Is a fixed monetary supply inherently better than a money supply which expands with population?

Economics Economics Questions
1

I am having a debate with some other people on this, and I feel I need to boost my own understanding in order to be able to respond correctly.

Here are a few points that I am a bit stuck on:

  • Does price deflation cause a significant imbalance between creditors and debtors, rewarding savers at the expense of borrowers? Is it unbalanced in this regard, and would the effect of high price deflation be the same as a high rate of real interest, thus causing hoarding?

  • Does a fixed monetary supply reward holders of currency for “no good work done?” i.e. if there were ten people on an island holding gold, and ten more people came onto the island, thus doubling the demand of gold, isn’t this getting value for nothing? These people became “wealthier” simply by holding gold since demand doubled but supply remained fixed. Shouldn’t the monetary supply be doubled in order to accomodate the new users?

  • I get statements such as this: “The key is to maintain the same value. As the supply is limited, but with growing demand, the units will be more valuable. Companies and individuals would prefer to know that a unit would be worth roughly the same now for many years in the future. This allows businesses and individuals planning easier.”

Again, I want to be sure I’m not spouting off BS before replying, so would appreciate a bit of commentary from more knowledgeable members than myself… thanks! :slight_smile:

2

So if you forecast deflation, you are lending out money with negative nominal interest rates (but with positive real interest rates).

Well it encourages saving that particular commodity. But if people are voluntarily saving it means they are deferring consumption, and the firms can spend more time investing in the present to meet the consumption coming later.

It would be impossible to fix prices on every firm’s output. If you fix the money supply so that computers always sell for $200 in an attempt to make accounting easier for microsoft, but also fix the money supply so that desks sell for $50, you are basically engaging in price-fixing. A sort of commodity version of Gresham’s law comes into effect, as well as whatever usual effects of price cielings and floors.

3

“- Does a fixed monetary supply reward holders of currency for “no good work done?” i.e. if there were ten people on an island holding gold, and ten more people came onto the island, thus doubling the demand of gold, isn’t this getting value for nothing? These people became “wealthier” simply by holding gold since demand doubled but supply remained fixed. Shouldn’t the monetary supply be doubled in order to accomodate the new users?”

As far as this question I would say: absolutely not.

Who says the ten new immigrants don’t bring anything of value with them to the island to trade for the gold? If not tangible goods, then them, themselves is enough. The work they are capable of doing will get them a share of the gold eventually.

And if the money supply is doubled, how does it get divided up? Do the ten new immigrants just all get an equal share? If so, that would truely punish the current holders at the expense of the new immigrants.

In time, the economy of the island will adjust to the original gold supply. The new immigrants will get their fair share of it if they are willing to work and trade.

4
5

Many concepts here. A chapter or two, or even an entire book, may be needed to respond to the questions posed by your friends in a rigorous manner. Here is a less rigorous, but hopefully useful, response.

Deflation question: There are two types of deflation. The first type is quite healthy. It is slow and steady, and results from increased productivity in an unhampered market, a market with sound money. The second type is painful, and is caused the collapse of the artificial credit bubble made possible by fiat currency, which we are experiencing now.

Most people don’t understand the difference. They think there is only one type of deflation, the fiat credit type. People “hoard” in response to the fiat credit deflation, a perfectly normal and healthy response. What is the alternative when faced with losing one’s job, spend like crazy? Your first question seems to imply that “hoarding” is a problem, which it is not. It is the collapse of the artificial bubble, a bubble that should never have occurred, that is the problem.

Quantity of money question (island example): No, the new people would not be rewarded by simply holding gold. First they would have to produce something, then exchange what they produce for gold, then exchange the gold for something they need. Division of labor is a wonderful thing, and everyone on the island could become wealthier due to the new arrivals. Money makes the division of labor possible, and the quantity of such money makes no difference at all. No need to double the quantity of money just because the population doubled.

Planning vs. increasing purchasing power: This would not be a problem at all under conditions of an unhampered market with sound money. Deflation would be slow, steady, and predictable.

Instead of addressing these questions point by point, a better approach might be to first discuss the nature of money, the nature of sound money, and the nature of fiat money. Once they understand these things, I don’t think they would even ask these questions. I contend that all three questions are really asking, "What is the nature of money". Your friends might be surprised by the answer, I know I was.

