain future. Also, there had been fewer people borrowing due to the same uncertainty. If he were to borrow and spend, it should certainly have some effect, but what should he spend the money on? Would it be enough? If he was too worried about deciding what to spend it on, he could always borrow the money and give it to the people. But, he also knew he would need to either repay those debts in the future by increasing taxes, reducing spending, or by making more gold. (fiscal policy)
Still, the problem was a lack of gold, and he could just make the stuff with almost no cost. Banks were currently holding on to a large amount of the Kingdom’s debt. Perhaps, by making gold and then using it to buy up the debt, he could make sure the banks had much more gold to lend out. This would cause the gold to circulate and the gold supply to expand. Doing things that way, if he went too far, he could always just sell the debt back to the banks to collect the gold back out of the market. (monetary policy)
Midas decides to make some gold and then use it to buy up the debt. As a result, the rate of interest fell, people started borrowing and spending again, and all the unemployed resources went back to work, creating real value for the kingdom. Midas had learned his final lesson about the role of money, and they all lived happily ever after. The end.
[1] In the modern world, we still see the occasional politician suggest price controls as a means to cure inflation. These politicians typically blame inflation, not on an increase in money circulating but greed. The problem with greed as an explanation for why inflation happens is that you would need to explain why the companies were not greedy previously. In economics, we tend to assume business greed is a constant! Would it really make sense to go to Zimbabwe and say “well clearly the reason people are now charging 200,000,000,000,000 zim dollars for breakfast is that they all suddenly got greedy!”?
Homo Economicish 