Deflation or Inflation?

[quote]ChrisL912 wrote:

[quote]Headhunter wrote:
This is a carryover from another thread.

This is a pic from the Federal Reserve Bank of St. Louis. It suggests that the money printing is having no effect, as banks will not lend. Such a scenario is highly deflationary.[/quote]

The Money multiplier is decreasing because the currency drain is increasing. The savings rate of the public is increasing and companies likewise are hoarding cash. So the monetary base has to be increased by an exaggerated amount. These are inflationary factors, but won’t mean much in the short run because of all this slack in the economy. As long as the fed can end quantitative easing and begin to drain excess liquidity appropriately (which is optimistic), then inflationary pressures should be quelled. Deflation is not likely. [/quote]

Chris, can you explain this in more detail. I am not sure I am following correctly.
I am referring to “these are inflationary factors.” Cash hoarding, by both the public and corporations, is deflationary if they are in the process retiring debt. Yes, there is more money in the banks, therefor allowing for the potential of more lending through fractional banking, which if it were to happen would be inflationary. But this is not happening.
Am I reading this correctly or am I missing a key factor.

Hoarding? You mean saving?

I see where my statement was confusing. By inflationary factors I meant the expansion of the monetary base and all the liquidity that has been put into the system.

I believe it was Milton Friedman who made the case that supply, demand, AND velocity of money are determinants of inflation.

So though there is excess liquidity in the system, it is not circulating efficiently and therefore not spurring inflation.

dhickey wrote

I am afraid I am going to butcher this, but here goes. There seems to be a flaw here that may account for your and my varying points of view.

The monetary base is coin, paper and commercial banks’ reserves with the central bank.
Money supply is the total amount of money available in an economy at a particular time. It includes all of the monetary base plus all of the additional money created through credit via the process of fractional lending.
The money multiplier measures the amount the money supply increases above and beyond the monetary base.
Therefore, if deposits are up and the coin and paper remain constant, then commercial reserves would be increased (but only reserves, which remember are only a fraction of the total money supply).

Now, if deposits are up but the money multiplier is the same, then you DO NOT have more money being lent. Actually, it would appear that less money is being lent. You simply have larger reserves on hand.

Expansion of money supply is primarily accomplished through the issuance of credit/loans through the process of fractional lending. That is the purpose of the money multiplier, to determine the amount of money that has been created through fractional lending, above and beyond the monetary base.

If the money multiplier is decreasing then it means that existing loans/credit is being retired at a greater rate than new loans/credit is being created. The money supply is shrinking. (Deflation)

Central banks mandate reserve requirements, the fraction of demand deposits that have to be kept on hand for the purpose of redemptions. In this way they can limit or control the amount of money creation. They also insure that the banks have enough cash on hand to cover normal withdrawals.

So what happens if a “black swan” event occurs and an abnormally large amount a people show up at once to redeem cash? This is a bank run or systemic crisis, such as happened in the GD. The central bank has devised methods to divert such events. They regulate banks, insure deposits, and act as a lender of last resort.

This seems to have worked just fine for the last eighty odd years. Then again, we have not experienced economic conditions and the gross negligence of that period, at least until now.

The public is for the moment pacified by the belief that if something were to happen at their bank that they are insured by the government and therefore have no risk of loss. They forget that they are the government, and also that the funds that are set aside to cover such loses are finite. Again, the system is set up to handle normal events and failures just as fractional lending is set up to handle normal rates of withdrawals with a added protection factor figured in. Black Swans are not accounted for.

Finally, I think part of the confusion lies in fully understanding money creation. When a loan is made, the borrower receives the funds for the intended use. Money supply is increased. However, the monetary base is not. That is the reason a multiplier is needed in the first place. It is not as if a call goes up to the Federal Reserve, they call the Treasury Dept., and the printing presses are started up. An amount of paper currency equaling the loan is not created and then shipped to the originating bank. Remember, it is fractional lending.

