Really? But for a Mona Lisa, I would offer 100 gold coins plus an Etch & Sketch.
In fact, these gold coins are not sufficient as a medium of exchange and fail to qualify as money.
Since part of a bank’s job is to serve as a warehouse of money, it seems natural that the existence of a bank would help decrease the money supply. It would encourage the transformation of money from liquid into illiquid forms: from cash into checking and savings acounts. Money warehouses are deflationary. The effect is minor since forms like checking accounts are typically included in most money supply measures - the money is readily available and almost interchangeable with cash.
However, fractional reserve practices also have a big inflationary effect since they appear to create money out of thin air. The total amount of money in existence is the same, but because the banks’ insolvency is generally overlooked, the effective money supply is increased. With fractional reserve banking, the money supply is typically increased by several times the amount held in the banks as reserve. Thus, fractional reserve banks are inherently inflationary.
If there were a run on all of the banks, causing them to collapse, many of us would discover that our accounts can’t be honored by the banks. We’d be lucky to get any money out at all. The money supply would shrink dramatically. Proving that the banks are inherently inflationary.
baxter,
The days of goldsmiths serving as banks are long gone because nowadays gold no longer serves as a monetary standard, but the goldsmith’s unbacked receipts can be likened to present-day fiat currency.
Fiat dollars are derived essentially from nothing more than bookkeeping entries. Fiat dollars are (1) loaned into circulation by banks and (2) bought into circulation by the Federal Reserve purchasing government treasury bonds.
I consider checking accounts, debit cards, and demand deposits to be liquid. A credit card acts as a micro-bank by, in effect, issuing an unsecured bank loan to the card holder when the interest-free period expires (usual 30 days) after a purchase and thus (1) increasing the total amount in circulation and (2) increasing the overall average interest rate because secured bank loans generally have much lower interest rates than unsecured bank loans.
When considering the amount of fiat in circulation, I would count all holdings of fiat whether liquid or non-liquid, e.g., including foreign Central Banks’ holdings of fiat dollars that has been loaned/purchased into circulation. NOTE: By 'loaned into circulation" I herein also mean purchased by the Fed into circulation (see sentence two, above).
There is no question that the practice of fractional reserves in banking inflates the amount of fiat in circulation as the reserve requirement is decreased and deflates the amount of fiat in circulation as the reserve requirement is increased. When bank loans proliferate in expanding economies and/or expanding populations, then the amount of fiat in circulation inflates. When bank loans are curtailed, then the amount of fiat in circulation deflates. If the fractional reserve requirement remains constant and the rate of bank loans also remains constant, then I contend that the amount of fiat in circulation deflates because of the drain on the fiat-loaned-into-circulation in order to make interest payments.
Correction of my above post of OCT 25 at 12:32PM: “…banking is basically deflationary if it keeps loans any part of the received interest payments.” out of circulation.
If there were a run on all of the banks, no doubt another “bank holiday” would be declared and the Fed would then load the banks with fiat before they reopened. A run on the banks is unlikely to happen because most of the population are now borrowers with large balances on their credit cards and mortgages.
You’re right, baxter. Therefore, without the interest payment to the bank diminishing the amount of fiat in circulation, my basic banking model would not be deflationary, afterall. Of course there would be a great shortfall if, say, 90% of the loans would suddenly be paid prematurely, but that’s extremely unlikely.
As a student of history, I had always been fed the same line about inflation being “natural” or “inevitable” and when it was explained by instructors as a decrease in value the dollar due to an increase in the number of dollars in circulation, I thought that the whole thing sounded ridiculous and that I would never understand economics. The fact is, it is ridiculous. It is not, however, inevitable; it is one of those things that we have simply been taught is inevitable, often by teachers who probably don’t understand it themselves.
Incidentally, it was my decision to do some research on Ron Paul after seeing his name chalked on sidewalks all over campus that lead me to realize this. Needless to say, I’m now a huge supporter. I am so thankful that he and others are opening up the discourse on this and allowing people to realize that, quite simply, this is not a free market economy, and that we desperately need to return to one.
I’m so pleased that I found this site. Glad to be here in the forums!
I would define inflation as an increase in the money supply relative to the supply of total goods and services in the economy.