This lecture by Mises is a good start. In 45 minutes, you will get an excellent foundation to build upon. On Money - Ludwig von Mises lecture, 1969

6

“So if you forecast deflation, you are lending out money with negative nominal interest rates (but with positive real interest rates).”

But would this really work like this? Would you ever lend out, say, 1oz of gold and ask for only 0.8oz back? Or lend out $100 and only ask for $80 back? Why would you do that, when you could just hold on to that 1oz of gold and take advantage of the lowering prices yourself? In order for lending to be worth it, you need to get more back in nominal terms, which would mean a high real interest rate.

Is this why we look at monetary deflation as bad? For example, let’s say Bob lends $100 to Jane, and this $100 represents 1% of the economy. If the money supply drops by 90%, then that $100 now represents 10% of the economy. Jane has to repay 10% back to Bob, which is quite the feat. I can therefore see how monetary deflation skews things against the debtor and why it could lead to high real interest rates and why it would be less than optimal.

If we look at price deflation instead; let’s say Bob lends $100 to Jane, and this $100 represents 1% of the economy. If the supply of goods and services multiplies by 10 times and prices drop by 10 times, then this $100 still represents only 1% of the economy. Jane has to repay more real goods and services, but the prices of the same have also dropped, so overall, things are still balanced between the creditor and debtor.

What do you think?

“It would be impossible to fix prices on every firm’s output. If you fix the money supply so that computers always sell for $200 in an attempt to make accounting easier for microsoft, but also fix the money supply so that desks sell for $50, you are basically engaging in price-fixing. A sort of commodity version of Gresham’s law comes into effect, as well as whatever usual effects ofprice cielings and floors.”

Agreed, I see this as completely unrealistic.

7

"Who says the ten new immigrants don’t bring anything of value with them to the island to trade for the gold? If not tangible goods, then them, themselves is enough. The work they are capable of doing will get them a share of the gold eventually.

And if the money supply is doubled, how does it get divided up? Do the ten new immigrants just all get an equal share? If so, that would truely punish the current holders at the expense of the new immigrants.

In time, the economy of the island will adjust to the original gold supply. The new immigrants will get their fair share of it if they are willing to work and trade"

I agree with this. The problem in explaining it to the debaters is that they don’t see it as fair. If I present it in a manner that shows that the redistribution comes at the expense of the current holders, perhaps that will be more effective.

8

"would the effect of high price deflation be the same as a high rate of real interest, thus causing hoarding?

This one sentence has many things wrong with it.

First, you make it sound like hoarding is something bad. What are we, Keynesians, who think the key to all good things is spending? If someone thinks so, he needs an education more fundamental than enlightenment on the benefits or disadvantages of deflation. He ahs to first understand why Keynes had it all backwards. Plenty of resources here for that.

Hoarding, or to use the more correct term, saving, is beneficial to the economy as a whole as well as to the saver. As pointed out above, people do not hoard under the mattress, historically. They put the money in banks, which is good, as explained briefly above."

Well, not me, but the debaters :slight_smile: I agree with you in general, but could hoarding become a problem if the money supply itself was shrinking? Such a situation would present itself with high real interest rates and no easy way (at least that I see) around the problem short of using another money system (indeed, competing monetary systems might be what helps prevent such situations from arising in the first place). I wrote about this in a bit more detail in reply to Sieben above.

"- Does a fixed monetary supply reward holders of currency for “no good work done?”

LOL, this one takes the cake. The incredible ignorance of such a statement boggles the mind. It is wrong so many different ways.

We must go back to basics. Why is there price deflation [in the absence of govt manipulations]? Only one reason: there are more goods in the world than there used to be. Man has found a way to increase the bounty of nature. So say the annual yield from an apple tree was 300 apples, and some genius found a way to double that. Result: price deflation of apples.

Who benefits from this? All of humanity that’s who! Instead of having to spend a lot of money on apples, they spend less, and have money left over for other things. So now we are being asked if all of mankind is benefiting from the work of that lone genius “for no good work done”.

