Does inflation really help lower debt?

I think you misunderstood me. I was trying to get you to imagine wealth being traded around and borrowed, rather than money, because that perspective might help give us some better insights, and help temporarily free us from the distractions of monetary issues which can only exist connected to money.

Think of it as a hypothetical thought experiment, or another perspective on the matter.

 

Let's be more specific with terms. What you are describing is currency, loosely defined as a unit of account created by some authority or business. Currency has no value on its own, it value is linked to some combination of what it can be used to acquire and people's faith in the ability to do so. In that sense, all currency is created out of thin air. But if a currency has no value without a connection to something real, then it is no different than a promise. Promises are created out of thin air. Their value is linked to whatever it is in the real world that has been promised and the belief that the promisor will deliver on the promise. Currency is merely a form of a promise that many people recognize, creating a more efficient system of transactions.

 

That's called barter, is it not? An extremely inefficient system and despite what you might believe, it is a system that has been used very sparsely throughout history, especially in areas of high population density. Representative money of one form or another has been used almost exclusively throughout history.

 

I think you are completely misunderstanding me again. I am not advocating barter, I am simply asking you to imagine that, as a better way to help see what is happening.

I want people to be able to understand a level of what's going on, beneath it all, and not get distracted by the money issues.

Sometimes simplicity (even if it is hypothetical) can help us understand a deeper more complex phenomena better.

 

Again, this is false. There is no correlation to the creation of currency and interest rates. Why?

Because we no longer operate on a system of scarcity with respect to currency.

What is the natural rate of interest?

It is ZERO.

Why?

Because there is no constraint on dollars. If the Fed did nothing, the interest rate would ALWAYS be at zero. The Fed manipulates the system to increase interest rates and that number, whatever it is, is related to the state of the economy, not the availability of loanable funds. In order to really understand this, you must understand how banks make loans. I'll give you a hint, banks don't lend customer deposits to other customers.

Now here is where I usually get something like, "So why doesn't the government send everyone a check for $1 million dollars?", or something like that.

Currency isn't scarce, the things of real value it can be used to purchase are. That's why you can't send everyone $1 million dollars.

 

I highly doubt this.

Every investment asset has a natural rate of return.

Again, I'm asking you to take money out of the equation for a moment and look at things without money, even if only temporarily, just to be able to look at things in a different light.

 

Would you take the time to answer the questions I asked?

Since this thread is asking about inflation, something I've taken a lot of time to understand, will you answer the following?

1) Can we agree that inflation is defined in the simplest terms as: "a rise in the general price level)"?

2) If yes, tell me what the cause of inflation is. If no, please explain.

 

That's because you don't understand banking.

Let me ask you, when a bank lends you $25,000 so you can buy a car. Where did the bank get the $25,000 (23,000 for the car and $2000 in interest)?

 

That's far too complicated for me to give you an answer here. Why don't you tell me where you're trying to go with this, and then I can give you a more specific answer.

 

Someone else put that money in their bank account.

In fact, it might not even be real currency that second person put in their bank account, it could represent a loan that someone else owes.

The currency (paper money) itself is not the real important thing in this transaction. The point is that the trade going on is denominated in unit currency.
In other words, if I pay you back, we know how many hours I have to work, because it is all connected to a known measure of value (which is the current going market value of currency).

Does that answer make enough sense?

I have argued in another thread that the money in bank accounts does not actually contribute towards inflation like currency does.
Is fractional reserve banking inflationary

Let me describe it this way: It would be like if a bunch of people traded around a bunch of IOUs, but those IOUs were almost never traded for actual money.
But those IOUs were still acting like money in facilitating the trade.

The IOUs are only worth something, of course, because they could theoretically be traded for actual money.

A very similar analogy existed when the currency was connected to a gold standard system.
(Money in bank accounts is to paper currency as paper currency under the old gold standard system was to gold)

 

My point was we should generally try to avoid inflation. Even if we average a little bit of deflation (let's say 0.4 percent) over long periods of time, it still doesn't matter. That wouldn't make it harder for borrowers to pay back their debts, because everyone would know what to expect and lenders would have adjusted their interest rates to compensate.

A little bit of inflation could be used as a part of the solution in a crisis. But again, it's going to be more effective if there was not constant continual inflation going on before then.

And of course I'm not saying large amounts of sudden unexpected deflation are a good thing either. In that case, the Central Bank could indeed be justified in creating some inflationary pressure to try to counteract that.
But I personally think it would be a bad idea to try to prevent absolutely all deflation from happening in that situation.
The economy should be allowed to some extent to deflate back down to what should have been normal healthy levels (if the bubble had never happened).
Although that's really beginning to get into another controversial subject.

Mostly I was just trying to point out the huge logical error of anyone who says we should have constant gradual inflation, all the time, because they think that will make it easier for borrowers to pay back the money.

