Inflation vs Deflation XII

Nate closes out the Great Inflation Debate with his final entry:

So at long last we understand how hyper-inflation works.  It is caused
by hyper-velocity.  Meaning folks are spending their money as soon as
they get it.  I’m not going to go much into the differences in Weimar
and today… because honestly the differences are actually smaller than
Vox indicates.  See we have the worlds leading reserve currency.  
Companies and governments have enormous amounts of cash on hand ready to
dump.  As I showed previously… the Fed has no idea how much cash is
actually out there in the international market.  We know that there is
roughly 2 trillion in corporate cash reserves in the domestic market…
but we’re told its actually as much as 5 or 6 trillion in the
international market.. and that’s on the low end.  Kids… that isn’t
even counting what the governments around the world are hoarding.
 Remember one of the benefits of being the foremost reserve currency is
that oil is priced in dollars…  so to buy oil you first have to buy
dollars. That’s important  Its a big deal.  So there is a lot of demand
for dollars out there.  And a lot of dollars hoarded up.

And thus we see that the engine is certainly sufficient to put the
train in motion.  In fact there is probably enough cash out there to
blow it to hell and gone.  No.. its not like Weimar.  Its different.
 Its very different.  But history doesn’t repeat.  It rhymes.

A common, but often ignored, phenomenon is that even during
hyper-inflation the central bankers think that there isn’t enough money
to go around.  Why?  Because I have explained it is velocity driving the
problem.  Not an increased supply in money.  Remember that central
bankers are all worshipers of John Maynard Keynes.  Damn his eyes.  So
they see complex economic situations as simplistic equations that can be
manipulated with god-like precision.  They have equations that they
really believe accurately can describe something as complex as an
economy.  To much X?  Add a little Y.  To much V?  take away some Q.  I
know this sounds insane… because well… it is… insane.
 Keynesianism is far more idiotic than you probably think it is.

I leave it to the readers to decide which case they found more convincing. Of course, time will be the only meaningful judge, as for all we know, the current state of monetary disinflation could, at least in principle, continue until the sun grows cold.  In this regard, I somewhat disagree with Nate, in that if hyperinflation doesn’t at least begin to appear by 2016, I don’t think it would be necessary for him to concede. In any event, as one reader commented, there are no winners in this debate, everyone, including Ben Bernanke and Goldman Sachs, looks to lose out in some way.  It is better to be a shopkeeper in peacetime than a king in chaos; those whose times are ignored by the historians because “nothing happened” are the fortunate ones.

It might be interesting, however, to learn if your views were modified at all as a result of the debate.  By which I mean if you were formerly inclined to expect deflation but now consider hyperinflation more likely, or vice-versa.

Nate is putting the debate into epub format which will be cleaned up a little for typos and then made available as a free ebook for future reference.

Inflation vs deflation XI

I’ll start off this last round in
the debate by pointing out that I have most certainly not claimed that
federal spending somehow doesn’t count as inflation. I was simply
pointing out that the Federal Reserve’s attempt to inject money into
the economy has been effectively limited to one delivery vehicle because
the banks and households have proven to be surprisingly ineffective channels for doing so.
Again, Nate inadvertently shows how his refusal to accept the intrinsic relationship between credit and money renders his analysis
I very much agree that “for the
purposes on inflation it doesn’t matter who’s spending the new
money”. And I agree that “government spending is merely the
delivery method for injecting it into the economy”, but what Nate
is failing to mention here is that government spending isn’t the only, or
even the primary, delivery method used by the Federal Reserve. The
significant thing is that government spending is the only delivery method of the
four the Fed has been attempting to utilize for the past five years
that has worked at all. Despite the larger part of the Fed’s efforts
being directed at the financial sector, that credit sector has
continued to shrink. So has the household sector despite the
attempts to replace the housing sector bubble with an education
bubble. The corporate sector has responded, a little, but the $1.8
trillion increase since 2008 is barely more than half the contraction in
the financial sector.
Nate claims that prices are rising
everywhere across the board and that it doesn’t matter where the
government spends the new money. Both assertions are incorrect. Gold
prices are down 24 percent since the start of the year. Home prices
are up 1.1 percent in that same time frame, but are still down 29
percent from their 2006 peak. Gasoline prices are up from January,
but have been trending down since the spring of 2012. And the
inflated stock market is showing every sign of a steep, long-overdue
price correction. But these are merely symptoms, and short-term
symptoms at that. I see them as reflections of the credit
disinflation, Nate sees them as signs of incipient hyperinflation.
Only time will tell who was correct, so there is no point in further
belaboring the price issue.
Nor do I see any point in providing an
extended explanation of why Ben Bernanke appears to be signaling an
end to the quantitative easing program, or the significance of the
initial indications that Shinzo Abe’s massive attempt to print money
in Japan is failing, because Nate took things in a rather different
direction with his focus on the idea that hyperinflation is a
psychological phenomenon rather than a material one. Those who are
interested can find effective summaries of those two
not-insignificant events on Zerohedge. Nate wrote:
Hyperinflation is what happens when
people decide that the fiat money they have in their pockets and in
their accounts is no longer going to be honored in the future and
start spending it as quickly as possible.  That is the
unstoppable train of inflation.  The printing presses cannot be
stopped because the people will not stop spending the money as soon
as they get it.
But this perspective on hyperinflation again fails to
account for credit, which is how most people are spending most of
their money these days. Even when literal credit cards aren’t
involved, they are paying their bills with direct bank debits and
debit cards that draw from their credit money account. If one
considers the recently reported fact that 68 percent of Americans
possess less than $800 in savings, it should be clear that they
simply don’t have any fiat money in their pockets. To quote the
report: “After paying debts and taking care of housing, car
and child care-related expenses, the respondents said there just
isn’t enough money left over for saving more.” Emphasis added.
Nate’s unstoppable train simply doesn’t have enough of an engine to
leave the station, especially when the credit money that is in those
accounts begins vanishing in the inevitable bail-ins. 
In considering the possibility of hyperinflation versus the likelihood of deflation, it is important to do something we have not yet done in this debate, which is to examine the differences between the present situation and the most famous historical hyperinflation. As has been previously noted, in the USA, L1 total credit has remained very close to flat since 2008, increasing only 11.2 percent in five years. By contrast, in the period leading up to the Weimar hyperinflation, the Reichsbank debt increased from 3 billion to 55 billion marks between 1914 and 1918, and to 110 billion by 1920.  
“Businessmen found it very profitable to borrow money from the bank and buy up goods, shares and companies. Their debt was wiped out within weeks by the rapid inflation, and the businessman remained holding the valuable assets he had bought. The net result was a huge “private inflation” caused by the rapid expansion of credit…. By October 1923, 1% of government income came from taxes and 99% from the creation of new money.”
It should be readily apparent that Weimar represented a very different scenario than the one we observe today.  We are not seeing an increase in private borrowing, but rather, a net contraction. This means the only way
hyperinflation can even theoretically begin in the present circumstances is if
the Federal Reserve elects to permit the debtors in the various debt
sectors to pay off their debts rather than encouraging them to default by raising interest rates, and uses the
government to begin electronically injecting dozens of trillions of
dollars into the economy through the mainstream equivalent of food stamp
Is it possible? Theoretically. Is it
improbable. I think so, which brings this entire debate back to the
beginning, which is that one’s opinion on hyperinflation versus
deflation depends entirely on one’s belief that the Federal Reserve
is willing and able to choose the former over the latter. Setting
aside the fact that there are already those who believe that Bernanke
has followed the Depression-era Fed’s lead in choosing the latter on
the basis of his cryptic remarks concerning “tapering”, it is my
contention that the Fed is not only unable to massively inflate, but
that it is totally unwilling to do so.
Nate will have the last word, but since you’ve indulged his
imagination concerning the widespread abandonment of the dollar,
perhaps you’ll indulge mine concerning the motivations and mindset of the Federal Reserve in the present environment. Inflation and hyperinflation benefit
borrowers. Deflation benefits lenders, as they are repaid in
increasingly valuable currency. Default also benefits lenders as long as the collateral backing the loan exceeds the value of the outstanding debt.
So, in closing, I will simply ask you one simple question: at this point in time, is the
Federal Reserve a net borrower or a net lender?
By way of example, let me propose a hypothetical scenario that is perhaps a little outlandish,
if not completely in the zone of economic science fiction. The Ciceronian
political cycle predicts aristocracy, not tyranny, as the post-democratic political system. And what would be a more effective way to legally
establish a wealthy aristocracy with a relative minimum of societal disorder
than to encourage vast indebtedness, then trigger mass defaults by raising interest rates,
which then results in the acquisition of title to all of the defaulted collateral?  Even the most hard core libertarian couldn’t find anything to complain about such an action; (merely the idiocy of the centralized structure that permitted it to happen), and it would be a damn sight more legal than three-quarters of the activities with which the administration’s agencies occupy themselves these days.

