Tag: Idea fountain

-Is inflation too much money chasing too few goods?


An alternative to popular faith

In the post “Do deficits cure inflation?” we saw that contrary to popular faith, deficit spending (i.e., too much money) has not caused inflation. We also saw that inflation can be cured by increasing the reward for owning money, i.e. by increasing interest rates.

Now we question another piece of popular faith: Is inflation caused by too much money chasing too few goods?

Begin with the notion of “too much money.” We already have seen that federal deficits are not related to inflation. What about another definition of money: M3? Please look at the following graph:

Clearly there is no immediate relationship between money supply and inflation. What about a subsequent relationship. Could “too much money” today, cause inflation later?

The graph indicates no such cause/effect relationship, with M3 peaks preceding inflation peaks by anywhere from 2 years to 10 years. It is difficult to imagine a graph revealing less relationship.

What about “too few goods”? If too few goods caused inflation, this would manifest itself with GDP moving opposite to CPI. Again, that does not seem to happen:

There seems to be no regular pattern, with GDP and CPI sometimes rising together and sometimes separately. In today’s international economy, it is difficult to substantiate the idea of a wide-spectrum commodity shortage when sufficient purchasing power exists.

Individual nations can experience shortages of individual commodities. Individual poor nations can experience shortages of a broad basket of commodities. But can a wealthy nation, with plenty of money to spend, suffer a shortage of a broad basket of commodities, thereby causing inflation? Has it recently happened?

Seems unlikely these days as products are made in multiple nations and shipped to multiple nations, with easy international shipping and instantaneous money convertibility. Your cotton shirt may have been grown in Egypt, woven in India, assembled in China, labeled in Italy and sold in the U.S. Clearly, a cotton shirt shortage would be rare, as any of these steps could occur in various countries, and that’s just one product. A nationwide “too-few-goods” situation, coincident with “too much money,” seems impossible.

There is however, one exception: Oil.

The graph below compares overall inflation with changes in energy prices, which are dominated by oil prices.

Oil is the one commodity that has worldwide usage, affects prices of most products and services, and can be in worldwide shortage. That is why, when oil prices rise or fall steeply, inflation rises and falls in concert.

The large oil price moves “pull” inflation in the same direction. When oil prices increased or decreased the most, inflation came along for the ride.

In summary, inflation is not caused by deficit spending or by “too much money chasing too few goods.” Inflation is caused by a combination of high oil prices and interest rates too low to counter-balance the oil prices.

The high oil prices can be caused by real shortages and/or by price manipulation.

Hyperinflation is a different beast, altogether. Every hyperinflation has been caused by shortages, most often shortages of food.

Zimbabwe, Weimar Republic, and Argentina had food shortages that created hyperinflations.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

-Open Letter to Maya MacGuineas, President of CRFB

An alternative to popular faith

        On September 23, 2009, Ms. Maya MacGuineas, President of the Committee for a Responsible Federal Budget, wrote an article titled, “Can Deficits Fix the Economy” (http://crfb.org/blogs/can-deficits-fix-economy). In the article, she agrees on the need for deficit “ . . . spending on public investments . . .” but she expresses concern about the government’s ability to borrow more money. I wrote her the following note:

Ms. MacGuineas,
         In your article, “Can Deficits Fix the Economy,” I’m pleased to see you understand the necessity of federal deficit spending for economic growth. This puts you well ahead of debt hawks like the Concord Coalition, who actually have called for surpluses large enough to eliminate federal debt, demonstrating their misunderstanding of money and its sources.
        Nevertheless, you said, “. . . given how much we have borrowed in the past, there is little room for deficit financing new investments, and I would instead shift our budget by cutting spending on consumption and directing it toward higher levels of public investment. If we had listened to budget scolds in the past, we would have more room on our balance sheet now for government borrowing – unfortunately, we did not.”
         Exactly the same concerns were expressed by many back in 1979, when the debt was less than $800 billion. In the past 30 years, the debt has grown 1,400% and not only does there remain plenty of room on our balance sheets, but the federal government does not need to borrow at all. See the post:
“How to Eliminate All Federal Debt, Deficits and Interest Payments”

        The government borrows by creating T-securities out of thin air, then selling them. The government far more easily could create money out of thin air, and eliminate the borrowing stage. This also would eliminate misguided concerns about our debt and our ability to borrow.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

-Another reason deficits are necessary

An alternative to popular faith

Here is one of the many reasons federal deficit spending is absolutely necessary — even more so, now — and why trying to reduce the deficit is dangerous and imprudent.

