Schiff Debates Swonk on Inflation
MSN hosts a debate between Peter Schiff and Diane Swonk on Inflation: Fact or Fiction?. Schiff makes a number of very Austrian-sounding points:
- inflation is an expanion of money and credit, not rising prices
- inflation affected mostly financial markets in the 90s - money created here went abroad for goods, while foreigners sent the money back for stocks, then later bonds, and then in the lat few years, real estate
- this cycle is now leaking into commodities
- risking stock, bond, and real estate prices are all forms of inflation
- the Fed is trying to confuse the public about the true nature of inflation
- financial markets have been fooled about inflation
- inflation creates mal-investments and distorts economic thinking
- foreign central banks have inflated in parallel with the Fed to prevent their currencies from rising against the dollar
- A lot of China's import demand for natural resources is an artifact of the export of US inflation
- US productivity growth is overstated by statistical manipulations
- the CPI is highly manipulated
Swonk makes a number of rather astounding counter-arguments:
- money supply growth is not relevant as a measure of inflation
- the Fed won't figh asset-based inflation, so investors shouldn't care about it
- the economy is "inflation-resistant" as long as profits are rising
- investors should be more interested in how the government defines inflation than in abstract theories such as inflation being a money and credit growth
- the Fed are "the experts" on inflation
- US productivity growth has been strong
- the US has the highest propensity to consume and invest of any country in the world
Comments (112)
Sybrenzki
I am dismayed that economists like Diane Swonk even exist. But, her remarks should not be considered unusual as they are coming from a former "chief economist" of a very large bank. Of course she doesn't see the growth of the supply of money as relevant to inflation. She also once declared "I put economics on the same level as some people practice religion." This can be seen in her book, The Passionate Economist, where she puts all her faith in the calculation of GDP and new age MBA mumbo-jumbo.
Published: June 16, 2006 12:29 AM
Artisan
Sorry but I didn't get why all "chief economists" of very large banks think like that. Do you mean because they make profit out of inflation?
Published: June 16, 2006 4:09 AM
mark
If devaluation of the U.S. dollar is a kin to a tax on holders of debt and foreigns hold much of that debt in actual federal reserve notes and or t-bills: why is that bad from the perspective of the U.S ?
How could the world run from the U.S. dollar if it is the Reserve Currency and world oil is sold only in U.S. dollars?
I wish Mises would catch on to the fact that we are in the Twenty-First century so that it could address these issues of what it means to live in a global economy.
Published: June 16, 2006 6:05 AM
M E Hoffer
Mark,
The funny thing about tomorrow is that there is no guarantee it will look like yesterday.
Remember, the British Pound was once the "World's Reserve Currency" and it denominated trade in many commodities. I'm sure, London still pines for those days.
Also, be sure, that much of our "current prosperity" is quite reliant on the continuing kindness of strangers--foreigners that Choose to Lend to us/the U.S.
This: "I wish Mises would catch on to the fact that we are in the Twenty-First century so that it could address these issues of what it means to live in a global economy."-- Sounds like: "It's different this time." + "We're 'special' because we're Ameri'Caines"
For me, I think Mises, his ownself, and vMI, by proper extension, are, both, correct in hewing to the clear thinking allowed by Austrian Econ orthodoxy.
If you'd like someone to continue to feed your delusions, I suggest that Ms. Swonk( see other thread ) would be more than happy to enable you.
Published: June 16, 2006 6:31 AM
M E Hoffer
Sorry, the Swonk mentioned, is in the above article.
Published: June 16, 2006 6:33 AM
alex_k
How could the world run from the U.S. dollar if it is the Reserve Currency and world oil is sold only in U.S. dollars?
Mises answer: "Trends Can Change"
(see in Planning for Freedom by Mises, p. 168-173)
P.S. U.S. dollar as the Reserve Currency is historical artefact. Gold is money in the long run .
Published: June 16, 2006 6:48 AM
quasibill
Mark,
"If devaluation of the U.S. dollar is a kin to a tax on holders of debt and foreigns hold much of that debt in actual federal reserve notes and or t-bills: why is that bad from the perspective of the U.S ?"
Because it is also a tax on my savings. And it causes misallocation of capital, as entrepreneurs believe there is more capital available than there actually is, so they invest in projects that are unsustainable.
Finally, as others have noted, just because the fur'ners are bending over for us today, doesn't mean that they will continue to do so forever. At some point, they're going to realize that they're better off investing in other areas, such as their own infrastructure, or in gold, or in oil. And the $'s status as reserve and the currency of trade for oil are not natural facts, but mere happenstance that can change overnight. Counting on those two facts as foundations is a recipe for a complete collapse.
Published: June 16, 2006 7:23 AM
mark
Mises answer: "Trends Can Change"
Hey, I ask tough questions what can I say?
As has been pointed out on Mies on several occasions, people trade real goods and services. If I buy from you today in return for something I sell you tommorow and we both acknowledge that I will have to sell you less tommorrow for what I buy today, can this not be considered deflation from my perspective today?
Perhaps CPI figures should use a discount method to account for the devaluation of the U.S. Dollar today, this would actually represent deflation!
In other words, the net present value of a dollar I give to you today is actual worth less because you don't trade it today but rather hoard it for use tommorrow.
Wow to the hoarder!
Published: June 16, 2006 7:39 AM
MARK
And the $'s status as reserve and the currency of trade for oil are not natural facts, but mere happenstance that can change overnight."
Think about what you just said?
Published: June 16, 2006 7:44 AM
RogerM
Mark,
You're right that Austrians don't spend much effort on international economics and it would be nice if they did. People need a better understanding of international trade and finance and Austrians are in the best position to provide it.
If you study the writings on the sites for the Institute for International Economics, OECD, World Bank and others, they're at least honest enough to admit they don't understand what's going on. But that doesn't stop them from making policy.
A good antidote for much of the poor thinking is in this article: http://www.iie.com/publications/pb/pb05-3.pdf. It's a contrarian view on the trade deficit.
It's true that the Feds have inflated the money supply and that causes many problems. But if the money comes back to the US to purchase debt and equities, that process creates demand for the dollar and cancels out the effect of imports, which reduces the demand for dollars.
But changes in FX rates don't make us richer or poorer. They just shift the wealth within the country between importers and exporters.
The purchase of oil doesn't cause the greatest demand for dollars; it's the demand for our debt and equities that causes demand for dollars. Also, oil producers could switch to the Euro any day. Why haven't they? Because Europeans, and everyone else in the world except for the Swiss, inflates worse than our Fed.
Inflation causes a lot of problems domestically, but have little effect on the trade deficit and FX rates.
Published: June 16, 2006 7:46 AM
Daniel M. Ryan
I believe that the reason why gold is hardly used at all, even as E-currency, is because of the tax headaches that using gold as money would create. If you spend gold, you're selling it at market price, and if you earn gold, you're buying it at market price. If the price changes, as it does every day, any gold you hold is subject to capital gains tax if the price goes up, or creates a capital loss if the price of gold drops, between buy date and sell date.
Just think of the tax-accounting head pains this would create! The only people who would bother are gold believers or raffish accountants.
Published: June 16, 2006 11:11 AM
Yancey Ward
Daniel Ryan,
Your comment got me thinking about something. What are the tax consequences of barter trades between two parties? For example, if I grew tomatoes and exchanged a bushel of tomatoes for a new television, is a sales tax still due? If I then sell the television for a bushel and one half of tomatoes, do I owe an income tax?
Published: June 16, 2006 12:23 PM
Paul Edwards
"Austrians don't spend much effort on international economics"
Roger,
You're being ironic, right?
Published: June 16, 2006 12:32 PM
Paul Edwards
"the Fed are "the experts" on inflation"
LOL! Well, if you interpret this slightly differently than how the Swonk intended it, you have to concede: they are the true experts on inflation.
After all, who else can claim to be the very root cause of all monetary inflation in the US, and a huge influence on it in many other parts of the world as well?
Published: June 16, 2006 12:39 PM
Reactionary
Daniel,
The conundrum only arises because our money has been detached from gold. This is also why I think the "e-gold" ventures are uneconomic. If paper money is becoming increasingly worthless, then the smart play is to hoodwink your vendors into accepting worthless paper in exchange for real goods and services and hoarding your gold.
Obviously the tables may turn one day (we can only hope) but gold won't really be useful as money until then.
Published: June 16, 2006 12:50 PM
M E Hoffer
Reactionary,
Take it easy with this: "then the smart play is to hoodwink your vendors into accepting worthless paper..."-- Oft times, if your vendor chain breaks down, so do you.
Published: June 16, 2006 1:10 PM
Paul Edwards
“But if the money comes back to the US to purchase debt and equities, that process creates demand for the dollar ...�
I’d like to address this point because I believe it is a very commonly held view outside of Austrian circles, and to a lesser extent, even among the Austrians, and I think it is not correct.
The thing that determines demand for dollars is purely the demand to hold dollars. That is, the inclination of people to want to keep dollars physically in their cash holdings. It is as Mises states, “There exists a demand for media of exchange because people want to keep a store of them.� Foreigners therefore, do not increase the demand for dollars by buying US debt and equities with them, but rather “by renouncing the purchase of commodities, securities, and interest-bearing claims, and by selling such assets…�.
I believe the way the dollar is kept from plummeting in value against other currencies, given that it continues to be inflated, is through the only means that can increase its relative demand: through an increase in people’s of the world desire to hold the US dollar in their cash holdings. This is significantly affected by other central banks inflating their own respective currencies and keeping pace with US monetary inflation.
Buying commodities, securities or debt with the USD cannot increase, but rather can only decrease the holdings of, the demand for, and so the value of the USD, compared to the higher value it would otherwise have if people and institutions abstained from buying, and rather held their US dollars in their cash holdings.
For more, read Mises at,
http://mises.org/humanaction/chap17sec3.asp
“There exists a demand for media of exchange because people want to keep a store of them. Every member of a market society wants to have a definite amount of money in his pocket or box, a cash holding or cash balance of a definite height. Sometimes he wants to keep a larger cash holding, sometimes a smaller; in exceptional cases he may even renounce any cash holding. At any rate, the immense majority of people aim not only to own various vendible goods; they want no less to hold money. Their cash holding is not merely a residuum, an unspent margin of their wealth. It is not an unintentional remainder left over after all intentional acts of buying and selling have been consummated. Its amount is determined by a deliberate demand for cash. And as with all other goods, it is the changes in the relation between demand for and supply of money that bring about changes in the exchange ratio between money and the vendible goods.
