The Fed’s Flow of Funds came out last Friday and that gives us an update on the sectoral balances. You can see that the government’s deficit continues to provide a big boost to the private sector at a time when it’s still very much needed. The good news is that we’re beginning to see signs of life in credit and investment, but the private sector remains far too weak by my calculations to run with the baton here.
The biggest risk to the economy continues to be a sharp contraction in the budget deficit. And if the CBO is right about the 2013 estimates that could be precisely what we get. My guess is the cuts in the CBO outlook are unrealistic and the new President (or returning President) will use the beginning of his term to bolster the economy through continued tax cuts (most likely given the political environment). That is of course unless the President decides to go all Bill Clinton on us in his second term and convince Congress and America that we need to bring in more money before we can spend it….
Bill Clinton’s surplus is such a tragic irony. It is celebrated as fiscal responsibility i.e. what a responsible federal government should do. It’s such a shame when ignorance is celebrated. Nearly the entire economics profession has not accounted for how economics changed when we switched to fiat money from money backed by and fixed to a commodity. What a gross failure of the economics profession.
Historically, what is this comparable too? What’s another example of a profession this asleep at the wheel?
I sometimes feel like MMT and MMR folks are Galileos trying to explain that the Earth revolves around the sun, and not the other way around.
Cullen thinks the biggest danger is reducing the deficit and I think the biggest danger is that the debt and deficit are already so out of control that the government can not longer limit its money creation. It is as if it has lost the ability to control how much money will be created, so it can no longer maintain the value. Every hyperinflation in history can count as an example where doubling the monetary base correlates with very high inflation. Do you think there has ever been a time when a country doubled the monetary base and did not get at least double digit inflation within 6 years?
Vince, the monetary base has little to no correlation with the rate of inflation. This is not surprising since the base has little correlation with the overall money supply. Banks don’t lend reserves. The money multiplier is a myth. That’s why QE’s didn’t result in massive inflation despite “printing” trillions. The thing to watch for is deficit spending which yes, can really cause inflation….But the key risk to a US hyperinflation, in my opinion, is a production collapse. And I just don’t see that happening….
Congress and their approval of tax cuts or spending programs are what increase or limit deficit spending…. do you really see that as out of control?
The usual hyperinflation suspects either had a collapse in production (Zimbabwe farm transfers) or outside debts (Weimar I believe owed war repirations in gold). While Japan has been well above the case-study levels for ages, but without outside debts, and even despite some production issues (tsunami and nuclear reactor) their currency isn’t budging.
The two areas I’d like to see addressed are the massive savings by large corporations and the uber wealthy – is there any way that money all of a sudden hits the economy (wishful thinking at this point – but “what if”), and second, who is collecting all the interest payments on the debt – and does that make it into the real economy (although a lot just adds to China/Japan’s holdings which seem to stay put, and a lot I’m sure goes to those in my first group). In general my question is – isn’t there an enormous amount of money in the real economy – but locked up in savings. I’ve also been curious if there’s a way to quantify how much the uber wealthy and large corporations are sitting on – if “gov debt = private sector savings” how much of the debt do the rich own?
Yes, the usual suspects on hyperinflation are (in my order):
1. Production collapse (weird how production matters so much to an economy!)
2. Foreign debts
3. Loss of a war
4. Regime change
Like I said a couple weeks ago… the most likely scenario for hyperinflation is that we have an alien invasion that destroys our productive capacity and burdens us with debt denominated in Martian Mints…
In which case, Paul Krugman’s utterly outlandish Keynesian scenario of preparing for an Alien invasion to rally people around getting the economy moving again is, ironically, our best solution to potential hyperinflation.
Using the monetary base as a predictor of inflation has been a monumental failure in years past.
Here’s why:
1) It doesn’t take into consideration velocity of money
2) It doesn’t take into consideration increases in productivity
3) It doesn’t take into consideration credit expansion/contraction
4) It doesn’t take into consideration that the base is used to purchase back bonds, which are money.
I think I understand vincecate’s concerns. But I really think the concerns are addressed in what I would call Monetary Dynamics. This is one aspect of currency regulation that I would like MMR to add to it’s discussions. Our currency regulation system is a feedback control system. And in this system the FED is the “controller” that no longer has control. This is because as Mike Sankowsky and I have talked about, we basically have an “over-amped” system. In a sound system, when the speakers are overamped the system loses control and a massive “sound bubble” occurs. In our currency system we have the same issue right now. And it is actually our BIGGEST issue. Of course Mike has written about repos as an aspect of this overamplification.
I’m quite surprised to hear that base money and inflation are not correlated. Are we sure? What’s the evidence for that?
http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=BOGAMBNS,CPIAUCSL&scale=Left,Right&range=Max,Max&cosd=1959-01-01,1947-01-01&coed=2012-02-01,2012-02-01&line_color=%230000ff,%23ff0000&link_values=false,false&line_style=Solid,Solid&mark_type=NONE,NONE&mw=4,4&lw=1,1&ost=-99999,-99999&oet=99999,99999&mma=0,0&fml=a,a&fq=Monthly,Monthly&fam=avg,avg&fgst=lin,lin&transformation=pc1,pc1&vintage_date=2012-03-22,2012-03-22&revision_date=2012-03-22,2012-03-22
Thanks Cullen.
Unfortunately, I don’t think we can really tell very much just from eye-balling a couple of series. We really need look at some more serious econometric work to discover the nature of the relationship between the two.
From the studies I am familiar with, it seems like the balance is very strongly weighted towards a strong correlation between all forms of money growth (including the base) and inflation.
I don’t agree with Vincent that we are about to see hyperinflation, but I do agree that the mechanism that produces inflation involves “printing” money.
My comment did not get placed properly and is located below.
There are “long and variable delays” between when the money is printed and when the inflation hits. In large part this does seem to be due to the change in the velocity of money. If a company can borrow money for 0.5% they are not in such a hurry to move it around as when they have to pay 10%. So at first when the Fed buys bonds and lowers interest rates they also lower the velocity of money, and there is no inflation. But after awhile interest rates can not go down any more and they keep printing money and you get inflation. Then it is not so easy to stop because as they raise interest rates (or not print so much) the velocity of money also goes up. I think the study I reference is more compelling proof than Cullen’s graph:
http://pair.offshore.ai/38yearcycle/#delay
Bonds are money… and the short variety tend to have very similar stability traits as cash… Further, most of our debt is concentrated on the short end of the curve, meaning that most bonds held are very similar to base money but for any interest they pay. But, of course, seeking return is secondary to the act of saving. People save first because they want to have something to spend later. They seek return for a little bit more to spend later.
So imagine yourself as someone saving in US treasury bonds because you want to consume in the future, but now your interest rate has gone from .8% to 0%. What, now, do you do in your decision tree… Hold, invest differently to increase return, or consume.
It’s much more likely that people are going to reallocate their savings to riskier assets, such as corporate stocks & bonds, and municipals… They’re not going to let .8% of interest turn them from savers into mad spenders. They’re saving in the common currency first, and seeking interest second. Seeking return is SECONDARY to the will to save.
In a rational world where money holds its value and you get an interest rate on top of that, savings makes sense. If you save today you can consume more in the future. But what if the value of money is going down and the interest rate is not enough to make up for that? So if inflation is 6% and the interest on your savings is 1%? At that point you are better off to buy anything you would like to get in the future today. If over the next 3 years your kids will eat 500 cans of tuna, you are better off to buy the 500 cans today than to put the money in the bank. Because the central bank has artificially tried to hold interest rates down by making lots of money and buying bonds, we have the unnatural condition where saving is foolish. You are better off to buy now than to save. These are the conditions for hyperinflation.
