As new money is created by the banking system, it enters the price system as the recipients spend it. As the prices of some goods rise, this should be captured in the CPI, right?
Not necesssarily. New money does not impact all prices uniformly. And the CPI does not include all prices, only consumer goods prices, and even then unevenly. If the effect of the new money is mainly felt through financial assets or those consumption goods not included in the CPI, then the CPI will not reflect impact of the new money on prices.
Substitution can even reduce the CPI. As money is created through the banking system by expanding credit, credit-sensitive assets may at the same time increase in price and become more affordable due to lower interest rates, so people may substitute credit-sensitive purchases for cash-purchases. If certain goods are primarily paid for in cash, their prices may even fall. If the falling prices are included in the CPI, then the CPI may decline during an inflationary period. And that is what’s happening with housing. Housing is a large component of the CPI. The housing component of the CPI consists not of home prices, but of “owner-equivalent rent”, a measure of how much it would cost home-owners to rent their home from themself. This rental input to the computation is estimated from prices in the rental market. So, while home prices doubled between 2000 and 2006, rents lagged because home ownership increased relative to renting as the primary means of shelter. This had the effect of keeping the CPI relatively low because the rapid increases in the cost of home buying were not counted.
Barry Ritholtz has been following ongoing developments in the relationship between the CPI and the rent/buy differential on his blog (see:
OER, CPI and the Fed: A Strange Love Story
and
OER / CPI and New York Rentals).
The key points as Ritholtz explains are:
- Core CPI is dominated by Owner’s Equivalent Rent (OER).
- Existing Home Sales in the NorthEast are outpacing the rest of the country.
- Existing Home Sales in New York are far outpacing the NorthEast.
- Manhattan Condos/Coops are far outpacing NY.
In summary, the owner-equivalent rent is slowing because of the strength of the New York apartment market. This shows up as a lower CPI. The Austrian Theory of the Business Cycle provides an explanation for how, in the early stages of an inflationary boom, financial asset prices will tend to rise while consumption good prices will remain stable. Because of New York’s position as the leading financial center, financial asset price inflation tends to show up as an increase in the incomes of people working in the financial sector. That is what is driving the New York real estate market.
More inflation, lower CPI.
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Is there an accurate method of calculating current U.S.
inflation ?
If so, what now is that number ?
If not, why bother analyzing faulty methods of inflation calculation ?
Mises argued that it is not possible to come up with a single measure of inflation because everyone buys a different basket of goods.
There is also the problem that Austrians have raised , of relative prices between capital goods and consumer goods being affected by credit expansion. The CPI will not capture this.
However, in spite of the fact that no measure is imperfect, it is still worth trying to measure as it gives people an idea of how rapidly the central bank is debasing the money in any country. While no measure is perfect, comparisons of the same measure over time will show some useful information.
One of the problems that I don’t address in this post is that the measure has been restructured over time in order to produce a lower and lower rate of inflation. Since many of the government’s costs (social security, pensions, etc.) are indexed to inflation, and its revenues are indexed as well through the inflation-adjustment of tax brackets, the government has a huge advantage if they get to decide what the rate of inflation is. For this reason, they have tended to want a measure that biases the value lower.
Economist John Williams has written extensively about this, see for example this interview . According to Williams, if the CPI now were computed in the way that it was during the 70s we would measure a rate of 8% or more.
So in spite of imperfections of measurement, it is important to keep track of how the measures that they have become corrupted over time.
Inflation is a monetary phenomenon that shows up in price inflation, whether as asset inflation, inflation in goods and services, or both.
Since M3 is the best measure of the money supply, reconstructing it is therefore the best way to gauge inflation, which is now running over 10%. Ensuing inflation in goods and services, while in keeping with John Williams’ analysis, is still lower than it would otherwise be due to the highly undervalued yuan (around 40%) and the flood of cheap Chinese goods that this allows.
As the dollar continues to weaken, however, this will eventually become a losing proposition for China, which is already accelerating its diversification out of the US bond market. The Fed will have no choice but to step in and make up the differnce, lest the economy tank, raising bond yields and hence interest rates, hammering the already reeling housing market and the increasingly debt-burdened consumer. This will in turn reduce the consumption upon which the economy depends, meaning that the best the Fed can do is postpone the inevitable, never mind that longer it does so, the worse the economic fallout — i.e., a hyperinflationary depression — will be.
“As new money is created by the banking system, it enters the price system as the recipients spend it.”
False from the get-go.
As a bank issues a new dollar, that bank receives a dollar’s worth of assets in exchange. Thus the bank’s assets rise in step with the bank’s liabilities, and the value of the dollar is unaffected.
