MCViewPoint

Opinion from a Libertarian ViewPoint

Posts Tagged ‘Deflation’

« Previous Entries

Watch “The Battle Between Deflation and Inflation” on YouTube

Posted by M. C. on November 26, 2022

Former Congressman Ron Paul gave the seventh talk in our online conference “End Inflation and End the Fed.”

Former Congressman Ron Paul of Texas enjoys a national reputation as the premier advocate for liberty in politics today. Dr. Paul is the leading spokesman for limited constitutional government, low taxes, free markets, and a return to sound monetary policies based on commodity-backed currency. While in Congress, he was known among both his colleagues in Congress and his constituents for his consistent voting record in the House of Representatives, never voting for legislation unless the proposed measure was expressly authorized by the Constitution.

https://youtu.be/6UsLUV7Y11E

Be seeing you

Posted in Uncategorized | Tagged: , | Leave a Comment »

Declining Prices Do Not Destroy Wealth; They Enable Its Creation

Posted by M. C. on November 11, 2022

Historically, the natural tendency in the industrial market economy under a commodity money such as gold has been for general prices to persistently decline as ongoing capital accumulation and advances in industrial techniques led to a continual expansion in the supplies of goods. Thus, throughout the nineteenth century and up until the First World War, a mild deflationary trend prevailed in the industrialized nations as rapid growth in the supplies of goods outpaced the gradual growth in the money supply that occurred under the classical gold standard. 

The Fed obviously doesn’t understand this. Congress is equally at a loss.

https://mises.org/wire/declining-prices-do-not-destroy-wealth-they-enable-its-creation

Most economists believe that a general decline in the prices of goods and services is bad news because it is associated with major economic slumps such as the Great Depression. In July 1932, the yearly growth rate of US industrial production stood at –31 percent whilst in September 1932 the yearly growth rate of the US Consumer Price Index (CPI) stood at –10.7 percent.

Many economic commentators claim that a general fall in prices is always harmful, since it postpones people’s buying of goods and services, which in turn, they believe, undermines investment in plant and machinery, setting an economic slump into motion. Moreover, as the slump further depresses the prices of goods, the pace of economic decline intensifies.

In contrast, Austrian economists such as Murray Rothbard have believed that in a free market the rising purchasing power of money—i.e., declining prices—is the mechanism that makes the great variety of goods produced accessible to many people. Rothbard wrote:

Improved standards of living come to the public from the fruits of capital investment. Increased productivity tends to lower prices (and costs) and thereby distribute the fruits of free enterprise to all the public, raising the standard of living of all consumers. Forcible propping up of the price level prevents this spread of higher living standards.

Also, according to Joseph Salerno:

Historically, the natural tendency in the industrial market economy under a commodity money such as gold has been for general prices to persistently decline as ongoing capital accumulation and advances in industrial techniques led to a continual expansion in the supplies of goods. Thus, throughout the nineteenth century and up until the First World War, a mild deflationary trend prevailed in the industrialized nations as rapid growth in the supplies of goods outpaced the gradual growth in the money supply that occurred under the classical gold standard. For example, in the US from 1880 to 1896, the wholesale price level fell by about 30 percent, or by 1.75 percent per year, while real income rose by about 85 percent, or around 5 percent per year.

Countering Falling Prices with Money Pumping Weakens the Economy

Whenever a central bank pumps money into the economy to counter a general decline in the prices, this policy benefits those engaged in activities tied to loose monetary policy, but at the expense of wealth generators. Through loose monetary policy, some individuals become consumers without the prerequisite of contributing to the pool of real saving. Their consumption is made possible by diverting real savings from wealth producers.

If the pool of real savings still is growing, goods and services patronized by non–wealth producers appear to be profitable. However, once the central bank reverses its loose monetary stance, diversion of real savings from wealth producers to non–wealth producers is arrested, undermining the demand of non–wealth producers for goods, and exerting downward pressure on their prices.

While the pool of real savings expands, monetary pumping generates the illusion that loose monetary policy is the right remedy to counter a general decline in consumer prices. This is because the loose monetary stance, which renews the flow of real savings to non–wealth producers, props up their demand, arresting or even reversing general decline in prices.

Because the pool of real savings is still growing, the pace of economic growth stays positive. Hence the mistaken belief that a loose monetary stance that reverses a fall in prices is the key to reviving economic activity. The illusion that through monetary pumping it is possible to keep the economy going is shattered once the pool of real savings begins to decline.

Lending Out of “Thin Air” Encourages Unproductive Activities

When loaned money is fully backed by savings on the day of the loan’s maturity, it is returned to the original lender. For instance, Bob—the borrower of $5—will pay back on the maturity date the borrowed sum and interest to the bank. The bank in turn will pass to Joe the lender his $5 plus interest adjusted for bank fees. The money makes a full circle and goes back to the original lender. In contrast, when the lending originates out of “thin air” and the borrowed money is returned on the maturity date to the bank, this leads to a withdrawal of money from the economy, decreasing the money supply.

Because there was no saver/lender, this lending emerged out of “thin air.” When Bob repays the $5, the money leaves the economy, since there is no original lender to whom the loaned money should be returned. Observe that the $5 loan involves an exchange of nothing for something, providing a platform for unproductive activities that prior to the loan would not have emerged.

While banks continue to expand credit, various unproductive activities will prosper. At some point, however, a structure of production emerges that ties up more consumer goods than are released. (The consumption of final goods exceeds the production of these goods.) The positive flow of savings is arrested and a decline in the pool of real savings is set into motion.

Consequently, productive activities deteriorate, and bad loans accumulate. In response, banks curtail their lending out of “thin air,” triggering a decline in the money supply.

See the rest here

Be seeing you

Posted in Uncategorized | Tagged: , , , | 1 Comment »

Forget What the “Experts” Claim about Deflation: It Strengthens the Economy

Posted by M. C. on May 10, 2022

Nonproductive Activities Come from Lending Fake Money

https://mises.org/wire/forget-what-experts-claim-about-deflation-it-strengthens-economy

Frank Shostak

For most experts, deflation is bad news since it generates expectations for a continued decline in prices, leading consumers to postpone the purchases of present goods, since they expect to purchase them at lower prices in the future. Consequently, this weakens the overall flow of current spending and this, in turn, weakens the economy. Economic activity, believe the experts, is a circular flow of money. Spending by one individual becomes the earnings of another individual, and spending by another individual becomes a part of the previous individual’s earnings.