To anyone who says, “bonds are money”, I agree that a 30 day bond is nearly the same as money, because it turns into money in 30 days. But a 30 year bond is very different. If you to not believe me please put your money in 30 year bonds and watch what happens as we go into hyperinflation. Your 30 year bonds will be worthless long before the dollars are worthless.
Almost all the treasury debt is short & medium term. That means the vast majority of treasury debt holders are holding very money-like instruments.
Further, you’re putting the cart before the horse… you’re arguing that QE causes inflation or hyperinflation, when we point out that it doesn’t change peoples’ savings accounts much, and they are saving because they have the will to save in the currency, not because of the interest, you say, “well they won’t have the will to save at low interest when inflation is high.”
To your point about tuna… assuming we can get to 6% inflation with 1% interest just because you say so, then what are people going to do (If we can assume they haven’t just invested in stocks & bonds instead of treasuries)? They’re going to buy things NOW instead of LATER. That’s hardly worse than hoarding cash and people being out of work. That means people are working to give people real things they want & need. It’s not the utter disaster inflationistas claim.
The problem is that if money is losing value fast and everyone is better to buy real things now than to hold onto money, you get a really high velocity of money and prices go up.
If you insist on looking at bonds as money then you can see them as slowing down the velocity of money. If grandma has a 30-year bond under her mattress the velocity of that money is really slow. But if everyone moves to short term bonds, and then to cash, the velocity of money can go way up. So the prices can go way up.
Then how do low rates SLOW the velocity above HIGH rates? Higher rates should have a slowing tendency.
If people are moving into bonds then the velocity of money is going down. High interest rates relative to expected inflation can encourage people into bonds. But in hyperinflation people want to get out of bonds even as the interest rates are going up.
Here is a good article on the relation between interest rates and the velocity of money.
http://www.hussmanfunds.com/wmc/wmc110124.htm
Vincent, I believe you are concerned that the economy might in fact improve and your gold and silver plays might not pan out. Invoking the hyperinflation boogeyman makes you feel safe.
No.
Vincent, looking at the paper you refer to it suggests that our money will be worthless at any moment. Our 38 years are up.
But I’m very fond of what reason and logic tells me so I want to go that way for a moment to see what I can learn from Gold as a currency. Gold provides two values I suppose. One is actual stuff backing my dollar. But of course, for 40 years I have bought a great deal of stuff with just digits in my bank account. Incidentally I can buy gold if I’m worried enough to back my own dollar I suppose.
The other thing Gold provides is an engine governor. Meaning I can only “create” money at the rate I can mine gold. Gold in this sense becomes the governor or god that controls our currency system. I believe this is where most people believe that the god of gold will solve our currency problems. However if the entire system blows out because of “overamping” instability, this god makes an economic recovery almost impossible. Because it ignores the real problem. The “overamping” of the system.
If some place gets hyperinflation the longer the government thinks “I am the monopoly issuer of currency, my subjects must use my currency” the longer it will take for the economy to recover. The sooner they give up that attitude and let people use gold, some other currency, or they make a more reasonable currency, the sooner they will get a recovery. Trying to really “force” people to use a money that is dropping in value fast, and so against their interest to hold, makes it hard for an economy to function. You end up with large portions of your economy having to ignore the laws for people to just stay alive. This “black market” gets bigger and bigger till there is nobody that accepts the old currency. But this is far from ideal economic conditions.
http://pair.offshore.ai/38yearcycle/#hyperinflationstages
vince,
Nobody’s stopping people from divesting their dollars for another form of savings, buying gold, indexing contracts to gold, etc.
In fact, we are exporting about $500 Billion per year to FOREIGNERS… people that don’t even get to vote in the US… and they love our eventual supposed confetti.
The REAL source of the tragedy of hyperinflation is the failure of a government to maintain a fair, free, sovereign, productive economy. The U.S. is one of the fairest, freest, most powerful, productive countries in the world, with plenty of capacity to spare. People won’t just reject our dollars. First, they’ll find slightly more risky investments and non-monetary investments to put their money into (stocks, bonds, and real estate)… if that doesn’t give the productive economy the juice it needs, then the fed might continue to hold rates down… and then, god forbid, those savers might start consuming cars, cans of tuna, homes, etc. Luckily, we have the productive capacity to oblige that request as well.
When everyone realizes that saving money is for fools and everyone rushes out to buy things it is called a “crack up boom”. You get a burst of economic activity as everyone spends their savings fast before prices go up more. But this only lasts till everyone spends their savings. Then things really get bad because prices are up high and nobody has savings.
Wait a minute… one person’s spending is another person’s income… how do we “lose our savings?” It’ll simply transfer faster as people consume more, supposedly… but even then, if we have people out there consuming a lot more, it will result in a lot of hiring to meet the new demand, and adjustment in monetary/fiscal policy.
I love how Austrians try to skip over “Prosperous Recovery,” by going directly from “Balance Sheet Dollar-starved Recession” to “Hyperinflationary dollar-rejecting Currency Collapse.”
Sure is convenient to skip over the middle ground where policy is adjusted.
The Austrians call it a “Crack Up Boom”. For a very short time before things really fall apart there seems like there is a boom. But it is just as people rush to convert their savings into something that is not losing value very month. But once everyone has done this prices are way up and things are not good. It is not a recovery. Austrians fit historical records. There is much history of these “crack up booms” right before hyperinflation.
You can be an expert on what happens in a hyperinflation environment all you want – but since we won’t be getting hyperinflation you ought to tell your tales to another crowd. And I’d like to borrow a line from Cullen… since you know hyperinflation is just around the corner, please, please, please send me your counterfeit. I’ve got lots of tuna fish I can send you in exchange
I already have bought a year supply of food and do not need to buy your tuna. Thanks.
So I think MMR emphasizes something a little less stringent than MMT. As an issuer of currency the US is certainly the only issuer of dollars. But I can buy gold with my dollars and I can even get other currencies which are on a floating exchange rate with my dollars. Both of these attributes serve to “reign in” excessive behavior in the FED. So MMR actually eschews “forcing” people to use money that is dropping quickly in value.
You can’t fight the Fed
From the Fed’s point of view all you’ve done with those transactions is move a dollar balance from one set of private hands to another.
Right. Even as more and more people realize it is foolish to hold dollars, the number of dollars out there will be going up not down. The velocity of money goes way up and the prices go way up.
I don’t know if MMR has a “stand” on the issue, but our economy is incredibly free to invest in hard assets, other currencies, foreign bonds & stocks, real estate, etc. The ability to divest onesself from dollar savings is so great that this is one area that I think the Austrians are living in a fantasy land.
Now I may have to use dollars to buy groceries and pay my rent (probably 95% because the private sector wants this and 5% because of legal tender laws), but as soon as I’m done paying my bills, I can save however I want. It’s probably easier to do so now than any other time in history. This isn’t 1855. I could get online now and turn my treasury MM fund into Swiss Franks in 5 minutes. It’s utterly asinine to pretend that the government has its thumb over us and if we slip just the wrong way and get out we’ll abandon our currency and overthrow our oppressive gov’t. Just because we have to spend day by day in dollars, even if we could pretend that this is all due to oppresive legal tender laws, it’s not the money we hold for 3 days we’re worried about losing to inflation… it’s the money we save… and never before has protecting one’s wealth from hyperinflation been easier.
Sorry… you’re probably in agreement… I just saw the theme of your post and had to jump on it.
It may be that the US has a deal with Arab dictators to protect them from attack in exchange for them pricing oil in dollars.
