[Winstonm]

I know how you feel!! And I'm the one who brought it up.

It is confusing and may be because our terms are so fixed in our minds about debt, etc.

No matter what, I thank you for the time and effort in responding - even if you want to throw up your hands and yell "uncle".

Let's try it this way.

My supposition is based on Mr. Eccles statement that the U.S. system is one of debt-money, i.e., all money must be borrowed into existence.

For ease, let's transfer this to balance sheet terminology, instead. If all money is borrowed into existence, then all money can be termed "liability" on the balance sheet. All loans that created that money can be termed "assets".

Thus, we have a 1:1 relationship between assets and liabilities. New money created will have a corresponding loan - new liability/new asset - still 1:1.

In the SS example - it is equivalent to an off-balance-sheet transaction - because it has yet to occur. When the SS promise becomes an obligation to pay, it comes onto the balance sheet. Again, New Money (Liability) must be created by New Debt (Asset). There will still be a 1:1 relationship when that occurs.

I think what you are saying - if I may paraphrase to my comprehension - is this future claim creates a mistrust in creditworthiness. The end result then would be the perception that the asset backing the liability is worth less than claimed.

And you are right - a reduction in the value of the asset would have the same affect as a currency debasement - to return to former language, what would happen is a demand for more dollars in exchange for this lesser value debt.

Where this would manifest itself would be in treasury bond prices - a demand for a higher return in exchange for the debased debt - in worse-case scenario, demand could be non-existent, which would cause a forced monetization by the Federal Reserve, which indeed would spark not only inflated prices but perhaps hyperinflated prices.

Returning to the balance sheet comparison, the oddity is that even in a hyperinflationay scenario as just described with the Fed printing money, the asset/liability ratio would not change. The only way to maintain confidence in the debt value would be to pay down the future payment obligation as it occurs - tax increases - in other words by not creating new asset/liability exchanges to finance the obligations.

So perhaps you have helped me refute my own argument - the more critical element of inflation is debasement of the debt, caused by confidence loss?

[DrTodd13]

Could someone summarize what questions are left unanswered? It seems there's a lot of confusion of cause and effect. Inflation is by definition an increase in the supply of money. Combine inflation with a wide variety of other occurrences and you can many different results. Hold everything else the same, increase money supply 2x and you'll get 2x price increases. I don't think the SS or Medicare (Medicare 5x worse than SS) "obligations" have been factored much into anything. The government doesn't list them as debts because they claim they can eliminate them tomorrow and thus not incur them, despite the fact that politically this will never happen.

Winston, I don't think that thinking in terms of ratios will help you here. Also, I don't think that it is possible to talk of interest rates and money supply separately.

[hrothgar]

DrTodd13, on Mar 3 2008, 09:44 AM, said:

Could someone summarize what questions are left unanswered?  It seems there's a lot of confusion of cause and effect.  Inflation is by definition an increase in the supply of money.

Actually, inflation is defined as a change in prices...

For example, Wikipedia defines inflation as

Quote

Inflation is a rise in the general level of prices of goods and services in a given economy over a period of time. It may also refer to the rise in the prices of some more specific set of goods or services. In either case, it is measured as the percentage rate of change of a price index.[1]

If you want, I can go and dredge up any number of Economics texts that offer similar definitions.

Montarists believe that inflation is caused by changes in money supply, but even they don't define it as such...

I'd even go so far as to say that most economists agree that monetary policy can have a significant impact on inflation. However, once again they don't define inflation as a change in the money supply.

[kenberg]

I'm thinking part of the problem is at the beginning:

"My supposition is based on Mr. Eccles statement that the U.S. system is one of debt-money, i.e., all money must be borrowed into existence."

It's not that I want to set myself up as disagreeing with a former chair of the Fed. But we are taking one sentence, uttered by one person more than sixty years ago, and using it as a basis for a theory. It would be fine to look at what Eccles said, the context in which he said it, what he meant by it (the meaning is far from transparent imo) and what others have said in this regard since then. But as a stand alone basis for a theory, it leads to confusion.