“…The use which people make of a medium of exchange consists eventually in its being given away. But first of all they are eager to accumulate a certain amount of it in order to be ready for the moment in which a purchase may be accomplished. Precisely because people do not want to provide for their own needs right at the instant at which they give away the goods and services they themselves bring to the market, precisely because they want to wait or are forced to wait until propitious conditions for buying appear, they barter not directly but indirectly through the interposition of a medium of exchange. The fact that money is not worn out by the use one makes of it and that it can render its services practically for an unlimited length of time is an important factor in the configuration of its supply. But it does not alter the fact that the appraisement of money is to be explained in the same way as the appraisement of all other goods: by the demand on the part of those who are eager to acquire a definite quantity of it.
“Economists have tried to enumerate the factors which within the [p. 404] whole economic system may increase or decrease the demand for money. Such factors are: the population figure; the extent to which the individual households provide for their own needs by autarkic production and the extent to which they produce for other people's needs, selling their products and buying for their own consumption on the market; the distribution of business activity and the settlement of payments over the various seasons of the year; institutions for the settlement of claims and counterclaims by mutual cancellation, such as clearinghouses. All these factors indeed influence the demand for money and the height of the various individuals' and firms' cash holding. But they influence them only indirectly by the role they play in the considerations of people concerning the determination of the amount of cash balances they deem appropriate. What decides the matter is always the value judgments of the men concerned. The various actors make up their minds about what they believe the adequate height of their cash holding should be. They carry out their resolution by renouncing the purchase of commodities, securities, and interest-bearing claims, and by selling such assets or conversely by increasing their purchases. With money, things are not different from what they are with regard to all other goods and services. The demand for money is determined by the conduct of people intent upon acquiring it for their cash holding.�
Published: June 16, 2006 1:31 PM
Curt Howland
Paul, that's very interesting.
For example, it's very clear looking at the graph of the price of gold in $s.
Jan 2001 was the date of introduction of the Euro. Everybody knows that the "official" exchange rates for the various national currencies obliviated by the Euro would be somewhat lower than "market" rates because governments are like that.
So there was a "demand" to hold dollars, and the price of gold in dollars dropped, dropped dropped, because there were fewer dollars in circulation.
Then the Euro is released, and the dollars begin to reenter circulation as Europeans convert from dollar savings to Euros. The dollars in circulation increase, the price of gold starts increasing. I only realized this in March or April of 2001, and missed buying gold at $280. Bummer!
So the "cash holding" argument has lots of repercussions in the real world.
Published: June 16, 2006 1:53 PM
quasibill
Yancey,
My memory tells me that barter trades are taxable for purposes of federal income tax purposes (on this part, I'm close to certain). IIRC, you get taxed to the extent the "fair market value" (this is where the utili-meters come in) of what you receive exceeds the fair market value of what you trade away.
Published: June 16, 2006 1:54 PM
Roger M
Paul--"The thing that determines demand for dollars is purely the demand to hold dollars."
I think you have two concepts mixed up here, which is causing confusion for several people. Mises is talking about the demand for cash holdings, not the demand for FX. Within the US, my demand for cash will not affect the FX value of the dollar, except indirectly. Directly, my demand for cash will affect prices and interest rates, the absolute value of the $, or it's purchasing power. Indirectly, prices and interest rates will affect FX if they change the relationship of prices and interest rates in the US relative to similar foreign items. Change in FX is not an absolute change in the purchasing power of the dollar as happens with inflation and deflation. FX change is a change in value only relative to another currency. It can happen only because of cross-country/cross-currency trading.
Demand for $ in the FX market comes about because foreigners want US products or securities, or Americans want foreign products or securities. Imports lower demand for the dollar because we're dumping dollars on the market for foreign goods. Then foreigners sell those dollars to buy local currency and that selling causes the FX value of the dollar to fall. Then, if they want to purchase US goods or securities, they sell their local currencies and buy dollars, thus creating a demand for dollars and driving up the price.
Published: June 16, 2006 2:20 PM
Paul Edwards
Curt,
Good points. It is the unpredictability of people's valuations and expectations that makes it so interesting. We watch the fed and the banks inflate the heck out of the dollar and quietly wonder why it hasn't been completely demolished by now. But there is that variable human demand on the other side, and all the myriad events that influence that demand to consider too. And that's not easy to quantify.
Published: June 16, 2006 2:44 PM
Roger M
I should add to my previous post that foreigners will never hold cash in $ because they can't spend them. They will always hold cash in their local currency. They will only want dollars when they want to buy US products or securities. So foreign cash holdings won't affect the FX value of the dollar.
Published: June 16, 2006 3:01 PM
Paul Edwards
Roger,
“I think you have two concepts mixed up here, which is causing confusion for several people. Mises is talking about the demand for cash holdings, not the demand for FX.�
The two are inextricably tied together. And the more the rest of the world is involved in the holding and dealing in USD, the more significant they become in determining its value. And this applies both in terms of currency and commodity exchange ratios.
“Within the US, my demand for cash will not affect the FX value of the dollar, except indirectly.�
Your demand for the USD will certainly influence its exchange rate. Economically, there is no difference between you, the American holding a USD, and a foreigner doing the same. If either of you hold it, and increase your cash holding, rather than spend it, you have increased demand for the USD, increased its value (all other things held equal) in both its purchasing power for commodities and foreign exchange.
“Directly, my demand for cash will affect prices and interest rates, the absolute value of the $, or it's purchasing power.�
All true except for what you said about interest rates. You can’t affect interest rates by increasing your cash holdings. The only way to influence that is to change your time preference, which is your ratio of investment to consumption (cash holdings are not investment).
“Indirectly, prices and interest rates will affect FX if they change the relationship of prices and interest rates in the US relative to similar foreign items. Change in FX is not an absolute change in the purchasing power of the dollar as happens with inflation and deflation. FX change is a change in value only relative to another currency. It can happen only because of cross-country/cross-currency trading.�
In the world of fiat currency, all currencies are essentially commodities that are bought and sold like any other commodity: supply and demand dictates each price or exchange ratio. Exchange rates on the international money markets are determined by peoples’ expectations of how supply and demand will play out. They try to anticipate relative purchasing powers, but also levels of taxation, government interventions, expropriation and other economic events. But your increased demand to hold the USD will tend to increase the value of the exchange for USD all else held constant. The same is true in reference to a foreigner.
“Demand for $ in the FX market comes about because foreigners want US products or securities, or Americans want foreign products or securities.�
Yes, this is correct, but now you must think about what you have stated more precisely. There is a demand to hold USD for the purpose of buying something in the future, denominated in USD, whether it is commodities or securities. However, the demand for the dollar is not expressed in the spending of the dollar, but rather in the holding of the dollar in cash holdings.
“Imports lower demand for the dollar because we're dumping dollars on the market for foreign goods.�
This seems true because we are paying for imports with the inflated USD. In fact, imports do not change the demand for the dollar, they reflect a foreign demand for the dollar. We supply dollars in exchange for imports. It is domestic inflation, an increase in the supply of the USD, that has the impact that causes the diminished USD purchasing power, and hence a reduction in the exchange price of the USD.
“Then foreigners sell those dollars to buy local currency and that selling causes the FX value of the dollar to fall.�
Yes, if they are selling the inflated USD, then we can expect, all things the same, an increase in the supply of USD will result in a decrease of its price or purchasing power, or exchange rate of the USD.
“Then, if they want to purchase US goods or securities, they sell their local currencies and buy dollars, thus creating a demand for dollars and driving up the price.�
OK. But only if the desire to purchase US goods and securities results in a general increase in the holding of USD, is this true. And it is true. However, it is not the buying of the securities and the American dollar denominated commodities that really increases the demand for the dollar; it is the increased general holding of the USD that accomplishes this. Any reduction in the holding of the USD, represents a reduction in the demand for it and hence a reduction in its purchasing power and its exchange rate.
Published: June 16, 2006 3:33 PM
Daniel M. Ryan
Thanks for picking up the ball, quasibill.
Published: June 16, 2006 4:11 PM
Roger M
Paul,
But foreigners don't hold cash in US$. People hold cash to spend, and they can't spend US$ locally. When an American holds cash, that has no affect on the value of the US$ in terms of Euros. When a German holds cash, he has no effect on the value of the Euro relative to the US$. Only when the German decides to quit holding cash and invest in US securities does he convert Euros to US$ and affect the FX rate.
Also, the German may buy US products from a German retailer using Euros, but that doesn't affect the FX rate, either. Only when the wholesaler purchases directly from the US so that he must pay in US$ is the FX rate affected, in which case, the transaction is an investment. So Germans holding cash only affect the German economy, not the FX rate.
Published: June 16, 2006 4:12 PM
Roger M
Here's something to think about: If the US and Europe inflate at the same rate, the FX rates won't change. However, the purchasing power of the US$ will decline, as will that of the Euro.
Published: June 16, 2006 4:15 PM
M E Hoffer
Roger,
This: "But foreigners don't hold cash in US$. People hold cash to spend, and they can't spend US$ locally"- is not true.
U$D acts as currency in many places around the globe. So much so, even the FedRes "thinks" that there are more U$D in circulation outside of the U.S. than within.
This: "If the US and Europe inflate at the same rate, the FX rates won't change. However, the purchasing power of the US$ will decline, as will that of the Euro." - though, is almost the exact case that we are witnessing as we type. )
Published: June 16, 2006 4:33 PM
Roger M
"U$D acts as currency in many places around the globe."
Yes, but that's only true for backward countries, such as Russia and China, and it's still illegal in most countries. When inflation becomes hyper, people will resort to US$ for cash transactions.
Also, if the US and Europe inflate their respective money supplies at the same rate, the FX rate won't change, but the desire to hold cash in both areas will increase because prices will rise. But that desire to hold cash won't change FX rates and isn't affected by FX rates.
Published: June 16, 2006 4:56 PM
M E Hoffer
Roger,
This : "When an American holds cash, that has no affect on the value of the US$ in terms of Euros. When a German holds cash, he has no effect on the value of the Euro relative to the US$. Only when the German decides to quit holding cash and invest in US securities does he convert Euros to US$ and affect the FX rate."-- is counter-intuitive.
