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.
I am interested in this one too. My guess is that when people take cash out of the banks, the banks cannot use fractional reserve banking as much, thus decreasing the money supply.
Of course they won’t recall debts loans that they already lent. So the effect on the economy is nil. It just limits [one source of] potential new inflation a bit.
Peter Schiff thinks it will have no effect on the economy, and inflation, not deflation, is amongst us we speak, with more to come.
Mike Shylock - spelling ??? google “mish” . he is pro AE and is anti- state.. however his take is opposite Schiff, and after hearing him talk about it- more convincing than schiff. he see’s big time deflation… because of all the toxic assests bought - and he says; banks are sitting on a lot of money, like they should in this climate.
“Inflation” defined as an increase in the money supply has already happend.
The trillions of dollars were created, there they are.
I don’t understand how deflation can occur? Can someone explain this? Does all the FED have to do is sell their bonds?
Mike Shedlock. He’s not the Merchant of Venice.
The deflationary argument is basically as follows: given the rise in uncertainty there is what one could call a liquidity trap. I hesitate to use the term, because it immediately draws parallels to Keynesian liquidity trap theory, but I am merely borrowing the term. The broad definition of liquidity trap is a situation in which savings are greater than investment, or where lenders are not lending. I argue in an upcoming article (which is a criticism of Krugman’s argument) that “liquidity traps” are a result of an increase in uncertainty, and that they dissapear as the economy bottoms out and fears begin to subside (and this assumes the market is allowed to clear - otherwise, you may have what Robert Higgs calls “regime uncertainty”, which he uses to account for the lack of private investment during the Great Depression).
In any case, given the lack of private investment and investment-oriented loans, the ability of banks to pyramid loans based on prior loans (where a loan is deposited in a bank, and thus this amount is again loaned, as described in Hayek’s Monetary Theory and the Trade Cycle) is limited. As such, fractional reserve banking does not lead to further accelerating inflation (increase in the supply of money). The responsibility to inflate, therefore, lies with the Federal Reserve. Currently, the base money supply has stagnated, and according to Austrian theory once there is a decceleration in the pace of credit expansion the price mechanism begins to adjust to this discoordination between time preference and savings/consumption. As this discoordination is revealed loans begin to be defaulted on, paid back, and the demand for money rises (due to uncertainty for the future), all of which could cause the supply of money to decrease.
The argument for price inflation is that the Federal Reserve will not allow this to happen, and will inflate the supply of money accordingly. As I cite in the upcoming article, Goldman Sachs estimates the necessary monetary inflation to be in the area of $10 trillion (no joke) [although Krugman uses this prediction as a figure which symbolizes the necessary amount of liquidity to guarantee long-term inflation, which is his solution to his liquidity trap theory].
Is it not also the case that the Fed is paying interest on reserves, at around 0.25%? Which is higher than the Fed funds rate (~0.12%??). So it seems that the Fed is encouraging banks to keep their money with the Fed and NOT to lend it out! That could be why the money supply is not growing, because the Fed does not want it to!
And why would it do that? Maybe because, despite what Austrians think, the Fed actually IS worried about inflation.
According to your own graph, the money supply is clearly increasing.
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 -
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:
- Lack of creditworthy borrowers.
- Borrowers are already overextended.
- Borrowers with good balance sheets have nowhere to use the capital (If your factory is running at 60% capacity why add more?)
- 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.
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.
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.
ravochol - great post!
@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.
@ 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
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
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.