Inflation vs Deflation X

Nate posts his latest entry in the Great Debate:

I know I said I would finally be explaining Hyper Inflation here, and I will be.  But there are a couple of points that Vox has made that I simply cannot let stand.  So as much as I loathe the call and response style of written debate, it appears I must resort to it.  I beg your indulgence….

Given that Vox acknowledges that there was a period of time when credit was contracting… and prices were going up, the actual timing of that period, be it July of 08 or Q1 09 is irrelevant.  He acknowledges that it happened.   The rest of this is elaborate hand waving.  Vox here is suggesting that the fact that the federal government is spending the new money, and that it somehow doesn’t count as inflation.   I am beginning to see the problem here.   Vox has literally just said, “Yeah but it doesn’t matter because its government spending.”  If we were arguing about the health of an economy… yes… we could certainly point to the distinction and say, “Its not real growth.”   But we’re not debating that.  We’re debating inflation vs deflation.  Inflation is never real growth.  That’s the point.  Of course its government spending.  Unless Vox wants to claim that inflation isn’t possible in a communist regime, then he must acknowledge for the purposes of this debate, the sector the increase is happening in doesn’t matter.  That just tells you who got to spend the money that was stolen from you.

Read the rest at his place.  My response, as usual, will be within one week.  At this point, all I will say is that in addition to the economics, the astute reader may also detect an aspect of the socio-sexual hierarchy in action.  I must certainly confess to an amount of wry appreciation for the irrational confidence of the alpha.

Inflation vs Deflation IX

Nate begins the eighth installment in the series by getting some things factually incorrect. To begin with, Z1 did not begin to decline in July 2008, as it peaked at $52.9 trillion in Q1 2009, a figure it did not reach again until Q3 2011, when it hit $53.8 trillion. 2008 merely served as the warning sign, as total credit growth ceased to keep pace with its 60-year historical rate, thus triggering two quarters of 10 percent growth in the federal debt sector in the latter part of the year. Gold and silver prices certainly did rise during that time, as did the stock market, but this was the result of the near-unprecedented increase in federal spending which was taking place at that time; even as the Household and Financial sectors contracted, the Federal sector expanded by $3.3 trillion.

Merely that Federal expansion, you will note, is considerably greater than the increase in savings over the same period. In fact, it is $1.2 trillion more than the total amount of extant currency plus demand deposits. And note that the government economists appear to have been keenly aware of the warning provided by the debt disinflation, (which you may recall was characterized as the “credit crunch” at the time), as the massive increase in government borrowing preceded the actual debt deflation by three quarters.

As Mises and others have remarked, inflation does not affect every sector of the economy at once. That is the whole reason it is desired by certain economic actors; they expect to benefit disproportionately from being able to spend less expensive money at its previous value. Nate’s tangent into malinvestment isn’t completely irrelevant, as real estate was certainly one of the primary areas of malinvestment, along with the health care and higher education sectors, but isn’t of particular importance because my case is not dependent upon housing prices. I have merely pointed it out because it shows that the inflation, despite massive reinflationary efforts, hasn’t been enough to counteract four years of ongoing credit contraction across the economy.

Nate is looking at Z1 – or to be more precise, L1 – as a whole rather than in its component parts. This is not unreasonable, but unless one looks at the component parts, one cannot understand the importance or the consequences of the shift in the nature of the credit market that has seen the federal element double from 10.3 percent of the entire credit market to the current 20.6 percent.