The 'Caine peep, here in the U.S., that choose to hold U$D increase the demand for U$D. There's an opportunity cost with the decision to hold U$D. One cannot, with the same value, hold U$D & Euro at the same time. One's preference to hold any currency( U$D, Euro, Krone, et al.) increases the demand, therefore the value, at the margin.
This is true at the micro- level of the individual, all the way through to Financial Institutions and CBs, on the macro- level, no matter geographic placement.
Published: June 16, 2006 5:39 PM
Paul Edwards
Roger,
“But foreigners don't hold cash in US$. People hold cash to spend, and they can't spend US$ locally.�
But as the example you gave in a previous post acknowledges, foreigners will and do acquire and spend USDs on commodities and securities denominated in USDs. Therefore, we know they will also be prone to holding these dollars. Certainly, foreign importers and exporters from and to the US, certain foreign retailers, and financial institutions will do business in USD and will also therefore hold some USDs.
But additionally, foreigners will also hold USDs simply for security, much like we might hold gold over here. It is not held for trading, but as a hedge against devaluation of the domestic currency.
“When an American holds [USD] cash, that has no affect on the value of the US$ in terms of Euros.�
But it must because it affects the demand for the USD in general, and therefore it affects its value, its purchasing power, and therefore its exchange value. A more valuable USD simply must imply a more expensive USD on the foreign exchange market.
“When a German holds [USD] cash, he has no effect on the value of the Euro relative to the US$.�
Yes, he must, just like his American counterpart holding USDs, he is influencing the demand for USDs and hence its price against all commodities including other currencies.
“Only when the German decides to quit holding [domestic] cash and invest in US securities does he convert Euros to US$ and affect the FX rate.�
If his business with US securities does not motivate him to actually increase his USD cash holdings, and rather he buys USDs and then immediately lends them, or sells them, he will not affect the demand for, nor the exchange rate of the USD.
“Also, the German may buy US products from a German retailer using Euros, but that doesn't affect the FX rate, either.�
Correct.
“Only when the wholesaler purchases directly from the US so that he must pay in US$ is the FX rate affected, in which case, the transaction is an investment. So Germans holding cash only affect the German economy, not the FX rate.�
There are two things: first, it doesn’t matter if you live in Germany or not, you can still hold USDs and you might do this either because you tend to trade in commodities denominated in USD, or you just want to hedge against domestic (non-US) inflation. Secondly, demand for any currency is a result of people wishing to and literally holding the currency in cash holdings.
Published: June 16, 2006 6:18 PM
Mike Sproul
Consider that there might be no such thing as fiat money (www.geocities.com/sproulmike.nofiatmoney.doc.
In other words, the value of paper or credit money is determined by its backing, just like any other financial security. If this is correct, then the value of any currency is determined only by its backing, and not by whether that currency is held by people in one country or another, whether Germans are spending it or buying it, etc. Nobody thinks that the value of GM stock is affected by whether it is held by someone in the US or in Germany. Similarly, nobody should believe that the value of paper money is affected in this way.
Published: June 16, 2006 8:21 PM
Mike Sproul
Sorry, that link was
www.geocities.com/sproulmike/nofiatmoney.doc
Published: June 16, 2006 8:24 PM
RogerM
Paul,
You're confusing the absolute value, i.e., the purchasing power, of the $ with it's relative value, it's value against other currencies. They're very different and have different causes and effects. Cash holdings by Americans affect the absolute value but not the relative exchange value. For example, in order for the $ to change value against the Euro, Americans must want to hold European bonds, or Europeans must want to hold American bonds. Americans holding American bonds, or cash, will have no affect on how many American bonds Europeans want to hold.
Foreigners don't hold US$ as inflation hedges, unless you consider short-term securities, such as Euro-dollar accounts, as cash. Third-world countries with hyper-inflation are an exception. Most foreigners will hold investments denominated in US$ but that's the opposite of demand for cash. Yes, there is a very short period when they must convert their local investments into cash, exchange it for $, then purchase US bonds, but these days it's almost instantaneous.
When Germans hold cash, they don't hold $ because they can't spend them. They hold Euros. The demand for Euros has no impact on the demand for dollars. A German might keep some money in a short-term Euro-Dollar account until he can invest in the U.S. But it's the German's demand for U.S. investments that causes his temporary demand for $, not his demand to hold cash that Mises describes.
This might help clear up the differences in the two values: Does the demand for cash change frequently? No. It's fairly constant and based largely on the price level and a person's time preference. Also, the $ loses about 3%/yr. in absolute value every year. It has never gained in value. But look at FX rate fluctuations. They're huge--10% to 20% per year, positive and negative. If the demand for cash is constant, and the dollar consistently loses value due to inflation, how do those translate into the fluctuations in currency values? They can't!
Published: June 16, 2006 10:27 PM
RogerM
Here's another way to look at it: What causes people to want to hold more cash? Lower interest rates and higher prices. But lower interest rates kills demand for US bonds by foreigners, which lowers the value of the dollar against foreign currencies. So an increased demand for dollars by Americans because of low interest rates depresses the dollar in the FX market. Higher prices cause Americans to hold more dollars to pay bills, so Americans demand more dollars. But high prices are a sign of an inflated money supply, which will depress demand for dollars by foreigners. Again, a demand for dollars at home translates into a avoidance abroad.
Mike, What backs the $?
Published: June 16, 2006 10:34 PM
matthew butler
Here's a thought...
Credit expansion in the economy has first and foremost manifested itself in the form of higher wages. Several points...which i know if incorrect stand for correction by visitors.
1st. Credit above and beyond Subsistence fund may have been granted, but that money has not been spent on equipment or machinery. We are accustomed to thinking of higher order goods as capital 'equipment', but strictly defined it is capital employed in higher order, longer term, more "roundabout" production. Right? I.E. in the late 90's Dot.com's frequently did not make money, but they were expected to in the long run. Much of their investment was in human capital.
2nd- The investment im talking about is "wages for labor." A sub 5% unemployment rate, 10MM alien workers employed at "low costs" over much of the period, a sustained housing boom, a low or negative savings rate and extended deficit spending cycle do in fact imply serious money creation these last 25 yrs. Right?
3rd-Problem. We are consuming so much, but so much of our manufacturing base has shifted overseas. Perhaps our own investment as an economy has been too much into service industries before our time preferences have adequately had time to change away from consumption of manufactured goods.
4th) The twin deficits have sped the shift in this manufacturing technology away from the the higher wages area to the low wages area, exacerbating and hiding this effect. Twin deficits allow for huge investment beyond the Subsistence level of saving in emerging economies.
5th-Soultion. Dramatic falloff of wages in service jobs at home. This is necessary to bring capital costs into line with consumer preferences for manufactured goods. The falloff in wages will precipitate lower capital costs and increasingly manufacturing capacity will shift back home to meet consumer demand. Loss of manufacturing capacity in low cost areas as some capital creation becomes capital consumption.
6th-Possible effect, domestic. Unlike capital equipment, labor is easily transferrable and can be redeployed with minimal loss. At least unlike much equipment, labor does not have to be scrapped altogethor! However serious investment in manufacturing capacity is needed as we would be underinvested on that front. But 1st and foremost savings must rise. This will be brought about by a drop in present consumption and a rise in savings to restock the subsitence fund.
...and foreign-
loss of manufacturing capital as stated above. Loss is not as severe however as in U.S. because capital still exists and can be reused as savings and subsistence eventually meet manufacturing needs. This is greatly helped by a rise in domestic consumption in the foreign lands as a result of not needing to finance twin deficits.
Published: June 16, 2006 11:14 PM
Mike Sproul
Roger:
The dollar is backed by the assets of the Federal Reserve--mostly gold and government bonds
Published: June 16, 2006 11:56 PM
Paul Edwards
Hi Roger,
“You're confusing the absolute value, i.e., the purchasing power, of the $ with it's relative value, it's value against other currencies.�
There is nothing of substance different between the purchasing power of the dollar against commodities, as opposed to other currencies. The principle is identical. There is no such thing as absolute value of the dollar; every price is simply a relative price.
“They're very different and have different causes and effects. Cash holdings by Americans affect the absolute value but not the relative exchange value. For example, in order for the $ to change value against the Euro, Americans must want to hold European bonds, or Europeans must want to hold American bonds. Americans holding American bonds, or cash, will have no affect on how many American bonds Europeans want to hold.�
Every price is a relative value. If a dozen eggs is six dollars, a dollar is two eggs. If a dollar is 8 yuan then a yuan is 1/8 a dollar. All fiat currencies are simply commodities with respect to each other and their prices are all relative.
“Foreigners don't hold US$ as inflation hedges, unless you consider short-term securities, such as Euro-dollar accounts, as cash. Third-world countries with hyper-inflation are an exception.�
It doesn’t matter. We both agree that some people in other countries will need to hold some USDs. Furthermore, it is this fact that gives rise to exchange rates at all.
“Most foreigners will hold investments denominated in US$ but that's the opposite of demand for cash. Yes, there is a very short period when they must convert their local investments into cash, exchange it for $, then purchase US bonds, but these days it's almost instantaneous.�
Roger, are you citing some economic law that states that non-US residents simply cannot or will not keep a cash holding in USDs, regardless of how much commerce they do in US markets? If so, you will need to cite me some Mises or Rothbard to convince me, because this assertion neither makes sense to me, nor sounds familiar based on any of my readings.
“When Germans hold cash, they don't hold $ because they can't spend them.�
You have made that assertion before, and I have explained why this is not strictly true. If I repeat my explanation once more in this post, will you repeat this assertion in your next post? Germans who do business in USDs will tend to also keep a cash holding in USDs. They are no different from US residents who also do business in USDs who also keep a cash holding in USDs for the same purposes.
“They hold Euros. The demand for Euros has no impact on the demand for dollars. A German might keep some money in a short-term Euro-Dollar account until he can invest in the U.S. But it's the German's demand for U.S. investments that causes his temporary demand for $, not his demand to hold cash that Mises describes.�
It is precisely the same principle that dictates that the German will keep a cash holding in USDs to do business in USDs. It may be for investments in debt or securities or US land, or it could be for the purpose of importing US commodities or receipts from selling to US buyers. It is all the same. In the process of doing commerce in USDs, the German is likely to require for himself a USD cash holding. This is the only demand that the German creates for the USD.
