Is hyper-inflation truly inevitable?
There have been lots of posts on this site regarding deflation versus inflation. At the moment deflation seems to be winning out, but I think if we were to poll everyone on this site the majority would argue that inflation–in fact hyperinflation–will occur at some point in the not-too-distant future. However, I read or heard something recently (don’t remember where) that caught my attention:
The U.S. stock market has lost nearly half its value in 2008, and markets around the world have lossed similar large amounts. Don’t have any idea what the actual $ #s are, but certainly in the trillions of dollars. That money has simply vanished–poof–it’s gone! And unlike homevalues, this was real money, no? So, although the FED is creating new money out of thin air, if they print 1 or 2 trillion dollars, but that same amount of money has been lossed, the two offset one another and at the end of the day it’s a wash.
What am I missing or not understanding?
I am not the best at explaining this, but I will try: Neither gains nor losses are real until you liquidate your position. That about sums it up. For example, say you bought 5,000 shares of GE at $20/share in 2002 ($100,000 investment), and held it through today. In October 2007, the stock traded at 41.03. You would have shown a paper gain of slightly over 100%. If you had sold then, you would have pocketed a profit of a little over $100,000. However, if you had not sold then, and were still holding it now, your investment would be worth $17.07 a share, or $14,650 less than what you purchased it for.
This relates to net money creation or destruction as follows: Your paper gain of slightly over $100,000 was not the result or cause of net money creation. The dollars somebody would have used to pay you for those shares when they were worth $41.03/share would have been real, previously-created dollars. They only seem like "new" dollars from your frame of reference, but the dollars themselves were not "created" by GE or the market in any way. Had you sold then, your profit would have simply been the result of someone else transferring their dollars to you. What if you held your shares through today, showing a paper loss of $-14,650? Well, the $100,000 you paid for the shares are still out there, somewhere. You paid those $100,000 to somebody. If you decided to sell today, someone would pay you $85,350. What happened to the $14,650? They were not "lost" from a global economic perspective. Someone out there has your original $100,000, unfortunately that someone is just not you.
The news outlets sometimes talk about money going to "money heaven". However, I do not see how that can happen unless they are referring to unliquidated gains (don’t get me wrong, these are very important too), or using the fram of reference of each investor that lost money. Of course there is a "money heaven" for gains that were never sold, but otherwise, money can only be destroyed in one of three ways: a) you burn it/destroy it b) you hide it so well nobody can find it, including yourself or c) you increase the quantities of it so that the value of all existing monetary units depreciates.
Don’t get me wrong: paper gains have a very real effect on the economy even though they are not "real money". People and businesses leverage themselves based on the presumed value of their savings and investments, make purchasing decisions, get loans, etc. But the number of physical dollars themselves, at least in our fiat-currency economy, can never decrease – they can only get shuffled from one person to another or increased via central bank printing. In a non-fiat economy, I suppose they could decrease by being cashed in for whatever is being used to back the currency – usually gold. They could also still increase in number, but only via increases in gold (or some other hard commodity) that get deposited in banks in exchange for demand deposits (which used to be known as money).
Hope this helps, although I don’t feel entirely comfortable with my own explanation.
To answer your original question:
The trillions lost by the stock market collpase were "paper gains". Therefore, increased printing by the fed will not be offset by such losses.
One of the great misperceptions folks have is that "I have my money in the stock market". No, you don’t. The money went to the person who sold you the stock. What you have is a piece of paper that you will eventually need to sell. If you sell it at a loss, your money didn’t vanish, you just couldn’t find anyone willing to pay as much for the piece of paper as you did. The money was gone on day 1.
Example: I buy a share of stock from Fred for $20. He takes his family out to dinner and spends it. The company later goes bankrupt and I can’t sell my stock. The papers report "$20 lost in stock market". The $20 didn’t vanish, it was given to Fred who traded it for a steak.
