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Source link: http://archive.mises.org/9457/printing-like-mad/

Printing Like Mad

February 17, 2009 by

We live in an age of grave economic ignorance, if central-bank policy is an indication of prevailing economic theory. It is apparent that we’ve learned nothing from several millennia of monetary destruction. The persistent demonstration that capital, not paper, is the basis for prosperity has fallen on deaf ears. Daily, we face the sad spectacle of government officials, pundits, and even Nobel laureates telling us that printing money is the answer to an economic downturn. FULL ARTICLE

{ 49 comments }

prettyskin February 17, 2009 at 10:10 am

“The US central bank (the Fed) has lowered its policy rate (the federal-funds rate target) from 5.25% in August 2007 to around zero at present.”

Pardon my ignorance for clarity:

The United States Central Bank -Public entity but privately owned/operated.

The Federal Reserve – Non-federal government institution and is The United States Central Bank.

The United States Treasury – Federal government institution that prints and mints all paper currency and coins.

So, who really lowered its policy rate to the present zero rate and how does non-elected members have much control over the nation’s monetary supply?

geoih February 17, 2009 at 10:12 am

Who would have ever guessed that it would be so hard to give away “money”. You’d think the obvious lesson would be learned.

(8?» February 17, 2009 at 10:19 am

Why is it so hard for the Cult of Keynes to use the words “hyper-inflation” to describe their “quantitative easing” policy, even when noting that “this will engender massive inflation down the road?”

(Other than “duh,” that’s rhetorical, btw.)

Last night when gold & silver jumped, I turned on the Bloomberg Channel to see what was happening. At the time they were interviewing a bank analyst who compared local (excluding HSBC) Hong Kong banks to everyone else. With a smile on his face, he stated that at least the HK banks had a balance sheet, implying the insolvency of all the rest.

It’s very interesting to see how people in Asia are watching and reporting on this story, as it looks nothing like the reporting in the US. Instead, they are watching a corrupt system in its death throes.

Which I’m sure they plan on profiting from.

StatusQuoJoe February 17, 2009 at 10:28 am

At this point the central banks have no choice but to lower continuously the prime rate, since they are now locked into a vicious cycle.

The prime rates were lowered in an attempt to battle the liquidation value of previously issued debt and the beginning of the economic downturn (a result of necessarily occurring defaults of mal-investments).

However the liquidation value of total debt is inversely proportional to the prevailing rate of interest. What kept this inverse relationship from entering into a perpetual down cycle before was existing capital. However once existing capital has been destroyed there is no support left and the inverse relationship then dominates the economic landscape. By lowering the rates, the central planners then increase the liquidation value of existing debt resulting in the need to further lower interest rates and print new currency to service existing debt.

The process then becomes an inward death spiral from which there is no return, the only possible escape from the process is to allow an external debt liquidator to enter the system and extinguish debt, i.e. gold, but all fiat systems oppose the use of gold from the depths of their being.

Re: Antal Fekete
http://www.professorfekete.com/default.asp

Deefburger February 17, 2009 at 10:35 am

Prettyskin: I would point you to Youtube for your answer. There is a series called “Corrupt Banking System” there that is the best explanation of current banking and money practices I have ever seen. It’s an animation, but it’s really well done and gets the point across very well.

http://www.google.com/search?q=corrupt+banking+system+youtube&sourceid=navclient-ff&ie=UTF-8&rlz=1B5GGGL_enUS310US312&aq=h

Deefburger February 17, 2009 at 10:49 am

Great link to Dr. Fekete! His historical insights into the monetary metal supply and who-what-where of it all is excellent.

I particularly like his view of the Comstock Silver dumping on China in the late 1800s and how that led to the “Cultural Revolution” in China. He says China is still sitting on all of that Silver. That long-term view and patience is one of those cultural traits the Chinese have that I think demands a great deal of respect, and awareness on our part.

Ron Paul cited Dr. Fekete’s work when he warned of our need to switch back to gold and silver base.

(8?» February 17, 2009 at 12:44 pm

So, just what is the “next shoe to drop?” Is it sovereign debt held by European banks? Better yet, how will the IMF react once it runs out of “money” to bail-out everyone? Will they ramp up Special Drawing Rights, or will that invoke panic?