Now, before I start getting pounded, yes there are mechanisms in place by which additional currency can be created and put into circulation. However, it is relatively rare and not anywhere on the scale of which would be required to offset deflationary pressures if and when they occur. If they did do so, it would take a matter of time just to offset the real difference between the monetary base and the money supply. In the beginning they would simply be replacing credits on an electronic ledger with real bills.

My head hurts now so I will leave it at that. Look this over, ask questions or make corrections and I will respond tomorrow.

Fine work JEaton.

To Dhickey, The reason we don’t let fed funds rate and the discount rate float is because it is that mechanism that is used to help smooth the business cycles. The Fed actually RAISED interest rates during the great depression (in response to your idea that it would spur deposit growth), but in fact it makes things worse because it makes money more expensive. While this is good for your cash you put in a savings account, it increases the cost of borrowing.

BTW, ChrisL012 welcome to the forum. Brand new and actually contributing substance. Unfortunately, we’re not used to than.

One thing that has been skirting around the edge of my mind that I have not got around to addressing is how the massive derivatives market fits into all this. I’ll spend a little time over the next few days, but if you or anyone else has ready knowledge, please share.

Thanks for the welcome. My roommate has been a member of the forum for a while now, and I’m starting to see why he always has it up on his monitor.

And what exactly are you looking for when you ask how the derivatives market fits into ‘this’? As in its role in causing the financial crisis, or just its role in the market in general?

[quote]ChrisL912 wrote:
The reason we don’t let fed funds rate and the discount rate float is because it is that mechanism that is used to help smooth the business cycles…[/quote]

Uhhhh…can you please explain what business cycles have been “smoothed” by Fed interference?

Also, it is a well know fact that the Fed actually creates business cycles.

The business cycle is caused by malinvestment due to artificially low or high interest rates. The Fed could never guess correctly what the market will set interest rates at as this is determined by savings and demand for credit.

We know what the Fed’s mission statement is but the only thing they can effectively do is devalue currency thru inflation.

The evidence is plain as day: just look at how much value the dollar has lost in nearly 100 years. And yet there are still business cycles.

It would seem to me that the Fed is nothing more than a Ponzi scheme to prop up the banksters and the established political order. These are the only people that have profited by the Fed. The average non financially savvy person can no longer save his money and profit through increased purchasing power since inflation kills it. This never used to be the case with commodity money.

[quote]LIFTICVSMAXIMVS wrote:

[quote]ChrisL912 wrote:
The reason we don’t let fed funds rate and the discount rate float is because it is that mechanism that is used to help smooth the business cycles…[/quote]

Uhhhh…can you please explain what business cycles have been “smoothed” by Fed interference?

Also, it is a well know fact that the Fed actually creates business cycles.

The business cycle is caused by malinvestment due to artificially low or high interest rates. The Fed could never guess correctly what the market will set interest rates at as this is determined by savings and demand for credit.

We know what the Fed’s mission statement is but the only thing they can effectively do is devalue currency thru inflation.

The evidence is plain as day: just look at how much value the dollar has lost in nearly 100 years. And yet there are still business cycles.

It would seem to me that the Fed is nothing more than a Ponzi scheme to prop up the banksters and the established political order. These are the only people that have profited by the Fed. The average non financially savvy person can no longer save his money and profit through increased purchasing power since inflation kills it. This never used to be the case with commodity money.[/quote]

you beat me to it. artificially cheap money and credit expansion = boom and bust cycle.

[quote]dhickey wrote:

[quote]LIFTICVSMAXIMVS wrote:

[quote]ChrisL912 wrote:
The reason we don’t let fed funds rate and the discount rate float is because it is that mechanism that is used to help smooth the business cycles…[/quote]

Uhhhh…can you please explain what business cycles have been “smoothed” by Fed interference?

Also, it is a well know fact that the Fed actually creates business cycles.

The business cycle is caused by malinvestment due to artificially low or high interest rates. The Fed could never guess correctly what the market will set interest rates at as this is determined by savings and demand for credit.

We know what the Fed’s mission statement is but the only thing they can effectively do is devalue currency thru inflation.

The evidence is plain as day: just look at how much value the dollar has lost in nearly 100 years. And yet there are still business cycles.

