Hello and Hi! I wonder how we bid up prices with newly created money. I can se how prices rise during an auction, but how exactly does the market know that there are more money in the system? I would like to know that.I thank you guys for your replies (as long as they are not mean ;)!
Ted Nugenthttp://www.youtube.com/watch?v=Q4LXwWilkRM
More money extant = more to be able to spend = subjective notion on the part of the seller to raise prices, knowing that there is more money around.
Sebastian Lundh:I wonder how we bid up prices with newly created money. I can se how prices rise during an auction, but how exactly does the market know that there are more money in the system? I would like to know that.
It should first be recognized that price inflation does take place uniformly throughout an economy. Inflation will take a series of steps, and prices will go up in different sectors at different times. For example, currently inflation has hit securities and bonds, and then hit capital markets. Furthermore, it's also important to realize that not all commodities, goods or services will go up in price uniformily. This is one of the important aspects of the Austrian school: inflation will distort relative prices, which further distorts capital markets and causes malinvestment. When we talk about a rise in the prices of consumer-goods, the same holds true. For example, while CPI has risen in the past two quarters, signifying an increase in the "average" price level, most goods have not increased in price.
This is a price inflation modeled in "mainstream terms". Let's assume that the inflation cycle has ended, and the inflation has finally hit wages. The result is that wage earners are now able to spend more money on the goods they buy. This graph models an increase in wages and the effect on demand for Good X:
The point at which the blue line (should be labeled S1) and D1 intersect represents the equilibrium price when demand was at where it was sustainable, given the original wages. The increase in wages allowed the consumer to buy more goods at the same price. This is represented in the following graph:
Because supply is the same and price remains the same (the seller has not responded to an increase in wages yet) there is a shortage, represented by the green triangle. This shortage is a signal to the seller to raise prices, as to meet the new equilibrium (or attempt to, since Austrian microeconomics teaches us that the equilibrium will never be reached and/or remain constant). And so, the price increase is represented by the gap between the old equilibrium and the new equilibrium.
This is where the quintessential truth that price acts as a rationing device (and the only true rationing device, at that!) comes from. Price is the only method by which shortages and surpluses can be corrected.
Keep in mind the two constraints that Austrians place on most things that being: 1. All other things being equal. and/or 2. In the long run or eventually.
In the near term inflation like any other distortion of market timing can do some odd things as the "new" money is in the hands of a small amount of people normally bankers. This money gets into the economy through loans where the activity is at the discression of both the banker and the borrower. Some prices may in fact go down like consumer electronics or software. Some may rise like food or energy or housing.
The key point here is that in this near term period entrepeneurs are borrowing this money and using it to form enterprises based upon what consumers are buying with this loaned money. Many of these purchases are not in line with what consumers would buy without the new money. So these businesses are not in line to provide consumers with what consumers want absent the money. Eventually consumers will either over extend themselves like in this last recession or businesses will have too many investments outside what consumers demand. The consequence is similar: Inflation creates a near term boom as entrepeneurs rush to provide consumers the things consumers seem to demand with the inflation. When the consumers expect or are forced to see a new environment they change their preferences leaving these entrepeneurs with too much capacity. This capacity must be liquidated and those resources used to provide products consumers want. This process takes time and requires that businesses remain idle.
You earn money by producing a good or service and offering it to the economy in exchange for another good or service or money that can be later used to trade with another good or service. Producers create wealth that can be purchased with money. Producers give money its purchasing power.
When you counterfeit some money, the person who gets it and spends it in the economy has not produced any wealth before hand. The spender consumes wealth from the economy. If the spender borrowed the new money, then he/she has a promise to pay - which is a promise to replace the wealth that they consumed but did not yet earn. If they default on their debt obligation (ie let their house foreclose) then the wealth will not be replaced in the economy. If the money supply continues to expand by counterfeit then non-producers will continue to consume wealth they have not (yet) earned simultaneously in competition with producers that earn money and are consuming the fixed amount of wealth that producers are producing. This depletes the economy of real wealth (material goods) and scarcity will drive the future price of these goods up. Supply is reduced while demand is increased - because non-producers holding counterfeit money can have the same demand for the fixed quantity of goods as the producers (money earners) demand.
If producers earn money and decide to save it, that money can be lent to someone else. The borrower can go into the economy and buy goods with the borrowed money. The lender cannot simultaneously buy the same goods because he has forfeited his right to his money because he lent it out. Prices will therefore not rise - because there is not an increase in competition for those goods. This happens when you lock your money into a bank CD or an investment bond. When the borrower produces wealth, replacing that which he consumed, he earns back the money and repays the saver. In the end, the economy has the wealth restored that was consumed by the debtor. If the debtor defaults on his debt obligation then the wealth he consumed is not replaced, but the saver / lender also loses his money and also cannot consume.
If you have perpetual debt creation by perpetual money printing then the economy will become depleted of wealth due to consumption by non-producers. When the economy becomes sufficiently depleted of capital it will create a depression or recession. More money printing or low interest rates will not solve the problem of a wealth deprived economy. Keynesians, however, believe that we are in recession due to excess capacity (excess real wealth) in the economy that no one has demand for or has enough "money" to buy. Their remedy is to print money.
