Christopher Pang
Mainstream economists tend to define inflation as the rise in general level of prices of goods and services. The Austrian School of Economics asserts that inflation is an increase in the money supply, and rising prices are consequences of monetary inflation. Inflation is an indirect tax on anyone owning currencies as the effect is a loss in purchasing power over time.There are generally two ways which money supply could be increased in a fiat currency economic model, through printing of new monies by the central bank or by having a fractional reserve banking system which is employed in most financial systems today. However, most central bankers and politicians conveniently distort the true economic effects of inflation by redefining inflation as rising prices. This draws attention away from themselves, the main culprits for inflation.
Fallacy of inflation
When central banks inflate the money supply, the excess money enters the economy at specific places and at different times, not spread evenly throughout. By creating additional money in the economy, the excess money exerts downward pressure on the price of money also known as interest rates to people today. The supply and demand of money should determine the equilibrium price of the money. However mainstream economists neglect this simple fact and further alleges that demand for money is infinite because everyone would never reach a point where they deemed to have enough of money.
Therefore they concluded that since demand for money is infinite, the only way to ensure that people do not hoard money and reduce the velocity of money is to control the money supply with a central bank. Austrian economists have disproved this fallacy of infinite demand because people must always continue consuming on some level regardless of their expectations. Since people must consume, they must also continue producing so that there can be some form of adjustment and full employment regardless of the extent of hoarding.
The primary reason for inflation is excessive money printing by the central bank, otherwise known as monetizing the debt in mainstream economics recently. To demonstrate the harmful effects of deliberate counterfeiting, we shall attempt to look at an example of a group of counterfeiters who were highly equipped with the latest printing technology that prevent them from being detected by authorities. After printing exactly the current amount of money in circulation, they would take this newly created money and spend it in the economy, e.g. buy goods/services, investments or repayment of debt.
As this new money spreads, it bids up prices as the money in circulation is now doubled but the goods/services remain at the same level of production. Suppose there is no change in velocity, prices will eventually double because goods/services generally require land/labour/capital and these resources are scarcer than paper money. Therefore printing more money does not produce additional resources to create an increase in productive capacity.
How inflation distorts economic reality?
Inflation does not generate any benefit for society. It merely redistributes wealth in favor of the early recipients at the expense of the laggards. It further penalizes thrift and encourages debt for any sum of money will eventually be repaid in lower purchasing power than when originally received. It endorses risk taking because of the illusory profits created by inflation. People get drawn in to the “capital appreciation” generated by inflation and such expectations are part of the assumptions used in valuations for their assets.
Furthermore, it keeps businesses which should have failed in business through the historical accounting practice. Business owners paid for their revenue generating assets for their business and accounts for the assets at “historical cost”. During an inflationary period, replacement cost of asset will be higher than the historical cost. Therefore inflation grossly overstates business accounting profits and business owners are unknowingly consuming their own capital sustaining their business. They could be making accounting profits but economic losses after adjusting for inflation.
Inflation also creates illusory profits for shareholders and real estate owners. The capital gains that were acquired during inflation could be drawn out with a margin trading account to leverage up or with a reverse mortgage where equity could be withdrawn based on market value of the real estate. Such credit access further creates an inflationary effect on the money supply as asset prices will constantly push towards a bubble like economy before ending very disastrously which we have witnessed a couple of times in the last decade, with the dot com bubble and the subprime crisis in US.
Hyperinflation is inevitable
History has not favored fiat currencies. In the last hundred years we have seen the fall of Wiemar Republic, Hungary, Yugoslavia, Argentina, Venezuela, Turkey and most recently Zimbabwe. All these historical examples were a result of excessive monetary printing by the government/central bank. The latest country to fall to hyperinflation was Zimbabwe, where inflation rate reported to be at 89.7 sextillion (10^21) percent in 2008, about 14% increase in prices daily.
The naivety of a government in thinking that it can generate wealth just by printing money with a printing press is inconceivable. As a result, queues formed outside banks everyday to withdraw their savings/income and supermarkets to get rid of their money to buy food items. Prices skyrocketed to trillions of dollars for basic food items such as eggs and bread. It is common to see someone carrying a wheelbarrow of money to a supermarket just to buy a loaf of bread during periods of hyperinflation.
Every dollar the government prints and spends is an obligation of the government to make good on the promise of the value of the dollar. However the fall out of the gold standard in the 70s has since reduce the fiscal discipline on government to do what is necessary to maintain the value of the dollar against gold as citizens can no longer redeem the currency in gold.
The money supply has since been multiplying at tremendous rates and we have seen asset bubbles forming one after another around the world. It is by no means coincidental that low interest rates with expanding money supply creates mal-investments and form asset bubbles which destroys wealth once the confidence fades off.
The value of a currency is merely a function of overall confidence in the nation’s ability to make good on the value. However consistent fiscal deficits will impair the nation’s ability to recover from an economic crisis, leading to a depression and a total collapse of the financial system and economy. The inevitable result is hyperinflation and it is not whether it will happen, but when it will happen. “Coming soon to a country near you.”
Money supply growth ideally should be pegged to real GDP growth.However,it is difficult to forecast real GDP growth, thus the undershoot or overshoot in money supply.
I disagree with the last statement:depression does not necessarily lead to hyperinflation provided that the country is disciplined to cut its deficit and managed to get help from external sources like IMF. Of course,it must improve productivity,some cut in wages and accept slow devaluation of currency.
Unfortunately, the Austrian school has become so non mainstream and the western economies is now dominated by either Monetarism( Friedman) or Keynesian which both advocate huge input of the money supply though the former through the central bank while the latter through big government spending.
