Sorry errors about Hyperinflation and Deflation.

Economics Economics Questions
1

A popular poster wrote about deflation, claiming that

“People will wait to make purchases of non essential items hoping for a better price.”

Asked for an example of when this happened, he replied:

“The great depression.”

He explained that this is what happened:

“During periods of intense inflation people rush to spend their cash. In other words, the expectation of severe future inflation leads to a “flight” away from the monetary unit towards other assets. This is self-reinforcing and eventually yields a hyperinflation. Similarly, when individuals expect future deflation, they will hold off on purchases until prices fall to, what they consider to be, “a low enough level.” This is also self-reinforcing, and is the inevitable result of human rationality.”

Let me quote our man Hazlitt, who, gifted with second site, 40 years ago wrote a rebuttal of the poster’s thinking:

The other major defect in the cash holdings approach is that, no
matter how much or often individuals decide to spend, the average
cash holdings of all individuals in the country cannot be reduced!
If a country has a population of approximately 200 million, and the
total money supply is $800 billion (counting currency in the hands
of the public, plus both demand and time bank deposits), then the
average cash holding of each individual must be $4,000. The money
must always be held by someone. What Peter spends, Paul receives.
If half the people in the country, by increasing their spending,
reduce their cash holdings by an average of $1,000 each, the other
half must increase their cash holdings by the same average amount.

In other words, you cannot have the whole country, or even most of them, or even an amount significant enough to change things, hoarding or dishoarding. Because someone is ALWAYS holding on to money. Every single dollar has to belong to someone.

Not only that, explains Hazlitt:

…even if otherwise correct, it would account only for a relatively

small change in prices compared with the rate of monetary increase.
Suppose people normally kept as an average cash balance the equiv-
alent of 10 percent of their annual incomes, or roughly enough to
spend over the next thirty-six days. If, in an inflation, they were
willing to let their cash balances fall even to zero, this would only
add some 10 or 11 percent to the total “active” money use. It
could not account for the almost incredible fall in the purchasing
power of the monetary unit, when compared even with the increase
in the money stock, that occurs in a hyperinflation.

In other words, you can’t pull off a hyperinflation or a severe deflation by playing with petty cash. Which is what people save, pretty much.

Another flaw in the argument is, to quote Hazlitt:

In order
for such an increase to occur, it is not merely necessary that the
holders of money should be eager to get rid of it as quickly as
possible, but that the sellers of goods should be correspondingly
ready to part with their goods for money.

In other words, for every smart person trying to ditch his money, there has to be a corresponding INCREDIBLY STUPID one willing to accept it. Which is is simply unlikely.

And indeed, if we check out our history we find the good ole Weimar Republic. The Weimar Republic’s hyperinflation was caused supposedly by people dumping their money like madmen, according to the poster.

However, Hazlitt points out that :

…Bresciani-Turroni
himself tells us, "The risk of transactions effected by payment in
paper marks became so great in the summer of 1923 that many
producers and merchants preferred not to sell at all, rather than
accept in exchange a money subject to rapid depreciation."1

In other words, guess what? People are not as dumb as they look.

Now the poster defended himself by saying Milton Friedman proved it all in his Monetary History of the US. But as our man Mark Thornton pointed out, that whole fat book is one big post hoc ergo prompter hoc fallacy. He gives no explanation for the correlations he discovers. And of course the poster’s expalnations have been shown deficient by our man Hazlitt.

Source for all this is Hazlitt’s short [free] classic, The Inflation Crisis and How to resolve it.

2

Great stuff, Dave.

And here’s some more from the same book:

What is called the cash balance approach is less fallacious than
the mechanical quantity theory of money. It does contain an ele-
ment of truth, but in some formulations it confuses cause and ef-
fect. It is true that when people think that the value of money is
going to rise — in other words, when they think commodity prices
are going to decline — they tend to spend less money immediately.
And when they think the value of money is going to fall — that

is, that commodity prices are going to rise — they tend to spend
more money immediately. But the cash balance approach puts too
much emphasis on a physical act and too little on the subjective
change of valuation that prompts the act. The value of money does
not decline because people try to speed up their spending; they
speed up their spending because they think the purchasing power
of their money is going to decline.

So that poster put the cart before the horse.

In his brilliant manner, Hazlitt explains it to the meanest intelligence:

We can understand this better if we consider the purchase and
sale of shares on the stock exchange. Suppose during a day’s session
American Steel publishes an unexpectedly favorable quarterly earn-
ings report, that 10,000 shares are traded in, and that the price rises
from 30 to 40. The price has not risen because Jones, Smith, and
Watson have bought 10,000 shares from Brown, Green, and
Doakes. After all, as many shares have been sold as bought. The
price rises because both buyers and sellers now estimate the value
of American Steel shares higher than they did before. Suppose,
again, that National Motors closed at 35 on Monday, that after the
close the directors unexpectedly fail to declare the regular dividend,
and that the stock opens Tuesday morning at 25. This sort of thing
happens frequently. There have been meanwhile no sales on which
to blame the decline. The stock has fallen in price simply because
both buyers and sellers now put a lower estimate on it. This is
precisely what happens with the value of money. It is changes in
value estimates that count, not changes in cash balances.

3

It’s called speculative behavior without which makets could not clear.

4

The point he is trying to make is that serious deflations and/or recessions could not hapen from that

5

Just to nitpick:

The other major defect in the cash holdings approach is that, no
matter how much or often individuals decide to spend, the average
cash holdings of all individuals in the country cannot be reduced!

This assumes the amount of cash is not changing (the central bank can do that) and that cash does not leave the country.

6

Andris,

His point is that the change in the amount of money in the country is the cause of inflation or deflation, not the decision by people to hold more or less cash. To prove his point, he assumes a constant amount of money [the ole ceteris parebis gag], and then shows that the cash holdings theory makes no sense.