First of all, excuse me for my late reply,I was busy and forgot about this forum for a while. Second, thank you for your replies, but I have a question; Jonathan wrote; "Because supply is the same and price remains the same (the seller has not responded to an increase in wages yet) there is a shortage, represented by the green triangle. This shortage is a signal to the seller to raise prices, as to meet the new equilibrium"But how does the seller know that there is a shortage? Let's say that I sell cars. I have 100 cars, and there are 100 people who want to buy them. Everybody gets a car, and everyone is happy, But lets say that some new money is created, and person 101 gets it. Now lets say that this person also wants a car, so there are 100 cars for sell, but 101 people who want them. How do I know that the demand has increased? Do I have to measure the speed at which the cars are being sold? Or what?
Sebastian Lundh: First of all, excuse me for my late reply,I was busy and forgot about this forum for a while. Second, thank you for your replies, but I have a question; Jonathan wrote; "Because supply is the same and price remains the same (the seller has not responded to an increase in wages yet) there is a shortage, represented by the green triangle. This shortage is a signal to the seller to raise prices, as to meet the new equilibrium"But how does the seller know that there is a shortage? Let's say that I sell cars. I have 100 cars, and there are 100 people who want to buy them. Everybody gets a car, and everyone is happy, But lets say that some new money is created, and person 101 gets it. Now lets say that this person also wants a car, so there are 100 cars for sell, but 101 people who want them. How do I know that the demand has increased? Do I have to measure the speed at which the cars are being sold? Or what?
I think this is a really good question.
My guess: You sell 97 cars at the old price. So you are down to three cars. You get four phone calls that day.
You tell the fourth woman "Sorry Maam, but we are all out of cars."
"But my daughter's sweet sixteen bla bla. I really need a car. How bout if I give you an extra thousand dollars for it?"
"Sold."
My humble blog
It's easy to refute an argument if you first misrepresent it. William Keizer
You'll probably be selling the cars through credit financing and since many auto dealers offer the financing themselves they'll recognize that more people are able to qualify for their credit etc. etc.
Sebastian Lundh:But how does the seller know that there is a shortage? Let's say that I sell cars. I have 100 cars, and there are 100 people who want to buy them. Everybody gets a car, and everyone is happy, But lets say that some new money is created, and person 101 gets it. Now lets say that this person also wants a car, so there are 100 cars for sell, but 101 people who want them. How do I know that the demand has increased? Do I have to measure the speed at which the cars are being sold? Or what?
If there are more buyers than cars then there is a shortage. The change in price is probably not immediate, but something that occurs over some time.
Inventories start to fall... More money is buying goods at the same price. Drop in inventories generally signals the rise of the demand. So you order more goods, however everybody else does the same. Backlog of orders start to grow at the producers. So they raise price, as well as retailers because they see they'll run out of goods if they leave the price unchanged and new stuff will not come in time. It propagates through the whole economy. It takes some time.
Sebastian Lundh:so there are 100 cars for sell, but 101 people who want them. How do I know that the demand has increased?
Sebastian Lundh:But lets say that some new money is created,
Sebastian Lundh:But how does the seller know that there is a shortage?
Subjective value scales change due to the money expansion. You, as the seller, would know because the 101st buyer (so to speak) appears on the scene. That person's value scale was different before the credit / money expansion. Have you read Lilburne's Human Action Comics?
EDIT: Here's a better link: http://anthropica.blogspot.com/2009/10/introducing-human-action-comics-by.html
"The market is a process." - Ludwig von Mises, as related by Israel Kirzner. "Capital formation is a beautiful thing" - Chloe732.
Since my comics haven't covered competitive bidding yet, I'll try to answer here.
Now, you're introducing two factors of change at the same time: an increase in the money supply and an increase in the number of buyers. In thought experiments, as in empirical experiments, it's good to consider just one at a time.
So let's just consider the money supply increase, since that is the subject of the OP. Let's say person 100 gets new money that didn't exist before. Money is an economic good, so it obeys the law of marginal utility (now that IS in my comics). As a person's money stock increases, the marginal utility of any given amount of money decreases. With units of money less dear to him in relation to cars, person 100 will have a higher maximum buying price than otherwise. In an auction this will allow him to overbid competitors, thus upbidding the price.
And from MES p.118:
"It is important to realize that this process of overbidding of buyers and underbidding of sellers always takes place in the market, even if the surface aspects of the specific case make it appear that only the sellers (or buyers) are setting the price. Thus, a good might be sold in retail shops, with prices simply “quoted” by the individual seller. But the same process of bidding goes on in such a market as in any other. If the sellers set their prices below the equilibrium price, buyers will rush to make their purchases, and the sellers will find that shortages develop, accompanied by queues of buyers eager to purchase goods that are unavailable. Realizing that they could obtain higher prices for their goods, the sellers raise their quoted prices accordingly. On the other hand, if they set their prices above the equilibrium price, surpluses of unsold stocks will appear, and they will have to lower their prices in order to “move” their accumulation of unwanted stocks and to clear the market."