The US did take everyone’s gold in 1933. So they have used force to get people to use their paper money in the past.
The US got England out of Egypt by threatening to dump their bonds. I know MMT/MMR people think that would not matter since England could print money and buy the bonds. But in the real world England knows it would have mattered and so they caved. The US is in danger of pressure like this from places like China.
I agree that MMR is closer to the truth than MMT on this point of imposing a currency on people. People do have choices. There are limits to what a government can get away with.
MMR isn’t really a statement on things like what government might do. Neither I think is it a statement on how Monetary War is waged. I think it’s really trying to help us understand the system well enough to avoid these alternatives.
But MMT/MMR do not seem to understand the delay or “fool in the shower” problem. They seem to think that a government can just look at the current inflation rate and adjust things as needed. The reality is that the big delay, big debt, and big deficits make this a trap. Governments think everything is fine right up to where they are over the edge of a cliff and there is nothing they can do.
Adjusting the money supply by just looking at the current inflation rate is like a fool in the shower who thinks “it is not hot enough turn it hotter, it is not hot enough, turn it hotter, it is not hot enough turn it hotter” who then gets burned because there is a delay between when you turn the controls and when the water changes temperature. There really have been many studies and the delay can be 4 years or more from when the money was added to when the inflation hits.
You should read this little post:
We can only use what we can observe as a guide to our actions. You are suggesting we cower in our caves in perpetual fear over things which may or may not happen at some unknowable time in the future.
http://traderscrucible.com/2011/05/03/the-concise-way-to-destroy-the-igbc-and-why-to-destroy-it/
I didn’t forget about our prediction. I’ve been busy.
It’d be interesting to know what would induce such an event, especially when people feel like they’ve completely undersaved compared to the debt they have, and we have so much productive capacity.
In the future people will look back and think that government bonds were a bubble that people put trillions into. They will not say “people undersaved”. They will find it hard to understand how people were so foolish to put so much money into 10 year bonds at 2% when the real inflation rate was at least twice that.
But sometime in the not too distant future there will be a sort of panic as people come to realize that bonds are dropping fast in value as interest rates go up. And fewer and fewer people will want to hold bonds. In hindsight people will say “the bond bubble popped”. And contrary to what MMT/MMR says, it matters when people get cash when their bonds come due and do not buy more bonds. You can say the velocity of money is going up or you can say long term bonds are not really the same as money. Either way, in reality when people are getting out of bonds and getting cash as they come due you are going to get a lot of inflation.
We fully acknowledge that policy doesn’t work overnight. But you’re being a bit dramatic. We lost trillions of dollars due to the credit collapse. The govt spending barely got us back to break-even. The alternative to the spending would have been the opposite of hyperinflation. It would have been a crushing hyperdeflation which would have driven us straight into a Greek-like depression. Would that have been better? Instead, we have a mild inflation and weak recovery….
And you’re still not explaining the catalyst for this surging inflation. Is it more spending from more money in the system because of this big delay? You do know that QE didn’t add money to the system, right? So it’s all about deficit spending. And that’s helping the economy by giving people more money to spend. So your theory doesn’t quite add up. Can you give me a detailed catalyst because I don’t see it….
Can you accept that inflation may come 4 years after the increase in the money supply?
So can you fully acknowledge that a big increase in the money supply might take 4 years to show up as a bump in the inflation rate?
Hyperinflation is part of reality. It is dramatic. It happens again and again in history. Seems to happen when debt is over 80% of GNP and deficit over 40% of spending. We got that.
I still say you are wrong to claim “bonds are money” when the value of a 30 year bond will drop drastically as interest rates go up even if dollars do not drop. If they are money then each different length of bond is a different currency because their values are not pegged to dollars or each other.
With that, let’s pretend bonds are money for the moment. If some parents buy a 10 year bond it may be because they have a child going to college in 10 years. If QE3 is buying up 30 year bonds with new dollars, can you see how this removing a low velocity money and adding a higher velocity money? If the average velocity of money goes up then prices can go up even if the total money is the same.
And I agree that the real core of the inflationary danger comes from the deficit. But they are spending nearly twice what they get in taxes and I don’t think they have any chance of fixing this. Do you think it can be fixed given the full reality of the situation?
Vince,
QE is simple. Bonds get replaced with reserves. There isn’t more purchasing power in the economy afterwards. They don’t add $1T of reserves AND leave the bonds there. They swap them out. The Fed holds the bonds in their account which is a blackhole for all intents and purposes. The banks get reserves. No change in private net financial assets!
If you’re right about velocity then why is velocity cratering? http://research.stlouisfed.org/fred2/data/M2V_Max_630_378.png
Cullen, any bank can withdraw any amount of its excess reserves as paper money. If the Fed does not have enough on hand, more will be printed. That the Fed pays interest now on excess reserves makes them like short term bonds really. But moving people from long term bonds to short term bonds is part of the setup for hyperinflation. People are moving toward cash and away from 30 year bonds.
Before a Tsunami comes ashore the water first goes out. Often people walk out and gawk at the exposed ocean floor. The slowing of the velocity of money is like that. I am not sure you can get the huge increase in velocity of money that is hyperinflation without first getting some decrease in velocity of money.
Demand for 30 year bonds is drying up? Not according to the latest auction results which were 3X bid to cover….http://www.treasurydirect.gov/instit/annceresult/press/preanre/2012/R_20120314_1.pdf
The Fed is buying 30 year bonds, so Goldman and friends are front running this at auctions. But as the Fed has increased its holdings of 30 year bonds the total of the non-Fed holdings of 30 year bonds is going down. And in general there has really been a move toward shorter term debt. Something like half of the US debt comes due in the next 12 months. There were times when the average duration of US debt was several years, not 1 year. These short term debts are far more like cash and far faster to convert to cash as they come due than long term debt.
http://howfiatdies.blogspot.com/2012/03/money-and-bonds.html
Kelly,
Thats a really good point. We have (see the TC rule) and will have policy proposals using MMR as a starting point, but these aren’t core MMR.
Understanding is the first step to good policy.
Not at all. I think a good theory of money should be able to help you understand what is going on and predict the future. In fact, I think I really understand the math for hyperinflation. Anyone think they can find any errors in this math for hyperinflation?
http://pair.offshore.ai/38yearcycle/#hyperinflationmath
Money doesn’t spend itself. If the govt secretly prints $100T dollars and buries it in a hidden location for hoops and giggles and no one ever knew it happened and never found it, there would be no inflation due to that event – to give the most extreme example. So you have to argue why spending on stuff is going to change as a result of policy over the past couple years. I could argue there is a random paradigm shift in which everyone decides they don’t want to save anymore and instead spend every dollar they earn ASAP- that would certainly drive up prices. But that’s not a great argument because I supply no reason for why all the sudden people would start doing that. But that’s kind of your argument, so you have to explain why. And you haven’t. You have just asserted that inflation will increase (*****how and why????****) and as a result, at some undefined level of inflation, people will decide to start buying tuna now instead of waiting and this creates a hyperinflationary spiral (this part oversimplified in my mind but I’ll grant you that part of the argument). It’s sort of a circular argument with no clearly defined starting point. You have also supplied data points such as deficit/debt as a % GDP when this has happened in the past, but that’s not a good argument why either, because you’re only supplying a correlation without supporting causal evidence and controlling for all the differences between the US now and whenever hyperinflation occurred in the past. And it’s not a 100% correlation, and even if it’s high, that’s still not a good explanatory argument IMO.