If people have become less confident about the future decide to reduce their spending, this weakens the circular flow of money. Once an individual spends less, this worsens the situation of some other individual, who in turn also cuts his spending.

According to the former Federal Reserve chairman Ben Bernanke,

Deflation is in almost all cases a side effect of a collapse of aggregate demand—a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending—namely, recession, rising unemployment, and financial stress.

Murray Rothbard, however, held that in a free market the rising purchasing power of money (shown by declining prices) makes goods more accessible to people. He wrote:

Improved standards of living come to the public from the fruits of capital investment. Increased productivity tends to lower prices (and costs) and thereby distribute the fruits of free enterprise to all the public, raising the standard of living of all consumers. Forcible propping up of the price level prevents this spread of higher living standards.

Economist Joseph Salerno adds: 

Historically, the natural tendency in the industrial market economy under a commodity money such as gold has been for general prices to persistently decline as ongoing capital accumulation and advances in industrial techniques led to a continual expansion in the supplies of goods. Thus throughout the nineteenth century and up until the First World War, a mild deflationary trend prevailed in the industrialized nations as rapid growth in the supplies of goods outpaced the gradual growth in the money supply that occurred under the classical gold standard. For example, in the US from 1880 to 1896, the wholesale price level fell by about 30 percent, or by 1.75% per year, while real income rose by about 85 percent, or around 5 percent per year.1

Money and Money out of “Thin Air”

Money emerged because it could support the market economy more efficiently than barter. The distinguishing characteristic of money is its role as general medium of exchange, evolving from the most marketable commodity. On this Ludwig von Mises wrote: 

See the rest here

Be seeing you

Posted in Uncategorized | Tagged: , , , , , | Leave a Comment »

Deflation: Bad for the Government, Good for Producers and Consumers. What’s Not to Like?

Posted by M. C. on April 15, 2022

Deflation is only bad for the government. In a deflationary economy, it cannot tax people indirectly via inflation and it can’t use monetary policy to artificially boost the economy and get votes before there is the inevitable recession. Consumers (mainly the poorer) and entrepreneurs are the ones who benefit from deflation (due to lower prices and larger profit margins, respectively).

https://mises.org/wire/deflation-bad-government-good-producers-and-consumers-whats-not

Andre Marques

Governments lie about the inflation rate and benefits from it, so, it is no surprise when they talk against deflation (for the purpose of this article, assume inflation as a general increase in prices and deflation as the opposite), which would be good for consumers and the economy, but bad for the government. (While Austrian Economists define inflation as an increase in the supply of money, the net effect of inflation is an increase in asset prices, as well as a distortion of the structure of production.)

Prices fall in a scenario where the currency is not inflated and, therefore, there are more sustainable investments and increased productivity. In an economy with little or no government intervention (at least few monetary interventions and few regulations, government spending and taxes), there are more long-term investments (capital investments, for example), which increase the economy’s productivity. In a deflationary economy, the purchasing power of money tends to increase, as there is no monetary inflation by central banks and prices tend to fall. Consumers can purchase more products and services and companies have higher profit margins.

But governments do not like deflation, they are the most indebted entities. Inflation is beneficial to borrowers, as they repay loans in a currency with lower purchasing power than when they took the loan. It is even more beneficial to the government since it can expand the money supply to pay the debt. Furthermore, inflation is good for the government because it creates an apparent economic boom, which will eventually be wiped out by a recession. But, as this can take a few years, the short-term incentive for the incumbents is to take advantage of this instrument.

Two typical arguments given by governments against deflation are as follows:

“Deflation Will Cost Entrepreneurs”

The reasoning behind this statement is that, if prices fall, entrepreneurs will sell products and services at lower prices than the cost to produce them. However, this statement does not hold if we consider the fact that, in a deflationary economy, the currency’s purchasing power tends to increase. So even if entrepreneurs get less money (nominally) than what their products cost, in real terms, they will still make a profit. In addition, the prices of the inputs used in production will also fall in a deflationary economy.

Therefore, with the use of productivity and management of expenses that every company must have, it is possible to sell the products at low prices, but with the same or even higher profit margin than in an inflationary environment. (Note: even if we disregard this gain in purchase power and lower production costs, it would be possible for the entrepreneur to protect himself through future contracts). And, precisely because prices get lower, consumers buy more products and services (without going into debt) and companies profit more due to the reduction in costs that occurs thanks to deflation. This is particularly the case in the technology sector. Computers today are cheaper and much better than they were 30 years ago. Because prices got lower (due to increased productivity), consumers began to buy more, which increased the industry’s profits, which brought more investments and higher productivity.

“Consumers Will Postpone Consumption under Deflation”

The reasoning behind this argument is that if prices are constantly falling, no one will buy the products and services because individuals will always expect prices to go down. This also does not make sense, as there are always products and services that people have to purchase (such as food and medicine). Nobody starves themselves to death or does not purchase medicines because a year later they will be cheaper. 

See the rest here

Be seeing you

Posted in Uncategorized | Tagged: , , , | Leave a Comment »

Four Myths about Money That Ought to Die Forever | Mises Institute

Posted by M. C. on May 21, 2021

https://mises.org/library/four-myths-about-money-ought-die-forever

Robert P. Murphy

With the possible exception of international trade, no topic in economics contains more myths than monetary theory. In the present article I address four popular opinions concerning money that suffer from either ambiguity or outright falsehood.

One: “Money represents a claim on goods and services.”

