[anthonyspen]

This is my first post here. If this has been discussed before, I would appreciate someone pointing me in the right direction.

I have been intrigued recently about inflation today and historically. Looking back through the centuries there have been many instances of a devalued currency due to too much of it in circulation. I am trying to find a common ground in each case. Was it simply too much money in circulation, or are there some other external forces involved as well? The reason I ask is because mathematically (at least with my basic arithmetic) there is no way the US and many other Western countries should not be spiraling out of control right now. What is holding everything together? In this completely Keynesian/Fiat environment are the rules different? I understand today’s economists work with complex mathematical models and algorithms that the layman probably does not comprehend. Perhaps this is the answer? Complete ignorance on behalf of so many? After all, if no one is paying attention or non the wiser, isn’t it all the same anyway? How can it be that so many business men around the country have to balance their books, but governments do not?

I realize that I just asked several question, so I regress. How are we not in a Weimar type environment right now?

[jmherbener]

A falling purchasing power of money (or rising prices in general) occurs when the money stock increases relative to the demand to hold money. Although the money stock has been increasing during the past few years, the demand for money has been rising also. On balance, then, prices have not increased much.

Here’s the great economic historian, Bob Higgs, on the topic:

http://blog.independent.org/2012/12/15/more-monetary-peculiarities-of-the-past-five-years/

[anthonyspen]

Thank you for the reply, Mr. Herbener. If I am understanding this correctly, there is a demand for dollars world wide and this is allowing the Fed to create so much money without any real immediate consequences. Many countries around the world (especially European) are worse off than the US and are putting their money into dollars (treasury bonds mostly?) because they think its safer than their own currency? This begs the question though, how long can it continue? Won’t all those dollars come home to roost at some point after these countries get their act together, or is this a trend that can continue forever because the Fed has the ability to create something from nothing and other central banks do not? I was recently listening to the latest Lew Rockwell podcast with Bill Haynes, and both agreed we are in an economic environment that is unprecedented. Again, I am asking a lot of questions, mostly because I am rather scatter brained on the subject.

The article you referred me to is interesting, but I don’t see how people making their money more liquid (larger checking account deposits) is a demand for more dollars. Isn’t it just a transfer of dollars from one account to another?

Thank you for taking the time to answer.

[swalsh81]

When he says a demand for dollars what he means is more of a demand for savings. Its a demand to hang on to cash as opposed to spending or even investing.

One of the reasons that the FED has the ability to print seemingly without repercussions is that the dollar is the world’s major reserve currency. Its the currency that other nations hold in there central banks sort of as the basis of their currency. In the past this would have been the place of gold. I am not sure of all the details about this and I am sure Prof. Herbener can explain this much better. Suffice to say, as long as the central banks of other nations want to hold dollars in reserve in their bank, the FED can keep printing because the dollar will stay in demand.

If one currency becomes more stable than the devaluing mess the FED has created, countries may start switching over to that currency. Then the demand for dollars would start to drop fast and we would have the inflation problem that you are expecting to see. In short, this part of the puzzle will continue as long as other nations see the dollar as the most stable currency. I am sure this isnt the whole story but I also cant see how it wouldnt at least play a part.

[porphyrogenitus]

Major banks currently have significant excess reserves where, traditionally, they have practically 0 as you can see. (See also this, which charts both excess reserves and the increase in the monetary base – they practically mirror each other).

Given the nature of fractional reserve banking, if/when the banks decide to put these excess reserves into the economy, well, watch out.

The question then becomes: why have they held onto excess reserves? What is the purpose of having so much excess reserves?

[anthonyspen]

@Porphyrogentitus…Yeah, it’s probably not a coincidence the two mirror each other. I bet they have just enough in reserve to prevent a collapse in the event of hyperinflation, or will use the reserves to buy commodities right before the crash does happen (assuming they know exactly what’s going on at the Fed). Wouldn’t it be nice to have the inside track

[anthonyspen]

@Sterling…Haven’t there already been a number of countries that have shown quite a resilience to the US dollar? The Yen, Australian and NZ dollar have all gone up since 2008. The Swiss Franc was also very strong, yet these countries continue to debase their currencies as well. Why? Would we go to war with a country that deliberately kept their currency strong?

[swalsh81]

I was saying that going by this graph http://en.wikipedia.org/wiki/File:Reserve_currencies.svg and you can see the IMF report from where the data was taken in the source section. There certainly are alot of countries that hold other currencies in reserve, but the dollar is the majority. Even though the governments of individual countries have given themselves a monopoly on the production of money based on fiat currency, the world as a whole is still more or less under a system of competing currencies. I would also assume that there is some amount of a “network effect” (http://mises.org/misesreview_detail.aspx?control=310) that comes into play in these currencies. one country might hold dollars over yen simply because it is easier to exchange with on the world economy should they need to. This might create more incentive to stay with a slightly more volatile currency.

