I asked a genuine question on my blog that nobody has answered yet. I was wondering if someone could give a satisfactory answer on this forum. I'm just not well versed on how relevant financial institutions operate. Here is the post reproduced,
There has been a lot of linking of rising commodity prices and money creation by the Federal Reserve. Recent examples include Mario Rizzo, Mark Thornton, and James Hamilton (sort of). Certainly, there is strong correlation. Correlation, however, does not imply causation.
I have little knowledge regarding this part of the financial network. How does money created during QEI/II get into the hands of investors who then bid this money towards commodities or their futures on the stock market? Or, is it a question of holding assets other than Federal Reserve notes, out of uncertainty?
In other words, how exactly is this money being injected into the economy that it focuses the new money towards commodities? Or, is it a question of people preferring to hold more of their savings in these commodities, expecting higher returns because of fear of inflation? It just seems that the latter is not really an accurate explanation.
Closest thing I can think of to that is the old Debt and Delusion. It talks about some things based on commodities, though not the underlying commodities.
If this question were coming from someone else, I would assume he didn't understand an economic concept or two...but since it's you it leaves me confused. You're asking how is it that commodities are so much more inflation sensitive than other goods, i.e. why they are going up first?
Banks and corporations are sitting on large piles of cash. They don't want to invest it in expanding the business, too much risk.
They don't want to leave it in dollars when the dollar is being killed by QE. They don't want to put it in bonds when they are yielding next to nothing. So, one of the most obvious options is commodities, they are generally highly liquid (unless you go into the grains or rare metals etc) and they are a known inflation hedge.
John James,
You're asking how is it that commodities are so much more inflation sensitive than other goods, i.e. why they are going up first?
I'm asking, if the rise in commodity prices is monetary (i.e. caused by an increase in the amount of money bid towards these stocks), then how is this new money finding its way into the hands of individuals that are buying these stocks. I'm asking for the injection pattern the money is following.
Johnny Five,
The banks themselves are buying commodity stocks? Businesses? Do you have any articles which suggest the same thing, and perhaps give some examples? I can see how they'd want to invest in short-term investments, but two points,
I guess I'm looking for more convincing evidence.
Point illustrated:
Caley,
Thanks for the link. However, I'm still suffering from the same reservation. The article states,
With financial assets absorbing most of the impact of new money, the outbreak of inflation into wages and consumption goods that proved so unpopular in the 70s has been (at least for a time) repressed. Newly created money was injected into capital markets, where it was initially spent on the purchase of bonds.
I'm asking who the recipients of this money are, and how they are getting the money (in pretty exact terminology and all that).
Jonathan M. F. Catalán:I'm asking, if the rise in commodity prices is monetary (i.e. caused by an increase in the amount of money bid towards these stocks), then how is this new money finding its way into the hands of individuals that are buying these stocks. I'm asking for the injection pattern the money is following. I'm asking who the recipients of this money are, and how they are getting the money (in pretty exact terminology and all that).
I'm still not sure I'm clear about which part you don't understand (again, because I'm aware you're quite well-read in Austrian theory and methodology). Are you under the impression that there is a difference between how the effects of monetary inflation show up in the prices of commodities versus other goods? Or do you really have no idea how Fed/FRB-created dollars enter the economy?
I think you are oversimplifying the problem. This is not a question about "how Fed/FRB-created dollars enter the economy" in general, since such a question is absurd — there is no universal method by which new money enters the economy. How the new money has entered the market is the most important factor in deciding the consequence of the creation of new money. This is what Yeager terms "injection effects", although Yeager critisizes Austrian theory more so than he praises it — I'm just borrowing the term.
I break my question down into two parts,
The injection mechanism would, by the way, be at least somewhat different from what usual Austrian theory focuses on. Austrian theory — well, specifically, business cycle theory — focuses on new money that manifests itself on the loan market and then is borrowed by entrepreneurs, who then invest this new money into the capital goods market. So, the mechanism is loan market → investor → capital goods.
Operating within this framework, my question is: how does new money get into the hands of commodities investors (if this indeed is what is behind the rise in commodity prices)?
Jonathan M. F. Catalán:How the new money has entered the market is the most important factor in deciding the consequence of the creation of new money.
Perhaps I'm oversimplifying still, but that makes no sense to me. Prices are a ratio, right? The market value of the dollar to the market value of the good. As the quantity of either one increases, the market value of it will decrease. So when new money is created, there is a greater supply of dollars...meaning the value of each one has decreased, thereby forcing the price of goods in terms of those dollars to go up (ceteris paribus, of course).
So perhaps it is your above statement that is too simplified, but I don't see how the new money enters the market has any baring on the consequence of the creation of new money. Unless I am mistaken the consequence of creating new money will always be the same: a devaluation of each money unit.
Sure, the way new money enters will have different initial effects, but I don't see how the way more cars get on the road are a factor in deciding the consequence of having more cars on the road.
Jonathan M. F. Catalán:I break my question down into two parts, What is the nature of the rise in commodity prices? Is it a rise that comes as a result in changing spending patterns? Or, is it a rise that comes as a result of an increase in the supply of money? These are two different ways prices rise. The former implies a relative rise in one area, and a relative fall in another area. The latter implies a rise in prices in one area, without a fall in prices in another area (one of the products is "general price inflation"). If the cause of the rise in prices is new money (i.e. new money being bid towards these commodities) by what injection mechanism is this taking place? The injection mechanism would, by the way, be at least somewhat different from what usual Austrian theory focuses on. Austrian theory — well, specifically, business cycle theory — focuses on new money that manifests itself on the loan market and then is borrowed by entrepreneurs, who then invest this new money into the capital goods market. So, the mechanism is loan market → investor → capital goods. Operating within this framework, my question is: how does new money get into the hands of commodities investors (if this indeed is what is behind the rise in commodity prices)?
Maybe you can help me learn something. How else do newly created Fed notes enter the economy other than open market operations?
I can't see any way that commodity prices can be a bubble apart from everything else. It has to correlate with financial instruments.
John,
As the quantity of either one increases, the market value of it will decrease. So when new money is created, there is a greater supply of dollars...meaning the value of each one has decreased, thereby forcing the price of goods in terms of those dollars to go up (ceteris paribus, of course).
Right, but we also know that inflation is not mechanical. It doesn't "just happen". The new money has to be bid towards the goods first, and therefore the goods that are bid towards first will be the ones originally affected by the increase in dollars. To apply this concept to a common example, this is the nature of the business cycle according to Austrian theory. New money is created both by the Federal Reserve and by banks, usually increasing the amount of money ready to loan, thus depressing loan interest rates (while the natural rate of interest hasn't changed) and consequently causing a rise in the price of capital-goods relative to consumer goods (see my article here).
How the new money enters circulation is an important factor in what the ultimate consequence of its introduction will be. For example, new money that is bid towards consumption may compress the structure of production, but it doesn't cause the business cycle (i.e. it doesn't create an artificial boom and the consequent bust). Here, we're not really seeing an increase in investment (capital goods market) or consumption (at least, dramatic increases in them), we're seeing an increase in prices in the commodities financial market.
So, to put it more concisely, you write,
Unless I am mistaken the consequence of creating new money will always be the same: a devaluation of each money unit.
Relative to what good. That's what matters. The devaluation of currency doesn't occur simultaneously nor proportionally amongst all economics goods.