It is lucky that Singapore cannot print money that easily or use interest rate to change the money supply.
“depression does not necessarily lead to hyperinflation provided that the country is disciplined to cut its deficit and managed to get help from external sources like IMF. Of course,it must improve productivity,some cut in wages and accept slow devaluation of currency.” Agree that depression does not lead to hyperinflation if the nation do the right thing. But overstimulating and constantly creating moral hazardous behaviour with bailouts in USA will lead to the hyperinflationary situation I am predicting. The money supply has increased so tremendously over the last 2 years. Such low interest rates further alleviates the situation with risk taking on the part of investment bankers to push the markets with their low cost funds from the Fed. This is also the main reason why the markets reached this height so fast after a great depression 2.0
No one should accept slow devaluation of their currency. There is in no logical sense why my savings/income should constantly be on the fall in purchasing power to feed off the fiscal expenditure. Why would anyone want to hold the dollars in their savings if they know its going to devalue, be it slowly or quickly? The ultimate decision is still to protect your own purchasing power by disposing your dollars for hard assets or diversify across other currencies.
Please enlighten. How does Singapore determine its money supply and on what basis, and backed by what ?. Is the Singapore currency also fiat money.
Would appreciate some insight on this.
The author recognized that inflation (and deflation) is the result of government’s interference in the money market through the central bank. Government interference in the economy is also the cause of all economic crises.
I wonder why he does not bring the government to task for its crime. (Perhaps he does not recognize it as one.) I also wonder why the author mentioned the gold standard only fleetingly and why he did not advocate the gold standard as the alternative to fiat currency.
The central bank is arguably the greatest legal violator of rights – specifically, property rights. The government, by manipulating the value of the money we hold, confiscates our wealth when it wishes to. It is, as the author wrote, an indirect tax. The worse is, we would not even know it until it is too late, unlike an explicit increase of income tax.
The solution is the gold–or any form of durable metal–standard. Gold acts as an objective inviolate value. A fiat currency of a nation, on the other hand, is backed by the fiat currencies of other nations, which is ultimately backed by nothing but the word, promises and guarantee of government.
Under the gold standard, a free banking system stands as the protector of an economy’s stability and balanced growth. In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. In the system of fiat currency, government holds the legal monopoly on money – which is the greatest monopoly of all, for it controls the very medium which we trade in.
Deficit spending is simply a scheme for the “hidden” confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.
The gold standard and economic freedom are inseparable.
@jeffgoh> any form of currency backed by nothing is a form of fiat money. Fiat money is any money declared by a government to be legal tender. In Latin, “fiat” means let it be done, which means let this paper be money. There is essentially no difference from the money you used to play in Monopoly board game and what you are using daily. The value is perceived and not intrinsic.
Unfortunately Singapore money supply is determined by MAS and it has not done us any favours in terms of maintaining the value of our dollar. There is a tool which we can play with on MAS website.
https://secure.mas.gov.sg/apps/msb-xml/index.jsp?tableset=I&table=I.1
This allows you to see the money supply expansion over any period of time you wish to. I ran the numbers and noticed we had double digits percentages increase in the money supply from 2006 and 2010 for M1, M2 and M3. M1 consists of checking accounts and currency in circulation. That rose by 181% over 10 years, 10.9% year on year. The most notable increase started from 2006 to 2010, 2006 – 13%, 2007 – 22%, 2008 – 18%, 2009 – 23%. It seemed to coincide with the speculative bubbles we created in both housing and stock market.
@HSP> I wanted to address the gold standard in another article. Trying not to mix too many issues into one article also. But good point because it doesn’t bring out the crux of the problem. Things that ought to be addressed includes whether we have gold as backing for currency or using gold as a universal currency or even other commodity such as oil, copper or silver. We should probably address why gold would be the best solution for all of us instead of this paper with a dead president face on it. Wanna work together on this next article and share ideas?
“We should probably address why gold would be the best solution for all of us instead of this paper with a dead president face on it.”
Because gold is the only thing that will always be worth its weight in gold?
Hi Christopher Pang, do you know what will happen to Singapore currency if many of the western countries(USA, UK, spain, italy, portugal, ireland and others) that are in extreme debt called a conference and they devalue all their currency at once.
thanks
my guess on what mas would do is they would most likely devalue together. we have been keeping our currency within a trading range for 2 reasons.
1. to keep our currency weak to the countries we are exporting to so as to attract them to purchase our exports.
2. to keep inflation low enough such that people do not realize they have been fleeced and subsequently blame it on any other thing, such as free market, foreign talent, etc.
USA, UK and the PIGS (Portugal, Italy, Greece, Spain) are effectively bankrupt. There is no way they can repay their current debt. I would describe the US government’s manner of financing its debt like some common folks on the street financing their mortgage using credit cards. What they are essentially doing now is financing interest on 30year Treasuries with short term (1-3 years) Treasuries. Unfortunately countries like Japan or China would ONE DAY (i hope sooner rather than later) wake up to their senses and cut their losses. This is also probably a reason why China is diversifying across the globe by buying up assets around the world, especially oil fields and gold mines. This would aid them in a slow devaluation of the USD, because they are the largest creditor of the US as any huge move in the market to diversify away from USD would cause a quicker collapse in the dollar that could cause mayhem in the markets.
Do you think they will try to adopt a new currency or revert back to the gold standard?
I mean if our singapore dollar is also devalued significantly, our purchasing power will drops significantly as the money might become useless. Have anybody written an article in what will happened to our value of our money if the scenario i described transpire and what are the possible things to safeguard ourselves. Is it better to buy some gold coins as a hedge or protection now?
