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Inflation, money spirals, and controls: which causes which?

 
 
shoes6
 
Reply Mon 2 May, 2011 01:42 pm
Hello,

Usually, when hearing or reading about economic depressions and the like, I get the impression that (1) the wage/price spiral causes (or is identical to) inflation, and (2) wisely controlling a sick economy is the best way to prevent economic disasters.

But recently, I've been reading stuff to the contrary. (No, I don't believe everything I read.)

I asked an economics professor to explain this and similar contradictions. He just said it's too complicated for anyone to understand.

Here's one example, which is presented as an example of Austrian and/or Monetarist thinking:

Wage and price spirals cannot exist unless somebody (i.e. the government) prints an increasing amount of money. A worker can demand a billion dollars (euros, yuan, whatever) per hour; a company can set the price of candy bars at a million dollars per candy bar; but these expectations will be rejected unless there actually are enough dollars (euros, yuan, etc) in the economy to perform the transaction.

So, the explanation goes, if anyone, whether laborer or capitalist owner, does succeed in raising his income in an economy with a fixed amount of dollars (which NO country has), someone else would necessarily lose income. There's only so much of it. But it doesn't work that way, because no country has a fixed money supply.

The government futilely attempts to fix this problem by increasing the money supply. Everybody gets more dollars! But in so doing, the government has only printed more dollar bills: it hasn't really created wealth. If there are more dollars circulating, the worker can successfully raise his wages, and the factory owner can raise his prices. Presto, inflation!

Thus, governmental interference in people's business causes inflation.

There is more to the approach than this one point. Supposedly, governmental meddling also causes depression, poverty, unemployment, and pimples.

I don't know enough economics to have an opinion about this. Can someone who understands econ please respond?

Thank you!

Ted Shoemaker
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parados
 
  1  
Reply Mon 2 May, 2011 01:48 pm
@shoes6,
You also have to remember there isn't fixed wealth in a society either. Wealth is added to society by more than just printing money. Wealth is added by mining minerals, growing crops, manufacturing items.
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cicerone imposter
 
  1  
Reply Mon 2 May, 2011 03:04 pm
@shoes6,
shoes, It's good that you are learning how to walk first (with shoes), to understand supply and demand about money. However, as your economics professor has already told you, it's very complex, because there are too many variables for anyone to be able to understand how money works in any economy.

If you understand the basics of supply and demand, most economists tell us that an oversupply of money will create inflation; too much money chasing the limited supply of goods and services. However, when you include the impact of the world economy that affects any currency, we get to understand how difficult it becomes to understand the effect of money.

Have you had the opportunity to study macro economics? It provides a pretty good understanding of how changes in interest rates can affect the whole economy - all in theoretical terms, but the real economy has many variables at play. If interest rates can affect GDP, think how the higher cost of energy will affect GDP. It does get rather complex, because it's impossible to consider all the variables of any economy.
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Pukka Sahib
 
  1  
Reply Thu 26 May, 2011 07:27 am
@shoes6,
The current economic crisis was due to the failure of the government to exercise proper regulatory control over mortgage banking and securities. Between 2004 and 2006, banks and mortgage lenders made millions of high-risk, subprime loans (i.e., 100% “piggyback” loans with adjustable interest rates “ARMs”, etc.) to borrowers that were unqualified for conventional financing and without due-diligence requirements for collateralization on the assumption that the real estate market could only go up and no one could lose. These loans were then packaged and sold as debt securities on the financial markets worldwide.

Then, predictably, things took a downturn. The interest rates on these loans went up, and borrowers started defaulting on their loans, precipitating a rash of foreclosures across the country. By August 2007, Countrywide Home Loans, the largest mortgage lender on the planet, was on the verge of bankruptcy; but was bought out by Bank of America in an effort to prevent its own equity position in the company from being extinguished. (A very risky move, for in taking over Countrywide, it had to assume a large portfolio of very bad loans.) The disintegration, however, continued with millions of defaults followed by foreclosures as real estate values plummeted. This in turn precipitated bank failures, including Indymac Bank (the largest since the crash of 1929), which was followed by the collapse of some of the biggest investment firms like Bear Sterns, Morgan Stanley, and Lehman Brothers (the biggest bankruptcy in history), the federal “conservatorship” of Fannie Mae and Freddie Mac, and finally the outright takeover of AIG. It had a cascading effect necessitating a government bailout with taxpayer funds just to stabilize the financial markets and prevent widespread, systemic economic chaos.

