Demand for goods arises because of perceived benefits. For instance, individuals demand food because it nourishes them. This is not so, however, about pieces of paper we call money, so why do we accept them?
According to Plato and Aristotle, the acceptance of money is a historical fact endorsed by government decree. It is government decree, so it is argued, that makes a particular thing accepted as the general medium of the exchange. Carl Menger, however, doubted the soundness of that view, writing:
An event of such high and universal significance and of notoriety so inevitable, as the establishment by law or convention of a universal medium of exchange, would certainly have been retained in the memory of man, the more certainly inasmuch as it would have had to be performed in a great number of places. Yet no historical monument gives us trustworthy tidings of any transactions either conferring distinct recognition on media of exchange already in use, or referring to their adoption by peoples of comparatively recent culture, much less testifying to an initiation of the earliest ages of economic civilization in the use of money.
Why Conventional Demand—Supply Analysis Fails to Explain the Price of Money
How does something the government proclaims become the medium of the exchange, acquiring value? We know that the price of a good is the result of the interaction between demand and supply. From this, we could reach a conclusion that the price of money is also set by the laws of demand and supply.
While demand for goods emerges because of perceived benefits, people demand money because of its purchasing power with respect to various goods. The demand for money depends upon the purchasing power of money while the purchasing power of money depends on the demand for money.
We are caught in a circular trap. (The demand for money is dependent on its purchasing power while the purchasing power is dependent for a given supply on the demand for money). The circularity seems to vindicate the view that the acceptance of money is the result of the government decree.
Mises Supports Menger’s Insight
Ludwig von Mises’s regression theorem supports Menger’s insights. Mises not only solved the money circularity problem, but he also confirmed Carl Menger’s view that money didn’t come from a government decree.
Inflation: the hidden tax. Usually used to pay for war.
As one immediate step, Congress should require the Federal Reserve to provide a formal savers impact analysis as a regular part of its Humphrey-Hawkins reports on monetary policy and targets. This savers impact analysis should quantify, discuss, and project for the future the effects of the Fed’s policies on savings and savers, so that these effects can be explicitly and fairly considered along with the other relevant factors.
With inflation running at over 6 percent and interest rates on savings near zero, the Federal Reserve is delivering a negative 6 percent real (inflation-adjusted) return on trillions of dollars in savings. This is effectively expropriating American savers’ nest eggs at the rate of 6 percent a year. It is not only a problem in 2021, however, but an ongoing monetary policy problem of long standing. The Fed has been delivering negative real returns on savings for more than a decade. It should be discussing with the legislature what it thinks about this outcome and its impacts on savers.
The effects of central bank monetary actions pervade society and transfer wealth among various groups of people—a political action. Monetary policies can cause consumer price inflations, like we now have, and asset price inflations, like those we have in equities, bonds, houses, and cryptocurrencies. They can feed bubbles, which turn into busts. They can by negative real yields push savers into equities, junk bonds, houses, and cryptocurrencies, temporarily inflating prices further while substantially increasing risk. They can take money away from conservative savers to subsidize leveraged speculators, thus encouraging speculation. They can transfer wealth from the people to the government by the inflation tax. They can punish thrift, prudence, and self-reliance.
Savings are essential to long-term economic progress and to personal and family financial well-being and responsibility. However, the Federal Reserve’s policies, and those of the government in general, have subsidized and emphasized the expansion of debt, and unfortunately appear to have forgotten savings. The original theorists of the savings and loan movement, to their credit, were clear that first you had “savings,” to make possible the “loans.” Our current unbalanced policy could be described, instead of “savings and loans,” as “loans and loans.”
As one immediate step, Congress should require the Federal Reserve to provide a formal savers impact analysis as a regular part of its Humphrey-Hawkins reports on monetary policy and targets. This savers impact analysis should quantify, discuss, and project for the future the effects of the Fed’s policies on savings and savers, so that these effects can be explicitly and fairly considered along with the other relevant factors. The critical questions include: What impact is Fed monetary policy having on savers? Who is affected? How will the Fed’s plans for monetary policy affect savings and savers going forward?
Consumer price inflation year over year as of October 2021 is running, as we are painfully aware, at 6.2 percent. For the ten months of 2021 year-to-date, the pace is even worse than that—an annualized inflation rate of 7.5 percent.
Facing that inflation, what yields are savers of all kinds, but notably including retired people and savers of modest means, getting on their savings? Basically nothing. According to the Federal Deposit Insurance Corporation’s October 18, 2021, national interest rate report, the national average interest rate on savings account was a trivial 0.06 percent. On money market deposit accounts, it was 0.08 percent; on three-month certificates of deposit, 0.06 percent; on six-month CDs, 0.09 percent; on six-month Treasury bills, 0.05 percent; and if you committed your money out to five years, a majestic CD rate of 0.27 percent.