I feel like starting to buy some but the price of gold is quite high now and i have no experience in differentiating between real gold or gold that are filled with tungsten. Anybody that have bought real physical gold can give advice?
@jamesneo
“Do you think they will try to adopt a new currency or revert back to the gold standard?” Do you think changing yusof ishak face to another president face and then calling it Singadollar would instill new refound confidence if the old currency collapse? The answer is probably no. In the event a currency collapse, it is also inevitable the government will be removed. Confidence in a currency need to be built over time. Once destroyed, its hard to rebuild.
It is extremely difficult to buy physical gold in Singapore. The prices are overcharged for the mints, especially the 1/4 ounce coins or 1 ounce coins as collectibles. Some of the bars out in the market are tungsten filled and the only way to verify is through melting them, as gold and tungsten have different melting points. It is extremely hard for experts to even verify the authenticity, let alone us.
If you get a gold account with UOB, they charge you .1% annual upkeep fee, instead of paying you interest. Furthermore to that, your account will still be subjected to counterparty risk because this is not the regular depository accounts which is being guaranteed by the Insurance for deposits.
The only way is to buy real physical gold in some other mints and store them there. But you still run the risk of them lending your gold out to other people without you knowing. As audit only occurs in intervals, during this period, you never know what might happen to your gold which you park with them.
You can buy physical gold from goldsmith in Singapore but they charge you for workmanship + gst. which works out to be probably more than 15% premium on the spot gold value.
Physical gold can also be bought from UOB and they store it for you also for the upkeep fee, but this time with a GST as it is considered a goods that you buy, instead of gold being money. The spreads are roughly 5%, so works out to be 12% premium over spot.
Gold futures contract is subject to counterparty/exchange risk when the counterparty fails to deliver, the exchange takes up the liability of delivering. And if the market becomes over bullish on gold and abandons all other currencies, the exchange might not be able to fulfill all obligations.
My personal opinion is to bypass all these premiums and costs is to buy mining companies or energy related companies. The correlation is high, the transactions costs are low. Bankruptcy of such firms in hyperinflationary scenarios is unlikely given the high premiums over their products and the needs for such commodities.
It’s utter rubbish to say that the a gold or silver standard protects the value of your savings. If they suddenly discover a mine in Russia that will double the world’s existing production rate of gold, then your gold-denominated savings will lose its value. Similarly, if all the gold mines were to close down, the value of your savings would increase.
There’s a reason why inflation was so rampant in 16th and 17th century Spain after they starting shipping silver and gold from their empire in the Americas.
Fox, under a gold standard, my savings is gold. It is not gold-denominated. Under a gold standard, paper money is merely a representative of the value of gold I hold in the bank – the value of gold, not relative to anything else, but gold, because gold is the standard of value!
If a person suddenly discovers a huge gold mine in Russia, the value of my savings (which is the value of gold) remains the same because of the simply fact that the value of gold is gold itself, and not $x.
Now, let’s talk about inflation. Inflation is an expansion of the money supply. The rise in prices is the consequence. Inflation is not the rise in prices.
So what happens when there is a sudden influx of gold in a gold-standard economy? The person who discover the gold is rich: he can either spend it, save it, or keep it idle.
Keeping his gold idle will have no impact on the economy, it is like discovering the gold and letting it remain underground.
If he decides to spend all his gold, say, on oil. (I choose oil because it is a crucial commodity, needed in the production of practically everything.) The price of oil increases. If it increases till the point where producers – the ones who need oil most – cannot stomach the rise any longer, the producers themselves will produce oil, instead of buying them, or switch to another source of energy, which was originally more expensive than oil but is now cheaper, like alcohol or whatever. This will lead to a reduction in the price of oil, back to the original price, since the market has adjusted to the new influx of gold. (This applies to every goods, be it wheat, bread, copper, or diamond.)
If he decides to save all his gold in the bank, the sudden increase in deposits will decrease interest rates. The first group to react to the cheap money will be companies. Companies will borrow more, and produce more. Price of goods will decrease. The companies who are producing more will be earning more. Wages will rise. The companies are earning more because, the general public, who are the consumers, have reacted to the low interest rate: they saved less, spend more, and price of goods will return to around their original price.
The end result is: more money in the economy, more goods in the economy at around the same price, and higher wages.
Price rises when more money chases fewer goods. If the price of bread rises, more people will consumer less bread and switch to an alternative. Price of bread will then drop.
But, if people are too damned addicted to their bread and prices remain high, some smart businessman will capitalize on the high price of bread to make money, i.e., he will produce bread. The increase in the supply of bread will then match the high demand of bread. Prices will again fall back to equilibrium.
Say Peng,
Out of curiosity, are you older than 12 years old? Have you ever read any economics textbook? Have you ever had any formal education in economics? Do you understand the concept of money supply? Does the equation MV = PT mean anything to you?
BTW, I’m not trying to be condescending. I’m just thinking of the appropriate books for you to read. You seem to have a few misconceptions about the concepts of inflation and price level. If you have the academic maturity, I think that Mankiw’s introductory textbook on Macroeconomics may be available in the public libraries in Singapore because it is probably too expensive in Singapore.
Christopher Pang,
“Unfortunately countries like Japan or China would ONE DAY (i hope sooner rather than later) wake up to their senses and cut their losses.”
Actually, public debt in Japan stands at 190 percent of its GDP and is comparable to the US public debt which stands at around 70 percent.
Has Fox been paying attention? I have been discussing inflation from the Austrian perspective.