Speaking of the IMF’s Special Drawing Rights, are there any Austrian analysis of them and their effect upon currency inflation? I’d like to understand the linkage between the two, given the point-of-no-return is long past.

redshirt February 17, 2009 at 12:51 pm

Does anyone know how much silver US gov holds if any?

Oh, and is possible to have a dollar set by the value of gold, but redeemable in gold and silver? (Allowing the market to set the value of gold and silver… the gov sets the redeemable ratio based on availability of the metal.)

Abhilash Nambiar February 17, 2009 at 1:38 pm

Why is Man, Economy and State being advertised with this article? The book is out of stock and has been out of stock for a while.

prettyskin February 17, 2009 at 1:52 pm

@ Deefburger, thanks.
Got that also from “The Creature from Jekyll Island”.

Printing is legalized and debt is encouraged to keep this legal process going. The gold standard is being laughed at, I see why. Banking cartels at the printing press spinning out of control.

Mark Knutson February 17, 2009 at 2:49 pm

I noted today a 6-7% price movement between dow going down and gold going up. I used to think one made money by investing in gold, now I understand its merely maintaining value while others lose money…

DD February 17, 2009 at 3:23 pm

Deefburger

I believe the series you pointed to is quite flawed. it seems to propose economic central planning as a solution by having government print money directly and loan out money interest free, and then claiming it will be non inflationary. It’s some socialist fantasy.

The economics is so flawed that even Krugman would object.

Michael A. Clem February 17, 2009 at 6:53 pm

I wouldn’t go that far, DD. It has some flaws, but it still does a good job of analyzing the banking system. The best solution is free banking, of course, and no fractional reserve system.

Colin Green February 17, 2009 at 6:56 pm

There is another way for governments to get money- set stupid policies, and fine people who do smart things! One of the homes that survived the Victorian Bushfires had clear-felled all the trees around it, and been fined 50,000 Aus Dollars because the council had wanted a ‘forest-like’ appearance which looked better than lawns and grass. The people who obeyed the rules lost their houses. Still, the council coffers are full!

Deefburger February 17, 2009 at 7:11 pm

@DD – Yes I agree. The series concludes with a questionable possible solution, however, the bulk of it is right on and a great primer for any layman to get his mind around the banking system in less than an hour.

I would really appreciate it if any of the “liberati” here at mises would post a blog with a link to this series, and a proper “Austrian” solution to the problems posited in the final chapter.

I still refer people to it because it is very easy to find and intellectually accessible.

selena February 17, 2009 at 7:47 pm

@deefburger:

there’s “gold wars: the battle for sound money as seen from a swiss perspective”. it’s on amazon, by ferdinand lips – with an introduction written by your beloved fekete

pbergn February 17, 2009 at 8:22 pm

Good article overall…

I don’t understand one thing, though. According to Austrians, if we keep the money supply constant, and banking system de-leveraged, we should not have any problems at all – in terms of inflation or deflation cycles…

Let me show that it is still possible to have deflatory/inflatory cycles EVEN if the money supply is held constant:

Let us say the total quantity of money supply in the Austrian ideal world is S monetary units (e.g. in weights of gold). That quantity S is distributed in a certain way among the participants of the free market relationship, and let us say, at some zero point of time it is distributed like this: X0 – in saving vehicles, Y0 – in active circulation for day-to-day market transactions…

Thus we have: X0 +Y0 = S, where S is constant, and is the total money supply.

Now, as the economy grows, more and more people begin to save, since they start having surplus earnings (e.g. due to productivity gains resulting in lower prices); that means the X is growing, or in mathematical terms:

X0 < X1 < Xi ... < Xn ... ==> Y0 > Y1 > Yi > … Yn, since Xi + Yi = S(const);

From the sequences above it follows that there exists such Xi that Yi < Ymin, where Ymin is the lower limit of money supply available for circulation to avoid deflation. This follows from the fact that the consumer needs are finite relative to the effort they are willing to put for additional reward, or put in mathematical terms, the series of benefit / effort ratios is convergent (or in plain English this means that when a person gets a yacht, a Mustang GT, a big mansion, etc., (in other words, all the stuff he/she possibly wanted while growing up), the level of extra effort he/she is willing to put to get even more rewards is steadily decreasing; so is the spending).

