A Keynesian friend posed a question to me which I am having trouble answering. He asked the following.
My initial thought was to say that it would certainly get people to spend more, but any growth would be illusory, and you would simply be inflating a bubble. I’m certainly ignorant when it comes to anything but basic economics, and I’m still working on my grasp of ABCT, so I wasn’t sure if this was faulty reasoning.
It also strikes me as wrong because if my answer were correct, then any expansion of the money supply would lead to trouble, and I can’t see any reasonable economist advocating a system with a fixed money supply, even if they wanted it to be commodity-backed.
The money supply is not fixed in a free market, people adopt new currencies as necessary and expand the money supply as necessary. IE, if gold coins are not right for day to day transactions people will start using silver, copper, whatever.
An increase in the supply of money will benefit the first recipients of this money. Since the money just entered circulation, prices have not yet been bid up and the holders of this money can buy more than they could otherwise (without the money). But, as the money continues to circulate and prices generally increase then this illusionary increase in wealth begins to show itself. It turns out that the original recipients of the money benefited over everybody else and created a shortage of whatever good they’re chasing (whether capital-goods or consumer-goods). So, we can conclude that over the long-run it actually has no positive bearing on wealth, as the stock of capital remains the same.
Whether or not a bubble is inflated depends on who receives the money. A more modern phenomenon is the advent of consumer credit, which is something which the original Misesians did not take into consideration. In order for the Austrian business cycle theory to take place, the expansion in fiduciary media must be invested into capital-goods. What occurs is a change in the price of capital-goods relative to the price of consumer goods (namely, the price for borrowing capital), making the former seem profitable. If the expansion of money slows or ceases and the general price level ultimately increases, and this price relativity ceases to exist, then entrepeneurs will see that their investments were not as profitable as once thought and liquidation will occur. Consumer-credit causes what can be considered an “opposite” effect.
Jesús Huerta de Soto, in Money, Bank Credit, and Economic Cycles (specifically, a chapter titled “Consumer Credit and the Theory of the Cycle”), makes the distinction between durable consumer goods and non-durable consumer goods. He considers durable consumer goods as true capital-goods, although there is little in the way of an explanation. This lucuna might be filled by Doug French, in “Is Housing a Higher-Order Good?”. In any case, in the case of credit expansion directly financing the purchase of non-durable consumer goods the productive structure flattens, as money is channeled to consumer goods (as the price of consumer goods relative to capital goods becomes more favorable for the former). Instead of a widespread boom, there is malinvestment which causes general impoverishment.
Friedrich Hayek believed that any increase in the volume of money would trigger malinvestments (see: Monetary Theory and the Trade Cycle), and at times so did Mises (I see conflicting interpretations of Mises, though). Free bankers hold that there will be no inflation as long as the expansion in money is only to meet demand for money (or demand for cash holdings). I don’t see how this is true, given that demand for money should be met by what those demanding had originally deposited, but to be honest I do not know the machinery behind the free banker’s positions as well as I would like to. In any case, all 100% reservists believe that inflation is caused by any increase in the money supply (such as Jesús Huerta de Soto, who’s analysis of credit expansion to consumers provides some insight on his views on money created to meet demand).
Very good. So would it be fair to say that increasing the money supply A. always benefits the first person(s) to receive the new money (at the expense of everyone else), and B. causes malinvestment at best, and a widespread bubble at worst?
Trying to pare down your excellent response to the core points regarding the expansion of the money supply.
That there’s a difference between printing notes backed by a hard specie (specie notes) and the unbacked fiat currency. Expansion of the money supply as a natural market process is fine, as people would decide if they wanted to use their specie for other purposes or not. Simply dumping notes into the economy is the same as running a current down a dead frog’s leg. Keynes never grasped that.
Although I haven’t read much on the topic of gold and expansion of the supply of gold coins, I am not sure that this holds true. For example, Spain’s conquest of the Americas caused a large inflow of gold. Spain remained relatively prosperous until the inflow of gold slowed and then ended. As prices throughout Europe bid up, Spain’s wealth suddenly dissapeared and Spain entered a long period of economic decline. This is an area of study that I am interested in, but have not had time yet to specialize in (Spanish economic history), but I’ve read a little bit via Rothbard. It seems, at least at first, that this episode is in line with Huerta de Soto’s explanation of what occurs when consumption is fueled by monetary expansion (in this case, not really consumption, but wealth was destroyed by funding wars which could be considered like consumption, since the goods were used and expended, as opposed to re-invested). Spain had two centuries of relative wealth, as continued inflow of gold gave them relative high expenditure capability as prices in Europe had not had bid up from the new arrival of gold, but then the flow ended and prices finally bid up to take into consideration all the gold introduced in the economy the Spanish Empire was not just back where it started, but completely broke. It had malinvested, and it had very little industrial base (and would remain backwards until the 1950s).
All the same, Doug French does not consider paper money during Tulipmania, but actual gold specie, as does Rothbard and Scott Trask when analysing the reasons behind the 1937 recession.
The other posters put it well, and I have a bit to contribute also.
There is a difference between people adopting a new currency as necessary and printing money. The difference is “are you being forced to accept it”.
If the gov prints money, you cannot refuse it and say give me gold instead. So the govt can take anything they want from you by printing money and making you take paper in exchange for whatever they want of yours. In short they are forcing you to take useless paper in exchange for a valuable good.