Off-topic analogy: In my college days in the 50s, existentialism was the rage. The motto was Sartre's "Existence precedes essence". This might be true, but I didn't know what it meant then and fifty some years later I still don't. I have similar issues with "all money must be borrowed into existence".

[Winstonm]

Quote

Actually, inflation is defined as a change in prices...

I believe the cause of the disagreement in terms is probably based on Miltion Friedman's observation that "inflation is always a monetary event."

To try to unsettle the matter is to find a universal definition - but it should seem to me that the definition in some way should reflect the cause.

For example, simple supply/demand imbalance due to lowered output can cause prices to rise but is that inflation?

In other words, perhaps a best (though not textbook) definition might be "a general rise in prices caused by ____.

[Winstonm]

Quote

Montarists believe that inflation is caused by changes in money supply, but even they don't define it as such...

This is somewhat at the root of my conundrum - I have seen this claim, as well, but it is in reference to expanding money supply greater that what?

If money supply and demand for money are in balance there should be no inflation it would seem.

Then I read the concept of debasement of money - a la the King calling in all the gold and re-issuing 1/2 gold coins.

It made me wonder if there were a mechanism that could accomplish this debasement of a debt-backed currency.

And now here we are - and I'm still confused.

[hrothgar]

Winstonm, on Mar 4 2008, 02:33 AM, said:

Quote

Actually, inflation is defined as a change in prices...

I believe the cause of the disagreement in terms is probably based on Miltion Friedman's observation that "inflation is always a monetary event."

To try to unsettle the matter is to find a universal definition - but it should seem to me that the definition in some way should reflect the cause.

For example, simple supply/demand imbalance due to lowered output can cause prices to rise but is that inflation?

In other words, perhaps a best (though not textbook) definition might be "a general rise in prices caused by ____.

Winston:

Listen to me: There is NO controversy

Inflation is a well defined term, like "Red" or "Carbon". When you say the word inflation economists know what you mean and they sure as hell DON'T mean a change in the money supply.

There are different measures of inflation: People will often use different market baskets measures the price index. However, there is widespread agreement about the basic definition.

Its all fine and dandy to argue about different causes of inflation - folks have suggested all sorts of different causes - but I don't see the point in trying to change basic definitions.

[Winstonm]

Quote

Hold everything else the same, increase money supply 2x and you'll get 2x price increases.

This is similar to Mike (Mish) Shedlock's definition of inflation: an expansion of currency and debt.

The hold everything else the same is the hard part to determine - currency and debt will naturally expand in an expanding economy with an expanding population to accomodate that expansion - how do you determine excessive currency and debt, which appears to be the real drivers of inflation?

[Winstonm]

Quote

I'm thinking part of the problem is at the beginning:

"My supposition is based on Mr. Eccles statement that the U.S. system is one of debt-money, i.e., all money must be borrowed into existence."

Actually, this was a the heart of my conundrum - as the problem assumed the statement as true, then....as so on.

[Winstonm]

I'd like to thank everyone for contributing to my understanding on this issue.

Edit: I changed my mind - I think Richard makes a worthy proposal to discuss the causes of inflation but let's leave the inflation definition intact.

I can start this off with a current hypothesis I have toyed with in that an artificial manipulation of the interest rates that are then held too low for too long (I'm thinking housing, here) has the real effect of compression of economic time.

It gives the illusion of growth but in reality it is simply growth borrowed from the future. If future economic actors are lured to make time preference change due to low interest rates, and they do so, then when this inititial "surge" of buyers has been expended, the only way to fill the future void of buying is with marginal buyers - those lower on the credit totempole.

Regardless, this time-compression phenomenon would create an artificially-driven demand/supply imbalance - driving prices higher.

