Economics Questions

Re: How is it possible that the money supply is contracting?

ravochol — Tue, 20 Jul 2010 23:44:11 GMT

What I'm saying is, that even when the debt is repaid, the dollar doesn't go away. The banker spends it. Am I wrong about that? If so, explain why.

My understanding is that when someone repays the dollar, it goes onto the asset side of the bank's balance sheet, replacing the value of the 'promise to pay' on the balance sheet with cash - but whether that cash re-enters the economy depends on whether (1) the bank is willing to loan it - they might need to hoard it to offset losses, and (2) whether anyone will take out a loan - a lot of people are maxed out and can't handle more debt.

So as long as people/corporations/other banks are defaulting on 'promises to pay' and thereby destroying the bank's balance sheets, and people/corporations/other banks are also strongly favoring using new money to pay down debt instead of spending or saving or using it as collateral for new loans, the Fed could conceivably drop a lot of money on the American people (throw it out of helicopters) and it would never enter the real economy -because it's first being used to pay down debt to banks and second getting sucked into black holes on the banks balance sheets.

Re: How is it possible that the money supply is contracting?

Smiling Dave — Tue, 20 Jul 2010 01:09:11 GMT

All of our fiat money indicates debt.

Every time a baby is born a placenta comes with it. Even if the baby dies, the placenta stays.

What I'm saying is, that even when the debt is repaid, the dollar doesn't go away. The banker spends it. Am I wrong about that? If so, explain why.

Re: How is it possible that the money supply is contracting?

z1235 — Tue, 20 Jul 2010 00:56:51 GMT

Weimar Deflation

Re: How is it possible that the money supply is contracting?

Smiling Dave — Tue, 20 Jul 2010 00:43:31 GMT

ravochol:

@ Smiling Dave:

if printing money always causes price inflation, why are the unprecedented bank bailouts not resulting in unprecedented price inflation?

You left out the key word, "eventually". Printing money always causes price inflation, eventually. Give it time. As you yourself said, the banks are sitting on a lot of the money, so that is a temporary reason why price inflation is not as awful as it will be.

In fact, we're even seeing deflation in the CPI now:

Surely you know that the CPI is one big fraud.

With unemployment at Great Depression levels, surely prices should have dropped drastically. But they haven't, have they? Inflation.

Re: How is it possible that the money supply is contracting?

ravochol — Tue, 20 Jul 2010 00:38:10 GMT

Certainly our fiat money does not indicate that anyone owes anything to anyone. What are you talking about?

All of our fiat money indicates debt. New money is created in two ways; 1. Federal borrowing and 2. private borrowing. "The government" creates money when it borrows money from the Federal Reserve, which itself creates the loan out of nothing. But either way, every dollar is backed by a public or private debt.

It can't all be repaid though because more $ is always owed back than is lent out. Under our system, either the money supply grows every year or lots of institutions and individuals have to go bankrupt and in a short time the system will impl0de.

1. Central banks generally earn money by issuing currency notes and "selling" them to the public for interest-bearing assets, such as government bonds. Since currency usually pays no interest, the difference in interest generates income, called seigniorage. In most central banking systems, this income is remitted to the government.

http://en.wikipedia.org/wiki/Central_bank#Currency_issuance

2. The mainstream economics theory of monetary creation is that commercial bank money is created by commercial banks re-lending central bank money: the central bank (an institution that can be characterised as a partnership between the government and a private corporation) lends money to another commercial bank, which re-loans part of it, due to fractional reserves, and this portion is in turn itself re-lent (it is re-re-lent central bank money).

http://en.wikipedia.org/wiki/Money_creation#Money_creation_through_the_fractional_reserve_system

Re: How is it possible that the money supply is contracting?

ravochol — Tue, 20 Jul 2010 00:21:24 GMT

@ Smiling Dave:

if printing money always causes price inflation, why are the unprecedented bank bailouts not resulting in unprecedented price inflation? In fact, we're even seeing deflation in the CPI now:

As Consumer Price Index falls for third month, deflation risk emerges

The Consumer Price Index declined 0.1 percent last month, following a 0.2 percent fall in May and a 0.1 percent drop in April. This suggests that the Fed hasn't completely removed deflation risks.

By Mark Trumbull, Staff writer
posted July 16, 2010 at 2:46 pm EDT

Deflation remains a threat for the struggling US economy, despite massive efforts by the Federal Reserve over the past two years to mitigate that risk.

