09 Aug 2013

Yet Another Post on Inflation

Inflation 77 Comments

OK first, let me show what a fair guy I am. (If I were a single lady I’d be the fairest maiden in the land.) Let me admit that the really catchy phrase from Milton Friedman–inflation is always and everywhere a monetary phenomenon–only makes sense if he’s using it to mean “rising prices.”

Now then, down to business. I think most free-market economists like to say things like:

“The government has three ways it can finance its spending: taxation, borrowing, and inflation.”
and
“Inflation acts as a tax, but a hidden one.”

Well guess what kids, those statements only work if you use inflation to mean “increasing the quantity of money.” Because the government can’t finance a deficit through rising prices. Nope, a government can finance a deficit by printing more money.

Now you might say, “Oh, but when it comes to making the public poorer–effectively ‘taxing’ them–the mechanism is through rising prices, so ‘inflation’ must mean rising prices for this to work.”

Wrong again, Zod. When the government prints money (or electronically creates new reserves, to be more accurate) it makes everyone holding dollar-denominated assets poorer than they otherwise would be, regardless of what happens to the level of some price index. When they arrest people for counterfeiting, they don’t go look at the trend in CPI to make sure the guy was hurting anybody by printing off $100 bills on his laser copier. No, when it comes to citizens doing the counterfeiting, everybody seems to get–it’s obvious–that the introduction of extra money, per se, makes everybody else poorer. Even if prices go down, the other holders of dollar-denominated assets are poorer because of the counterfeiter, because without the counterfeiting the prices would have fallen even further.

Now it’s true, if the government has been “counterfeiting” since 1913, we’re going to see a big rise in the price level; it is an indication of just how much skullduggery has been afoot. The fact that wages rise doesn’t negate the fact that the initial counterfeiters benefit; wages would rise if your neighbors doubled the quantity of money from their laser copiers, too. (That’s the point I made in this article, which Blackadder somehow thought proved that I used “inflation” in today’s conventional sense.)

77 Responses to “Yet Another Post on Inflation”

  1. GabbyD says:

    “The government has three ways it can finance its spending: taxation, borrowing, and inflation.”

    where can one see this? whenever i see statements like this, i usually see “…and printing money”, not “…and inflaton”

    • Bob Murphy says:

      Hmm that’s interesting GabbyD. I googled it and you’re right, most people say “creating new money.” I’m not inventing that people often say “taxation, borrowing, and inflation”–after all, that’s nice and pithy to have a single word for each approach–but you’re right, it’s not as obvious as I thought before I googled it.

      • Razer says:

        Bob, if we accept the definition to mean ONLY a rise in prices, then what would we call the act of creating new money by the government? Would that not have a definition? Is it not inflating the money supply? Do we have to redefine this act? Can an inflationist help me out here? What euphemism will satisfy you? I’m guessing debasement or dilution won’t, but what do we call it when the money supply is expanded?

        How about wealth growth? Who could object to the government doing that? Perhaps we can say that the government isn’t inflating the money supply but increasing the wealth. And the terrible effect of all this ‘wealth growth’ can be called inflation as long as the two aren’t linked in a cause and effect relationship.

        • Cosmo Kramer says:

          “Bob, if we accept the definition to mean ONLY a rise in prices, then what would we call the act of creating new money by the government?”

          Monetary inflation…..

          “I’m guessing debasement or dilution won’t, but what do we call it when the money supply is expanded? ”

          Actually they will do just fine.

          “How about wealth growth? Who could object to the government doing that?”

          Printing money grows illusory wealth.

          “And the terrible effect of all this ‘wealth growth’ can be called inflation as long as the two aren’t linked in a cause and effect relationship.”

          It circles back to the quantity theory of money. And thus far money velocity has slowed (as expected) to compensate for the increasing quantity. This is still a problem via redistribution and cantillon effects. When velocity picks back up, dollar values will plunge. And to you there will be no difference in wealth as you define it.

          Austrians aren’t what you think. Money created in the free market is completely acceptable to Austrians. This is monetary inflation, but it isn’t phony. Besides being anti-inflation (per above) we are anti-deflation (confiscatory deflation).

          At will increases or decreases in paper supply distorts the meaning of the dollar, and thus existing contracts. This is why it is so bad. Market participants can’t reasonably predict the future inflation rate with the Federal Reserve at the helm.

        • Cosmo Kramer says:

          My often used market capitalization analogy helps to illustrate my point. When a public company issues new shares, it redistributes the % of market capitalization. Existing holders of shares are poorer than they otherwise would be.

          With increased USD, dollar values do not adjust as rapidly as stock prices do per the above example. With an increase in USD, there is a new equilibrium that takes time to reach. It is a feeling out process. There is a mismatch between sellers and buyers.

          An doubling of our money supply overnight will not double prices overnight. Thus, there is an illusory gain in value USD x quantity.

          BUT, that money is not just sitting idle. Look at capital market inflation. The expectation of inflation makes us change the way we use USD. How is this good? The FED is forcing us out of savings accounts and into the stock market and junk bonds.

          “Everyone loves an early inflation” J. Parssons (alias)
          Why? Because of all the illusory wealth gains. They put lipstick on a pig, and no one is the wiser. When the bust comes, they think they instantly lost 60 percent of their wealth. or……. they never really had that level of wealth. The boom is when all of the distortions and malinvestments happen. It is in these times, the so called good times, that we have to secure our wealth.

    • DesolationJones says:

      The three methods I usually see are taxationg, borrowing, and seigniorage.

