Asked if it's tax money the Fed is spending, Bernanke said, "It's not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. It's much more akin to printing money than it is to borrowing."
"You've been printing money?" Pelley asked.
"Well, effectively," Bernanke said. "And we need to do that, because our economy is very weak and inflation is very low. When the economy begins to recover, that will be the time that we need to unwind those programs, raise interest rates, reduce the money supply, and make sure that we have a recovery that does not involve inflation."
This is mind-boggling! Need some more money? Here, just let me access your account... I'll just tack a few zeroes on the end there and call it good. Whew, crisis averted.
Good ol' Ben Bernanke is admitting that they create money out of thin air! By magically increasing the amount of money he has effectively made the dollars that you worked hard to earn worth less. This is a blatant inflation tax!!! Where's the outrage???
I am sorry to say but this is no secret. The Fed has always increased the money supply. In fact, they increase the money supply about 3% every year to "keep up" with inflation. If they did not increase the money supply, there would not be enough available funds in the economy to grow and function as is.
ReplyDeleteWhen the demand for money is high (i.e. a high demand for credit), this puts upward pressure on the cost of money (i.e. interest rates). In order to keep this cost of money down, one thing the fed can do is increase the money supply so that there is more money to lend which puts downward pressure on the cost of money.
That is usually the last tool in the Feds arsenal that it tries to employ. But when you have decreased the Federal Funds rate to 0% and it still is not increasing lending then you have to pull out even more of the stops.
The counterpoint to this is that the Fed can just as easily DECREASE the money supply to combat inflation. This money that it creates is given to the banks in a complicated reserve system and it can just as easily be taken back. Same with interest rates; they can be raised as easily as they are lowered.
I applaud the Fed for its efforts. Thank goodness they are an autonomous agency and not subject to partisan politics. If it were not so then I guarantee you things would be way more screwed up than they are!
-Jared T
“Keeping up” with inflation or creating it? Let’s not get confused about inflation. To quote from what Henry Hazlitt said back in 1964:
ReplyDelete"Inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit. In fact, inflation is the increase in the supply of money and credit. If you turn to the American College Dictionary, for example, you will find the first definition of inflation given as follows:
Undue expansion or increase of the currency of a country, especially by the issuing of paper money not redeemable in specie.
In recent years, however, the term has come to be used in a radically different sense. This is recognized in the second definition given by the American College Dictionary:
A substantial rise of prices caused by an undue expansion in paper money or bank credit.
Now obviously a rise of prices caused by an expansion of the money supply is not the same thing as the expansion of the money supply itself. A cause or condition is clearly not identical with one of its consequences. The use of the word "inflation" with these two quite different meanings leads to endless confusion." -(www.mises.org/story/2914)
The Fed is responsible for the current mess, not the ones who are going to fix it. Doesn’t the fact that the Fed has free reign over our currency with no accountability to the citizens scare you? Do you really trust these guys implicitly? I don’t. When price inflation starts to set in they will not be able to decrease the money supply fast enough. They’re playing with fire and we’re all going to get burned.
I sure do trust the Fed about a bazillion times more than I would trust politicians to manage our country's monetary policy.
ReplyDeleteSo why is everyone so afraid of inflation? What you should be afraid of is hyperinflation. Inflation is better for an economy than the alternative; deflation.
Follow me on this (drastic) thought experiment. Lets say you have saved up some money and have decided that you want to purchase a new TV (plug in any other durable or semi perishable good here).
Scenario #1: You think the prices of TV's might go UP in the next couple of months by 50%, but you don't know when. There is talk about increasing prices of TV's in the news. You go out to Best Buy and purchase this TV this week so that you can get it at a better price now.
Scenario #2: You think the prices of TV's might go DOWN in the next couple of months by 50%, but you don't know when. There is talk of decreasing prices of TV's in the news. You decide to stick it out for a few months, maybe longer, to see if you can get a better deal.