This also goes to the misperception of "money on the sidelines". For every dollar that came out of the market, someone had to put a dollar in. It nets to zero in that sense. While, unlike Futures trading, stocks aren’t a zero-sum game, you can’t take money out of the market unless the same amount is put in by someone else.
Thanks for saying what I was trying to say in 1,000 less words! I have one disagreement though. When people refer to "money on the sidelines" they could be referring to one of two things: If they are referring to money that was taken out of the market, of course you are right – they could only take it out if someone else put money in – therefore, no net difference. However, they could also be referring to the stockpiling of money in 401ks and mutual funds that come from automatic withdrawals from people’s paychecks. The money managers in charge of the 401ks and/or mutual funds can and sometimes do "sit on the money". Since this is not money that came from the sale of stocks, but rather money that came from automatic deductions from paychecks or other deposits into mutual funds, then it can be truly considered "sideline" money.
Another way of looking at the inflation/deflation issue is that you really can’t have a meaningful debate about it unless you define what is being inflated or deflated. You can have decreasing asset values and increasing consumer prices. You can have an increase in money supply and a decrease in asset prices and assets. Personally, I think we will have a prolonged deflationary period in things like cars and homes but we will ultimately have inflation in things like gas and food prices.
Inflation looks inevitable in most consumer goods but I do not think hyperinflation is inevitable. Hyperinflation is a pretty rare phenomenon and I still have some faith that we have some people in government that would prevent it from happening. If anything, they can come up with a new currency (like the Amero) and replace the dollar which would obviously create its own problems. I just think that a plan B is probably already in place, waiting for the day if/when the dollar completely collapses.
This may be way too simplistic but here goes. I had to think about it and this is how I see it.
The concept of money can usefully describe two types. Working money and Lazy money. Working money is what someone is prepared to expend their effort for and only exists while their effort is expended. For example baking bread or building houses.
Lazy money sits in banks, under beds or in someones back pocket. When someone buys something already in existence, oil, a house, stocks, bread etc. Nothing changes except ownership which is trivial. The money used is Lazy money.
Deflation occurs when less people work and more lazy money sits in banks (or wherever)
Inflation occurs when more people work and less lazy money sits in banks (or wherever)
At the moment treasuries are printing more lazy money that is sitting in banks with fewer and fewer people working.
If or when lazy money tries to get people (poor suckers) working for it we will see inflation. People will find that they need more and more money to get people to do the same work.Thats why anything not already in existence, like newly baked bread or new houses will cost more. It is quite possible that things already in existence will not cost any more until inflation has got hold as it is working money that will be expanding first.
Hope this makes sense. I am sure I will be corrected if I am wrong. Lots of economists around here.
7 billion people can be wrong, very wrong
Gra8ful’s question is one I have been grappling with as well….trying to figure this out since the deflation/inflation debate carries quite a bit of personal consequences that one should prepare for. I appreciate all the answers but I am not finding myself understanding this issue and I am still more than confused. First of all, I do not understand why the stock market figures so prominently into the original question and some of the answers posted. As I understood the deflation/inflation "question," the answer lies with the Fed (and also Treasury as far as stimulus goes) creating more dollars and therefore cheapening those dollars. I beleive that one of the crash course sections dealt with this (something about the price of bananas on a boat maybe??? I’ll have to find that one) but, as I understand it, it more or less boils down to a supply and demand equation. If there are lots of dollars out there, the supply brings down the price. Hence in the Wiemar Republic they created lots of currency and it became worthless. The U.S. is "creating" a lot of dollars – right? Inflation is the obvious outcome, right? That seems to be the very basic conclusion but apparently it is not so simple. Deflation is all the rage right now but is it really even our very near-term future? There seems to be a "price destruction" in tangible assets such as houses, commodities etc but I just can’t imagine that inflation, even hyper-inflation, won’t win the day with the huge amounts of money the govt is creating and, I suppose, eventually being somehow used. Can someone provide a cogent explanation or even argument for where the economy is headed: deflation/inflation? Maybe I need to take Econ 101 again? (But somehow I don’t think I’ll get the right answer there. )
lisa, i believe you are correct when you ask why the stock market figures into the equation, the stcok market does not destroy or create money, it just tranfers the money. just like every good student of the crash course should know, ‘all dollars are loaned into existence’. so now that we know that banks turn $1,000 into $10,000 through fractional reserve banking, we can see that $9000 is magically created. but what happens when there is a default, the bank has to take the loss and the money is destroyed, or better yet, written off. so with so many defaults that have happened and will happen the federal reserve is looking to plug the holes left by defaults with new money (it’s not actually new money, it’s magically created from your savings account) to prevent deflation.