  2. joe says:

    Financing via inflation means reducing the debt relative to GDP. It does not mean monetizing the debt.

    Population growth and productivity growth also reduce debt relative to GDP.

    That is why the nominal value of the debt always increases and the only way debt gets paid down is relative to GDP.

  3. JimmyA says:

    “Inflating away the debt” is a pretty common phrase, imo.

    Bob is right.

  4. Lord Keynes says:

    ” When the government prints money (or electronically creates new reserves, to be more accurate) it makes everyone holding dollar-denominated assets poorer than they otherwise would be”

    When the private-sector banking system creates credit money or private agents create negotiable financial instruments used to buy goods, it “makes everyone holding dollar-denominated assets poorer than they otherwise would be.”

    So are you a supporter of coercive interventions to stop banks from creating credit money and private agents from creating bills of exchange, negotiable cheques etc? Otherwise there is an absurd double standard.

    But, of course, what is missing from your analysis is the inability to see that flexible money supply via FR banking and credit instruments has certain advantages that outweigh disadvantages when we live in a world where money/credit demand fluctuates and wages and prices are relatively inflexible and debt deflationary dynamics would cause macro problems anyway even if they were flexible. Moreover, those negative consequences or externalities of FR banking are precisely what should be controlled by financial regulation and limits on private sector banking creation of money.

    “No, when it comes to citizens doing the counterfeiting, everybody seems to get–it’s obvious–that the introduction of extra money, per se, makes everybody else poorer.”

    Even that does not follow. In an economy with idle capacity, unemployment, and idle resources, some limited counterfeiting and spending on goods per se would increase demand and probably capital investment, raising output and employment, and making the community richer.

    But that this is not a convincing argument for counterfeiting, because there must be controls on the amount of money creation and, legally, it is only the central bank/government that should have accountable, democratic responsibility to create and destroy high powered money — the highest form of money — and manage it for the community.

    • Major_Freedom says:

      “When the private-sector banking system creates credit money or private agents create negotiable financial instruments used to buy goods, it “makes everyone holding dollar-denominated assets poorer than they otherwise would be.”

      If someone murders another at a conference of Keynesian economists, then that proves Keynesianism advocates murder.

      —————————

      But, of course, what is missing from your analysis is the inability to see that flexible money supply via FR banking and credit instruments has certain advantages that outweigh disadvantages.

      It’s not missing, because that is gobbledygook.

      Advantages and disadvantages are subjectively determined, meaning, there is no advantages or disadvantages other than individual advantages and disadvantages. Given that central banking relies on coercion against individuals, it means you cannot lump in those disadvantaged by such coercion into some social blob that is “more advantaged than disadvantaged.”

      Even that does not follow. In an economy with idle capacity, unemployment, and idle resources, some limited counterfeiting and spending on goods per se would increase demand and probably capital investment, raising output and employment, and making the community richer.

      Again you’re ignoring the basis of what constitutes “richer” and “poorer.” Richer and poorer are also subjectively determined, meaning, again, that only individuals become richer or poorer.

      Since central banking rests on coercion against individuals, it ipso facto makes those individuals poorer, because they are prevented from achieving their goals, so that others can achieve their coercive goals.

      Furthermore, your claim that increasing spending and prices will “probably increase capital investment”, if it takes place at all, takes place after individuals have already been impoverished, namely, those who are outbidded for scarce resources now that they have risen in price, as the initial receivers of the new money have a greater purchasing power.

      The concepts “idle capacity” and “idle resources”, other than the fact that they mean the same thing, so you’re not listing two things but rather one, do not exist apart from the individual owner’s intentions for those goods.

      If for example I choose to hold onto my car because I am holding out for a higher price than what is currently being offered, it does not follow from my car being “idle” that all of a sudden coercion is therefore justified against other individuals via central banking. It’s a non-sequitur. The lack of a good being exchanged by choice does not justify someone else calling themselves a statesmen to violate property rights of both the car owner and everyone else.

      But that this is not a convincing argument for counterfeiting, because there must be controls on the amount of money creation and, legally, it is only the central bank/government that should have accountable, democratic responsibility to create and destroy high powered money — the highest form of money — and manage it for the community.

      There must be controls over how many cars and computers are built as well, because other needed goods also need to be produced. Therefore, according to your logic, because only the state can be held “accountable” (haha!), it means that the state should monopolize car and computer production, in order to “manage them for the community.”

      • Lord Keynes says:

        “if it takes place at all, takes place after individuals have already been impoverished, namely, those who are outbidded for scarce resources now that they have risen in price,”

        (1) Not, as in my example, if the economy does have these resources available and

        (2) it does not follow that prices will rise if the consumer goods or the factor inputs in question are produced in fixprice markets.

        • Bob Roddis says:

          The game perpetually played by the Keynesian obfuscators is to try and prevent a clear statement being made of the difference between free people engaging in voluntary exchange and people enduring coercive state interventionist policies such as Keyneisianism. They cannot and will not admit that their vision is based upon their implicit claim that they have superior information and skill in managing the lives of the peons than the peons themselves. That is why they can never allow a clear statement concerning the concept of economic calculation to ever appear because economic calculation depends upon people being free of the Keynesians in order to not miscalculate.

