As I imagine most members on these boards know, the US money supply has been growing massively for some time starting, i believe, around the 70s, even before bush and obama.
My main query is why have prices not been increasing in a correlated manner with the money supply in the US? I have heard some various explanations for this. That the productivity of the US economy to some extent covers up the inflation, that we are exporting cheap goods from china in essence "importing wealth", that the provision of government services covers up some of this inflation and that the increase in national debt also keeps prices low.
So, what are in your opinions, the methods and mechanisms by which prices have not sky rocketed in the US for the past few decades? Certainly by looking at the money supply alone this should have happened a long time ago. To some extent I understand someways in which this has not happened but I am myself eager to learn this strictly from an academic point of view. I eagerly await your explanations.
Thank you.
jimmy: Prices always had a tendancy to decrease, as production techniques improved and the amount of effort required to produce things decreased. For example, if my memory serves correctly, only around 3% of the US economy is currently concerned with agriculture. As recently as around 300 years ago, perhaps 80% of all of the people in the US would have concerned themselves with the production of food and this (proportionately) greater effort would have met their annual needs much less completely (both in quantity and quality). If a farmer can spend 3 hours producing more food than he was previously able to produced in 80 hours then the cost of producing food is clearly decreasing. What previously cost the equivallent of 80 hours work now only costs 3 hours work... the same is true of a nation. When you walk into a store and you can buy a new car for the equivallent of 2 month's salary, as opposed to a couple of years annual salaries (which is what cars used to cost) this is because cars are cheaper to produce. So the Fed would be required to inject additional funds into the banking system even if all they wanted to do was to 0% price inflation - since they would need to counter the deflationary effects of increases in the productive output of the economy (due to technological and business process improvements). On aggregate, of course, they rarely settle for a mere 0% and seem to prefer something in the 4-7% range lately (they're not very happy at present). Still, inflation statistics like the CPI are just broad aggregates and obviously the improvements in the production techniques in some industries (notably the tech industry) oustrip those in other industires (such as oil and agriculture)... so the prices of computers and flat screen TVs can continue to fall even as other prices rise by 3-4%. Imagine how cheap computers would be in the absence of monetary inflation? Quick Reply
Prices always had a tendancy to decrease, as production techniques improved and the amount of effort required to produce things decreased.
For example, if my memory serves correctly, only around 3% of the US economy is currently concerned with agriculture. As recently as around 300 years ago, perhaps 80% of all of the people in the US would have concerned themselves with the production of food and this (proportionately) greater effort would have met their annual needs much less completely (both in quantity and quality).
If a farmer can spend 3 hours producing more food than he was previously able to produced in 80 hours then the cost of producing food is clearly decreasing. What previously cost the equivallent of 80 hours work now only costs 3 hours work... the same is true of a nation. When you walk into a store and you can buy a new car for the equivallent of 2 month's salary, as opposed to a couple of years annual salaries (which is what cars used to cost) this is because cars are cheaper to produce.
So the Fed would be required to inject additional funds into the banking system even if all they wanted to do was to 0% price inflation - since they would need to counter the deflationary effects of increases in the productive output of the economy (due to technological and business process improvements). On aggregate, of course, they rarely settle for a mere 0% and seem to prefer something in the 4-7% range lately (they're not very happy at present).
Still, inflation statistics like the CPI are just broad aggregates and obviously the improvements in the production techniques in some industries (notably the tech industry) oustrip those in other industires (such as oil and agriculture)... so the prices of computers and flat screen TVs can continue to fall even as other prices rise by 3-4%.
Imagine how cheap computers would be in the absence of monetary inflation?
This is a quote from the user jimmy in a post relating to what you are asking.
hmm.. that seems logical, rothbard describes the 1920s growth in the money supply being hidden by the productivity of the period.
however, the money supply growth occuring the past few decades seems to be something else:
http://dollardaze.org/blog/posts/2007/July/24/1/USMTotal.gif
do you think productivity is the only reason for the price stability or are there other factors at work?
Nah, just thought that it could be one possibility, yet there is also the crack-up boom scenario: mony is greatly expanded, yet people don't immediatly see it and when they do they spend, spend, spend and prices burst upwards due to increased demand. I bet there are also many more scenarios.
can anyone shed a light on this "imported wealth" idea?
Well, the money that was printed has in part been used to buy up the T Bills to keep rates artificially low.I guess this works as long as foreigners are willing to support our debt. With many 'export' economies dependent on US growth there is a willingness to go along and keep the bubble from bursting further by not liquidating their T Bill holdings. this would further impede US growth and thus dampen exports.