if the fed were to do nothing about deflation, people would be scrambling for hard money as it became more rare, deflation would take hold, our current debts would become more more expensive, defaults would accelerate, and the viscous cycle would ensue. of the options; deflation or inflation, i would much rather choose the inflation route… and so would bennie.
As someone pointed out, fractional-reserve banking leads to highly-leveraged banks. That is, although the bank only borrows X amount from the Fed, they are allowed to lend 10X (or thereabouts) into the economy. With the mortgage-industry credit collapse, many banks have had to de-leverage. That is, they are calling loans back, not making new loans, etc. This is referred to as a "contraction" in the money supply, and it can result in deflation. When you take leverage into consideration, you understand why only a 4-5% default rate on outstanding loans can have the same effect as a 40-50% default rate in a non-fractional reserve banking system. That’s why banks are deleveraging. They have to bring their ratio of liabilities to assets down – a lot.
If the Fed did nothing, it is feared that deflation would take hold. Prices would come down because there is less money in circulation in the economy. The money is actually really there, it’s just being held by banks and/or foreign buyer’s of US Treasury bonds. In any case, it’s not in any of our pockets chasing cars or houses or hamburgers. If deflation took hold, incomes would come down, US tax revenues would come down, and economic activity in general would come way down. This would make the credit crisis worse because everyone’s loans would become more difficult to pay off (you’re making less money but have to make the same payments). It’s a very scary downward spiral and the Fed will do anything and everything to avoid this.
So, the Fed is creating gobs of money and using it to buy US Treasuries. The US Treasury is using some of that money to buy "toxic" assets from banks, lend money to the Big 3, and coming soon to a neighborhood near you, bailing out little Johnny’s lemonade stand, probably. Upon aquiring these Treasury bonds, the Fed is inflating it’s asset collumn, which it uses to lend money (again printed out of thin air) out to banks. So you have money being added from two sources – the US Treasury in the form of buying assets from banks, and in some very scary cases, taking equity positions in companies (AIG); and from the Fed, in the form of it’s usual lending of money to banks.
The strategy is to inject enough money into the system to get the banks’ liability/asset ratios back to normal and unclog the credit freeze. Once the credit freeze is unclogged, they hope, businesses will again be able to borrow, and therefore hire, people will borrow to buy cars, houses etc, and so on and so on. Note the recent CC graph on free money from the Fed.
So where does inflation or hyper-inflation come into play? First of all, we’ve already seen how good the Fed is at timing it’s credit expansions or contractions – pretty bad. In fact, they seem to figure everything out 12-24 months after it’s already happened, so many people fear that they will overshoot and go on creating dollars long after it is necessary. Remember, easy money is what got as into this problem to begin with. Imagine what yet another bubble popping will do to us.
Secondly, all these dollars being created, like all dollars and as the CC shows, are loaned into existence. That means that after that supposed magical day when the economy has been saved, we are going to have to start paying these dollars back. That will mean higher taxes, just as our baby boomers enter their 2nd or 3rd or 4th year (depending on how long you predict this downturn will be) which will require higher taxes anyway, further dependence on owners of US debt, and further weakening of the $ as a reserve currency.
Hope this helps.