“This might help clear up the differences in the two values: Does the demand for cash change frequently? No. It's fairly constant and based largely on the price level and a person's time preference. Also, the $ loses about 3%/yr. in absolute value every year. It has never gained in value.�
I dispute your assertion that you know that the USD generally loses about 3% in absolute value. How can you know this absolute value? Would you use the price of gold as an indicator? Curt Howland reminds us that gold was recently selling at US$280/oz in this decade. Several years before that it was at US$800. How does that square with your estimate of the dollar’s absolute value losing 3% per year?
“But look at FX rate fluctuations. They're huge--10% to 20% per year, positive and negative. If the demand for cash is constant, and the dollar consistently loses value due to inflation, how do those translate into the fluctuations in currency values? They can't!�
I’m not sure what you think causes these fluctuations, but I will tell you my impression, which I’ve alluded to already. The international commodities and currency markets are driven somewhat by speculation. Speculators bid the prices of one currency up and down wrt to the others based on expectations. Expectations are on future relative currency purchasing powers, government interventions, inflation, tariffs, confiscations, taxes, quotas and other market hampering regulations. They’re only human, they can get carried away, and they make mistakes and re-adjust their assessments. They can’t really entirely and perfectly predict how much and which governments are going to screw the international markets, it’s all a bit of a crap shoot in this barter market that fiat currencies have reduced international commerce to. There is error and adjustment. But that is what is happening to swing these exchange ratios.
Published: June 17, 2006 1:44 AM
Peter
The dollar is backed by the assets of the Federal Reserve--mostly gold and government bonds
1) The Federal Reserve doesn't have any gold. Whatever gold the US has, if any, is owned by the US Treasury, not the FedRes. It hasn't been audited since the 1950s, and there's a possibility they don't have a single ounce. "Government bonds" is just "future taxes".
2) Under a proper gold standard, dollars are not "backed by" gold; dollars are gold. Current dollars are not anything; nor are "backed by" anything. They are certainly not backed by the assets of the FedRes. You could argue that a fraction of the dollars, those that come into existence through the actions of the FOMC, are "backed" by FedRes assets, since they are created by printing money to pay for assets, but that would seem silly, and that's only a small minority of the dollars in circulation.
Published: June 17, 2006 2:27 AM
Paul D
Mike, two problems with your idea (though you deserve credit for thinking about it):
1. It's not clear how much gold or how many goods, if any, back the supply of dollars.
2. No one has any idea how many dollars actually exist.
These are both in marked contrast to a true security like a stock, for which:
1. You know what the issuing companies assets and liabilities are.
2. You know exactly how many stocks have been issued, down to the last one.
Therefore, it's impossible to establish any rational valuation for the dollar as a non-fiat currency.
Published: June 17, 2006 7:34 AM
mike sproul
Peter:
Maybe this is too obvious of a point, but the Fed's balance sheet shows that it does own gold and bonds. If you're saying that balance sheet is fiction--that the Fed's vaults are actually empty and the pictures of gold bars stacked in the Fed's vault are all fake, then I suppose there's nothing I could say to change your mind.
"You could argue that a fraction of the dollars, those that come into existence through the actions of the FOMC, are "backed" by FedRes assets, since they are created by printing money to pay for assets, but that would seem silly, and that's only a small minority of the dollars in circulation."
Actually, there's nothing silly about that. FR paper dollars are backed by FR assets, and Bank of America checking account dollars are backed by B of A assets, but all dollars are backed by the assets of their issuer.
Published: June 17, 2006 9:58 AM
mike sproul
Paul:
The Fed knows exactly how many paper dollars it has issued, just like GM knows how many shares of stock it has issued. Nobody knows exactly how many paper dollars have been lost or destroyed, but the same is true of GM stock.
Assuming you believe the Fed's balance sheet, we know exactly how much gold and government bonds back the Fed's paper dollars. In fact, the Fed's assets are much easier to quantify than the assets of a private company, since the latter's assets are mostly in the form of intangibles like good will, future sales, etc.
Published: June 17, 2006 10:05 AM
M E Hoffer
mike,
You may want to try a different textbook. The U$D are totally Un-backed by anything other than mere "faith".
If you don't believe it, try getting anything from either the FedRes or the U.S. Treasury that is anything other than "more of the same".
This: "all dollars are backed by the assets of their issuer."-- is a Complete Canard. The 'dollars" that we use as currency, Federal Reserve Notes, are nothing more than evidences of debts that were created to create them.
Try this, from the horse's ***** :http://64.233.161.104/search?q=cache:SoyMslNz7BYJ:www.treasury.gov/education/faq/currency/legal-tender.html+Federal+reserve+Notes&hl=en&gl=us&ct=clnk&cd=3
Published: June 17, 2006 11:21 AM
M E Hoffer
better link
http://www.treasury.gov/education/faq/currency/legal-tender.html
Published: June 17, 2006 11:22 AM
RogerM
Paul--"Germans who do business in USDs will tend to also keep a cash holding in USDs." Since it's illegal to use US$ to purchase things in Europe, where is a German going to spend his US$? There are no stores anywhere in Europe that will accept US$. That's why tourists have to change their US$ into Euros if they want to buy something. No European can hold US$ in a bank checking account except the special Euro-Dollar banks.
When Mises, and most economists, talk of demand for money, they're talking about the need to hold cash for the purpose of paying bills and buying necessary items for daily living. Why in the world would a European hold dollars to do that? Obviously, you think that some people might hold cash for speculative purposes, but it's generally agreed among monetary economists that people don't do that because it doesn't make sense. Keyenes came up with that idea, but it has been forgotten for many years. People put their money in short term securities instead of cash while waiting to make longer term investments.
Yes, it's possible that a very small number of people in the world hold US$ in currency under their mattress. But that wasn't your point. Your point was that the demand for US$ causes the changing FX rates. My point is that the number who would hold US$ currency is so small as to be insignificant.
"Curt Howland reminds us that gold was recently selling at US$280/oz in this decade. Several years before that it was at US$800."
Gold is not the only measure of inflation. In fact, the World Gold Council writes that it's a very poor short term hedge. Supply affects the price of gold probably more than the demand. You also have to consider other commodities, real estate and other assets. I realize the flaws in the CPI, but have we ever experienced deflation in the US since the 1930's? And the CPI probably underestimates inflation by a huge amount. Also, look at the money supply. Has it ever declined? Do you really believe there are periods when the Fed hasn't actively destroyed the value of the US$?
The US$ value against domestic goods is determined partly by demand, but mostly by supply. Demand for money changes little across time. Supply changes dramatically.
Here's a test: Plot the FX rate between the US$ and the Euro since 1980. Then on the same graph plot the demand for money, or the money supply, or even interest rates. You won't find any correlation. I've done it.
The causes of FX rate changes are numerous and complex. To a large degree, it's the relative inflation rates between two countries. But comparative advantage figures in as well. Then there's political environment. People want to stash their savings in the US so that their own governments can't steal it. Others find growth opportunities in the US the most appealing. But there are many more factors to consider. The demand for cash is not one of them, if for no other reason than that it varies little.
Published: June 17, 2006 11:33 AM
RogerM
Paul,
After this long discussion, I think our differences may come down to definitions. When I read "demand for money" I was taught that it applies to the demand for cash, that is, currency, checking account and possibly bank savings accounts, to pay for current living needs such as food, clothing, and to pay bills due. What accountants call current liabilities.
You're saying that the demand for American investments causes the FX rate of the US$ to rise, and I agree. But, technically, at least according to my text books, that's not considered demand for money. It's demand for investments. Techinically, yes, you have to convert to cash to purchase investments, but economicsts don't consider that demand for money because you're not holding on to it for a period and it's not intended for current liabilities.
So, yes, the demand for American products and investments will cause the US$ to appreciate.
Published: June 17, 2006 11:52 AM
mike sproul
ME Hoffer:
"The U$D are totally Un-backed by anything other than mere "faith"."
Paper dollars are not physically convertible into gold. But there is a clear difference between a currency that is unbacked and a currency that is inconvertible. The fed issues dollars in exchange for equal-valued assets, and it can and does sell those assets to retire the dollars it has issued. As long as this is the case, physical convertibility of the dollar is irrelevant.
If modern paper money is unbacked, why does every central bank hold assets against the currency issued? Answer: because so-called fiat money is actually backed.
Published: June 17, 2006 12:06 PM
RogerM
Mike,
"Available evidence suggests that the value of money is determined more by its backing than by its quantity. The best explanation for this finding is that all money is backed, and that there is no such thing as fiat money."
In your paper, you argue that the value of stock issued by a corporation is backed by the assets of the corporation, and thus the value of the stock doesn't decrease with the issuance of stock. However, don't you think that the value of the stock would decline if the assets of the company remained static while company issued more stock? Also, demand plays the most important role. Investors don't look at just assets when valuing stock. They look at future revenue. If investors don't think the future of a compnay is bright, the assets that it owns matters very little. Otherwise, all stocks would have the same price:assets ratio and they don't. So demand for that stock plays an important role in its value.
Applying that to money, supply is just as important. The demand for money remains fairly stable over time, but the supply varies dramatically. If the supply outpaces the demand, the value will fall. This is true even for gold, which I think some gold bugs forget. Some of the earliest economic writings were attempts to figure out why gold could buy so much more in some places than in others.
We will never go back to using gold and silver as currency; it's just too bulky. And most transactions are electronic signals, anyway. The reason for wanting paper money to be fixed to something like gold is to remove the power of the government to destroy the value of paper money. Gold retains its value, generally speaking, because it's rare and difficult to mine. As a result, it's very hard to flood the world with it as it is with paper money.
Gold backing isn't perfect, but it's sure better than backing by government assets and bonds. Just look at the history of the value of gold versus the value of the dollar in purchasing power. Gold is relatively stable. The dollar has fallen in value relentlessly since 1912, when the Fed was created.
A US gov bond is othing but a promise. So the dollar is backed by promises, which the US government can break simply by inflating the currency supply and destroying the value of the bond. As for assets backing money, I seriously doubt the US gov will trade my dollars for one of its federal buildings so that I become the owner.
The rest of your paper is a defense of the real bills doctrine, which other writers have treated on this sight.