[barmar]

I'm also not well schooled in economics (I took one econ class in college).

I wonder about your simplifying step of ignoring interest. If you want to consider money in terms of debt, can you really afford to ignore interest? If there were no interest, there wouldn't be any debt, except on a very small scale by altruists (e.g. families and neighbors).

Another question I have is about creation of wealth. When a manufacturer takes a bunch of raw materials, puts them together into a product, and it's worth more than the sum of its parts (including the labor), wealth has been created. In the information era, this happens on a grand scale: software, web sites, etc. have very inexpensive raw materials (because labor and "bits" can be amortized over so many units). But if someone is going to become an Internet millionaire, the money they're earning has to come from somewhere, doesn't it? Doesn't this fuel inflation, too?

[Winstonm]

Quote

I wonder about your simplifying step of ignoring interest. If you want to consider money in terms of debt, can you really afford to ignore interest? If there were no interest, there wouldn't be any debt, except on a very small scale by altruists (e.g. families and neighbors).

Interest only facilitates exchange - the incentive to lend. Of course, due to interest there is not a pure 1:1 ratio of money (liability) to debt (asset). But to understand the underlying priciple, it is easier to eliminate the interest component.
When a commercial bank has $100 dollars in deposits, it can lend $900 according to our fractional reserve banking system. The $900 is created money - out of thin air. The transaction is shown as a loan (asset) to the bank, and a debt (liability) to the borrower. This is the 1:1 relationship I mention.

This is the concept behind money being "borrowed into existence." Without the new debt, there is no new money created.

At the Federal Reserve level, the same thing occurs when the Treasury Department needs cash. The Treasury issues a bond, which the Federal Reserve monetizes by creating money. (Not a complete example as these bonds can be sold to outsiders, but it is the core idea we are addressing.) In this case the government debt creates the new money, a 1:1 relationship.

Quote

Another question I have is about creation of wealth. When a manufacturer takes a bunch of raw materials, puts them together into a product, and it's worth more than the sum of its parts (including the labor), wealth has been created. In the information era, this happens on a grand scale: software, web sites, etc. have very inexpensive raw materials (because labor and "bits" can be amortized over so many units). But if someone is going to become an Internet millionaire, the money they're earning has to come from somewhere, doesn't it? Doesn't this fuel inflation, too?

This is describing normal economic activity - If you buy a lemon for $1 and some sugar for another $1 and produce 10 glasses of lemonade that you sell for $0.50 each, have you created new wealth? Not really, customers simply decided to buy your lemonade instead of a candy bar. Intellectual labor is the same - if you invent the round wheel and it becomes popular, the square wheel will see a drop off in sales.

An example is Google - while their advertising revenue has soared, newspaper advertising has fallen - it is simply a preference where the money is spent.

The classic definition of the cause of inflation is "too many dollars chasing too few goods."

Quote

(I took one econ class in college).

That puts you one econ class ahead of me, then.

[mike777]

Lets back up
Lets assume inflation is good......in some reasonable definition.....very good.

1) Lets assume a little inflation is good very good
2) lets assume zero inflation is bad..very bad....including neg infl
3) lets assume alot of inflation is bad..very bad....

If we make these big assumptions


Then we all want inflation in some reasonable, agreed defintion.
We need ....really really need debt assumption.....in some reasonable form.....

[kenberg]

Benjamin Franklin once railed about mathematicians as tiresome people who are always asking for precise definitions. Probably so, but like the elephant's trunk we can be useful.

"We need debt assumption"

This means?

This means that someone should pick up someone else's debt? Is this right? And who is to pick up whose?

Winston was willing to shut down this thread but it appears to have a life of its own. Actually, as a broader discussion of economic issues, it seems very timely. My broad view is that as individuals and as a country we have been doing a truly impressive job of spending money we don't have. Chickens do come home to roost, sooner or later.

[mike777]

"This means that someone should pick up someone else's debt? Is this right? And who is to pick up whose?"