If you are following my thinking, you see that it is not just “holders of currency” who benefit from lower prices. Because EVERYONE is going to be “holding currency” from now on, right? People are working for a living and getting paid in currency. Are we saying now that the whole world has turned into evil parasites who are benefiting for no good work done, since apples are going to be forever cheaper?"

Some people might say that. I kind of like your reply, but I’ll take care not to outright call the debaters ignorant. I don’t want them to close their minds to the message :slight_smile:

"- I get statements such as this: “The key is to maintain the same value. As the supply is limited, but with growing demand, the units will be more valuable. Companies and individuals would prefer to know that a unit would be worth roughly the same now for many years in the future. This allows businesses and individuals planning easier.”

Very presumptuous of them to tell me what I want. I would much rather have my money constantly increasing in value, thank you. It will make my planning for my old age so much easier.

Hey, let’s be scientific about it. Let’s take a poll. The question is “Would you rather the price of everything you buy go down all the time, or stay the same forever.” I wonder what people will say."

Hah, me too.

"Again, I want to be sure I’m not spouting off BS before replying, so would appreciate a bit of commentary from more knowledgeable members than myself… thanks! :slight_smile:

There is an easy way to make yourself knowledgeable. read the short free readable work, What Has Gvt Done to Our Money, available as a pdf and as a free audio book right on this site."

I’ll have to check this out when I have the chance. There are so many books I want to read, but so little time!

9

I may be mistaken, but isn’'t this is an example of an evenly rotating economy, where everybody is certain what future prices will be? Profit and loss can only come out of uncertainty, which is the world we live in.

10

"Deflation question: There are two types of deflation. The first type is quite healthy. It is slow and steady, and results from increased productivity in an unhampered market, a market with sound money. The second type is painful, and is caused the collapse of the artificial credit bubble made possible by fiat currency, which we are experiencing now.

Most people don’t understand the difference. They think there is only one type of deflation, the fiat credit type. People “hoard” in response to the fiat credit deflation, a perfectly normal and healthy response. What is the alternative when faced with losing one’s job, spend like crazy? Your first question seems to imply that “hoarding” is a problem, which it is not. It is the collapse of the artificial bubble, a bubble that should never have occurred, that is the problem. "

I don’t see hoarding as a problem when the money supply is not shrinking, but could it become a problem when it is, due to high real interest rates?

'Planning vs. increasing purchasing power: This would not be a problem at all under conditions of an unhampered market with sound money. Deflation would be slow, steady, and predictable. "

Agreed.

"Instead of addressing these questions point by point, a better approach might be to first discuss the nature of money, the nature of sound money, and the nature of fiat money. Once they understand these things, I don’t think they would even ask these questions. I contend that all three questions are really asking, “What is the nature of money". Your friends might be surprised by the answer, I know I was.”

They seem to understand the nature, but they still see the issues that I pointed out. I believe much of the misunderstanding comes from a confusion between the causes and effects of monetary deflation and price deflation.

“This lecture by Mises is a good start. In 45 minutes, you will get an excellent foundation to build upon. On Money - Ludwig von Mises lecture, 1969”

45 minutes is doable :slight_smile: Thanks!

11

We are getting into a point that is very unclear to me,and I would very much appreciate any info and help about it. To wit, how does the “money supply itself” shrink? I mean, if lightning strikes many bank vaults simultaneuosly and burns up the dollar bills there, that’s one way. But short of that, I don’t see how it can happen.

Now, I’ve seen people here, non Austrians I imagine, saying that when a debt is repaid the money supply shrinks. But I don’t see how. The dollar bill that the banker gets is still there, waiting to be spent.

I’ve heard that Milton Friedman wrote a whole book about how the shrinkage of the money supply caused the Great Depression, but I don’t have his book.

In any case, if we assume no central bank, the way it should be, let’s say the money supply did magically shrink for some reason, and debtors are screwed because of it. So what? Is it our duty to make sure everyone who loses money gets it back? How are we going to fund this?

Let us remember, money doesn’t grow on trees. Meaning that, given a fixed amount of goods on the planet, there is no way in the whole wide world of giving one person purchasing power without taking it away from someone else. Printing money and giving it to anyone at all doesn’t give him free money at no one elses expense. It is taking purchasing power away from everyone else who did not get the free money.