Published: June 17, 2006 12:15 PM
M E Hoffer
Mike,
As Roger correctly points out : "A US gov bond is othing but a promise. So the dollar is backed by promises"-- This is the Best case.
The U$D, anywhere found, is nothing more than the promise of future taxation.
The near simultaneous passage of the Income Tax Act and The Federal Reserve Act was hardly a mere coincidence.
And this: "The fed issues dollars in exchange for equal-valued assets, and it can and does sell those assets to retire the dollars it has issued"
--is categorically untrue.
The Federal Reserve deals in its own Notes denominated in "dollars" and not Dollars.
This link: http://goldismoney.info/forums/showthread.php?t=3993
Will give you an accurate understanding of the monetary system extant today.
As I've already showed you, the USTreasury does not disagree with your take. For that matter, neither does the Federal Reserve, its ownself.
http://www.federalreserveonline.org/
You should do readers at least one service, preface your posts with a disclaimer: "Follows: Opinion."
Published: June 17, 2006 2:35 PM
mike sproul
Roger M:
Supply and demand is an appropriate model for apples and oranges, which are consumable goods, but not for corporate stock, which is not. For example, if GM owns $60 worth of assets for every share of stock it has issued, then the supply of and demand for GM stock will be horizontal at $60. There is a good reason why stock market analysts focus on a corporation's assets and liabilities, and not on supply and demand for pieces of paper that can be costlessly issued in unlimited amounts.
Of course a bond is a promise. So is every other financial security. That doesn't mean those promises can't serve as backing for money.
"As for assets backing money, I seriously doubt the US gov will trade my dollars for one of its federal buildings so that I become the owner."
The US government has sold buildings on more than a few occasions, and if I wanted to buy one of them, I'm pretty sure I could buy it with green paper dollars.
And yes; the real bills doctrine has been rejected by nearly all economists. A very interesting story--how a good theory like the RBD was rejected in favor of a bad one like the quantity theory. I have a paper called "Three false Critiques of the Real Bills Doctrine" (which you could find on google). It explains a small but interesting part of the story.
Published: June 17, 2006 3:26 PM
mike sproul
ME Hoffer:
"And this: "The fed issues dollars in exchange for equal-valued assets, and it can and does sell those assets to retire the dollars it has issued"
--is categorically untrue."
Follows: Opinion.
The Fed buys bonds with green paper dollars and thereby puts dollars in circulation. The Fed sells some of those same bonds and receives green paper dollars in exchange, thereby retiring those green dollars.
The foregoing is categorically true.
Published: June 17, 2006 3:32 PM
M E Hoffer
mike,
try : http://blog.mises.org/archives/004951.asp
And, with this: "Supply and demand is an appropriate model for apples and oranges, which are consumable goods, but not for corporate stock, which is not. For example, if GM owns $60 worth of assets for every share of stock it has issued, then the supply of and demand for GM stock will be horizontal at $60. There is a good reason why stock market analysts focus on a corporation's assets and liabilities, and not on supply and demand for pieces of paper that can be costlessly issued in unlimited amounts."-- where did you learn this? Could you be so kind as to provide some supporting documentation??
Needless to say, it is entirely contra to my learning and experience.
Published: June 17, 2006 5:00 PM
mike sproul
ME Hoffer:
I couldn't say where I learned this. Somewhere in my 25 years of teaching economics.
You might have noticed, in reading economics textbooks, that supply and demand curves are always discussed in the context of goods that are produced and consumed. Financial securites (including money) are just bookkeeping entries, and can be instantly created in unlimited amounts--obviously very unlike the apples and oranges discussed in economics books. While I have heard economists speak carelessly about the "supply and demand" for financial securities, they will always back off when they realize the obvious difference between goods and bookkeeping entries.
Of course those same economists are pretty glib about applying supply and demand principles to money, and despite my one-man battle against it, they show no signs of reforming.
Published: June 17, 2006 6:34 PM
RogerM
Mike,
"Supply and demand is an appropriate model for apples and oranges, which are consumable goods, but not for corporate stock, which is not."
Real estate is not consumable either, but it still follows the laws of supply and demand.
"There is a good reason why stock market analysts focus on a corporation's assets and liabilities.."
Where did you get that? Stock market analysts focus primarily on discounted future expected earnings. Most don't even care about assets because no one, not even the company, knows their market value because they're recorded at cost. If analysts focused on corporate assets, then every stock would have the some price:asset ration, but they don't; the price:assets ratios vary dramatically among stocks because the price is focused on discounted future earnings.
One of the reasons companies purchase their own stock when it's value is low is to increase its price. It does this by reducing the supply with respect to the demand. So if a corporation can increase the value of its stock simply by purchasing it in the market, it can also lower the value of its stock by issuing more.
Anyway, even if analysts did focus on assets, it's just common sense that if the assets of a company remain fixed, while the company issues twice as many shares of stock, the value of each share would have to decrease by half, because you have twice as many shares for the same amount of assets.
In the same way, if the Fed issues twice as much money for the same amount of assets, the value of the dollar will have to fall by half.
Now you argue that the Fed can create new assets out of thin air by creating bonds. So it can argue that the dollars it has created is backed by bonds. How is that different from just printing money? Paper money is a promise to pay, and it's based on a promise to pay.
You say that the bonds are backed by assets, such as real estate. But with national debt at $16 trillion, does the US gov have enough assets to sell to pay that debt? I don't know, but I doubt it. It would be an interesting exercise to force the US gov to limit its debt to a percentage of its hard assets, such as real estate.
Published: June 17, 2006 6:39 PM
mike sproul
Real estate is not consumable either, but it still follows the laws of supply and demand.
Real estate is consumed in the economists' sense of that word, and of course it follows the laws of supply and demand. Bookkeeping entries, on the other hand, are not valued according to the laws of supply and demand, and nobody says they are.
"There is a good reason why stock market analysts focus on a corporation's assets and liabilities.."
Where did you get that? Stock market analysts focus primarily on discounted future expected earnings. Most don't even care about assets because no one, not even the company, knows their market value because they're recorded at cost. If analysts focused on corporate assets, then every stock would have the some price:asset ration, but they don't; the price:assets ratios vary dramatically among stocks because the price is focused on discounted future earnings.
By "assets", I mean the discounted expected value of future revenue, and likewise for liabilities.
One of the reasons companies purchase their own stock when it's value is low is to increase its price. It does this by reducing the supply with respect to the demand. So if a corporation can increase the value of its stock simply by purchasing it in the market, it can also lower the value of its stock by issuing more.
That's not because of what you call supply and demand. It's because the company's purchase makes the public expect higher future profits.
Anyway, even if analysts did focus on assets, it's just common sense that if the assets of a company remain fixed, while the company issues twice as many shares of stock, the value of each share would have to decrease by half, because you have twice as many shares for the same amount of assets.
My point exactly--and I assume you'd agree that if new stock is issued in exchange for assets of equal value, the stock price would be unaffected.
In the same way, if the Fed issues twice as much money for the same amount of assets, the value of the dollar will have to fall by half.
Exactly, but if the Fed issues new money for equal-valued assets, the value of the dollar in unaffected.
Now you argue that the Fed can create new assets out of thin air by creating bonds. So it can argue that the dollars it has created is backed by bonds. How is that different from just printing money? Paper money is a promise to pay, and it's based on a promise to pay.
It's no different from the fed issuing 100 new dollars for $100 dollars worth of silver. Assets rise in step with liabilities. It works the same if the Fed buys bonds.
You say that the bonds are backed by assets, such as real estate. But with national debt at $16 trillion, does the US gov have enough assets to sell to pay that debt? I don't know, but I doubt it. It would be an interesting exercise to force the US gov to limit its debt to a percentage of its hard assets, such as real estate.
Obviously the market thinks those government bonds are valuable.
Published: June 17, 2006 7:25 PM
Peter
In your paper, you argue that the value of stock issued by a corporation is backed by the assets of the corporation, and thus the value of the stock doesn't decrease with the issuance of stock. However, don't you think that the value of the stock would decline if the assets of the company remained static while company issued more stock?
I assume what he's suggesting is that if the stock is selling at, say, $10 now, then if the company issues another million shares and sells them for $10 each, the company's assets have increased by $10 million, in line with the issue of shares. Of course, as you suggest, that's a ridiculous argument: people buy shares because they think the company will make money, not just sit there with cash in the bank. If the company isn't capable of turning that $10 million in cash into more at at least the same growth rate it had before, the stock value will go down!
If the supply outpaces the demand, the value will fall. This is true even for gold, which I think some gold bugs forget.
Not at all; but the supply of gold is pretty much fixed!
We will never go back to using gold and silver as currency; it's just too bulky.
Well, that is just completely insane! For one thing, gold coins with the same value as today's fiat denominations would be far less bulky than the corresponding fiat. For another, gold being money doesn't require you to use coins and only coins. You can do electronic transfers, write cheques, issue warehouse receipts (bank notes), etc., on a gold standard just as on fiat.
PS: interesting article here.
Published: June 17, 2006 7:55 PM
Peter
Maybe this is too obvious of a point, but the Fed's balance sheet shows that it does own gold and bonds.
Greenspan has stated several times, before Congress, that the Fed has no gold.
If you're saying that balance sheet is fiction--that the Fed's vaults are actually empty and the pictures of gold bars stacked in the Fed's vault are all fake, then I suppose there's nothing I could say to change your mind.
I've never seen pictures of gold bars stacked in their vault. The gold the Treasury dept. claim to have hasn't been audited for 50 years. Many central banks "loan" their gold to bullion banks, who sell it. The loaned gold stays on their books, so it's still listed as an asset even though it's been sold. Eventually, the borrowers are supposed to give it back, but of course there's no way all that gold sold into the market is recoverable - it's gone! So yes, there's absolutely no doubt that much of the gold listed as assets by various central banks around the world is "fake". How much of the US Treasury gold has been "loaned" into the market, and is thus "fake", is an open question.
Published: June 17, 2006 8:08 PM
M E Hoffer
Peter,
Thank you for lending your sound mind to this discussion of unsound "money".
That art. you linked to delineates some powerful ideas that people should turn themselves on to...
Published: June 17, 2006 8:22 PM
Paul Edwards
Mike,
I think we’ve strayed a bit from my original point, so let me just summarize it here:
This statement: “But if the money comes back to the US to purchase debt and equities, that process creates demand for the dollar ...� is false.