Although there is a grain of truth in this view, it is quite simplistic and misconceives what money really is.1 Money is not a claim on goods and services, the way a bond is a legal claim to (future) cash payments or the way a stock share is a claim on the net assets of a company. On the contrary, money is a good unto itself. If you own a $20 bill, no one is under any contractual obligation to give you anything for it.2

Now of course, in all likelihood people will be willing to exchange all sorts of things for your $20 bill; that’s why you yourself performed labor (or sold something else) to obtain it in the first place. Nonetheless, if we wish to truly understand money, we must distinguish between credit liabilities on the one hand, and a universally accepted medium of exchange (i.e., money) on the other.

Two: “The purchasing power of money equals the supply of real output divided by the supply of money.”

As with the first view, this one too has a grain of truth. Specifically, if everything else is held equal, then the “price level” (if we ignore the problems with measurement and arbitrariness) will go up if the money supply grows by more than real output, and will go down if real output grows by more than the stock of money.

However, other things need not be equal, in particular the demand to hold money. As with every other good, the “price” of money (i.e., its purchasing power—or how many units of radios, televisions, etc. people offer in order to receive units of money) is determined by the supply of dollars and the community’s demand to hold dollars. A given stock of money can be consistent with any price level you want, so long as you are allowed to change the demand for money.

For example, even if output and the stock of money stayed constant, all prices could double if everyone in the community wanted to cut in half the purchasing power of his or her cash balance. How is this possible? Initially everyone thinks he or she is holding “too much” cash and so tries to spend it. But since the merchants too think they are holding too much, they agree to sell only at higher prices. (If this seems odd to you, consider: Even if you are uncomfortable with $1000 in your wallet—maybe you just won big at the casino—if someone walked up and offers you another $1000 for your shoes, you’d probably accept.)

If we ignore all of the real world complications caused by timing issues, it’s easy to see that in the new equilibrium, where everyone is content with his or her cash holdings, nothing “real” will have changed. Instead, the unit price of everything (in terms of dollars) will have doubled, so that even though the per capita quantity of dollar bills is still the same, now the average person can only buy half as much real stuff with the money in his wallet. Of course this type of example (which I picked up from Milton Friedman) is very unrealistic, but it does serve to illustrate the point that prices are not a mechanical function of physical stocks of goods and dollar bills. On the contrary, people’s subjective valuations are also critical.

Three: “Under a gold standard the money is backed by something real, whereas under our present system dollar bills are backed up by faith in the government.”

Again, I sympathize with this type of view, but when my upper-level students write such things on their exams, I have to take off points for imprecision. Strictly speaking, under a gold standard the money isn’t backed by anything; the money is the gold. Now if we have a government that issues pieces of paper that are 100% redeemable claims on gold, I wouldn’t classify those derivative assets (i.e. the pieces of paper) as money, but perhaps as money certificates. Yet this is a minor quibble.

My real objection to the view quoted above is that it denies that our current fiat currency is really money. Although (as a libertarian, Austrian economist) I fully condemn the monetary history of the United States, and deplore the means by which the public was forcibly weaned from the gold standard, nonetheless it is simply misleading and inaccurate to deny that the green pieces of paper in our wallets and purses are genuine money. They satisfy the textbook definition: They are a medium of exchange accepted almost universally in a given region. No one is forcing you to accept green pieces of paper when you sell things. (If you don’t want anyone foisting pictures of US presidents on you, then just charge a billion US dollars for everything you sell.) The fact that government coercion (past and present) is necessary to maintain this condition is irrelevant; cigarettes really circulated as money in World War II P.O.W. camps, even though this wouldn’t have occurred without the artificial and coercive environment in which those traders found themselves.

Four: “Deflation is undesirable because it cripples investment. If prices in general are falling, no one will invest in real goods because he can earn a higher return holding cash.”

Although this last myth is understandable when espoused by the layperson, it is inexplicable that some trained economists believe it. (For three examples: An NYU professor used it to “shoot down” my Misesian friend in class, Wikipedia’s entry on deflation mentions this argument, and even Gottfried Haberler advances a version of it in this essay.) For one thing, the argument overlooks the fact that there were many years of actual deflation in industrial economies on gold or silver standards; I don’t think investment fell to zero in every single such year. So clearly something must be wrong with the argument.

Specifically the argument fails because it carelessly assumes that the relevant data for an investor are the spot prices of a particular good from one year to the next. But this is wrong. For example, suppose someone is considering investing in bottles of fermenting grapes that will be ready for sale as wine in exactly one year.3 The rate of return on this investment concerns the 2005 price of the grapes and the 2006 price of wine. So let us further refine the example and suppose that all prices fall 50% every year; i.e., there is massive deflation and presumably no one should be willing to invest in wine or anything else.

Yet there is no reason to jump to this conclusion. For example, the 2005 price of the bottle of fermenting grapes might be $100 and the 2005 price of a wine bottle might be $400, while the 2006 price of the bottle of grapes will be $50 and the 2006 price of a wine bottle will be $200. (Notice that, as stipulated, all prices have fallen by 50% per year.) Would our investor prefer to hold his cash, which in a sense appreciates at a real rate of 100% per year? Not at all! With our numbers, the investor would earn a 100% nominal (not just real) return on his money if he invests in the wine industry: He pays $100 for a bottle of fermenting grapes in 2005, then waits one year and sells the resulting bottle of wine for $200.

Had our investor sat on his $100 in cash in 2005, its purchasing power would have risen from 1/4 of a bottle of wine (in 2005) to 1/2 of a bottle of wine (in 2006). But by investing the cash, his purchasing power goes from 1/4 of a bottle in 2005 to 1 bottle in 2006. Once we allow for the prices of capital goods and raw materials to adjust to expectations of deflation, there is no reason for falling prices to hamper investment whatsoever. 4

Conclusion

Most of the myths concerning money are easily exposed when we consider what money is. Some of the more subtle myths, especially those concerning price deflation, are exposed once we consider the intertemporal price structure. On both counts, the Austrian School of economics serves us well.