What Nate sees as evidence of inflation, the modestly higher prices in the gold, silver, and equity markets, is largely limited to the areas of direct federal intervention.  This is why health care and higher education prices are still rising to new heights, while real estate prices are struggling to get back to where they were.  The areas that are reaching new heights are where the outstanding $11.6 trillion in government credit is flowing.  That is where the malinvestment is still being directed.

I will not dig further into Nate’s answers. I don’t know the answer to them either, the point was to direct attention to what Nate sees as significant, which is the total amount of savings and the cash in the various banks. What Cyprus should have sufficed to demonstrate was that the greater part of the “savings” he cites do not exist in any material capacity except as debt claims.  As has been repeatedly pointed out here, deposits are legally defined as debts owed by the bank to the depositor and therefore qualify as credit money even before they are subsequently loaned out, and “multiplied”.

Now, Nate concludes with citing the 56 recorded historical incidents of hyperinflation. It is true that hyperinflation is possible within a nominal credit money system, (especially in the broader sense in which Mises and I question the existence of true fiat money), but that is not to say that all credit money systems are created alike.

I note that each of these hyperinflationary scenarios were very short-lived and tended to be closely tied to serious political upheaval.  The longest period is two years, which happened twice in China during the 1940s.  Note, however, that these hyperinflations tended to take place AFTER the wars or major political upheavals; the frequency with which they take place after independence is gained by a nation is reminiscent of the high inflation that plagued the American colonial currencies and the Continental Dollar.  If any hyperinflation were to take place, history suggests it would likely take place after the collapse and political chaos; it would be a result of it, not a cause.

What Nate omits to mention is that there have been even more sovereign defaults, which he concedes are deflationary, than hyperinflations since the first hyperinflation on his list took place in 1919.

Nate is correct to say that one must be careful not to mistake “can’t” with “won’t”. But his flight analogy fails, because I am not claiming that something must be lighter than air to fly in defiance of the 56 airplanes soaring overhead, but rather, pointing to a particular vehicle, constructed from empty shipping containers and bound together with string, chewing gum, and tefillin straps, watching the pilot repeatedly taxi up and down the tarmac, and expressing my doubts that it is going to take flight.

We have seen massive increases in virtual every monetary measure. We have been told to expect considerably inflation. And yet, we are still not seeing a rise in general prices concomitant with the size of the expansion. Ben and Mario are monetizing the debt like mad. Kuroda is acting even more aggressively. To the extent their efforts to expand the limited amount of inflation they have created in the financial markets and move money out of the bank reserves and into the general economy have failed, the situation appears to be more “can’t” than “won’t”.

Remember, it’s not enough to merely print the money. The amount printed and distributed has to be greater than the continuing contraction of private credit and the evaporation of bank deposits.  And keep in mind that the combined $4.2 trillion decline in outstanding Household and Financial sector credit since 2009 alone exceeds, by a factor of nearly four, the ENTIRE AMOUNT of U.S. currency presently in circulation.

The amount of credit outstanding is simply too great for helicopter dropping of actual cash and coins to be able to compensate for much of it. And simply flipping an electronic switch and adding a zero to everyone’s bank account isn’t going to change anything at all because the entire financial system depends upon inflation working its way gradually through it.

Nate is correct to note that people are becoming increasingly drawn to holding cash in the hand, but he is forgetting that when cash becomes more valuable in this manner, it is strongly indicative of a deflationary environment, not an inflationary one.  In an inflationary environment, one wants to take on more debt and hold less cash. In a deflationary environment, one wants to avoid debt and hold more cash.  The intellectual gymnastics notwithstanding, one’s true position on this matter can be ascertained by one’s material preferences and actions.

“In fact, a money that is continually depreciating becomes useless even for cash transactions. Everybody attempts to minimize his cash reserves, which are a source of continual loss. Incoming money is spent as quickly as possible, and in the purchases that are made in order to obtain goods with a stable value in place of the depreciating money even higher prices will be agreed to than would otherwise be in accordance with market conditions at the time. When commodities that are not needed at all or at least not at the moment are purchased in order to avoid the holding of notes, then the process of extrusion of the notes from use as a general medium of exchange has already begun. It is the beginning of the ‘demonetization’ of the notes.”
– Mises, The Theory of Money and Credit, p. 227

Inflation vs deflation VIII

As is probably becoming rapidly apparent, this debate over inflation vs deflation, despite its esoteric nature, is turning out to be much more practical and relevant than anyone would have previously imagined it to be. The events in Cyprus make this more a discussion of current events than a purely academic matter.  In his most recent post on the subject, Nate began with an admission concerning that we are both talking about the same definition of fiat in one sense of the term.

 Broad definition…  narrow
definition…  it is readily apparent the
broader definition is what I am referring to here. But one must remember that I
am actually no longer using Mises’ definitions at all. I am defining money as
it relates to the commodity competition… not its nature.  I call it fiat money not because it has
government force behind it, but because it is that government force that makes
the commodity win the commodity competition and therefore become the
money.  Credit money doesn’t exist at all
in physical form and thus doesn’t compete in the competition and is not
actually money.  

Why he calls it fiat doesn’t really matter for the purposes of this debate.  However, while he is right to say that credit money is not actually money, (you may recall that I defined it as a “money surrogate”), he is incorrect in stating that it doesn’t exist in physical form.  It does exist; the paper dollars you hold in your pocket and the paper Euros that the depositors in Cyprus are presently unable to obtain are both representatives of a form of credit money.  Now it is true that the paper to mark all current credit claims are seldom, if ever, printed, this doesn’t change the fact that some of them are printed and that they are actual physical representations of the outstanding credit claims.

What is important to note… and what Vox is missing… is that
it when the credit money is created by time-shifting like this is not
considered inflationary.  The interest is
rewarding those who have saved, and it all washes out in the end.  The interest rate, which is the price of
time-shifting money, fluctuates as demand for time-shifting increases and
decreases… and that.. all by itself… mitigates the boom and bust cycle created
by the lending.  As more people borrow,
the price of borrowing goes up… bringing that number back down.  As fewer people borrow the price is lowered
so more will borrow… bringing the number of borrowers back up.  We find a happy medium where the interest
rate is moving around, but the purchasing power is relatively stable.  The risk banks take when leveraging money also
influence that price… which we call the interest rate. All of this works
together nicely.  Which is why when Mises
talks about inflation he always talks about government. 