I think you need to explain 1) how and why inflation will start increasing and reach X% and 2) the X% level that causes the private sector to decide to spend now instead of later and kick off the hyperinflationary spending spree. Supplying correlations or making assertions doesn’t explain that.
Maybe the correlations make someone more cautious or interested in researching hyperinflation further, but they are not explanations. Actually, I’ll take that back. They are only explanations if you can argue that X% deficit or debt vs. GDP triggers something in the private sector’s mind to make them change their spending habits or fear hyperinflation such that it is a self-fulfilling event at that point.
All it takes is for people to follow their own rational self interest and for inflation to be at a higher rate than interest rates. Then people should hoard and not save. We already have the setup of inflation higher than interest rates, so I don’t see any need to explain how to get to this point. Once people start realizing they are better off buying extra cans of tuna than rolling over their bonds we can get a positive feedback loop. As less people save and more people hoard prices go up faster, so it becomes even a better idea to hoard instead of save.
http://pair.offshore.ai/38yearcycle/#hyperinflationfeedback
Vince, I don’t have the chart, Cullen could probably make it in a jiffy, but we have gone through several extended periods of inflation being higher than interest rates with no hyperinflation. So again, you are providing a correlation, not an explanatory argument.
Or rather a detailed explanatory argument. I am not saying that basic argument would not be a factor, but you need more substance in explaining when, how, and how much. And one can easily counter your argument that it’s in one’s self-interest to buy now if inflation > interest rates. It completely depends on my utility curve, what I want to buy, what I am saving for, how much inflation > interest rates etc etc. What if all I am saving for is some unknown emergency or my kid’s college education? I might decide to spend EVEN LESS to put MORE money away for the future so I can make sure I have enough money for that emergency or my kid’s college education.
Just for fun:
Thanks Cullen.
Vincent, does this model work with salmon rather than tuna?
Not really, because most people can’t store salmon that well, unless it’s canned, but most people don’t like canned salmon that much
.
Vincent- sorry for being tongue in cheek. I do think you have identified a bunch of interesting and somewhat compelling correlations, but I don’t think you have done enough due diligence overall. It’s too surface level for my tastes.
Bernholz wrote a book on hyperinflation. He studied many cases and what he found was things spiral out of control after you get debt over 80% of GNP and deficit over 40% of spending. You need both to have trouble. If it was just the debt you could default and be fine. If there was no debt and a deficit people would be fine lending you money because you could borrow for many years before getting a high debt level. But if you have both it seems the governments always end up with out of control money creation. So the danger of the feedback loop, historically, comes after these levels are crossed.
At lower levels it seems the government has time to increase taxes or cut spending so as to limit the rate of money creation. After these levels it seems you are headed for this dangerous feedback loop, though the exact timing is fuzzy.
Again, just surface level assertions and correlations. And it’s not literally “always.”
Money does not spend itself, but governments spend it like crazy. When they are spending twice what they get in taxes they are adding lots of new money. At the end of the day it is really the deficit that is the source of the inflationary pressure.
But people still have to end up spending even if the govt spent it. Again, think of my secret $100T deficit. I think the economy has much excess capacity so I don’t think we’ll see sustainable inflationary pressure until we start nearing full employment. Remember MV = PY –> Y matters but you pretend like it doesn’t. That’s why Cullen says the production side of the equation is so important. And he is operating under the assumption that increased spending is going to hike Y in our economy, counterbalancing price increases.
Vimothy,
There is a feds’ research article(s) that I am having a problem finding right now indicating a strong correlation between the M2 aggregate and inflation.
I am not aware of there being studies on the relationship between M0 alone and inflation although my feeling is that there may be, under stationary conditions, albeit with a smallish rho
. QE’s experience objections are burdened by the abnormal conditions of the current stagnant economy that may mask such effects.
This paper seems good and it sites other work:
http://www.lancs.ac.uk/staff/ecajt/inflation%20lags%20money%20supply.pdf
Part of the problem in looking at the correlation is that there is a delay between when the money supply increases and when the inflation hits. So if you look over a short enough period you can think there is no correlation, even though in the long run their clearly is.
http://pair.offshore.ai/38yearcycle/#delay
Госбанк
I’ve definitely seen research suggesting that there is a link between growth in the base and inflation.
Here’s one example:
McCandless, George T. and Warren E. Weber, “Some Monetary Facts,” Federal Reserve Bank of Minneapolis Quarterly Review, No.3, Summer 1995, pp.2-11
http://minneapolisfed.org/research/qr/qr1931.html
(IIRC, they find evidence of a unit coefficient).
But I quite agree that we are not in normal times–given quote-unquote “liquidity trap” conditions and an interest on reserves policy regime.
In the situation we’re currently in, there’s an equivalence between bills and money, so that one should not necessarily expect much effect from issuing money rather than bills (suggesting that the policy maker should be somewhat indifferent between the two). But if there is a regime switch, and the Fed keeps to its commitment of no rate increases to 2014, then there might be some relatively high inflation.
Interesting, almost a unity.
One might speculate, though, that M0 growth, as a settlement tool, had been accommodative of M2 growth due to “naturally” growing economy, etc., hence a unity.
I vaguely remember reading somewhere when I was interested in this sort of things that there is a strong evidence of bidirectional Granger causality between M0 and amount of loans banks are willing to extend with some countries, including as I recall UK and US, but not others. If “true”, that would explain M0M2 in “normal” times.
Vimothy,
Cmon. That’s poor statistics and economics combined by the Fed authors. Time for some disagreements.
First, the central bank does not control or expand the money supply. In the equation MV=PQ, the causality is always opposite of the Monetarist causality.
Here’s what Joan Robinson said about the equation.
“If the quantity equation had been read in the usual way, with the dependent variable on the left and the independent variable on the right, though rather vague, it would not have been silly”
Now money supply grows and prices also rise so naturally you will find some “correlation” even if its near about 1 – which in reality means zilch.
The paper you quote sneaks in a 45% line which doesn’t start at the origin.
Here’s what you can do: Take the 45 degree graph and take a graphical software and make a line between (0,0) and (100,100) and see how less scary the graph looks!
Except for points around 100% annual inflation or so, it just shows that growth can be achieved at a stable price rise!
That is I can draw a graph which implies that an 10% growth can be achieved with 4.5% inflation.
The “print money” story as usually presented (helicopter drops and “more realistically” open market operations) is deeply flawed. Open market operations usually done by the central bank is just a “defensive” operation because of fluctuation in banks’ reserves due to various reasons. It has nothing really to do with monetary expansion.
Plus to the case of the United States, check how much the money supply has gone since the last 30 years and the CPI, rather than doing some “correlation” analysis.
The whole Fed paper is meaningless for practical economics. It is more confused that the saving-netsaving debate about how the world runs and how it needs to be run. It just presents some graph and gives out some confused Monetarism.
Sorry, I am strongly anti-Monetarist.
That’s the thing about these studies. It matters so much what variables you control for and how you interpret the results, particularly in a causal sense , and both are heavily influenced by the economic persuasion of the author and reader. A correlation is nice but if you don’t have robust qualitative logic, I will be even more skeptical the study is not well controlled from the perspective of understanding causality.
Yeah exactly.
And not only is the case of how it is presented but what the implications are etc – usually nothing much.
Imagine this.
Inflation 2%, money stock change 6%
Inflation 2.5%, money stock change 7.5%
Inflation 4%, money stock change 12%
Highly correlated because both increase together. But totally harmless!
Also, the Fed paper takes sample across various countries and seems to do an analysis on them, rather than on a time series. That is silly but still from the graph it looks completely harmless. Some inflation is harmless. And the analysis goes into nothing about the cause of inflation itself. If prices rise, obviously borrowings rise and thereby increasing the money supply.