[Originally published February 28, 2006, as “What Money Isn’t”]

  • 1. For a more systematic introduction to the Austrian theory of money, see this article.
  • 2. Even legal tender laws don’t affect this statement. If you owe someone, say, $1,000 and the government says a particular $20 bill counts as partial payment, that’s not the same as saying that someone owes you an item in exchange for the $20 bill. Rather, it’s just the government declaring that your debt can be partially satisfied with the $20 bill in question. (Naturally I oppose legal tender laws.)
  • 3. I suspect that this story is far from an accurate description of wine making, but it was the easiest way for me to illustrate my point.
  • 4. A sophisticated critic could answer that the true problem with deflation is not that it would completely eliminate all investment, but rather that investment would stop at the point at which the marginal real return equaled the real return from holding cash.  I’m not sure that even this version of the argument is valid, but in any event it’s not what many of the economists (such as the Wikipedia author) seem to be saying.”

Author:

Contact Robert P. Murphy

Robert P. Murphy is a Senior Fellow with the Mises Institute. He is the author of many books. His latest is Contra Krugman: Smashing the Errors of America’s Most Famous Keynesian. His other works include Chaos Theory, Lessons for the Young Economist, and Choice: Cooperation, Enterprise, and Human Action (Independent Institute, 2015) which is a modern distillation of the essentials of Mises’s thought for the layperson. Murphy is cohost, with Tom Woods, of the popular podcast Contra Krugman, which is a weekly refutation of Paul Krugman’s New York Times column. He is also host of The Bob Murphy Show.

Be seeing you

Posted in Uncategorized | Tagged: , , , | Leave a Comment »

In Unprecedented Monetary Overhaul, The Fed Is Preparing To Deposit “Digital Dollars” Directly To “Each American” | Zero Hedge

Posted by M. C. on September 24, 2020

In short, ever since the Fed launched QE and NIRP, it has been making the situation it has been trying to “fix” even worse while blowing the biggest asset price bubble in history.

https://www.zerohedge.com/markets/loretta-mester-hints-fed-preparing-deposit-digital-dollars-directly-each-american

by Tyler Durden
 

Over the past decade, the one common theme despite the political upheaval and growing social and geopolitical instability, was that the market would keep marching higher and the Fed would continue injecting liquidity into the system. The second common theme is that despite sparking unprecedented asset price inflation, prices as measured across the broader economy – using the flawed CPI metric and certainly stagnant worker wages – would remain subdued (as a reminder, the Fed is desperate to ignite broad inflation as that is the only way the countless trillions of excess debt can be eliminated and has so far failed to do so).

The Fed’s failure to reach its inflation target – which prompted the US central bank to radically overhaul its monetary dogma last month and unveil Flexible Average Inflation Targeting (or FAIT) whereby the Fed will allow inflation to run hot without hiking rates – has sparked broad criticism from the economic establishment, even though as we showed in June, deflation is now a direct function of the Fed’s unconventional monetary policies as the lower yields slide, the lower the propensity to spend. In other words, the harder the Fed fights to stimulate inflation, the more deflation and more saving it spurs as a result (incidentally this is not the first time this “discovery” was made, in December we wrote “One Bank Makes A Stunning Discovery – The Fed’s Rate Cuts Are Now Deflationary“).

 

In short, ever since the Fed launched QE and NIRP, it has been making the situation it has been trying to “fix” even worse while blowing the biggest asset price bubble in history.

And having recently accepted that its preferred stimulus pathway has failed to boost the broader economy, the blame has fallen on how monetary policy is intermediated, specifically the way the Fed creates excess reserves which end up at commercial banks instead of “tricking down” all the way to the consumer level.

To be sure, in the aftermath of the covid pandemic shutdowns the Fed has tried to short-circuit this process, and in conjunction with the Treasury it has launched “helicopter money” which has resulted in a direct transfer of funds to US corporations via PPP loans, as well as to end consumers via the emergency $600 weekly unemployment benefits which however are set to expire unless renewed by Congress as explained last week, as Democrats and Republicans feud over which fiscal stimulus will be implemented next.

And yet, the lament is that even as the economy was desperately in need of a massive liquidity tsunami, the funds created by the Fed and Treasury (now that the US operates under a quasi-MMT regime) did not make their way to those who need them the most: end consumers.

Which is why we read with great interest a Bloomberg interview with two former Fed officials: Simon Potter, who led the Federal Reserve Bank of New York’s markets group i.e., he was the head of the Fed’s Plunge Protection Team for years, and Julia Coronado, who spent eight years as an economist for the Fed’s Board of Governors, who are among the innovators brainstorming solutions to what has emerged as the most crucial and difficult problem facing the Fed: get money swiftly to people who need it most in a crisis.

 

The response was striking: the two propose creating a monetary tool that they call recession insurance bonds, which draw on some of the advances in digital payments, which will be wired instantly to Americans.

As Coronado explained the details, Congress would grant the Federal Reserve an additional tool for providing support—say, a percent of GDP [in a lump sum that would be divided equally and distributed] to households in a recession. Recession insurance bonds would be zero-coupon securities, a contingent asset of households that would basically lie in wait. The trigger could be reaching the zero lower bound on interest rates or, as economist Claudia Sahm has proposed, a 0.5 percentage point increase in the unemployment rate. The Fed would then activate the securities and deposit the funds digitally in households’ apps.

As Potter added, “it took Congress too long to get money to people, and it’s too clunky. We need a separate infrastructure. The Fed could buy the bonds quickly without going to the private market. On March 15 they could have said interest rates are now at zero, we’re activating X amount of the bonds, and we’ll be tracking the unemployment rate—if it increases above this level, we’ll buy more. The bonds will be on the asset side of the Fed’s balance sheet; the digital dollars in people’s accounts will be on the liability side.”

Essentially, the Fed is proposing creating a hybrid digital legal tender unlike reserves which are stuck within the financial system, and which it can deposit directly into US consumer accounts. In short, as we summarized “The Fed Is Planning To Send Money Directly To Americans In The Next Crisis“, something we reminded readers of on Monday:

So this morning, as if to confirm our speculation of what comes next, Cleveland Fed president Loretta Mester delivered a speech to the Chicago Payment Symposium titled “Payments and the Pandemic“, in which after going through the big picture boilerplate, Mester goes straight to the matter at hand.

