I am sorry if my question is in any way stupid - I am extremely new to austrian economics!
Anyways, I was talking to my friend not too long ago about economics. He's a big moral right neocon so I don't trust too much of what he says. But, he did make some good points. I was saying that the increase in the money supply wouldn't change anything - that if everyone had $20 million then that would just mean that $20 million would become worthless while if everyone had a hundred dollars stolen, that would mean that the value of the dollar would go up. Either way nothing really changes. But, he was saying that an increase in the money supply is a good thing, because with the increase in the money supply, banks could loan out more money and with more loans that would mean more business activity, more investment, more competition etc. And, he was saying that if there were a gold standard, then not enough money would be able to go around. He used an example of a village of 40 people basing their currency on some rare sea shell and only 20 of those sea shells existed; only 20 out of those 40 people then would be able to get money. So, he was saying that we need a Federal Reserve system in order to make sure there is more wealth - the wealth that we have today would not exist if there was a gold standard (according to him). I said, though, that under a free banking system, if the gold standard didn't work, then that would mean people would move onto another commodity to back their currency. And then he said that if I could find such a commodity, I would become really famous, ie in a free banking system, that would not happen and we would be stuck with the gold standard.
There must be something wrong with this guy's logic...the guy still thinks that the war in Iraq was a good thing! But, due to my lack of economic knowledge (in my only economics class in high school, the teacher didn't do anything and we would all drink whiskey and drop acid and eat hash brownies - good times! see, mind expansion does happen in our public school system!) I can't find anything wrong with what he said!
If everyone has more money, prices rise. Monetary inflation leads to price inflation. It's simple. Your neocon friend is wrong.
tangobob5000:he was saying that an increase in the money supply is a good thing, because with the increase in the money supply, banks could loan out more money and with more loans that would mean more business activity, more investment, more competition etc.
Money, first and foremost, is simply a media of exchange; it's used to exchange commodity x for commodity y. Printing more money does not mean increasing the actual commodities/inputs available in the economy, thus, all of those investment activities brought about by inflation (and therefore an arbitrary reduction in interest rates) cannot be completed either on time or at all. Furthermore, since the supply of inputs remains unchanged, the exponential increase in the supply of money can only mean higher prices for those inputs. Money is not wealth, wealth is the amount of "stuff" the economy has; simply printing money does not make society wealthier.
tangobob5000:He used an example of a village of 40 people basing their currency on some rare sea shell and only 20 of those sea shells existed; only 20 out of those 40 people then would be able to get money. So, he was saying that we need a Federal Reserve system in order to make sure there is more wealth - the wealth that we have today would not exist if there was a gold standard (according to him).
Gold standards don't mean people walk around carrying giant chunks of gold, it only means that the notes employed are fully covered by that gold. So to address his horrible example, the village would use notes denominated in seashells. 1 seashell dollar could equal 1 seashell, and then you could have 50 seashell cents denoting half a seashell, ect.
tangobob5000:I said, though, that under a free banking system, if the gold standard didn't work, then that would mean people would move onto another commodity to back their currency. And then he said that if I could find such a commodity, I would become really famous, ie in a free banking system, that would not happen and we would be stuck with the gold standard.
This, in fact, happened a lot. When gold became scarce and gold notes became too valuable, societies began using silver as a media of exchange as well. So there you go, now you can tell him that you're really famous.
tangobob5000:Anyways, I was talking to my friend not too long ago about economics. He's a big moral right neocon so I don't trust too much of what he says. But, he did make some good points. I was saying that the increase in the money supply wouldn't change anything - that if everyone had $20 million then that would just mean that $20 million would become worthless while if everyone had a hundred dollars stolen, that would mean that the value of the dollar would go up.
I'm amazed that in the same sentence he claims that an increase in the money supply wouldn't change anything and would also make $20 million worthless. I think what he meant is, simply doubling everyone's balance uniformly would not really change anything - prices would simply double, as well. However, when the Fed increases the money supply, the increase is not evenly distributed across the population. Those who receive the new money first have the benefit of the use of those new funds at current prices. As the new money circulates, those whose balances have not increased at all, especially those on fixed incomes, are faced with higher prices.
tangobob5000:And, he was saying that if there were a gold standard, then not enough money would be able to go around. He used an example of a village of 40 people basing their currency on some rare sea shell and only 20 of those sea shells existed; only 20 out of those 40 people then would be able to get money.
