Two different definitions of "inflation": Ron Paul's, and Ben Bernanke's

Yesterday I heard Rep. Ron Paul of the House Banking Committee questioning Fed Chairman Ben Bernanke about inflation and the value of the dollar.  It was at best a confused exchange, because, clearly, Ron Paul's definition of "inflation" differs from Ben Bernanke's definition of that same exact word.  (Ron Paul is using an old definition, according to the two definitions compared on this web page.)

It would seem important that our public servants in charge of "controlling inflation" should agree on the definition of "inflation" before debating what to do about it—wouldn't it?  Shouldn't the House Banking Committee, along with their counterparts in the Senate, eliminate the prevailing confusion by choosing one of the two (very different) definitions of the word "inflation"? 

Ron Paul defines inflation as any increase in the "money supply" (which, by itself, begs several questions; see the end notes).  Ben Bernanke defines inflation as an increase in the price level.  To Ron Paul, zero inflation happens when zero "new money" is created.  To Ben Bernanke, zero inflation is the scenario in which the prices we pay for goods and services do not increase in the aggregate. 

Let's temporarily make the dubious assumption that we are able to measure and control the "money supply"—in spite of Milton Friedman's admission that that's nearly impossible.  In a growing economy, there's a growing amount of goods and services, by definition.  It takes money to make and buy those goods and services.  How much money?  That's the question, and there are at least two possible answers:

• In Ron Paul's zero-inflation scenario, the "money supply" stays unchanged, which implies that, in a growing economy, wages and prices must decrease.  In simplified terms, the same amount of money paid out for producing and purchasing more goods and services translates to lower wages and prices in the aggregate.  Ron Paul's definition of zero-inflation, in a growing economy, equates to what many others think of as "deflation."  [Would you feel comfortable with a pay cut, just because Congressman X said "don't worry, prices are dropping too, and there's no inflation"?] 

• In Ben Bernanke's zero-inflation scenario, the "money supply" grows at the same rate as goods and services.  In simplified terms, x% more money paid out for producing and purchasing x% more goods and services translates to unchanged wages and prices in the aggregate.  [Wouldn't you feel more comfortable with constant wages and constant prices?]

Most of us, I think, implicitly agree with the "inflation" definition Ben Bernanke is using: rising prices = inflation; falling prices = deflation.  I also think most of us would be averse to wage cuts—even if prices were falling at the same rate—just to hold (Congressman X's definition of) the "money supply" constant.  [Can you picture a future economy, after decades of holding the money supply constant, in which a large pizza costs ten cents and the average wage is fifteen cents an hour?  I can't.  Apparently, Ron Paul can, however.]

But I've been wrong before.  If Ron Paul's definition of "inflation" is the one our public servants can agree on, I'll start trying to think of ways to convince my friends that falling wages are not a bad thing.  Either that, or I'll give up on the hope that growth can accelerate, because when wages and prices fall, people typically want to hoard money, instead of using it for economic transactions. 

In any case, wouldn't it be a good thing for the House Banking Committee to pick one definition or the other, to clarify the debate for us?

=============
End notes:
Ron Paul's position supposedly comes from the "Austrian" school of thought.  I'll have to reread Mises' writings on this subject, because I'm not sure he was as explicit about the money supply as the position Ron Paul is taking. 

Some additional questions for supporters of Ron Paul's constant-money-supply idea:

• Milton Friedman admitted in this interview that the "money supply" is almost impossible to measure.  If we can't measure it, we can't manage it.  How would we hold something constant if we can't measure it?

• Even if we could measure the "money supply," there are several possible definitions of that term: base money, M1, M2, and a revived M3.  Which one should be held constant, and why, and how?

Comments

[Tom Hanna]

I suspect that as a hard money advocate Ron Paul is probably referring to M0. With a truly free market in banking, there's no reason that I can think of to assume that a constant M0 would necessarily equate to constant M1, etc. and price/wage deflation. Also, theoretically wages rise faster than prices because of productivity growth, so if money supply of all types were held constant, wages should also fall slower than prices.

What we could probably all agree on is that predictability is important and I suspect Ron Paul simply thinks that gold is more predictable than Fed chairmen.

[Bob]

I'm in total agreement with Friedman that the money supply cannot be measured. At least not in a manner that would be useful.

However, I'm not sure that the current measurement of prices is any help either.