In the section titled “Central Bank Digital Currencies”, the Cleveland Fed president writes that “the experience with pandemic emergency payments has brought forward an idea that was already gaining increased attention at central banks around the world, that is, central bank digital currency (CBDC).”

And in the shocking punchline, then goes on to reveal that “legislation has proposed that each American have an account at the Fed in which digital dollars could be deposited, as liabilities of the Federal Reserve Banks, which could be used for emergency payments.“

But wait it gets better, because in launching digital cash, the Fed would then be able to scrap “anonymous” physical currency entirely, and track every single banknote from its “creation” all though the various transactions that take place during its lifetime. And, eventually, the Fed could remotely “destroy” said digital currency when it so decides. Oh, and in the process the Fed would effectively disintermediate commercial banks, as it would both provide loans to US consumers and directly deposit funds into their accounts, effectively making the entire traditional banking system obsolete. Here are the details:

Other proposals would create a new payments instrument, digital cash, which would be just like the physical currency issued by central banks today, but in a digital form and, potentially, without the anonymity of physical currency. Depending on how these currencies are designed, central banks could support them without the need for commercial bank involvement via direct issuance into the end-users’ digital wallets combined with central-bank-facilitated transfer and redemption services. The demand for and use of such instruments need further consideration in order to evaluate whether such a central bank digital currency would allow for quicker and more ubiquitous payments in times of emergency and more generally. In addition, a range of potential risks and policy issues surrounding central bank digital currency need to be better understood, and the costs and benefits evaluated.

The Federal Reserve has been researching issues raised by central bank digital currency for some time. The Board of Governors has a technology lab that has been building and testing a range of distributed ledger platforms to understand their potential benefits and tradeoffs. Staff members from several Reserve Banks, including Cleveland Fed software developers, are contributing to this effort. The Federal Reserve Bank of Boston is also engaged in a multiyear effort, working with the Massachusetts Institute of Technology, to experiment with technologies that could be used for a central bank digital currency. The Federal Reserve Bank of New York has established an innovation center, in partnership with the Bank for International Settlements, to identify and develop in-depth insights into critical trends and financial technology of relevance to central banks. Experimentation like this is an important ingredient in assessing the benefits and costs of a central bank digital currency, but does not signal any decision by the Federal Reserve to adopt such a currency. Issues raised by central bank digital currency related to financial stability, market structure, security, privacy, and monetary policy all need to be better understood.

Read the rest of this entry »

Posted in Uncategorized | Tagged: , , , , , , | Leave a Comment »

Why Deflation Can Be a Good Thing | Mises Wire

Posted by M. C. on March 7, 2020

The supply of money determines the price level in the long run. Whether prices will rise or fall depends on the relative variation of the money in circulation…

What sense does it make to expand the money supply and then try to control it by raising the interest rate? The result of such a policy is market turmoil and confusion.

Yet if central banks had left the system alone, such a deflation would be very gradual and not only be not harmful but beneficial for the economy.

https://mises.org/wire/why-deflation-can-be-good-thing?utm_source=Mises+Institute+Subscriptions&utm_campaign=ed8fcb5bf8-EMAIL_CAMPAIGN_9_21_2018_9_59_COPY_01&utm_medium=email&utm_term=0_8b52b2e1c0-ed8fcb5bf8-228343965

[André de Godoy, a Brazilian journalist from the Mackenzie University of São Paulo, interviews economics professor and Mises scholar Antony Mueller about the causes and consequences of credit expansion and the relations between credit, money, and price inflation.]

André de Godoy: Please explain the relationship between the money supply, the price level, and economic activity.

Antony Mueller: The supply of money determines the price level in the long run. Whether prices will rise or fall depends on the relative variation of the money in circulation compared to the relative variation of the supply of goods. However, one must take into account that the process from the creation of money by the central bank, the so-called monetary base, and the impact on the economy in terms of demand is long and contains a series of variables. These transmitters of the monetary impulse can work in tandem and strengthen the original impulse or, say, may counteract each other. Let me give you an example: over the past fifteen years, the main central banks have practiced the policy of “quantitative easing,” which has expanded their balance sheet by a factor of over five. In the United States, the monetary base rose from $830 billion in January 2008 to over $4 trillion in September 2014 and stands as of now, in January 2020, at $3.4 trillion. Yet this drastic increase has not led to a price inflation and has stimulated economic activity only moderately. The reason for this is that the commercial banking sector did only transform a part of this base money into money in circulation and that the economic agents reduced the transaction velocity. For the monetary aggregate M1, the velocity halved from 10.6 in early 2008 to 5.5 in the fourth quarter of 2019.

Godoy: Authors like Ludwig von Mises and Milton Friedman hold that inflation is a monetary phenomenon. However, I have heard that it is possible to expand the amount of money in circulation without causing negative effects for the economy because inflationary effects could be controlled by the adjustment of the interest rate. Is this true or just a remedy?

Mueller: This is a very confused view. What sense does it make to expand the money supply and then try to control it by raising the interest rate? The result of such a policy is market turmoil and confusion. It is interventionism of the worst kind. Why should the money supply increase anyway? If the supply remains fixed, and productivity rises, prices will fall. That is beneficial deflation. Why should one complain when the goods become cheaper for the consumers? The point is whether price deflation happens slowly according to productivity increases in the economy or abruptly as a hefty liquidity contraction due to a financial market crisis.

Godoy: Why do central banks try to manipulate the money supply?

Mueller: Central bankers have a deep-seated fear of deflation. They presume that a price deflation will lead to an economic contraction. Yet if central banks had left the system alone, such a deflation would be very gradual and not only be not harmful but beneficial for the economy. If the central banks intervene and expand the money supply and implement, as it is the case today, a “zero interest rate policy“ (ZIRP), or even a “negative interest rate policy” (NIRP), a tension builds up between the natural tendency of the prices to fall because of productivity increases and the inflationary money supply. A deep discrepancy builds up between the human time preference and the monetary rate of interest which would converge in a free market without central bank interventions.

Godoy: Would a stable money supply not be too rigid for the economy?

