[Winstonm]

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If you keep increasing productive effort but keep the money supply constant then either the velocity of money will increase or prices will fall.

This is interesting as Austrians don't put much faith in Velocity affecting prices. (See Frank Shostak on Velocity).

Increasing productivity is not the same as increasing demand - increased demand can come from population gains. Productivity gains come usually from tecnnological advances - the worker producing more value per hour than before. Productivity gains make the worker more valuable which can then lead to higher wage demand.

What causes falling prices is oversupply or dwindling demand - or what you have now in housing and automobiles, overcapacity brought about by misallocations of resources.

If you increase demand and keep a constant money supply, prices will rise and costs of borrowing will rise - not that this is all bad but to extremes it leads to stagnation and crimped economic growth.

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We had a thriving economy while we were on the gold standard and from what I've read there is no reason it couldn't be so again.

A great little economy....except for that little gold-standard episode from 1929 to 1939....and a few others earlier that were not quite so severe.....

Gold is not a cureall - it brings with it its own type of problems.

[luke warm]

maybe you guys can help me with my major concern re: gold... does that open every thing up to speculators even more than it is now? and even if it does, is it a bad thing?

[DrTodd13]

Money doesn't even represent labor any more than it represents anything else.

It isn't fair to say the great depression occurred during the gold standard because this was also during the era of the FED and they had some bizarre fractional reserve gold system where they kept decreasing the fractional reserve requirement. So, in essence, they were inflating the money supply and when tough times hit they contracted it. The double whammy. They now think they learned their lesson and so rather than contract now they want to inflate like crazy.

[Winstonm]

DrTodd13, on Dec 20 2008, 02:14 PM, said:

Money doesn't even represent labor any more than it represents anything else. 

It isn't fair to say the great depression occurred during the gold standard because this was also during the era of the FED and they had some bizarre fractional reserve gold system where they kept decreasing the fractional reserve requirement.  So, in essence, they were inflating the money supply and when tough times hit they contracted it.  The double whammy.  They now think they learned their lesson and so rather than contract now they want to inflate like crazy.

You tell me what money isn't, but you fail to say what it is.

The U.S. except for rare and isolated instances utilized a gold-standard until 1971. What is not fair is to discount the problems of a gold-standard.

I say money is a unit that expresses the value of labor, and its usefulness is that it facilitates trade. You say money does not represent labor. O.K. Fine. Then what is it and how do you support that definition?

[eros2]

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In simplish terms increase money supply per long term growth of
GDP.

This would be fine if GDP growth actually represented the creation of wealth. Unfortunately, the US economy is built upon consumption, which accounts for ~70% of GDP. This would also be fine if people were spending their own money. However, they are borrowing to consume, and that money originates from savers abroad in Asia and the Middle East. American "growth" is therefore largely dependant upon debt. This is a problem because taking on debt is the exact opposite of wealth creation; not only must the debt be repaid, but with interest. Wealth is created by investment. Investment is funded by saving, not consumption. The US economy is phoney and unsustainable.

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You tell me what money isn't, but you fail to say what it is.

Money is a proxy for value. All else held equal and constant, it is a very good proxy. However, introduce speculators, information asymmetry, intervention and mistaken expectations, and it completely fails as an accurate indication of real value.

[Winstonm]

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Money is a proxy for value.

I agree with this in so far as it goes -- but what does it value? No matter how hard anyone tries to look other places for the answer, the simple and complete answer is that money represents the value of labor, either physical labor or intellectual labor.

Debt, on the other hand, is the opposite of money - it is a claim against future productivity.

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This is a problem because taking on debt is the exact opposite of wealth creation; not only must the debt be repaid, but with interest. Wealth is created by investment. Investment is funded by saving, not consumption. The US economy is phoney and unsustainable

I concur with these thoughts for the most part only I wouldn't say the economy is unsustainable - the economy has a limit and that boundary is solvency - and that makes the economy dependent upon continued borrowing from the world.

I call it the Blanche Dubois economy, i.e., dependent on the kindnesss of strangers - or the Jerry Seinfeld economy, i.e., the economy about nothing.

[DrTodd13]

Winstonm, on Dec 20 2008, 12:47 PM, said:

You tell me what money isn't, but you fail to say what it is.