This is indeed how it is supposed to work.  It is how economists are taught that it works.  But it doesn’t work this way and Nate is incorrect in stating that the creation of credit money is not inflationary.  There are several ways of demonstrating that this is the case.  The one I will utilize here is to look at the supply and demand curve and what happens when credit money is injected.

The creation of credit money always has an immediate effect on prices because it increases the applicable demand.  I shouldn’t need to draw any SD curves, as we can see the effect that expanded home loans had in the housing market, that increased student loans have on the price of tuition, and even in the health care market, where governments borrow the money that is used to pay for the “free” health care delivered to indigent patients.  No cash is being printed, and yet credit money is being created, transactions are taking place, and prices are rising.  While these effects are localized to the relevant markets I suspect the reason why economists historically failed to connect them to the broad increase in price levels that is usually described as inflation is because until relatively recently, it was not possible to obtain general, pre-approved credit for even the smallest transactions.

The economists failed to anticipate either the “credit card” or the debit card, which allows the depositor to tap directly into the credit expansion system without the need to interfere with the expansion by withdrawing the physical debt markers.  And those few who did failed to grasp the full extent of the eventual consequences.  This is why the bankers and governments are so firmly against cash economies; it is actually less about control and tracking, (although obviously governments appreciate the potential benefits of the latter), but because a wholly digital system theoretically allows for unlimited credit expansion… from the traditional perspective.
That is how it is supposed to work.  And when its working like that… we can look
at the amount of money in a given account that exists above and beyond the
deposits in that account and we call it credit money.  Because it exists above and beyond the
deposits in the account, it has no physical representation.  The coins, or dollar bills, do not
exist.  I need you to be clear on
this.  I have a checking account with say…$45,000
in it.  If I go to the bank and ask them
for $45,000 in cash… they will laugh in my face.   However, debit cards are swiped, and the
credit money is accepted exactly like cash is accepted.  That is the miracle.  And it is a miracle… of faith.  
The key phrase being “when it is working like that”.  Nate is correct on all the details here, except that he is still failing to recognize that it is ALL the money in a given account that is credit money, not merely “the amount of money in a given account that exists above and beyond the
deposits in that account”.  This should be abundantly clear in light of the Cypriot situation, where the banks cannot open because, despite their nominal billions on deposit, they have literally no paper markers left to give out even though there are numerous levels of government that are capable of declaring fiat markers to represent those credit claims.  The problem is not that there is no government to print the fiat, but rather, the fact that no one wants to be stuck with the underlying credit claims.
So now that we understand borrowing and lending we can
discuss what is wrong.  And what is wrong…
is the central bank.   Central banks
break the link between savers and lenders. 
Rather than the deposits being the source that creates the leverage, you
now have a central bank that is merely using the deposits to rationalize its
decisions to expand credit.  The deposits
of savers are reduced to mere justification. 
The central bank sits on high, and manipulates the interest
rate… which eliminates its ability to mitigate the booms and busts of the business
cycle.  Then on top of that… the evil
bastards then set themselves up as the Credit Gods… passing out credit as they see
fit… attempting to manage an economy every bit as much as the communists ever
did, and failing just as spectacularly.
If you get nothing else… I hope and pray you grasp
I can’t argue with anything here, except to note that as has been demonstrated with MF Global, the deposits themselves are, quite literally and legally, loans from the depositor to the bank or fidiciary entity.
So if you have made it this far you now realize that the
money in your checking account doesn’t actually exist.  its not that the
banks just don’t keep that much cash stored.  There isn’t that much
cash in existence.  Not even close.  
So now that the terror has sunk in… what is the urge that
you’re squelching down right now?  Is it the urge to go borrow more money?  Or is it the urge… to go get your cash and
stick it under your bed?
Exactly.  And now you
see why Vox’s measure of the money supply is incorrect.   M1 is the real
money.  M2 and TSM2 are close approximations of the
purchasing power currently available… though obfuscated through
shenanigans.  Z1… well Z1..  Is just a measure of claims on money.  It
doesn’t reflect a limit on new future
claims.  At best it can serve as an
indicator of how much new credit money is being created.  Z1 will never
be able to show deflation.  That’s because Z1 doesn’t show a credit
it shows a credit balance.  See if I have
a $5000 credit limit on my credit card… and I owe $5000… then my credit
card is
showing up as $5000 on the Z1 report.  If
I pay my credit card down to a balance of $2000, then my credit card is
up as $2000 on Z1 which Vox would then say is a reduction in purchasing
of $3000.  This is incorrect.  My high credit is still $5000.  I can go
spend that $3000 in credit money any
time I want to.  Z1 is certainly a
valuable tool, but it is a limited one.  Now…
as has been said… one cannot print borrowers… so if the rate of credit
is slowing, or going down instead of up it can mean bad things…for
example the
delivery system for new credit can be interrupted.  That said, if one
considers the nature of the
financial abomination that we have before us, I can certainly not fault
Vox for
going that way.  However, it is not where
I go.
Here is where Nate begins to go more seriously awry.  M1 and M2 are not real money anymore than Z1 is, they are merely money substitutes whereas Z1 is a money surrogate that encompasses them both.  I recognize that Nate is not using the Misean definitions any longer, but I don’t see that his rationale for refusing to do so is necessarily justified or even relevant to determining the inflation/deflation question.  More importantly, his distinction between credit limit and credit outstanding is, if not necessarily false, entirely irrelevant.  It is only credit outstanding that matters; the “limit” is an entirely artificial one that, in this case, represents the extent to which the bank is willing to enable Nate to expand the credit supply.  But that’s not an actual limit in the sense that Nate’s decision to not use his potential credit or even to pay down his outstanding credit is, which is the limit I mentioned in Limits of Demand when I proposed it as an alternative mechanism for powering the Austrian Business Cycle.  Nor is there any macro credit limit; this is why Bernanke and the European Central Bank imagine, erreoneously, that they can expand it indefinitely as they see fit.

