Wikinvest Wire

Inflation and money

Monday, December 01, 2008

Via, with whom I had the pleasure of having lunch earlier today (not the .net part, just the Patrick part).


Anonymous said...

mind blowing and fascinating. No wonder we're all encouraged to borrow

Chuck Ponzi said...

This is not a description of inflation. This is a description of debt monetization.

It's hard to watch a show when it's basic premise is flawed as deeply as this one.

The multiplier effect is then described. Of course, the FED keeps track of the entire money supply. It does not publish the statistics.

Of course, the fundamental flaw of the math on the movie is that velocity is not infinite, nor does all money get deposited into savings accounts. Also, fractional lending does not always translate into 10:1. Indeed, checking, savings, and CDs have different reserve ratios.

Drawing paralells between government debt and money supply is a spurious relationship.

Are you suggesting we abolish a fractional lending system? How about getting rid of monetary growth?

Add in some ominous music, and a fixed monetary supply would de facto result in deflation. That's a movie I don't want to watch.

Sufficient monetary growth to support population increases and increases in commerce is a good thing, not a bad thing. Inflation, whose relative effects based on population and commerce growth are excessive is what the author would want to do, not raise the basic transaction costs of commerce through onerous borrowing costs. Unfortunately, you cannot abolish fractional lending without imposing significant restrictions on capital raising. Hence, no major public works, no substantial increase in commerce, and higher unemployment.

Seems like the person who made this movie is either a sociopath or enjoys mischaracterizing the basis of our money supply.

Chuck Ponzi

Nick said...

It's interesting; I have been meaning to write up a larger blog posting about this myself. I would agree with most of the analysis, sans the ominous music and negative undertones: the fractional reserve system allows large amounts of money to be created. I would go further, and say that derivatives such as credit default swaps allowed even more "money" (as debt obligations having asset valuation) to be created.

However, this is only partially inflationary. If we separate goods and services into investments (things with durable value which can be traded) and consumables (things with no durable value and largely inelastic demand), we'll notice something interesting. As the money supply (both currency and debt obligations as monetary assets) increases, the "value" of investments goes up roughly proportionally, as people are willing to borrow to buy "assets". Conversely, the value of consumables doesn't increase substantially, because people will not usually borrow to buy significantly more consumables with inelastic demand.

However, when the governments increase the money supply, something else happens. In that case, the overall supply of money (in all currencies) is increasing. This makes all assets go up in money prices (inflation), but only by the amount of the governmental currency increase. In essence, the intrinsic values are preserved, and adjusted to the new value of the fiat currencies.

I think these two things, taken together, explain all the effects we have seen recently and are likely to see soon. To wit, the CPI is composed mainly of consumables (especially with OER), and thus has been low during the recent credit explosion, due to low government money creation (mostly private money creation during the last 10 years). However, "investment" assets (eg: houses, stocks, MBS's, etc.) prices have soured, as people borrowed at low rates to buy assets at exponential valuations.

Now, we are seeing the government pay off all the bad debts with newly created "real" money, in the form of national debt, in coordination with other nations. This will cause a jump in "real" inflation (cost of consumables), as the prices adjust to the inherent constant value. At the same time, the private credit is declining much faster than the government is "printing" money, so we will continue to see overall investment asset devaluation ("deflation", to the naive).

Now, if we could just get everyone to separate the value of investment assets from consumables, we could end the whole inflation / deflation, he said / he said argument, and everyone could see how the world really works, and what to expect. Or, we could keep letting the man behind the curtain telling us what we should be doing with our money.

Pacquiao VS De La Hoya FREE Live Stream said...

The video is very informative.. Appealing and persuading somehow!

Neutral observer said...

Chuck seems to have some emotional reaction to the video. Taking his points seriatim:

1) Inflation - the video explains how money is created and it does so correctly. Inflation is defined by Ron Paul in the video as the expansion of the money supply without an offsetting increase in value of goods and services produced. This causes the purchasing power of the dollar to decrease.

It's hard to see how anyone alive today could argue that this hasn't occurred. In other words, the basic premise of the video is exactly correct: purchasing power has fallen dramatically.

2) Multiplier effect - This point is simply an observation of another point made in the video; it's no criticism.

3) Velocity - Whether the velocity of money creation is infinite or not is an extremely technical point that has virtually no relevance to the concepts being explained in the 10 minute video. This 'criticism' is picayune and shows a clear bias by the writer who is grasping at any straw to try to prove a pre-determined point.

As a theoretical matter, the velocity is, in fact, mathematically infinite but that completely misses the point being made.

Whether the multiplier effect is 10 to 1 or 20 to 1 or infinity to 1 is not the point; the CONCEPT being explained is that money is created when banks make loans.