In a 100% gold standard system, economic growth would at first decrease the relative supply of currency naturally, simply by an increase in tot\al goods and services. But as this would increase the purchasing power of the individual monetary units, it would become profitable to produce gold – especially under a system of free coinage – as the capital and labor that would go into mining and production of gold coins would be lesser than the labor and capital involved in producing the goods and services that those coins could be traded for. As people worked to produce more gold coins and introduced them into the general economy (by spending them on goods and services), the supply of money relative to the supply of goods and services would then increase, and as an equilibrium is again reached, it would no longer ve profitable to produce gold coins, as the labor and capital involved in doing so would be the same or more than the labor and capital needed to produce the gooods and services the coins are traded for. This is the built-in defense against inflation in a 100% gold standard.
In the 21st century we can have no increase in the money supply without having to go back to the gold standard. Banks could provide a market mechanism where money newly created would be destroyed at a later point.
I would define inflation as an increase in the money supply irrespective of the supply of total goods and services in the economy.
While you are correct in stating that an increase in purchasing power would spur greater production of the monetary unit, I don’t think the effect of that extra production is completely neutral or benign. Gold is useful as a monetary unit because it is rare and hard to produce, even when it’s purchasing power increases. An increasing money supply can still cause all the distortions in the economy that Austrians talk about, even if the supply of goods and services keeps pace at approximately the same rate.
In the 1920s, improvements in technology and methods of production greatly increased the supply of goods, but the newly created Federal Reserve allowed the money supply to expand at about the same rate. Prices appeared more or less static, but the distortions in the economy caused by the monetary expansion resulted in the Great Depression.
The ideal monetary unit is one where it’s supply is non-inflatable. Gold is about as close as you can get to this ideal, which is one reason why throughout the ages it has been used as money. With a completely non-inflating currency, prices will steadily diminish as production of goods and services increases, so people become wealthier, but equally importantly, the structure of production in the economy remains undistorted.
I admit that I have not been studying this quite enough to be absolutely certain of the soundness of my thinking, but I tend to think of the equilibrium of currency (gold) to goods and services as a good thing, price stability being the fundamental point. I agree that the increase of purchasing power of money holders is a good thing, but I see no reason why that purchasing power cannot be represented by an increased quantity of monetary units. Besides, the problem that I envision – and again, I may well be suffering from unsound thinking due to not being as fully well read on the subject as I intend to become – is that the increase in the purchasing power of individual monetary units, though on one hand would be beneficial considering the lowering of prices, would also seem to me to be problematic where wages and costs of production are concerned.
Instead of a gradually increasing wage rate sch as most Americans have now, we would have to figure in gradually decreasing wage rates to accomodate sufficiently low costs of production so that sufficent profits could continue to be reinvested, etc., due to the deflationary effects of a static money supply.
Please let me know if this scenario is incorrect or if there is already a prescribed method for dealing with it.
Reisman sort of discusses this in this article:
Sounds nice when you say it (maybe) but remember that the increase in the money supply needed to do this will cause a business cycle. Why is this goal of “stable prices” worth causing all that misallocation of resources and the resulting recession?
Because this penalizes savings, and emphasizes wages. You’re saying, I think, that the worker’s standard of living goes up because prices remain stable, but his wages increase. But this means that only current income increases in purchasing power, not previous income.
Except that none of this is how wages are determined. Employers cannot decrease wages in order to increase reinvestment - if they could, they would have done it already. Wages are determined by the interplay of various subjective valuations - i.e. “supply and demand.” Also, why do we need to “accomodate” low costs of production?
Why is price stability good? Falling prices are good in the context of increased produtivity and monetary stability.
Because an incease in the quantity of monetary units leads to misallocations of capital and distortions in the structure of production irrespective of price stability.
No, because while the other factors of production are becoming cheaper and more plentiful due to increased productivity, the supply of labor does not, so in relative terms the price of labor (wages) becomes higher.
The cost of any factor of production is determined by its discounted marginal value product (DMVP), which in turn is determined by the price of the finished good in the market. In an economy with static money supply where prices of goods are falling, the DMVPs of all factors of production fall in nominal terms, but the price of labor falls less than the price of other factors. Thus, relative to the price of goods, wages rise (i.e. they rise in real terms), and the cost of other factors fall.
Thanks for the replies, all.