But, as we saw in 2008, outstanding credit can and will contract.  Even a slowed expansion of the sort we have seen since 2009 can have a deleterious effect on an economy which depends on a reliable 2.4 percent growth rate per quarter.
The whole reason credit money works, is
because there is a faith-based link from that credit money directly to
cash.  Thus, the money, right now, is cash.  What you’re seeing is
precisely what happened
in the Great Depression.  People wanted
their cash.  They hid it inside walls and
buried it in jars.  Banks collapsed destroying
massive amounts of credit money, but folks still wanted their cash.  But
Vox fails to recognize a critical
underlying difference between then, and today. 
He looks at those in control… the government and the central bankers…
and he sees them expanding credit.  He
understands the system better than almost everyone, including the
bankers, and thus he uses that understanding to predict how the system
behave.  He expects it to behave the way
it behaved in the 1930s. 
The link is stronger than Nate asserts.  These days, credit money is cash and cash is credit money.  And Nate also credits me with more confidence than I actually possess.  I know the system won’t behave the way it did in the 1930s, in fact, that is precisely what concerns me most.  Unlike before, the banks are not being permitted to collapse, which is why Z1 hasn’t collapsed yet either.  But the bad loans still exist even though they still haven’t been written off.  We are in strange and unpredictable waters here.
I have to take you back again to the competition which
Vox , to his peril, ignores. So we have these commodities battling it
in a competition of demand.  Not supply.  Demand. 
The one most in demand wins and becomes the money.  The demand is the
key.  People want that commodity.  They want it badly and everyone knows
want it badly.  So because everyone knows
they want that commodity badly… everyone knows that they will be able
trade that commodity.  They have faith…
faith friends… that they will be able to exchange that commodity in the
for other goods and services they require
That’s all good and well if we’re talking about something like
Gold or Platinum or Silver.  People want
it because of what it is… and what it is will not change.  But fiat money?  Well… they want it because of all manner of
government related enhancements.  If it
weren’t for those enhancements… they wouldn’t want it at all.  But those enhancements exist…  so long as
the people have faith in that government. And that is why I define it as fiat

I suspect Nate has made a fatal error here, because recent events show that faith in government, in the banking system, and even in cash itself is rapidly dissolving.  Everyone now understands that the Cypriot banks don’t have 7 billion cash euros in their vaults, but more importantly, they now also understand that the government can instantly make 10 percent of it disappear regardless of whether if it was in cash form or not.

And when money surrogates, money substitutes, or solid money itself disappears, that is a deflationary action.  Our continued differences of opinion notwithstanding, I think we’ve now covered sufficient theoretical ground that we can move on to the practical aspect of the debate, so I will conclude by asking Nate three questions. 

  1. If the expected outcome is, as he suggests, inflationary, due to the central bank printing presses why has the European Central Bank not simply used the bank holiday to print the required 13.5 billion euros and allowed its customers to withdraw as much of it happens to suit them?  
  2. Why is the ECB risking the Cypriot banking system, the wrath of the Russian depositors, and the fate of the European Union itself on these various schemes rather than simply printing the cash and permitting its withdrawal?
  3. Imagine an American analog, where a bank with billions in deposits but already emptied of all its cash was simply shut down without the usual FDIC shell game of “transferring its deposits” to another bank.  Would this be a deflationary action?

Inflation vs deflation VII

Nate responds with post entitled “Half-Truism”: 

“There are those who say that he cure for inflation is deflation.
 And… there are those, though they are few, who say that the cure for
the man who has been run over by a motorcar, is to have the same
motorcar run over him in the opposite direction.”

– Ludwig Von Mises, “Lecture on Inflation”, 1968

Broad definition…  narrow
definition…  it is readily apparent the
broader definition is what I am referring to here. But one must remember that I
am actually no longer using Mises’ definitions at all. I am defining money as
it relates to the commodity competition… not its nature.  I call it fiat money not because it has
government force behind it, but because it is that government force that makes
the commodity win the commodity competition and therefore become the
money.  Credit money doesn’t exist at all
in physical form and thus doesn’t compete in the competition and is not
actually money. 

As you have noticed by now these responses are coming slower
and slower.  That’s because, by the very
nature of the problem, as we drill down, more and more remedial teaching is
required.   There is a knowledge base
that is required to understand these points… and we must first make sure the
reader has it.

I shall respond to this within the next day or three, as before.

Inflation vs Deflation VII

In his post entitled Fiat or Shenanigans, Nate contested the idea that US money is credit money and not fiat money with the characteristics of credit money:

Remember I said our money was fiat money… with characteristics of credit money.  Right?  Vox says I am wrong about that.  And… while I considered rushing off to donate some money to an unrelated charity in his name and make a video about it…  instead… I just decided I would address his well made point like an adult…  mostly…

Vox said: “Nate’s first mistake is the identification of credit money as fiat money, even though he clearly has his suspicions concerning the problematic nature of the distinction as it applies to the US monetary system.  That this distinction is false can be demonstrated in two ways, first with a legitimate appeal to authority and history, and second by the money creation process.”

He then provides a quote from Mises, that I agree, does indeed say that fiat money doesn’t yet exist and probably hasn’t existed.  Vox appeals to Mises who appeals to history.   And Nate points out… well shit…  this book was written in 1912…  it appears we have some more history to investigate before that holds water doesn’t it?  Well lets look at this new history then… especially… recent history.

Say what does our buddy Murray have to say about fiat money?

“Under a fiat money standard, governments (or their central banks) may obligate themselves to bail out, with increased issues of standard money, any bank or any major bank in distress. In the late nineteenth century, the principle became accepted that the central bank must act as the “lender of last resort”, which will lend money freely to banks threatened with failure. Another recent American device to abolish the confidence limitation on bank credit is “deposit insurance”, whereby the government guar­antees to furnish paper money to redeem the banks’ demand li­abilities. These and similar devices remove the market brakes on rampant credit expansion.”

While the quote from Mises does date back to the 1912 text, Mises himself lived until 1973 and witnessed all of the innovations mentioned, even the removal of the convertibility to gold by President Nixon.  I am not aware of any point at which he changed his opinion on this matter, nor does Nate suggest that he did.