But, of course, Fox belongs to the group of people who have “formal education” in economics – specifically, Keynesian economics. But, like most around him, he does not question the basic premises of what he has been taught: he accepts them like a passive unthinking sponge.
If Fox had any intellectual honesty, he would read some history and notice that Keynesian economics has been an utter failure, from the economic problems of the 70s which Keynesian central planning policies did not solve, to occurrence of stagflation, also in the 70s, which contradicts Keynesian models.
These Keynesian economists recognize the contradictions in their theories, but instead of identifying the flaw of its basic premises, they merely adapted them, resulting in several spawns of Keynesian thought: Neo-Keynesianism, New Keynesianism, Post-Keynesianism, Military Keynesianism; etc.
The same applies to Monetarism, which has its roots in the monetary theories of Keynesianism. The basic premises of both schools of economic thought is that the free market is not competent enough and somehow government, through its policies, can optimize the macroeconomic situation of a nation.
This is a flaw. When Keynes formulated his theories, he took data not from free economies, but from mixed economies. And he concluded from the data that there were inefficiencies and the sort, and blamed them on the free market, and argued for more government intervention. Keynes blamed the free market when a free – i.e. a pure, uncontrolled, unregulated, laissez-faire – market has never existed in human history.
*Sigh*.
Since you are not receptive to good advice, then let me point out what is wrong with your reasoning. Take the last three paragraphs of your post on April 16, 2010 at 10:00 and replace ‘gold’ with ‘fiat money’. Repeat your scenario with a discovery of a briefcase full of 1000-dollar bills. Your reasoning would work exactly the same. In fact, your explanation contradicts Christopher Pang’s example in which criminals were able to print money. He claims that if criminals were able to increase the fiat money supply, then the price level will go up. On the other hand, you claim that if gold-backed money supply go up, prices will remain the same. Suppose criminals were able to fake gold perfectly and put it into circulation, would the price level go up or stay the same?
Prices are just units of measurements. If you double the price of everything tomorrow, there is no loss of purchasing power because your wages would double too. If someone is paying double for something, then someone else would be getting that doubled payment. If you understand the equation MV = PQ, then you’ll understand why inflation is not a big problem. The nominal is distinct from the real. What matters is Q, not P.
The supply of money fluctuates because banks make loans and take in deposits and the loans/deposits change with the real output of the economy. When the supply of money M increases by 1 billion dollars, it doesn’t mean that the central banks has printed 1 extra billion dollar bills. If money supply in the US expanded by 12 percent in the last two years, why didn’t we had any inflation in 2009?
This is merely the classical theory of money, something that is taught routinely in introductory undergraduate economics. This has nothing to do with Keynesian economics. In fact, Keynesians do not believe in the classical theory of money!
“…a free – i.e. a pure, uncontrolled, unregulated, laissez-faire – market has never existed in human history.”
OK. A completely free economy has never existed in human history but you believe that it will be best thing next to sliced bread. If Keynesian economics is based on flawed empirical data, then how do you ascertain the validity of assertions made by the Austrian school? Oh, BTW, economics can be divided into many sub-disciplines. Not all economists are Keynesians which is after all a school of thought on public policy. For example, people who study financial economics, decision making or econometrics don’t care about public policy.
Are you beginning to see why some people may have trouble taking you seriously?
Again, has Fox been paying attention? We are only discussing macroeconomics here. So we can leave out microeconomics, which are environmental economics, labor economics, health economics, financial economics (which Fox has so smartly pointed out), etc.
“Take the last three paragraphs of your post on April 16, 2010 at 10:00 and replace ‘gold’ with ‘fiat money’. Repeat your scenario with a discovery of a briefcase full of 1000-dollar bills. Your reasoning would work exactly the same.”
In the context of a free market under a gold standard, which my example is set in, and assuming the $1000 bills (which are not fiat money now since we are under a gold standard) are legitimate, yes, it is exactly the same.
“[Christopher Pang] claims that if criminals were able to increase the fiat money supply, then the price level will go up. On the other hand, you claim that if gold-backed money supply go up, prices will remain the same. Suppose criminals were able to fake gold perfectly and put it into circulation, would the price level go up or stay the same?”
Do you think the price level, when it goes up, will remain there if criminals injected counterfeit fiat currency into the economy? No, eventually, the market will recognize the illegitimacy of the notes, reject them and correct itself. Prices will drop and return to normal. The same thing would occur if criminals faked gold.
If real gold is discovered…I already explained what would happen in my previous post.
“A completely free economy has never existed in human history but you believe that it will be best thing next to sliced bread. If Keynesian economics is based on flawed empirical data, then how do you ascertain the validity of assertions made by the Austrian school?”
The theories of Austrian economics are not formulated from empirical data, but from logical deduction and deductive inferences. It is very philosophical and not very mathematical. But, the purpose of Austrian economics is not to come up with economic policies (the policy of the Austrian is no policy), but to explain the causes and effects if any policy is implemented.
I want to add that logical deduction is by no means infallible. So, if the theories do not correctly explain the happenings in the economy, then it is false.
Say Peng,
“Do you think the price level, when it goes up, will remain there if criminals injected counterfeit fiat currency into the economy? No, eventually, the market will recognize the illegitimacy of the notes, reject them and correct itself. Prices will drop and return to normal. The same thing would occur if criminals faked gold.”
Christopher Pang’s example involves the circulation of counterfeit bills that cannot be detected by the authorities and everyone else. His intention was to highlight how an increase in money supply (legal or illegal) can correspond to an increase in price level.
Your answer is irrelevant and has nothing to do with the concept of fiat money.