Rather than investing their tremendous mental energies to the question of “How do we create more money, and who should get it?”, your friends should insteadthink about “How can we increase the world’s productivity and make everyone bettor off thereby?” Like the story of the apples in the earlier post.

12

"We are getting into a point that is very unclear to me,and I would very much appreciate any info and help about it. To wit, how does the “money supply itself” shrink? I mean, if lightning strikes many bank vaults simultaneuosly and burns up the dollar bills there, that’s one way. But short of that, I don’t see how it can happen.

Now, I’ve seen people here, non Austrians I imagine, saying that when a debt is repaid the money supply shrinks. But I don’t see how. The dollar bill that the banker gets is still there, waiting to be spent."

I suppose a massive fraud is another way it could happen. I’m not completely clear on the aspects of monetary deflation, either, and would like some more clarification on it. If someone could just elaborate on my creditor vs. debtor analysis for monetary deflation and price deflation, that would be great, too.

"I’ve heard that Milton Friedman wrote a whole book about how the shrinkage of the money supply caused the Great Depression, but I don’t have his book.

In any case, if we assume no central bank, the way it should be, let’s say the money supply did magically shrink for some reason, and debtors are screwed because of it. So what? Is it our duty to make sure everyone who loses money gets it back? How are we going to fund this?"

Depending on how and why it happened, there could probably be more options than simply saying “too bad for you”.

“Let us remember, money doesn’t grow on trees. Meaning that, given a fixed amount of goods on the planet, there is no way in the whole wide world of giving one person purchasing power without taking it away from someone else. Printing money and giving it to anyone at all doesn’t give him free money at no one elses expense. It is taking purchasing power away from everyone else who did not get the free money.”

Under price deflation, I agree with you. Under monetary deflation, this argument is not that strong. The other guy can argue, rightfully, that the destruction of money is hurting everyone since now even honest businesses will have trouble paying back their loans, or borrowing in the first place, due to the floor on the rate of interest. This comes about through no fault of their own.

“Rather than investing their tremendous mental energies to the question of “How do we create more money, and who should get it?”, your friends should insteadthink about “How can we increase the world’s productivity and make everyone bettor off thereby?” Like the story of the apples in the earlier post.”

Indeed; what is the best way out of monetary deflation? If I can make the argument about price deflation, then I think these points can be dealt with fairly straightforwardly, but it doesn’t seem as straightforward when dealing with monetary deflation. Is it just that even honest businesses get wiped out due to a collapse of the monetary supply? Such an event is quite redistributory in terms of winners and losers, and this is where the other side can argue that it is unjust and that some intervention in the case of a monetary collapse is justified. I am not willing to reply “well it sucks for everyone then”, because I don’t believe that, myself. Surely there is a better answer, here?

13

Ultima - “They seem to understand the nature, but they still see the issues that I pointed out.”

By “understanding the nature of money”, I mean understanding the origins of money as a commodity, the most marketable commodity, as explained by Carl Menger. I, or most anyone here, can find some links for you if you would like.

Your friends seem to have an underlying assumption, as follows:

  • Sound money was tried in the past and failed.

  • Sound money has many “ills”, which is why it is no longer used.

  • A central bank solves the problems of sound money.

  • A central bank is vital to a modern, growing, technologically advanced economy.

  • A central bank is the “next logical step” in the evolution of money.

  • Money is a creature of government, only government can provide a stable currency.

  • Money creation must not be left in the hands of private citizens. Its function is too important.

Of course, each of the above is wrong. But when one thinks that these things are true, then questions such as those being discussed will arise. That is why I continue to focus on the nature of money. I don’t think they understand.

14

This makes quite a bit of sense. It definitely seems much better than a fixed supply.

15

facepalm

16

(This post is long because the topic is extremely complex)

First, I do not support an invariable supply of money, but these arguments are either invalid and/or irrelevant. Next, I think a proper definition of inflation/deflation is required in order to avoid confusion. Inflation occurs when the supply of money is elevated beyond the demand for cash holdings, and deflation occurs when the supply of money is reduced below the demand for cash holdings. Thus, you can have inflation without a change in the objective price level whatsoever (due to productivity gains). Inflation and deflation, if such terms are to be useful at all, do not refer to general or aggregate price levels measured by various indices.

