Monetary Inflation/Deflation

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    Been reading Theory of Money and Credit with Robert Murphy’s study guide,What has the Govt Done to Our Money, Mystery of Banking, The Ethics of Money Production, my head is spinning…

    Do I have this right:?
    A society has $1,000 paper dollars. The fed injects an additional $ 100 paper dollars by lending it to Joe at 20%. So now there is $1,100 in the society. Joe and those who do business with Joe benefit the most. As the money spreads across the society some people benefit less until a point where some people are harmed and the end users are harmed the most. There is no net gain to society because no additional capital goods were created by this process.
    After one year Joe pays off $120. The fed decides to burn the $100, keeping the $20 in interest. The society, minus the fed, has $980. Now the people who hold on to their money and spend last will benefit the most from price deflation.

    And some questions:
    1 If Joe happens to create the new i-phone or discovers a cancer cure with this loan can there be a net gain to society?
    2 What can/does the Fed do with the $20 it has made in interest?
    3 If we used credit money instead of paper dollars in the above scenario would that change anything?

    Thank you


    1. If Joe had a plausible investment project like the iPhone or a cure for cancer, he would have obtained funding in the capital markets. It’s capitalist who use economic calculation to weigh the different investment projects for which the entrepreneurs seek funding (of course an entrepreneur can be a capitalist by self-funding his projects). Outside of the market, we can’t tell whether or not a particular project generates a net gain to society. Furthermore, government bureaucrats can’t use economic calculation to select from among the investment projects that clamor for state funding.

    2. The Fed uses its interest income (earned on securities that it buys via open market operations and then holds onto) to fund its own expenses. By law any surplus must be returned to the Treasury department.

    3. Credit money is a claim to money itself that the government promises to make redeemable for money on demand at par but the claim is currently not so redeemable. It does not have to be a debt instrument. So, no substituting credit money for fiat money in your example wouldn’t change anything.

    If by credit money you mean a money substitute (like a checking account), that too would not affect the analysis.

    One element you have not mentioned in your scenario is money demand. Since each dollar of money can be spent over and over again during some period of time, the array of demands across the economy are not strictly limited by the amount of money. The $1,000 may generate tens of thousands of dollars of spending during a year’s time. The effect on the array of prices, then, depends upon both the money stock and the demand to hold money.


    Thank you,I’m not sure I understand “Outside of the market, we can’t tell whether or not a particular project generates a net gain to society.” If some government program accidentally discovered a cancer cure would that not probably be a net gain?

    Does money demand have anything to do with the “circulation of money”? Would you have a recommended article on that topic? Is there a rate of circulation? Does it matter?


    Every action has a value gained and a cost foregone. The cost of any action is the value of the next best end that could have been achieved if the resources had not gone to attain the end that was achieved. An action is only justified when its value exceeds its cost. In society, the resources used to attain one end satisfy a particular group of people and the the same resources used to attain the next best end satisfy a different group of people. The only way to objectively compare the value to all the persons who benefit from one end attained with the value to all the person who forego the benefit from the next best end is the market, i.e., each person demonstrates his preference for each end relative to money. Outside of the market, i.e., without a market, it is impossible to objectively compare the preferences of different persons.

    Money demand is fulfilled by the holding of a stock of money. This principle of action an be generalized to all goods. People participate in exchange to obtain a more valuable stock of goods. They give up what the value less to obtain what they value more. It is imprecise and unnecessary to say that money “circulates.” Metaphors are unnecessary in reasoning when the concepts themselves are clearer. Moreover, it makes little sense to generalize this metaphor for all goods. Of course, one can calculate all sorts of strange figures from market data. Would any economic-theoretical knowledge be gained by calculating the rate of circulation of automobiles per year or shoe factories per month that could not be gained in a more straight-forward manner. It is more meaningful to say that the demand to hold money has increased than to say that the circulation of money has slowed down. Money is actually held by people. It does not circulate.

    Here is Henry Hazlitt on the velocity of circulation of money.


    Thanks again, read the Hazlitt article, his application of velocity to commodities sheds light on the issue.

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