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Non-Tech : Money Supply & The Federal Reserve -- Ignore unavailable to you. Want to Upgrade?

To: glenn_a who wrote (343)	8/16/2002 8:12:24 AM
From: Cush	Read Replies (2) \| Respond to of 1379

Inflation and Deflation. Hi Glenn. These are just a few quick thoughts before I have my coffee. You defined these two as- Inflation = an increase in money in circulation compared to the supply of goods and services in an economy. Deflation = a decrease in money in circulation compared to the supply of goods and services in an economy. While Money Supply can have an effect on Inflation and Deflation, I would not normally use it in helping define them. For me- Inflation - a fixed amount of anything costs more today than it did yesterday. Deflation - a fixed amount of anything costs less today than it did yesterday. Perhaps your post was a deeper perspective on my simple view. I'll go get a coffee and take another look. That was an interesting post. Beginning to feel like I'm back in school. My reading these days runs more to Carl Hiaasen than to Thorstein Veblen. <gg> And, I enjoy it more. Cush

To: glenn_a who wrote (343)	8/16/2002 8:22:45 AM
From: UnBelievable	Read Replies (2) \| Respond to of 1379

I Appreciate Your Comments Your comments about forces other than the Fed that may decrease the money supply are very useful. I'd like to take a little bit of time and think about them before responding. Your explanation does seem to illustrate quite clearly the way in which deflation may arise regardless of the Fed's monetary policy. I'll try to post something this weekend. The nuance which you have highlighted is "in circulation". While your definitions of Inflation and Deflation are correct (and ones to which I fully subscribe) the difficulty is defining (not to mention quantifying) money and real goods and services tends to enable the definitions to both be correct and yet somehow not very meaningful from a practical perspective. Previously I have written a post on Inflation and Deflation; Money and Wealth which attempted to clarify the distinction between money and wealth. It was written in response to someone expression of the idea that we might see both inflation and deflation at the same time depending in various sectors of the economy (inflation in health care. deflation in building products or commodities). In that post, a copy of which I'll post as a response to this post, I took issue with the concept of sector based inflation or deflation. In it I drew a clear distinction between wealth (anything that participants in an economy have a demand for because of some characteristic of the thing itself) and money (something which participants in an economy value solely because of the existence of a shared belief or understanding that it will be exchangeable for wealth). I also attempted to explain inflation and deflation from an "operational" perspective. I even made the point that if stock is goods and services and not money then when the value of stock declines the money supply should be decreased if the objective is stability of the unit of money. Part of what became clear to me in the process of developing that post was that the concept implicit in the classical definitions i.e. that maintaining a constant relationship between absolute increases or decreases in money vis a vis an absolute increase of decrease in goods and services may not be not produce a stable currency. Its getting to be time when I need to focus on the market if I hope to maintain my unemployed status so I'll have to finish later. In the meantime any comments you may have on the post would be of interest.

To: glenn_a who wrote (343)	8/16/2002 12:32:20 PM
From: Ahda	Read Replies (1) \| Respond to of 1379

Inflation = an increase in money in circulation compared to the supply of goods and services in an economy. Deflation = a decrease in money in circulation compared to the supply of goods and services in an economy. Would these be appropriate definitions or not? The definitions are dictionary correct but when you have surplus dollars in a market there has to be something that absorbs the excess. When you look at the past bubble the profit for business did not increase but the wages of the CEO's in certain companies increased due to a surplus of dollars. Then you look at the fact that not all who played the market lost. The cost of housing has better than doubled in Ca in the last six years but the population has not doubled. Product prices did not increase as efficiency in production maintained reduced costs but wages associated with bringing those products to market did. Surplus dollars found their way into the housing industry. So if you think about it the dollars buying ability has decreased but the dollars out there have increased. Then when you think in terms of deflation You are thinking in terms of too much dollar creation and that has decreased buying power of the dollar. Too many dollars are inflationary. If bread goes from 3.00 to ten it is only the dollars that are out there that causes the price of bread to rise. The vast portion of excess dollars end up in wage inflation which allows the cost of bread to rise.

To: glenn_a who wrote (343)	8/17/2002 3:41:10 PM
From: UnBelievable	Read Replies (1) \| Respond to of 1379