It would seem to me that the Fed is nothing more than a Ponzi scheme to prop up the banksters and the established political order. These are the only people that have profited by the Fed. The average non financially savvy person can no longer save his money and profit through increased purchasing power since inflation kills it. This never used to be the case with commodity money.[/quote]

you beat me to it. artificially cheap money and credit expansion = boom and bust cycle. [/quote]

I believe Chris was merely stating the dogma held by the Fed and its cronies in both government and academia, as well as big business (particularly banking).
This accurately describes the rhetoric that Greenspan used to brainwash the masses with from the late '90’s through 2007. Remember all the talk of “hard” and “soft” landings. These meatheads actually thought they could finely control vast economies by these relatively simple manipulations.

[quote]JEATON wrote:

I believe Chris was merely stating the dogma held by the Fed and its cronies in both government and academia, as well as big business (particularly banking).
This accurately describes the rhetoric that Greenspan used to brainwash the masses with from the late '90’s through 2007. Remember all the talk of “hard” and “soft” landings. These meatheads actually thought they could finely control vast economies by these relatively simple manipulations. [/quote]

That rhetoric has been around longer than Greenspan. Longer than he was at the fed anyway. It’s been the battle cry of the Keynesians.

What’s frustrating about Greenspan is that he once seemed to be of the austrian school of thought. I guess when the controls were handed to him, he just couldn’t resist tinkering. I often wonder if he really had any choice. I wonder what role political pressure and the vote of others at the fed had in the actions they took during his time there. His book doesn’t really shed that much light on it.

[quote]LIFTICVSMAXIMVS wrote:

[quote]ChrisL912 wrote:
The reason we don’t let fed funds rate and the discount rate float is because it is that mechanism that is used to help smooth the business cycles…[/quote]

Uhhhh…can you please explain what business cycles have been “smoothed” by Fed interference?

Also, it is a well know fact that the Fed actually creates business cycles.

The business cycle is caused by malinvestment due to artificially low or high interest rates. The Fed could never guess correctly what the market will set interest rates at as this is determined by savings and demand for credit.

We know what the Fed’s mission statement is but the only thing they can effectively do is devalue currency thru inflation.

The evidence is plain as day: just look at how much value the dollar has lost in nearly 100 years. And yet there are still business cycles.

It would seem to me that the Fed is nothing more than a Ponzi scheme to prop up the banksters and the established political order. These are the only people that have profited by the Fed. The average non financially savvy person can no longer save his money and profit through increased purchasing power since inflation kills it. This never used to be the case with commodity money.[/quote]

The Feds Mandate: Price stability and Full employment

Their (conventional) tools to attempt to achieve that mandate: Very-short term bank lending rates and restrictions on reserve requirements for member banks.

It is misguided to put primary blame on the fed for failing to control things such as boom-bust cycles simply by using these two methods that were granted to it almost 80 years ago. This crisis has made it apparent that the fed was fundamentally ill-equipped to effectively control the cycles of lending and expansion. Monetary policy is still a relatively young area of study and through failures such as the one we’ve just gone through we learn that things such as the shadow money supply and proper regulation of securitization and derivatives also need to be further understood and taken into account when setting monetary policy. The constant ebb toward inflation is a necessary trade off for continued economic expansion that would not be possible if we were still constricted to arcane “commodity money”. And of course the Fed is managed mainly people in the banking industry. If a person is shot, who are you going to get to try and save the persons life… DOCTORS. So if you are trying to effectively set monetary policy and deal with monetary problems who are you going to handle that… economists, bankers, and people who professionally handle money.

Don’t get me wrong, there has been political meddling in monetary policy and there have been mistakes made by the Fed in terms of keeping interest rates too high or too low for a certain amount of time. But that is not to say that Monetary Policy and centralized banking is wrong and should be abandoned, It has done far more good than bad.

But how can the Fed out guess the market?

The market will always do better what the Fed cannot.

Planned economies always fail.