While you as a consumer would initially like scenario #2, think about the effects on the economy. This leads to reduced spending of TV's, therefore reduced demand, therefore a reduced need for production capacity (labor & capital investment). This usually results in company layoffs. Not so fun especially if you have a job tied to TV production, distribution, or retail.
Now lets say that the prices of ALL goods are decreasing. Can you say recession? How about mass layoffs? A deflation in house prices is exactly what triggered this entire recession (not ignoring the fact that we did have an overvaluation in the housing market, perhaps hyperinflation!).
So anyway, dont be so afraid of inflation. A bit is healthy for an economy. The key is to keep it under control.
As far as expanding money supply and credit, if the money supply was never expanded and was tied to something as silly as a gold standard then it is very likely you would have never worked for ZARS or perhaps your current company because they would have never existed. They would have never been able to get the money to even begin their businesses. You would likely see the economy even more dominated by a few large corporations because they would be the few with access to limited dollars available for credit. As most jobs are created by small businesses, you would likely experience a higher natural rate of unemployment and a stifling of innovation. All this because of a restricted monetary base which makes it very difficult to start a business.
I think you’re still stuck on the “inflation = increase in price” fallacy. Rising prices are NOT inflation, they are a RESULT of inflation (increase in money supply). Likewise, falling prices are not the same as deflation. You’re whole argument hinges on the idea that if we don’t increase the amount of money in circulation then there won’t be enough money to go around to purchase an increased amount of goods. Take a moment and reflect on this. It is really NOT a valid assumption in true free-market system.
ReplyDeleteIf the amount of money remains constant, then prices and wages will have a tendency to go down if the amount of goods increases… but you will be able to buy more with your money. The buying power of the dollar goes up. It ends up being a zero-sum gain. You’ll be able to buy more with less money. The constant amount of money in the system may affect the price, but it will not affect the profitability of the goods. However, there are two scenarios that would be scary to the consumer when prices go down [not to be confused with deflation because the amount of money is constant]. (1) The consumer has a lot of debt, and now with falling wages it is harder to repay that debt; (2) wages are not allowed to fall thereby leading to unemployment. Either of these situations would be undesirable to the consumer. Both of these situations are prevalent right now, which is why everyone is all worked up about falling prices.
So, you say that inflation is healthy for the economy? You say that a gold standard is silly? I say that A SYSTEM BASED ON MONOPOLY MONEY IS NOT JUST SILLY, BUT DOWNRIGHT LUDICROUS! I say that inflation is necessary to artificially support high wages and high prices. Inflation is necessary to allow people easy access to credit, and the huge debt that goes with it. It’s necessary for an instant gratification mentality. The housing bubble is just the ugly monster of the enormous credit bubble that created it.
Throwing more money at the problem (i.e. inflation, by definition) will serve to devalue my hard-earned money. It is essentially an INFLATION TAX imposed by the government on all holders of American Dollars. I guess I can sit back and feel good that the Chinese, Japanese, and all other investors in our currency will bear the brunt of this tax as much as I will… at least until we piss them off so much that they stop buying our treasuries and sell off the ones they already have. What do you think that will do to the value of the dollar?
We are walking a really fine line right now. I guess we’ll see in the next decade whether you are right or I am right. I tell you what. You stuff your pockets with dollars and I’ll stuff mine with gold and we’ll see who comes out on top in 2019. Deal?
Nathan,
ReplyDeleteAre you really stuffing your pockets with gold? I think it would be really cool to have a little treasure chest full of gold coins hidden under my bed. And I could pick up the coins and let them cascade through my fingers like Scrooge McDuck. Problem is I think I could only afford 2 or 3 coins right now. Not enough to fill even a mini treasure chest.
I've actually considered putting some money into Treasury Inflation Protected Securities (TIPS) as a hedge against the high (with no basis at all, I predict between 8 and 13% annually some time in the next 3 years, probably for at least a few years in a row) inflation that I anticipate. TIPS are basically low-yield bonds with interest payouts adjusted for inflation, so you're hedged a bit. Versus gold, TIPS have the disadvantage that they are based on the US government's ability to pay, so if the government goes belly up, I'd be outta luck. I'm OK with that risk at this point. They have the advantage of being less subject to market pressures than commodity (i.e. gold) prices. With gold, as with any other security or commodity, the trick will be to get out while the price is relatively high. The price can move very quickly and is likely to tank during the next economic expansion. I don't like trying to time the market.