4) Government debt and money supply - There is nothing "spurious" about drawing parallels between government debt and money supply. In fact, they have a great deal in common and the bald statement that they don't is obviously wrong. There are countless articles on the web about the relationship. Here's just one:

Anyone who sees NO RELATIONSHIP between government debt and the money supply isn't looking at all.

5) I don't know what Tim is suggesting but the makers of the video appear to be unhappy with fractional banking. They might want to require bank lending only come from time deposits. It's unclear from this snippet. This approach is possible, whether you like it or not.

In fact, the makers of the video want to completely do away with the monetary system! If you didn't watch the whole video, however, you'd never know that.

Asking questions as if the 'correct' reply is obvious is, again, no criticism and, again, only shows a built in bias by the author of the questions.

6) It's hard to respond to a criticism of the MUSIC in a video about money. This, again, clearly shows Chuck has some irrational issues with the video that one can only guess at.

7) If you haven't watched the entire video, then how in the world can you competently critcize it?
I have watched the entire 2 hour video which this snippet was taken from and found it very interesting. Anyone with an open mind and an interest in money would enjoy it.
If you've got some emotional investment in the current mess we call a monetary system, you might not like it since it will challenge your thinking.

Chuck Ponzi said...


I did not watch the whole movie. Is it available somewhere online?

Indeed, I did have an emotional response to it. Are you saying you did not? I guess my emotional response was not the one that the creator was hoping for.

The section above stated it was supposed to be about inflation, right? What they describe, however, is debt monetization, which can cause inflation, but which is not in itself inflation. Indeed, it is one of the most minor causes of modern US Dollar inflation. Perhaps sinister in its intent, but nevertheless minor. Have you seen official statistics for debt monetization? If my memory serves, it was somewhere near 320M last year. Yes, million. Much of the rest of the deficit was financed by foreign and domestic bond purchases. Hardly a significant threat to a money supply that is expanding by trillions; even with the multiplier effect.

However, the relationship between the 2 is spurious, especially when the charts are not inflation-adjusted, or better adusted for a percentage of GDP, since the federal debt is paid out of the earnings of the entire US via taxes. It would be akin to comparing the growth of federal debt to the decline of pirates and drawing some inverse relationship. There is only a very minor direct relationship between debt monetization and overall inflation.

I don't dismiss that we have a problem. I just don't think it's inflation right now.

Chuck Ponzi

Besides, ad hominems are sooo 2004. Try engaging me directly instead, ok? That way we can make this more productive.

Chuck Ponzi said...


I have noticed the same relationship as you have related to "consumables".

I guess that I might have attributed the lack of price increases on consumables to increased productivity that would normally be driving the price down. Hence, the FED is targeting consumables 1-2% inflation when we are in a consumables anti-inflationary period. This could make this the "golden age" of monetary policy where significantly increasing moneary supply does not translate into consumables inflation. When it ends is the main question. Until then, we were just inflating away on the assets. Indeed, even in this strong deflationary actions to the monetary supply, we are still seeing fairly steady prices on consumables. This is perhaps since the fixed investment in production of consumables has already been largely made, and the pricing is largely related to variable costs of production.

Chuck Ponzi

Anonymous said...

Chuck's analysis has one fatal flaw - piracy is rising, not declining.

Tim said...

Friedman was right in that CPI-inflation is a monetary phenomenon, but nearly all of economic theory has been wrong in not realizing that asset-inflation (related to credit expansion) has been the bigger problem over the last two decades. The dim bulbs at the Fed are now only grudgingly acknowledging this.

Neutral observer said...

Hi, Chuck
I don't know how to engage you more directly than I did. I tried to take each of your points and reply to them directly.
At the same time, I felt it was useful to share it with everyone so others would have a balanced review of the video and could make up their own minds whether to watch it.
You seem to have a problem with the definition of inflation propounded by the video makers, Ron Paul and many others.
You apparently don't like the one that many people use and that's fine for you but not for everyone. As long as the author defines the term, I can live with it and try to get the main concept the author is espousing.
Just because you don't agree with the definition used in the film, doesn't mean the entire premise of the video is wrong and thus, useless and not worth the time to watch.
Finally, the only ad hominem attack in my prior post was the observation that you seem unduly emotional about the topic and therefore unable to logically follow the arguments made in the film.
You seem to admit that now. So, apparently, the 'attack' was correct and you might want to consider WHY you react viscerally when someone tries to speak on this topic.
Maybe there's a clue there somewhere...

Nick said...

See, I guess the point I'm trying to impress is that the inflationists and deflationists are both right, from a certain point of view, but it better serves everyone if both sides could realize why both are somewhat correct.

