Inflation, what is it and what causes it and why does it matter?

[Pete in Panama]

...But that's just it, opening a currency account is not the same as creating dollars...

It is the same when you borrow on that account. The way banks work is that you put money in the bank, the bank pays interest, and the money from the interest comes from loans. No loans no interest. Loans means dollar creation.

 

[Pete in Panama]

The examples of lowering currency value
are more known...cuz it's disastrous, eg,
Weimar Republic, Zimbabwe.

--and a good example (of a bad example) of artificially raising the value by meaningless fiat is w/ the old Soviet Union, where they paid in rubles whose real value was far less than the face value, and the only places to spend the money at face value was at stores w/ empty shelves. Whenever goods came in --for sale at ruble face value-- there ended up be long long lines.

Socialism doesn't work.

 

[Pete in Panama]

[citation needed]

More like various degrees of failure.

You can try to raise the value of your currency artificially by lying and hope you don't get called out but it's nearly impossible. As @Revoltingest pointed out, the other way around is more likely. And both cases were deliberately, at least at first before it got out of hand.
That's why today central banks are usually independent institutions, you can't trust politicians with money.
Unfortunately bankers aren't much more trustworthy.

The big example of raising currency value by fiat was what I described in my post #62 where they substituted long lines for payment.

 

[Pete in Panama]

I am very familiar with one such case in Brazil. Brazil changed its currency in 1994, replacing the Cruzeiro Real with the Real. The Real was introduced as part of a broader plan to stabilize the Brazilian economy, known as the Plano Real.

Here's an excerpt from an article that explains what they did:

"We called it a Unit of Real Value -- URV," Bacha says. "It was virtual; it didn't exist in fact."

People would still have and use the existing currency, the cruzeiro. But everything would be listed in URVs, the fake currency. Their wages would be listed in URVs. Taxes were in URVs. All prices were listed in URVs. And URVs were kept stable -- what changed was how many cruzeiros each URV was worth.

Say, for example, that milk costs 1 URV. On a given day, 1 URV might be worth 10 cruzeiros. A month later, milk would still cost 1 URV. But that 1 URV might be worth 20 cruzeiros.

The idea was that people would start thinking in URVs -- and stop expecting prices to always go up."


Now perhaps you're talking about something different? I'm not sure. But I'm not sure what this has to do with the US and more specifically your claim that devaluation is all that matters or that the fact that governments can manipulate their curacies relates the things I've said to you.

Please understand that I was talking about something different from the beginning, just having a hard time making myself clear.

 

[Revoltingest]

Do you think that "lowering value", or hyperinflation, was the result of fiscal policy or do you think hyperinflation was the result of something that preceded each nations currency decline?

Picking just the one....

Both. Zimbabwe ejected the white farmers, so agriculture
& other commerce collapsed. Economic ruin was addressed
by expanding the money supply so that Zimbabwe $'s near
parity with the US $ dropped to well under a penny.
Inflation hit about 80 billion % per month.

 

[Curious George]

That was a hypothetical example.

Let's look at some real numbers.

The median wage in 1950 was $3,033 or just over $25,000 in inflation adjusted dollars.


The median wage today is about $69,000

In 1950 a wage of $3000 puts you in a 22% federal tax bracket.
In 2020 a $69,000 income puts you in a slightly higher 24% bracket.

However, as I'm sure you know, tax brackets in the 1950's went all the way to 91% where as today they stop at 37% Of course there are nominal numbers that don't account for exemptions ( I don't have access to a table with real figures), but what I see is incomes that are 176% higher from 1950 to 2020, but the value of the dollar has declined by 25% over the same period and taxes are similar.

So why wouldn't a person making the median wage be better off today than in 1950?

I am not sure what you are trying to say here. Are you suggesting that the value of a dollar from 1950 would be the equivalent to four dollars today? on what are you basing that the value of a dollar has declined by 25%?

 

[Revoltingest]

--and a good example (of a bad example) of artificially raising the value by meaningless fiat is w/ the old Soviet Union, where they paid in rubles whose real value was far less than the face value, and the only places to spend the money at face value was at stores w/ empty shelves. Whenever goods came in --for sale at ruble face value-- there ended up be long long lines.

Socialism doesn't work.

Soviet joke from back in the day....
"So long as the bosses pretend to pay us, we will pretend to work."

 

[Heyo]

The big example of raising currency value by fiat was what I described in my post #62 where they substituted long lines for payment.

Didn't you say that only the free market value counts? The ruble wasn't overvalued there.

 

[EconGuy]

It is the same when you borrow on that account.

With respect, I think you have mistaken notions of how borrowing works.

The way banks work is that you put money in the bank, the bank pays interest, and the money from the interest comes from loans. No loans no interest. Loans means dollar creation.

How banks lend is really one of the keys to understanding economics. You are correct in that banks create currency, but the way they do it is not the way most people believe.

There is one currency that can be created one of two ways.

1. The government creates it when it spends.

2. Banks create currency via balance sheet expansion.

The difference is, the government has no obligation to repay the money it creates, ever. Not to be confused with band sales and repayment, that does not create money.

Banks on the other hand MUST repay money it creates.