When we say people adopting a new currency we are talking about you voluntarily accepting something in exchange for your goods. Since you would probably only accept something that has intrinsic value, nobody can just start printing as much of it they want. They have to get ti from somewhere.
And that is also why printing is automatically harmful. It gives the gov the right to rob anyone they please of whatever they wish, with no one even thinking about protesting. Obviously if your economy has a parasite that consumes as much as it can get away with [40% of GDP, I think] and gives nothing in return, that is only harmful.
To really get a clear picture, imagine two towns. One has only good citizens, one has a Mafia. Every once in a while, the Mafia goes around to the stores, taking what they wish. In return they give you a picture of their leader. Which town is better off? Is there any short term advantage to having a picture of the leader?
Course, you could argue that you can take that picture and make people give you stuff. They think anyone who flashes the picture is a Mafioso and so they obey him. The town will become one giant game of Old Maid, as people foist the pictures on each other. Still, which town is better off? And is the town stuck with the pictures better off with more or less of them?
I don’t think that’s what he was getting at. I think, and I could have misinterpreted his post, that he was questioning whether or not fractional reserve free-banking would be better than 100% commodity backed free-banking. Either could theoretically exist without state interference, but one has to wonder whether or not fractional reserve free-bankers would cause those malinvestment problems when they expand the money supply.
…So would it be fair to say that increasing the money supply A. always benefits the first person(s) to receive the new money (at the expense of everyone else),…
would getting gold/silver out of the ground require someone giving up some gold first?
if 1oz of gold invested into some miners yielded 2oz of gold a month later , wouldnt the receiver of the 2oz have been without 1oz of gold PP for a months time making the extra ounce of inflation without the harmful aspects of inflated money? why would anyone else be at expense?
…if my answer were correct, then any expansion of the money supply would lead to trouble…
but if this is true
“when prices are adjusted for inflation, Americans today spend '40% less on clothes, 20% less on food, more than 50% less on appliances, about 25% less on owning and maintaining a car’than they did during the early 1970s…”
this sounds like three decades of govt inflation and many vital goods have fallen in price.
so i dont know what you mean by trouble exactly.
unless every other good out there has gone up in price due to malinvested inflation-money far beyond the decreases of the goods listed above - and those other goods likely take up a greater share of incomes.
maybe you could look that up tio see if there is trouble.
now my dad, who isnt very bright, and has had some people dick him over lost 100k in the so-called tech-bubble around 2000.
he lost 100k in a state govt managed retirement fund just a year before his retirement. nearly half, and there werent many bells ringing about the coming tech bubble collapse making there way from state fund managers to blind useless state employees.
he was also managing a fund of money for some visually impaired advocacy group of around 250k.
that lost half in less than a year. the earning smith barney guy told my dad…leave the money in there the market is right about to turn around. my dumbass dad didnt listen and placed the money elsewhere and if he hadnt the he would have lost another 20k. so he was told.
there may be some trouble in the above scenario caused by money manipulation form the govt or elsewhere, im not sure
did the so-called tech bubble investment help the economy in the short run? if what i posted above actually happened short run gains were likely quickly erased from 40 percent losses in various money funds.
unless, voia! all the new infrastructure from the 99-2000’s is now providing some productive use at 2000 prices.
Just adding a trivial detail that may/ may not be relevant to some, depending on who’s reading the thread. Expansion of the gold supply over time (let’s say due to mining) will be anticipated and won’t have much of an effect in terms of inflation.
If I’m wrong here, I hope someone corrects me, because I myself have ways to go…
Well a bubble will always be inflated because producers can always demand and pay a higher rate of interest due to their remunerations. And since more remoter methods of production are more profitable, the structure of production will always lengthen.
Bohm-Bawerk talks about it a little. He says that consumption credit also diminishes the necessary subsistence fund which should increase the natural rate of interest, but once the natural rate rises, it will necessarily push out the demand for consumer credit. Thus, from this, we can deduce that reducing the market rate of interest below the natural rate will not only stimulate the demand for producer credit, but also for consumer credit. And, as Hayek has demonstrated in Prices and Production, this means the economy will be dragged in both directions more dramatically than if producers only receive the credit (all while real capital is continuously consumed).
Hmm, weird.
Houses used for rents or business activities are long-term durable capital goods (which would have been the vast majority of houses during the boom as they were really financial assets). Houses used only to live in are durable consumer goods.
Because the demand for cash holdings is required only for normalized transactions (which frequently become non-normalized), and as such, don’t affect the demand for real capital. There are also self-correcting forces which prevent banks from continuously suppressing the market rate below the natural rate (banks begin to hoard competing banks bill and seek redemption). No one worries about banks keeping the market rate above the natural rate (though this may happen during crises). To be honest though, this is very questionable to me as well.
If you stop printing money, you’ll cap the money supply. This will boost the currency’s value. Although have a negative impact on a country’s economy. And if you are running a trade deficit, it will really have a profound impact.
An if the population is growing, it’ll have devastating effects on future generations. As the available money supply will be locked up in the pockets of a few.
It´s not easy for the policy makers to decrease the amount of money spent on public expenditure. When taxes aren´t enough to cover the expenditure, the Government prints more money. In the short term it works, in the long run an inflation occurs.