Is there an illustrated example to show how you don't need a growing money supply for a growing economy?

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Nielsio Posted: Sat, Dec 26 2009 5:25 AM

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I'm going to try to make one, but maybe one already exists?

So I mean a 12-person society type of example where people get more goods but not more money.

Or another way to actively illustrate this.

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Nielsio replied on Sat, Dec 26 2009 6:43 AM

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Can you explain these? I know the 2nd one is a play on 'going out of business sale', but I don't quite see the implications.

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nirgrahamUK replied on Sat, Dec 26 2009 6:49 AM

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falling prices is the mechanism by which the same quantity of money can purchase greater quantity and quality of goods over time.

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David Sherin replied on Sat, Dec 26 2009 11:48 AM

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Are you looking for historical examples?

If you look at one particular sector, electronics/computers, you see price deflation occurring all the time, and that industry is booming.

If you go back in history, there was general price deflation in the late 1800's I believe and the economy was very prosperous. I'm no expert on this subject though.

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DD5 replied on Sat, Dec 26 2009 5:47 PM

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 The footnotes from Jesus Huerta De Soto provide some good examples for this:

56. Milton Friedman and Anna J. Schwartz, in reference to the period from 1865 to 1879 in the United States, during which practically no increase in the money supply occurred, conclude that,

[T]he price level fell to half its initial level in the course of less

than fifteen years and, at the same time, economic growth

proceeded at a rapid rate. . . . [T]heir coincidence casts serious

doubts on the validity of the now widely held view that secular

price deflation and rapid economic growth are incompatible.

(Milton Friedman and Anna J. Schwartz, A Monetary

History of the United States 1867–1960 [Princeton, N.J.: Princeton

University Press, 1971], p. 15, and also the important statistical

table on p. 30)

In addition Alfred Marshall, in reference to the period 1875–1885 in England, stated that

It is doubtful whether the last ten years, which are regarded

as years of depression, but in which there have been few violent

movements of prices, have not, on the whole, conduced

more to solid progress and true happiness than the alternations of

feverish activity and painful retrogression which have characterised

every preceding decade of this century. In fact, I

regard violent fluctuations of prices as a much greater evil than a

gradual fall of prices. (Alfred Marshall, Official Papers, p. 9; italics

added)

Finally, see also George A. Selgin, Less Than Zero: The Case for a Falling

Price Level in a Growing Economy, Hobart Paper 132 (London: Institute of

Economic Affairs, 1997).

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Nielsio replied on Sun, Dec 27 2009 3:11 AM

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Thanks for the historical examples guys, these help.

But what I am really looking for is an illustrated example. That means that you show through a hypothetical example how you can have economic growth without intervention in the supply of money. So with some producers, some products, some prices, some trades. So that you can see what actually happens with the money. What happens to profits and how they recirculate.

So basically the same as:

How an economy grows and why it doesn't ( http://www.youtube.com/watch?v=bFxvy9XyUtg )

Except to illustrate the main myth in question.

I'm thinking you could have something like this:

There are 8 farmers, 2 engineers, 2 bakers, 2 miners. The farmers make wheat, the engineers make farm and baking tools, the bakers make bread. The money in this case would be a basic metal that the miners get out of the ground, which is always useful in farming and baking tools, so it's a good money.

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scineram replied on Sun, Dec 27 2009 10:01 AM

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DD5:

Finally, see also George A. Selgin, Less Than Zero: The Case for a Falling

Price Level in a Growing Economy, Hobart Paper 132 (London: Institute of

Economic Affairs, 1997).

Just  to be clear, he talks about price level here. Money supply growth is independent of that per se.

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Clayton replied on Mon, Dec 28 2009 7:15 AM

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Nielsio:

Thanks for the historical examples guys, these help.

But what I am really looking for is an illustrated example. That means that you show through a hypothetical example how you can have economic growth without intervention in the supply of money. So with some producers, some products, some prices, some trades. So that you can see what actually happens with the money. What happens to profits and how they recirculate.

So basically the same as:

How an economy grows and why it doesn't ( http://www.youtube.com/watch?v=bFxvy9XyUtg )

Except to illustrate the main myth in question.

I'm thinking you could have something like this:

There are 8 farmers, 2 engineers, 2 bakers, 2 miners. The farmers make wheat, the engineers make farm and baking tools, the bakers make bread. The money in this case would be a basic metal that the miners get out of the ground, which is always useful in farming and baking tools, so it's a good money.

Guido Hulsmann discusses some of the issues you are concerned with here, concerning the innate demand for money as a circulating medium.

I think when you start with the history of the emergence of money, your question kind of answers itself. Rothbard says of the origin of money in The Case Against the Fed:

... Jones produces a barrel of fish and exchanges it for Smith's bushel of wheat. Both parties make the exchange because they expect to benefit; and so the free market consists of a network of exchanges that are mutually beneficial at every step of the way.