That's the message coming from the Consumer Price Index (CPI), which posted a decline in June for the third straight month, according to a Labor Department report released Friday.

The price index declined 0.1 percent last month, following a 0.2 percent fall in May and a 0.1 percent drop in April.

The index, designed as an overall gauge of price pressures from the grocery store to college tuition, is still higher than it was a year ago. But the recent trend suggests that the Fed hasn't completely removed deflation risks.

http://www.csmonitor.com/layout/set/print/content/view/print/314603

Re: How is it possible that the money supply is contracting?

Smiling Dave — Tue, 20 Jul 2010 00:11:03 GMT

ravochol:

@Smiling Dave

You're conflating the Austrian and standard definitions of inflation.

No I'm not. I'm using the Austrian definition exclusively. I also carefully mentioned "increase in prices", to account for the other definition.

If $10 is created out of nothing and used to hire someone who creates $10 in value in goods or services, the money supply has increased by $10 and the goods and services available in the economy have increased by $10 also - meaning no price inflation.

I'm glad you made this explicit. Because it is a very good case to study and show the flaws in your thinking.

1. There seems to be a hidden assumption that the guy would not have been hired if the new money was not printed. Why not? If he can create $10 in value, why does nobody want him? Is everyone flat broke? Where is the existing supply of money? Why isn't that used to hire him?

The answer is that of course he will get hired. No new money need be printed.

2. If there is $100 of money and $100 of goods in this little market, and the worker adds $10 of value but the amount of money stays the same, then everyone has gotten WEALTHIER. Prices will have to drop. So that everyone has more purchasing power than they used to. This is what is supposed to happen as time goes on in a developed economy.

But if we print another $10 bill, then the price of things has stayed the same, instead of falling like it should have. That too, is price inflation. Which of course shows why the non Austrian definition of inflation is fatally flawed.

Our money is debt tokens, no?

No. It is a medium of exchange. That's it. Certainly our fiat money does not indicate that anyone owes anything to anyone. What are you talking about?

So if money is repaid through loans, doesn't that imply that the money supply shrinks when loans are repaid?

No. If I owe the bank $100, and repay them with a $100 bill, that $100 bill has not vanished off the face of the Earth. The banker will spend it.

Re: How is it possible that the money supply is contracting?

ravochol — Mon, 19 Jul 2010 23:44:39 GMT

@Smiling Dave

You're conflating the Austrian and standard definitions of inflation. If $10 is created out of nothing and used to hire an otherwise idle person who creates $10 in value in goods or services, the money supply has increased by $10 and the goods and services available in the economy have increased by $10 also - meaning no price inflation. Money supply and price inflation are related but are not a 1:1 correlation.

Our money consists of debt tokens, right? So if debts are repaid, doesn't that imply that the money supply shrinks as this happens?

wikipedia, "Money Creation":

When a commercial bank loan is extended, new commercial bank money is created. As a loan is paid back, the commercial bank money disappears from existence.

If everyone started paying off debts (or defaulting) rather than buying new things and/or taking on more debt, this would reduce demand for goods and services, which would in turn lower the price of goods and services - deflation - and also decrease the money supply - deflation. I think this is roughly what is happening now.

In this type of environment, the Fed could presumably print a lot of money to keep the money supply and demand stable - meaning without producing (standard definition) inflation (higher prices), although the number value of the new dollars issued might be astounding.

Re: How is it possible that the money supply is contracting?

jmorris84 — Mon, 19 Jul 2010 23:30:47 GMT

ravochol - great post!

Re: How is it possible that the money supply is contracting?

Smiling Dave — Mon, 19 Jul 2010 22:28:32 GMT

ravochol:

For example, I just got a windfall cash payment. Know what I spent it on? aying down various debts. So *I* got more money, but guess how much of it created demand for goods or services? None - I just used it to pay down debt.

The thing is, most of the banks have used their bailout money the same way. They had huge asset depreciations (defaulted loans), which would have made them go bankrupt, so the government gave them a pile of cash, and they spent it on- making themselves sovent, meaning hoarding it to offset the depreciated assets, so they won't be technically bankrupt.

The thing is, everyone's in so much debt, the Fed could run the printing presses a lot more than they are without causing price inflation -they could even throw it out of helicopters - because so many Americans who had the cash dropped on them would behave like me - just send it right back to pay down the mortgage/credit cards/student loans.