The U.S. except for rare and isolated instances utilized a gold-standard until 1971. What is not fair is to discount the problems of a gold-standard.

I say money is a unit that expresses the value of labor, and its usefulness is that it facilitates trade. You say money does not represent labor. O.K. Fine. Then what is it and how do you support that definition?

I did say what money is. It is anything that people agree is a common unit of exchange. Money expresses the value of everything, not just labor. I support this definition the same way every definition works. It is the way that people have agreed to define the term.

My contention is that as soon as you don't have a 100% reserve gold standard then the benefit of the gold standard starts to go away. So, while technically there was small amount of gold backing to our currency until 1971, that is looking at it at a shallow level. The system in 1971 much more resembled the current system in terms of restraint on money creation than it does 1910 when, IIRC, we had 100% gold backed currency.

To be clear, I'm not in favor of a government run monopoly on money whether that is fiat or gold-backed. However, if money must be solely created by governments then I think that gold is better that fiat. I would support anybody being able to issue currency backed by whatever they desire and to have free trade in those currencies.

[Al_U_Card]

How about:

money= ( (time required to perform the work)x(desire to obtain the item)x(the effectiveness of the item to fulfill the need) ) / the availability of the item

[mike777]

Feel free to disagree with the below points but it seemed a good place to start to get some basic terms down.

Again my main point is that I hope that mortgage rates get down to 4-4.5% and that is a good first step toward alleviating this crises.

I don't think anyone disagrees that inflation, a high rate of inflation is bad and very difficult and painful to fix. I just argue to try and fix one crises at a time. IF people are starving, feed them, teach them to fish next week.




http://www.friesian.com/money.htm


"As Milton Friedman says in Money Mischief [HBJ, 1992], anything can be money: stones, iron, gold, tobacco, silver, shells, cigarettes, copper, paper, nickel, etc. What makes these things money is not what they are, but what they are used for. They may have value in themselves, like gold ("commodity" money), or they may not ("credit" money, which means banknotes, bank deposits, tokens, markers, etc.); but their value as money is separate from their intrinsic value. What gives money value as such is that it is, or can be, used for exchange, replacing the original human system of trade, which was barter. The value of money is thus the value people attribute to what they want to exchange, no more, no less. As a medium of exchange, all money is in effect "credit" money: credit on an incomplete barter, like an IOU. An IOU can also be anything, as long as it is recognized as a contractual obligation on an incomplete exchange. Commodity money was originally the most natural money, but the value of money is not always the same as its value as a commodity. The intrinsic value of commodity money and its value as money can actually interfere with each other.[2] As a medium of exchange, money also establishes a standard of value (e.g. items A and B may both be worth $5, £5, ¥5, etc.), and as money is held in between exchanges, money becomes a store of value.

What the value of money actually is (i.e. what units of the standard will buy, in general) depends on 1) how much money there is, 2) how much money is held out of circulation, and 3) how many exchanges circulating money is used to cover. This is the "quantity theory of money" and can be expressed in a famous equation by the American astronomer and economist Simon Newcomb: MV = PT. "M" signifies the actual quantity of money; "V" signifies the "velocity," which is the rate at which money circulates or how long money is held out of circulation; "T" is the number of transactions, or exchanges; and "P" is the level of prices. This equation easily illuminates most questions about inflation or deflation, which is how money becomes less or more valuable over time. The evidence for the "quantity theory" is that historically inflation and deflation have occurred independently of economic growth and recession, as can be seen in the data from Friedman and Schwartz given below.[3]

Inflation is where the aggregate level of prices goes up and deflation where the aggregate level of prices goes down. Inflation will occur if V and T remain constant but M goes up, i.e. the supply of money increases without any other changes. Inflation can also occur if V goes up (people spend money more quickly) or T declines (the economy shrinks), as the other variables are constant. Most inflations, however, occur because of independent increases in the money supply. That can happen either with commodity money or credit money. A flood of silver from the New World caused a devastating inflation in 16th and 17th century Spain; and gold strikes in California, Australia, South Africa, and the Yukon produced inflations in the 19th and early 20th centuries. Now inflations are always the result of increases in the supply of credit money: it is easy to print paper, and governments that have begun issuing paper money have always eventually fallen to the temptation of just printing and spending new money.[4] Paper money achieved legitimacy in the first place only because the Bank of England, which was privately owned (founded in 1694 and nationalized in 1946),[5] was the first note issuing agency in history that behaved responsibly and restrained its issue of paper money. Consequently, Bank of England notes were "as good as gold." Inflation does not occur because of a "wage-price spiral," an "overheated" economy, excessive economic growth, or through any other natural mechanism of the market. A government debasing the currency would not have fooled anyone a century ago. Now, through deception, a government can try to blame inflation on anything but its own irresponsible actions.