But this system of "direct exchange" of useful goods, or ''barter," has severe limitations which exchangers soon run up against. Suppose that Smith dislikes fish, but Jones, a fisherman, would like to buy his wheat. Jones then tries to find a product, say butter, not for his own use but in order to resell to Smith. Jones is here engaging in "indirect exchange," where he purchases butter, not for its own sake, but for use as a "medium," or middle-term, in the exchange. In other cases, goods are "indivisible" and cannot be chopped up into small parts to be used in direct exchange. Suppose, for example, that Robbins would like to sell a tractor, and then purchase a myriad of different goods: horses, wheat, rope, barrels, etc. Clearly, he can't chop the tractor into seven or eight parts, and exchange each part for a good he desires. What he will have to do is to engage in "indirect exchange," that is, to sell the tractor for a more divisible commodity, say 100 pounds of butter, and then slice the butter into divisible parts and exchange each part for the good he desires. Robbins, again, would then be using butter as a medium of exchange.

Once any particular commodity starts to be used as a medium, this very process has a spiralling, or snowballing, effect. If, for example, several people in a society begin to use butter as a medium, people will realize that in that particular region butter is becoming especially marketable, or acceptable in exchange, and so they will demand more butter in exchange for use as a medium. And so, as its use as a medium becomes more widely known, this use feeds upon itself, until rapidly the commodity comes into general employment in the society as a medium of exchange. A commodity that is in general use as a medium is defined as a money.

Once a good comes into use as a money, the market expands rapidly, and the economy becomes remarkably more productive and prosperous. The reason is that the price system becomes enormously simplified. A "price" is simply the terms of exchange, the ratio of the quantities of the two goods being traded. In every exchange, x amount of one commodity is exchanged for y amount of another. Take the Smith-Jones trade noted above. Suppose that Jones exchanges 2 barrels of fish for Smith's 1 bushel of wheat. In that case, the "price" of wheat in terms of fish is 2 barrels of fish per bushel. Conversely, the "price" of fish in terms of wheat is one-half a bushel per barrel. In a system of barter, knowing the relative price of anything would quickly become impossibly complicated: thus, the price of a hat might be 10 candy bars, or 6 loaves of bread, or 1 /10 of a TV set, and on and on. But once a money is established on the market, then every single exchange includes the money-commodity as one of its two commodities. Jones will sell fish for the money commodity, and will then "sell" the money in exchange for wheat, shoes, tractors, entertainment, or whatever. And Smith will sell his wheat in the same manner. As a result, every price will be reckoned simply in terms of its "money-price," its price in terms of the common money-commodity.

It should be clear from money's function as a universal medium of indirect exchange that the "optimum quantity of money" is neither here nor there. The exception being when we take into account the effect of production of the medium of exchange on its relative value against other goods and the demand for circulation money on the production of the medium of exchange (see Hulsmann's article above).

An example which will illustrate this would likely be too complex and contrived to be of any use. I like to think about it in the following manner. Imagine we live in a world where only commodity money is used (e.g. gold or silver). Now, divide all human goods into money and non-money goods and services. Over time, more and better goods are constantly being produced, so that the quantity and quality of non-money goods and services is constantly growing. This is true regardless of the quantity of money, the net effect if the quantity of money remains fixed over time is a steady decrease in prices. If there are 1 thousand cars in existence and a car costs 10 ounces of gold, then when there are 2 thousand cars in existence (and twice as much of everything else except gold), we would expect the price of a car to drop to 5 ounces of gold. Of course, this relationship would not hold for any individual good or service since people's preferences will change along with the size of the stock of non-money goods and services. But, in any case, if there is twice as much non-money goods and services at time t+1 than there were at time t, then we would expect the general price level (for a fixed quantity of money and a fixed demand for cash balances) to be half what it was at time t.

Clayton -

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chloe732 replied on Mon, Dec 28 2009 11:34 PM

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Clayton's reply provides the authoritative explanation.  However, here is a shortened version of the same story: 

Crusoe builds a "pool" of real savings (berries).  He consumes these berries while building sticks and nets (which requires time).  The sticks and nets allow him to be more productive in gathering berries (what took 12 hours to gather by hand, now only takes 4 hours).  He can now spend 8 hours building other things.  There you have it; goods increased (a growing economy) without an increase in money.  In fact, there was no money at all in this example.

Now, if Crusoe wants to obtain fish hooks from Friday, he could exchange berries for fish hooks.  Since this is problematic, Crusoe could instead exchange berries for "money", then exchange "money" for fish hooks.  So, money is merely a means of facilitating indirect exchange.  Notice, Crusoe needed REAL GOODS to exchange for money, so the real goods had to exist first.  Money is extremely important in the development of an economy, because indirect exchange removes roadblocks to exchange that would otherwise exist.  It is not growth in money that causes the increase in goods.  It is the real savings that allowed for the building of factors of production, which increases productivity, that causes the increase in goods. 

I concede, it is a challenge to distinguish "real savings" from "money", but the two are not exactly the same.  Notice the "real saving" was the collection of berries that sustained Crusoe while he built sticks and nets. He can't eat gold, but he can exchange gold for food.  But, he needed to possess real goods FIRST in order to obtain the gold. 

I have no idea if this helps, maybe it's overly simplified for what you are asking about.