Given the fact that the FDIC’s deposit insurance observably does not take the form of paper money being furnished to redeem the failing banks’ demand liabilities, but rather transfers those liabilities to other banks in the system without any paper money at all being furnished to anyone, I think it is safe to conclude that Murray does not have a sufficient grasp on the difference between fiat money and credit money for his statements to be relevant here.  Moreover, the statement that the central bank is “the lender of last resort” itself tends to underline the fact that the “deposits” are, in fact, credit and not pure fiat.  The central bank is not actually “lending money” to banks under duress, it is merely inflating the amount of credit at their disposal.

Recall that when you make a payment from your ebanking account, the bank declares it will make the payment “provided there is sufficient credit” on your account.  It’s all credit, both in electronic form and paper form.

Nate continues:

Are we done?  No… no no no… we’re along way from done.   Remember.. Mises characterized fiat money by legal privilege.  Legal Privilege?   Consult the MisesWiki!  According to Hülsmann, there are four groups of legal privileges granted by the state (usually more than one is granted):

  1. legalized counterfeiting – the promises of banks are allowed to be more “elastic”. For example, a coin marked “an ounce of gold” will be allowed to have any amount of gold or none, and can have any meaning. Banknotes were named “promises to pay”, but were obscure on the details.
  2.  monopoly – only some monetary products may be produced by law, like a specific metal; or only the banknotes or coins of a certain bank. This limits the freedom of choice of users of money and benefits the producers and first recipients at the detriment of others.
  3. legal tender is a money, that must be accepted in exchanges under a predefined price. Some monies may be driven out of the market due to Gresham’s Law.
  4.  legalized suspension of payments allows banks to avoid paying their obligations, while receiving payments from their debtors. If a bank is freed from contractual obligations to redeem its money and it is also legal tender, its banknotes become genuine paper money. With legal privileges are the banks allowed to behave more irresponsibly, which increases moral hazard.

Here we get to the crux of Nate’s error.  Nate is correct to point out that the Federal Reserve’s credit money is declared to be legal tender and is legally privileged by the federal government.  In this sense, he is correct in saying that the US monetary system is fiat money.  However, this only is the wider sense in which the Mises Institute defines the term:

Often called paper money, fiat money is in a wider sense any money declared to be legal tender by government fiat (ie law). In the narrower sense used here, fiat money is an intrinsically useless good used as a means of payment and a storable object.

The narrower sense of fiat money is clearly the sense Mises was using the term when he declared “most of those kinds of money that are not commodity money must be classified as credit money” and questioned whether fiat money had ever existed.  And that narrower sense cannot possibly apply to the Federal Reserve notes, as most “dollars” are a) not a good, useless or otherwise, b) not a storable object, and c) not a risk-free convertible claim to real money.

Nate would be correct to claim credit money is fiat money in the wider sense, but then, I completely agree with that.  I am simply declaring that US currency is credit money that is not fiat money in the narrower sense.  Nate is incorrect to say that it is fiat money in the narrower sense, which is the sense that most people believe it to be.  Nate continues:

Now are we done?  Well… not really.  Because what I’ve done here isn’t intellectually honest, in the sense that I have not represented the whole of Vox’s point.  The reason I hated Chapter three is not because of confusing terms like fiduciary media.  Its because Credit Money itself is a category error.

Credit money is a description of leverage. But…  Leverage can be applied to all types of money….  Thus… Credit Money… is a subcategory.  Credit Money is what happens when you take money of any other type.. and then leverage it up for lending purposes….  Leverage is something that happens to Money Types.  It isn’t a money type itself.  Its like including cancer cells in a discussion of  human  cells because they form in the human body.  Cancer cells aren’t human cells.

We must always go back to competition.

Money is money because of the constant commodity competition   Every day the competition is on going… and every day one commodity is winning.  that one commodity that is winning… is the money.   The money types… are explanations of WHY the competition is being won.  Fiat money is fiat money because the government helped it win artificially and it wouldn’t have won otherwise.  Take away the government advantage… and its not the money anymore. Commodity money types?  Well they have no artificial government advantage.

That is the true definition of sound money.

Its money that wins the competition… every minute of every day…  the on going competition… not some past competition .. on its own without aid of the government.

All modern paper currencies are fiat money.

The bits that are loaned into creation from thin air?  Those are credit money too… but it is dishonest to ignore the fact that it is fiat money as well.  Loans may have created the individual dollar bills… but those dollar bills wouldn’t be money… if it wasn’t Fiat.

May God have Mercy on my soul…   Ludwig Von Mises… was wrong.  You cannot disregard the fiat nature of the original money… just because most of it was created through leverage.

So Fiat?  Shenanigans?

The answer is both.  Not one.  Not the other.   Both.  To fail to grasp that… will totally blind you to the inherit problems of our current economic system.  The money is fiat money and credit money.. because much of which was created via leverage… but also much of it was created through counterfeiting.   This is why I created the word “clusterfutastrophe” while attempting to parse the US money supply.

Nate is stumbling towards the truth here, which is that credit money is fiat money in the wider sense but not the narrower one, but is still stumbling.  He is still hung up on the basic concept of credit money, which is why he erroneously calls it a category error.  What he is failing to grasp is the central importance of credit in the monetary process, one which precedes the role that government plays in either guaranteeing the credit claims or establishing the legal privilege of those claims.

“When all exchanges have to be settled in ready cash, then the possibility of performing them by means of cancellation is limited to the case exemplified by the butcher and baker and only then on the assumption, which of course only occasionally hold good, that the demands of both parties are simultaneous. At the most, it is possible to imagine that several other persons might join in and so a small circle be built up within which drafts could be used for the settlement of transactions without the actual use of money. But even in this case simultaneity would still be necessary, and, several persons being involved, would be still seldomer achieved.

These difficulties could not be overcome until credit set business free from dependence on the simultaneous occurrence of demand and supply. This, in fact, is where the importance of credit for the monetary system lies. But this could not have its full effect so long as all exchange was still direct exchange, so long even as money had not established itself as a common medium of exchange. The instrumentality of credit permits transactions between two persons to be treated as simultaneous for purposes of settlement even if they actually take place at different times”
 – Mises, The Theory of Money and Credit, p. 282

The important aspect of credit is not its ability to be leveraged, which is a consequence of the characteristics of money rather than an integral aspect of credit, but rather its ability to transcend time.  It is the fact that the credit is a claim to money rather than to some other commodity that permits its expansion beyond the existing money supply.