Banks pay interest because the Fed pays interest. However, even the Fed can only create currency though expanding it's balance sheet. The Fed works closely with the Treasury to accomplish its mandate given to it by Congress.

Banks pay interest on savings. Money in your savings adds to the banks reserves. The Fed pays interest on reserves called Interest on Reserve Balances (click the link to see the latest rate) today's rate is 5.15%. Right now the range that banks are paying are 0.5% all the way to 5% or more, the reasons for the wide margins is that some banks have plenty of reserves, while others are trying to attract reserves.

To your last point, loans create dollar creation, this is true, but don't forget that every loan created by a bank creates 2 assets and 2 debts.

The borrowers asset is the money they borrow, the Banks asset is the promissory note the borrower signs. The Borrowers debt is the money that must be repaid. and the Banks debt is the money it creates and deposits in the borrowers account. Of course the bank "wins" in the end because the borrower is expected to repay more than they borrowed. Interest is the reward for taking risk. What risk? If the borrower does not repay, the money is taken from investors (unless there is an '08 style meltdown, but we'll cover that if you're interested.

Suffice it to say, the government and ONLY the government creates new perpetual money (though the government can chose to reduce money in circulation). Banks create credit by taking risk. The credit they create is denominated in the governments dollar, but every dollar created by a bank has a date when it will be deleted (also known as loan repayment).

If that sounds confusing, I understand.

If you have questions or what to challenge my understanding, please ask.

Respectfully,

EG

 

[EconGuy]

Both. Zimbabwe ejected the white farmers, so agriculture
& other commerce collapsed. Economic ruin was addressed
by expanding the money supply so that Zimbabwe $'s near
parity with the US $ dropped to well under a penny.
Inflation hit about 80 billion % per month.

So can we agree that economic output declined as a result of Mugabe's "Fast Track" policies that began in the late 1990s?

Just to emphasize the point we can see how land taken from productive commercial farms and redistributed resulted in a massive decline in agro output which IIRC was about 40-50% of the nations total economic output.

So, just in wheat the reduction in output was 270,000 tons in 1998 and 62,000 tons in 2007.

Now, my question to you is, if the amount of money in Zimbabwe stayed exactly the same, hypothetically, and economic output were reduced as we see above, would you agree the result would be inflation? More money chasing fewer goods?

My point is that inflation was the result of poor policy that preceded it resulted in the loss if real goods in the economy. Hyperinflation, or money creation wasn't the precipitating cause in Zimbabwe, it was the resulting cause, when the economy collapsed the government resorted to creating money to deal with a problem it had created.

If a person is pushed off a roof and falls to their death, what was the cause of death, the push or hitting the ground? One comes before the other. Bad policy in this case resulted in hyperinflation, hyperinflation wasn't the precipitating cause it was the result.

Would you agree?

 

[Revoltingest]

So can we agree that economic output declined as a result of Mugabe's "Fast Track" policies that began in the late 1990s?

Yes.

Just to emphasize the point we can see how land taken from productive commercial farms and redistributed resulted in a massive decline in agro output which IIRC was about 40-50% of the nations total economic output.

View attachment 79349

So, just in wheat the reduction in output was 270,000 tons in 1998 and 62,000 tons in 2007.

Now, my question to you is, if the amount of money in Zimbabwe stayed exactly the same, hypothetically, and economic output were reduced as we see above, would you agree the result would be inflation? More money chasing fewer goods?

My point is that inflation was the result of poor policy that preceded it resulted in the loss if real goods in the economy. Hyperinflation, or money creation wasn't the precipitating cause in Zimbabwe, it was the resulting cause, when the economy collapsed the government resorted to creating money to deal with a problem it had created.

If a person is pushed off a roof and falls to their death, what was the cause of death, the push or hitting the ground? One comes before the other. Bad policy in this case resulted in hyperinflation, hyperinflation wasn't the precipitating cause it was the result.

Would you agree?

I'm not going to spend time addressing
hypothetical analogies. There are big
demands on my time at RF.

Monetary policy can be examined by exmaming
what the Zimbabwe $ can buy outside the country.
If it's worthless elsewhere, then this points to
monetary policy being the driving factor behind
hyperinflation. And it's a policy that was enacted
in response to economic collapse.

 

[EconGuy]

I am not sure what you are trying to say here. Are you suggesting that the value of a dollar from 1950 would be the equivalent to four dollars today? on what are you basing that the value of a dollar has declined by 25%?

Thnaks for asking for clarification.

No, according to the CPI calc, $1 in 1950 is worth about $12 today, that's a LOT more than 25%.

 

[EconGuy]

And it's a policy that was enacted
in response to economic collapse.

Excellent, we agree. That was easy.

 

[EconGuy]

The big example of raising currency value by fiat was what I described in my post #62 where they substituted long lines for payment.

Government's cannot change value by fiat, but government's in control of a sovereign currency are essentially price setters in the own economies. In other words, if a government can create money and spend it, then the government can set prices though purchases,

For example, if the government wants to purchase something like steel which currently sits at $3700 per ton. If the government wanted to purchase steel, it can purchase as much as the market can supply, however at some point the government can demand more than the market can produce at that price. Eventually the price of steel will increase causing the private sector to pay a higher price set by the government via demand.