See http://www.csun.edu/~hceco008/realbills.htm
Just look at Manhattan versus the rest of the country. Prices have been spiking there, in Real Estate especially, compared with a place like Des Moines, Iowa. I think this is proof of how uneven inflation can be and also how easy it is to trace who is getting the benefits first.
I believe that eventually, OER will catch up, resulting in rising CPI. This is what is happening right now in Australia:
Australian property good investment? Part 2—Rental & affordability crisis
The statement by Mr. Sproul “Thus the bank’s assets rise in step with the bank’s liabilities, and the value of the dollar is unaffected.” is a non-sequitur. While it is true that the assets of a fractional reserve bank equal its liabilities – at least instantaneously at the moment of issue, this implies exactly nothing about the value of the monetary unit. The fact that the bank holds the loan (or another good that the bank bought with the new money) as an asset does not contradict that fact that new purchasing power was created out of nothing by the bank.
The relevant fact is that when a non-fractional reserve bank (non-FRB) issues a loan, it is loaning money that either it has borrowed from a saver or out of its own equity capital (the savings of the equity holders). In either case, the purchasing power granted by the credit is offset by an reduction in purchasing power by an amount equal in both magnitude and duration by a saver in the economy. In contrast, when a fractional reserve bank (FRB) issues a loan the recipient of the loan receives an increase in purchasing power but, there is no corresponding offset anywhere else. That is why new purchasing power is created by FRBs but not by non_FRBs.
The assets and the liabilities of both fractional reserve banks and non-fractional-reserve banks (non-FRBS) both increase by the same quantity when the bank issues a loan. But for an FRB, the bank’s liabilities are new money, while for a non-FRB they are not. Jesús Huerta de Soto has a discussion of this point in his book on bank credit (p. 547):
First, Keynes claims bank credit has no expansionary effect whatsoever on aggregate investment. He bases this assertion on the absurd accounting argument that the corresponding creditor and debtor positions cancel each other out:
We have, indeed, to adjust for the creation and discharge of debts (including changes in the quantity of credit or money); but since for the community as a whole the increase or decrease of the aggregate creditor position is always exactly equal to the increase or decrease of the aggregate debtor position, this complication also cancels out when we are dealing with aggregate investment.
Nonetheless a statement like this one cannot obscure the strong distorting influence credit expansion exerts on investment. It is indeed true that a person receiving a loan from a bank is the bank’s debtor for the amount of the loan, and creditor
for the amount of the deposit. However, as B.M. Anderson points out, the borrower’s debt with the bank is not money, whereas his credit is a demand deposit account which clearly is money (or to be more precise, a perfect money substitute, as Mises maintains). Once the borrower decides to invest the loan funds in capital goods and in services offered by the factors of production, he uses the money (created ex nihilo by the bank) to increase investment, while no corresponding increase in voluntary saving takes place. He does so without altering the stability of his debt with the bank.and p. 548:
Nevertheless all saving requires discipline
and the sacrifice of the prior consumption of goods and services, not merely the renunciation of the potential consumption afforded by new monetary units created ex nihilo. Otherwise any increase in the money supply via credit expansion would be tantamount to an “increase in saving,†which is sheer nonsense.
Whatever the bank bought for $1 (or the recipient of the new money) was something that was offered for sale at $1 but previously had found no takers. The sale of this good for $1 could not have taken place at that price without the new money being created.
Moreover, the value of the bank’s assets are not independent of the amount of money in circulation. The prices of all goods in the economy result from the valuations of all of the owners of goods and all of the owners of money. The bank may buy something, say a desk, for $100 that it creates, but as the money works its way through the economy, the price of the desk might rise to, say, $110. In this way, increasing amounts of credit are demanded as the prices of goods rise, due to the prior increase in the amount of credit.
Inflation is also often disguised by increases in productivity. For example, if a business becomes 10% more profitable – but I steal 9%. Technically speaking the business hasn’t lost anything. But in practice it is stealing and has all the consequences of that.
["Mises argued that it is not possible to come up with a single measure of inflation because everyone buys a different basket of goods."]
———
…well, the science of statistics (..including averages/means/medians, standard deviation, etc) is quite helpful in measuring groups of things with differences.
Americans buy houses/homes in all manner of prices/locations/size/construction/etc. — but it is far from impossible to gauge national, state, and local prices on average… as a useful number.
Surely U.S. “inflation” can somehow be accurately measured on average, perhaps with a specific error range (e.g., plus-or-minus 2%) ?
Economists constantly speak of “inflation”, but strenuously avoid stating what that number now is…. except in quoting the bogus U.S. government pronouncements.
From previous posts here — it seems actual U.S. inflation is now 10% (+/- 2%) ??
Great article! Thanks! Very informative. One way to track monetary inflation might be to consider debt levels/increases, since almost all new money today comes from loans. To track price inflation, it seems to me that Rothbard used an index in his book on the Great Depression that aggregated assets and consumer prices. Does anyone know of a similar index?
