I agree. If there has to be fiat money then its supply should not be increased (i.e. the “price level” should be allowed to gradually decline in line with economic growth as it has many times in history).

Even Milton Friedman accepted that the “monetary base” should be frozen – thus giving up his old position that it should be increased at the same speed as economic growth in order to produce a “stable price level” (Dr Friedman accepted that central banks or other institutions can not be trusted to achieve this over the long term).

As for what is happening at the moment.

In most major nations the money supply (which ever one of the “Ms” we choose to look at) is growing fast.

This is being reflected in asset price rises (share bubbles, property bubbles and so on)as well as a general “price level” that is not falling in line with economic growth (i.e. the capital struture is being distorted and a consumer credit boom has been generated).

The future.

Most major nations, including the United States, have a large government deficit, this will get worse as the economy goes into recession (a recession perhaps triggered when one of the credit bubbles bursts).

The United States will then face a choice.

It could increase taxes in order to try and pay its creditors (this will just make the slump worse).

It could issue more money (i.e. the Fed and other financial institutions could play more credit money games) – which would mean open inflation and a collapse in the confidence in the Dollar.

Or it could default on the national debt – or at least that part of it owed to people and institutions overseas.

This third last option would also have a downside.

Of course the government could cut other government spending in order to pay its creditors – but do not hold you breath waiting for the scrapping of unconstitutional programs like Social Security, Medicare and Medicaid.

Hi Gavin,
Indeed, Milton Friedman was (and presumably is) criticial of government run central banks. His reasoning: central banker will inevitable cause costly policy mistakes and/or commit fraud. Friedman recommends to (i) make them independent and (ii) subject them to a strict rule, that is expanding money supply at a constant rate. He does not subscribe to free banking, fearing the government could start meddling into such a system (by, for instance, issuing its own money etc.).
As it seems, however, central banks are now doing away with any limits imposed upon them as far as discretionary scope is concerned.

The author’s implicit faith in rule-based central banking gets a VERY faint response from me. Vis a vis (blatant) discretion, rules can be wrong, they can be evaded (jimmied about to purpose), and the data can be wrong, as well. By wrong, I mean to include rendered obsolete or irrelevant by novel practices brought about by the very rules themselves.

To concern oneself with rules governing the policies of central banks is to overlook the elephant standing in the middle of the room: government-run monetary systems.

I hate to be so pure (doctrinaire) as to be irrelevant, but I just can’t get around the essential evil of government-run monetary systems. I have no hope of seeing them overthrown, but then, I never thought I’d live to see Germany reunified, or the Soviet Union stand down, either.

I agree that the international monetary system is a shambles, however I have to make the point that I disagree with Thorsten’s analysis. Just because bond yields are low does not mean that investors are expecting lower inflation. The argument for this is based on the idea that bondholders will ‘accept’ only higher yields if inflation is high. This fallacious argument is analogous to saying that as costs rise, firms raise prices, but firms cannot raise prices because of higher costs, only if the relative scarcity of that particular good rises (which occurs because marginal producers are forced elsewhere). To make the claim that firms can simply raise prices at will runs into the question of why don’t they raise prices before costs go up, (and keep on raising them).

With bond yields, the intuition is the same, if bondholders could get higher yields simply by refusing to accept low yields then clearly they would, regardless of how high inflation is. Of course if there is one country who is pursuing lunatic monetary policies and other countries pursuing sensible policies, then clearly the bonds of that country will fall, but what if all countries are pursuing lunatic policies as is the case now? It is not a priori obvious where all the excess liquidity will go, it may go into commodities, houses, bonds stocks, consumer goods, small business etc.

In short, high bond prices do not necessarily represent investors’ expectations of low CPI, they could occur as a direct result of inflation (true inflation – ie an increase in money and credit).

punter,

“The argument for this is based on the idea that bondholders will ‘accept’ only higher yields if inflation is high.”

Yields or discounts are the difference between the bond’s face value and its selling price. It is not current bond holders who can obtain a higher yield because they have developed expectations for a decreasing dollar purchasing power in the future; it is the potential bond buyer who will obtain the higher yield because as the risks involved in a bond purchase appear to increase due to inflation, demand for the bonds decrease and so, all other things remaining equal, the price of bonds will decrease. This results in a necessary increase in bond yields over what they would have been had the perceived risk of inflation been less. This is necessarily true.

Art,

to me, it seems as it was (1940)