It would be correct to say that if the money did not come back to the US to purchase debt or equities (or commodities for that matter), but rather was kept to increase the USD cash balances of these foreign exporters to the US, this process would create or would represent an increased demand for the dollar and, ceteris paribus, to the extent that the forex markets accounted correctly for this action it would tend to increase the value of the USD on the foreign exchange markets.
Published: June 18, 2006 2:15 AM
mike sproul
Paul:
I don't think you'd claim that the value of GM stock is affected by whether it goes out of or into the US, or whether it is used to increase the GM stock balances of foreign stockholders. I think you'd agree that the value of GM stock is determined by investors' beliefs about GM's present and future profitability.
I know you'd disagree that money is backed by the assets of its issuer, and that it is valued on the same principles as any other security, but assuming for the sake of argument that it was, then supply and demand would be no more appropriate to valuing money than it is for valuing GM stock.
Published: June 18, 2006 9:35 AM
Paul Edwards
Mike,
Sorry, it seems i addressed "Mike" rather than "Roger" who i was debating with. I hope i didn't create too much confusion there.
But since you've asked, i'll answer:
"I don't think you'd claim that the value of GM stock is affected by whether it goes out of or into the US, or whether it is used to increase the GM stock balances of foreign stockholders."
Any added demand for GM stock will increase its price. If foreigners, who did not demand GM stock before, start to demand it, then the demand and price will increase, ceteris paribus. This is a universal principle which applies to all commodities, money and securities.
"I think you'd agree that the value of GM stock is determined by investors' beliefs about GM's present and future profitability."
I agree. And the larger the base of potential investors who believe in this future profitability, the more demand there will be for this stock.
"I know you'd disagree that money is backed by the assets of its issuer, and that it is valued on the same principles as any other security, but assuming for the sake of argument that it was, then supply and demand would be no more appropriate to valuing money than it is for valuing GM stock."
I think that I’ll refrain from assuming something I know is not the case. Although i don't think even the invalid assumption leads to the conclusion that price for anything at all is determined by anything other than supply and demand.
I am entirely convinced that the Misesian model of money is the correct one and that yours deviates from it in a multitude of fatally flawed ways. Money is not a security; it is not a claim on future goods. It is a present good. In our present system our money is fraudulent in at least two ways: the first fraud is the state's demonetization of gold. The second fraud is the fed's expansion of bank reserves, and the banking industry's further expansion of credit based on fractional reserve banking.
You can back a loan with collateral assets; but there is no ethical manner to view money as backed in this same way. As for money substitutes, they are simply (or should be rather) warehouse receipts for an actual commodity money sitting safely in warehouse storage.
Published: June 18, 2006 8:30 PM
Paul D
Mike:
The Fed knows exactly how many paper dollars it has issued
Are you sure? And more importantly, is that precise number available to "investors"?
"Assuming you believe the Fed's balance sheet, we know exactly how much gold and government bonds back the Fed's paper dollars."
There is likely no gold in the Fed's vaults, and backing the dollar with a dollar-denominated government bond is no backing at all. It's not clear at all what you have a claim on if someone gives you a dollar; most likely, nothing at all — unlike a stock certificate.
Published: June 19, 2006 5:45 AM
M E Hoffer
Paul D,
From: http://www.treasury.gov/education/faq/currency/legal-tender.html
This: "Federal Reserve notes are not redeemable in gold, silver or any other commodity, and receive no backing by anything This has been the case since 1933. The notes have no value for themselves, but for what they will buy. In another sense, because they are legal tender, Federal Reserve notes are "backed" by all the goods and services in the economy."
"The notes have no value for themselves, but for what they will buy. "
The value of Federal Reserve Notes is predicated upon nothing more than the Greater Fool theory.
This: "It's not clear at all what you have a claim on if someone gives you a dollar..."-- is not true.
It is Quite clear, from USTreas themselves, again: "Federal Reserve notes are not redeemable in gold, silver or any other commodity, and receive no backing by anything. This has been the case since 1933. The notes have no value for themselves, but for what they will buy."
The true beauty of our current system is that, for a great many questions that one may have about it, the answers, and real ones at that, are usually quite readily available.
Published: June 19, 2006 7:55 AM
Paul D
Yes, the answer is out in the open, isn't it? :)
Private currencies would indeed be just like other market securities, but fiat currency is just paper backed by force.
Published: June 19, 2006 9:36 AM
M E Hoffer
Paul D,
Now, if "they" would only be so blunt about _Why?_ it changed in 1933...
People should really take a trip to New Hyde Park and find out for themselves...
Published: June 19, 2006 9:44 AM
mike sproul
Paul D:
The Fed's balance sheet shows a gold stock of $11041 ( in millions), and currency in circulation of $794515 (but as I said, no indication of how many paper dollars have been lost or destroyed). If you claim that's false, I think it's up to you to explain why.
"Backing a dollar with a dollar" is indeed possible. If a bank takes in 100 ounces of silver on deposit and issues 100 paper receipts called dollars in exchange, then each dollar will be worth one ounce. If the bank then issues another $200 in exchange for worth $200, then the additional $200 are backed by the bonds. See
www.geocities.com/sproulmike/nofiatmoney.doc
for further explanation
Published: June 19, 2006 10:07 AM
Roger M
Mike,
You make some good points. If the Fed have $1 trillion in gold, then add the real estate, it could act like a corporation and retire debt by selling assets. Do you have any figures on the real estate assets of the federal gov? You could also consider military hardware as assets. So you make some good points that the dollar is backed by hard assets, even though I don't consider their bonds to be hard assets.
However, the backing for the dollar is only valuable to us if we can use it to limit the money supply. Even if Feds backed the dollar with gold, it that backing didn't limit the money supply it would be worthless. In wanting a gold backing, what we really want is a limit to the money supply. The Feds obviously recognize no limit. The destruction of the value of the dollar since the creation of the Fed in 1912 is all the testimony we need to the fallacy of the real bills doctrine.
Published: June 19, 2006 10:28 AM
mike Sproul
Roger M
I think it's pretty clear that the Fed has enough assets to back $794 billion, which is the most they could possibly have in circulation. Last I looked the Fed's gold was officially valued at $42 per ounce, so your $1 trillion figure wouldn't be too far off.
As for limiting the money supply, this is unnecessary on real bills principles, as long as every dollar issued is backed by assets of equal value.
Published: June 19, 2006 3:52 PM
mike sproul
Paul Edwards:
"Any added demand for GM stock will increase its price. If foreigners, who did not demand GM stock before, start to demand it, then the demand and price will increase, ceteris paribus. This is a universal principle which applies to all commodities, money and securities."
Suppose that GM's only assets was $60 million in cash, and its only liability was 1 million shares issued, and suppose that everyone knows it. GM will then be worth $60 per share regardless of all the supply/demand and international issues you mentioned. If GM ever sold for $61, then GM (along with short sellers) would "supply" infinite amounts of stock, while investors would "demand" xero. If the stock sold for $59 the reverse would hold.
I repeat: Both supply and demand for any financial security (including money) are horizontal at the market value of the security, and supply and demand are both meaningless for the valuation of those securities.
Published: June 19, 2006 4:01 PM
Paul Edwards
Hi Mike,
I can’t really argue with your assessment in the GM case, given the situation you specify. However, I will point out the limitations to the usefulness of this scenario.
First, you have not only denominated the value of GM’s assets in terms of a monetary basis, you actually have specified that the entire worth of the company is in cash assets. The scenario does not involve any speculation on the future earnings of the company as there will be none. So essentially, an investment in this company is simply ownership in cash. Therefore, you are perfectly correct that the share value should amount to the value of the currency, with a ratio of shares to dollars accounted for. This scenario reduces to essentially the demand for dollars period. But this is hardly the basis on which people buy securities.
More significantly, your view that money is a security is fundamentally flawed. Money is a current good. It’s a commodity that has acquired universal marketability such that it functions as a medium of indirect exchange in the present and future. As Mises states, the demand to hold money is influenced by such things as
“…the population figure; the extent to which the individual households provide for their own needs by autarkic production and the extent to which they produce for other people's needs, selling their products and buying for their own consumption on the market; the distribution of business activity and the settlement of payments over the various seasons of the year; institutions for the settlement of claims and counterclaims by mutual cancellation, such as clearinghouses.�
However, as Mises continues, although “All these factors indeed influence the demand for money and the height of the various individuals' and firms' cash holding.�, “…they influence them only indirectly by the role they play in the considerations of people concerning the determination of the amount of cash balances they deem appropriate. What decides the matter is always the value judgments of the men concerned.�
What decides the demand for money, therefore, as it decides demand for all other commodities, is the value judgments of men. The price of any good, or the purchasing power or foreign exchange ratio of any currency, is dependent on the objective supply of this good and the demand for it due to the value judgments of men.
There is no horizontal demand curve for money. It must slope downwards. People will always value the next increment of money in their pockets less than the previous one. And they will part with the next unit of money from their pocket more easily than the one after that. This is an essential and basic fact of economics, and this means the demand for money must slope down.
Published: June 19, 2006 5:20 PM
Roger M
Mike:"As for limiting the money supply, this is unnecessary on real bills principles, as long as every dollar issued is backed by assets of equal value."
And that's the problem in a nutshell. If the money supply were limited by real assets of the US government, we wouldn't have this problem with inflation. Doe real bills people not care about inflation? I'm getting that sense from from you. If you don't care about inflation, then I can see why you would like real bills.
To curb inflation, gov bonds would have to be limited to the hard assets of the US gov. Technically, bonds aren't an asset to the US gov. They're a liability. They become assets for the purchasers, but people purchase them only as long as they have confidence in the US gov's ability to repay. Having money backed by US gov bonds is no different than just printing the money directly. The US gov can create new bonds anytime they like. There is no limit. And that's how they've been able to destroy the value of the dollar over the last century. But then, if mutualists don't care about inflation, that doesn't matter.
Published: June 20, 2006 11:57 AM
chance
I think Dollars do have real value:
If you live in the the United States, and don't want to be a vagrant, you'd better be able to send in some tribute to all levels of government : city, county, state, and federal or they will send somebody to come and take your stuff and/or put you in jail. And, for the most part, one form of payment is accepted: dollars.
Foreigners know this too, so it doesn't seem irrational that they could expect to be able to trade them for goods or services from americans.