Mueller: One must remember that a falling or rising price level is the result of the difference between the rate of variation of the supply of goods and the rate of variation of the money stock and the velocity of economic transactions. The monetary system has a natural elasticity. Even when the money supply is linked to a fixed supply of central bank money, expansions and contractions of nominal spending will take place. Money has loose joints, but when the monetary base is stable, the system has a definite anchor. There is elasticity of money under a gold standard even when the stock of gold is constant. Different from what we observe today, no long-term and extreme divergences were possible. We must change our present monetary system which is highly dysfunctional.

Godoy: Some prominent Brazilian economists mention the post-Keynesian theory as a counterpoint to the classical quantity theory of money and claim that the so-called modern monetary theory would provide a better model for the present.

Mueller: As I explained above, even when the money supply stays fixed the use of money is volatile, and thus even a gold standard has monetary elasticity. It is wrong to claim that only fiduciary money would provide financial flexibility. The point, rather, is that with an anchored monetary system, the degree of deviation is limited, while under the current fiat money regime there is no constraint. That is the problem with the modern monetary theory. Its adherents praise an anchorless system, because it would allow unlimited funding of government expenditure. Even these theorists, however, recognize the problem of price inflation when the money supply is excessive. In this case, they believe, the government could control price inflation through taxation and then siphon off the excess money. Yet while the adherents of this “new” monetary theory praise anchorless money as a boon because they live under the illusion that the economy is in permanent need of macroeconomic management, the truth is that it is not the free market that produces booms and busts but the intervention of the governments and their central bankers.

Godoy: Could you cite a few examples of how inflation comes about in our day because of the monetary policies that governments have recently pursued?

Mueller: Venezuela is currently a sad example along with the very tragic case of Zimbabwe. Let’s concentrate on Brazil’s neighbor country. Massive government spending, foolish interventionism, and the expansion of the money supply are behind the gigantic price inflation in Venezuela. These policies form part of the grander plan of implementing a “Socialism of the Twenty-First Century.” But what they got was not prosperity and equality but even sharper social divisions, a brutal hyperinflation, and mass misery. Venezuela is the empirical verification of what we have discussed: the process begins with the false promises of social justice and comprehensive welfare. Private property is no longer secure, government intervention is on the rise, and business investment falls. Yet instead of the deteriorating economy inducing the political leadership to change course, government expenditures, based on credit expansion, increase even more and with them rises the money supply. While more regulation and interventionism suffocate the supply side, inflationary demand is on the rise. The country enters a deadly spiral of economic, political, and social crises that reinforce each other. At the very beginning of this process, some illusionary benefits appear, yet after a short while the poorest people are those who suffer most until it also brings down the whole rest of the society in a cataclysmic collapse.

Godoy: From what I’ve gathered, monetary inflation itself is not the problem that causes a raise in the price levels. The problems are people’s expectations and the speed with which transactions happen, is that correct?

Mueller: Well, let us put it this way: the reason for obesity is not the food but how much one eats. The expansion of the money supply is the food. Whether the economic actors take the offer is another question. In this decision expectations play a major role. Here, however, we must consider that expectations do not come from nowhere. They have a point of reference in the economic reality and in the public discourse, including the media. The laissez-faire approach to money does not mean the absence of control. It is rather the present monetary system, with constant central bank intervention and the craving of governments for deficit spending, that is out of control. In contrast to a fiat money system, a gold standard or a similar system with a strong anchor would combine short-term flexibility with long-term stability.

Godoy: The mechanism that uses interest rates to control inflation is actually a way to try and contain price raises in a fiat money system, right?

Mueller: For the policymakers, interest rates are an instrument of intervention while for Austrian economics they should reflect time preference and as such would be the natural rate. Policymakers can only manipulate the monetary rate of interest. What matters is the money supply and the expectations. A higher interest rate makes borrowing more expensive and thus may stop the expansion of the circulation of money in the economy. Furthermore, higher interest rates may change expectations about future price inflation and thus reduce the velocity of circulation. The main point, however, about raising the interest rate is that the central bank has to reduce the monetary base in order to obtain higher interest rates. Central banks cannot just raise the interest rate and leave the monetary base as it was. When central banks target a certain level as their policy rate of interest, they must manage the monetary base accordingly.

Be seeing you

proxy.duckduckgo.com

 

 

Posted in Uncategorized | Tagged: , , , , , , | 1 Comment »

Why Government Should not Fight Deflation | Mises Wire

Posted by M. C. on November 9, 2019

Thus attempts to reverse price deflation by means of a loose monetary policy (i.e., by creating inflation) is bad news for the process of wealth generation, and hence for the economy. On the other hand, in order to maintain their lives and well-being, individuals must buy goods and services in the present. So from this perspective a fall in prices cannot be bad for the economy.

https://mises.org/wire/why-government-should-not-fight-deflation

For most experts, deflation is considered bad news since it generates expectations of a decline in prices. As a result, they believe, consumers are likely to postpone their buying of goods at present since they expect to buy these goods at lower prices in the future.

This weakens the overall flow of spending and in turn weakens the economy. Hence, such commentators hold that policies that counter deflation will also counter the slump.

Will Reversing Deflation Prevent a Slump?

If deflation leads to an economic slump, then policies that reverse deflation should be good for the economy. Or so it is held.

Reversing deflation will simply involve introducing policies that support general increases in the prices of goods, i.e., price inflation. With this way of thinking inflation could actually be an agent of economic growth.

According to most experts, a little bit of inflation can actually be a good thing. Mainstream economists believe that inflation of 2 percent is not harmful to economic growth, but that inflation of 10 percent could be bad for the economy.

There’s good reason to believe, however, that at a rate of inflation of 10 percent, it is likely that consumers are going to form rising inflation expectations.

According to popular thinking, in response to a high rate of inflation, consumers will speed up their expenditures on goods at present, which should boost economic growth. So why then is a rate of inflation of 10 percent or higher regarded by experts as a bad thing? Clearly there is a problem with the popular way of thinking.

Price Inflation vs. Money-Supply Inflation

Inflation is not about general increases in prices as such, but about the increase in money supply. As a rule the increase in money supply sets in motion general increases in prices. This, however, need not always be the case.