“A person who has a thousand loaves of bread at his immediate disposal will not dare to issue more than a thousand tickets each of which gives its holder the right to demand at any time the delivery of a loaf of bread. It is otherwise with money…. The fact that is peculiar to money alone is not that mature and secure claims to money are as highly valued in commerce as the sums of money to which they refer, but rather that such claims are complete substitutes for money, and, as such, are able to fulfil all the functions of money in those markets in which their essential characteristics of maturity and security are recognized. It is this circumstance that makes. it possible to issue more of this sort of substitute than the issuer is always in a position to convert.  And so the fiduciary medium comes into being in addition to the money certificate. Fiduciary media increase the supply of money in the broader sense of the word; they are consequently able to influence the objective
exchange-value of money.”
 – Mises, The Theory of Money and Credit, p. 267

Note that the credit aspect not only predates the broader fiat aspects, but is, in fact, intrinsically necessary for the eventual expansion.  Nate concludes with a question

Its not that there is no money.   I already explained that there is always money.  Money…is like energy.  It cannot ever be destroyed.  It can change forms… its velocity can change.  But it cannot be destroyed.  The problem is… our system is so screwed up through fiat and leverage… that we can’t even measure the money supply any more.  Come Vox… be sensible… you’re absolutely right to point out that the leverage can’t be ignored… but you were wrong to suggest that the fiat aspects can.  Now tell us Vox…  What IS the best way to measure the abomination posing as the US money supply?  He asked knowingly…

First, I’ll point out that since we have a system “in which the actual transfer of money has been completely superseded by fiduciary media”, it doesn’t matter that we can’t measure the money supply anymore.  Because we’re no longer using actual money, we are merely using possibility of money in order to support the extensive system of potential claims to theoretical future money.  Or, as Nate rightly calls it, a financial abomination.  As strange as this sounds, it was anticipated at least 101 years ago, as Mises notes:

“Use is made of money, but not physical use of actually existing money or money substitutes. Money which is not present performs an economic function; it has its effect solely by reason of the possibility of its being able to be present.”

In answer to Nate’s question, the best way is to measure the sum total of all the current outstanding claims.  This is approximated in the Federal Reserve’s Z1 Flow of Funds Accounts, specifically the L1 credit market debt outstanding report.  And it is the expansion of this supply, though not strictly speaking “inflation” per se, that effects exchange value and therefore the prices of goods and services.

Inflation vs Deflation VI

Nate boldly elects to defends his position concerning fiat money in a post entitled Fiat or Shenanigans:

You.  Whimpering in the corner.  Suck it up and get back on your feet.  You knew the US money system was a wreck or you wouldn’t be reading this debate in the first place.  So Vox and I conspire through competition to show you precisely how wrecked it is… and at the first glimpse you curl up in a little ball.

Man up.  Its not going up hill from here.

Setting aside the obvious difference of opinion that we have (he’s wrong by the way which I will presently demonstrate with no little amusement), our view of where we stand in the grand scheme of things is profoundly similar.   If you look carefully… you’ll see that I was the one that dropped the bomb… not Vox.  Vox just stepped back and said.. “did you see that bomb he dropped? Say boys… That’s a big freaking bomb.  I doubt even he knows how big a bomb he just dropped.”  Then, being the cruelty artist he is, he explained the bomb. Then you realized…  “Oh damn.  There’s a bomb.”

You see what this debate is important?  It’s the format.  The format itself allows you to accept things that you would otherwise refuse to believe. 

The five or six of you still attempting to follow this debate should read the rest of it there.  My response will be posted tomorrow.

Inflation vs Deflation V

In his second response, Mount Chapter 3, Nate provided four categories of money:

  1. Commodity money
  2. Fiat money
  3. Money certificates
  4. Credit money

He also answered my questions, which I shall summarize as follows:

  1. When they function like money, gold and silver are commodity money, as evidenced by the historical preference for them.
  2. Federal Reserve Notes are fiat money, with some characteristics of credit money.
  3. TMS2 does not represent his definition of the money supply, but serves as a useful tool for estimating it.
  4. All of the categories in TMS2 are fiat money; some may be credit money as well.

It was a strong and informed response, much better than one would likely receive from a professional economist or a central banker.  Two of his answers were also incorrect, for reasons I shall presently demonstrate.

Nate’s first mistake is the identification of credit money as fiat money, even though he clearly has his suspicions concerning the problematic nature of the distinction as it applies to the US monetary system.  That this distinction is false can be demonstrated in two ways, first with a legitimate appeal to authority and history, and second by the money creation process.

With regards to the first point, Mises writes:

“It can hardly be contested that fiat money in the strict sense of the word is theoretically conceivable. The theory of value proves the possibility of its existence. Whether fiat money has ever actually existed is, of course, another question, and one that cannot off-hand be answered affirmatively. It can hardly be doubted that most of those kinds of money that are not commodity money must be classified as credit money. But only detailed historical investigation could clear this matter up.”
  – The Theory of Money and Credit, p. 61

So, we recognize that while fiat money can potentially exist in theory, the question of its actual existence, in the United States or anywhere else, is not settled.  Nate himself notes that Federal Reserve Notes have some characteristics of credit money and that some of the categories in TMS2 may be credit money, but he fails to take the critical step, which is to recognize that the reason they have those characteristics is that they are credit money.  Note in particular the statement that most kinds of money that are not commodity “must be classified as credit money”.

This leads us to our second point.  The “fiat money” of TMS2 includes Demand Deposits, Other Checkable Deposits at Commercial Banks, Other Checkable deposits at Thrifts, Savings deposits at Commercial Banks, Savings Deposits at Thrifts, Demand Deposits, Time and Savings Deposits, and US Government Demand Deposits, among other things.  But from whence do these deposits come?  We know they are not simply printed by either the U.S. government or the Federal Reserve; there is simply not enough currency to account for them.

