I will be writing a history paper on the economic effects of the increase in the money supply that occured in Europe, specifically Spain, after huge amounts of gold were brought over from the Americas. As this forum has been helpful before in both economics and history I’m hoping I’ll be able to get some answers here.
I have a basic understand of the economics behind credit expansion that occurs with fiat money. What I’m less sure about is the difference, if any, between credit expansion (the creation of money not backed by commodity) and what I’ll call ‘just’ inflation, that is, an increase in the real money supply, be it gold, silver or whatnot, through legitimate means, either discovery, being taken out of the ground or whatnot.
I have recently read the article that appeared in the QJAE about tulipmania, and the author explains, as I see it that the reason for this phenomenon was inflation, that is, an increase in the money supply. But he also specifically states that credit expansion was not the culprit, as the Dutch Bank was a 100% reserve bank that issued no fiat. This confuses me because, and I may be wrong, I remember reading about Rothbard or someone else specifically saying that real increases in the money supply cannot cause these boom-bust cycles. So whats up?
The author gives very little detail about the theory or mechanics of a non credit-expansion induced inflationary boom and bust and I feel if I could have this explained to me in basic terms it would greatly help me for the paper on inflation in Spain, as well as improve my theoretical knowledge.
I would also greatly appreciate any sources you guys know that could help me with this project, i.e. the Spanish economy and the effects that the increase in gold had on it. In terms of both people and government.
“Gold inflation,” that is, the increase in the gold money supply, creates rising aggregate expenditure (i.e., a boom) and, if it is substantial enough, even rising broad-based price indexes. Although it certainly could result in malinvestments, which would tend to be liquidated in the “bust” following the slowing down or stopping of the “gold inflation,” this “bust” would be modest since the gold money supply itself would never tip into decline. The situation chages in the case of fractional reserve banking, whether gold is involved or not. Fractional reserve banking tends to multiply the de facto money supply–potentially many times over. The correction in aggregate expenditure and broad-based price indexes, thus, is exaggerated as well. Fractional reserve banking also introduces the very existence of “credit money”–credit indistinguishable from money. A bank’s creation of loans–to a multiple of its “reserves”–amounts to creation of money. To the extent it is created on the back of newly-created reserves (created by the central bank under government sponsorship and legislative protection), it amounts to credit money inflation–that is, governmental expansion of the aggregate money supply. Since “gold inflation” is so modest in extent and in any negative results, I would not even call it “inflation” and thereby associate it with the same egregiously harmful and dishonest phenomenon of government sponsored inflation of the coin-clipping, printing press, or modern “fractional reserve” variety.
Can you be more specific when you say aggregate expenditures? Does this mean consumption or investments? Also, how would an increase in gold cause these malinvestments. Isn’t more gold an authentic increase in wealth, which is just the same as investment due to new savings? How would an increase in real wealth create the same negative effects as credit expansion?
A step by step explanation would probably help a lot.
What do you mean de facto money supply?
But what about tulipmania? (Here’s the link btw http://mises.org/daily/2564 ). If you look under it, where the comments are you’ll also see that there seems to be some debate on the matter. The effects seemed to be quite heavy when the thing finally collapsed but the author gives no mention of credit expansion and describes the banking system as relatively sound.
By aggregate expenditures I mean any of the largest statistical aggregates relating to purchases of production or to payment of income–like GDP/GDI or Reisman’s GNR. Think “large aggregate,” the larger the better, and it will tend to rise given expansion of the money supply over time. The smaller the aggregate, the less reliably would it rise. You could think of a case where “investment” might not rise, owing, say, to mere businessmen’s fear, but GDP could still be rising because of inflation (money supply increase). In general, though, expect all large expenditure numbers to rise in any era of sustained money supply expansion. Gold money supply increase could cause a rather limited malinvestment in a narrow sense of “not being precisely the investment pattern that would have occurred without the gold increase.” However, it would be too limited, for practical purposes, to matter in a large and diverse economy. (In a gold producing “boom town” it would be more problematic! Too many saloons left standing when the mine runs out!) Sure, more gold is an increase in wealth, but does not act in exactly the same way as saving out of income does. Again, increased gold mining does not have the same negative effects as credit expansion because (a) it is very limited in extent and (b) it does not eventually collapse in quanitity as does fiat-credit-money in a fractional reserve context or in a hyperinflation.
By “de facto money supply” I mean the money supply people use, not just the “high-powered money” the central bank creates directly.
I have not yet looked into the history of the tulip bubble, so I have no particular comment on that question.
You might find more help about the issue by contacting Juan de Mariana Institute. As far as I know, Juan de Mariana criticised inflationist policies, and he wrote an important treatise on the matter: De monetae mutatione (On the alteration on Money), 1605.
Yep, already did. At the end the author concedes that the boom-bust was caused by an increase in gold and specifically states that credit expansion did not occur. This was what confused me.
Malinvestment (and hence booms and busts) will occur as a result of any sudden increase in supply of a monetary medium - gold, paper, or anything else. The reason for this is simply that the rest of society’s resources have not also increased in supply. The increased supply of money is not immediately reflected in the price of all other goods, and thus purchasing power is transferred to those in possession of the new money. The mechanism is no different than in the case of a deliberately inflated fiat currency.
The point of the gold standard is not that it prevents economic fluctuations (although it would certainly minimize them), but that it makes it impossible for the money supply to be manipulated by the state.