Note how debt growth declines before recessions and increases to cure recessions

Source: Joe Weisenthal and Kamelia Angelova, Clusterstock – Business Insider, September 9, 2009

Economic growth requires spending by consumers, businesses, local governments and the federal government. When consumers aren’t spending, businesses also spend less. The federal government must spend even more to take up the slack.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

-Learn to love the debt

An alternative to popular faith

       Deficits are necessary. They add money to the economy. A large economy has more money than does a small economy. Therefore a growing economy requires a growing supply of money. Quod erat demonstrandum.
       Concern about the federal debt revolves around two beliefs: Someone (often characterized as “our grandchildren”) will have to pay those debts, and large debts cause inflation.
      For us citizens, personal debt is concerning, because our debt must be repaid. People go bankrupt when they can’t repay their debts. But, if you owned a magic printing press, and you had the legal right to print as much money as you wished, your debt never would concern you.
       Received a bill for a million dollars? No problem. Turn on the magic press and poof!, it’s paid. Unfortunately, you and I don’t own a magic press, so we worry about our debt.
       The federal government, uniquely among all U.S. debtors does own that magic printing press. It can pay bills of any size, which is how today, it easily services a gross debt of $12 trillion. Not even during the current recession has any federal check bounced. Not even close.
       Still we worry about federal debt as though it were our own. Why? Partly because so many people tell us we owe the federal debt. How silly. Debt is owed by borrowers. We are not the borrowers. In many cases, we are the lenders, the owners of T-securities. The government is the borrower, and we are not the government. There will be no bill collectors on our doorsteps, demanding that we pay our mythical share of the federal debt.
       But won’t “our grandchildren” have to pay for the debt through higher taxes? For the past 50 years, tax rates actually have gone down, despite massive deficits. There is no relationship between deficits and tax rates, which are political, not financial, decisions.
      What if tax rates were to rise moderately? Let’s do the math. Say in Year One, taxes total $10 trillion and spending totals $11 trillion. Spending exceeds taxes, which causes a $1 trillion debt.
       In Year Two, tax rates rise, so taxes now total $11 trillion, but spending rises to $12 trillion, and now the debt has risen to $2 trillion.
       How much of Year One’s debt did taxpayers pay? Answer: None. Taxes weren’t even sufficient to pay for Year two’s spending, let alone pay for last year’s debt. The only time taxpayers pay for debt is when taxes exceed spending, i.e a surplus.
       That is why surpluses have caused all six depressions in U.S. history. Surpluses, not debt, cost taxpayers money.
       The inflation logic is that federal debt increases the money supply (true), which dilutes the value of money (not true). Money value is based not only on supply, but also on demand.
       Money supply can increase massively, and still not cause inflation, if demand goes up as much. Demand is determined by risk and reward. Risk is inflation (which is a result, not a cause), so the key to money value is reward.
       What is the reward for owning money? One reward is the ability to buy things with it, but in a massive economy like ours, there always are plenty of things to buy. The real reward for owning money is interest. The higher the rates, the more valuable the money. That’s why the Fed raises rates at even the hint of inflation, and that also is why in the past 50 years, there has been no relationship between federal deficits and inflation. None. (See: See Do Deficits cure inflation?
       In conclusion, rather than being concerned about federal debt, we should welcome it. Money growth brings economic growth.

Rodger Malcolm Mitchell
For more information, see http://www.rodgermitchell.com