The worst thing in the Milton Friedman story was that he came with papers after papers and books after books – and finally found out that the central banks do not control the money supply. He then called them incompetent! Nonetheless there was a huge political pressure because of him and the Fed and other central banks were forced to raise rates to high levels bringing the world into a recession.
There are many “strong statistical relationships” in macroeconomics but have zero usefulness.
It’s nice being on your side for once
.
So Ramanan:
Does the fact that raising rates caused a recession and stopped inflation mean that monetarism has some merit?
What would you have done as President during the 1975-1980 period?
These aren’t rhetorical or loaded… just wondering for real…
Dan M,
The Monetarists continued to believe the central banks were controlling the money supply but in reality they were just changing interest rates till it went to such a point that nations such as the UK went into a recession. They continued to believe in their theories in which money supply is “controlled” and wages adjust to achieve full employment. However inflation was “cured” by creating a highly deflationary environment and by creating high unemployment so that people accepted low wages. But that’s hardly the way to run an economy.
So somewhere there is a way to run the economy at full employment without going through all that nonsense.
Also the Monetarists believed that before full employment is reached inflation starts to *accelerate* forever. Again a statistical relationship but without sense because inflation accelerated due to a wage-price spiral.
The NAIRU theory is really silly if you think of it. If the US were to deport the unemployed to some country, then does that mean some fraction of the already employed have to go into unemployment for inflation to not accelerate?
Most of macro can simply be gotten rid of by simple reasoning.
What about you as president from 1975-1980?
Difficult question. Know less about the US but I think in the UK, there was a problem that wages were indexed to inflation and this led to a huge problem with labour unions simultaneously gaining power. Heard this – labour unions can’t afford to be too successful. So what the Monetarist experiment did was to bring down the powers by deflationary strategies. Keynesian policies have to be supplemented by other things as well. But this is not a problem in the advanced world right now where employers have more power now. But political power needs to be used in controlled prices in addition to fiscal and monetary policy.
Ramanan, I agree with you for the most part, but I think you overstate the lack of control the central bank has here. They can substantially alter the price of credit and the money supply if they implement policy correctly. I’d argue that monetary policy is most effective at extremes. For instance, if they set the 30 year bond at 0% they could certainly influence the money supply by making long-term loans very near cash. Also, they can make lending onerous for banks by inverting the yield curve. It’s not a coincidence that recessions almost always follow inverted yield curves. Now, the other 95% of the time I’d argue that monetary policy is MUCH weaker than monetarists presume, but we shouldn’t ignore the fact that the Fed has powerful weapons at their disposal should they decide to use them….
Cullen,
Agree. My tone may have come across that but Monetarism can be a scourge as in the late 70s and early 80s.
Also, low interest rates can also be effective at times. QE IMO had an effect due to increase in general financial asset prices.
Fiscal and monetary policies need to be coordinated in general.
Also I think when the Fed started raising rates before the crisis, household burden – interest payments etc increased a lot – and may have caused a lot of drop in private sector expenditures.
Okay. Sorry to misconstrue!
Ramanan,
“Time for some disagreements.”
Before we disagree over theory, let’s agree on the empirical evidence and what it says. You say “poor statistics”, but then you don’t really say anything about the actual stats or methodology. When I read that a study, that seems like fairly strong evidence of a one-for-one relationship between money growth and inflation, without saying anything about causality.
So what’s what’s wrong with the study?
Vimothy,
You took the results and said you may agree with Vincecate though of course much less in degree and said inflation occurs due to printing money – whatever that may mean.
Would you think a cashless economy (as in no currency notes) will have no inflation?
Yes the central bank print notes on demand that is something else.
One is immediately led to believe that somehow the central bank injects excess money in the economy and this raises prices. This IMO is the most crude way to put it and it is hurtful because most of the profession believes this story.
What’s wrong with the study? It is based on this whole Monetarist intuition!
The high correlation is simply an artifact of the fact that in general the money stock and prices rise. You also use 1:1. But that’s not what correlation is. I can have two variables where one rises 5 times whenever the other rises. Yet these numbers are highly correlated and says nothing much. Now this is time series but that’s not what the authors seem to do.
The authors do a correlation analysis of 110 countries and plot a graph giving one the impression that prices rise “one-to-one”. Well, does it happen with the United States or the UK ? Of course not.
So why use it for the US and the UK? Prices and money don’t rise one-to-one in these countries.
If I draw a 45 degree line from the original, one point nearly touches the graph and there are just 2 more which are above the line – that too with countries of high inflation. Surely one cannot conclude prices rise 1:1?
Have you seen how the CPI rises against the money stock over last 30-40 years in the United States? It doesn’t increase one-for-one. So why use data for some poor nation which may have its problems and use it for the US?
So what filter did the authors use?
Plus of course if you take the data from recent years, where central banks have increased the monetary base, you’ll get a massively different result
The one-to-one is misleading to begin with is what I am saying.
About the other graphs: What’s the statement no correlation between money supply and real output suppose to mean. Take any country, real output grows over time and consequently the money stock grows. How do I interpret this statement?
And using another graph, can I legitimately conclude that real output growth can be enormous with low inflation (since there is no correlation)? Isn’t it a giveaway? I can have good growth and consequently the money stock will expand and still have low inflation?
Anyway, the major reason for suspicion is that a country with higher inflation skews the graph toward it, leading to the supposed 45 degree line. So let us say you have a lot of countries with 2% inflation and 8% nominal growth in the money stock and you find one country with 24% inflation and 28% growth in the money stock, the graph you draw will show nearly a 45 degree line. With a correlation equal to 1!
But that doesn’t mean if the money stock in the 2% country increases 1:1 with prices!
“If I draw a 45 degree line from the original”
sorry meant origin.
Ramanan,
Let me also try to respond more directly to your comment.
“First, the central bank does not control or expand the money supply.”
Well, I agree with you. But that doesn’t really have anything to do with it in a first order sense.
A regression estimator gives you a figure for a sample average conditional on the other covariates in the regression being held constant. It tells you about an observed relationship in the data. What you do with that observed relationship is something else.
From the Fed study, it seems that there is a strong long-run relationship between money growth and inflation. Explaining that relationship is the job of theory. If a theory can’t explain it, then another theory is needed.
“Now money supply grows and prices also rise so naturally you will find some “correlation” even if its near about 1 – which in reality means zilch.”
There either is or there isn’t a relationship. If there is a relationship, but it means zilch, that’s very different from there being no relationship. I don’t see how you can hold both those views simultaneously in a coherent way. So which is it?
“The paper you quote sneaks in a 45% line which doesn’t start at the origin.”
It doesn’t really sneak it in though. It reflects the actual data in the study.
“The evidence in Chart 1 seems to support the quantity equation, at least as a long-run constraint on the effects of monetary policy. That the 45-degree line through the grand means does not go through the origin of the graph suggests that a central bank cannot generate a particular longrun rate of inflation by choosing an equal long-run growth rate for the money supply. The long-run inflation rate is influenced by the growth rates of real output and velocity
as well as by the growth rate of money. However, a central bank can be confident that over the long run a higher growth rate of the money supply will result in a proportionally higher inflation rate.”
“Here’s what you can do: Take the 45 degree graph and take a graphical software and make a line between (0,0) and (100,100) and see how less scary the graph looks!”
That doesn’t make sense to me. A regression estimator is meant to produce a sample estimate of a population conditional expectation function. Drawing a 45 degree line through a graph just shows you where the estimate with a unit coefficient and no intercept lies. Wherever you draw that line, the actual coefficient on the regressor in question is going to be exactly the same. So what’s the point?