As far as a gold standard rather than a fiat currency (monopoly money like we have now), I've been trying a little bit to understand it, just as a hobby. You seem to have done more research than I have. Can you tell me if I'm off base with the following:
By tying a country's currency to gold, you essentially tie monetary policy to a conglomerate of mining operations rather than putting it in the hands of a treasury secretary. Because there is only a fixed amount of gold, or because it is only being produced at a relatively fixed rate, expansion of the money supply takes place at a very predictable (and essentially unalterable) pace. There's not a lot that's really particularly special about using gold as the standard. You could just as easily use any other resource with a fixed production rate, if the resource was relatively immutable. So say, silver, dinosaur bones, diamonds, geodes, or maybe moon rocks. Any of those could form a "standard" for a currency, which would be roughly as reasonable or as silly a choice as gold.
The main benefit I see of a fixed standard is it keeps the fed from screwing up because it takes away their power to print money. The main disadvantage of it is that it keeps the fed from printing money and basically takes away or severely limits the fed's ability to control the money supply to react to economic conditions. So when we say gold standard = good or gold standard = bad, the main thing we're arguing about is whether fallible people controlling the money supply is good or bad. Is that basically it or am I missing something big? I know there are other smaller considerations, but to me, that seems to be the main one.
For the record, your inflation / printing money = hidden tax argument is exactly right, even if it's not exactly news. I thought people knew that. Maybe I give the general populace too much credit. When the government is going into debt, it has to pay for that somehow. Methods of payback include taxation (explicit and hidden--i.e. increasing money supply) and/or reducing future services. If you have debt and you have income, inflation is awesome because it means I can make my mortgage payment using worthless dollars. If you have savings rather than income, deflation is awesome because it gives your savings more buying power. To me, inflation or deflation, it doesn't really matter as long as it's relatively constant and predictable because then you can make reasonable decisions in business negotiations like getting a loan or getting a particular ROI based on a particular risk. It's the unpredictability that really makes a mess of things.
Eh, I gotta get back to work. Tell me whether I'm off base about gold standard stuff. I'm curious.
Plus I'm stuffing my pockets with shares of well-managed, profitable companies while they're on sale, rather than stuffing them with gold or dollars. The idea that there are only two choices is a fallacy.
Alan, Thanks for the additional perspective on the matter. Unfortunately, I don't have the funds required to accumulate large amounts of gold to literally stuff my pockets. However, I have put about 10% of my now-decimated portfolio into precious metals, but not for investment purposes. I want to be prepared for a worst-case scenario. So, for the same reason I have food storage I also have a small amount of silver and gold; just in case the time comes when I need a hard currency because my dollars are effectively worthless.
ReplyDeleteYou asked the question, “…am I missing something big?” My answer is that you’re light years ahead of most people. I always felt like I was missing something. Even though I consider myself a person of above average intelligence, the whole economics thing never really made complete sense to me until I discovered the Austrian School of economic theory. It was like a light went on in my head and suddenly things started to make sense! The business cycle, inflation, and bubbles are all making sense to me now in a new enlightening way. And it scares me. The disciples of John Maynard Keynes are unwittingly bringing the system down, and they don’t even see it. Anyway, I think you should visit the website: www.mises.org and check out the Austrian School of economics. In particular, go to this story: http://mises.org/story/3368 to learn more about the gold standard. I think you’ll find it highly insightful. Also, there are tons of free economics book available from the Mises Institute. I’m reading one now about inflation that is very interesting.