Economics is still relatively new to me. I feel I have a firm grip on the philosophical context of Individualism, i.e. the merits of voluntary association over coercion, property rights, etc., but I’m still not straightened out on the fine details of market dynamics and such. Finished Economics in One Lesson, finished the Road to Serfdom, just started For A New Liberty, Man Economy & the State is in the mail.
It could. But it means that additional monetary units have been created out of thin air by some people, who then stole the riches they could get with this counterfeit money. Even if prices are stable, with an increase of money supply this way, there would be a transfer of riches from those who earn their money to those who get it for nothing. Not to mention the business cycle as others already pointed out. But in a free market, this transfer could be the price people find ok for using that currency from the company offering it. Only the market could tell.
And so? Lower prices, lower wage rates, higher real incomes, everyone’s happy
Paper money is not created out of thin air. Nobody is stealing anything, and there is no comparison of paper money issue to counterfeiting. Every time any bank (the Fed included) issues a dollar, it gets a dollar’s worth of assets in return, and it stands ready to use those assets to buy back the dollars it has issued. As long as the bank’s assets rise in step with the money it issues, the value of each dollar is unaffected. The same is true of any financial security. If General motors issues new shares of stock and sells them for the market price (say $60 each), then GM’s assets rise in step with the number of shares issued, and the value of each share is unaffected.
If there is no steal, I guess that it is a profitable game. Why not then buy all the bonds detained by the financial institutions, all the bonds newly issued by the Government and perhaps all well rated corporate and municipal bonds ? You’d have under the premise of profitability a more ample money supply, bond issuers would just have to get a good rating.
Well it does not work this well. Rather, it is a loosing game.When the Fed creates money, generally rates go down : the Fed buys Bonds from commercial banks and every financial institutions buy Treasuries from others. When the Fed sells Bonds, less money circulates and every financial institutions sell Treasuries too. But the money supply is still higher than it was at the onset of the creation of money by the Fed as unfavorable Bond prices can not pump enough money out.
At the end of the cycle, The Fed has lost money, it has given out more money than it has received. A central bank would not exist this way without the power of the government. Everyone seems to like the idea of having a central bank. The price to pay is inflation, destruction of profitabilty (the CPI can not go down) and worse, financial crises every 5 years.
Why is it that any time there is a chance Wall Street can get hit hard in the financial sector, the fed (entity of congress) goes on a charitable crusade in the form of lower FFR (federal funds rate) and a rather large cash infusion??? If this fiat money wasnt effected by lack of confidence, the fed would let WS correct itself. Instead, poor banking practices and weak investment gets bailed out…
What happens when the assets the bank requires for collateral decrease in value relative to the initial amount of money loaned??? Its times like this when foreclosure is the most apparent. What happens to that floated money after only a % of it was collected after a default???
Seriously, there has become a lack of responsibility. Some would call this a “moral hazard”.
The argument i receive at a constant rate from left wing America is, “the feds ability to help cushion the fall on businesses and banks allows for recessions to be less severe and people dont have to suffer as much. During the “gold era”, recessions were much more turbulent and our current system makes life easier for us all.”
I dont know whether to throw up when hearing that, or say to myself, “Darwin was right”. As said very effectively by George Carlin, “the kid who swallows to many marbles shouldnt grow up to have kids of his own.” If a company was/is unable to make it through a recession without going completely under, it didnt deserve to be in business in the first place…
The reason that people ignore the Austrian (Correct) view and subscribe to some other view is that people hope that their suppliers of life, governments, are telling them the truth. It is just that simple. People have become so dependent on government that they believe it to be their savior.
We got there through the ultimate government program: WAR!!! People had a stupendous amount of faith in government at after WWII that they kept the stupid ideas of Keynes and Rosevelt. People thought what could be a more powerful agent of peace and prosperity other than the government that won WWII?
First, let me say I am a neophyte to this subject so please excuse my ignorance as I work my way through the subject of inflation. Earlier someone mentioned the price decrease in computers, so using that item for my question; if the supply of money is the cause of inflation, and computers have bucked this trend trough productivity, technological advances… Using lets say $1,000 as the starting price and then a few years later the price is now $800 is it safe to assume that the new $800 price was still affected by the inflationary factors of the money supply? In other words without the inflation the computer my have only cost (for agreements sake) $600 now?