Except for points around 100% annual inflation or so, it just shows that growth can be achieved at a stable price rise!
That is I can draw a graph which implies that an 10% growth can be achieved with 4.5% inflation.
Don’t understand what you mean here. If just you draw a line on a scatterplot of data, that doesn’t tell you anything about a population relationship. It’s just a line on a graph. You can’t do inference on a line that you’ve drawn arbitrarily. That’s nonsensical.
The “print money” story as usually presented (helicopter drops and “more realistically” open market operations) is deeply flawed.
I used “print money” in scare quotes because I meant it figuratively. I just meant “money growth and inflation go together”.
Open market operations usually done by the central bank is just a “defensive” operation because of fluctuation in banks’ reserves due to various reasons. It has nothing really to do with monetary expansion.
I think there’s more to it than that, but I know what you mean.
Plus to the case of the United States, check how much the money supply has gone since the last 30 years and the CPI, rather than doing some “correlation” analysis.
Not sure what you mean. Whatever you do is going to boil down to looking at correlations because you’re trying to find out whether money growth and inflation are correlated.
The whole Fed paper is meaningless for practical economics.
I find that statement pretty baffling. If you can make a case for its meaninglessness, I would like to see it.
It is more confused that the saving-netsaving debate about how the world runs and how it needs to be run.
The paper presents a bunch of regression output and does a little lit review. There’s not really anything that it can be confused about, as far as I can see.
It just presents some graph and gives out some confused Monetarism.
What it presents is the result of regression analysis on a particular dataset. Monetarism is neither here nor there as far as I’m concerned.
V,
Rather than answering point-by-point I will do the opposite:
I understand your point that the paper just gives “the facts”.
“From the Fed study, it seems that there is a strong long-run relationship between money growth and inflation. Explaining that relationship is the job of theory. If a theory can’t explain it, then another theory is needed.”
There is no “strong” relationship. Prices rise in general and so do output and the money stock. For a country such as the United States, prices do not rise “one-to-one” *with time* with a rise in the money stock as can be seen from the data.
The dataset uses data of other nations which have seen high inflation and not due to an action of increase in the money stock on the part of the central bank. Such analysis call for tightening of policy when not required.
While there is nothing wrong with individual dataset, statistical methods, graphs and so on, my point is that it is misleading, in spite of having qualified that correlation is not causality. Usage of statements such as “neutral” is a proof to my claim.
As I said, it is easy to produce the result by hand with data having been skewed due to nations having high inflation leading to rise in the money stock in those nations. I do not see this in the paper.
Ramanan,
The paper isn’t monetarist or non-monetarist. It’s just a set of observed facts about the world.
If you want too say, “that’s poor statistics”, then you need to criticise their methodology.
If you don’t have anything to say about their methodology, then it seems a bit off to say, “that’s statistics”.
Regression analysis is something that all economists do until they’ve got OLS coming out of their ears. I find it quite hard to believe that Fed economists don’t know how to perform something so basic.
And if you don’t have anything to say about their methodology, then you either need to explain those observed facts theoretically, or explain why you don’t need to explain them.
But that’s a separate issue. I was pointing out an empirical regularity. It is what it is.
Vimothy,
I said poor statistics and economics combined.
This is because it’s a bit illogical to use other nations’ data for one country and make what I think is misleading. In the United States there is no “one-to-one” relationship between prices and the money stock.
In general I rank these papers as part of the problem because whether the Fed authors intended or not, it gives the reader the impression that a rise in money stock will be a worry. All this leads policy makers to keep fiscal policy tight.
I can easily construct 110 points in which the data gets skewed by a few countries because of price rise (with money stock increase as a consequence) and get the high correlation and the 45 degree line which starts at 5% on the x-axis and excellent looking fit. But when someone looks at individual data point, things look fine for most nations.
I have done this with some data points and will post it soon.
Ram,
“There is no “strong” relationship”
This contradicted by the data. You are entitled to your own opinion but not your own facts, as the saying goes.
Of course it’s true that prices, output and money rise over time; the question is whether there is any pattern in there. It turns out that inflation and money growth are strongly correlated, whereas there is no correlation between real output growth and money growth or real output growth and inflation (in the full sample).
You say that the data is skewed by including nations who have had high inflation and high money growth. But this concedes the argument! You can’t go about excluding data on the basis of it affecting the outcome that you want. That really is bad statistical practice.
The reason that the authors include lots of countries is they want to measure the effect across policy regimes. If you just take one country then you might have selection effects that bias your results.
Looking at the time series evidence is more complicated, because time series generally do not have stationary distributions. It’s totally wrong to simply put two trending series together and come to some conclusion about them on the basis of standard cross-sectional methods or how they look.
If central banks set policy on the basis of a particular reading of this evidence, that’s different to what the evidence says. What the evidence says is an observed fact and not theoretical. Theory is up for dispute; facts are not.
I understand what you’re saying. I think Ram is jumping ahead to whether this tells us anything useful, and it’s not clear to me the paper’s intention is to be as objective as you are being.
“You can’t go about excluding data on the basis of it affecting the outcome that you want. That really is bad statistical practice. The reason that the authors include lots of countries is they want to measure the effect across policy regimes. If you just take one country then you might have selection effects that bias your results.”
Can’t that be argued the other way as well? Maybe there are some unique or important things about those outliers that should be controlled for? Isn’t that basic econometrics? So maybe not exclude the data, but at least identify some variables that should be controlled for.
Vimothy,
I wrote a post here btw http://www.concertedaction.com/2012/03/24/some-monetary-facts/
If you see the last graph, you can see that M2/CPI has risen a lot contrary to the misleading claim that money and inflation have a “strong relationship”.
It is misleading.
“This contradicted by the data. You are entitled to your own opinion but not your own facts, as the saying goes.”
Misleading statistics and IMO totally dishonest paper by the Fed authors. No contradiction AT ALL. See the last graph I mention. Has the CPI risen one-to-one with the money stock?
“But this concedes the argument! You can’t go about excluding data on the basis of it affecting the outcome that you want. That really is bad statistical practice.”
I’d say the opposite. You (as in anyone, not you in particular) cannot include countries with high inflation and make claims that inflation and money are correlated. Indirectly you are giving the impression that a rise in the money stock leads to inflation inevitably.
This is the problem of the economics profession. Almost everyone outside the small community of people who know money is endogenous has a Monetarist intuition at some time or the other. It doesn’t help trying to justify the positions by such misleading analysis.
“If central banks set policy on the basis of a particular reading of this evidence, that’s different to what the evidence says. What the evidence says is an observed fact and not theoretical. Theory is up for dispute; facts are not.”
Central banks DO NOT control the money supply in any sense. But the authors continue to claim that it does.
If you happen to read some literature on PKE or even NKE, they (the latter) concede that there has been a divorce from the money stock. The paper referred has no application in real life – that is central bank behaviour itself.
The central bank may simply react to the increase in prices – but that has nothing to do with money. The money stock may have risen 10% but prices only 2%.
The Fed itself in official communications has said that it stopped caring about the money stock. Even heard Ben Bernanke saying the money supply has risen x% and we need to increase the Fed Funds rate?
That the authors completely fail to say the most obvious fact that the money stock in the United States has risen far higher than the CPI is telling. Instead they chose to present it “facts” with “unit coefficient”.
No “strong relation” as the chart I plot shows!
“whereas there is no correlation between real output growth and money growth or real output growth and inflation (in the full sample).”
Take a country such as the United States. The real output has risen homogeneously over the years/decades and so has the money stock. No correlation? That’s a silly claim.
