Inflation: Primitive and Advanced
You have to read this fascinating piece on Zimbabwe in the NYT: "How bad is inflation in Zimbabwe? Well, consider this: at a supermarket near the center of this tatterdemalion capital, toilet paper costs $417. No, not per roll. Four hundred seventeen Zimbabwean dollars is the value of a single two-ply sheet. A roll costs $145,750 — in American currency, about 69 cents.... Mr. Mugabe's government has printed trillions of new Zimbabwean dollars to keep ministries functioning and to shield the salaries of key supporters... In February, the government admitted that it had printed at least $21 trillion in currency — and probably much more, critics say — to buy the American dollars with which the debt was paid...."
Fine reporting: the article shows, perhaps not as clearly as it might have but the information is there, that price inflation is caused by printing money.
Now turn to page one of the business section, to find that in the US inflation is caused by consumer spending, while the central bank, far from printing money, is said to do the opposite of curbing people's appetites. "Robust spending on homes, cars and other consumer goods kept the economy moving at a brisk pace and sent a critical measure of inflation higher in March, the Commerce Department reported yesterday, renewing concerns that the Federal Reserve will have to raise interest rates further."
Thus we see how inflation in poor African countries ruled by despots is caused by a very primitive and ridiculous action of printing money. How pathetic! But in enlightened and advanced democracies, inflation is caused by consumers who buy too much, so thank goodness we have scientific economists at the Fed who know when and how to stop us from getting carried away with our desire to consume.
(A note to the commentator who always says: who cares about the NYT?!. I'm not trying to single out the paper but rather use it as a proxy for the public and media understanding of economics.)
Comments (17)
bill wald
"inflation is caused by consumers who buy too much"
Hald of all credit card holders have "printed" an average of $8,000 per credit card in new U.S. currency. How does this comparev to the Fed?
Published: May 2, 2006 11:02 AM
Dennis Sperduto
"'Robust spending on homes, cars and other consumer goods kept the economy moving at a brisk pace and sent a critical measure of inflation higher in March, the Commerce Department reported yesterday...'"
But where does the money come from that U.S. consumers are spending? As Jeffrey indicates, it is printed or otherwise created by the Federal Reserve and the banking system. Absent a decline in the demand for money and/or a decline in the quantity of goods and services available for purchase, price inflation is always and everywhere the result of an increase in the quantity of money and fiduciary media.
Published: May 2, 2006 11:08 AM
John F
I am not an expert on this matter, but...
Doesn't US money supply consist of much more than just printed currency and coins? I, for example, buy and spend without using much money in physical form. When I get paid by my employer, my paycheck is direct deposited to my checking account... no physical currency is involed. And I am not alone; no longer is the payroll an inviting target for armed robbers. I buy groceries and gas using a debit card, by books and other things using a credit card. Periodically I sit down at my PC, log in to my on-line banking service, and pay all my bills. Again, no paper money or coins. This anecdote basically is to set up the question... what fraction of the US economy actually involves physical currency? I imagine it is a much lower fraction for the US economy than for the Zimbabwean economy (just a hypothesis, I have no data). So perhaps comparing the US economy to the Zimbabwean economy is not quite valid.
But.. back to inflation. Perhaps the term "government printing press" should be used metaphorically. Any action by the Fed that increases money supply, whether it be in the form of physical currency, or in the form of 1's and 0's in a computer, will potentially fuel inflation.
As for consumers causing inflation... I think Milton Friedman might disagree on that one.
Published: May 2, 2006 12:03 PM
Happy-lee
Good catch. Does anyone remember how Zimbabwe essentially destroyed its economic engine? Mugabe kicked out 600 white families who basically ran a hugely successful agricultural economy. A few years later, in a desperate attempt to plug the hole left by kicking out its most productive member, Zimbabwe is trying to inflate it's way to prosperity. Can't create wealth that way. There is no substitute for hard work and brains. Too bad the people of Zimbabwe have to find this out the hard way. The US will follow. We alienate our productive members.
Published: May 2, 2006 12:08 PM
Paul Edwards
Hillarious!
The fed is awesome; we can always rely on it to curb our irrational exuberance! LOL.
John F,
We do use the term "printing money" metaphorically. It is exactly as you are alluding to. Money exists in the form of checking and savings accounts as well, and even in cash surrender values of insurance policies. Anything that is redeemable at a fixed rate, for cash at par and on demand is arguably a part of the money supply.
Inflation arises when the fed buys, with funds created from thin air, more assets in a week than it sells on net. This is the inflation which increases banking reserves.
Now, the banks use these new reserves, which quickly end up in the banking system, as a basis on which to expand bank credit further. That is, they lend out even more money by creating more new checking deposits, again with funds they now create from thin air through the concept called fractional reserve banking. FR banking has been a historically very profitable endeavor, with the one drawback that until the advent of central banking, has generally resulted in banks going bankrupt due to its inherently unstable and fraudulent nature.
So an increase in the money supply can certainly come from just an increase in bank deposits in say checking accounts rather than in the printing of Federal Reserve notes we call dollar bills.