Deflation usually occurs from one of two causes. Either the economy grows and the volume of transactions (T) increases, or the quantity of money (M) decreases. After the Civil War, when the United States issued hundreds of millions of dollars in paper money ("greenbacks") to spend on the war,[6] greenbacks and gold dollars circulated side by side: but gold dollars were worth several greenback dollars.

UNITED STATES PRICE LEVELS: 1929=100% [data from Milton Friedman, Money Mischief, Episodes in Monetary History, Harcourt Brace"

[eros2]

Winstonm, on Dec 21 2008, 05:28 AM, said:

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I wouldn't say the economy is unsustainable - the economy has a limit and that boundary is solvency - and that makes the economy dependent upon continued borrowing from the world.

So the world produces and America consumes? How is this sustainable? Consider the following analogy (borrowed from Peter Schiff); There are 4 people shipwrecked on an island, 3 Asians and an American. The Asians split themselves to forage, fish and start a fire. The American is designated the role of eating. However, the Asians are perfectly capable of eating the food themselves and once they realise this, the American is redundant.

The truth is that US creditors already know this, but are stuck between Scylla and Charybdis. They are loath to stop lending to America because a run on the greenback would destroy the value of their vast foreign currency reserves held in USD. That is not to say this eventuality will never happen. America is NOT too big to fail. China is still buying US assets and treasury bonds for example, but there will be a tipping point. Of course the short term consequences would be disastrous for all concerned, but the creditors will be better off in the long term. However, US recovery would be much much slower and significantly more painful.

Barack Obama's plans will only exacerbate the problem.

"The Americans can always be depended upon to do the right thing after they have exhausted every other possibility" - Winston Churchill.

I know so many people who are betting against the dollar now.

[mike777]

eros2, on Dec 21 2008, 09:28 AM, said:

Winstonm, on Dec 21 2008, 05:28 AM, said:

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I wouldn't say the economy is unsustainable - the economy has a limit and that boundary is solvency - and that makes the economy dependent upon continued borrowing from the world.

So the world produces and America consumes? How is this sustainable? Consider the following analogy (borrowed from Peter Schiff); There are 4 people shipwrecked on an island, 3 Asians and an American. The Asians split themselves to forage, fish and start a fire. The American is designated the role of eating. However, the Asians are perfectly capable of eating the food themselves and once they realise this, the American is redundant.

The truth is that US creditors already know this, but are stuck between Scylla and Charybdis. They are loath to stop lending to America because a run on the greenback would destroy the value of their vast foreign currency reserves held in USD. That is not to say this eventuality will never happen. America is NOT too big to fail. China is still buying US assets and treasury bonds for example, but there will be a tipping point. Of course the short term consequences would be disastrous for all concerned, but the creditors will be better off in the long term. However, US recovery would be much much slower and significantly more painful.

Barack Obama's plans will only exacerbate the problem.

"The Americans can always be depended upon to do the right thing after they have exhausted every other possibility" - Winston Churchill.

I know so many people who are betting against the dollar now.

Interesting post. And if your main point is if the USA only consumes who can argue with you.


The USA does have one small glimmer of hope. Consider the following analogy. That "Asians" living in the USA and future "Asians" who move to the USA produce/create something that "Asians" who do not live in the USA will buy.

That leaves "Asians" who do not live in the USA to become consumers.

As for those who win your bet on the dollar. Once the dollar is worthless, perhaps they will take their winnings and come here and spend/invest it. You are more than welcome!