Why exclude energy and food prices from the inflation measurement? We have to eat, heat the shelter and transport ourselves around. If the price for doing so rises (gasoline has doubled in 4 years, for example), that's inflation by any definition.

And will someone, any one, convince me that, given increasing global demand for food and energy, the Fed has the tools to measure said supply and demand?

If we can't realistically measure prices and choose to exclude certain prices from the measurement we do use, shouldn't the Fed come up with something different? Or perhaps fess up and let everyone know that there is a target or range that is acceptable given the new global market.

Lastly, if anyone mentions equilibrium, I'm going to hunt them down and throw a pie in their face. I'll make it two pies if you
mention inflation in the seventies because I'm still waiting for my COLA.

[markg]

If holding the money supply steady is Ron Paul's position, this is very dangerous. Most money is created via credit. But look at the following example. I get a 30 year mortgage with a $1000 monthly payment. My income is $2000 per month. After 10 years of holding the money supply steady with prices and incomes falling, my income drops to $1000 per month. All I can afford is the mortgage payment. I have no money left to buy anything else.
Even at 0% interest, I would be stupid to ever buy anything with credit. Same holds true for business; no more borrowing to invest in new production.
What you would see is an accelerating drop in the money supply, along with the economy and living standards. Just look at the deflation in Japan during the 1990's. 0% interest rates - no economic growth. Like I said, this is very dangerous and explains why the Fed targets for some inflation.

[Nathan Benefield]

Aren't they both half right? I don't think inflation is simply "increases in the prices of goods and services." This is why the CPI overstates inflation - it ignores improvements in quality and substitution good, etc., which increase the price level.

That is to say that inflation is the increase in the price of goods and services due to increases in the money supply.

[Keith R]

I think you're also disregarding the effect of asset bubbles on the economy.

If M3 is growing far faster than the economy, it's blowing these bubbles that keep popping.

Paul always argues this point. The growth of the money supply drives up asset prices artifically, which is why no one saves, why basic commodities are roaring, and why income inequality is so severe.

[Steve]

Bob:
I agree with your argument that food and energy should not (always) be excluded from the inflation calculation; that's why, if I had to pick one measure, I'd watch the "trimmed mean" PCE inflation. The items "trimmed" from the calculation are chosen by an algorithm, not humans; the algorithm excludes what look like outliers instead of trends. If food and energy stay high, they are not trimmed from the calculation. Here's a link to it; links to explanatory pages are at the bottom: http://dallasfed.org/data/pce/index.html

In spite of that, no one measure is perfect; just look at the differences among CPI, PCE, PPI, nominal minus real interest rates, and the GDP deflator. I keep an eye on all of them, but lean towards the TM-PCE as the least-inaccurate measure of current and past inflation.

[Don Lloyd]

"In Ron Paul's zero-inflation scenario, the "money supply" stays unchanged, which implies that, in a growing economy, wages and prices must decrease..."

Presumably, your assumption here is that the objective exchange value of the unit of money increases due to an increase in the supply of goods. This ignores the fact that the demand for holding money can change for many reasons, for example, the increasing availability and acceptability of credit cards, which serve to substitute for the need to hold actual money.

Regards, Don

[Gil]

I think I agree with SO on this one. If with inflation, people wages pretty much increase with prices then there's an upward scalar effect. But the complaint is there's a lag effect, those who print the money get to spend it before sellers realise what's going and are getting a free ride. On the other hand, why wouldn't wages fall in a deflationary environment such that there's a downward scalar effect? Interestingly, this time the freebies are for those who are holding currency and are getting more purchasing power with time.

Doubly interesting is that complaints about inflation come from those who use the term 'fiat currency' and who just happen to be the same people who prefer deflation with a gold currency economy.

[Ron Hardin]

Ron Paul's definition gives the deflation trap, which is what the Fed has to avoid, and keeps inflation positive to prevent. Namely that in times of falling prices, people stop spending, for things will be cheaper tomorrow. Velocity goes to zero.

The Fed then loses control of the money supply.

So it makes inflation as small as it dares, but not zero.

[Ron Hardin]

Ron Paul's definition gives the deflation trap, which is what the Fed has to avoid, and keeps inflation positive to prevent. Namely that in times of falling prices, people stop spending, for things will be cheaper tomorrow. Velocity goes to zero.

The Fed then loses control of the money supply.