 

"Does inflation really help lower debt?"

if pay goes up, yes... time to raise the min wage

if all Americans made 2x the pay they do today, they would pay more taxes, the debt would still be the same - thus be easier to pay off

Bush jr set the debt on a course to bankruptcy unless we do something

 

It's hard to hear my tone via text. So please don't read my tone as condescending or argumentative. I mean no disrespect.

No, banks cannot lend your money to other people. Banks can only lend within the banking system. However, that's become largely unnecessary since 2008 when the government began QE.

Here you mention "Fractional Reserves". I'll take some time and read that post after we've had some time to discuss this topic.

Reserves are probably the single most misunderstood aspect of the banking system. There was a time when they served the role most people imagine they do today, but this is 100% inaccurate.

Reserves exist only to facilitate the clearing of each days transactions. Prior to 2008, it was the availability of reserves within the banking system that was used to set the interest rate. The Fed could add or remove reserves from the system creating artificial scarcity. It was that scarcity that banks would set the interest rate.



We can see the availability of reserves changes very little

Now let's look at the interest rate compared to the availability of reserves.




Do you see a correlation?

Now let's look at reserves after 2008 when compared with reserves prior to 2008.




Look at the scale. If interest rates were truly determined by the availability of reserves, we'd never get above zero.

Here are total reserves science 2008 (take care to note the scale)


Do you find it curious that reserves relative GDP stay so steady?




(I had to use a relative index measurement rather than actual numbers so we can compare the two in this image)

The reason is that the Fed manipulates the supply of reserves. It does this by shifting money into and out of reserves by manipulating the interest rate. If rates go up, people are incentivized to trade cash for securities. This causes the scarcity of cash reserves to increase because the demand increases.

Inflation is the indicator the Fed watches. If inflation increases, the Fed increases its target rate, if inflation falls, the Fed decreases it.

Of course, raising and lowing rates like this does NOTHING to slow it increase inflation (something I can explain if interested).

All of this said, I understand you are making a distinction between government-created money and bank-created money.

This distinction is known as endogenous and endogenous money. The government creates currency, banks create credit. So I understand what you mean, but to understand what I mean, you need to understand that "Loanable Funds Theory" no longer applies. banks create currency (Again, I call it credit) by expanding their balance sheets. To really understand this, you need to know how banking really works.

You need to understand the distinction between capital and reserves and how each affects the system. You need to understand (and I think you are on to something, you just don't realize how to explain it) that when banks creat credit, when looking at assets and liabilities in the economy, banks really don't create anything.

Let me explain that a little better.

Let's imagine that I could create currency. I would have but to write $1 on a slip of paper just as you would a check and poof! $1 would be in the economy. Now let's imagine as part of this excersize, like a checkbook, I write down the amount in my leger as -$1.

So I would have, in one hand $1 and in my leger I would have -$1. Now just do the math. $1+(-$1)=$0

This is a massive oversimplification, but this is how banks create currency. The government allows banks to create credit denominated in the government's unit of account, the US dollar. Why? Well that's a story best left for those that care to ask, but I assure you there is a very practical reason I'll explain.

Ok, back to the example. A bank creates $1 and records -$1 on its own leger. The bank DOES NOT lend out existing dollars, it creates them. However, if you really, really understand the system, you begin to understand that YOU create the dollars, not the bank. The bank is merely a system that ensures that the dollars created will eventually be destroyed. Without the destruction of every single dollar created the system would collapse.

What you feel, but cannot properly explain is that there is a perpetual system of dollar creation and destruction that keeps the system full of dollars.

Metaphorically think about it like this.

If you fill up your bathtub with water and open the drain, the level of the tub will fall, but what if you turned on the faucet at the same time equal to the amount flowing out? The level would stay the same, would it not? That is, metaphorically speaking, how the banking system works, but to make the metaphors complete you have to imagine a tub (the capacity of the economy) getting larger. Thus to keep the tub full relatively speaking, the water from the faucet must be slightly greater than the water exiting out the drain.

In banking, the total amount of new loans over time slightly exceeds the amount of money being destroyed via loan repayment. Here it is visually.....



You have to imagine that each arc is some total amount of money created by millions of people over time The rise is the cumulative total of new loans created, the fall is the amount of money removed as people repay their loans. But there are enough people that there are always more people taking loans than repaying them (except during a fiscal crisis as in 2008 where repayments exceed new loans).

Why does it keep increasing and is that sustainable?

Well, the reason it increases is that population and per-person productivity increase (thanks to technology). The nation needs more money or p[people will be unemployed.

Ok, so that's a lot to take in but I will leave you with this...


1. The federal government does not print money. It prints
Federal Reserve Notes (FRN), which are not dollars, but rather are bearer certificates: Titles to dollars.

Only a small percentage of dollars are represented by FRNs.

2. Dollars are balance sheet numbers. They have no physical existence. You cannot feel, see, hear, smell, or taste dollars.

3. The government, being Monetarily Sovereign, has the unlimited ability to create dollars. The government never unintentionally can run short of dollars.

4. Printing FRNs does not cause inflations. The reverse is true. The printing of FRNs results from inflations.

5. The cause of inflations — a general increase in prices — is shortages, generally scarcities of energy and/or food.

Scarcity causes prices to rise, and widespread scarcities of food and/or oil, cause widespread price increases.