It was the fault of deregulation. The FDIC, FSLIC, HUD and FTC failed in regulating the banks and mortgage lenders, and the SEC had failed to exercise proper oversight of the sale of mortgage-backed securities. Even Alan Greenspan was forced to admit that he was wrong in thinking that the market could regulate itself. And, it will happen again because the Congress lacks the political will to establish regulatory control over financial markets. Even to this day, the government cannot account for all the bailout money spent.
cicerone imposter
 
  1  
Reply Thu 26 May, 2011 08:22 am
@Pukka Sahib,
Another problem that Greenspan created was the low interest rates that exacerbated the problems you identified above. Bernanke is doing the same thing with interest rates; banks can borrow on the cheap to speculate and charge usury interest to borrowers of money, while paying low interest on savings. They're doing everything ass-backwards; penalize savers and borrowers at a time in our economy when the rate of return on savings should match current inflation rates.
Pukka Sahib
 
  1  
Reply Thu 26 May, 2011 11:17 am
@cicerone imposter,
What is needed is to curb undisclosed speculation on the financial markets and provide more transparency to commercial transactions. The problem with regulating banking and the stock market can be easily solved with a single piece of legislation. Congress should repeal the safe-harbor provisions of title 11 that exempt financial derivative contracts from bankruptcy. (Derivatives are really secret liens that conceal leveraged borrowing carried “off balance sheet” - this was the lesson learned from the Lehman Brothers bankruptcy, and why AIG was “too big to fail” necessitating the government “bail-out.”) Without that exemption for “anonymous creditors” the market will be forced to regulate itself. It’s really that simple.
0 Replies
 
talk72000
 
  1  
Reply Thu 26 May, 2011 11:37 am
The current debt level of $14 trillion can only be explained that the Federal Reserve Bank put in $3 or 4 trillion in the banks that had something like $50 trillion in bank derivatives or over-leveraged loans or mortgages held by them. At the time of GWB leaving office the national debt was $9 trillion. The bailouts that were publicized amounted to just $800 billion or so.
cicerone imposter
 
  1  
Reply Thu 26 May, 2011 11:53 am
@talk72000,
Those same banks still have not acknowledged their losses on their real estate portfolios-derivatives, while they now show huge profits. Something is wrong in Kalamazoo.
talk72000
 
  1  
Reply Thu 26 May, 2011 11:58 am
@cicerone imposter,
Aren't they cunning. They reap the profits but want the nation to pony up for the losses. They the crowd - Israel lobby?
cicerone imposter
 
  1  
Reply Thu 26 May, 2011 02:01 pm
@talk72000,
This new language, "too big to fail," has gotten our government into a position that will continue to bite the middle class in the arse. Bankers are reaping huge bonuses, while the middle class continues to struggle in this economy.
0 Replies
 
Thomas
 
  1  
Reply Fri 27 May, 2011 04:33 pm
@shoes6,
Ted Shoemaker:

The basic equation governing the relation between money and the price level is the so-called Quantity Equation, which both Keynesian economics and Monetarism build on. (Even "Austrian Economics", whose support among reputable researchers is narrowly limited although conservative think tanks love it, doesn't explicitly deny it.)

M * V = P * T, where

M is the quantity of money,
V is the velocity of money (the speed at which money circulates)
P is the price level, and
T is the volume of transactions of money for value.

So yes, printing money will lead to inflation, other things being equal. But in the current economy, things are not equal because the recession is keeping V way down. Banks are hoarding newly-printed money in their vaults rather than investing it, consumers are putting it in the bank to pay down their debt rather than spending it. That's why, in the current economy, the Fed can print a lot of money without raising inflation, or even inflation expectations.

Hope that helped. For further reading, Google "Quantity Theory of Money"
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