For a pretty good description of what should or could constitute the money supply, I recommend Rothbard’s “Austrian Definitions of the Supply of Money� at
http://mises.org/rothbard/austrianmoneysupply.pdf
Published: May 2, 2006 12:50 PM
Paul Edwards
(and the fed buys its assets by wring a check, which ends up as deposits in the banking system)
Published: May 2, 2006 12:53 PM
carl marks
I actually think the article got it partially right. It merely said that a messure of inflation was sent higher by more increased consumer spending. It said nothing about this being the cause of inflation. You could easily insert another line into the articles that went something like:
"Robust spending on homes, cars and other consumer goods due to expansion of the money supply kept the economy moving at a brisk pace and sent a critical measure of inflation higher in March"
though i might want to take out the "kept the economy moving at a brisk pace" part.
Published: May 2, 2006 1:19 PM
ted
Instead of handing over all those bills to buy toilet paper, why not use the bills directly? ;-)
Published: May 2, 2006 5:22 PM
Andrew
Maybe it is not too late for them... If they follow the trendsetters and start spending all freshly printed money on Chinese and Japanese goods, in a few years they would manage to export most of the paper, and the purchasing power (inside the country) of the remaining bills would be restored.
Published: May 2, 2006 6:00 PM
Ryan Fuller
Good point, Ted! There is in reality a cap on the ability of a central bank to devalue the currency by printing new bills. After a certain point they are just another toilet paper manufacturer, and no matter how much more money they print it will never be worth less than toilet paper. :)
Published: May 2, 2006 6:58 PM
averros
Carl Marks -- I'd say the right phrase should go like "kept the destruction of the economy moving at a brisk pace".
Published: May 2, 2006 8:10 PM
quincunx
" and no matter how much more money they print it will never be worth less than toilet paper. "
Hey, you know, devalued dollar bills don't even make good toilet paper. They would hurt (I imagine). So I would say that they can be worth less than toilet paper.
Published: May 2, 2006 10:25 PM
Chris Marshall
"Instead of handing over all those bills to buy toilet paper, why not use the bills directly? ;-)"
Its a good thing they don't use Australian dollars, Australian dollar notes are made of plastic.
Published: May 3, 2006 3:50 AM
lorenzo sleakes
Now, the banks use these new reserves, which quickly end up in the banking system, as a basis on which to expand bank credit further. That is, they lend out even more money by creating more new checking deposits, again with funds they now create from thin air through the concept called fractional reserve banking.
Paul, do we know approx. what percentage of the increase in the money supply is attributable to frb and what to printing press?
Published: May 3, 2006 9:08 AM
Paul Edwards
Lorenzo,
If we define the federal reserve's inflating of reserves as the printing press, then i believe the banking system as a whole should theoretically expand credit and bank deposits based on it, by a factor of 1/R, where R is the reserve ratio. So it would be a factor of 10 with a reserve ration of 10%.
I don't know how close theory stacks up against practice, or how good the measurements are, but the theory makes a lot of sense to me. Look on mises.org for Rothbard's discussion of fr banking to get the feel and flow of how it plays out. It's very interesting.
BTW, factors affecting reserve balances on the fed's page (http://federalreserve.gov/releases/h41/) will give you a feel for the FOMC's weekly activities and what they are really up to. You can see that from week to week they can add or subtract a few billion dollars in reserve money out of thin air from the economy.
It's an eye opener.
Also, a very cool book on mises.org by Rothbard on America's Great Depression is a very worthy read if banking and money is interesting to you. He appears to use similar statistics provided in the link i mention in his analysis of the credit expansion induced boom leading up to the crash of 1929. Absolutely fascinating stuff man.
Published: May 3, 2006 9:44 AM
R.P. McCosker
Tucker catches the NYT inconsistency. But why is there this inconsistency?
It's standard procedure across the planet for governments to print extra money and thereby inflate the currency. There are major reasons for this: (1) it enables the government to spend even more than direct tax revenues generate, yet if kept low enough the public accepts inflation as a natural occurrence and doesn't think of it as taxation at all; and (2) a new higher level of inflation can trigger a bump in consumer spending, creating the illusion that the economy is being temporarily "stimulated." (When the latter effect has exhausted itself, though the economy ends up in worse shape than it would've been otherwise -- it's rather like "stimulating" your finances by frivolously maxing out your credit cards, only to eventually lose out when having to face the consequences of all that racked up debt. But, as the public choice economists never tire of noting, politicians in democracies are under the greatest pressure to act for the near term.)
So long as the inflation is kept relatively low -- this observably falls in the ballpark of 1-7%, and the political class of industrial countries seems to sense this -- government layouts can keep growing without the public getting wise to what the State is doing to them and their money.
But when a tinpot dictator hyperinflates in some Third World hellhole, there's no credible way to fool the masses -- even the would-be sophisticates who read the NYT -- into thinking that *that* inflation is caused "robust" consumer spending. (We're expected to be oblivious that there's an awful lot of unbacked currency creation in America too, even though it's not so bad as in Zimbabwe.)
But, hey, didn't the socialist G.B. Shaw say that consistency was the hobgoblin of little minds? (This same kind of disconnect is at work when people call for an $8 minimum wage, but not an $18 one.)
Published: May 3, 2006 4:54 PM
lorenzo sleakes
So long as the inflation is kept relatively low -- this observably falls in the ballpark of 1-7%, and the political class of industrial countries seems to sense this -- government layouts can keep growing without the public getting wise to what the State is doing to them and their money.
If it were true that the state received most of the benefit of the 1-7% inflation tax and that was used to offset other harmful taxes and also offset the growing defecit then I wouldnt mind that much. But (if as Paul says above) 6% of that 7% inflation tax goes to private banking sector then inflation tax (in the west) is just a subsidy to one industry.
Published: May 4, 2006 7:59 AM