But I think with gold flirting with new all time highs the market is starting to look ahead 6-9 months and might be starting to sense inflationary pressures.
We might experience a mixture of inflation and deflation. Inflation in commodity prices with deflation in paper asset prices (yikes!).
The reason prices have not increased is that inflation in a fiat currency economy is based on the overall supply of money AND credit. Many are only looking at the supply of money. The existing supply of credit has been reduced so drastically over the course of the past 24 months that virtually no amount of government 'printing' will bring the overall supply back up to 2006 levels. All signs are currently deflationary.
That said, there are several events that could swing the economy into inflation-mode, or even result in inflationary depression. So far, the only thing keeping the dollar afloat is the fact that other nation's fiat currencies are in worse shape. China is on the verge of economic implosion, as is the EU. However, if treasuries cease to be viewed as a (relatively) safe haven, we could see dollar implosion as an enormous flight to hard assets makes what happened last summer look like a relatively small blip.
I have three reasons for "prices" not going up in the US and most of the Western World. I am giving them in my order of rank as to most sigificant to least significant:
1. Governments lie about the increases in price level. For example prior to the summer of 2008 the USG always failed to include food and energy when it computed the change in Consumer Price Index. But in the fall of 2008 into 2009, low and behold they are suddenly including energy in this computation, I wonder why??????? Look at items that you need and see if the prices have gone up: Clothing, nonperishable food, home improvement products and services, etc. The USG also adjusts the CPI for functional advancements, so if you have $200 TV and buy one for 1000, they adjust for the performance of the new TV and reduce the price.
2. In the past 20 years the Western World added 2.5 billion folks, China, India, Brazil, etc. to the division of labor. This has increased the wealth of the planet and has reduced costs of production for a giant volume of things.
3. We are not yet at the true long run effects of the past 20 years of inflation. Right now consumers are correcting past mis-allocations of resources. This correction will end and when it does the US Central Bank and the other Central Banks of the world have created tons of money being stored in banking reserves. Banks will get around to lending these reserves. When they do, you will see prices rising. How confident am I in this? I purchased a gold mining mutual fund the day Our Dear Leader, Obama, blessed us with his stimulus. AND I WAS NOT EVEN STIMULATED!!!!!
o the Fed would be required to inject additional funds into the banking system even if all they wanted to do was to 0% price inflation - since they would need to counter the deflationary effects of increases in the productive output of the economy (due to technological and business process improvements). On aggregate, of course, they rarely settle for a mere 0% and seem to prefer something in the 4-7% range lately (they're not very happy at present).
Prices falling because productivity is increasing the number of goods to the market at lower prices is NOT deflation. Such price decline will not bring depression or recession. Prices are falling because input costs of production are also falling. This means that profit margin is still healthy and the company is still profiting. Deflation is when prices fall because the previous price height was due to high prices bid up by fiduciary credit expansion. When the bubble of debt is not sustainable the debtors begin to default and/or refuse to take on no more debt. People stop buying goods because they don't have money to buy. Prices therefore have to fall in order to clear the market of the goods. This is what creates depression / recession. The cause is the previous inflation of fiduciary credit, the remedy is to let the tower of debt to collapse to let debtors deleverage and become solvent again.
I think US prices have not noticeably gone up yet because not many people are spending any of the newly created money. The banks are getting all the new money and they are hording it - not loaning it out. This is because they've been burned before by flaky borrowers unable to repay. In the current economic conditions they see most borrowers as flaky and unable to repay. Therefore they only lend to the most stable and solvent businesses & individuals - unfortunately most of these don't need loans. There still aren't enough borrowers accessing this new money to spend it at a rate to sustain asset prices. Therefore, prices still have to fall in order to liquidate / clear the market of excess inventory. Now the Fed & gov't are taking over the responsibility of spending. The Fed is creating money and buying assets directly from the market via "quantitative easing" or monetization. This directly injects cash into the economy. Obama's spending package will be taking money and directly injecting it into the economy as well. If any of the spending package money has directly or indirectly came from the Fed's printing press then that spending will too be inflationary. As prices start to prop up or even rise and particular sectors of the economy (the special interest groups) become profitable from such price rises then things will appear to become stable in those sectors. Banks will likely start to lend money to that sector. When the money starts to trickle into different sectors of the economy the banks may start lending to those businesses if they appear stable. Therefore, the big dam holding back all this new money will start to flow out through a chute which pours the money into the economy via the first groups benefiting by government spending. Prices will rise. Those of us further down the chain from these special interest groups will have to wait for some of the new money to trickle down and our wages to rise for us to benefit from the inflation. Until that happens we will be impoverished by having to pay higher prices while maintaining lower wages.
