Monday, July 21, 2008

Money, Part 3

Oh Boy! Things are a hoppin' in the comment section of the last post! I am really excited about it... even though my eyes are bulging and my brain is hurting. I've got some things to research and think about, but I would like to get to some of the things that have been said once I learn some more! In the mean time, I am going to continue onward... kind of. I said in the last post that I wanted to go deeper into the FED and get into Fannie Mae and Freddy Mac. I'm not going to do that quite yet because I'm still trying to figure out how best to explain it. I'm all about cutting through the big words and complicated explanations in an effort to really understand it. I am a blond afterall.

So... back to inflation. Remember inflation is an increase in the money circulating. Some people think prices rise because workers demand higher wages so the businesses must raise the prices of their goods so that they have the money to pay the workers. Because of the higher prices, the workers demand higher wages... and the businesses raise their prices again. Around and around they go. Wages and prices spiral upward. It makes sense right? Hmmmmm... but where does the money come from? Businesses can ask any price it wants for its goods, but, it will only get what it asks for if the money exists. Yup, you got it, someone printed it.

If the supply of money does not change then the only way for someone to have more money is for someone else to have less. When someones wages went up... another person's would go down. When one product's price went up... another products price would have to go down. The value of the money would not change. The only way for wages and prices to go up is for someone to print money.

Let's take a little look at oil prices, the hottest topic around these days! Some people think inflation is caused by rising oil prices. Supposedly... oil is involved in the production of just about everything. What about products made from oil... like plastic? Well, in the case of plastic and other products made from oil... like gasoline... the prices will sharply rise. But, what about other prices? Being a housewife, I do the grocery shopping and I see a sharp rise in the cost of food. Most attribute this to the rising gas prices. The goods need to be transported to the stores, right? If it is costing more to transport goods then it follows that the price of those goods will also increase. And they have. If people are spending more money on gas and other oil related items, they will have less to spend on other things. The prices of other things will fall... or should fall... unless more money is printed and put into circulation. Right? If money is not being printed, then each rise in price would have to be matched by a fall in some other price. What if the demands for money are faster than it is created? Think about it.

What happens if a business raises prices faster than the government inflates? People just won't have the money to buy those products... so the business will either lower prices or go out of business. In the case of unions... they try to push wages up faster than the government inflates. Then the employers don't have money to hire as many workers. They get machines to replace workers... or go to another country where the price of labor is cheaper. Strikers don't understand that when the price of their labor goes up, the demand for their labor goes down. Supply and demand people.

What about when the people cry out for wage and/or price controls? If the amount of money goes up, the value per unit goes down. That is a fact, not an if/or. If people are not allowed to increase their wages or prices during and inflation (that is causing other goods and services to rise)... the value of their money goes down and they can't get more to make up for the loss. They quit working. Whenever the government is asked to start controlling prices, shortages happen... and black markets develop.

A black market is simply the buying, selling or making of something that the government does not allow... or at higher prices than the government allows. Some people just don't get it... the wage/price spiral does not cause inflation. It is a result of inflation. Wage/price controls are not a good idea... it has never worked. Increases in the money supply always increases wages and prices. Decreases in the money supply are followed by a fall in wages and prices. Wages and prices simply do not rise without someone creating more money.

Now... any of you smart people reading this... help me out here. I just don't get some stuff. Like... if the FED were to be abolished what would that look like? What problems would arise from that? What would it mean for all the housewives out there like me? And... what if the government bailed everyone out that got into financial trouble? What kind of impact would that have on everyone? Who is really controlling the amount of money in this country? I want to know.

6 comments:

One Salient Oversight said...

If people are spending more money on gas and other oil related items, they will have less to spend on other things. The prices of other things will fall... or should fall... unless more money is printed and put into circulation. Right? If money is not being printed, then each rise in price would have to be matched by a fall in some other price. What if the demands for money are faster than it is created? Think about it.

Inflation is when the price of goods and services increase in relation to money. There doesn't need to be a big increase in the money supply for inflation to occur.

Let's say you have $1000. Let's also say that an earthquake wipes out 95% of all the production of goods and services. You still have the $1000 - that hasn't changed - but suddenly there is a shortage of goods and services and thus you have inflation (demand outstrips supply, so prices go up).

One Salient Oversight said...

What would happen if the Fed were abolished?

Well, how would money be created? If there was simply a fixed amount of money created by fiat that could not be increased through fractional reserve banking, you would have a fixed amount of money being used to purchase a growing amount of goods and services.

In other words, continual deflation and people hoarding money.

One Salient Oversight said...

what if the government bailed everyone out that got into financial trouble? What kind of impact would that have on everyone?

Then there would be no risk associated with spending or investing. This is problematic because stupid people who waste money would not suffer the consequences of their actions. If the government bailed everyone out it would be a case of "socialising risk" - everyone loses.


Who is really controlling the amount of money in this country? I want to know.

Money is used as an exchange for goods and services. As people buy, sell, invest and borrow, money goes in and out of the commercial banking system and increases the amount of money in an economy.

So one answer is: The market controls the amount of money in the country.

But the Fed, unlike commercial banks, has the ability to affect the money supply through monetary policy (interest rates).

So another answer is: The Fed controls the amount of money in the country.

So who controls? Both the government and the market.

BLBeamer said...

I have to disagree with my good friend OSO.

We cannot prove inflation merely by pointing to price increases. In the US in the 1920's wholesale prices were essentially flat (see below), yet the Fed was inflating to beat the band (mostly through continual lowering of reserve requirements). This inflation was masked by productivity increases which lowered the costs of production and increased the supply of goods.

Per the US Bureau of Labor Statistics: the Index of Wholesale Prices was = 93.4 (1921); 104.5 (1925); 100 (1926); 95.2 (1929).

BLBeamer said...

What would happen if the Fed were abolished?

Well, how would money be created?


The Fed in the US is not even 100 years old. How was money created before its establishment?

In the "good old days" of hard money, the amount of gold and silver mined and put into circulation increased the money supply. Banks still took deposits and made loans, creating money in the process but they had to make sure they had enough gold and silver at their command to cover potential withdrawals. If they became too leveraged, they failed because there was no lender of last resort such as the Fed.

Clarification: there was no government entity like the Fed that acted as lender of last resort. Guys like J. P. Morgan acted in that role.

Two Dogs said...

Common currency is necessary in my opinion, so therefore I deduce that the government must print it to ensure that stability. But, money is never the most common form of trade in goods and services. That needs to be accounted for. Anyone that assumes that actual currency is the only form of trading refuses to understand the economy has shifted to a more "abstract" one. The "abstract" representation of wealth at some point will not require the actual dollar bill. So, "currency" is quickly becoming irrelevent. Contradictory? Not yet.

blbeamer made a interesting point, Morgan bailed out the market one time. Then the government went after him and other businessmen. Government bit the hand that fed them, which is always the case.

This all kinda boils down to the old saw that "government is evil, but necessary."