The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning.
A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days.
What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.
What has this got to do with monetary policy?
Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.
By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.
We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days.
What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.
What has this got to do with monetary policy?
Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.
By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.
We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
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9 comments:
"indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal."
Whatever Ben, you're already doing what you're saying. This reminds me of the time Paulson threatened savers with a bazooka.
I've posted from this speech a few times, yet I feel like most of you still aren't getting it.
This is the most important economic speech ever given.
You should be able to recite it word for word.
This speech will have more impact on your life than any other.
It hath been foretold.
I have come to believe that there are a limited number of things you really need to know to make big judgements.
For example, to identify the housing bubble, you really only needed to know about the ratios of home prices to incomes and home prices to rents.
To predict wild inflation and the destruction of the USD, you really only need to know that statement from Bernanke.
Bernanke has told us everything about where the USD is headed.
My picks to protect myself:
1) GDX - this is an etf based on gold miners that rises (and falls) proportional to the price of gold
2) DAG - this is a double-long etf based on the price of the most liquid (highest volume) agricultural commodities (corn, soybeans, sugar, wheat)
3) PST - ultrashort etf that moves inversely to the price of 7-10 year US treasury bonds
Disclosure: right now I only actually own GDX but that's because I'm waiting for the automaker bailout to pass before selling my GM lottery ticket.
By the way, the yield on the 10 year treasury is at it's lowest point EVER - if that is not a signal to short them then I don't know what is. Sure, yields could fall even further but they simply cannot stay this low for an extended period.
Good luck to all. Tell the truth.
Paul E - careful shorting t-bills (TBT is another ETF for that). Bernanke can start buying direct from treasury. He told us he'd do that. He wants to get 10-year down to 2% or even lower I think. The only way to prop up housing prices, and also get more cash into peoples' hands via refi's.
But the dollar is f*cked. It may be terminal. It's a game of hot potato now. I intend to be out of dollars by 12/31. What they go into, that's still open to debate.
We're entering the end-game now.
http://www.themoscowtimes.com/article/1016/42/372593.htm
Driven by rising supply and falling demand, yields on U.S. government bonds may spike. This will cause interest payments, which currently measure some $450 billion per year, to skyrocket. The worst-case scenario would be if the United States finds that it can't borrow what it needs at any price -- the same situation many consumers and companies already face in the current credit crunch.
Unlike private borrowers, however, the government has a solution. It can simply print money to meet its financial obligations.
This is an old trick. The printing press is the last resort of any government that discovers it can no longer raise money from lenders or taxpayers. It was used by the German government after World War I and, more recently, by such debtor nations as Argentina and Brazil. Printing vast quantities of money inevitably produces higher inflation, but, on the other hand, inflation has the advantage of reducing the real value of debt and, in countries with a progressive taxation system, of boosting government revenues, since it pushes more taxpayers into higher income brackets.
"inflation has the advantage of reducing the real value of debt"
It also reduces the value of assets and savings. Again, how f'd is it that the government encourages debt and discourages savings?
Thanks for the caution, Keith. What you said makes sense. I was not aware of how Bernanke intended to keep yields so low. He is one tricky little bastard - you can't take your eyes off him for a second.
Hey, wait a minute... where the hell is my wallet?? BERNANKEEEEEE!!
wouldn't that actually reduce real demand though, causing more companies to go out of business? people will buy less if everything costs more. fewer vacations, fewer cars, etc. as more and more money gets spent on food.
This is not a problem. *Mild* inflations are better than deflations:
Eliminates damaging recessions, forces price renegotiations.
I know there are a lot of DOPES here who don't understand Advanced Econ. or the word MILD.
And you myopic imbeciles need to look back prior to 1929. Maybe you'll learn something.
To the ignorant Fed haters and gold standard idiots:
You folks are booted from class and relegated to tinfoil 101.
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