Prices rise because of the perception that the value of money is falling. This causes the velocity of money/goods transactions to increase. Some economists incorrectly refer to the flawed Irving Fisher equation of MV=PY to say that low money velocity keeps prices low. This same theory says that increased money velocity creates higher prices. This is not how it works. Money velocity does not change prices. It is the perceived underlying change in value of either the money or the commodity that makes holders of money choose to prefer the commodity instead of the money. The change in valuation gets transactions moving and this increases the rate of transactions and therefore money velocity. You know that gasoline will be more expensive on Friday (money will be worth less with respect to gasoline) so you and everyone else are buy gas on Wednesday. The anticipated fall in the value of money on Friday drives the price of gasoline up on Wednesday.
http://mises.org/story/2916
Could someone please explain the mechanism by which the increased monetary base is likely to translate into price inflation.
How long can a credit collapse be met with the "costless" solution of replacing worthless structured assets with treasuries, before there are consequences?
When I explain that these bailouts and eternally revolving Fed loans are irresponsible in the extreme, I get the response that the government is only replacing a worthless asset on deposit and therefore it has simply been canceled with no consequences. Could someone explain further what is wrong with this replacement of assets, and maybe point me towards an article that explains this phenomenon better?
Loans / debt is a result of past consumption of someone elses wealth, based on a promise that the consumer will reimburse that wealth to the lender. If the debtor defaults then the wealth is never paid back. Paper money is not wealth, but a certificate to be able to secure existing economic wealth. If the Fed prints money to reimburse the lender because the debtor has defaulted, no wealth is created in the bailout. The created money only gives the lender back the paper that he can use to secure whatever remaining wealth there is in the economy.
Example: I grow 5 pounds of potatoes, eat four pounds and save two. This is wealth. I want bread (which trades at one loaf per pound of potatoe) so I sell two pounds of potoatoes to someone who wants them and I get say $2 dollars in exchange. I use my $1 dollar to buy a loaf of bread today and I put my other $1 in the bank so I can buy another loaf of bread next week. My neighbor asks to borrow $1 from me, promising to pay it back next week, because he wants bread too. I, or the bank, lends $1 to him and he goes and buys the last loaf of bread in the economy. Before next week he looses his job and can't repay the $1 to me. He defaults on his debt and does not contribute any wealth to the economy. In a round-about way this could mean that the equivalent wealth of a loaf of bread is either not created or is lost from the economy. The Federal Reserve bails out my friend and prints up a new $1. My friend gives this $1 back to me. I go to the economy to buy a loaf of bread but there is none available. I got my money but from the bailout there was no equivalent wealth created that I can spend my money on. The end result is that there is now fewer goods (or wealth) in the economy, but the same amount of money exists to chase after those fewer number of goods. Prices rise because people are willing to bid up prices to buy whatever goods are remaining. The purchasing power of the dollar is reduced.
bearing01:I grow 5 pounds of potatoes, eat four pounds and save two.
Sounds more like the FED, making potatoes out of thin air! 4+2=6 not 5lbs of potatoes, good analogy though.
Another example:
Bob buys a house in 1990 for $200k (and never pays a penny of it off). House prices rise and in 2006 I get a $600k loan from the bank, this is new money created out of thin air. I give bob this money and take his house. Bob has $400k in realized profits. Bob buys a $100k house in another city and takes his $300k profit to buy a sports car and retire. Bob will use this profit to consume for the next 10 years.
I owe the bank $600k of which $200k is likely for the true value of the house and $400k for which I have promised to pay back to the economy over the next 10 years. What do I owe? I promise to reimburse the economy with the equivalent wealth $400 for Bobs new sports car, new house and consumption that Bob will take from the economy during the next 10 years.
I loose my job. House prices fall back to $200k. My house could be sold for $200k again and this leaves a hole in my balance sheet of $400k, which I still owe the economy. If I default then the wealth that Bob consumes during his retirement is never reimbursed by me. If the Fed prints up a $400k bailout to make the bank's balance sheet even then the bank and myself are both off the hook. This does not change the fact that the economy has lost $400k worth of wealth, which Bob has consumed.
I guess I should have only ate three pounds.
Unfortunately the Fed can't create potatoes. If they did then the world would be fat by now.
bearing01: Sounds more like the FED, making potatoes out of thin air! 4+2=6 not 5lbs of potatoes, good analogy though. I guess I should have only ate three pounds. Unfortunately the Fed can't create potatoes. If they did then the world would be fat by now.
If the FED had that much control over potato-production, we'd have no french fries ("If the government was in control of the Sahara Desert, within 5 years there'd be a shortage of sand").
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