[Winstonm]

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To be clear, I'm not in favor of a government run monopoly on money whether that is fiat or gold-backed. However, if money must be solely created by governments then I think that gold is better that fiat. I would support anybody being able to issue currency backed by whatever they desire and to have free trade in those currencies

.

I do not have any dispute with these sentiments - in fact, they seem to express what I understand Von Mises thought of gold-backed currencies and central bank interventionism.

[Winstonm]

Mike777,

Thanks for that posting above. Not being either an economist nor a mathematician, I have difficulty accepting a quantitative method of expressing a human activity. MV=PT works in academia, but is it valid in the real world?

My thinking is that M in the equation must represent actively circulating money else an increase has no effect. Let me explain:

MV=PT to me is the same as (2M)V=PT if the increased M amount is hoarded. After all, the monetarist idea is simply about supply and demand of the money stock. If an increased supply does not get into the markets, it does not have the effect of an increase.

The classical definition of inflation is too many dollars chasing too few goods - but if those extra dollars do no chasing there is no affect on prices, no?

A further more elegant discussion by Frank Shostak: http://www.mises.org/story/918

Excerpt:

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Contrary to mainstream economics, velocity does not have a "life of its own." It is not an independent entity--it is always value of transactions P(T) divided into money M, i.e., P(T/M). On this Rothbard wrote: "But it is absurd to dignify any quantity with a place in an equation unless it can be defined independently of the other terms in the equation." (Man, Economy, and State, p. 735)

Since V is P(T/M), it follows that the equation of exchange is reduced to M(PxT)/M = P(T), which is reduced to P(T) = P(T), and this is not a very interesting truism. It is like stating that $10=$10, and this tautology conveys no new knowledge of economic facts.

Should we then be alarmed with growing money supply despite the fact that the so-called velocity of money is falling? Does the fall in the velocity of money imply that no damage to the economy will occur?

What matters right now is the fact that money is growing at an alarming rate, which sets in motion an exchange of nothing for something and, hence, economic impoverishment and consequent boom-bust cycles. Furthermore, since velocity is not an independent entity, it as such causes nothing and hence cannot offset effects from money supply growth.

[mike777]

ok, how does one hoard money without saving/loaning or investing it?

However, I can loan out money in such a fashion that reduces velocity compared to other ways. You give me 20 billion in capital and I buy 3 month Tres. rather than make business loans.

In any event I would think if I do not have to sell, and I have a product in demand and I know there is alot of money out there that may lead to higher prices. Why, because I limit supply. My best guess today is that there is a lack of demand or at least a reduction. I am spending less.

In any event your quote seems to imply a fear of massive inflation, good fear.

[Winstonm]

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So the world produces and America consumes? How is this sustainable?

I didn't say it was sustainable - I said it was not unsustainble. I qualified this by saying the difference depended on the kindness of strangers. Unsustaibable means it must collapse - but this system will only collapse if the support is withdrawn. Therefore, its sustainability is dependent, which is different than saying it is without hope.

The interconnectedness of the world's economies makes it less likely for support to be withdrawn. In fact, for exporting countries like China and Japan, there is a faction that woud encourage greater dollar support in order to prop up there own exporting sectors. There is argument that this is already occuring as Foreign Central Banks shed their positions in Agency paper and increase their holdings in Tresuries - giving the dollar a boost along with their exports without having to devalue their own currencies.

Understand, I am not supportive of the current system - I am only attempting to be objective as to the reality of the situation.

As John Maynard Keynes famously stated: "When the facts change I change my mind. What do you do, sir?"

[mike777]

http://www.friesian.com/money.htm


"The government determined to deflate the greenbacks until they could trade at par with gold.[7] There was considerable political opposition to this. Deflation is bad for borrowers, whose debts become worth more over time. They would rather have inflation, which reduces the value of debts over time.[8] This turned farmers, who are commonly in debt and were a significant part of the population in those days, in favor of the Greenback Party, which promoted paper inflation, and the Free Silver movement, which wanted both gold and silver used for money (instead of just gold, as on the Gold Standard).[9] This political opposition prevented too many greenbacks from actually being withdrawn from circulation, but deflation occurred anyway because the economy grew into the money supply. By 1878 greenbacks traded at par with gold dollars, and the Treasury began to redeem them in gold ("resumed specie payments"). The entire period from the Civil War to the late 1890's was a era of deflation, simply because the economy grew so much (see table). Nevertheless, this was not well appreciated at the time. Falling prices mean falling wages; and it was hard for workers to understand that if their wages were being cut, those same wages might nevertheless be worth more. That is what happened, but the fact of falling wages led to terrible labor strife. Employers knew that they had to cut wages, but even they didn't understand quite why, and wouldn't have been believed anyway.