I feel like I’m proselytizing, but I think that it’s important that people understand that there is a different school of thought out there and we are not limited to what’s popular in today’s classroom. Don’t worry, I can still be friends with Keynesians even though I don’t agree with them :)
You should definitely proselytize if you find something which you find valuable. Regarding fiscal economics, it's nice to see another school of thinking. Anyone with any education at all in economics these days (I have very little) is heavily steeped in the Keynesian school. Perhaps not providing the opposing viewpoint early in economics education is a disservice to students.
ReplyDeleteThe article on the gold standard was quite useful. Thanks. It confirmed most of what I was thinking. I came away from reading it thinking that Friedman's idea of just setting a standard expansion rate for the money supply and not altering it would be really a pretty good policy, even though the writer kinda dissed it.
Some of the arguements presented were specious (i.e. Look! Gold had a constant exchange rate vs. the dollar before we killed the gold standard.---Duh. It was constant because the government forced it to be that way by definition. The author presented the argument and then shot it down himself. It was such a stupid arguement it was insulting to even present it.) The real argument, which is fairly convincing at first blush, is the CPI before and after the cancellation of the gold standard. Even that's tricky though because of the way the CPI calculation has changed over time. Read about hedonics some time and it will really get you steamed. Talk about hidden taxation! Jim Jubak at MSN Money has written some about it.
Should you include or not include energy in the CPI? Early 20th century I assume energy costs were a negligible impact on CPI. Not so much after WW2 and toward the end of the century. Not clear what goods went into the CPI the author was quoting. He cited approptiately, but I would have to do a lot of digging to figure out what was used / not used for each particular data point. But I'd bet money it's not the same across the whole time span.
I've read a few articles from the Austrian school regarding the places where Keynesian theory falls apart. The Austrian theory presented as an alternative also has problems, which, from what I can tell, Austrian school economists seem to ignore. I may read more so I can understand the arguments better. At the very least it provides interesting mental gymnastics, which I love to engage in.
So far I have:
Keynesian problem as defined by Austrians: Wealth production doesn't come from spending money, it only comes from investing in capital (which the Austrian school disingeniously and confusingly calls "saving", as if it's the opposite of spending or consuming, which it clearly is not).
Austrian response: Encourage "saving" (i.e. investment in capital) and everyone will prosper.
Austrian problem: Invest in capital and equipment all you want. If no one buys your goods, you just sunk your money for no gain. It seems perilous to ignore the demand side of the equation.
Austrian response: ????? (I haven't found it yet.)
Keynesian view: Who cares about production? If people want stuff, someone will produce it. That's where your investment (i.e. Austrian "saving") will be stimulated. Focus on the consumption, that's where it's at.
Keynesian blindness: If we just focus on stimulating consumption and completely ignore investment, it will lead (and has led) to leveraged consumption (debt) for things of questionable value (fancy car, bigger house than you need, fancy clothes, awesome sword-canes). Forcing capital investment in equipment to produce goods of questionable value doesn't make an economy or a country any more wealthy, I don't think. It seems perilous to ignore the supply side of the equation.
Austrian view: If you build it, they will come. Just invest in capital and produce stuff. Someone will buy it. Don't worry about who or why. If there's stuff, it'll be bought.
Austrian blindness: Already stated. It's a big assumption to think that just because you build stuff someone will want it at a price that's profitable for a capital operator. It worked for Kevin Costner in the movies, but not for a large number of failed small business owners.
Seems to me there should be some sort of harmonization between the two schools which would make the most sense to me. That's 'cause I'm a Libra though. Always looking for a third way. It's possible the Austrians have "the way". I haven't read enough to feel like I can clearly elucidate their ideas. I'm pretty sure Keynesians don't quite have "the way" though. But I'm not convinced yet that Keyensianism couldn't be tweaked to work right. Maybe it can't though.
Interesting stuff. Back to work. Good thing I'm not in charge of the world. We'd never make any decisions or get anything done.
