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Inflation and Monetary Regimes, Part II: The Introduction of Paper Money
Before moving onto the Characteristics
of Hyperinflations, Bernholz introduces the concept of Moderate
Paper Money Inflations. A few basic conclusions are made here
which we’ve summarized below:
-
During inflation, an
undervaluation of paper money develops compared to gold, silver or
copper. It’s difficult for us to argue with this point, except that
we’d caution investors not to assume that rising gold prices
necessitates a coming inflation. Precious metals are rising against all
paper currencies today. We view this as more of a sign of mistrust for
the developed world’s reckless fiscal and monetary policies.
- An increase in the money supply
first stimulates economic activity, whereas price increases lag. On the
other hand, if the rate of growth of the money is substantially
diminished or even becomes negative, then depressive consequences are
felt before the price level recedes. We’d ask that all the
Inflationistas out there re-read that last sentence, which appears to be
completely lost by Milton Friedman and Company who focus solely on the
supply of money with no respect for the multiplier. With that said,
we’ll reproduce an important chart from our last post, which should be
somewhat of a recurring nightmare for our Federal Reserve Chairman,
except that he no longer pays attention to what he does not want to see.
- The developments just sketched lead
to political reactions which may even strengthen or bring about
sequences of events. Hmmmmm. - If a moderate inflation turns into a
high inflation, economic activity is adversely affected. This
minor detail appears to be lost on our policymakers who are determined
to create “just the right amount” of inflation to offset the economy’s
post-crisis, deflationary tendencies and avoid Great Depression 2.0.
Needless to say, we have our doubts. Bernanke is so set on not
repeating the mistakes of 1937-1938 – when the punch bowl was removed
too soon – that it is almost a near certainty that he will err on the
“too late, too long” side of the inflation coin. Will give handsome
odds, to anyone willing to take the other side of that bet. - Wage increases usually lag behind
the rise of the price level. Translation for tomorrow’s domestic
economy: Structurally high unemployment and declining real wages. Ruh
Roh!
- Currency substitution plays an
important role if inflation is progressing and the fixed exchange rate
can no longer be maintained. Finally, the bad money will be driven out
of circulation, and the unstable money becomes worthless.
Bernholz concludes by constructing a
picture of a full inflationary cycle. First, paper money with no
intrinsic value is introduced – initially convertible at a fixed rate of
course. These notes are a welcome addition at first as they are not as
heavy and easier to store and transport than gold bars. But with more
and more paper money, convertibility becomes difficult since official
reserves dwindle (just ask Roosevelt), and ultimately, convertibility
can no longer be expected.
We’ll be spending the next few weeks
reviewing the meat of Monetary
Regimes and Inflation – Characteristics of Hyperinflations. One
lovely trait is that people try to spend their money as quickly as
possible, since they expect that it will soon lose its value by future
inflation. As a consequence, prices rise more quickly than the supply
of the paper money and the real stock of money decreases. Lovely.
Disclosure: At the time of
publication, the author was long Gold and long MarketVectors Gold Miners
ETF, although positions may change at any time
»
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Deflation is not a bad thing. It is normal correction if not interfered with. Read the Austrian's work: Ludwig Von Mises, Henry Hazlit, Murray Rothbard. If we did not have fiat, the recessions would be relatively mild and put us back where we need to be. If you argue for fiat, know that mankind will never allow it to be properly regulated so that any short term benefits you get from small increases in supply of paper will soon turn into larger and larger ones until the system destroys the working classes and collapses. Therefore, given the choice, I'll take hard money and the smaller expansion and contractions that get naturally regulated over any form of fiat money system. You just have to hold some back as savings, which don't get penalized in true hard money times, for when smaller contractions occur.
"An increase in the money supply first stimulates economic activity, whereas price increases lag. On the other hand, if the rate of growth of the money is substantially diminished or even becomes negative, then depressive consequences are felt before the price level recedes. We’d ask that all the Inflationistas out there re-read that last sentence, which appears to be completely lost by Milton Friedman and Company who focus solely on the supply of money with no respect for the multiplier. With that said, we’ll reproduce an important chart from our last post, which should be somewhat of a recurring nightmare for our Federal Reserve Chairman, except that he no longer pays attention to what he does not want to see."
The problem with Gresham's law is that, after a while, few will accept the "bad" money for anything of real value, so it is good money or nothing, the exact opposite. For example, the worth less greenbacks after the Civil War.
Finally, the bad money will be driven out of circulation, and the unstable money becomes worthless.
Is this a misprint, or did I miss something? I thought Gresham said "bad money drives out good". If there's a choice between using bad money and good money, people will hoard "good money", and spend the bad, in a game of fiscal musical chairs. If I'm wrong in this, please educate me.
Gresham's Law only applies to situations in which the coercion of legal tender laws forces market participants to accept bad money at an artificially high value relative to that of the good money --- in such a circumstance, and ONLY in such a circumstance, "bad money drives out good", whereas in the absence of such legal coercion the normal rules of the market would pertain, and the good would drive out the bad.
So your saying from extreme to extreme and no compromise?
So you're saying that paper money is a scheme whereby real money, in the form of precious metals, is traded for its "determined value", as declared by the local authorities, and that afterward these authorities always decouple the paper from its relationship to the precious metal, the paper becomes worthless, and people who sold the precious metal for the paper live to spend another day? I don't think ZH readers are going to believe that.
Man I hear so much about inflation / deflation
If gold is reacting like a real currency in relationship to what it can buy we are seeing deflation. Now when you consider fiat we see inflation. So we have both.
Our hole economic system is build on a continues inflation. Once it stops and goes the other way there is nothing that can stop it as there is nothing that gives money it's support anymore. A support would be gold or real printed money. These days, most of the money exists in a electronic way.
Our hole economic system is build on a continues inflation.
I don't know if the "hole" in your comment is just a typo, or a very perceptive and ironic comment. As I've noted in the past, from 1800 to 1900, on a gold standard, the US price level fell in half - a century of massive deflation (with periodic inflationary bouts). From post-Napeleonic Britain to the verge of WWI, under the sterling standard, prices were amazingly stable. From 1830 to 1910, for example, the cumulative change in the retail price index was zero, and the GDP deflator actually fell slightly.
On the other hand, as thousands here have commented, since the introduction of the Fed in 1913, the US dollar has lost over 95% of its value, and we know have a massive amount of debt to try to cover. Black "hole", indeed.
Deflation will persist for years and years to come.