As far as why they devalue, in the case of the US, when the central bank prints money, it is either used to buy treasury bonds so the government can spend or to be loaned out to other banks and the fractional reserve banking scheme starts. In either case, the government or the banks and the large companies they loan to are able to be the first ones to spend that money. This means that the they can spend money at pre-devalued valued since the money hasnt yet worked its way through the economy and caused inflation.

They also do it based on the false Keynesian idea that more money moving in the economy must necessarily be better.

I certainly dont understand international banking as well as I would like to so these are merely my speculations

[jmherbener]

If you total the value of capital markets in the world it comes to $212 trillion. U.S. bonds make up 24% of the total value of all bonds and U.S. stocks constitute 45% of the total value of all stocks. If you want to raise capital, the biggest markets are denominated in dollars. This is the main reason that the dollar is the world’s reserve currency.

http://qvmgroup.com/invest/2012/04/02/world-capital-markets-size-of-global-stock-and-bond-markets/

[anthonyspen]

Awesome info, Thank you!

[porphyrogenitus]

Anthony wrote: “I bet they have just enough in reserve to prevent a collapse in the event of hyperinflation, or will use the reserves to buy commodities right before the crash does happen (assuming they know exactly what’s going on at the Fed).”

Recall the dynamics of fractional reserve banking; with X amount of reserves, they can generate (approximately) 10X in “money.” Basically if/when they do what you say, they will not just be buying things up right before the crash does happen, but precipitating the inflation that until now has been held in check.

Also we have to define “crash” – a normal crash tends to produce falling prices; so they won’t be buying just before that kind of crash, if they know it is coming (a big if; possibly a lot of these guys think they know, but their past performance in predicting isn’t anything to write home about. This includes having “inside information” from the Fed on any pending crash; the predictive powers of the Fed when it comes to crashes is….); anyhow, if they wait for everything to tank, then buy things up “on the cheap” using their excess reserves, they’ll then be precipitating the inflation.

OtoH, if by ‘crash’ here you mean “they try to buy things right before teh inflation,” well that’s practically self-fulfilling because as soon as they do so, they’ll be unleashing a torrent of currency into the economy.

[Caviates are probably in order with respect to the degree to which financial institutions can directly transform their excess reserves into 10X monies that they themselves can directly use to buy up teh stuffs. But most of these large financial institutions have enough “partners” that they could basically swing it. However, – and this is a big however – it is not really in the interest of U.S. banks to destroy the currency that all their banking transactions are denominated in. Which may explain why they’re sitting on vast amounts of excess reserves right now and are not willing to unleash cash into the economy to reduce this to the usual level of reserves – which is, practically zero “excess” reserves. I mean, basically that will only happen in the Gotterdamerung of the U.S. Banking System. Which we may not have to wait more than a few years for, anyhow. I certainly don’t expect it to take longer than another decade.]

[anthonyspen]

When I said collapse to begin with, I was referring to the bank itself not the economy in general. To protect themselves, I meant they could buy a ton of gold right before the price sky-rocketed. Then it wouldn’t matter if they unleashed a torrent of dollars, they would be protected and be able to ride the storm without collapsing the institution.

[porphyrogenitus]

“A” bank can’t buy assets prior to its collapse, unless you mean “buy assets to prevent collapse” in which case it is not in a pre-collapse situation, anyhow (since its flush with liquidity)

If “A” bank buys assets then declares “whoops, we’ve collapsed,” those assets would be liquidated in bankruptcy and go to creditors. In normal times. Admittedly, we do not live in normal times, but even now most banksters won’t take that level of risk. (They’d have to find a way to shift the assets). If one, even major, bank steps out of line in this way, odds are they just get their throat slit for not playing well with the others (though the executives will parachute away quite rich, still, even as all the customers get screwed, MF Global-style, baby!); so “a” bank won’t do it until they credibly believe others are about to do it, too; then each will rush to be first lest they get left holding the bag.

If all the major banks jump together they could do what you describe but they would then, as I described, be precipitating the very crisis their jumping would be responding to (“it’s impending, so we jump now”); they could then hope to get away with it because it’s “systemic” and they would hope to be bailed out again, and probably would be, but it’s not an obvious winning move for them because they would also be destroying most of their current banking assets (such as those are), which are various dollar-based accounts & derivatives.

Of course, if and when they decide those assets are already essentially worthless anyhow, they could say “screw it, lets do it.” I guess that’s what to watch for. But probably it won’t be a coordinated plan but a near-simultaneous response in the face of a panic precipitated by some external event (like a major bank in China or Dubai, or sovereign wealth fund, deciding the dollar has had it and dumping tons onto the market at one time, causing others to do the same). I dk what the odds of that happening is, but Professor Herbener’s replies suggest that it’s very low in the near term.

Each year the current policy path goes on, though, the odds go up. Something I’m not sure Professor Herbener would disagree with.

[Author]

Posts