Let me ask you once again: if forgers are somehow able to fake gold with such skill so much so that they cannot be detected by the authorities (as in Christopher Pang’s example) and everyone else, how would the price level change?
Fox, when counterfeit bills are forged and injected into the economy, i.e. someone has used the fake money to trade, it is right to state that there will be an increase in the price level, provided a sufficiently large amount of counterfeit bills is introduced.
However, the increase in the price level is short run. Eventually, the counterfeit notes will be discovered (either by authorities, private citizens, etc) and the market will readjust. The price level will return to the original level. Until the counterfeit notes are discovered, the market is operating on partially non-existent resources. The mistake will keep compounding until the fake money is discovered which will culminate, either mildly if it discovered soon, or disastrously. The latter does not often occur.
This is like the central bank increasing the money supply. But it does it on a much larger scale, which results in economic crises.
No one would be “able to fake gold with such skill so much so that they cannot be detected by the authorities and everyone else.” A simple density test would suffice.
“[H]ow would the price level change”?
The same as, if counterfeit notes are introduced. There will be a short term price rise until the fake gold is discovered, and price will return to normal.
@ Fox
Japan debt is owed to themselves, their citizens, just like Singapore. They are forced to use JPY as daily transactions, their livelihood, savings and assets are all in JPY, similarly to Singaporeans. The main difference is China and Japan both hold trillions worth of USD treasuries and the debt is owed to foreigners who do not need USD. You might say it is for international trade. But what use is a currency if it is going to be depreciating whether quickly or slowly? If you know that the US is not going to repay or have the ability to repay the debt, it is time to take measures to diversify away from such allocation, which is what China is doing brilliantly now, buying mines, minerals and hard assets. The fact that it is the reserve currency does not help the US but is complacency on their part that people need their dollars. GBP was once the reserve currency too. Look where it is today. Tides change as times change.
MV = PQ is a Keynesians theory. The only reason why inflation is not rampant now is because of the fact that the money is currently used to filled up the black hole which has been lost with the mortgages crises and everyone is already cautious with spending with the high unemployment rate. The only spending in US comes from the government with their reckless programs, like cash for clunkers and cash for appliances, rebates for housing.
“If someone is paying double for something, then someone else would be getting that doubled payment. If you understand the equation MV = PQ, then you’ll understand why inflation is not a big problem. The nominal is distinct from the real. What matters is Q, not P.” You are effectively stealing from the people who saved or are on pension schemes. What you are advocating is wiping out their savings and their retirement plans. No doubt people on wages would see increases in their pays but what happened to the savers, the people living on pension schemes, bonds? Supposed you saved 1m for your retirement estimated to be able to last you for 20 years of spending upon retirement. But nearing your retirement, the inflation is so rampant, that prices have doubled, you have only saved enough to last 10 years. No doubt your wage has doubled, but what good is that now given that you are already 65 and wanting to retire? It is an indirect tax on you and any other citizens who are on pension schemes.
The gold standard is just a way of preventing counterfeiting from the government. Having the power to print limitless money is as good as stealing from every citizen that saves, owns and possess any such currency. Gold is valued because of its ability to maintain a value and not so easily counterfeited. Why we ask for a gold standard is so that everything would then be priced in terms of gold. Supposed gold is really that easily mined, can be doubled overnight, then yes we might have higher inflation. But the process of mining is long, and supply would not be easily doubled overnight. What we are advocating for is prices of goods to be priced in gold. It will also prevent banks from having this fractional reserve banking system where they can just hold 10% of their total deposits that they take in and lend out long term 90%. In a gold standard, banks will be more prudent with their lending, as the entire sum is redeemable, and they cannot ask for “emergency” lending from Federal Reserve.
Christopher Pang,
I don’t understand what the problem here is. Yes, you are right about the US owing a lot of debt to Japan and China. So what? All these countries operate on a fiat money system. So what exactly is the problem here? Is the cause of the US’s problems its reliance on fiat money? In that case, would the cause of the strength of Japan and China’s positions be also their reliance on fiat money too?
You see why I am having trouble here? If the USD does revalue downwards (which is what the US govt wants), the winners would be holders of RMB-denominated assets (the Chinese people for example) and the losers the holders of USD-denominated assets (the Chinese central bank for example). How does this affect the *real* economies of US and China?
“You are effectively stealing from the people who saved or are on pension schemes. What you are advocating is wiping out their savings and their retirement plans. No doubt people on wages would see increases in their pays but what happened to the savers, the people living on pension schemes, bonds?”
There is some discomfort in the very short run (hyperinflation is another story) but real interest rates nearly always move in tandem with inflation because interest rates reflect the price level of holding money. It’s called the Fisher effect.
In this case, the ‘stealing’ is done by every wage-earning person. Consumption is shifted from the retirees to wage-earning people.
The solution to your proposed problem is trivial. Let’s just benchmark pensions to the price index or even eliminate public pension schemes altogether. Actually, the former is already done in many public and private pension schemes.
Also, there are bonds assets which are benchmarked to the price index.
I just don’t understand what the problem here is.
“MV = PQ is a Keynesians theory.”
No it’s not. Milton Friedman also believed in MV = PQ. I don’t think anyone can accuse Friedman of having been a Keynesian.
Okay. I may have simplified things a little. I have to be a little wonkish here.
MV = PQ itself does not say much. However, assuming that the money velocity is constant, the fact that M is a homogeneous function of P and Q implies that the percentage increase in money supply is always equal to the percentage increase in price level plus the percentage increase of real production of goods and services. No serious economist, Keynesian or not, disputes this.