This shows that as the economy grows, and as participants begin to save (i.e. become richer), the money supply available in circulation (Yi) for business transactions can be represented by decreasing series, thus leading to the deflatory cycles (necessarily succeeded with inflatory ones), where the value of the money increases due to decrease in its quantity in circulation…

Now, how do the Austrians counter this paradox of steady money supply still causing deflation/inflation cycles?! Any thoughts or comments from the Purists?

pbergn February 17, 2009 at 8:27 pm

[RE-POST (HTML encoding issues with mathematical formulas]

Good article overall…

I don’t understand one thing, though. According to Austrians, if we keep the money supply constant, and banking system de-leveraged, we should not have any problems at all – in terms of inflation or deflation cycles…

Let me show that it is still possible to have deflatory/inflatory cycles EVEN if the money supply is held constant:

Let us say the total quantity of money supply in the Austrian ideal world is S monetary units (e.g. in weights of gold). That quantity S is distributed in a certain way among the participants of the free market relationship, and let us say, at some zero point of time it is distributed like this: X0 – in saving vehicles, Y0 – in active circulation for day-to-day market transactions…

Thus we have: X0 +Y0 = S, where S is constant, and is the total money supply.

Now, as the economy grows, more and more people begin to save, since they start having surplus earnings (e.g. due to productivity gains resulting in lower prices); that means the X is growing, or in mathematical terms:

X0 < X1 < Xi … < Xn … ==> Y0 > Y1 > Yi > … Yn, since Xi + Yi = S(const);

From the sequences above it follows that there exists such Xi that Yi < Ymin, where Ymin is the lower limit of money supply available for circulation to avoid deflation. This follows from the fact that the consumer needs are finite relative to the effort they are willing to put for additional reward, or put in mathematical terms, the series of benefit / effort ratios is convergent (or in plain English this means that when a person gets a yacht, a Mustang GT, a big mansion, etc., (in other words, all the stuff he/she possibly wanted while growing up), the level of extra effort he/she is willing to put to get even more rewards is steadily decreasing; so is the spending).

This shows that as the economy grows, and as participants begin to save (i.e. become richer), the money supply available in circulation (Yi) for business transactions can be represented by decreasing series, thus leading to the deflatory cycles (necessarily succeeded with inflatory ones), where the value of the money increases due to decrease in its quantity in circulation…

Now, how do the Austrians counter this paradox of steady money supply still causing deflation/inflation cycles?! Any thoughts or comments from the Purists?

Gerry Flaychy February 17, 2009 at 8:33 pm

” We shouldn’t overlook the fact that, since embracing the aggressive lowering of rates, central banks have been aggressively pushing money into the banking system without succeeding in reviving economic activity. So why should aggressive money pumping work now? ” _Frank Shostak

Perhaps it is because central banks are pushing money in the wrong places !

Willabus February 17, 2009 at 8:49 pm

pbergn,

I am currently self-educating myself in Austrian theory so I wish I could answer you directly. I am, fortunately, in the middle of readings Hayek’s ‘The Paradox of Saving’ where he answers your question. You can either choose to seek the answer for yourself or wait for someone else to explain it to you.

Deefburger February 17, 2009 at 9:18 pm

@pbergen – I believe the answer is the increase in unit value for Constant. Your equation states the constant in terms of weight or some physical amount. the Value of that weight is increasing with time as the value of the goods, services, and production increases.

S in your formula is a constant quantity of a commodity used to store value. The value must go up. In your example, then, deflation is the norm.

I’m no economist, but it seems obvious to me. Someone correct me if I’m off base.

Ghost February 18, 2009 at 1:14 am

Pbergn

I recommend you read some of the basic Austrian texts such a Rothbard’s “Man, Economy, and State” or perhaps just the first few chapters of Rothbard’s “Amercia’s Great Depression” for a quick overview. You’re viewing the economy through a hopelessly Keynesian lens (which isn’t particularly surprising if you’ve taken econ classes through the university system).

In short, your distinction between money being held as “savings” and “in circulation” is completely artificial. The only thing that can change over time with money (given a constant money supply) is its ownership.

