Tax cuts don't make basic economic sense

I don't see the correlation.

For example, we have not seen inflation increase or decrease corresponding to the amount of debt issued.

 

If the U.S. decided to suddenly default on their debt, and if there wasn't any government debt held by the Federal Reserve Bank, you'd see massive deflation.

My guess is if (hypothetically) the government did ever decide to default on their debt, the deflation would be roughly balanced out by the inflation from the holdings in the Federal Reserve (which theoretically back the dollar) suddenly being worthless.

Basically on the one hand much of people's savings and pensions would be wiped out (less money, deflation), but the remaining money would be worth less.

The reason why government debt held by the Fed backing the dollar adds value to the dollar is because it signifies that at some (unspecified future) point those dollars are going to be retired, by the U.S. Treasury to buy back its debt. A debt default would basically mean those dollars issued by the Fed would not be retired in the future (i.e. there exists more money but not more Reserve Assets).

 

You'd see all kinds of terrible things. But I don't know if there would be massive deflation. Cancelling US debt would not eliminate money. The Fed buys assets to create money, but the Fed creates base money literally out of thin air. It holds the assets so it can reduce the money supply by selling the assets.

 

But it would cut the money supply.
("money supply" isn't just composed of actual dollars)

Yes, and if those assets dissappeared, suddenly you'd have inflation.

Expanding the money supply doesn't necessarily create inflation. As long as the actual real market value of the assets being bought match the amount of money creation.
But that often isn't actually the case.

The Fed often acts as the buyer (or lender) of last resort, when the open market won't buy something (at that price). That's why you have inflation.

 

How?

How?

I don't understand "actual real market value".

It has don't this only one time, to my knowledge.

Depends on other factor, such as whether banks are lending.

 

If the Fed pays more money to buy an asset than the open market private sector would, it will cause inflation.

If all the Reserve Assets held by the Fed suddenly dissappeared, the dollar would be worth a whole lot less.

That would mean those dollars are going to stay floating around and there's no way for them to go back to the Fed, because the Fed wouldn't have the assets to sell.

When the Fed buys something (like U.S. Treasury debt, for example) and pays more than the market price, that dilutes the value of the dollar you hold.
Suddenly the ratio of dollars (that are out there) to amount of asset wealth the Fed is holding changes.

 

I see. Now, that is not the case. What creates inflation is the Fed putting more money into the market and banks lending it. It doesn't matter what it buys. In the crisis the Fed put a bunch of money into the system, but the banks didn't lend it. Still aren't, really.

Why? A dollar would be worth the exact same amount. A dollars value is relative to the amount of goods and services in the economy, not the assets the Fed holds.

The all the assets the Fed holds were to disappear, however, the Fed would have a problem getting dollars out of the system. That could cause some problems.

Right. But as a general matter, they don't have to go back to the Fed.

That happens whenever the Fed creates money, regardless of what it pays.

That doesn't affect value, unless it were to get way out of whack (so that the Fed didn't have the assets to remove dollars). Since the Fed isn't likely to try to recall all base money at the same time, it doesn't need and exact match. Furthermore, the Fed usually buy high quality debt like Govt bonds or Govt back securities, which reduces the risk of such a mismatch.

 

Why did you skip my other questions? Address them please.

 

No, that is not true. It's a common misconception.

Many economists seem to think it's true, but it's obvious they didn't think things through. Whenever the banks expand the money supply, that creates personal debt that exactly balances out the new money creation. Personal debt does just the opposite to inflation that having money in the bank does. The net effect is zero.

(Theoretically. It's more complicated than that but I'm just covering the basics)

Having someone owe you dollars, like your bank when you have an account with them, adds inflation; but owing someone else dollars tends to counteract that. You can't (or shouldn't) spend those dollars if you're going to owe them to someone else soon.

Like I already explained to you before, the Fed putting more dollars in the market doesn't necessarily have to cause inflation either. Or to be more precise, the inflation is not in proportion to how many new dollars they issue.

There are a lot of economists who apparently don't understand this.

Yes, there are more dollars out there now, but the Fed has also removed assets from the marketplace. And there is an inherent assumption, at least theoretically, that at some point the Fed is going to sell back that asset into the marketplace to buy back the dollar it issued.