          Likewise, if Krugman were confident about his views of the Austrians, he would explain calmly in plain language exactly where they allegedly go wrong. Instead, he implies that the Austrian School is nothing more than what goofball Paul Ryan learned from fictional Ayn Rand characters.

          http://www.economicpolicyjournal.com/2013/08/krugman-smacks-hayek-then-gets-pounded.html?showComment=1376088970080#c2107156374976768926

          • guest says:

            Instead, he implies that the Austrian School is nothing more than what goofball Paul Ryan learned from fictional Ayn Rand characters.

            Note that Paul Krugman is speaking about monetary policy, there; Which is odd since Paul Ryan believes essentially the same thing as Paul Krugman about monetary policy:

            Paul Ryan BEGS Congress to Pass TARP ( PATHETIC )
            [WWW]http://www.youtube.com/watch?v=RyJBZYz858M#t=2m11s

            Madame Speaker, this Bill offends my principles. But I’m going to vote for this Bill in order to preserve my principles; in order to preserve this free enterprise system.

            This is a Herbert Hoover moment. He made some big mistakes after the Great Depression, and we lived with those consequences for decades. Let’s not make that mistake.

            There’s a lot of fear and a lot of panic out there. A lot of what this is about is getting that fear and panic out of the market.

        • Major_Freedom says:

          1) Not, as in my example, if the economy does have these resources available

          Money is spent on resources that exist. New money is added to spending on goods that exist.

          It is nonsensical to assert that inflation of money has any effect at all on the economy apart from exchanges using money.

          it does not follow that prices will rise if the consumer goods or the factor inputs in question are produced in fixprice markets

          It does not follow that prices aren’t higher in “pricefix markets” in a context of monetary inflation, than without, just because you call it “fixprice”.

          Here, the prices of factors would rise, which is ALSO “price inflation.”

      • Bob Roddis says:

        1. If LK’s mythological regulator has such brilliant advice for lenders and borrowers, why doesn’t he just write a book and tell us? Plus, how do we know in advance that his regulator has this brilliant and benevolent insight that “private sector” actors lack?

        2. On this same topic, DK challenged us to find smart things that Henry Hazlitt said. I like this one:

        http://factsandotherstubbornthings.blogspot.com/2013/08/its-been-hazlitt-love-fest-lately-what.html?showComment=1376101087679#c7111377882594081063

        • Richie says:

          DK’s blog format is not at all appealing. I’m glad I stay away from it.

          • Razer says:

            Nor is his logic. A thoroughly unimpressive thinker. Should make a fine Fed Chief one day.

        • guest says:

          Naturally the businessmen who have earned money have shown that they have no foresight; but the politicians who haven’t earned the money will exhibit almost perfect foresight.

          LOL +1

    • Silas Barta says:

      When the private-sector banking system creates credit money or private agents create negotiable financial instruments used to buy goods, it “makes everyone holding dollar-denominated assets poorer than they otherwise would be.”

      When I murder someone, I reduce the value of their labor. When I offer a product for sale competitive with that person’s most valuable labor, I also reduce the value of their labor. Gosh, what’s the difference between the two?

      (The ultra-amoral inflationist, of course, will remark that the person must have died because because someone else wanted them dead and they couldn’t afford to bargain their way out with a transfer payment, so the murder must have increased total utility. Then angrily point you to a Coase essay.)

    • Innocent says:

      we live in a world where money/credit demand fluctuates

      Okay, but should not the interest rate adjust according to this? The less demand for credit the lower the interest rate and the higher demand for credit the higher the interest rate? Should not the interest rate be a factor in determining the fluctuating demand for idle resources?

      wages and prices are relatively inflexible

      Well isn’t this due to Government and Union intervention? Isn’t the inflexibility due to self fulfilling regulatory environments? Remove those barriers and you remove the issue of wage stickiness. I know I saw my wages go down during the recession. As well as prices at the store when they had large surplus inventories. I think you are seeing what you want to see in this case.

      As far as FR banking, isn’t that ‘why’ we went through the mess we just went through in essence? Yet your argument is that FR banking has advantages that outweigh the negatives? Why because it amplifies the movement of money up until the point of retraction? Causing the Deflationary pressure?

      Even that does not follow. In an economy with idle capacity, unemployment, and idle resources, some limited counterfeiting and spending on goods per se would increase demand and probably capital investment, raising output and employment, and making the community richer.

      Okay, this is a ridiculous argument. It is the good old, ‘grease the wheels’ argument that I have heard from Keynesian’s over and over again. What this does instead of ‘increasing demand and capital investment’

      What should happen in a down economic time is a reallocation of labor and deflation of prices that caused the down economy. If you ‘grease the wheels’ rather than repair the car all you have done is treat the symptom rather than fix the problem.

      The problem in the first place was a mis-allocation of resources. By counterfiting and placing new resources into the economy without allowing the economy time to reallocate the resource issue in the first place you ARE placing the idle capacity back into the swing of things, but not in what actually needs to be done. If I was to counterfeit and hire for instance street sweepers in order to stimulate the economy, then would not demand for services go up? Yes. Will not the added aggregate demand increase the price of goods? Yes. Will this in turn create additional capital for people to hire. Of Course. Will it create inflation? You tell me. If the answer is ‘No’ then you are correct creating a bogus fiat money supply is a fine way to stimulate the economy. But if the end result is that EVERYONE loses purchasing power than I would suggest that all you have done is cause a mis-allocation of resources that would have eventually figured out a new wage point, price point, etc. Will there be short term fluctuations while this adjustment goes on? Of course it will but in the end you propose a zero sum game no matter what you do. Finally what purpose did the street sweepers actually do for the economy? They were simply a shill to enter into the monetary supply chain.