Of course it's not that easy, there are real constraints on spending (inflation), but, that said I don't think this is what you mean.

Instead of using a term like "government" can do something, why don't we stick to the US, or at least the largest nations with sovereign currencies?

 

[Pete in Panama]

...How banks lend is really one of the keys to understanding economics. You are correct in that banks create currency, but the way they do it is not the way most people believe....

We're not together on terms.

Let's agree that most people say that currency is the physical paper bills and coins that people use as money in small transactions. Currency is money but "money" can include bank transfers, checks, card transactions, etc. Next, let's understand that when a bank recieves deposits the deposits were made w/ money and they remain money, as possessions of the depositors. When a bank makes loans, they are creating new money because the loaned out money becomes a possession of the borrower.

Perhaps I'm mistaken but sometimes I get the impression each of us thinks we understand economics better than the other. If that's true then we'd be better off setting that aside and simply explored the topic together.

 

[EconGuy]

Let's agree that most people say that currency is the physical paper bills and coins that people use as money in small transactions

Agreed, but you and I know that paper money only makes up about 3-5% of all money in circulation.

Currency is money but "money" can include bank transfers, checks, card transactions, etc.

Sure, the M0, M1, M2, M3 forms of money.

Next, let's understand that when a bank recieves deposits the deposits were made w/ money and they remain money

Yes, but we understand that when a deposit is made (non-cash) what's really happening in the background is that reserve balances are settled between banks. In other words, If I write you a check and you deposit it, my bank transfers reserves to your bank. Of course our banks settle up at the end of the day, thus only the delta between banks needs to be transferred.

Of course your deposit is your money, but your deposit increases a banks reserves and banks are paid the Federal Funds rate for all reserves a bank holds.

When a bank makes loans, they are creating new money because the loaned out money becomes a possession of the borrower.

Using double entry accounting, which is fundamental to understanding how banks operate, there are 2 parties and 2 transactions per party or 4 total entries. I went over this in my last post, hopefully you agree?

But yes, within the boundaries of the terms of the loan, money borrowed "belongs" to the borrower, however, in most cases money borrowed is as part of the loan agreement is transferred to a third party to make a purchase, like a car, house, anything purchased on a credit card ect, so the borrower borrows to receive something of real value.

Perhaps I'm mistaken but sometimes I get the impression each of us thinks we understand economics better than the other.

I try not to think in those terms, though I often sound confident of my position, it is because I've spent the better part of 20 years understanding the topic. I will fiercely debate the topic based on my understanding of the evidence, which I'm happy to share, but I enjoy correction as it only increases my knowledge.

If that's true then we'd be better off setting that aside and simply explored the topic together.

Not sure what you mean "setting aside". If we're going to have a friendly discussion it's important that when we talk about a subject we agree on terms. If we don't it gives us the opportunity to share what we believe is correct. If you can convince me you're right and I'm wrong, or at the very least I don't understand, that only informs me that I have more work to do in learning.

 

[Curious George]

Thnaks for asking for clarification.

No, according to the CPI calc, $1 in 1950 is worth about $12 today, that's a LOT more than 25%.

And if we agree with difference in value, we should probably also agree that many major areas such as real estate, college tuition, medical costs (such as the price of having a baby) have increased significantly more than in 1950, even when adjusting for inflation. So, if major life expenses that most individuals incur or hope to incur, cost significantly more than they did in 1950 even accounting for the inflation, wouldn’t you say that people are at a financial disadvantage?

 

[EconGuy]

And if we agree with difference in value, we should probably also agree that many major areas such as real estate, college tuition, medical costs (such as the price of having a baby) have increased significantly more than in 1950, even when adjusting for inflation

Especially when adjusting for inflation.

Though it's worth mentioning that somethings have decreased in price as seen in graphs like this.

Though as you point out, necessities seem to be rising faster than other things, healthcare and education are the two that stick out most.

So, if major life expenses that most individuals incur or hope to incur, cost significantly more than they did in 1950 even accounting for the inflation, wouldn’t you say that people are at a financial disadvantage?

The answer to your question is there are more people today at a disadvantage than in the past, yes, I would also point out that there are more people in the middle of the upper class today than there were in 1950.

I would say that there is more wealth in our system today (even accounting for inflation), enough for everyone to afford the things needed, the problem is the distribution of money and wealth has increased significantly since 1950.

When looking at charts like this:

We can see how wealth in the bottom 80% of America has declined.

A cursory search for stats shows that In 1950, the top 20% of income earners accounted for approximately 43% of total income, while the bottom 80% accounted for the remaining 57%. By 2020, the share of income for the top 20% had increased to around 52%, with the bottom 80% accounting for the remaining 48%.

Then when you consider just a handful of the wealthiest people control more wealth than the bottom 40% of working aged people in the US.

The problem, IMO, isn't that there isn't enough money, it's a problem of distribution.

Now, don't jump to any conclusions about that statement, you've been kind enough to ask questions, please continue to do so.

Look forward to your responses.

Respectfully,

EG