I’ve often asked here what I should look at if I want to know “real” inflation. I think I have the answer: insulin prices.
Why insulin? Lots of reasons:
1) Demand is stable, so its price isn’t affected by demand shocks. (People only buy it when they need it.)
2) Supply is stable because so many inputs are used in its production that supply shocks to any one input won’t have much of an impact.
3) Insulin cannot be debased, as other goods can, in response to falling money value. It must be made to a rigorous standard.
The implication of 1-3 is that inflation due to monetary expansion must be captured in insulin prices, and it will be the main influence on its price. (Gold fails 1 and 2.)
So, does anyone know if there’s a published insulin price index? And is there a security of set of securities that tracks it?
of course, there is not such a thing as the “price level”.
but we can determine how much it cost for the average family to eat and have shelter as a way of reference.
what its ridiculous is this none sense of hedonics and “substitution effects” that make statisticians able “make decisions” on how a family should better make its spending.
“if steaks are becoming expensive well, lets have burgers and viola!!!!… my cost of living have gone down.”
“or, everything else is becoming pricier so lets make people buy flat screens TVs as they are deflating faster than inflation and viola!!!…prices are not rising that fast”.
theses are a small part of these statistics shenanigans we have today.
olmedo
Robert:
Assume a banker gets 100 oz. of silver on deposit and issues 100 paper receipts (“dollars”) in exchange. The banker then lends another 200 newly-printed dollars to a farmer, who offers his IOU–backed by his farm and with a fair market value of $200, in exchange.
The banker’s loan triples the supply of paper dollars. One might expect the value of the dollar to fall—perhaps to one-third of an ounce of silver. This is incorrect. No matter how many dollars are issued, each dollar remains worth 1 ounce of silver as long as the bank only issues a dollar for a dollar’s worth (or ounce’s worth) of assets. This can be demonstrated by assuming that the contrary is true. Suppose, for example, that the tripling of the supply of dollars caused their market value to fall to something less than one ounce of silver. The bank has promised to redeem each dollar for one ounce of silver, so holders of dollars will present them at the bank and demand one ounce of silver for each dollar. Since there are 300 dollars outstanding and just 100 ounces of silver in the bank, it might seem that the bank is unable to redeem all of the dollars it has issued. But in fact the 300 dollars are fully backed by the silver plus the $200 IOU, and the bank is capable of redeeming every dollar at par. For example, the bank could sell the $200 IOU for 200 of its own paper dollars. It could then destroy the 200 paper dollars, and be left with 100 outstanding paper dollars laying claim to 100 ounces of silver in the bank. The bank could then redeem each of the remaining 100 dollars for 1 ounce of silver. At no point in this process would the value of the dollar fall below 1 ounce of silver.
m. sproul states…..”But in fact the 300 dollars are fully backed by the silver plus the $200 IOU,….
if i was moving and preferred my silver and the bank happened to have it, grrreat, …but i cant dig up a portion of topsoil for exchange in another region, can i?
re: insulin as a proxy for inflation,
this guy wrote an article about using the price of a postage stamp as a proxy for inflation. Although it is not a true market price, the costs faced by the USPS consist of an aggregate of various prices – real estate, energy, transportation, etc. He found that the price of a postage stamp tracked the CPI pretty well until the started fiddling with the CPI, then they diverged.
Mike_Sproul: What happens if the market “re-values” the farm to less than $200? Or interest rates change the value of the IOU?
Mike: “But in fact the 300 dollars are fully backed by the silver plus the $200 IOU, and the bank is capable of redeeming every dollar at par. For example, the bank could sell the $200 IOU for 200 of its own paper dollars. It could then destroy the 200 paper dollars, and be left with 100 outstanding paper dollars laying claim to 100 ounces of silver in the bank. The bank could then redeem each of the remaining 100 dollars for 1 ounce of silver. At no point in this process would the value of the dollar fall below 1 ounce of silver.”
If the RBD works so well, why have there been so many bank failures in the past? The reason is that when people holding $300 worth of paper money suddenly demand $300 worth of silver, your bank doesn’t have it. It must try to convince money holders to accept IOU’s instead, which they don’t want because they want silver. So now you have to call in the IOU’s and demand payment in silver, which causes the businesses who borrowed the money to go bankrupt.
Or, most of your IOU’s become worthless because the low interest rates your bank caused with its monetary expansion encouraged businessmen to invest in ventures that are unprofitable. So you then have money backed by worthless IOU’s.
However, having money backed by some asset is not the issue with price inflation. We can have price inflation even with gold/silver as money if the gold/silver money supply increases. Is it any wonder that we have had such horrendous price inflation in the 20th century when it’s so easy to expand the paper money supply?
David C> Inflation is also often disguised by increases in productivity.