The real dispute is what happens when you try to change the money supply exogenously (e.g. through government intervention). For instance, a 5 percent increase in the money supply can result in:
(1) a 4 percent (positive) increase in price level and 1 percent (positive) increase in real good and service production. This is a good thing because an increase in Q is always a good thing.
(2) a 6 percent (positive) increase in P and a 1 percent (negative) decrease in Q. That’s a bad thing for obvious reasons.
(3) a 5 percent (positive) increase in P and a zero (neutral) percent change in Q.
Outcome 3 will always occur in the long run. The level of goods production is insensitive to what the money supply is or what the money supply is backed by. Changing the money supply will simply change the price level. The price of everything will double but everyone gets doubled returns on labour, land and capital.
What is interesting is the short run. Outome 1, 2 or 3 can occur depending on the current state of the economy. Depending on your school of thought, in the event of a recession, there are several options you can choose. You can try to directly stimulate aggregate demand by getting the government to buy a lot of things. However, you run the risk crowding out private sector spending with the net effect of having no effect or little effect on Q. On the other side of the spectrum, you can try to adjust the money supply. If done properly, you will have some price inflation and an increase in Q. If done incorrectly, you will have more price inflation and a decrease in Q.
However, if you do nothing, there is no reason for Q to move back to its original level. That was how the Great Depression started. Basically, no one did anything.
Back to the question of the gold standard. There is a reason why Milton Friedman was dead against the gold standard: the government cannot adjust the money supply when the situation demands it and the money supply would depend on the gold mining companies. In the event of a economic recession, the government would have no choice but to use direct fiscal (Keynesian) stimulus which may not work.
Christopher Pang: “Supposed gold is really that easily mined, can be doubled overnight, then yes we might have higher inflation. But the process of mining is long, and supply would not be easily doubled overnight.”
(Are you using the term “inflation” – as in an expansion of money supply – correctly? I think you meant an increase in price. But even so, it will not occur.)
There is a reason why gold is used as the standard of value. What medium of exchange will be acceptable to all participants in an economy is not determined arbitrarily. The ‘store of value’ factor is an important consideration. The medium of exchange must be a durable commodity, usually a metal. A metal is generally chosen because it is homogeneous and divisible, i.e., every unit is the same as every other and it can be blended or formed in any quantity.
More importantly (and this addresses your point above), the commodity chosen as a medium must be a luxury good, i.e., the good is scarce and has high unit value. Human desires for luxuries are unlimited and, therefore, luxury goods are always in demand and will always be acceptable.
So, if somehow, there is an overnight doubling in the supply of gold, demand for it will follow immediately. The evening news will read something like this: “An unprecedented amount of gold was discovered in a gold mine located in an isolated region of South Africa this afternoon. This might signal a sharp drop – experts estimate more than a 40% drop – in the price of jewelry and other gold-related items.”
The next day, all the women, industrialists and jewelers of the world will go screaming in demand for cheap gold, thereby, eventually, raising its price back to equilibrium.
Fox: “Depending on your school of thought, in the event of a recession, there are several options you can choose. You can try to directly stimulate aggregate demand by getting the government to buy a lot of things. However, you run the risk crowding out private sector spending with the net effect of having no effect or little effect on Q. On the other side of the spectrum, you can try to adjust the money supply. If done properly, you will have some price inflation and an increase in Q.”
Implementing fiscal or monetary policy in a recession will only worsen the situation. A recession is a correction, a readjustment of a bloated economy, i.e., an economy where consumption and investment (future production) are mismatched, not in equilibrium. Recession is not the problem. The problem is government, the cause of the recession. The last thing you need in a recession is for government to give an artificial stimulus to consumption by either spending or lowering market interest rates. Such policies will only prolong the recession. The perfect example is Japan – the Lost Decade. Besides, you do not create wealth by consuming, you create it by producing.
John Stuart Mill refuted the fallacy that consumer spending boost the economy 200 years ago: “What a country wants to make it richer is never consumption, but production. Where there is the latter, we may be sure that there is no want [lack] of the former. To produce, implies that the producer desires to consume; why else should he give himself useless labor? He may not wish to consumer what he himself produces, but his motive for producing and selling is the desire to buy. Therefore, if the producers generally produce and sell more and more, they certainly also buy more and more.”
“Implementing fiscal or monetary policy in a recession will only worsen the situation.”
Well, I did say that the a fiscal or monetary stimulus, if not implemented properly, *can* worsen the situation.
“A recession is a correction, a readjustment of a bloated economy, i.e., an economy where consumption and investment (future production) are mismatched, not in equilibrium.”
OK. Show me an academic paper/reference which demonstrates this assertion.
Also, how do you tell if consumption and investment are mismatched?
“The problem is government, the cause of the recession.”
But we also have had recession in countries where the government interferes minimally in the market e.g. Hong Kong. Historically, there have been prolonged recessions of similar severity to the Great Depression in the US even before the establishment of any central banking authority.
“The last thing you need in a recession is for government to give an artificial stimulus to consumption by either spending or lowering market interest rates. Such policies will only prolong the recession. The perfect example is Japan – the Lost Decade.”
So you are telling us that the cause of Japan’s lost decade is over-consumption?
“Besides, you do not create wealth by consuming, you create it by producing.”
Aggregate demand is *always* equal to aggregate supply. You can’t consume what has not been produced and you cannot produce what is not wanted.
