1.2 trillion out of thin air and Inflation (redux)

[Kurt_and_Hunter]

I posted something a few days ago about how RW hysteria about looming hyper-inflation is farcical.

Some further observations inspired by a Sunday catch-up tour of some favorite econ blogs...

Money is created primarily by banks, not by the government. The government essentially gives banks permission to create money.

The Fed recently made some money by fiat and started buying things with it. A lot of RW types bitched about it. Milton Friedman types set great store in basic money-supply and see this fiat money as profoundly inflationary.

But even in the simplest model government money-printing is a side-show in the money supply circus. A bank with a 10:1 reserve ratio creates $9 for every government dollar someone deposits. (And eventually $99 dollars as it passes through a series of banks and borrowers)

We know that Bernanke has doubled M0 (base money supply) in four months, which is incredible. But does it really tell us anything about inflation?

Banks create most of the money by issuing loans. Everyone knows banks are not loaning money like they used to... that's a central feature of our current woes.

So Bernanke's doubling of M0 is like a numerator without a denominator.

If banks failed to create $2 trillion and the Fed printed $1.2 trillion than the net effect is still less money overall.

I don't have the figures, but since Ben Bernanke is a slightly more sophisticated kind of Friedmanite it seems likely that he over-estimates the inflationary impact of printing money. I would guess he is merely tossing a little government-money dirt in a ginormous bank-money hole.

(This is not an endorsement of Steve Keen, but you can read an interesting argument that the Fed would need to print about $20 trillion to cause noteworthy inflation here: http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/ )

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A related note of much import: Even if reserve requirements are kept at (low) historical norms banks can still bootstrap something approaching infinity money if asset prices are going crazy. When people see assets going up more than the cost of money they borrow to invest and the rising price of their investments collateralizes more borrowing for more investments, and so on.

When people see it as worthwhile to invest by going into debt (mortgages on investment properties, stock margin accounts) things are probably out of hand. If you can reliably profit as a passive investor by borrowing money then the price of money is probably too low.

I will once again offer my extreme proposal for prophylactic bubble-regulation: the only way to regulate bubbles is to regulate the bubble itself. Indirect regulation will always be worked around one way or another. Markets are plenty clever.

Tax inflating assets themselves in some way that makes a bubble unprofitable (and thus impossible). Be agnostic about whether there is or is not a bubble. Just tax valuation gains above a certain level of appreciation annually (15% 20%? 25%) at whatever small rate is necessary to disincentivize chasing the bubble.

You could tax the difference between an annual gain and the prime lending rate to be fair; again, penalizing the speciffic behavior of going nuts when interest rates are much lower than asset appreciation.

This wouldn't apply to you increasing the value of a business and I immagine primary residence would be exempted.

The implicit "good productivity" cap would be a tolerable loss compared to the down-side of the bubbles that wreck to world economy periodically. IMO.

Yes, I do recognize why this would be hard to implement: All markets would have to share the same valuation tax or else money would flow from sane countries into markets where bubbles remained possible. That goes for all regulation to some degree but actual taxation of large valuation gains would definitely create a competitive disadvantage for investment money flow. C'est la vie.

Taxing overly-successful investment appreciation in addition to realized gains seems unfair, and it is, but any indirect bubble control is also unfair and more subject to clever evasion. (For instance, raising interest rates to knock down a stock-bubble... why should I have to pay more for a car loan because Ebay stock runs up to $300/share? There's nothing particularly fair about that either.)

[Terry in Austin]

1. Thanks for the econ refresher

Our money system is so arcane, it's a wonder that there isn't even more misunderstanding about it. There are so many ways to fiddle it, and the moneyed class likes it just fine that way, don't they?

After all, who wouldn't like to gain income without doing productive work? That's what's so interesting about interest. The proverbial free lunch, and it's built right into the system. Just imagine one where charging interest is illegal, as it was in other historical periods.

But wait -- then it wouldn't be capitalism any more. Oh, well...

[soothsayer]

2. how come no one cares that they've BEEN doing this all along

opening their discount window to everyone, for long before the tarp ripoff

how much funny money helicopter ben shalom bernanke has thrown to them i know not