What you seem to be implying in your model, however, is that as people become wealthier, they will decide to buy fewer things and instead just increase their cash holdings (hoarding in the Keynesian model). Putting aside how realistic this state of affairs is (because, after all, what you’re really saying is that all desires for health and comfort can somehow be sated after attaining a certain level of goods), an increase in the amount of cash balances held by the population can only be deflationary. The deflation, however, would be limited by the fact that some amount of money will need to be spent on consumption and maintaining previous capital investments.

Of course, realistically, people are always going to want to obtain a higher standard of living. This higher standard of living can only be obtained by making investments in capital goods. These investments will also tend to lead to declining price levels given a constant money supply (more goods will be able to be bought for the same amount of money).

In sum, then, a constant money supply can only lead to deflation. Inflation only occurs when the actual stock of money increases (fewer goods can be bought for the same amount of money).

Oil Shock February 18, 2009 at 1:23 am

Ghost,

People like pbergn refuse to read, even when the book is available for free.

Pat February 18, 2009 at 7:02 am

“Inflation only occurs when the actual stock of money increases (fewer goods can be bought for the same amount of money).”

Or a natural or man-made disaster causes the amount of goods and services to decrease more rapidly than the money supply. That would also result in fewer goods and services being available for the same given amount of money.

newson February 18, 2009 at 7:41 am

pat says:
“Or a natural or man-made disaster causes the amount of goods and services to decrease more rapidly than the money supply. That would also result in fewer goods and services being available for the same given amount of money.”

in practice, given the impossibility of adding up heterogeneous services and goods in any meaningful way, and the ready availability of imports even in a national disaster scenario, increase in money supply is the only believable cause of inflation.

friedman was right, at least about this.

newson February 18, 2009 at 7:46 am

to deefburger:
dr fekete is a proponent of real bills doctrine, and so his theory is antipathetic to the austrian view.

jason4liberty February 18, 2009 at 8:44 am

Inflation and deflation are monetary phenomena. If the total supply of money in the economy isn’t changing, then there is neither inflation or deflation.

When there is progress (more goods), the prices of goods will fall if there is a fixed money supply. The purchasing power of money will increase. This may necessitate a downward adjustment of monetary wages, but this would be the direct result of an increase in real wages. Falling prices per se is not deflation. Rising prices is not inflation. Price action can be the result of inflation or deflation (of the money supply).

newson February 18, 2009 at 8:52 am

to pbergn:

ghost is right, until you are actually clear about what you mean about saving and hoarding (ownership effects only), no formula will help you out.

“This shows that as the economy grows, and as participants begin to save (i.e. become richer)”

this is all backwards. the process is that people save first; invest second; and thanks to their investments, become more productive (richer) third.

the balance between consumption and investment and hoarding is purely personal, and defies calculation.

hoarding can only have a transient impact on prices (causing them to drop), as even misers consume (and die, therefore re-introducing hoarded money into the broader economy).

capital stock must be constantly replaced as it wears out, and additional investment must occur if productivity gains are to continue. it’s the constant innovation from new investment that gives us falling cost-of-living in fixed money supply environments.

Deefburger February 18, 2009 at 9:32 am

@ Newson – Thanks. I don’t know what the real bills doctrine is, but I’ll look into it. I read Fekete’s work on the history of gold and silver in China and Russia and found it to be very enlightening.

I do day trading in the FOREX and that knowledge has been useful for watching the long term prospects concerning trade with China. The Chinese do not currently trade their currency openly on the FOREX and instead negotiate goods for foreign currency through their bank in Hong Kong. According to Fekete, China’s internal currency is silver backed, and if they should start trading it directly on the open FOREX market, it would depress the other currencies tremendously. I would look to buy Yuan long and go short on the Dollar and Euro in that scenario. Unless of course we can manage to end the Fed and return to a gold backed Dollar. In which case it would be harder to determine the market direction long term. That determination would require knowledge of the total supply of Yuan versus Dollars and an estimate of the trade deficit between the two currencies, as well as knowledge of the volume China allowed out of the country. It get’s sticky when you consider that the Dollar is propped up by debt bought by China with trade in real goods for debt paper rather than currency for debt paper.