@jamesneo: Hi Christopher Pang, do you know what will happen to Singapore currency if many of the western countries(USA, UK, spain, italy, portugal, ireland and others) that are in extreme debt called a conference and they devalue all their currency at once.
thanks”
These countries can’t devalue their currencies at will because the US and the EU don’t maintain active currency pegs. Japan and China do. That’s why China and Japan have such huge foreign reserves – they have to accumulating foreign currencies to keep the JPY and the RMB at their current depressed valuation with respect to the USD and the Euro.
That’s also why the so-called PIIGS are in such trouble. If they had their own currencies, they could simply devalue their currencies to get out of the rut they are in now.
HSP: “More importantly (and this addresses your point above), the commodity chosen as a medium must be a luxury good, i.e., the good is scarce and has high unit value. Human desires for luxuries are unlimited and, therefore, luxury goods are always in demand and will always be acceptable.
So, if somehow, there is an overnight doubling in the supply of gold, demand for it will follow immediately.”
How can something still be scarce if its supply is doubled overnight?
Also, how can the demand for gold be unlimited? Why are they not subjected to the law of diminishing returns on utility? Given that there are no diminishing returns for gold, do you spend ALL your money on buying gold? Why not sell your belongings and buy gold instead?
Fox: “Well, I did say that a fiscal or monetary stimulus, if not implemented properly, *can* worsen the situation.”
The point is, the implementation of any fiscal or monetary stimulus, is bad for the economy.
“OK. Show me an academic paper/reference which demonstrates this assertion.”
I refer you to the works of Austrian economists. To be specific, you can refer either to Thomas E. Woods or Peter D. Schiff.
“But we also have had recession in countries where the government interferes minimally in the market e.g. Hong Kong.”
As long as countries have central banks who hold monopoly over money, and manipulate the money supply, recessions will occur.
“Historically, there have been prolonged recessions of similar severity to the Great Depression in the US even before the establishment of any central banking authority.”
Government can interfere in the economy in many ways other than through the central bank. Any government intervention will have adverse impact on the economy.
“So you are telling us that the cause of Japan’s lost decade is over-consumption?”
I am telling you that Japan’s Lost Decade was due to heavy government spending, government bail outs, low market interest rates set by central bank, and any other government intervention into the economy.
“Aggregate demand is *always* equal to aggregate supply. You can’t consume what has not been produced and you cannot produce what is not wanted.”
Your first sentence is correct, only in the context of a free economy. Your second sentence is correct in its essentials, though with a little grammatical mistake. But, I don’t see how this addresses my point “Besides, you do not create wealth by consuming, you create it by producing” which you quoted.
“How can something still be scarce if its supply is doubled overnight?”
I said “if somehow, there is an overnight doubling in the supply of gold”. “If somehow”. It is only a hypothetical.
“I refer you to the works of Austrian economists. To be specific, you can refer either to Thomas E. Woods or Peter D. Schiff.”
No. These people are not professional economists. They offer no economic models for modeling economic behaviour, no explanations for why recessions occur, etc.
“Government can interfere in the economy in many ways other than through the central bank. Any government intervention will have adverse impact on the economy.”
You can’t just make assertions like that. You have to show how government intervention leads to recessions.
“I am telling you that Japan’s Lost Decade was due to heavy government spending, government bail outs, low market interest rates set by central bank, and any other government intervention into the economy.”
Then why did Japan suffer deflation during the lost decade? According to your interpretation of ‘Austrian economics’, given that interest rates were so low and it was so easy to borrow money (effective zero percent interest), then Japan should have had roaring price inflation.
“Your first sentence is correct, only in the context of a free economy.”
Every purchase is a sale and vice versa, regardless of whether the economy is a free economy or not. This is a matter of simple arithmetic.
“But, I don’t see how this addresses my point “Besides, you do not create wealth by consuming, you create it by producing” which you quoted.”
Total consumption is always equal to total production. If consumption increases, so does production.
Fox: “No. These people are not professional economists.”
Peter Schiff is a graduate in finance and accounting from University of California, has more than 10 years of work experience in the financial industry, is a regular guest on financial news networks, is economic adviser to Ron Paul’s presidential campaign, and accurately predicted the financial crisis of 2007-10, spelling in great detail how different factors of the economy would collapse. Is that not professional enough?
And, while Schiff was warning of an impending economic collapse from 2005-07, I suppose what you call the “professional economists” – who are mostly Keynesian economists – such as Ben Stein and Arthur B. Laffer were laughing their heads off at him. Well, who has had the last laugh?
Although Thomas Woods is not formally schooled in economics, he is fully knowledgeable about Austrian economics working in the Ludwig von Mises Institute. He also has a PHD in history which gives him the capability to frame economics in a historical context. He has demonstrated in his 2009 book Meltdown, how government policies caused the Great Depression and the recent financial crisis.
“They offer no economic models for modeling economic behavior, no explanations for why recessions occur, etc.”
Austrian economists do not rely on economic models and econometrics, because, unlike the natural sciences, factors of the economy – one of them being the actions of human beings – cannot be isolated in laboratory conditions or broken down into mathematical formulas which treat its variables as passive (unchanging) and non-adaptive. Instead, Austrian economists begin by asserting axioms – i.e. self-evident truths or irrefutable facts – of human actions, and continue to form theories through logical deduction based on these axioms.
Austrian economics offer its own explanation of the occurrence of recession using the Austrian business cycle theory.
“You can’t just make assertions like that. You have to show how government intervention leads to recessions.”
I will explain briefly how the US government’s intervention into the economy ultimately resulted in the recession which spread across the world. If you want a more comprehensive answer, please read Meltdown by Thomas Woods or other books by Austrian economists.
