Money Supply Question

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tabletop's picture
tabletop
Status: Bronze Member (Offline)
Joined: Jan 14 2009
Posts: 29
Money Supply Question

I just watched a Glenn Beck interview of Ron Paul where Beck mentioned a statistic, from a source I cannot remember, noting that since October our "supply of money" has increased by 70%.

If this is indeed accurate, why am I seeing reports of deflation as opposed to inflation?

 

 

scepticus's picture
scepticus
Status: Silver Member (Offline)
Joined: Jan 16 2009
Posts: 129
Re: Money Supply Question

All your deflation questions answered here!

The money supply is inflated when a bank takes the money ron paul refers to and lends the same money out many times over - this is 'fractional reserve banking. For example,

the gov prints $100 and gives it to a bank.

the bank loans say 10 people each $100. That inflates the money supply to $1100, the orihinal 100 printed by the gov plus $1000 of new 'debt money'.

Now that is only inflationary if the bank makes these loans. If it chooses to sit on it, then the money supply stays at $100.

Note that each time a loan gets paid back or defaulted on, then the money supply shrinks. That is happening alot at the moment, so we are deflating. The new printed money will only be inflationary once :

1) the banks want to lend it

2) someone wants to borrow it.

Neither of those look likely to be happening soon. 

 

 

 

 

bearing01's picture
bearing01
Status: Silver Member (Offline)
Joined: Sep 7 2008
Posts: 153
Re: Money Supply Question

You observe rising prices as a result of a weaker dollar.  When the money & credit supply inflates (expands) only on the bank's balance sheet the money is there to be lent to the economy.  It has not been spent yet.  It's as if it were stuffed in a mattress.  Right now the banks are only lending to sound credit-worthy businesses or individuals to make asset purchases or investments that are worth their list price.  Because banks are reducing their risks of borrower default and tightening the lending standards The Fed Reserve is doing everything they can to get the banks to take on these greater risks and lend the money.  The Fed are actually bypassing the banks and trying to put the money directly in the pocket of special interest groups, no matter what their credit rating, to get them to spend.

When the economy begins to come back or all this newly created money starts to get spent in the economy it will begin to bid up the prices for commodities and other goods.  Why, because the money was created out of thin air.  Normally money is not created but rather is just the medium of exchange between different goods.  To earn money one must first produce a good or service to make a contribution to the wealth of the economy.  He/she can sell their produce in exchange for money and then spend that money on either another consumable good or on a new tool or machine to increase the productivity of their business, or save it to make a purchase tomorrow.  When the Fed prints money to be spent there is no goods or services created before hand.  It's just a paper claim to secure already existing products on the market.  This money bids away the products/commodities/services away from the rest of us that should be able to secure different goods because we have produced.  As a result, the prices eventually get bid up. It's as if someone counterfitted some money and then used it to steal away goods from the producers of the economy.  Because prices rise the effect is observed as less dollar purchasing power. This weaker dollar will become expected through what gov't call's inflation.  If interest rates don't rise to get people to take their dollars out of the economy in exchange for gov't treasury bonds (thus those dollars are not available to consume the goods/services) then a price-dollar strength spiral can occur where people expect future prices will be more expensive.  This motivates people to take out loans to either consume or to invest in business, expecting to either profit from the price rises or to secure goods today at the lowest possible price.  When this starts to happen, this big supply of money behind the bank balance sheets will come out of no-where.  It will start to flow into the economy and bid up prices of everything, because as I said, there has been no previous production to support the new bigger volume of money. 

Normally how it should work is that banks make loans from existing bank savings deposits of banking clients.  When I deposit $1000 into my bank as savings then I won't spend it on goods like a haircut or gasoline or bread.  Someone else borrows the $1000 from the bank and he buys those things instead of me.  There is no increase in demand.  The goods/services that I could claim with my money are insted transfered/granted to someone else.  If many people demand to borrow money then because of limited supply of savings the interest rates should rise with rising demand.  That makes me want to keep my $1000 in the bank and less people wanting to borrow it.  It equalizes out the supply/demand for money.  When either the bank, via fractional reserve banking, or the Fed, create money out of thin air I have access to my money to spend on goods.  Others will also have access to more money to spend on goods.  Prices rise as a result.  Right now we have a huge supply of newly created money sitting on the side (as if it were an additional new pile of savings - without the production that created it) waiting to get lent out.  In addition, the average American has very little savings in their banks because they anticipated their home equity to be their nest egg.

People talk about money velocity and how it will cause prices to rise. What happens is that as people expect future prices to be higher they start to spend their savings or loans immediately to secure goods/services at the lowest  possible price. The larger supply of dollars will have diluted purchasing power and the money flows in the economy until the long term new prices of things begin to reflect the new quantity of money.  Short term there could be bumps due to supply constraints but as prices rise profitability in those industries go up so more production eventually supplies the increased demand.  It is the increased number of dollars, the dilution or perceived weakening of it power, that increases money flow velocity in the economy. 

Deflation right now, in modern day terminology, is the prices of assets falling.  People are loaded up with debt or have failed businesses and they need to liquidate / sell off their assets to raise cash to pay their debts.  Everything on sale has caused asset prices to decline.  This is claimed to be deflation.  On the money supply, by true classical economic definition of the term, deflation is a contraction in the supply of money and credit.  We know the Fed has created hundreds of billions of new dollars for banks and to buy up mortgage bonds, etc., and to lend out.  On the credit side, people are taking the cash from the asset sales and are paying back their loans, and not taking out new loans until their faith in the economy has come back.  And banks aren't creating credit because of the risks.  Therefore, there is not much demand for new credit now and therefore the money supply on the credit side is not expanding.  While this should be apparent through interest rates being low because of low demand for new debt, it is not an accurate measure because the Federal Reserve now have been making the rates artifically low to motivate businesses and consumers to take on more debt.

tabletop's picture
tabletop
Status: Bronze Member (Offline)
Joined: Jan 14 2009
Posts: 29
Re: Money Supply Question

Thanks so much scepticus and bearing01.  This is the best forum in town. :-) I just got smarter today.

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