I estimate, as shown in the table below, that monetary policy since 2008 has cost American savers about $4 trillion. The table assumes savers can invest in six-month Treasury bills, then subtracts from their average interest rate the matching inflation rate, giving the real interest rate to the savers. This is on average quite negative for these years. I calculate the amount of savings effectively expropriated by negative real rates. Then I compare the actual real interest rates to an estimate of the normal real interest rate for each year, based on the fifty-year average of real rates from 1958 to 2007. This gives us the gap the Federal Reserve has created between the actual real rates over the years since 2008 and what would have been historically normal rates. This gap is multiplied by household savings, which shows us by arithmetic the total gap in dollars.
To repeat the answer: a $4 trillion hit to savers.
The Federal Reserve through a regular savers impact analysis should be having substantive discussions with Congress about how its monetary policy is affecting savings, what the resulting real returns to savers are, who the resulting winners and losers are, what the alternatives are, and how its plans will impact savers going forward.
After thirteen years with on average negative real returns to conservative savings, it is time to require the Federal Reserve to address its impact on savers.
Alex J. Pollock is a Senior Fellow at the Mises Institute. Previously he served as the Principal Deputy Director of the Office of Financial Research in the U.S. Treasury Department (2019-2021), Distinguished Senior Fellow at the R Street Institute (2015-2019 and 2021), Resident Fellow at the American Enterprise Institute (2004-2015), and President and CEO, Federal Home Loan Bank of Chicago (1991-2004). He is the author of Finance and Philosophy—Why We’re Always Surprised (2018) and Boom and Bust: Financial Cycles and Human Prosperity (2011), as well as numerous articles and Congressional testimony. Pollock is a graduate of Williams College, the University of Chicago, and Princeton University.
If the federal government does not protect the American people from the Fed’s reckless monetary policies, which have caused prices to accelerate and have blown up another financial bubble, then the public “could go on strike” and withdraw their money until banks pay us a market rate of interest.
The front-page headline in the Wall Street Journal on October 14 says it all, “Inflation Is Back at Highest in over a Decade.” The Labor Department reported that the Consumer Price Index (CPI) increased 5.4 percent from a year ago. This should not have been a surprise to Federal Reserve chairman Jerome Powell and his fellow board members nor to its hundreds of PhD economists who drill into the economic data to forecast the economy.
In 2020, when the US economy imploded under the lockdown orders of the federal government and state governors, the Federal Reserve’s balance sheet exploded from $4.17 trillion in February 2020 to $8.48 trillion in October 2021. In other words, the Federal Reserve bought more than $4 trillion in mortgage-backed securities and US Treasury debt in less than two years. This increase in the Fed’s balance sheet in eighteen months is more than was purchased in the first hundred-plus years of its existence. This unprecedented “money printing” has had enormous consequences for the economy and the American people, not the least of which is accelerating price inflation.
As the new money created by the Fed diffuses throughout the economy prices rise in an uneven fashion. Economic sectors and geographic regions are affected differently depending on how the recipients of the newly received dollars spend them, an observation I identified forty years ago in my doctoral dissertation on the spread of inflation through the economy.
The broad measure of the money supply, M2, consists of cash, checking accounts, savings accounts, small denomination time deposits, and money market funds. M2 increased from $15.4 trillion in February 2020 to nearly $21 trillion dollars in September 2021—nearly a 33 percent increase in liquid assets that the American people have at their disposal to buy goods and services in the marketplace.
Any PhD economist should have been able to conclude that opening up the monetary spigot full blast to “stimulate” because of the lockdowns would raise prices down the road. We are now down that road. Price inflation will probably continue for at least two more years. Once price inflation accelerates as it did in the mid- to late 1960s and then again in the early and late 1970s and early 1980s, it takes “tight money” by the Fed to slay the price inflation dragon.
Forty years ago was the peak of the double-digit inflation that began in the mid-1970s, when the Federal Reserve inflated the money supply to boost the economy after the 1973–75 deep recession. In addition to the recession, double-digit inflation rocked the US economy. In 1979, to get inflation under control President Jimmy Carter appointed Paul Volcker Fed chairman, who continued his tight money policy after Ronald Reagan was elected in November 1980. The fed funds rate (the rate at which banks borrow from each other overnight, controlled by the Fed) climbed to 22 percent in December 1980. Three-month Treasury bill rates topped out at 16.30 percent in May 1981, while the inflation rate was about 10.00 percent. In short, savers were getting a substantial real rate of return on their T-bills and their money market accounts.
Since the early 1980s the fed funds rate has been dropping, not in a straight line, but more like a staircase. Currently, the fed funds rate is a tad above 0 percent while the inflation rate has clearly accelerated in the past year to more than 5 percent. The interest rate on bank money market accounts is 0.02 percent at my bank. Inasmuch as I have a substantial amount of cash reserves—funds for the proverbial rainy day—I and tens of millions of Americans are losing hundreds of billions of dollars in interest due to the Federal Reserve’s super easy money policies.