[quote]ChrisL912 wrote:
Don’t get me wrong, there has been political meddling in monetary policy and there have been mistakes made by the Fed in terms of keeping interest rates too high or too low for a certain amount of time. But that is not to say that Monetary Policy and centralized banking is wrong and should be abandoned, It has done far more good than bad.[/quote]

The Fed shouldn’t be keeping interest rates anywhere. Interest rates are prices like any other. Why people think interest rates are somehow special and not tied to the laws of supply and demand is beyond me. The control they try and exert over the money supply is no different than trying to set market prices and supply/demand for any other or good or service. If it were to have a net positive effect, it would only be by luck.

There are an uncountable number of economic transactions that happen every day. Every economic transaction has cost or trade-off. Nothing is for free, so to speak. These transactions are based on local/specific economic knowledge and triggered by market signals. 1) There is no way to centralize this vast economic knowledge. It exists in all of us. We all make economic decisions based on our personal circumstances and market signals.
2) When you artificially fuck with the supply and demand curve, you altering crucial market signals. You cannot expect sound economic action with inaccurate information. The phrase “shit in shit out” comes to mind.

So there is no conceivable way for a central power to account for every economic consequence of a particular action, and they are scrambling the vital inforamation we need to take the appropriate action individually/locally. Sounds like a spectacular plan.

If you want accurate market signals, from which you can make sound economic decisions, you have to let supply and demand work. You have to let each participant in the economy cast a vote by acting in a manner that is best for them. It is the only way to truly know what is best for a majority of the economy, ie net benefit.

I can’t think of one reason why we would not be better of in long run with a completely private banking system.

The Fed does not magically state an interest rate and all of a sudden it just IS the interest rate. They set TARGET interest rates then go to the open market (Hence the Federal Open Market Committee) and they attempt to hit those target rates through the purchase or selling of short term debt in the market. We’ve had completely private banking systems before, but the fact is if we are going to have fractional banking and an economy NOT tied to a gold standard (and if you happen to advocate going back to a gold standard I would like you to explain how we could possibly sustain let alone GROW a near 14 trillion dollar economy based on metal… it’s not possible) then you must have some sort of central management of the money and a lender of last resort to insure deposits.

The fact is markets are not efficient, supply and demand absolutely works in mathematical equations and the grand idea that everybody going at each other in an unregulated environment will some how turn out to be perfect may sound eloquent. But the fact that humans are interacting in the market (as opposed to some sort of automatons or perfectly predictable robots) reduce the finite conclusions derived from the mathematical models to estimates at best. You cannot accurately calculate, individually or in aggregate, what people will do or how the environments will change over time and how that will affect the psychology of consumers and investors. Markets are BY FAR the most PRODUCTIVE means of letting buyers and sellers come together, but they are not always efficient. The Fed is not there to replace the market, but to be a productive counter-cyclical force in the market.

Liken free markets to a flame in a fire place: It’s obviously the best way to create heat, but if you constantly feed the flame for growths sake then it’s going to burn everything down, and if you don’t feed it then it’s going to die. But if you feed it when it’s low and quell it when burns too hot then you can heat the whole house.

[quote]ChrisL912 wrote:
The Fed does not magically state an interest rate and all of a sudden it just IS the interest rate. They set TARGET interest rates then go to the open market (Hence the Federal Open Market Committee) and they attempt to hit those target rates through the purchase or selling of short term debt in the market. We’ve had completely private banking systems before, but the fact is if we are going to have fractional banking and an economy NOT tied to a gold standard (and if you happen to advocate going back to a gold standard I would like you to explain how we could possibly sustain let alone GROW a near 14 trillion dollar economy based on metal… it’s not possible) then you must have some sort of central management of the money and a lender of last resort to insure deposits.

The fact is markets are not efficient, supply and demand absolutely works in mathematical equations and the grand idea that everybody going at each other in an unregulated environment will some how turn out to be perfect may sound eloquent. But the fact that humans are interacting in the market (as opposed to some sort of automatons or perfectly predictable robots) reduce the finite conclusions derived from the mathematical models to estimates at best. You cannot accurately calculate, individually or in aggregate, what people will do or how the environments will change over time and how that will affect the psychology of consumers and investors. Markets are BY FAR the most PRODUCTIVE means of letting buyers and sellers come together, but they are not always efficient. The Fed is not there to replace the market, but to be a productive counter-cyclical force in the market.