From what I understand, the first paragraph I quoted is flawed. You didn't spend it on good and services, but the bank might. Also, your getting money and spending it or not has nothing to do with inflation. Money printed creates inflation [by definition] and will increase prices eventually.

The second paragraph I agree with. As long as the banks sit on the money it won't get spent, obviously, so won't raise prices.

The third paragraph has the same flaw as the first. The recipients who pay off their loans won't spend it, but the creditors who get repaid will. And theothe robjection applies as well. The creation of the money that islater dropped off the copter is by definition inflation, and will cause prices to rise when it gets spent eventually by the creditors.

Re: How is it possible that the money supply is contracting?

ravochol — Mon, 19 Jul 2010 22:16:02 GMT

How can it be possible with record deficits and stimulus spending that money supply is contracting? And what does it mean for prices going forward? Deflationary environment? I just can't make sense of this.

It makes perfect sense. It's called DEBT. You have to understand that the U.S. economy is super-saturated with debt. For example, I just got a windfall cash payment. Know what I spent it on? Paying down various debts. So *I* got more money, but guess how much of it created demand for goods or services? Hardly any - I mostly used it to pay down debt.

The thing is, most of the banks have used their bailout money the same way. They had huge asset depreciations (defaulted loans), which would have made them go bankrupt if nothing else happened, so the government gave them a pile of cash, and they spent it on- making themselves sovent, meaning hoarding it to offset the depreciated assets, so they won't be technically bankrupt.

The government gave the banks more than a trillion dollars, and the banks used it to balance their books. None of the money has actually entered the real economy to compete for goods and services (although the big banks that got the bailout $ have used it to buy smaller banks.

The thing is, everyone's in so much debt, the Fed could run the printing presses a lot more than they are without causing price inflation -they could even throw it out of helicopters - because so many Americans who had the cash dropped on them would behave like me - just send it right back out to pay down the mortgage/credit cards/student loans etc.

You know they WON'T do that, because the Fed works for the banks (not the government), and the banks want everyone as deep in debt as physically possible, because the extent to which everyone is in debt is the extent to which banks have wealth and power. A debt for you is an asset on someone else's balance sheet.

Re: How is it possible that the money supply is contracting?

JB.McMunn — Mon, 19 Jul 2010 21:57:21 GMT

I was thinking about that this weekend. They are not only paying banks to keep the money on the sidelines, they are basically paying the banks, period. IMHO this was a stealth method to plump up the banks' liquidity without actually cutting them a check. I guess overtly writing them checks would be frowned upon.

The reason there is no inflation is because the velocity of money is low. In simple terms, nobody is using it. The banks aren't lending and the borrowers aren't borrowing. There are probably multiple factors involved:

1. Lack of creditworthy borrowers.
2. Borrowers are already overextended.
3. Borrowers with good balance sheets have nowhere to use the capital (If your factory is running at 60% capacity why add more?)
4. Uncertainty. IMHO this is a biggie. If the government is actively fiddling with things in a big way (health care reform, finreg reform, cap and trade, etc) why would you take the risk of walking into a buzz saw? Even though the laws have been written, the rules haven't. Those rules will be written by faceless bureaucrats and not even subject to the kind of public discussion we have over the original bills.So if you re-tool your widget factory and the new cap and trade law says widgets will be hit with a 100% carbon tax you're screwed.

Re: How is it possible that the money supply is contracting?

Clayton — Mon, 19 Jul 2010 07:55:51 GMT

Money supply is not contracting, the rate of money supply expansion is decreasing. See these charts for the money supply measures. The only good money supply measure is the Austrian True Money Supply but LvMI hasn't updated it since mid-'09. Attn. LvMI: Update TMS!! (Hint: TMS is usually somewhere between M2 and M3 so you can make a rough estimate of TMS from SGS using that rule of thumb).

Clayton -

Re: How is it possible that the money supply is contracting?

DD5 — Mon, 19 Jul 2010 06:13:13 GMT

razerfish:

http://www.shadowstats.com/alternate_data/money-supply-charts

How can it be possible with record deficits and stimulus spending that money supply is contracting? And what does it mean for prices going forward? Deflationary environment? I just can't make sense of this.

According to your own graph, the money supply is clearly increasing.