Distinguishing Inflation and Deflation From The Growth Or Destruction Of Wealth (Many of the terms and concepts which I refer to here were introduced in a prior post Message 17885050 For purposes of this post I am going to assume that the reader has first reviewed the prior post) So I'm then led to ask, well what exactly is money? Can we say that money is properly reflected in the standard monetary aggregates M1, M2, and M3? If so, what economic force would powerfully reduce the amount of this money in circulation? Money is a claim on wealth. A notional unit of exchange implemented in society as the complexity of their economic interactions makes the use of such an artifact useful. It is something which, were it not for the fact that the society has agreed to recognize it as being a claim on real wealth, has no value at all. I don’t think that any of the standard monetary aggregates, which are measured by the Federal Reserve, are correct. As you are aware they are: M1 - Money that can be spent immediately. Includes cash, checking accounts, and NOW accounts. M2 - M1 + assets invested for the short term. These assets include money- market accounts and money-market mutual funds. M3 - M2 + negotiable certificates of deposit. (This is a link to a publication from the Chicago Fed on money and the monetary aggregates: landru.i-link-2.net None of the categories actually measure only money. They each include both money and wealth. Money is a risk free claim on a constant unit of wealth. There is no time value of money. But wealth does have time value. A car today is more valuable than a car tomorrow or next year. In addition there can be no risk of loss of value as a result of economic transactions. When a dollar is deposited in a checking account or money market fund, from the perspective of the depositor, the dollar of money has been used to purchase a dollar’s worth of wealth in the form of invested capital. Depending on the type of capital purchased, the degree of risk may vary considerably. But there are very significant differences between a dollar and even a dollar deposited in a checking account, not to mention money market funds and negotiable certificates of deposit. What economic force would powerfully reduce the amount of this money in circulation? There is no economic force reducing the amount of money in circulation. It is wrong to assume that a price reduction in something is attributable to changes in the monetary aggregate because the prices of things are not determined by the monetary aggregate alone. They are primarily determined by supply and demand. In fact, what people are characterizing as deflation, and believing can be corrected with sufficient increases in the monetary aggregate, is a significant reduction in the demand for most things that is the result of a significant reduction of the wealth in the economy. The essence of what is going on in an economy is people exchanging stuff for other stuff. The artifact of money has been created to facilitate those transactions, but creating more money does not correct the destruction of stuff. We agree that inflation and deflation are monetary phenomena. The only can occur is an economy that has adopted some form of money. They cannot occur in a barter society. So a test that we can apply to determine if something is inflation or deflation is to attempt to replicate it in a barter economy. If we can, than it is not inflation or deflation. Well, speaking from my own example, a little over two years ago I had perhaps $80,000 in cash in a variety of cash or chequing accounts. This money came from liquidating capital gains made in the stock market during the course of 1999 and 2000. I presently have a negligible amount in liquid cash parked in cash and chequing accounts (or money market instruments). The reason being largely is that I took this cash and reinvested it in the equities, which have subsequently declined in value so that my total wealth as measured by the value of non-liquid assets has also been reduced, but my liquid assets are very close to zero (for arguments sake). Let’s put you in a barter economy and see if we can account for the change you describe. In this economy there are five people, you, three farmers, and a carpenter. Two of the farmers grow wheat and one grows vegetables. You are in the seed supply business. A while back you found out that farmers would give you more of their crop for their seeds at harvest time than they would at planting time. So you established the policy that a pound of seeds would cost a bushel of wheat, or ten pounds of vegetables in the spring, or you would be willing to wait for payment until the harvest, but then you would expect to receive two bushels of wheat or twenty pounds of vegetables. Two years ago you had many pounds of seeds. The farmers elected to pay you the higher price at harvest time and you sold them your seeds. But come fall while the vegetable farmer paid you as expected, one of the wheat farmers came to you and said that because of poor growing conditions he had a poor crop and could only pay 1 bushel of wheat per pound and he would try to pay you back the rest in future years. The other farmer never came to pay you at all. When you went to his farm you found out that this farmer had found out that he could distill whiskey from your seeds, had never planted them at all, but rather made them into whiskey and, to add insult to injury, he had already consumed all the whiskey so he could not even give you any of that. Now two years ago, when you had many pounds of seeds you were interested in having the carpenter build you a storage shed for your seeds. In fact you had spoken to the carpenter and he indicated that while he had no need for seeds that he would build you a shed for 100 bushels of wheat. But since you would not have the wheat until harvest time you told the carpenter that you would not be able to undertake the project until then. Well here it is harvest time and you have a lot less wheat than you expected. Additionally you have a lot less seeds that need to be stored. The carpenter comes to see you and asks if you would like to go ahead with the project. Since you don’t have as great a need, and since you don’t have as much wheat as you expected, you are less in need of the shed and have less wheat available to pay for it. So you tell the carpenter that at this point while you are still willing to have him build you a shed you can only pay him 50 bushels of wheat. He really does not like that deal but since he doesn’t have any other customers he agrees, after you agree that the shed will be a little smaller than you had originally discussed. (But still much bigger than you could have gotten him to agree to build for 50 bushels of wheat when you first talked to him.) The carpenter builds the shed, you give him the wheat, and he then goes to the vegetable farmer to buy vegetables with half of his wheat. The vegetable farmer already has more vegetables in inventory than expected since neither of the wheat farmers bought what he expected them to. The carpenter tells the vegetable farmer that while he is interested in buying vegetables he does not have as much wheat as he thought he would and works out a deal with the vegetable farmer to buy more vegetables with less wheat. This is the essence of what happened in you case and in the economy as a whole. Real stuff was wasted or destroyed. This has resulted in an overall reduction in the demand for stuff (remember that demand is not want, but rather the willingness to pay a certain amount for something). As a result people who wish to sell their products must reduce their prices. This is not deflation – this is loss of wealth. Increasing the supply of money is going to do little to resolve that problem in the present. Further it is going to make things worse than they otherwise might have been in the future. A major determinant of an economies productivity and wealth is its capital base. Capital is created when individuals decide to forgo things now for more later. To the extent that the increase in money supply results in greater uncertainty with regard to the constant value of a dollar, and further lowers the interest that people will get by investing, the amount of new capital formation will be less than otherwise would be the case. The fact that people are spending less now has much less to do with their willingness to spend or their confidence in the future than it does with the fact that they have less to spend. Until people can eat money or run their cars with money rather than gas (or for that matter drive money rather than a car) the idea that the central bank can correct the consequences of mal-investment and poor management by increasing the money supply will remain what it is – fantasy and illusion.