For example, if the Fed owns your mortgage, once you pay it back things are reversed back to the way it was before. Now that money is taken out of the marketplace and the Fed doesn't own the asset (your debt) anymore.

If that still doesn't make sense to you, maybe imagine it this way. Why couldn't a person lend money to themselves and that cause inflation?
After all, it's just an amount of money written in a ledger that probably never even gets translated into actual dollars.

 

You have an apple. The Fed decides to issue a new dollar to buy your apple.

But now someone needs that dollar to be able to get that apple. Because the Fed is holding onto the apple, it can issue that dollar without it causing inflation.

But that's assuming people are actually paying one dollar for an apple in the open market.

Now it might not be an apple, of course. You have a mortgage. You need dollars to pay back your mortgage.

Guess who actually owns the equity in your mortgage. Your bank may have bundled up a lot of mortgages into a giant package and sold it to the Fed. When you're paying back that mortgage, the money is ending up going to the Fed.
That process is a little complicated and indirect, but essentially that's how it works.

How much will someone else pay for an apple? One dollar?

If the Fed says it will buy an apple from you for $1.20 that is going to cause inflation.

Suppose there are zero dollars in circulation, intitially. The Fed first decides to issue $1 and buy 1 apple. Then it issues $1.20 and buys another apple. Guess what? That caused 10% inflation. The Fed now has 2 apples and there is $2.20 in the marketplace. The new price of one apple has gone up to $1.10
You will notice how the market value of the total reserve assets always matches the total amount of dollars in circulation. There is an inherent correlation.

 

None of the above should minimize the dangers of inflation.

What I am saying, however, is that if the Fed doubled the number of dollars in existence, it would probably not reduce the purchasing power by half.

An extremely high rate of hyperinflation, however, would start becoming roughly proportional to the number of dollars in circulation because the dollar also derives some of its inherent value from taxation.

 

According to what and whom?

Unlikely. Because it makes perfect economic sense. The value of money, like anything else, is a function of supply and demand. If you double the amount of money the relative value of other assets falls in half, all other things being equal.

That makes absolutely zero sense. First, personal debt is not money. Second, when someone gets a loan, they spend the money.

Folks generally don't take a loan with interest they have to pay to sit on the cash.

Your position is making less and less sense.

I've never said that the Fed creating money necessarily causes more inflation. As I said, it depends on other factors, primarily whether banks loan out the additional money.

Usually they do, but in periods of economic stress (i.e. they GR) they become cautious and don't necessarily.

A lot of economic analysis on the subject is based on the banks lending out the money they get, which is the normal situation.

Has nothing to do with the Fed removing assets, which is always the case.

That assumes the 1) the Fed owns it, and 2) the Fed isn't creating more money by buying other assets.

Because a person isn't a bank that multiples deposits.

When you (or the government) lend money, there is a decrease in one depository account which offsetts an increase in another.

When a bank lends money, there is no offsetting decrease in depository accounts.

When you use improper and ambiguous terms like "actual dollars" its easy to get confused as to what is meant.

But bank transactions are done in "actual dollars" (i.e. base money) in the millions every day.

 

You're not being very clear. But if the transaction involves paying money into the Fed, then yes, I agree that there is a potential decline in the amount of money in the system (assuming the Fed doesn't use the money to buy other assets).

If an only if there is a net increase in the money supply which is greater than the volume of goods and services.

OK. The Fed is increasing the money supply faster than the amount of goods and services. The will cause inflation, which is just what I said above.

You have to be much more precise about what your talking about. But in your example, if the Fed were to give the apples to someone, it wouldn't change the value of the apples.

 

That's because the effective number of dollars in the system depends on other factors, including bank lending and velocity of money.

If the Fed creates a bunch of money and it goes into someone's account and sites there, and doesn't get spent or lent out, then the effect on inflation will be negligible.

If the created dollars are spend and lent out by banks, multiply the effective money supply, then you can get inflation.

 

These might not cause inflation.
I started a separate thread about this: Is fractional reserve banking inflationary?
If you want, we can take the discussion there. That thread is intended to discuss why an increase in the money supply might not create inflation. (What people are commonly taught about the relationship between the m2 money supply and inflation may not be true)

 

Especially when you have a national debt approaching $22 TRILLION!!

 

Yes, exactly.

 

Well...$6-7 trillion of public debt owned by foreign interests won't be spent in the US...