Published: June 20, 2006 3:48 PM
Yancey Ward
Roger M,
You may have not been around these parts at the time, but Mike Sproul confirmed to us once that his theory did, in fact, mean that the US government could borrow the entirety of the budget, if it wished, without dire consequence.
Published: June 20, 2006 3:58 PM
anarkhos
All this talk about 'backing' reminds me of the intrinsic value fallacy.
What on earth does 'backing' have to do with the value of a real good like MONEY?! Financing needs backing, not cash--cash IS THE BACKING!
People demand money for what they use it for, not for some abstract 'backing' which has no bearing on limiting the supply or making money more useful.
Published: June 20, 2006 7:51 PM
RogerM
Yancey,
Thanks for the heads up! I guess if inflation is your friend, you'll prefer a system that gives you more of it, like real bills.
Published: June 20, 2006 9:16 PM
Mike Sproul
Roger M
A little accounting exercise:
ASSETS LIABILITIES
100 oz. silver $100 paper bills
IOU worth $200 $200 paper bills
The bank above starts by accepting 100 ounces of silver on deposit and issuing 100 paper receipts (dollars) in exchange. It then prints another $200 and lends them to someone who offers an IOU worth $200 in exchange. If all dollar holders suddenly wanted silver, then the bank could immediately sell the $200 IOU for 200 of its own dollars and then burn the 200 dollars. There would then be 100 ounces left to hand out in exchange for the last $100. Conclusion: The paper dollars are fully backed by the so-called fractional reserves of the bank. Issuing adequately backed dollars does not cause inflation. Also: It doesn't matter who issued the IOU, so the money supply is not tied to government assets. Not sure where you get the idea that I don't care about inflation. On real bills principles it results from inadequate backing.
Published: June 22, 2006 1:29 PM
Mike Sproul
Anarkhos:
ASSETS________________ LIABILITIES
100 oz. silver ________$100 paper bills
IOU worth $200 ________$200 paper bills
Repeating the accounting exercise from my post to Roger M. Hopefully the table lines up right this time. The paper dollars in this example are clearly backed by the bank's assets, and backing clearly matters. Nothing abstract about why people would demand and use these dollars.
Published: June 22, 2006 1:35 PM
Mike Sproul
Paul Edwards
The dollars I mentioned in the post to Roger and Anarkhos are clearly claims to silver and IOU's, and reasonably qualify as financial securities. As they are bookkeeping entries, they are clearly not current goods, but they are clearly money. If these paper dollars ever sold on the market for 1.01 oz of silver, then banks would "supply" infinite amounts, earing a profit of .01 ounces on each one. If they ever sold for only .99 oz., banks would supply zero. So the supply curve is horizontal.
Demand for the dollars is, to a first approximation, also horizontal. The cases where it can slope down are discussed in my paper
www.geocities.com/sproulmike/nofiatmoney.doc
Published: June 22, 2006 1:44 PM
Yancey Ward
Mike,
You wrote, in your accounting example: "If all dollar holders suddenly wanted silver, then the bank could immediately sell the $200 IOU for 200 of its own dollars and then burn the 200 dollars. There would then be 100 ounces left to hand out in exchange for the last $100".
However, the point is that there are claims on 300 ounces of silver, and 200 of those have to be satisfied to take the IOU. The holders of the dollars in your example demanded to exchange for silver, not IOUs.
Published: June 22, 2006 1:47 PM
Vince Daliessio
More to the point, what is the discount on that $200 IOU? Most rational beings are not just going to take your word for debts owed by a third party, unless the whole thing has the hazy 'backing' of the Fed, FDIC, the US Treasury, or some other agency of moral hazard...
Published: June 22, 2006 1:55 PM
Mike Sproul
Yancey:
OK. Change the wording on the paper dollar to read "Bank will pay 1 oz. of silver most of the time, except for nights and weekends, and during bank runs. During bank runs the bank promises to buy its dollars back with the $200 IOU."
Published: June 22, 2006 3:48 PM
Mike Sproul
Vince:
I was assuming that $200 was the discounted present value of the IOU, and that the IOU was backed by something worth at least $200--a house, a farm, tax liability, etc.
Published: June 22, 2006 3:50 PM
Vince Daliessio
That MIGHT be true, if the bank had nothing to gain by being less than forthcoming about the quality of their paper. In reality, it could be backed with assets worth $200, $300, $500, $1M, or nothing at all. The risk of a third-party default is unknowable and the deposit will not be made unless there is some guarantee, in the current case, a Federal guarantee or set of guarantees. Then no actual assets have to be pledged at all - the risk just gets - wait for it - socialized.
Published: June 22, 2006 4:24 PM
RogerM
Mike:"Issuing adequately backed dollars does not cause inflation."
Then what has caused the inflation of the past 100 years?
Published: June 22, 2006 9:12 PM
Mike Sproul
Roger M
"Then what has caused the inflation of the past 100 years?"
Inflation has been caused by inadequate backing. In my accounting example above, this could happen if the bank issued another dollar without getting any new assets in return, or it could happen if the assets fell in value while the quantity of dollars rose or stayed constant. In practice, if a central bank pays $100 for a bond worth only $99, or if the bank lends $100 for an interest rate of 4% when the market rate is 5%, then inflation results.
Published: June 22, 2006 11:05 PM
Mike Sproul
Vince:
When I said the IOU was worth $200, I meant that the market price of the IOU, determined by investors who are aware of risk, was $200.
Published: June 22, 2006 11:07 PM
Peter
OK. Change the wording on the paper dollar to read "Bank will pay 1 oz. of silver most of the time, except for nights and weekends, and during bank runs. During bank runs the bank promises to buy its dollars back with the $200 IOU."
And if you do that, assuming there's nobody pointing guns at their heads to force them not to, people will discount the value of your "dollars" to account for the fact that they're not worth the full face value. I.e., prices will increase. Exactly the same result as from any other inflation.
Published: June 23, 2006 1:06 AM
quasibill
Mike,
Help me out here. I'm really trying to understand your position, but I'm getting stuck at a point where I think there is a circular referrent:
You say that you can print a dollar everytime you receive an IOU that pledges to pay you present value one dollar (or perhaps a little more for risk). But what is the dollar worth in the first place? You're defining the value of your money by referencing your money.
As an example of where my problem lies, your bank has $50 circulating, backed by silver. Now it receives an IOU that says IOU $250. Now, some objective utili-meter is used to determine that the IOU is worth $200 (I have a problem here, also, since value isn't objective, but I'll skip it). So you print $200 and use them. A run occurs, and your bank gives up all its silver and it's IOU. Clearly, the IOU debtor will not have all $250 of your $s. So he won't be able to pay in that denomination. At which point he can say "I charge $250/hr for teaching the RBD. I will give you one hour of education in exchange for the IOU."
Do you (switching hats and now you are the IOU creditor after the bank run) accept? What happens when you don't? What exactly is a dollar worth?
Published: June 23, 2006 7:32 AM
Roger M
Mike, Your response just raises a lot more questions. How is what you describe different from what the Fed has been doing the past 90 years? How and why would a bank issue another dollar without getting a new asset in return, and how would you control that? Why would the value of assets fall? Why would a bank lend at 4% when the market rate is 5%?
And if inflation is caused by insufficient backing, how is that different from what we’ve been arguing? We have been saying that insufficient backing causes uncontrolled expansion of the money supply which then causes inflation. And how would you stop this under a real bills system?
Published: June 23, 2006 9:34 AM
Mike Sproul
Peter:
"people will discount the value of your "dollars" to account for the fact that they're not worth the full face value."
Actually, banks issued dollars in exactly this way in the US in the 1800's, and many other countries had the same experience. The bank's customer is confronted with a choice: Do I want to hold an ounce of silver in my pocket, where it can be lost or stolen, or do I want to hold the bank's promise to pay 1 ounce on demand (which can also be lost or stolen)? Privately-issued paper dollars sometimes sold at par and sometimes at a discount, and the discount depended on the adequacy of the bank's assets.
Published: June 23, 2006 12:52 PM
M E Hoffer
Mike,
This: "Actually, banks issued dollars in exactly this way in the US in the 1800's, and many other countries had the same experience. The bank's customer is confronted with a choice: Do I want to hold an ounce of silver in my pocket, where it can be lost or stolen, or do I want to hold the bank's promise to pay 1 ounce on demand (which can also be lost or stolen)? Privately-issued paper dollars sometimes sold at par and sometimes at a discount, and the discount depended on the adequacy of the bank's assets." -- is the truest thing you've posted in this thread, though, how does it apply to your previous line of inquiry?
Published: June 23, 2006 1:02 PM
Mike Sproul
Quasibill:
As to your circular referrent, consider an analogy: GM owns $60 million in cash and has issued 1 million shares of stock, so that each share is worth $60. Then Merrill Lynch issues 100 "hypothecated shares", each of which is ML's promise to deliver 1 share of GM on demand. Now GM itself issues 50 new shares, which it trades for 50 of ML's hypothecated shares. GM's assets rise by the 50 hypothecated shares, while its liabilities rise by the 50 genuine shares, but there is no effect on the value of GM stock, even though, in a sense, GM is backing GM stock with GM stock. The same is true of a central bank that issues paper dollars in exchange for an IOU that promises to deliver dollars. This is further explained at
www.geocites.com/sproulmike/nofiatmoney.doc
As for the $250 IOU: Recall that its market value is $200, not $250. If all 250 paper dollars are presented to the bank for payment, then the bank can sell the $200 IOU in exchange for 200 of those dollars and then burn the $200, leaving just $50 outstanding laying claim to 50 ounces. The new owner of the IOU can either hold it to maturity, at which time he receives 250 ounces from the writer of the IOU (assuming paper dollars no longer exist), or if 250 ounces are not readily available, he can be paid in something of equivalent value (gold, wheat, land, etc.) If the writer of the IOU defaults, then the holder of the IOU takes whatever collateral backed the IOU in the first place.
A dollar is worth one ounce of silver.
Published: June 23, 2006 1:11 PM
Mike Sproul
Roger M
"Mike, Your response just raises a lot more questions. How is what you describe different from what the Fed has been doing the past 90 years?"
1) What I describe does not differ in any important way from what the Fed has been doing.