To rectify this highway robbery I propose the Congress pass and President Biden sign the Savers’ Protection Act. The act would state that if the interest rate on savings accounts, money market funds, and other short-term instruments are less than the rate of inflation, savers will deduct the lost savings on their tax return. For example, if someone has $100,000 in a money market fund the account should pay at least the rate of inflation for the year. Today that would be about $5,000. I propose a tax credit of at least 50 percent of the lost interest, $2,500 or more.
If the federal government does not protect the American people from the Fed’s reckless monetary policies, which have caused prices to accelerate and have blown up another financial bubble, then the public “could go on strike” and withdraw their money until banks pay us a market rate of interest. As every undergraduate business student learns in a corporate finance course, the nominal rate of interest on a risk-free asset, such as a bank account, equals the real rate plus the inflation premium. The American people should earn 7 percent on their savings accounts. I would be content at this time to earn the inflation rate on my money market account.
Dr. Murray Sabrin retired on July 1, 2020 as Professor of Finance. On January 25th 2021, the Board of Trustees awarded Dr. Sabrin Emeritus status for his scholarship and professional contributions during his 35-year career. His book, Universal Medical Care: From Conception to End-of-Life: The Case for a Single Payer System, calls for the individual or family to be the single payer to restore the doctor-patient relationship. His latest book, Navigating the Boom/Bust Cycle: An Entrepreneur’s Survival Guide, was published in October 2021. Sabrin is the author of Tax Free 2000: The Rebirth of American Liberty, a blueprint on how to create a tax-free America in the 21stcentury, and Why the Federal Reserve Sucks: It Causes, Inflation, Recessions, Bubbles and Enriches the One Percent, which is available on Amazon.
Central banks continue to be obsessed with inflation. Current monetary policy is like the behavior of a reckless driver running at two hundred miles per hour, looking at the rearview mirror and thinking, “We have not crashed yet, let’s accelerate.”
Central banks believe that there is no risk in current monetary policy based on two wrong ideas: 1) that there is no inflation, according to them, and 2) that benefits outstrip risks.
The idea that there is no inflation is untrue. There is plenty inflation in the goods and services that consumers really demand and use. Official CPI (consumer price index) is artificially kept low by oil, tourism, and technology, disguising rises in healthcare, rent and housing, education, insurance, and fresh food that are significantly higher than nominal wages and the official CPI indicate. Furthermore, in countries with aggressive taxation of energy, the negative impact on CPI of oil and gas prices is not seen at all in consumers’ real electricity and gas bills.
A recent study by Alberto Cavallo shows how official inflation is not reflecting the changes in consumption patterns and concludes that real inflation is more than double the official level in the covid-19-era average basket and also, according to an article by James Mackintosh in the Wall Street Journal, prices are rising to up to three times the rate of official CPI for things people need in the pandemic, even if the overall inflation number remains subdued. Official statistics assume a basket that comes down due to replicable goods and services that we purchase from time to time. As such, technology, hospitality, and leisure prices fall, but things we acquire on a daily basis and that we cannot simply stop buying are rising much faster than nominal and real wages.
Central banks will often say that these price increases are not due to monetary policy but market forces. However, it is precisely monetary policy that strains market forces by pushing rates lower and money supply higher. Monetary policy makes it harder for the least privileged to live day by day and increasingly difficult for the middle class to save and purchase assets that rise due to expansionary monetary policies, such as houses and bonds.
Inflation may not show up on news headlines, but consumers feel it. The general public has seen a constant increase in the price of education, healthcare, insurance, and utility services in a period where central banks felt obliged to “combat deflation”…a deflationary risk that no consumer has seen, least of all the lower and middle classes.
It is not a coincidence that the European Central Bank constantly worries about low inflation while protests on the rising cost of living spread all around the eurozone. Official inflation measures are simply not reflecting the difficulties and loss of purchasing power of salaries and savings of the middle class.
Therefore inflationary policies do create a double risk. First, a dramatic increase in inequality as the poor are left behind by the asset price increases and wealth effect but feel the rise in core goods and services more than anyone. Second, because it is untrue that salaries will increase alongside inflation. We have seen real wages stagnate due to poor productivity growth and overcapacity while unemployment rates were low, keeping wages significantly below the rise of essential services.
Central banks should also be concerned about the rising dependence of bond and equity markets on the next liquidity injection and rate cut. If I were the chairperson of a central bank I would be truly concerned if markets reacted aggressively on my announcements. It would be a worrying signal of codependence and risk of bubbles. When sovereign states with massive deficits and weakening finances have the lowest bond yields in history it is not a success of the central bank, it is a failure.