6. Federal deficit spending actually can prevent or cure inflations, if the spending cures the shortages.

Let me know what you think.

Cheers,

E4E1

 

Wages in general increase with inflation as wages are just another price.

Looking at the situation over the last 100 years or so, the relative value of $1 has decreased by 95%, but wages over the same time have increased by 6600%.

 

over the last 20 years, the min wage has fallen behind inflation imo, cost of living has surpassed the increase in wages for many Americans

I think the way to have solved this would be to tie min wage increases to congresses cost of living increases

 

Yes, that's true particularly if you are in the 60th percentile or below. From 61-80th percent, your income in real terms is about the same and if you are in the top quintile your income has grown, but it's the top 1% and 0.1% that have seen the greatest gains.



When you factor in inflation costs, the lowest three quintiles have less disposable income today and the amount of disposable income has been declining for 40 years.

 

Here is the piece you're missing...I'll use a simple analogy to explain.

Let's say there are 1000 people in an economy and the output of that economy is 10,000,000 units of production each month (each unit sells for an average of $1) and all products are consumed (these conditions are ideal in order to keep this simple).

Each person earns $1000 units of currency per month so $1000 x 1000 = 1,000,000 units of total currency. Making the average price of each unit of production about half a dollar.

Now, don't get overly hung up on the numbers I'm just trying to demonstrate a very simple point.

What happens if the number of people increases in this economy? let's say the population increases by 10% per year, what would happen in this scenario?

Also...

What would happen in this economy if, at the same time population was increasing, technology decreased the number of people needed to create the same number of units of productivity by 0.1% per year, let's look at what happens in 20 years.

The number of people in 20 years increases by roughly 230 and the number of people it takes to make the same amount of production is reduced by about 20. So now you have 1,230 people, but it only takes 980 people to do the work needed to maintain the same level of productivity.

Inflation increases the number of dollars in the economy. It also incentivizes those that have money not to save it in dollars (because the relative value is decreasing), but since value is measured against the things dollar can buy, it makes sense to use those extra dollars to invest in real goods and services because prices of those things are going up. This creates opportunities for new people that enter the economy each year. In the real economy, we get about ~150k net new workers that enter the economy each month. Since 1980 it takes 2.5 times fewer people to create the same level of economic output compared to today. Any deflation at all, no matter how small, discourages people from spending money on real goods and services which in turn limits employment and drives down wages as people become desperate to obtain the bare minimum.

 

How would you define "actual money"?

 

Well, first of all, production would likely not rise in proportion to population.
There is an old thread that covers that here:
The U.S. is being transformed into a Third World Country

That being said, I realize this is all kind of besides the point you're trying to make.

Yes, in general (in a very theoretical sense here), I agree that if you if you increase the population 10%, you can also increase the money supply 10% without that causing inflation. (assuming production rises in proportion to population, and overall average standard of living remains the same)
But if you had 10% deflation over this same time period, what would be so wrong with that? That might be beneficial to the population in some ways.
Just because you wouldn't have inflation doesn't mean it's the good option.

If the price for goods drops (or is going to drop) 10%, for some reason (let's say improved efficiency), and you think we should use that as an opportunity to print more money without causing inflation (keeping the price at the same level it was before), I question that course of policy there.

 

Sorry for the confusing terminology. When I said "actual money" I meant currency issued by the Central Bank or government, actual paper money that you can hold.

 

I covered in a different thread that per capita GDP (adjusted for real inflation) in the US has only increased by about 20% since 1970.

How much has GDP really increased since 1970 ?


I don't believe overall production efficiency in the economy due to technology has increased nearly as much as some people think.
You'll need much higher overall per capita real GDP increases than that, to get the type of effects you are talking about.

 

I financed my car at 0% over 72 months. My payment is $550 a month

In real terms, the $550 I paid for my first payment will only cost me $461 in inflation-adjusted terms for my last payment, but as you say, that's not really the benefit of inflation because at an individual level most people never notices that. What matters is how their wages adjust to expenses over time (which can be affected by increases in inflation).

The real benefit of inflation, as I described in my last reply is that it encourages those that hold large dollar balances to move them into real investments in the real economy giving other people the opportunity to earn some. This matters in a world where there are more people and increasing levels of efficiency and automation.

 

Then what you are talking about is bank reserves. Bank reserves are created by the government and never leave the banking system.

 

As long as the money has been issued by the Central Bank.

I'm not specifically referring to bank reserves, but I suppose those could be included in what I am talking about.

Look, I'm not trying to make this too complicated. I was just trying to draw a distinction between money and fractional reserve banking created "money" in bank accounts.

 

I think there is a lot that you don't understand about money and banking and it's leading you to some erroneous conclusions. If your interested in discussing these topics more broadly, let me know, otherwise I don't think there is a point in discussing this with you as I think there is more you need to understand to have an informed opinion.


Respectfully,

E4E1