1. Fannie Mae and Freddie Mac, because of their status as “government-sponsored enterprises” enjoyed special tax and regulatory privileges which other private competitors do not possess. Backed by these privileges, they bought, bundled and sold mortgage-backed securities. The whole process spurred more mortgage-related activities than would otherwise have taken place. This artificial diversion of resources into the mortgage market inflated home prices – it is artificial because the mortgage market was fueled by largely by capital granted by the special privileges from government. The mortgage market attracted capital it could not attract under free market condition – capital that would have entered into other industries, instead of the housing market. This result in the distortion of the market: other industries suffered reduced efficacy from lack of capital, while the housing industry attracted excess capital and built itself into an artificially-driven boom, which eventually collapsed into a mortgage crisis. The mortgage crisis spread to parts of the economy where it was connected to, which was, in fact, a lot of it, and the whole economy collapsed as a result.
2. If Fannie Mae and Freddie Mac is the root cause of the crisis, the Federal Reserve (central bank) is the soil which fertilized the problem. The central bank started and fueled the housing boom by increasing the money supply with the aim of lowing interest rates. The new money and credit found its way overwhelmingly into the housing market – because of factors discussed above and below – and distorted the housing market. The boom in housing was not stimulated by genuine consumer demand, but was stimulated by the arbitrarily low interest rates set by the central bank. The central bank’s artificial stimulus was not in line with real consumer preferences or the current state of the US economy’s pool of savings. It draws resources from projects that cater to real consumer demand into more projects than the economy can sustain. Too many homes were built. Ultimately, people stopped buying, and because of the artificial base on which the boom was launched from, prices plummeted immediately, leading to a mortgage crisis – and you know what happens next.
3. There are other factors such as the “pro-ownership” tax code and Community Reinvestment Act. They are the handiwork of government politicians, in a bid to increase home ownership by lowering taxes only for home owners and to pressurize lenders to make riskier – i.e. sub-prime – loans in the name of “racial equality”.
I will address your other points in the next post. Too tired now.
Fox: “Then why did Japan suffer deflation during the lost decade? According to your interpretation of ‘Austrian economics’, given that interest rates were so low and it was so easy to borrow money (effective zero percent interest), then Japan should have had roaring price inflation.”
Deflation is the contraction of money supply, but I think you mean the reduction in price. The interest rate set arbitrarily by the Japanese central bank is by no means an accurate indicator of the economy’s real demand and supply of money.
Japan’s economy was in a recession, i.e., Japan’s economy was in an adjustment/correction phase. Jobs – which would not have been possible in a free economy, but were created because of the artificial economic growth spurred on by the low interest rate arbitrarily set by the Japanese central bank – were terminated when banks and other companies invested in the financial and real estate market collapsed when the asset bubble burst (due to the central bank reversing its interest rate policy; but the bubble would have burst eventually even if the central bank continued to keep interest rate low, like the US).
There was high unemployment. With low or no income, in addition to the Japanese’s emphasis on frugality, consumption reduced dramatically. The Japanese consumer reduced spending despite the low interest rate. Like the Americans today, the Japanese are acting with some financial sensibility. This, in addition to falling real estate and equities prices, cheaper Chinese imports and an increased buying of gold (thus reducing the money supply), led to falling prices.
Hi to my friends here.
I have been following Marc Faber for a few years now, trying to learn as much as I could understand.
It is clear that Singapore’s money supply has been growing very rapidly and in view of further bailouts when the second wave of mortgage resets hits (2010-2012), I think our money supply will continue it’s pace, otherwise, it would hurt our exports.
Looking at the rapid growth 2007-present and assumed high growth rate present-2012 at least, inflation should be very high for us over a long period of time.
The government “borrows” our annual CPF contributions at interest rate of 2.5-4% but looking at current situation, Singaporeans are the biggest loser since we “lend” at low interest rates but get high inflation in return, devaluing our future CPF receipts.
Is the above correct?
1. Apart from 2008 and 2009, inflation in Singapore has always been very low (equal or less than 2.0 percent) and is largely determined by the exchange rate which is in turn managed by MAS. Singapore’s exchange rate is largely determined by its balance of payment.
2. On average in the 90s and 2000′s, the nominal return on CPF was on average higher than inflation.
3. Inflation usually lags economic growth by a year or two. Since Singapore is expected to have VERY strong economic growth his year, expect to have relatively high inflation (more than 2.0 percent) in 2011 and/or 2012.
Thanks Fox.
Good thing you mentioned projected growth for us this year. I am very convinced we will be experiencing another mortgage meltdown, due to the second wave of mortgage resets.
This time, not only more banks will go bust, but we will be seeing a bigger sovereign debt crisis. Worse, the real estate bubble could burst anytime this year, affecting other sectors and overall growth of the Chinese economy.
Therefore, not only our major customers in US and Europe are going down, our trade with China and other asian countries seem to be at risk. I don’t think we will see more sunny days in Singapore from now till 2011.
What do you think?
The rates to which ARM rates are reset are *based* on the US Fed Reserve rate which is at a record low and will probably stay low for at least one more year. 10-year T-bill rates have just fallen to 3.42 percent. I wouldn’t sweat the ARM resets now when we actually have effectively zero inflation and zero interest rate. The ARM were a problem 3, 4 years ago because the Fed rates were much higher at around 5 percent when the US property market collapsed. There will be more resets but they will be reset to a low rate.
It is unlikely that there will be a wave of default from the ARMs in 2010 when their rates start to be adjusted, which in any case will not be adjusted upwards. Empirical studies show that most defaults happen before the rates are adjusted.
If you are interested, do have a look at http://www.federalreserve.gov/pubs/FEDS/2008/200859/
Thanks a million, Fox!