Deflation also occurs because the money supply shrinks. One way that can happen is because of trade. If there are more imports into an economy than exports out of it, then there will be a net outflow of money to pay for the imports. In the Merchantilist 17th century and the protectionist 20th century this has been regarded as bad; but David Hume (in "Of the Balance of Trade," 1752) had already recognized that it really didn't make any difference: the outflow of money would inflate foreign prices and deflate domestic prices, rendering foreign goods less attractive and domestic goods more attractive, both for domestic and foreign markets. Thus, before too long, imports would naturally decrease and exports would naturally increase, until money flowed back in to rebalance prices. As Hume put it in a letter to Montesquieu in 1749: "It does not seem that money, any more than water, can be raised or lowered anywhere much beyond the level it has in places where communication is open, but that it must rise and fall in proportion to the goods and labor contained in each state." A trade deficit is thus a sign of nothing except the export of a certain kind of commodity, money. When money can simply be printed by the government, exporting it is an extraordinarily profitable business.

Another way that deflation can occur is because of banking. A bank receives money on deposit, holds part of it as a cash reserve, and loans out the rest. In effect this increases the supply of money since both the loaned cash and the credited deposit at the bank function as money. The result could be inflationary, but the system tends to be self-balancing because bank loans, especially commercial loans which are used to create or expand businesses, multiply transactions. A loan is also a kind of deposit, as a bank credits itself with the money it has loaned. A bad loan, to an unsuccessful person or business, cannot be paid off and so at some point must be written off as a loss by the bank. Thus the bank's "deposit" is simply lost, and the money supply thereby decreases by that amount. Banking therefore can stimulate the growth of an economy through loans but usually will not produce an inflation, as bad loans balance the transactions created by the good loans. Instead of inflation, sometimes loans and credit get overextended and their abrupt collapse can decrease the money supply to produce a conspicuous deflation.[10] This was particularly severe in 1929. Such credit crises previously had healed themselves in a year or two, as bad loans were written off and the extension of new loans began again, without causing a Depression.[11] Herbert Hoover and Franklin Roosevelt, however, both thought that high wages were the key to healing the economy. They promoted high wages all through the Thirties. But, in a deflationary period, that far overvalued labor, which in effect was priced out of the market. People with jobs, especially union jobs, were very well paid in the Thirties, but unemployment peaked at 28.3% in 1933 and was still up at 20% in 1939 -- it had previously never been higher than 18.4% (in 1894). The inflation and price controls of World War II broke the logjam of wages, and unemployment didn't return after the War (to everyone's surprise).

UNITED STATES PRICE LEVELS: 1929=100% [data from Friedman & Schwartz, op. cit.; unemployment figures from Richard K. Vedder & Lowell E. Gallaway, Out of Work, Unemployment and Government in Twentieth-Century America, Holmes & Meier, 1993]. Divide by 2.162 to convert to 1967 prices.

70% 75% 80% 85% 90% 95% 100% 105% 110% 115% 120% 125% 130% 135%"

[Winstonm]

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ok, how does one hoard money without saving/loaning or investing it?

You cannot. However, the point I was making is that if the increased money supply is simply plowed into 3-month T-bills at 0% instead of being lent then there is no current effect on inflation. In other words, if the equation is valid it can at times only be valid with a huge time lag.

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My best guess today is that there is a lack of demand or at least a reduction. I am spending less.

That certainly appears to be the case. This seems to go along (to me) with the explanations of Austrians (Von Mises) of time-preference change rather than a monetarist phenomenon. That's all I am saying.

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In any event your quote seems to imply a fear of massive inflation, good fear

I think this is the fallacy of the monetarist - theie activities do no good until they have gone too far, at which point the next bubble is already growing and it is too late politically to reign in the new pseudo-growth.