I don’t claim to completely understand the Austrian school, but I think that the definition for “savings” that you have imposed on them is actually more limiting than they intended. While exact definitions differ from one expert to another, the general meaning that I have adopted is much broader (i.e. does not include just capital equipment). For example, I think it would be unwise to invest in capital equipment at a business where the demand did not justify it (if you build it, they will come mentality). That doesn’t make a whole lot of sense. It would be foolish to ignore things like supply and demand. I like what Frank Shostak had to say about savings in one of his articles, quoted below (http://mises.org/story/1882).
ReplyDelete“What is saving?
Saving as such has nothing to do with money. For example, if John the baker produces ten loaves of bread and consumes two loaves his saving is eight loaves of bread. In other words, the baker’s saving is his production of bread minus the amount of bread that he consumed. The baker’s saving now permits him to secure other goods and services. For instance, he can now exchange his saved bread for other consumer goods or he can exchange it for oven parts and tools…
…The existence of money also resolves the difficulty of saving perishable goods. Rather than trying to save by storing the bread the baker can now exchange his unconsumed bread for money and avoid the need of storing the bread. Needless to say that the storing of the bread runs the risk that in a few days time it will become an unwanted good. The unconsumed production of bread is now “stored” so to speak in money.
Money can be seen as a receipt, as it were, given to the producers of final goods and services that are ready for human consumption. When a baker exchanges his money for apples the baker has already paid for them with the bread produced and saved prior to this exchange. Money therefore is the baker’s claim so to speak on real savings. It is not, however, savings. Money only provides the ‘facility’ for the baker to pay for various goods and services he wants with his produced and saved bread. Likewise other producers by means of money can now secure the final goods and services they desire.
So if we do not save money as such what then are various savings deposits and other savings schemes? Don’t we save money by placing them in various saving deposits? No. What we are doing here is lending money to financial intermediaries, which means that we are transferring claims on real savings to financial intermediaries. Financial intermediaries in turn lend the money out to various individuals, i.e., transferring claims on real savings to the borrowers.
Let us now examine the effect of monetary expansion on the pool of real savings. The expanded money supply was never earned, i.e., goods and services do not back it up, so to speak—it was created out of “thin air.” When such money is exchanged for goods it in fact amounts to consumption that is not supported by production. (As a rule it leads to nonproductive consumption).
Consequently, a holder of honest money, i.e. an individual who has produced real wealth that wants to exercise his claim over goods, discovers that he cannot get back all the goods he previously produced and exchanged for money. In short, he discovers that the purchasing power of his money has fallen—he has in fact been robbed by means of loose monetary policy. The printing of money therefore undermines wealth generators and thereby weakens the pool of real savings over time.” – Frank Shostak
This broader definition of "saving" makes more sense than the one I originally attributed based on reading a few articles. I still take umbrage at the twisting of the definition though. "Saving" in common parlance means not spending money. To use that word and attribute a slightly twisted meaning to it just serves to confuse the argument. It's kind of a snooty way for academics to say "Oh yeah, well you don't even know what _saving_ is!" It's juvenile and not in the spirit of true knowledge discovery.
ReplyDeleteNonetheless, it is an interesting way to look at things. A new perspective is always good.
Notice that the Austrian blindness I alluded to before is vividly present in Shostak's article. In his example of the bread baker saving 8 loaves of bread by not consuming them himself, he blatantly ignores the demand side of the equation (just as Keynesian thought blatantly ignores the supply side). He asserts that by producing and not consuming 8 loaves of bread, the baker has created stored value (saving). And further he can now "secure other goods and services" using his saved loaves.
I think it is obvious that the baker has created no value and "saved" absolutely nothing unless there is a market that demands his output and is willing to exchange value for it. All the writing from the Austrians that I have read, as with Shostak's, blatantly ignores this fact. Perhaps they feel it is so obvious that it goes without saying. After all, why would someone waste time producing something he can't sell at a profit? (ask a failed business owner and see what they say).
In much the same way, Keynesians probably feel it is obvious that if there is demand, production will certainly arise to meet it, so they never discuss production. After all, why would any businessman ever leave a dollar on the table? Ask anyone who tried to buy a Nintendo Wii for Christmas 2 years ago how well that assumption works.