Sorry in advance if you take it the wrong way. Silly as in the authors
Japan clearly has the debt level but I think most of the time they were under the 40% deficit level. Do you know of any other example where a government that was a currency issuer and had debt over 80% of GNP and deficit over 40% of government spending lasted for more than 6 years without hyperinflation?
What do you mean by deficit over 40% of spending? Deficit = Govt spending – Tax Revenue. What is ‘spending? I do know debt was well over 80% of GDP during WWII in the US.
These guys are right vince. The total amount of money in an economy has no bearing on prices. When you examine the consumer price index you will find that prices are determined independently for each product and service. Prices only go up when people SPEND their money or supply changes. The money bill gates has in some account somewhere has no bearing on the equation.
I have seen many studies that show that over long enough periods the growth of the money supply is correlated with inflation, just that the inflation is delayed. Do you know of any study looking at long periods of time, like 20 years or more, that shows there is no correlation between money supply and inflation? A quick google scholar search of “money supply” inflation correlation, gives me over 25,000 papers. Do you think any of these say “no relation whatsoever”? If you find one please keep track of how many you had to check before you found it.
http://scholar.google.com/scholar?q=%22money+supply%22+inflation+correlation&hl=en&btnG=Search&as_sdt=1%2C5&as_sdtp=on
The delay makes sense and with that the correlation seems very solid
http://pair.offshore.ai/38yearcycle/#delay
Deficit/Govtspending > 0.40
After WWII ended they cut back the size of the military and then there was no deficit. If there is no deficit then the debt is not growing. If the debt is not growing it is not in danger of getting out of control. So the situation now is really very different than the situation after WWII.
http://pair.offshore.ai/38yearcycle/#debtlevel
Okay, so now you’re changing your tune. You asked me for an example, and I gave you one. Now you say the next condition is that it has to perpetually continue with the threat of getting out of control. You still haven’t defined what that means or how it will happen, and we debunked your too-simplistic inflation > interest rate argument, because it’s not always true as you claim and you’re not explaining how much inflation is needed relative to interest rates and how that inflation will even happen. All you do is continue to provide data points with correlations, no detailed analysis or explanation, and assertions. Again, interesting but not convincing.
I may not have stated the debt over 80% of GNP and deficit over 40% of spending enough times for you, but I think Cullen has heard it enough times. For years. I think he tires of hearing it.
I am not surprised I have not convinced you. My success rate is very low.
But I like to keep checking the arguments from time to time, looking for any new ways to think about it. I typically bother Cullen for a couple weeks then leave him alone for a year. 
Vince,
Nowhere in your analysis do I see an adjustment for a currency issuer being the world’s reserve currency, therefore having to supply not only domestic demand for base currency, but foreign demand… in our case of about $500 Billion per year.
I would think a money-issuing country would have to adjust for that money-drain when deciding what deficit/debt/base-money levels could lead to hyperinflation.
I’m sure if you looked before 1492 you would find oodles of papers saying how the world was flat. That doesn’t mean it was so. Correlation does not always imply causation. If your quantity theory is correct, why do some prices fall while some prices rise?
There has never been a world reserve currency that got hyperinflation. The US dollar is the first fiat currency used as a world reserve currency. So “this time is different” for real. It may be that other countries get out of treasuries faster than a local population would, or maybe things go much slower since the whole world is involved. Things could really be different but it is really hard to say how they will be different. We are in uncharted waters.
Well if the rest of what you say is correct about hyperinflation’s ignitors (not conceding this at all), I’d suggest that a drain of $500 billion per year to foreign demand for our currency might change some of that. This means we have to run deficits not just for ourselves but for foreigners to save as well. That, to me, indicates that at least in the short-to-medium term we have a lot more wiggle-room before balance-sheet-recession ignights into hyperinflation. Most countries with relatively small drains of currency need much smaller deficits to have the same affect on a domestic economy’s money supply.
First, I do believe that the velocity of money is also important. And I am even ok with counting bonds as money if you accept that they are slow moving money that helps reduce the average velocity of money.
There are other things that impact individual prices than just the total amount of money. There are supply and demand issues for each item, say corn, rice, oil, etc. Also, when times get tough people can cut back on what they pay for housing, by moving in with parents, getting a smaller place, etc. But they have to buy food to eat and gas to get to work. So the prices for necessities can go up even as the prices for houses is going down. The Fed would like to print money and just make housing and stock prices go up, but unfortunately the new money will probably affect oil and food prices first.
Maybe I missed it, Vince, but I like the description of bonds as “slow money” (the interest rewards you for holding it), and cash as “fast money” (very liquid and there’s no interest reward) not because you definitely will see cash move fast and bonds move slow in all environments, but moreso because it creates a visualization of peoples’ potential motivations if they think they’re losing to invlation in SOME environments for LONG ENOUGH…
That said, I believe you posted that high interest rates INCREASE the velocity of money and low rates DECREASE it… that makes no sense to me… can you clarify your point? It seems like you’re contradicting yourself.
Sure. I see 2 different things. First, the more people you have in long term bonds the slower your average velocity of money (assuming we count bonds as money like MMT/MMR likes to). But this is a question of the total holdings of bonds and the term lengths on these bonds, not the interest rate.
A separate issue is the current interest rate. This is like the “cost of money”. If the cost of money is very low you don’t need to be so efficient with it. If the cost is high you want a sort of “just in time” inventory system where your money is not sitting around idle. When you get interest rates of 100% per day people will run from getting their paycheck to buying food at the store. If a company is paying 0.5% per year, they may have a few extra billions sitting around because it makes life a little easier for them. This is another one of those things where there is data showing a correlation and it makes sense to me, but you can argue that I have not proven it. Here is some more on this idea with data:
http://www.hussmanfunds.com/wmc/wmc110124.htm
Now if the interest rate is well above the inflation rate then people may tend to move into bonds. But in hyperinflation the interest rate is usually below the inflation rate and people want to get out of bonds. So you get a flood of new cash as the bonds come due.
Vince,
Since we’re kind of bouncing around between high interest rates and high inflation rates let me break down the way I see it and let me know what you think:
I’m going to change your “cost of money” to “REAL cost of money,” because that will more likely drive velocity, will it not? The 100% rate per day would be true if you were LOSING a bunch to inflation… but if you were being properly rewarded for holding it, that wil slow down your sprint to Sam’s Club. So really it all comes back to real interest rates… not the rate itself. The 100% rate is irrelevent until you know inflation.
So as a manufacturer, yes, if you have debt to pay off at a REAL 8% rate but can only get a real 4% rate in a checking account, you’ll want to sell your inventory… but looked at at a macro-level, high REAL interest rates will cause people to hold their money as opposed to get rid of it, making it difficult for producers to get buyers in the real economy. The real source of the producer’s haste to sell is that they can’t get as much in their checking as their loan, not because they can’t stand holding cash at high rates.
They are not other factors they are the only factors. Supply and demand/spending is it. Money creation isn’t enough. The money has to be spent or have velocity. You understand it.
When people buy bonds they are usually saving. This means the money is not likely to go towards consumption. All that money the fed created is sitting at teh fed as reserves.
That’s kind of what I like to visualize… people make the decision to SAVE FIRST… then they decide what instrument to use…
It’s much more likely that savers will go from T-Bills to Corporate bonds than from T-Bills to canned tuna.
Yes. In normal situations people save using banks, T-bills, corporate bonds, and stuff like that, not canned tuna. However, hyperinflation is not the normal situation. It is not the likely situation. It is not the common situation. But it does happen. It is real. And I think it is worth understanding this strange situation if you really want to get realistic about paper money.