Yes, if “we” are indeed “doing better, then it is in spite of the fact that government funnels more and more money into unproductive and/or wasteful activity. Yet the government counts that useless activity as adding to GDP.
M Sproul> Assume a banker gets 100 oz. of silver on deposit and issues 100 paper receipts (“dollars”) in exchange. The banker then lends another 200 newly-printed dollars to a farmer, who offers his IOU–backed by his farm and with a fair market value of $200, in exchange.
That is a classic case of mixing apples with oranges. “[F]air market value of $200″ is far too much fuzzification.
M Sproul> As a bank issues a new dollar, that bank receives a dollar’s worth of assets in exchange.
When the central bank buys government debt (securities), the government has no assets to back it with. Any assets it does have were obtained by force (illegitimately — they aren’t really its to “back” with). Also, any tax receipts are someone else’s assets, and again obtained by force. Moreover, the government funnels dollars into unproductive or underproductive activities and overvalues these by fiat (hidden inflation). Also, the central bank can hold the debt forever, meaning the idea that it was backed is incorrect. Also, the government can terminate the debt held by the central bank at any time. The Fed does not receive a dollars worth of “government assets” for the dollar it “prints.” The worthless dollar it prints gets multiplied via FRB. Unlike a real lender, the Fed could not care less what the “value” of the government securities are, since it simply returns the profit from the IOU to the issuer of the IOU (the government). It is quite a racket.
Person:
“What happens if the market “re-values” the farm to less than $200? Or interest rates change the value of the IOU?”
If the backing loses value, the dollars lose value, just like any financial security. The dollars would also lose value if the bank were robbed of some of its silver.
Robert,
Do you have an updated link for the interview of economist John Williams? The link is no longer correct.
Mike, you’re obsessed with having money backed by assets, but no one cares about that. The increased money supply causes inflation and the lower interest rates encourage malinvestments which cause boom/bust business cycles.
Sorry about the bad link to the Williams interview. This should work:
http://www.weedenco.com/welling/Downloads/2006/0804welling022106.pdf
Then you admit your error, Mike_Sproul: The two cases are not equal. If one bank maintains 100 silver oz, and 100 outstanding notes, it can maintinan a note at 1 Ag oz value, while the other bank cannot. It’s true that the former could lose value for its notes if the silver is stolen, but in the latter case it does not require a property rights violation at all.
Person:
The fractional reserve bank does not have to be able to pay 1 oz. on demand. As long as customers agree to accept dollars that are backed by a combination of silver and IOU’s, sometimes redeemable for silver and sometimes not, nobody’s property rights are violated.
BTW: I could count on one hand the number of times I’ve seen anyone on this website admit to an error, no matter how wrong they were.
M. Sproul, is there a confusion between wanting the paper money versus the silver as currency? Some people are presumed to want to use paper currency per se but want to make the money stable by anchoring against a standard to make sure that a known paper money quantity standard is adhered to and therefore don’t care what the dollar/ounce ratio is as long as it’s openly known. Others, on the other hand, want to use silver as money but apparently find paper money more convenient yet at the same time are expecting to redeem a pre-determined amount of silver for a dollar every now and then and are going to be most grumpy when the bank decides to change the silver/dollar when it’s convenient or declare that silver is not redeemable at the moment.
Mike_Sproul: The question was whether the bank can maintain a dollar at 1 Ag oz when it expands credit. You claimed it could. I showed you how it could not. That is your error. (Remember, the bank notes cannot be worth *more* than an Ag oz, because the bank isn’t obligated to give more than one Ag oz for a note.
And my other point was that this inability to maintain value is a result of behavior that *does not* violate any property rights — specifically, revaluation of farms and future streams of income.
M Sproul> As long as customers agree…
Oh dear.
TLWP:
I give green paper dollars to my bank all the time, and they give me checking account dollars in exchange. If I try to get back my green dollars at night or on the weekend, I can only get $300, unless the ATM is broken, in which case I can get nothing. I’ll admit that this makes me grumpy, but I still do business with the bank and voluntarily hand them my green dollars in exchange for interest and other banking services. The case is no different for silver.
Person:
Bank A issues $200, backed by 200 oz. of silver. Bank B issues $200, backed by 100 oz of silver plus IOU’s that can be sold at any time for 100 oz. of silver. The dollars of both banks will be worth 1 oz. each. If they fell to .99 oz., then anyone, including the bank itself, would eagerly buy them back and make a profit of .01 oz per dollar.
Furthermore, bank B is less vulnerable to robbery, and has the advantage of earning interest to cover expenses,
I have heard from other sources that the inventory of New York luxury condos is rapidly shrinking, even while brokers and agents continue to complain that sales are slow. Not quite sure I understand how these two factors can be in place at one time.
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