      Finally your own conclusion destroys your entire argument.
      But that this is not a convincing argument for counterfeiting, because there must be controls on the amount of money creation and, legally, it is only the central bank/government that should have accountable, democratic responsibility to create and destroy high powered money — the highest form of money — and manage it for the community.
      So basically we can hold people accountable for when things finally blow up in our faces, and then have them make promises to fix it by simply doing the same thing over again? You say that Counterfeiting is okay, but only if it is controlled? Isn’t that akin to saying, it is okay to steal so long as it is the Capo dalla famillia? I mean so long as the Mafia leader says it is okay to extort a little money that is okay. But he has to be held accountable to the people if he takes too much? In a country of 315 Million people how much of a say do I get to the monetary policy? This is not ‘Democracy it is mob rule at that point and we are not a Democracy in the first place but a Republic.

      Anyway… I am shocked at your statements and I am becoming more shocked at the belief that Keynes had it right every day. Oh will it work? Of course Ponzi Schemes always work until they stop.

      Sorry if I seem a little hostile today, I am simply flabbergasted at what people believe is sound fiscal policy. Because it seems to be working right now. Well heck if you look back in history ALL fiscal policy worked until it didn’t. Are things REALLY that much better now than in 1850?

      • skylien says:

        “…I know I saw my wages go down during the recession. As well as prices at the store when they had large surplus inventories. I think you are seeing what you want to see in this case.”

        Ditto!

    • Razer says:

      So counterfeiting makes us all richer? Oh, boy. This is so stupid it’s actually scary.

      Zimbabwe must be the wealthiest country on earth, no? And the government, the entity you believe should rightfully counterfeit is behind it too. For an empiricist, you should be embarrassed by how easy it is to find empirical examples that show how full of BS you are.

    • vikingvista says:

      The ability of a receiver of newly created fiat money to outbid a nonreceiver for resources is quite a different phenomenon than the ability of a receiver of private credit to do so. The former in all economic respects resembles a simple theft transfer. The latter resembles the voluntary trade of one person’s present income for another person’s future income, including the risk failures inherent in all future predictions.

      Broad money and basic money do not work the same. That is why, e.g., 200 years of fractional reserve banking mostly upon a gold monetary base resulted in no long term price inflation in the U.S. M2 is economically different than M0.

      But RM is exaggerating that all dollar holders are made poorer by the expansion of a fiat monetary base. Instead, many are made poorer for the benefit of a few nearest the money creation, and this effect takes time (or more specifically trades) to materialize to its full extent.

  5. Tel says:

    Because the government can’t finance a deficit through rising prices. Nope, a government can finance a deficit by printing more money.

    But if prices never rise then the punter at the bottom of the heap never needs to pay the tax. After all, if $100 buys me this much stuff today, and also the same stuff next year, then I haven’t paid anything.

    • Tel says:

      Even if prices go down, the other holders of dollar-denominated assets are poorer because of the counterfeiter, because without the counterfeiting the prices would have fallen even further.

      OK, you already answered me… Not very convincing though, I mean its one of those counter-factual things, would it hold in court? Could you prove similar injury in other situations? If someone distracted you on your way to buy a lottery ticket, could you claim that you would have won the lottery and hit them up for the difference?

      Counterfeiting is just illegal, no attempt is ever made to demonstrate that it damages anyone.

      • martin says:

        If someone distracted you on your way to buy a lottery ticket, could you claim that you would have won the lottery and hit them up for the difference?

        If someone steels $100 dollars from you and someone else pays you $200 dollars for some reason, does that mean you were not really robbed because on net you have more money than you started out with?

        • Tel says:

          But in the case where prices do not change, you have yet to show that anything was taken from me.

          • guest says:

            Price changes occur the moment new money is first spent.

            You may not be affected right away, but it will reach you in time.

            (And money isn’t the only thing that can be taken from you; There is also time/opportunity.)

            With newly printed money I am able to acquire something that I wasn’t able to so soon; and the seller is able to acquire purchasing power sooner than he otherwise would.

            Depending on how long he would have had to wait for someone to buy from him, the seller might have had to lower his prices consistent with consumer [lack of] demand.

            But even if the seller would have sold his wares anyway, the spender of newly printed money will force others to defer their purchases for a time (because one has been artificially made able to make his purchase sooner than he otherwise would have) – a minor inconvenience in some cases and the difference between life and death in others, but a loss in wealth in all cases, nonetheless.

      • Major_Freedom says:

        “OK, you already answered me… Not very convincing though, I mean its one of those counter-factual things, would it hold in court?”

        So if I shoot you, then you can’t say that you otherwise would have lived had I not shot you, because not shooting you is a counter-factual.

        • Tel says:

          The penalty for murder is constant, regardless of whether you kill a young person or an old person. That’s because we generally agree amongst ourselves that murder is a bad thing.

          The penalty has no relation to how long the victim might otherwise have lived.

          • Razer says:

            So all murders serve the exact same time in prison? Hmm. Facts don’t support that claim at all.

            • Tel says:

              Can you demonstrate any correlation to loss of the victim?

              If prison happens to let some people out early on parole I can’t see how that is related.

              • Razer says:

                I merely challenged your claim. Penalties for murder are not the same everywhere.

      • kavram says:

        I think it’s pretty obvious that counterfeiting makes everyone else poorer. Think about it – someone is consuming from the economy without producing for the economy (aka working).