The average paper currency seems to die within 27 years. So maybe it is about a 4% chance on a random year for a random currency to die. At least 1/4th of these are from hyperinflation. So lets say 1% chance of hyperinflation in a random currency in a random year. But we can see what conditions it happens under, namely debt over 80% of GNP and deficit over 40% of government spending. In these conditions it seems hyperinflation is far more likely than normal. Looks to me like, given those conditions, the odds of hyperinflation in the next 6 years are over 90%.
Time will tell. But the deeper issue is that a theory of fiat money has to explain hyperinflation, because it is a big part of the history of fiat money.
There are other factors to take into consideration other than the size of the debt and deficit. If the private sector decides to divert money from consumption to savings and deleveraging the deficit is what supports economic activity in absence of that spending. Absent that the economy would no doubt be experiencing a deflationary spiral. The deficit is consuming output that would otherwise go unsold.
If the rest of the work keeps taking another $500 billion each year then there is little risk of hyperinflation. I agree.
But China and Russia seem not to want more dollars. If other countries follow this, then there may not be $500 billion into the rest of the world this year.
But if US bonds are paying less than the inflation rate, why would other countries keep putting more into dollars each year? If they bought gold or silver it seems they would be better off, as nobody is devaluing those.
In hyperinflation the “real cost of money”, (nominal interest rate minus inflation rate) goes negative. This means saving is a losing proposition and everyone would like to borrow money form the central bank, which must be printing like crazy to achieve this unnatural state. So we trend toward less and less savers and more and more money coming out of the central bank. As there are less and less savers and more and more money the velocity of money goes up.
There was some real fear that in the late 1970s the Fed was headed toward hyperinflation. However, the government did not have debt over 80% of GNP or deficit over 40% of spending, so all it took was letting interest rates get above the inflation rate and then the “real cost of money” became sane again and you got savers again.
Vince,
You are right, saving is a losing proposition during a hyperinflation… however, that wasn’t the context of your velocity example during high rates. You were arguing high costs of money cause high velocity because companies want to sell their inventory quickly because the money was expensive… and I was pointing out the macro perspective on that. When REAL rates are high, money slows down, when REAL rates are negative, money speeds up. 10% inflation and 18% treasury bonds will leave me investing in treasury bonds….
REAL rates drive velocity (among other things that drive velocity, such as quantity, productivity, expectations, etc), not nominal rates. Your example of a company was not looking at things correctly, IMO.
You imply that savings went down in the seventies because of inflation. That is incorrect. Savings were between eight and ten percent not only during the seventies but the sixties and fifties. Savings went down beginning in eight;y five to aroung 6 percent. Your data is incorrect.
We’re not “forgetting” the debt, but simply realizing that debt is always taken in context of productivity (hence the oft-used debt/GDP ratio). The netting to zero of the financial asset doesn’t mean money hasn’t been created in a sense… but simply that there’s an asterisk next to it that I look forward to being analyzed over the next few months/years here.
If NFA balances were the short-term driver of the economy (either investment, consumption or inflation), then we wouldn’t have gone from 1997-2008 of NFA drain in our economy before experiencing a deflationary monetary event.
Simply put, ANYTHING that takes that long to work is obviously not driving the economy in the short/medium term. Much like Austrians claiming hyperinlfation WILL HAPPEN someday… claiming that the NFA drain beginning in 1997 would lead to a deflationary recession would have had to wait until 2000 to see the first sign of it, and then again all the way into 2008 to see the next sign.
In the meantime, the horizontal system was doing massive amounts of legwork and funding massive amounts of investment, good or bad. But we’re told it all nets to zero so it doesn’t matter, and that NFA’s could have prevented all ills, can keep our daughters from getting pregnant, and cure cancer.
I could be wrong on those last points
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I think I agree that real rates are what is important. Yes, there is also an issue of expected inflation rate, not just current inflation rate.
It seems strange to have someone on an MMT/MMR site correct me for not using inflation adjusted rates as most people on these sites never adjust for inflation.
For example, “if the government deficit spends then the private sector gets to do more saving”, but without adjusting for inflation. Maybe after inflation there is not additional savings and the government ended up with a bigger share of the total wealth as they printed some. I think “inflation is a tax on money” is the right way to look at it. When he tax on money gets too high, people stop using it.
Haha… well things do become a lot clearer when you focus on real interest rates… velocity, gold prices, savings rates, etc. Focusing just on interest rates or just on inflation really doesn’t paint the fullest picture.
When I say “real” rates, I do tend to mean “expected future” real rates… though I think we as people tend to have a recency bias and use past inflation too much as an indicator… you know what they say… expectiations are like a$$holes
. Maybe that wasn’t 100% correct :\…
To your point about injecting NFA’s only to result in inflation… I’d say that you’re right that on one level it’s fair to adjust it for whatever inflation may have happened as a result, but often the MMR argument would be that NFA’s are injected first and foremost to create liquidity and stability into a system that is deeply craving them (and if you don’t think we’re deeply craving them, tell that to all the unemployed and underemployed people with low savings account balances who are underwater on their home).
If that liquidity increase is immediately resulting in inflation, it’s likely that the public desire for these is weak, we have fullish employment and MMR’ists would probably say “pull back on the reigns.”
So, yes, it is possible to be shoving NFA’s into a society that doesn’t desire them, but that’s the whole balance MMR tries to strike. And it’s also why MMR doesn’t like to look at NFA’s as the “only way to save,” because it could lead to false assumptions about the good that’s being done by over-emphasizing fiscal policy and underplaying the horizontal money sector.
“Money doesn’t get “destroyed”.”
Sure it does. When the bank pays back its reserves to the Fed plus interest, those “profits” are then forwarded to the Treasury’s account from whence it never emerges. It never gets spent again, it never funds anything. It’s just gone.
The more people that put money into bonds the less danger of inflation. You can look at this several ways:
1) Imagine the government burns all the money it collects from taxes or bond sales. Then bond sales make for less money, till they are paid back.
2) Each duration bond is like another currency. But the longer the bond the slower the velocity of money. So the more people that move into longer term bonds the slower the overall average velocity of money.
Either way, a temporary lower quantity of money, or a temporary lower velocity of money, the bonds temporarily lower prices. But if people, for any reason, start to just cash in their bonds as they come due and not roll them over, then prices will tend to go up.
Money having velocity implies that it’s being spent. The government paying off a bond is not velocity. It is a conversion from one asset to another. This has 0 ffect on prices especially when most are probably rolling their bonds over. For prices to rise savers would have to take their bond money and spend it on tuna fish or whatever.
If dollars, on average, change hands every 2 months we can say that “their velocity is 6 times per year”. We talk about them having this velocity even if they are sitting under my mattress at the moment. Same thing with bonds. The average 10 year bond might only change hands once every 3 years. We can still say it has a “velocity” of 0.33 per year. If you have a mix of 10 year bonds and cash as your money supply then the velocity will be somewhere between 0.33 and 6. If you count bonds as part of your total money supply then when looking at the “velocity of money” you need to include their velocity. With this and the equation of exchange I think it is clear why prices go up if everyone switched from bonds to cash, even in the MMT case where we say the quantity of money did not change. If everyone is switching to cash it means the average velocity of money is going up. If the quantity of money is the same (both cash and bonds counting) and the velocity is going up, then prices go up. This is what historically happens when the public stops rolling over bonds and makes new money to pay them off, prices go up.
M*P = V*Q
http://en.wikipedia.org/wiki/Equation_of_exchange
http://en.wikipedia.org/wiki/Velocity_of_money