The price of a good is the amount of money asked per unit of it. For a constant amount of money and an expanding quantity of goods, prices will actually fall. Prices will also fall when the rate of increase in the supply of goods exceeds the rate of increase in the money supply. For instance, if the money supply increases by 5 percent and the quantity of goods increases by 10 percent, prices will fall by 5 percent.

A fall in prices however cannot conceal the fact that we have inflation of 5 percent here on account of the increase in the money supply.

The reason why inflation is bad news is not because of increases in prices as such, but because of the damage inflation inflicts to the wealth-formation process. Here is why.

The chief role of money is the medium of exchange. Money enables us to exchange something we have for something we want. Before an exchange can take place, an individual must have something useful that he can exchange for money. Once he secures the money, he can then exchange it for the goods he wants.

But now consider a situation in which the money is created “out of thin air,” increasing the money supply. This new money is no different from counterfeit money. The counterfeiter exchanges the printed money for goods without producing anything useful. He in fact exchanges nothing for something. He takes from the pool of real goods without making any contribution to the pool.

Note that as a result of the increase in the money supply what we have here is more money per unit of goods, and thus, higher prices.

What matters however is not that prices rise, but the increase in the money supply that sets in motion the exchange of nothing for something, or “the counterfeit effect.” The exchange of nothing for something, as we have seen, weakens the process of real wealth formation. Therefore, anything that promotes increases in the money supply can only make things much worse.

Why Falling Prices Are Good

Changes in prices are just a symptom, as it were — and not the primary causative factor — of a falling growth momentum.  Thus attempts to reverse price deflation by means of a loose monetary policy (i.e., by creating inflation) is bad news for the process of wealth generation, and hence for the economy. On the other hand, in order to maintain their lives and well-being, individuals must buy goods and services in the present. So from this perspective a fall in prices cannot be bad for the economy.

Furthermore, if a fall in the growth momentum of prices emerges on the back of the collapse of bubble activities in response to a softer monetary growth, then this should be seen as good news. The fewer non-productive bubble activities we have, the better it is for the wealth generators, and hence for the overall pool of real wealth.

Likewise, if a fall in the growth momentum of the CPI emerges on account of the expansion in real wealth for a given stock of money, this is obviously great news since many more people could now benefit from the expanding pool of real wealth.

We can thus conclude that contrary to the popular view, a fall in the growth momentum of prices is always good news for the wealth generating process and hence for the economy.

 

 

Posted in Uncategorized | Tagged: , , , | Leave a Comment »

The High Price of a “Free Lunch” | Mises Wire

Posted by M. C. on September 7, 2019

Two of the greatest periods of GDP growth in the US, 1820 to 1850 and 1865 to 1900, had deflations of 50%. Deflation should be hailed instead of being scorned as it is currently by most professional economists and central bankers.

https://mises.org/wire/high-price-free-lunch

One of the Ten Commandments is “thou shalt not steal,” and theft is generally condemned in most religions, yet our religious leaders and followers have essentially turned a blind eye to government theft.

Based on a policy of envy, Bernie Sanders, for example, has bluntly stated he intends to tax the rich to fund his programs, as though the word rich itself justifies theft. The current crop of other democratic candidates is offering a beehive of free programs without any real discussion on how to pay for them.

Three Ways to Pay for the State

Governments can finance these programs in only three ways: (1) direct taxation of its citizens, (2) borrowing money, and/or (3) printing money. Few citizens understand the nefarious effects these methods can have on their own well-being. None of them provide “free” money.

The first and most obvious way to raise money is by direct taxation. When you pay your income tax or sales tax, you are brutally aware of how much money is being taken out of your own pocket. If the government only uses these taxes to fund itself, it would quickly run into serious taxpayer opposition; would we still be in Afghanistan today if the government took your flat-screen TV or cell phone to pay for soldiers half a world away?

The second way to raise money is by government borrowing. When the government borrows, it takes money from people who are trying to save, promising a seemingly riskless asset: a government bond. The government has displaced money that would normally have been used to invest in a new computer or machines or buildings, or even a consumption good as a new car. When the government borrows, there are real sacrifices today, not in some distant never existing future when the debt is repaid. There are real resources that are extracted from the economy in the now and present. This is a good example of what is seen, what is not seen and what should be foreseen. Government borrowing finances government consumption which crowds out investment spending that would normally have created a more prosperous economy.

Government Crowds Out Other Borrowers

Now, government borrowing is normally also constrained. The more the government borrows, the greater the demand for loanable funds and the higher the rate of interest. Here again, taxpayers who are also trying to borrow to buy a car or a house would soon realize that it’s the government borrowing that is crowding them out of the loan market. Of course, there is a point of no return for government debt, when the markets doubt a country’s ability to repay this debt — as Greece discovered in 2010.

Now, the obvious question is, how can the US or any other country run record budget deficits and have rock-bottom interest rates at the same time? The answer is the third way by printing money, or often called “quantitative easing.” This way also impacts the government’s ability to borrow.

A simple example will make this path of funding clearer. Suppose an economy has $10 to purchase 10 pencils. The price of the pencils will be $1 each. If the price increases (inflates) to $2 each while the supply remains constant, there would be 5 pencils that can’t be purchased, but if the cost of the pencils were reduced (deflated) to only 50¢ each, there would be people holding $5 looking to purchase nonexistent pencils. Supply and demand in the marketplace give us a price of $1 per pencil. Now suppose the economy is growing and is now producing 20 pencils. Because there are now more pencils in the supply pipeline, the price of pencils will drop to 50¢, a deflation rate of 50%. Deflation here reflects society pushing back the constraint of scarcity. It cannot eliminate scarcity or all prices would be zero, but this deflation shows an increase in the standard of living for everyone.

Two of the greatest periods of GDP growth in the US, 1820 to 1850 and 1865 to 1900, had deflations of 50%. Deflation should be hailed instead of being scorned as it is currently by most professional economists and central bankers.