        They are consuming goods/services that would have otherwise remained in the economy’s inventory. This lowers “aggregate supply” and thus makes prices higher than they would otherwise be

  6. Maurizio says:

    the other holders of dollar-denominated assets are poorer because of the counterfeiter, because without the counterfeiting the prices would have fallen even further.

    Though I certainly agree that the prices would have fallen further, I am not sure this is why people think counterfeiting should be illegal. I don’t think people dislike a counterfeiter because he damages them. It might have more to do with cheating in a competition. Maybe they think he is gaining an unfair advantage.

    OTOH, maybe they think “if everybody did that…”. Which probably implies they think his behavior is actually harmful.

    • Tel says:

      Right, but if everyone did it, then prices would rise. The rising price can easily be shown to deplete purchasing power and then tangible damage is done.

      • Razer says:

        If I can cheat you without you knowing it, did I still cheat you?

  7. Bill Woolsey says:

    The inflation tax framing has some truth.

    If the demand for money is growing, and money has a zero nominal yield (like gold coins or traditional paper hand-to-hand currency,) then money creation at a rate slower than the rate of increase in the demand to hold money results in the issuer “taxing” the real yield that would otherwise be created by a rising purchasing power of money. The real yield on money would still be positive, just lower than it otherwise would be. If the government is issuing the money, then it is taxing part of the real yield.

    The government spends the revenue from the inflation tax by spending the newly-created money.

    If the quantity of money grows more rapidly that the demand for money, then the purchasing power of money falls. Again, if money has a zero nominal yield, then its real yield is negative. That negative yield is more obviously a tax on holding money. And the rate of tax is equal to the rate of decrease in the purchasing power of money. And that is the same thing as the rate of increase in the price level.

    Think about taxes on stocks or bonds. While the tax rate on the real yield can be over 100%, it doesn’t have to be. The way it is “supposed” to work is that those holding financial assets earn a real return and the government takes a part of that real return. It isn’t supposed to be that the government takes all of the real return and part of the principal as well. Of course, that happens when the tax is on nominal returns and there is high inflation.

    This is very much has a “monetarist” framing. Money is framed as “paper gold.” The constant “optimum quantity” is a baseline. The alternatives are various rates of money creation that result in various rates of proportional rates of price change. At low rates of money creation, the tax takes away part of the real return that would exist with a constant quantity of money. And higher rates of money creation, the rate of tax is higher than the real rate of return that would occur with a constant quantity of money.

    I don’t see the framing as useful if inflation or nominal GDP is targeted and most money takes the form of interest bearing financial intruments. The zero-interest hand-to-hand currency in that framing is a type of debt. The issuer is borrowing at zero nominal interest. The rate of price change shows the real interest rate that implies. The higher the targeted inflation rate (rate of price increase) the more negative the borrowing rate for the currency issuer. With a targeted deflation rate, then the real interest rate that the currency issuer is paying is positive. For most money, the rate of price increase just impacts the nominal interest rate paid.

    The Mises position carried forward by Rothbard defined inflation in a truly anachronistic way from the middle of the 19th century. Paper money issued beyond gold reserves. This sort of inflation doesn’t necessarily result in a rising price level.

    From the point of view of economic science, the question of what determines the price level. I think that the general public worries quite a bit about increases in the cost of living and drops in incomes. And so, they are concerned about the purchasing power of money too. If there is no gold standard, then the creation of money beyond gold reserves just becomes any creation of money. I don’t see why a constant quantity money is a particularly relevant baseline for either economic science or the concerns of the general public.

    I favor a 3 percent growth path for nominal GDP, which should generate zero “price” inflation on average. What this implies for the quantity of money is uncertain. It depends on what happens to the demand to hold money, but I expect it to usually grow with real output so that the quantities of monies issued by various banks would be growing. The nominal interest rate on the monies would reflect the competitive real rate on average. I think hand to hand currency should be issued by private banks as well in quantities reflecting the demand to hold it. Competitive banks will compete away whatever gain there is from borrowing at zero nominal interest. I think the most likely scenario is paying interest on the deposits of the person withdrawing the currency from the bank, but maybe extra ATM machines would be built.

    Under the status quo, the government is borrowing by issuing hand to hand currency at a zero nominal interest rate. The 2 percent inflation target is that new borrowing by the government by the issue of currency will be always at a negative 2 percent real interest rate. How much they get to borrow at that rate depends on the demand for currency, which is usually growing. If the national debt is bigger than that, then they borrow the rest at competitive interest rates. I don’t think “money growth” creating an “inflation tax” is a useful framing.

    • Razer says:

      The words price level and science don’t belong in the same sentence. Rothbard shattered the shaky foundations of what constitutes the price level and it’s hard to take anyone seriously who talk of this mythical statistic. So why not go back to a definition that provides clarity — defining inflation as the creation of new money? It’s easy to understand, can be measured, doesn’t require nonsensical new tools like the oft-calibrated CPI to interpret? The truth of the matter is that inflationists hate the traditional definition shows them for what they are — inflationists. And since that is an unflattering public image, they changed the meaning. That is the plain truth. Notice that every inflationist hardily supports this new definition. That is no coincidence.

  8. Ken B says:

    This is a fair cop.

    I try to be careful discussing with people and say the govt will either default or print money, but I can’t swear I haven’t said “inflate their way out of it” or something similar. Of course this could just show the effect of the Austrian redefinition conspiracy ….
    ;)

    • Bob Murphy says:

      Ken B. were you visited by the ghost of Free Advice future? Why the agreeableness? :)

      You’re right that if we’re using it as a verb, then of course “to inflate” can only mean “to issue more money.” Point Mises/Rothbard.