A lot of people have [incorrectly] attributed the lack of consumable price increases during the private credit boom to increased productivity, but that is without basis (in my opinion). It's the conclusion people draw when they are duped into thinking that private credit expansion is equivalent to national debt expansion, a distinction I have made clearly in my analysis. Similarly, those people are likely to think that the national debt can be increased proportionally without corresponding price increased in consumables, which is flawed for the same reason. What you (Chuck) are observing so far is directly predicted by my theory.

As for asset inflation, it's definitely a problem, but I'm not sure it's a huge problem, or even a bigger problem that consumable inflation, in the absence of bailouts and other idiocy. Sure asset prices become ridiculous, but that's a somewhat unavoidable and temporary phenomenon which can be mitigated by ensuring proper risk pricing, negative government feedback, and most importantly strict financial accountability for both private individuals and businesses when the asset bubble bursts. As long as the government doesn't do anything monumentally stupid like encouraging excessive risk with low federal funds rates, encouraging speculators, or bailing out participants by absorbing the losses into national debt (quite possibly the worst and most idiotic thing they could do), the system will regulate itself in a relatively short period of time.

On the other hand, I guess, if the emperors are revealed to be drooling retards who lack even the intellectual aptitude to formulate basic coherent logical conclusions, we could all be screwed. However, I'd say it's not really the asset-inflation which is the big problem in that case, the inability to elect competent leaders is much more to blame.

Chuck Ponzi said...


Don't take it so personally, there's nothing "visceral" about my response. Don't misinterpret direct answers as arguments. They're not.

Ron Paul has argued that inflation is the increase in money supply and I agree with that. Debt monetization is only a very small vehicle to inflation in the present environment. Using images of his testimony to make a point that Ron Paul does not endorse is misleading at best. It's the mote/beam problem. Inflation is going to be an issue, but it's not now, and it's not being caused by debt monetization, at least not now, nor in the forseeable future.

Just pull up a chart of national debt to GDP and it'll make my point:

It's bad, but it's not ominous music bad.

PS don't take advice from me. I have no idea what I'm talking about.

Chuck Ponzi said...


I agree with your assessment. If you look over the past 5-6 years during the credit boom, I don't think that the lack of price increases in consumables is wholly related to increased productivity, although I can attest that over the longer term (past 30 years), the relative decrease of consumables to incomes is explained by productivity changes (larger farms for food, outsourced production for textiles, migrant labor and improved technology for homebuilding, etc.) I still think from a pricing standpoint that this reduces relative prices. Meanwhile, we have been increasing monetary supply substantially to try to put a line under falling prices. (That's only my opinion). That money has been sloshing around from asset to asset and appears to be finally demising in debt (hopefully).

I guess I'm more concerned about consumable inflation if it is a substantial part of average incomes in the US. I'm very concerned about income disparity; where consumables take up a significant portion of the poor's resources and only a tiny part of the wealthy's. I'd like to see income disparity decrease.

However, the quality of life for Americans is quite high compared to the rest of the world. We could either fall substantially or raise up the rest of the world substantially before being equal. If the world is truly flat, one or the other needs to happen, or parts of both.

However, this is a not a simple subject and you're quite likely right about all of your points. It'll take time to see how it all plays out, and history will write its own summary.

Indeed, the true shortage is as you pointed out, knowledgeable leaders.

Anonymous said...

I find it interesting that someone labeled "Chuck Ponzi" would argue against our entire Ponzi system.

Bruno said...

How's this for ad hominem, Chuck. You're just another "smartest guy in the room" type with more technical knowledge than common sense. Or you have it but you're so cynical you don't mind trying to fool people and lose them their life savings in the process. It's your type who leads the lambs to slaughter, because you manage to baffle them with your impressive sounding BS so much that they actually believe you can create money out of thin air without any ill effect. You know, just like the "goldilocks economy" that we had that turned out so great.

"nothing to worry about here folks, it's all under control"

You know, in the middle ages it was the church that used its superior knowledge (like how to read, for starters) to fleece the masses who didn't know any better. Today it's the financial class doing it. So go ahead, pick a technical nit. That makes EVERYTHING in the video wrong, right? That changes EVERYTHING, eh?

Neutral observer said...

IMHO you've nailed it!
The criticism of the video struck me as unfair, uninformed and unsubstantiated and so I spoke up.
That's also why I suggested the author consider what he was up to with his comments; I was hoping he might get the message and tone it down.
Sadly, that doesn't seem to have worked and that simple fact might explain why so many 'smartest guy in the room' types continue on forever.
"The unexamined life is not worth living."

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