Additionally, in a perfect theoretical world, newly created sums of money would flow to those who wish to increase their cash holdings and not their consumption and/or investment. In the real world, however, financial rigidities make this process problematic. Thus, even if the demand for cash holdings rises, and if the supply of money rises pari passu with this altered demand for money, relative and arbitrary price distortions may still occur.

This argument is irrelevant. The degree by which there is an imbalance between debtors and creditors depends on the degree of inflation/deflation. Severe deflation will benefit creditors at the expense of debtors if the interest rate is not property adjusted. At the same time, though, high inflation will benefit debtors at the expense of creditors because it lessens the debt burden (you pay off your debts with devalued currency). But this issue is the least of our worries. It is raised by inflationist’s who lack any actual theoretical support.

Furthermore, “high interest rates” are only “high” if they are arbitrarily set above the natural or equilibrium position. This means that a 15% rate of interest may be “too low,” and a 4% interest rate may be “too high.” The interest reflects time-preference, that is, the rate at which individuals prefer current goods relative to future goods. In other words, it attempts to establish inter-temporal equilibrium; it tells entrepreneurs how to order their capital, what production methods to employ, what capital goods to produce, and tries to create a logical capital structure from the various individual capital combinations amongst firms. It is a price just like any other price which reflects subjective valuations.

First, “no good work done” is both meaningless and arbitrary. “Good work” is determined by the market and not by subjective whims. Next, money is not wealth. The newcomers would produce and would engage in cooperative production relationships because cooperation is always economically superior to isolation. The goods they produce, and the capital they create, will give them bargaining power. It is highly unlikely that money would emerge on an island with a 10 person population, but if it did, it would circulate (exchanged for commodities) and prices would merely adjust.

The first part of this statement is inherently meaningless. Value cannot be aggregated, nor can it be compared. Value is purely ordinal, i.e., it’s a list determined by subjective preferences that are in continuous flux. It cannot be added, divided, subtracted, or whatever. The goal of economics is not to “maintain” some imaginary level of “total value,” but rather to facilitate coordination and production amongst individuals with different tastes, levels of knowledge, and abilities.

The second part of his statement is correct if he means that inter-temporal and monetary equilibrium are relatively beneficial and preferred conditions. He is absolutely incorrect, though, if his position is that stable objective prices is an economically efficient condition. Price “stability” is an inflationist dogma which has failed time and time again.

17

Let the market decide.

18

"Your friends seem to have an underlying assumption, as follows:

  • Sound money was tried in the past and failed.

  • Sound money has many “ills”, which is why it is no longer used.

  • A central bank solves the problems of sound money.

  • A central bank is vital to a modern, growing, technologically advanced economy.

  • A central bank is the “next logical step” in the evolution of money.

  • Money is a creature of government, only government can provide a stable currency.

  • Money creation must not be left in the hands of private citizens. Its function is too important."

Actually, the people I am debating with only really take issue with the first two points. They are not pushing for a central bank, necessarily, but they do think that sound money has its limitations since, by its nature, it cannot have its supply changed very easily. They would prefer to see a monetary system whose supply expands easily, in order to keep the “value” of each unit stable rather than to keep the supply stable. They prefer if 1 unit of currency can always buy a similar amount of goods and services. That is what they are arguing for.

19

“Let the market decide.”

Good answer, and I agree (along with the debaters), but it’s a cop-out answer. It just ends the debate without any progress being made.

The thread you linked is interesting, Merlin. However, do you think that states are able to expand to the degree they have in places such as the USA, mainly because this is what the majority of the population wants? When the BP oil well burst, who did people call first? When people don’t have enough money for their pensions, who do they call first? When people are out of a job… etc…

Many people treat the government as an extension of parental authority; when things are good, they resent the authority, but when things go bad, the government is the first one they run to for help. There is that degree of consent inherent in government which is very difficult to replicate.

20

“This makes quite a bit of sense. It definitely seems much better than a fixed supply.”

Yep, that’s the point they’re making as well, “it seems better”. They can’t quantify that, but that’s what they think.