      On the other hand, “joe” above is half right (in my opinion) that to say “the government is effectively defaulting on its debt through inflation” is a little more ambiguous. Technically, the gov’t could benefit just by somehow getting prices to double, even if it weren’t the one issuing the new money. (It could relax reserve requirements for example.) So he’s right (I think this is the point he was getting at), that when we talk about the government benefiting from inflation because it’s a huge debtor, that one aspect refers more to the fact that the gov’t already had existing dollar-denominated debts, not that it was covering new deficits by printing money.

      • Ken B says:

        I was thinking on Newton and the re coinage. And the Byzantine empire and its sound solidus. For a long time people were aware of and spoke about debasing coinage. The connection between that and prices was clearly well understood and discussed.

        So why did debasing pass from the language more or less when we got paper money? It could be etymology, the word comes from base metal, and that doesn’t fit paper so well. If so then you need another word …

        I am well aware this could be an argument on Bob’s side.

    • Tel says:

      … the Austrian redefinition conspiracy …

      You mean un-redefinition counter-conspiracy don’t you?

    • skylien says:

      Ken,

      Do you really think that the USG will either at some point default or will print their way out of it? I mean this is what you expect the USG to do?

      • Ken B says:

        Kinda. I do expect monetary (and hence price) inflation to be a way to reduce unsustainable debt. I expect inflation to be used to devalue denominated debt. $100 savings bonds cost less to pay off with inflation. And I expect an indirect default: that many costs will be pushed onto the states, and from the states onto cities, and cities will default.

        • guest says:

          And I expect an indirect default: that many costs will be pushed onto the states, and from the states onto cities, and cities will default.

          Hey, check it out: You just described Cantillon Effects. I think that’s great.

          You don’t yet see this as a bad thing, but that’s probably because you think government going into debt for some things is actually a good thing.

          All we have to do now is show you why all of those things are necessarily destructive of wealth.

          May I suggest this:

          Appendix B: “Collective Goods” and “External Benefits”: Two Arguments for Government Activity
          [WWW]http://mises.org/media/6738/Appendix-B-Collective-Goods-and-External-Benefits-Two-Arguments-for-Government-Activity

          • Ken B says:

            I do see it as a bad thing. I confess I see Detroit’s default as a better thing than bailing it out though! Better not to get into such a mess in the first place.

        • skylien says:

          Well, it seems, then your are predicting the same pattern as Schiff does. You are differing at best in degree. Don’t you think?

          • Ken B says:

            Well, you and Krugman both breathe. Sometimes a cigar is just a cigar.

            • skylien says:

              You act as if there is no alternative prediction.

              The alternative prediction is the Keynesian/MM one; that if enough money is pumped into the system, investment and consumer confidence returns, and money taken from the hoards is spent again, which will grow real GDP and the debt problem is solved by growing out if it instead of a real or hidden default. Also there will be no problem normalizing the balance sheet for the Fed.

              I just think it is a bit strange given your thoughts on this that you mock Schiff. The only thing you can mock Schiff for is that he is off in timing, of which as far as I know he never gave a clear time frame so I am not really sure you can even do that. So at best you can mock him for being so alarmist about it and that he exaggerates… However qualitatively you are on the same page.

  9. Silas Barta says:

    When they arrest people for counterfeiting, they don’t go look at the trend in CPI to make sure the guy was hurting anybody by printing off $100 bills on his laser copier. No, when it comes to citizens doing the counterfeiting, everybody seems to get–it’s obvious–that the introduction of extra money, per se, makes everybody else poorer.

    Careful there! I’ve seen inflationists “bite the bullet” on this one and claim that counterfeiters can, in fact, Pareto-increase social welfare, so long as they are deliberately judicious about how and when they print money (or conversely, when they destroy it). Here’s an example of Landsburg suggesting it (with link to a less prominent advocate of the view), though I can’t find the clearer example I remember.

  10. Collin says:

    The reason Counter-fieting is a “bad thing” is because of what Bob is saying. Is that the reason people think it should be illegal? Probably not. People don’t really know why it should be illegal, they just know that it is. The real reason it is illegal has nothing to do with inflation. It is illegal because government hates competition, the same reason a competing post office is illegal and why there is a government road monopoly.
    It seems weird to focus on “what people generally mean when they say…” Who cares what they mean if these people are wrong? Inflation has to be about the money supply. If it is about “prices” then it is about nothing.

  11. Tom E. Snyder says:

    For my classes I modify the PowerPoint slides from “inflation” to “price inflation”. I have to introduce the concept of “monetary inflation” at the proper time because the textbook does not use the term. I try to avoid using the term “inflation” without the modifier.

  12. Max says:

    If the Fed allowed the quantity of money to determined the value, then money would be an unstable bubble. Hyperinflation would be a possible result. Instead, the Fed fixes the value of money and adjusts the quantity up or down as needed.

    • guest says:

      Think of it like: You would have made 5% profit, but someone comes along and takes 1% of your profit, such that you only make 4%.

      You’re still making a profit, but not as much as you would have.

      This is what central banks aim for; Inflate the money supply to skim profits off of everyone else so that they don’t notice and so that they can blame the free market for the inflation’s destruction.