Liken free markets to a flame in a fire place: It’s obviously the best way to create heat, but if you constantly feed the flame for growths sake then it’s going to burn everything down, and if you don’t feed it then it’s going to die. But if you feed it when it’s low and quell it when burns too hot then you can heat the whole house. [/quote]

Good post, Chris…
Although you did not say this, I often wonder if the Fed is a necessary evil. I say evil, in that I still believe they have way to much power. I have just enough paranoia to wonder exactly what they are doing behind closed doors. What is happening off the books? When the markets begin to consider anyone infallible, such as they did with Greenspan before the shit hit the fan, you can bet that the floor is going to drop out somewhere.

But as your say, markets are not fine tuned machines. They are organic, flowing, and in many ways totally unpredictable. When everything aligns and the economy is humming, the Fed takes credit. When it goes to pieces, it was somebody else fault, or so totally outside the realm of normal events as to be unavoidable.

End the end, as long as we have a fiat currency and fractional banking, I do not know of an alternative. You are correct in that a gold standard is no longer feasible (not even if you add silver and platinum, etc.). I do think there is a need for more transparency, and that an audit is long overdue, not that it will ever happen.

[quote]ChrisL912 wrote:
The Fed does not magically state an interest rate and all of a sudden it just IS the interest rate. They set TARGET interest rates then go to the open market (Hence the Federal Open Market Committee) and they attempt to hit those target rates through the purchase or selling of short term debt in the market.
[/quote]
What’s the difference? They ought to leave supply and demand alone.

why? There is nothing wrong with a fractional reserve system or a fiat money supply…unless there is no competition. All we need are choices/competition. Again, there is nothing special about money when it comes to supply and demand.

I don’t. I believe there are more efficient ways to keep politics out of money.

why?

So. No system is perfect. As I said, every economic decision has both positive and negative effects depending on your POV. Supply and demand is as efficient as you are going to get. Bad decisions and miscalculations are made individually and on a small scale, rather than on a global scale. Centralized management of economies cannot come close to the efficiencies of a free market. Impossible.

why do you need to?

Bullshit. Cheap and easy money is what fuels the cycles they claim to counter. They’ve done a fantastic job.

[quote]

Liken free markets to a flame in a fire place: It’s obviously the best way to create heat, but if you constantly feed the flame for growths sake then it’s going to burn everything down, and if you don’t feed it then it’s going to die. But if you feed it when it’s low and quell it when burns too hot then you can heat the whole house. [/quote]
What’s too hot? Here in lies the problem.

[quote]JEATON wrote:

Good post, Chris…
Although you did not say this, I often wonder if the Fed is a necessary evil. I say evil, in that I still believe they have way to much power. I have just enough paranoia to wonder exactly what they are doing behind closed doors. What is happening off the books? When the markets begin to consider anyone infallible, such as they did with Greenspan before the shit hit the fan, you can bet that the floor is going to drop out somewhere.

But as your say, markets are not fine tuned machines. They are organic, flowing, and in many ways totally unpredictable. When everything aligns and the economy is humming, the Fed takes credit. When it goes to pieces, it was somebody else fault, or so totally outside the realm of normal events as to be unavoidable.

End the end, as long as we have a fiat currency and fractional banking, I do not know of an alternative. You are correct in that a gold standard is no longer feasible (not even if you add silver and platinum, etc.). I do think there is a need for more transparency, and that an audit is long overdue, not that it will ever happen.
[/quote]

I agree, there definitely needs to be more accountability at the Fed. The point that you made about the Fed officials taking credit when things are good and delegating blame when things are bad also holds true for the Presidency, law makers and other positions of power in general. I understand the possible need for delayed disclosure of certain decisions by the Fed, or possible other mechanisms, to help better insulate the Fed from political pressure. But there definitely needs to be significant structural changes at the Federal Reserve.