Now, returning to our initial example of $10 and 10 pencils. Suppose the government prints another $10 to buy pencils but our supply of pencils has not changed. The money supply has doubled so we now have $20 chasing 10 pencils. The price for each pencil will inflate to $2, and the government will be able to buy 5 pencils by cutting the purchasing power of money in half. In other words, you have been robbed or taxed 5 pencils because your cash can now purchase less than before.

If at the same time the economy is growing, then we would have $20 chasing 20 pencils and the price of pencils would have remained at $1. There is no inflation but the rise in real income, exemplified by the 10 pencils that would normally have gone to the citizenry, has been siphoned off or stolen by the government. To a large degree, this is what has been happening since we moved to a fiat currency system in 1933. The central bank has been keeping the CPI in check but has created massive asset inflation, a massive redistribution of income from the poor to the rich and has been a major contributor to financing ever-growing government expenditures.

As Lord Keynes said,

By a continuing process of inflation governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but at confidence in the equity of the existing distribution of wealth.

Many in the lower rungs of the economic ladder blame their declining real incomes, and other inequities, on capitalism. They should, instead, be blaming the central bank.

When the government borrows, it increases the demand for loanable funds, and with a fixed supply, interest rates should normally rise. If at the same time the central bank is increasing the supply of loanable funds by printing money to buy government bonds, then interest rates will decline if the increase in supply is greater than the increase in demand. Here, we are basically monetizing the debt. Worldwide, this printing has currently driven interest rates to zero or into negative territory. Using the economy as an excuse, central banks have been monetizing government debt, alleviating any pressure on governments to control their spending.

Continuing from Keynes,

As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

Many economists are currently predicting we will experience another devastating recession in the US. Will we repeat the errors of the past by trying to fix a credit crisis with more debt? Or will we find a permanent solution by ending central banking, fractional reserve banking, and the government’s ability to borrow and print money? If we do, any future government spending would require an immediate and clear sacrifice on the part of the citizenry: unlike what politicians would have you believe; there is no free lunch.

 

 

Posted in Uncategorized | Tagged: , , , , , | Leave a Comment »

Of Two Minds – The Source of Killer Inflation: Services

Posted by M. C. on August 4, 2019

https://www.oftwominds.com/blogmar19/services-inflation3-19.html?fullweb=1

Charles Hughes Smith

The soaring cost of services is driven by a number of factors.

What will the future bring: fire (inflation) or ice (deflation)? The short answer: both, but in very different doses. Goods that are tradeable and exposed to technologically driven commodification will decline in price (deflation) while untradeable services that are difficult to commoditize will increase in price (inflation), generating a self-reinforcing feedback loop of wage-price inflation.

Gordon Long and I discuss these trends in our latest program The Supply-Demand Services Problem (YouTube).

The big difference between goods that drop in price (TVs, etc.) and services that are exploding higher (healthcare, childcare, elderly care, higher education, local taxes and fees, etc.) is the relative size each occupies in the household budget: a new TV is a couple hundred bucks and a once-every-few-years purchase, while all the services cost thousands of dollars annually– or even tens of thousands of dollars.

A new TV or electronic gew-gaw is signal noise in the household budget while services consume the most of what’s left after paying for housing and transport.

A 10% decline in the cost of a new TV is $25, while a 10% increase in annual tuition and college fees is $2,500. Add in thousands more for childcare, elderly care, local taxes and fees and healthcare, and the deflationary impact of tradeable goods is trivial compared to the increases in untradeable services.

Not all goods are declining in sticker price. vehicles are rising sharply in price, a fact that’s erased by hedonic adjustments in official inflation (the new car is supposedly so much better than the previous model that the “price” actually declines-heh).

Then there’s the inexorable shrinkage of quantity and quality. The package that once held 16 ounces now contains 13.4 ounces, and the appliance that once lasted for years now lasts a few months as the quality of components is reduced.

The soaring cost of services is driven by a number of factors:

1. The cost of staying in business is rising: wages are going up, overhead is going up, rent is going up, regulatory burdens are increasing, compliance costs more and local taxes, fees and licensing are skyrocketing.

This drives the costs of local small services ever higher: childcare, haircuts, elderly care, educational enrichment programs, and so on.

2. Competition that would suppress price increases has been destroyed by cartels and monopolies and regulatory capture. Big Pharma has eliminated foreign competition, higher education is a rapacious cartel, healthcare is nothing more than a collection of cartels, Internet and telephony providers are either local monopolies or cartels, and so on.

3. In the endless quest for higher quarterly profits, Corporate America has stripped out on-the-job education, preferring to poach high-value workers from competitors rather than invest in in-house training. This has reduced the pool of workers with up-to-date real-world skills, as a college diploma even in the sciences doesn’t translate to marketable skills.

This dynamic pushes wages higher via poaching while reducing the supply of qualified workers.

4. Service-sector infrastructure is often obsolete, kludgy and costly. Insiders are loathe to invest in technologies that might reduce headcount, and even when funds are made available the integration of legacy systems often yields extremely poor results.

5. The cartel-monopoly structure of service sectors has inhibited the spread of cost-cutting technologies; online education that leads to a diploma should be nearly free and universally accessible, (see my book The Nearly Free University), but instead the higher education cartel continues to exact its pound of flesh for a diploma, a scrap of paper with rapidly diminishing returns in an economy over-supplied with college graduates and workers with advanced degrees.

6. The demands on workers’ time and energy continually increases, leaving many unable to provide the services that were once performed in the home–childcare, elderly care, food prepared at home, and so on.

7. The cultural focus on academic achievement and entertainment has stripped away basic skills that were once common, forcing households to pay for pricey services: changing the oil in a car, basic plumbing and home repairs, etc. are now uncommon skills.

8. These social and demographic trends are reducing the supply of service expertise: small business owners (Baby Boomers) are retiring and the skills of starting and operating a service business in a costly regulatory thicket are not being taught or nurtured.

As a result, there is a widening gap between demand and supply of essential services. This asymmetry is not easily remedied and as a result it will generate self-reinforcing inflation that the economy is ill-prepared to pay.

There is much more in our program:

(39:52)

Posted in Uncategorized | Tagged: , , | Leave a Comment »

« Previous Entries