    • Tel says:

      Instead, the Fed fixes the value of money

      Indeed that does appear to be what is happening, but “value of money” is a subjective thing. At the moment the value is determined on the commodities market, although we don’t know how long that might last.

    • Cosmo Kramer says:

      “Instead, the Fed fixes the value of money and adjusts the quantity up or down as needed.”

      Wow, a Federal Reserve fanboy. Did it ever dawn on you that what it does isn’t needed?

    • Razer says:

      Fixes the value to what? How? Does that value change via manipulation of its measurement? If people get sick of the Fed money,can they freely return it to the Fed for whatever the Fed is fixing its dollars to?

      • Max says:

        Good questions. The fix is currently to a price index, but if people got sick of dollars, then the Fed would have to switch the fix to something else, like a foreign currency.

  13. Tel says:

    Just to bring this back to Bitcoin for a moment.

    In the case of this particular (synthetic) currency, the algorithm of Bitcoin is deliberately designed to max out at some finite number of coins, and never have more coins than that. People using Bitcoin have an expectation that there is a general agreement amongst all Bitcoin users that such a maximum value exists.

    Suppose some guy figured out how to make more Bitcoins (let’s not get into an argument about whether this is possible or not, just suppose it happens) now, every other Bitcoin user would have an expectation of a finite total number of coins but the expectation would be broken by the counterfeiter. This is the same as breaking a contract, or using fraud. Thus, Bitcoin users do have a valid reason to claim damages against a counterfeiter, because they made an agreement amongst themselves that the currency would max out. Of course, making this mathematically difficult to do is also a good idea… use locks first, and lawyers second.

    No such general agreement exists for US dollars. People know that the Fed controls the currency, and people know that the Fed can print what they like, and give low-interest loans. That’s just part and parcel of how the US dollar works. There’s no claim to be made when the Fed does exactly what it said it would do.

  14. Cosmo Kramer says:

    Bob, thank you for the wonderful post.

    The logic behind it is something that All economic schools should share, but do not.

  15. Gil says:

    It would rather be argued someone on a laser printer cannot produce a real dollar bill but a visually close fake which is the same as a someone who inserts tungsten bars into a gold ingot. However if people play the “counterfeit” game where more dollars hurt those who already hold dollars then gold miners are counterfeiters by introducing more gold into the system and devaluing existing gold fortunes. If you argue “but gold continues to have a high market price” then consider how much higher the gold price would be If people were forbidden from gold-mining. Currency is principally a tool to make transactions work than a store of long term value. As long as the economy is growing there’s always a place to trade your money in for something which will grow with the economy.

    • guest says:

      However if people play the “counterfeit” game where more dollars hurt those who already hold dollars then gold miners are counterfeiters by introducing more gold into the system and devaluing existing gold fortunes.

      More gold wouldn’t devalue gold fortunes because its value is the demand for gold given the current supply – though, yes, prices would rise in terms of gold; But this isn’t devaluation.

      Gold’s value comes first and foremost from its utility as a commodity. It’s value as a money is derived from that.

      When the supply of gold increases – just like when the supply of any other good increases – it’s marginal utility goes down, so the value of each unit is SUPPOSED TO go down.

      If the supply of gold was able to be increased more rapidly, people would stop using it as a currency, but now people would have a cheaper commodity. The economy wouldn’t suffer because of it, just like the economy wouldn’t suffer if vastly more food could be created.

      But since the function of money is to enable [I said "solve", before - oops] a double coincidence of wants, the money has to represent something that is traded for the utility it offers to individuals. Paper claims to money in excess of the actual supply is fraud (paper claims that are not immediately redeemable are not money, but contracts).

      The only reason to issue paper without any kind of backing as the money is to force other people to work for you for nothing. This is slavery.

      It’s also fraud because the claim is that the paper is money, when it’s not; Printing MORE paper money is fraud on top of fraud.

      If people wanted to trade paper, they wouldn’t need government to do so.

      If people want the supply of paper to be limited, it’s because they think it should represent something that has utility as a non-money; There is no other reason a consumer would want the supply of paper to be limited.

      • Gil says:

        Gold continues to be valuable because of the hoarding effect – people buy gold then take it off the market. The gold price only applies to those actively buying and selling gold. However if everyone for some reason were to put all the gold in existence onto the market then the price of gold would plummet as gold bugs find out the hard way how much gold there really is in the world.

        On the other hand, gold miners are devaluing gold fortunes, period. Just as a dollar continues to hold a value regardless of how many dollars are in the system so too an ounce of gold continues to have some sort of value. Hence imagine how much gold would be worth had no gold had been mined since 1900?

        Furthermore, the simplistic notion that the marketplace wants gold and silver coins as currency has no bearing. Credit systems have existed since Sumer. Merchants have always wanted to have a paper/credit system for everyday transactions while using gold and silver to store their wealth when their money is not in active use. But that’s what happens now: you’re free to spend your spare money on buying up gold and silver if that’s your thing.

        • guest says:

          The gold price only applies to those actively buying and selling gold. However if everyone for some reason were to put all the gold in existence onto the market then the price of gold would plummet as gold bugs find out the hard way how much gold there really is in the world.

          Gold is hoarded because it’s a good store of value. The only reason to spend it is if it has less value than that which you want from it.

          So when you say that if people just went out and spent their gold, the price would plummet, that’s a tautology – it’s what the spending of gold would MEAN.

          You save/”hoard” something because you believe it will have value for you later. There’s no REASON to spend something right away that you think will have more value being spent later on.