"How and why would a bank issue another dollar without getting a new asset in return, and how would you control that? Why would the value of assets fall? Why would a bank lend at 4% when the market rate is 5%?"
They would only do these things by mistake, but it happens all the time.
"And if inflation is caused by insufficient backing, how is that different from what we’ve been arguing? We have been saying that insufficient backing causes uncontrolled expansion of the money supply which then causes inflation. And how would you stop this under a real bills system?"
The difference is that I'm saying that the money supply can expand without causing inflation as long as assets rise in step with money. Naturally, if money outruns assets, the inflation will result, but on real bills principles the bank would prevent inflation by only issuing new money in exchange for assets of adequate value.
Published: June 23, 2006 1:28 PM
Mike Sproul
ME Hoffer:
I don't think anything I said about nineteenth century bank differs from anything I said before.
Published: June 23, 2006 1:30 PM
Roger M
Mike,
But obviously, the controls on inflation that you describe simply are not adequate. Look at the inflation we've endured for 90+ years, while we've been following the real bills doctrine in principle. How would you stop inflation?
Published: June 23, 2006 1:32 PM
Mike Sproul
Roger M
The inflation has resulted from a failure to take adequate backing, which means the Fed has failed to follow the RBD. In fact, for the past half century, (when inflation was worst) everyone at the Fed has explicitly disavowed the RBD. I would stop inflation by having the fed only issue new money for assets of adequate value. I would also say that the fed should avoid buying dollar-denominated assets, since that increases the dollar's volatility.
Published: June 23, 2006 1:50 PM
Roger M
Mike,
That's all we're asking. But what assets are you talking about? Real estate or bonds?
Published: June 23, 2006 2:30 PM
Mike Sproul
Roger M
I'm talking about any asset from land to lottery tickets. The form of the assets is irrelevant. What matters is their value.
Published: June 23, 2006 2:47 PM
quasibill
Mike,
"A dollar is worth one ounce of silver."
Can't be true if there are 250 dollars and
"if 250 ounces are not readily available"
In such a case, you'll have to figure out what is "equivalent" in value. And again, what are you going to say when I offer to teach RBD for an hour as my equivalent? Or that we can't agree as to what is an equivalent - I say 3 oranges and you say 10. What if I have nothing that is equivalent? What if I die while we're negotiating? What if all I have are IOUs from other people?
In the absence of sufficient silver to back up your claims, what IS the objective value of your dollar?
Published: June 23, 2006 2:49 PM
Mike Sproul
Quasibill
The issuing bank could just print on the bill that it is redeemable either for one ounce of silver or the equivalent value of something else. In a world where prices are widely known, sensible customers would not have a problem with this.
Published: June 23, 2006 3:07 PM
Roger M
"The form of the assets is irrelevant. What matters is their value." It seems to me we're going around in circles here. If the cause of inflation has been insufficient backing, as you wrote, then it doesn't seem that just any asset will do. Some will retain their value better than others. If an asset could be a lottery ticket, then how about an IOU scribbled on the back of a napkin? If you're backing for money is as flimsey as a lottery ticket, the value of what backs your currency is going to be highly volatile. That means you're money supply will be highly volatile, which probably means even greater inflation than what we've experienced.
Published: June 23, 2006 4:22 PM
Mike Sproul
Roger M:
Of course, stable assets result in stable money, and volatile assets result in volatile money. Naturally a central bank should lean towards holding more stable assets.
Published: June 23, 2006 4:33 PM
Peter
You (Mike) seem to be highly confused over the meaning of "value". The value of an ounce of silver is an ounce of silver. Any other "value" it has is entirely subjective, so whether some other thing has "equivalent value" or not depends on who you ask. Prices being widely known is irrelevant. If I had an ounce of silver and was going to exchange it for something else (spend it), I'd decide whether that something was worth more to me than the price the seller wants in silver. If not, I wouldn't buy it. You're basically saying the seller can just say "well, it's worth x amount of silver", and take that amount, whether I like it or not - a banker can decide that my note for "one ounce of silver" is going to be exchanged for this thing of "equivalent value", just because that's the market price.
Published: June 23, 2006 8:22 PM
Mike Sproul
Peter:
I'm just talking about a price where market supply equals market demand--not the personal valuation of some individual. If a bank issues paper dollars, and if I understand that those dollars will be redeemable for one ounce of silver 99.9% of the time, and the other 0.1% of the time they will be redeemable into something that a bankruptcy judge deems to be of equivalent value, then I'd be willing to take a dollar instead of an ounce of silver in ordinary transactions. That's exactly what we all do when we hand a paper dollar to a banker and receive a checking account dollar in exchange. We all recognize that the checking account dollar is just as valuable as the paper dollar. In the 1800's people carried this a step further, and recognized that an adequately backed paper dollar was just as valuable as a silver dollar.
Published: June 24, 2006 12:32 AM
M E Hoffer
Mike,
This: "...to take a dollar instead of an ounce of silver in ordinary transactions. That's exactly what we all do when we hand a paper dollar to a banker and receive a checking account dollar in exchange. We all recognize that the checking account dollar is just as valuable as the paper dollar."-- you jest, yes?
There is No correct correlation between the two actions you set up here: "to take a dollar instead of an ounce of silver in ordinary transactions. That's exactly what we all do when we hand a paper dollar to a banker and receive a checking account dollar in exchange."
This: "We all recognize that the checking account dollar is just as valuable as the paper dollar."--I hope that the readership, and yourself, realize that the truth value of the above is such, because both "dollars" are intrinsically worthless. Much contra to, the earlier above, posit: "to take a dollar instead of an ounce of silver in ordinary transactions. That's exactly what we all do when we hand a paper dollar to a banker and receive a checking account dollar in exchange."
Published: June 24, 2006 1:05 AM
Peter
and the other 0.1% of the time they will be redeemable into something that a bankruptcy judge deems to be of equivalent value
But the relevant question is not what some bankrupcy judge deems equivalent, but what you deem equivalent. And it's not up to the judge anyway; he can only give you something that the bank owns as "backing" for its dollars, which severely limits what you can get.
We all recognize that the checking account dollar is just as valuable as the paper dollar.
Actually, no, we don't. In a sensible world, without fractional reserve banking, they would be because the paper dollar would be sitting there in the bank's vault "backing" the chequing account dollar (and an fraction of an ounce of gold, or whatever, would be sitting in another vault "backing" the paper dollar - obviously you can burn the paper dollar in this case and the gold can directly back the chequing account dollar). In this world, that's not the case. Thus, a chequing account dollar is worth less than a physical banknote. Bank runs are very uncommon events today, so nobody worries about the difference - unless they happen to live in some South American banana republic that has a currency meltdown. (The central bank could print paper notes to save the banks, but it would soon be put back into the banks, and you'd have the most massive hyperinflation in history...)
Published: June 24, 2006 8:04 AM
Mike Sproul
Peter:
"Thus, a chequing account dollar is worth less than a physical banknote."
Anyone with a checking account trades checking account dollars for paper dollars on a 1-1 basis. In fact, I prefer checking account dollars to paper ones in most cases, since they are less likely to be lost or stolen.
On the day I deposit silver for a paper dollar, I deem that I am willing to risk the .01% chance of being at the bankruptcy judge's mercy, since I understand that the world has risk. In fact, I'd deem a fractional reserve bank les risky than a 100% reserve bank, since the latter is more vulnerable to robbery, and earns less interest with which to cover its costs.
Published: June 24, 2006 10:27 AM
Mike Sproul
ME Hoffer:
No jest.
Since people do in fact exchange paper dollars and checking account dollars for real goods, and since those dollars are intrinsically worthless, the simplest explanation is that both are backed, just like any other financial security. Since all banks, including central banks, have balance sheets that show assets backing their money, the real question is why people ever came to believe that unbacked money exists.
Published: June 24, 2006 10:34 AM
M E Hoffer
Mike,
Just because people engage in the "hard to explain": "exchange paper dollars and checking account dollars for real goods", it doesn't lead to: "the simplest explanation is that both are backed,...".
The Federal Reserve Note is un-backed. In answer to your "real question" : "why people ever came to believe that unbacked money exists(?)".
Nowhere throughout the chain of "claims" that you may believe are "backing" the U$D FRN will you get Anything other than "More of the same".
Your continuous positing to the contrary is simply wrong. To reiterate, nothing "backs" the U$D FRN, it is irredeemable, its very issuer, the Federal Reserve, will tell you as much.
Published: June 24, 2006 2:43 PM
Peter
Anyone with a checking account trades checking account dollars for paper dollars on a 1-1 basis.
Yes, I said that in the very next sentence: "Bank runs are very uncommon events today, so nobody worries about the difference".
Published: June 25, 2006 12:21 AM
Dale
I saw the Diane Swonk-Peter Schiff debate on Schiff's website, europac.net. Diane Swonk thinks that there is "asset based" inflation and "goods based" inflation. However, basic accounting tells you that inventory is no less an "asset" than land, so Schiff is right, there is no distinction, there is only inflation. What is truly missing from this that the reason the Fed is not "willing" to fight asset based inflation, as Swonk says, is because the only beneficiary is the government, which levies a stealth tax. If I own a store and it's value increases by $1M via inflation, and I sell it to B and buy a warehouse from C which has also increased in value by $1M via inflation, and C buys a casino from B which has increased in value by $1M, then the government can tax $3M in gain and no one has truly gained at all in real terms.
Published: July 14, 2006 3:44 PM
Robert Blumen
Dale,
The point you make is valid, that inflation of assets results in a stealth tax increase. Not totally true that "no one has truly gained at all in real terms". But inflation is not totally uniform. Some things go up more than others. There are some people who make real gains as they are able to cash out of inflated assets and pass them along to someone else before consumption goods prices catch up and neutralize the gain in the assets.
Published: July 15, 2006 2:23 PM
Mika Nystrom
About gold and silver being too bulky---I've heard this ridiculous comment before:
Today's most common note is the $20 bill, no?
$20 in gold, even at today's artificially low prices, weighs almost exactly the same as a $20 Jackson (which ways about 1 gram). And gold
being about 20 times as dense as paper, the gold would take up about 1/20 as much space. So the biggest American banknote, the Franklin, is still 4x as bulky as the same value in gold!
I suppose gold is about the same volume as a 500 Euro note. I saw a few of those in Austria...
Mika Nystrom
Published: December 27, 2006 6:12 AM