He's using a false analogy, unless the shells could be broken into smaller pieces and still be considered money. Remember, generally speaking, gold is measured in weight. If there aren't enough ounces to go around, people will spend grams, and then milligrams. If the portions become too small, some other commodity will take its place for smaller transactions, leaving gold for large.
tangobob5000:So, he was saying that we need a Federal Reserve system in order to make sure there is more wealth - the wealth that we have today would not exist if there was a gold standard (according to him). I said, though, that under a free banking system, if the gold standard didn't work, then that would mean people would move onto another commodity to back their currency. And then he said that if I could find such a commodity, I would become really famous, ie in a free banking system, that would not happen and we would be stuck with the gold standard.
This is just silly. He's equating wealth with money. These are clearly not the same thing. Wealth is created every time a voluntary transaction occurs. Were the money supply to remain constant, as the total wealth in the world increases, the purchasing power of each unit of money would increase - a gently price deflation. Simply put, the same amount of money would purchase more goods. On the other hand, as he mentioned earlier, with a large enough increase in the money supply, $20 million would become almost worthless. In that case, would the wealth of the world suddenly disappear? Would everything else in the world that has value suddenly lose its value? Clearly not. The amount of money in the world has nothing to do with amount of wealth in the world.
You are correct in pointing out that multiple commodities can function as money, so long as the market accepts them. He clearly does not understand that gold and other fungible goods can be divided into smaller units as needed. Nor, it seems, does he understand that multiple commodities can coexist as money.
tangobob5000: was saying that the increase in the money supply wouldn't change anything - that if everyone had $20 million then that would just mean that $20 million would become worthless while if everyone had a hundred dollars stolen, that would mean that the value of the dollar would go up.
First of all, increasing the money supply doesn't cause all prices to rise at the same time. If I printed off a million dollars and gave it to you, would prices across the country go up in synchronicity? No, whomever receives the newly created money first(in this case you, but in the case of the Fed it's investment bankers) is clearly the winner and the last people to see an inflationary increase in their income(or people on fixed income like the poor, disabled, and elderly) are the losers.
tangobob5000:But, he was saying that an increase in the money supply is a good thing, because with the increase in the money supply, banks could loan out more money and with more loans that would mean more business activity, more investment, more competition etc.
He's absolutely right. Printing money can spur economic growth for a short time. I believe it's called a bubble! If we think about the case of me giving you a million dollars, sure you can spend or invest it, and either way whomever you spend it or invest it with and temporarily create more business activity. But production coordination will change with how this new money trickles down, and not change in coordination with the needs of all consumers in the market. Scarce goods will be going to companies or entire sectors that should be going to a more economically necessary venture(for instance, moving goods and labor from the housing sector to various other sectors). This is what is loosely known as malinvestments.
Furthermore, printing money as such tends to entice people to consume more and save less, as they believe the economy is healthier and on a more sustainable growth path than it actually is. Since there is no real savings for them to consume from, but the illusion of savings from inflationary fiat money, they are only consuming now what they would save up for in the future to. Inflation displaces consumption forward in time, and producers respond by increasing production.
Unfortunately there comes a point where money creation has to slow. Inflation picks up and central bankers try to calm it by raising interest rates. They mistakenly believe that the previous growth was natural and the economy is healthy and can easily handle an increase in interest rates and a reduction in money creation. When consumption was shifted forward in time, this also meant that these people cannot buy that good in the future when they originally were going to. For instance, everyone that bought houses during the housing bubble is no longer going to buy a house after the bubble, they already have the house. Producers were still on track to keep supply matching the artificial increase in demand, so now they are left with too many workers and too much machinery for the current needs of the market place. Voila, you got yourself a recession/depression.
When Tango is discussing the doubling of money will cause a doubling in prices he is I think refering to Rothbard's 'angel Gabriel' model in which is a hypothetical situation where the angel Gabriel descends from heaven and being a man individual but not an economist tries to doubt the amount of everyone's income. This will only cause a change in prices and non necessarily a profit. It is kind of like Friedman's money helicopters.
'It is difficult to imagine any normal person wishing to meet Marx for a third time.' - Alexander Gray, The Socialist Tradition
So ask your friend why Zimbabwe isnt propsperous with all the money printing.
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