Deefburger February 18, 2009 at 9:46 am

Oh THAT real bills doctrine!!! DUH! Thank’s Newson for that wake-up call!

redshirt February 18, 2009 at 10:23 am

Pbergn, ghost is dead on! My take is… Sound money should lead to mild price deflation as the currency actual becomes more valuable over time. (Not really deflation… the potential is still there as the money supply hasn’t been destroyed, just saved.) High savings would signal for lower interest rates and tease out some new investment.

This is the point of sound money. The money you save now has the same or better value in the future. Fiat money forces riskier investments in order to just break even. Riskier ultimately means malinvestment. (Is that even a word?)

Regardless, as noted, normal rates of consumption would set the lower bound on the economy. Money is always changing hands.

Gerry Flaychy February 18, 2009 at 7:46 pm

“Likewise money is just a medium of exchange. Its function is to permit the exchange of the products of one specialist for the products of another specialist. More money cannot generate more real savings or real economic growth. ” Frank Shostak

In our economy, for those products to flow in one sense, you have to have money flowing in the opposite sense. If for some reason the flow of money is stopped or reduced, then the flow of products will also be stopped or reduced.

If that reason is less money to exchange for those products, then more money should restore the flow of products.

Is it not the case in our present economic situation ?

Mike Sproul February 18, 2009 at 8:46 pm

Newson and deefburger

“dr fekete is a proponent of real bills doctrine, and so his theory is antipathetic to the austrian view.”

Fekete’s version of the real bills doctrine holds that issuing money for ‘productive’ loans will not cause inflation, because each new issue of money will be accompanied by a comparable increase in goods produced.

My version holds that issuing money in exchange for assets of equal value will not cause inflation, because the bank’s assets, which back the money, rise in step with the quantity of money issued.

–Just so you know.

newson February 18, 2009 at 11:38 pm

to deefburger:
i don’t subscribe to rbd (just so you know), but i agree that rbd/sproul is more logical than rbd/fekete (less arbitrary, as mike has highlighted). if you click on mike’s name, you can download his papers.

rbd is in conflict with the austrian outlook, nonetheless.

newson February 19, 2009 at 12:26 am

g flaychy says:
“If that reason is less money to exchange for those products, then more money should restore the flow of products.”

the growth in money supply during the boom years has created distortions in real things – services and goods that would not have otherwise received funding.
now there is an entire army of personal trainers, reiki practitioners, real estate agents, wealth consultants who are faced with the virtual disappearance of their career. no printing of money will turn these unfortunates into the professionals that the market deems necessary (who knows, maybe geologists, water scientists, aged-care workers, farmers…?).

likewise, in the goods market, many resources have been dedicated to products that are now unlikely to be deemed high-priority. the plants/factories/offices either will be gutted or refitted for more viable businesses. more painful change. (fewer plasma tv’s, more electricity-grid spending; fewer luxury cars and more motorbikes etc.)

providing more money is a bit like taking down the mirrors in a chronically-obese person’s house.
sure, it’s easier than ditching the fries and coke, and pounding away on the stairmaster, but it only serves to delude, and delay the evitable tough workout to shed the fat.

Gerry Flaychy February 19, 2009 at 1:34 pm

newson, I think that printing more money does not necessarily put more money in the flow of money i.e. in the process of exchanging money for goods or services. When that surplus of money goes in the reserves of the banks and stays there, that doesn’t put more money in the flow of money. It’s seems to me that presently there is a big problem at this level.

Moreover, for example, according to Thomson Reuters LPC , loan issuance in the U.S. contracted by 55% in 2008 compared to 2007. So its seems that the supply of money did not grow last year but instead, decrease, suggesting that there is now less money in the flow of money.

Then now, what will be the result if the authorities succeed in putting more money in the flow itself instead of the banks reserves ? That remains to be seen !