Inflation is not a social policy. It disproportionately benefits the first recipient of newly created money, government and asset-heavy sectors, and harms the purchasing power of salaries and savings of the low and middle class. “Expansionary” monetary policy is a massive transfer of wealth from savers to borrowers. Furthermore, these evident negative side effects are not solved by the so-called quantitative easing for the people. A bad monetary policy is not solved by a worse one. Injecting liquidity directly to finance government entitlement programs and spending is the recipe for stagnation and poverty. It is not a coincidence that those that have implemented the recommendations of modern monetary policy wholeheartedly, Argentina, Turkey, Iran, Venezuela, and others, have seen increases in poverty, weaker growth, worse real wages and destruction of the currency.
Believing that prices must rise at any cost because, if not, consumers may postpone their purchasing decisions is generally ridiculous in the vast majority of purchasing decisions. It is blatantly false in a pandemic crisis. The fact that prices are rising in a pandemic crisis is not a success, it is a miserable failure and hurts every consumer who has seen revenues collapse by 10 or 20 percent.
Central banks need to start thinking about the negative consequences of the massive bond bubble they have created and the rising cost of living for the low and middle classes before it is too late. Many will say that it will never happen, but acting on that belief is exactly the same as the example I gave at the beginning of the article: “We haven´t crashed yet, let´s accelerate.” Reckless and dangerous.
Inflation is not a social policy. It is daylight robbery. Author:
If a company is creating value, it is rewarded with profits. If it is destroying value, it is punished by losses.
The Federal Reserve and its manipulation of the monetary system short-circuits this process. You end up with a misallocation of recourses and all kinds of asset bubbles — not to mention piles of debt.
The only joy I would receive from the War Street Journal was in the comments section after Janet Yellen would repeat the state of the economy address (which was always the same as the last). The Journal would bloviate on what a great job Yellen was doing. The commenters would mostly all agree she didn’t have a clue and was worthless.
It made me wonder why all these commenters read the journal to begin with.
How are all of these unprofitable companies staying afloat and even making big splashes with media-hyped IPOs?
Peter Schiff addressed this question, along with the supposed “failure” of capitalism in his most recent podcast.
The rideshare company Lyft had its lowest close since going public yesterday (April 9). In fact, the company has only closed above its IPO price twice – the day it went public and last Friday. This probably shouldn’t shock anybody, given that the company has never turned a profit.The
Meanwhile, social media company Pinterest is gearing up for its IPO with a lot of media hype. The company has been around since 2010. It’s never made any money either.
Peter asked a poignant question. What makes people think these companies will ever make any money?
[Pinterest] has been around for 10 years. If they haven’t figured out how to make a profit yet, are they ever going to do it? Because at least in the frenzy of the dot-com mania, people were saying, ‘Look, the company hasn’t made a profit yet because it’s only been around for a year. But don’t worry because it’s got all of this explosive growth.’ You know, ‘We’re grabbing eyeballs,’ or whatever it was. But people were willing to bet the companies would eventually be profitable, and they didn’t have a lot of data to go on because the companies hadn’t even been in existence for very long before they were going public. It was a rush to the market. But now that you’ve got these companies that have been going on for 10 years — I mean, they’ve had 10 years at Pinterest to try to figure out how to make a profit and they haven’t done it.”
But as Peter pointed out, because of the easy-money policies of the Federal Reserve and the resulting availability of cheap capital, companies have been able to continue to operate even though they don’t make any money.
A lot of companies are able to attract funding and stay in business that under a normal free market system – a capitalist system – they would have gone bankrupt.”
This is one of the unseen impacts of central bank monetary policy. It distorts the market.
Consider Pinterest. The company has a lot of employees. It consumes a lot of resources to operate its website – land, labor and capital. These are resources that could be put to some other use if they weren’t being consumed by Pinterest. So, how do you know whether these resources being put to their best use? In a capitalist system, profits provide that information. Profits signal that resources are being well-used. The lack of a profit tells us these resources are not being put to good use. If the lack of profit persists, the company goes under and frees up those resources for better uses.
As Peter put it, if a company can combine resources to produce a product and then sell it at a higher price then the resources that it consumed, it is adding value to the economy. The consumer gets more enjoyment out of that product then the resources consumed in producing it.
You see, resources are scarce, but demand is unlimited. And the idea behind an economy is how to satisfy unlimited demand with limited resources. And resources that are utilized for one purpose are not available for another purpose. And if a company though is losing money, then the market is basically saying, ‘Hey, you’re destroying value. You’re creating products, but your customers don’t even value those products as much as the resources were worth that you used to make them.’”
If a company is creating value, it is rewarded with profits. If it is destroying value, it is punished by losses.
The Federal Reserve and its manipulation of the monetary system short-circuits this process. You end up with a misallocation of recourses and all kinds of asset bubbles — not to mention piles of debt…
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