I'll present a Keynesian demand arguement just for fun. To go back to our wealth-conscious baker, let us consider what would happen to his wealth if he were only able to sell 6 loaves of bread per day. Now the money fairy waves a wand and creates some colored paper ex nihilo which dilutes the money supply. Let us say that 1 piece of colored paper used to represent the stored value of 1 loaf of bread. After dilution, 1 piece of colored paper only represents the stored value of 0.9 loaves of bread.
The magically created colored paper goes in the account of some magic central bank which feels a compulsion to lend the colored paper. The paper is lent to a previously unproductive person who chooses to use this loan to set up a shop making awesome sword-canes. This shop owner could not previously obtain funding for his enterprise, but because of a concentrated injection of funds into that one bank, he met the bank's loosened loan cutoff requirements.
The sword-cane shop is successful and employs three people. Each of these people happen to like bread, and they consume 1 loaf per day, which they purchase from our conveniently located baker.
The baker is now able to exchange 9 loaves of his valuable bread per day for colored paper representing his stored value for a loaf of bread. Because he was a nice guy, he took a hit on his profit margin and is still exchanging the stored value of his bread for a receipt of 1 piece of colored paper per loaf. Before the money fairy diluted the money supply, he was able to store 6 loaves worth of value units per day (6 loaves x 1 paper per loaf). After dilution, he was able to store 9 loaves worth of value per day, albeit at a reduced value per loaf, so 9 loaves x 0.9 papers per loaf = 8.1 value units (undiluted loaves) per day.
The industrious baker had his money devalued, but by the same stroke was able to increase his daily wealth accumulation by over 30%. He may decide that the money fairy is his new best friend. Especially if he didn't have a great deal of savings which were devalued.
Obviously that's a very simplified presentation, with the numbers rigged to make the Keynesian point. Maybe in the real world the money gets devalued 50% and the baker goes out of business because he can't raise prices quick enough to cover his costs. Hard to say.
The trick with the Keynesian model would be to inject just enough money to get new funding to businesses that would in turn create actual value. The initial money injection definitely has no inherent basis for value (as Shostak clearly points out), which is why purchasing power is eroded. One of the things that happens when money's too loose is dot com bubbles (i.e. tons of companies getting funding for businesses that would never create actual value). So you've got to be careful to get actual wealth creation in exchange for your currency dilution. You have to do just enough to get money to the right value-creating enterprises while avoiding excessive dilution. I don't know if it's possible to do that or if it's a zero-sum exercise or if it's always a losing exercise, but my gut says if it were managed just right, it would be possible to have money dilution be a net positive.
In short, I think the next writing I need to seek out is that of an Austrian writing about the importance of demand and also that of a Keynesian writing about the importance of production. I would be quite interested to see what they would say. I think both writers would be challenged and quite out of their element.
You know Nathan, one of the regrets I have in us both leaving ZARS is that I never got a chance to really write anything with you. You are a good writer and you have a brilliant mind. If we ever get a chance, it would be fun to publish something together.
Have a great weekend!
I would thoroughly enjoy a good writing adventure, especially if it involves fairies and sword-canes!
ReplyDeleteI might just have to come up with something. I've had sword-canes on the mind because my back has been acting up again and the herniated disc has me walking with a pronounced limp and weakness in one leg. I've actually been considering getting a cane, kind of as a joke, but kind of because it would be a really helpful thing until I get this disc back under control. And if I get a cane, it's going to be a sword-cane for sure. When I mentioned it, the doctor I'm seeing actually recommended a place that sells really awesome hand-carved ones from Africa, though they cost 500 or 600 bucks. A little steep, but it's hard to beat the awesomeness of a sword-cane.
ReplyDeleteIf you want a sword-cane that's a little more economical try www.budk.com. That's where I got the spiked flail for Wade. I bet you could get a sword-cane for under $50. Not as cool as a hand-carved cane from Africa, but more accommodating to the wallet.
ReplyDeleteIf I had $500-600 to spend on weaponry, I would much rather buy a good rapier with matching main gauche.