Clarity is established here via the the endogenous vs exogenous money debate.  We’re not likely to get sidetracked here, because Nate ultimately comes down on the endogenous side, he simply hasn’t connected it to his conception of fiat money.  Mises, too, comes down firmly on the side of endogenous money, as evidenced by the following passage:

“It is not the State, but the common practice of all those who have dealings in the market, that creates money. It follows that State regulation attributing general power of debt-liquidation to a commodity is unable of itself to make that commodity into money. If the State creates credit money – and this is naturally true in a still greater degree of fiat money – it can do so only by taking things that are already in circulation as money substitutes (that is, as perfectly secure and immediately convertible claims to money) and isolating them for purposes of valuation by depriving them of their essential characteristic of permanent convertibility. Commerce would always protect itself against any other method of introducing a government credit currency. The attempt to put credit money into circulation has never been successful, except when the coins or notes in question have already been in circulation as money substitutes.”
  –   The Theory of Money and Credit, p.78

The significance of endogenous money to us here is that it shows that deposits of the sort that make up the TMS2 are created by loans.  They are, to the extent they can be considered money at all, quite literally credit money.  As the market in commercial paper demonstrates, these loans, these future claims, whether created by the central bank, the member banks, or other corporations, have become a commodity in their own right.

And yet, although we can establish that M1, M2, TMS2 all consist of credit money, none of these various money supply measures can be considered money by our original definition, even with its stamp of fiat approval, because the credit money concerned is not directly convertible into commodity money on demand and has not been since 1971.  Despite its use in exchanges, by our agreed-upon definition, this credit money merely represents claims to money rather than money proper, it is a money-substitute money surrogate, which Mises rather confusingly describes as “fiduciary media”.

(“We shall use the term Money Certificates for those money substitutes that are completely covered by the reservation of corresponding sums of money, and the term Fiduciary Media for those which are not covered in this way.” Mises, p. 133)

At this point, it is understandable if the mind shies away from the inescapable logical conclusion.  The question of inflation and deflation of the U.S. money supply is a category error, because there is no U.S. money supply.  This category error and failure to understand that what we have been taught to consider money is merely a money-surrogate is why all of the various quantity theories and complicated attempts to calculate the money supply and predict the consequence of changes in it go so reliably awry, because they are attempting to estimate something by looking at the derivative without realizing that it is a derivative.

To put it in more straightforward terms, while there is no U.S. money supply, there is a money-surrogate supply that consists of fiat-backed credit money.  This was inevitable with the introduction of money-surrogates, given Gresham’s Law, which is popularly summarized as “bad money drives out good money”, and which I would modify as “surrogate money drives out genuine money when it is assigned exchange value by the State”.  This has considerable implications that go well beyond the simple question of inflation versus deflation and merits serious contemplation, however, what concerns us is the three questions it raises that are directly pertinent to the current debate:

  1. What is the best measure of the money-surrogate supply?
  2. Is the money-surrogate supply growing or shrinking?
  3. To where has the genuine money been driven?

In conclusion, I will note that the great Austrian sage recognized and prophetically described the very process of transition from commodity money to credit money, from genuine money to money surrogate, that we have seen take place in American history, although he appears to have been more than a little naive concerning how the diminution of purchasing power might be considered desirable by those in a position to systematically benefit from it.  In the chapter entitled “Influence of the State”, he wrote:

“The exaggeration of the importance in monetary policy of the power at the disposal of the State in its legislative capacity can only be attributed to superficial observation of the processes involved in the transition from commodity money to credit money. This transition has normally been achieved by means of a State declaration that inconvertible claims to money were as good means of payment as money itself.  As a rule, it has not been the object of such a declaration to carry out a change of standard and substitute credit money for commodity money. In the great majority of cases, the State has taken such measures merely with certain fiscal ends in view. It has aimed to increase its own resources by the creation of credit money.  In the pursuit of such a plan as this, the diminution of the money’s purchasing power could hardly seem desirable. And yet it has always been this depreciation in value which, through the coming into play of Gresham’s Law, has caused the change of monetary standard.”
  –   The Theory of Money and Credit, p.77

Inflation vs Deflation IV

Nate has put together an excellent response entitled Mount Chapter 3, the full significance of which I suspect even he doesn’t recognize yet, but which I will begin to illuminate in my next post on the subject:

So… now here we sit happily atop Mount Chapter Three.  Ain’t the view grand?  Now… with all of this as a basis of monetary understanding… we can address Vox’s traps… I mean… questions.

1. Are gold and silver commodity money?  All gold and silver?  Money is a condition that can be deferentially diagnosed by behavior.  Are they functioning like money?  Then they are money.  Its the behavior that makes them money.  It is the commercial commodity that lends subjective value and thus allows us to categorize them in LVM’s terms.

2. Are the Federal Reserve Notes, in both cash and deposit form, commodity money or fiat money?  The standard answer is fiat.  But in reality FRN’s have characteristics of both credit money and fiat money.

3.Does TMS2 represent your definition of the money supply? No.  like M2  it is only a useful tool for estimation.  It is flawed… but it serves for watching trends.  I am agnostic on the claim that money supply can even be measured  accurately.  But I lean toward it being a pure impossibility.  Its like watching ants at a huge ant mound.  You have no idea how many ants are actually there…  guessing is pointless… but you can stand back and watch them and tell if the swarm is growing or shrinking.

4. What are the various components of TMS2, commodity money, fiat money, or some combination therein?  Given the nature of my explanation of Chapter 3’s 4 types of money… its abundantly clear that all categories in TMS2 are fiat money.  Many are credit money as well… but its impossible to parce in our banking system due to the various shenanigans… AND… if you listen to Ludwig… well…

“As a rule it is not possible to ascertain whether a concrete specimen of money-substitutes is a money-certificate or a fiduciary medium” 
– Human Action( p. 433)

With apologies to Vox, he has taken a large list of money substitutes and asked me to  do what Mises says literally cannot be done.

Read the rest of it there.  As for those who are concerned about the score, I think I can assure you, that is almost certainly the least interesting aspect of this debate.  Not, of course, that I am conceding anything in the slightest.  I am just as capable of seeing the obvious as anyone else, the difference is that I also see that which is, apparently, considerably less obvious.