          On the other hand, gold miners are devaluing gold fortunes, period.

          To devalue something is not to create more of something such that its marginal utility goes down; Rather, to devalue something is to make the price of something go up in terms of units of the IOUs that are supposed to represent that something.

          If the amount of gold increases, it’s marginal utility, and therefore its value, is SUPPOSED to go down.

          Furthermore, the simplistic notion that the marketplace wants gold and silver coins as currency has no bearing. Credit systems have existed since Sumer.

          Credits aren’t money, they are contracts; They represent one side of an incomplete transaction.

          A failure to pay back a loan, with interest, is a breach of contract and a theft of the actual money that was lent.

          Merchants have always wanted to have a paper/credit system for everyday transactions while using gold and silver to store their wealth when their money is not in active use.

          Again, credits aren’t money. The paper credits were supposed to represent the actual supply of gold.

          So even if paper is traded, people understood that the paper wasn’t the money.

          It’s why there were bank runs; Why have a bank run if you have a piece of paper from the bank that says its money?

          People want the commodity that the credits represent, not the paper on which it is written.

          • Gil says:

            Gold has no “intrinsic” value. Since gold was delinked from the dollar its value has wildly fluctuated. Gold doesn’t “store” any thing rather you hope the price of gold is higher than when you want to sell it.

      • Gil says:

        Maybe the whole economy per se wouldn’t suffer but if the price of gold plummets in a way that those investing in gold just saw their net wealth plummet then they’d be suffering. Similarly, farmers whose food production didn’t spike would suffer from low food prices.

        • guest says:

          Maybe the whole economy per se wouldn’t suffer but if the price of gold plummets in a way that those investing in gold just saw their net wealth plummet then they’d be suffering. Similarly, farmers whose food production didn’t spike would suffer from low food prices.

          That’s what’s supposed to happen to bad forecasters.

          You can’t invest in just anything and expect to make profits.

          And I want you to note how ready you were, in the previous comment, to say: “you’re free to spend your spare money on buying up gold and silver if that’s your thing.”

          You say this as if I’m kicking myself; But by spending money on gold and silver I am reducing my spending on something else such that those businesses which I am NOT spending paper on are deprived of business.

          Is there no corresponding grief over the poor businessman I am depriving of paper money to go along with your allowance that I have the right to spend my money stupidly, as you see it?

          No, because the one contradicts the other.

          If I am permitted to spend my money “stupidly”, then I am permitted to spend my money in such a way as to result in some businesses succeeding while others fail.

          But if it’s OK, in your view, for businesses to fail because I choose not to shop there, then it’s OK for farmers to go out of business because I chose to shop where it’s cheaper; Therefore, there is no cause for alarm when certain farmers DO go out of business, and nothing for the government to stimulate.

          • Gil says:

            If gold and silver are such wonderful stores of value then buying gold and silver would make sense especially as Libertarians think there’s a conspiracy to make precious metals artificially cheap.

            • guest says:

              It’s not the precious metals, per se, that are being made cheap, but the paper futures market for them.

              Gold and silver ARE such wonderful stores of value, but if you trick people into thinking there exists far more than there actually is, then don’t be surprised that people mistakenly treat them as if they were less valuable than they are:

              Gold, the Titanic & Lifeboats – Why it’s Important to Own Physical Gold
              [WWW]http://www.youtube.com/watch?v=5z5xwb2xCyk

            • Richie says:

              “as Libertarians think there’s a conspiracy to make precious metals artificially cheap.”

              You know nothing about what “Libertarians” think, you POS troll. Go back to the LvM site.

    • Richie says:

      Whadda ya know, the troll from the LvM site.

    • vikingvista says:

      1. Somehow you managed to miss the point of the counterfeiting example. Whether the notes are real, or fakes successfully passed off as real, is irrelevant.

      2. It is the nature of a commodity to be produced. Production of gold was a well-known feature of gold before it ever emerged as a money.

      3. Even with history’s intermittent gold rushes and the associated local price inflation of the boom towns, overall price inflation of goods and services denominated in gold-based monies has been trivial compared to fiat monies.

      4. A gold producer can outbid a non-gold-producer only to the extent of his profit margin, and no profit margin is guaranteed. The profit margin of a state monopoly fiat money producer is virtually100% of the nominal value of the money he produces, and is whatever he wants it to be up until the point it ceases to be a money at all.

      5. The seigniorage of a state money producer is determined by the violent suppression of competitors and imposed requirements of its use in certain key transactions, and is therefore confiscatory. Gold production, on the other hand, can be readily regulated by the voluntary marketplace.

      Expansion of a gold monetary base is substantively different than expansion of a state fiat monetary base.

      • Gil says:

        1. Nope. The that the definition of counterfeiting. A similar scenario was when the building early Ford cars were becoming so efficient that newer models sold cheaper than the older models in a way that it was hard to for owner resell their cars. Thus the Ford company stole the value of the early cars from the owners.

        2. A tautology or just an obvious statement?

        3. I suppose that true if you far enough away from the gold rush so the inflation doesn’t hit you? However if you were expected to be paid in gold it was supposed to the other person engaged in productive activities to get the gold to pay you. Someone who promises to pay you in gold then goes off to mine it is no different from someone who prints up some dollars then hands them to you.

        4. But then cue the government exists per se. They take over the law, enforcement, currency, etc.

        5. in such a scenario the gold isn’t regulated rather the parties involves take what they can get.

        • Richie says:

          Great, another troll to clog the comments.

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