Inflation does..as others have said in this thread.

The trick is to not debase the currency too much in order to pay off the debt as Germany did in 1920's paying off its WW1 penalty debt.

Perhaps we are going through a current time where we are debasing it a bit too much now but .....the usa is a big country with lots of land, raw materials and most importantly smart, hard working, creative people and new immigrants....assets that are much bigger than any trade or budget deficit.....

In any event I still have blind faith in innovation and that our children will have better lives than we have.

[DrTodd13]

I've heard that M3 has increased 40% in the last 2 (or was it 4?) years. Does that sound like a "reasonable" level of inflation?

[mike777]

DrTodd13, on Mar 4 2008, 04:25 PM, said:

I've heard that M3 has increased 40% in the last 2 (or was it 4?) years.  Does that sound like a "reasonable" level of inflation?

Heck I've been in Health Care and commodities ever since they flooded the banking system with dollars to stop that computer glitch problem back in what 1999,2000,2001 or whenever that was going to bring all the computers crashing down... The Fed has been flooding us with M's for a long time.

[Winstonm]

Getting somewhat back to the debt discussion, the tremendous growth in the securitization industry had the effect of negating both reserve requirements and captial requirements, allowing an almost unlimited expansion of debt.

Mike777 can correct me if I'm wrong here, but I understand for U.S. banks the Basel I capitalization requirements are followed, and the reserve requirements are supposedly 10% (but this is fallacy due to all the modifications - true picture is it is probably closer to 7%-8%).

These constraints limit the amount of loans a bank can make - but when those loans are packaged and sold to investors, the bank is then free to make an equal amount of loans again.

To a great degree, banks from 2001-2007 became loan originators who collected fees, and not lend and hold the loan type banks we are accustomed to thinking about.

This has been a huge driver of inflation - virtually limitless credit.

[mike777]

Winstonm, on Mar 4 2008, 08:24 PM, said:

Getting somewhat back to the debt discussion, the tremendous growth in the securitization industry had the effect of negating both reserve requirements and captial requirements, allowing an almost unlimited expansion of debt.

Mike777 can correct me if I'm wrong here, but I understand for U.S. banks the Basel I capitalization requirements are followed, and the reserve requirements are supposedly 10% (but this is fallacy due to all the modifications - true picture is it is probably closer to 7%-8%).

These constraints limit the amount of loans a bank can make - but when those loans are packaged and sold to investors, the bank is then free to make an equal amount of loans again.

To a great degree, banks from 2001-2007 became loan originators who collected fees, and not lend and hold the loan type banks we are accustomed to thinking about.

This has been a huge driver of inflation - virtually limitless credit.

I am sure you know this but I will just repeat it.

Banks create money, they do this through creating loans or "virtually limitless credit", as you put it.

As many others have said all this is really just too much money chasing to few goods or services.

This may be a bit extreme but basically the Fed, politicians and most us prefer option one debase the currency, flood the system with liquidity, money, credit than option two which is a worldwide depression. As some point, not this year, the cycle will reverse and tight money ala 1981...82...etc will come back in vogue.

Granted option one and two are extremes but I think it is those fears that drive us.

[jtfanclub]

mike777, on Mar 5 2008, 11:24 AM, said:

This may be a bit extreme but basically the Fed, politicians and most us prefer option one debase the currency, flood the system with liquidity, money, credit than option two which is a worldwide depression. As some point, not this year, the cycle will reverse and tight money ala 1981...82...etc will come back in vogue.

It could be very soon. Depends on how many other banks collapse. Yeah, I know, technically Countrywide didn't collapse. They just got bought out for pennies on the dollar. The tight money of the early 80s and the S&L crisis in which 1600 banks collapsed of the early 80s were not coincidence, though the cause and effect there were kind of a cycle (banks collapsing causing tightening credit which caused more banks to collapse and more tight money, etc.).