Travis February 19, 2009 at 10:02 pm

Inflation and deflation is still possible with a constant money supply. If a large amount of the money was taken out of circulation and stored or lost without being used the supply would change. When it is found it would change back. Prices are not directly related to money supply. There are many other variables to consider.

newson February 20, 2009 at 1:15 am

g flaychy says:
“Moreover, for example, according to Thomson Reuters LPC , loan issuance in the U.S. contracted by 55% in 2008 compared to 2007. So its seems that the supply of money did not grow last year but instead, decrease, suggesting that there is now less money in the flow of money.”

money supply is not to be confused with supply of credit. money supply (see tms chart on this site) has held up (thanks to bail-outs/money issuance), whilst dramatic credit contraction has occurred.

in a sound money environment, credit availability would be determined solely by peoples’ time preference (that is the austrian theory, anyway).

newson February 20, 2009 at 1:22 am

travis says:
“Inflation and deflation is still possible with a constant money supply.”

not if the definition of inflation is an increase in the money supply. falling and rising prices are possible with a constant money supply, but that’s a supply/demand function.

hoarding/dehoarding of money balances itself out except in the most extreme circumstances like when people increase cash holdings before a war, tornado etc. even then, the effects are only transitory as no national contingency lasts forever.

Gerry Flaychy February 20, 2009 at 9:48 am

” money supply is not to be confused with supply of credit. money supply (see tms chart on this site) has held up (thanks to bail-outs/money issuance), whilst dramatic credit contraction has occurred.” newson

You are right. Good point.

In the page of the tms chart, it is said that tms “represents the amount of money in the economy that is available for immediate use in exchange.”
Even if more money is available, that doesn’t mean that more money will be use in exchanges. It is even possible that less money be used than before the increasing of the available money. So I think there is a distinction to be made between the supply of money and the effective use of that supply.

What is your view or the view of the austrian theory on this matter ?

Ethan February 22, 2009 at 8:51 am

Could someone please explain the mechanism by which the increased monetary base is likely to translate into price inflation.

How long can a credit collapse be met with the “costless” solution of replacing worthless structured assets with treasuries, before there are consequence?

When I explain that these bailouts and eternally revolving Fed loans are irresponsible in the extreme, I get the response that the government is only replacing a worthless asset on deposit and therefore it has simply been canceled with no consequences. Could someone point me towards an article that explains this?

Mike Sproul February 22, 2009 at 11:03 am

Ethan:

“Could someone please explain the mechanism by which the increased monetary base is likely to translate into price inflation. ”

There are at least two views: (1) The quantity theory, which says that price inflation results when there is more money chasing the same amount of goods. This view falls apart when you start to ask questions about the effects of foreign currencies, credit cards, checking accounts, gift certificates, etc.
(2) The backing theory, which says that the value of the money issued by some institution is equal to the value of the assets held as backing by that institution. A corollary is that an increase in the money supply, accompanied by increased assets of the issuers, will not cause price inflation. This view is logical, coherent, and supported by the evidence. It is also not mentioned in any economics textbooks. Furthermore, it is the only theory of money that is consistent with libertarianism, since it does not imply a need to restrict fractional reserve banking, or to place arbitrary limits on the issue of money. Austrians hate it, of course.

dave October 18, 2009 at 8:59 pm

Can someone answer this please:

“The artificial lowering of interest rates and monetary pumping only give rise to various false activities by diverting a portion of the flow of real savings to these activities. The more false activities that emerge on the back of the artificial lowering of interest rates and monetary pumping, the less real savings will be available for wealth-generating activities.”

What is the difference between a false activity and a wealth-generating activity?

scott t October 19, 2009 at 1:09 am

i am not exactly sure….”if” central-bank interest-rate lowering and money-pumping creates short-term economic advantage for a few while creating increased prices (debt???) for many — ‘in a way’ that free-market-risk aquisition of new commodity-money wouldnt — i assume the activities funded by the former method of money aquisition rather than the latter is the ‘false activity’.

i am not sure exactly how the federal reserve operates..only what i have read at the mises and lrc sites.
i am not sure if they are correct or not.

i admit it is a poor choice of words.

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Sounds pretty much in line with what Ron Paul has been promoting over his last 3 campaigns. I think this powerful statement sums it up, “..money is just a medium of exchange. Its function is to permit the exchange of the products of one specialist for the products of another specialist. More money cannot generate more real savings or real economic growth.” Consequently, if money is printed like nothing, than is there really an exchange?? Great post!

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