So it makes inflation as small as it dares, but not zero.

[Robert Michael of the Saints]

Look, it's pretty simple..if there is 1000 dollars in an economy, prices will reflect the available money supply. You now cant charge $2 for bread.

Now if you have 10 dollars of that 1000 you are RICH. you have 1% of the money. If someone prints another 1000, you have .5% of the money, they STOLE 1/2 of your wealth. That's TRUE INFLATION.

Everytime the Fed prints money, they STEAL from those who have money saved. PERIOD END OF STORY

[Mike Sproul]

99.9% of economists define inflation as an increase in prices, so Ron Paul should just say "money inflation", so we all know what he means. The problem is that money inflation by itself does not cause price inflation. As long as every new dollar is issued for a dollar's worth of assets, the assets of the issuing bank will rise in step with the money, and the value of money will be constant.

[Devin]

"Everytime the Fed prints money, they STEAL from those who have money saved. PERIOD END OF STORY"

Nonsense. Your wealth isn't determined by what percentage of the total money supply you possess at any given time. It is determined by the purchasing power of the money that you own. If the supply of money increases 2x from $1000 to $2000, and the demand for money also increases 2x, your $10 is still worth $10, only now you probably have a lot more options of where to spend your $10 because the economy has grown so much.

[Robert Micheal of the Saints]

On the gold standard, the price of bread had not gone up in over 100 years. The only time is has gone up is,,

1. During the civil war when lincoln printed 150 million dollars to pay for the war. BUT this was later taken out of the economy, bringing prices down.

2. In 1913, when the Fed was instituted, since then it has done nothing but climb.

THE FEDERAL RESERVE IS A PRIVATE BANK. GET THIS INTO YOUR SKULL, THEN YOU WILL REALIZE WHAT IS GOING ON. THEY PLAN TO TAKE ALL YOUR WEALTH, AND LEAVE YOU WITH NOTHING.

MY GOD STOP LIVING IN FANTASY LAND!!!

GET RID OF THE FEDERAL RESERVE.

You need to watch some movies on the Federal Reserve, the Federal Reserve is no more federal than Federal Express...

[Bob]

Robert Micheal,

No sir, it is the pork addicted politicians that you should be after. Them and the good folks at NASA that send up Tonka toys to pick up rocks on Mars.

We're studying rocks on Mars while sending billions in petro dollars to
the whackos in the ME. Amazing.

[bbypy]

Actually, Paul isn't recommending a zero inflation scheme. He advocates getting the government out of economic planning altogether. Austrian economics argues that central planning can never be as efficient as free market planning. Still, a constant money supply would be a vast improvement over the present case. BTW, wages do not necessarily decline in a constant money environment ... if you increase your productivity.

[Gil]

But then bbypy, if your productivity goes up nowadays your income would go above the rate of inflation than (hopefully) keep up with it. I tend to think those who want deflation are intimidated by big numbers as in "look how much you could buy if you had $10 in your pocket in the year 1900" and/or can't translate the relative purchasing power of the lower price figures as in "$10 was a lot of money back in 1900 and the average schmoe probably wouldn't carry that much money at any one point in time".

[Kevin]

I'm still chuckling at the thought of an ignorant, paranoid whack-job like Ron Paul thinking he can challenge a thoughtful economist like Bernanke. I bet Ron Paul still has the closet full of beans and gold coins he stockpiled before Y2K.

[cwurden]

[ "It takes money to make and buy those goods and services. How much money? " ]
__________

Misunderstanding the basic concept of "money" is a key source of confusion here.

"Money" is merely a medium of exchange -- you can't eat Dollar Bills for food nor fuel your car with them. Ultimately you can only buy
goods & services... with other goods & service you have to sell.
It's a 'trade' function.

"Fiat Money" like the U.S. Dollar has no inherent physical value, but is easily produced in unlimited quantities by official printing-presses & ethereal credit accounting book entries. Bernake's worry is how much 'phony money' to produce for Congress -- without killing the American economy.

Money of genuine inherent value (like precious metals) or directly tied to real goods & services ... has no need of government 'management' -- the market economy itself decides & produces the right amount of money.

Real money cannot be inflated. Fiat money is always inflated (debased by its producer)...but requires 'management' to slow the destruction of the currency and hide its effects from the populace. Historically, all fiat money eventually becomes worthless as a medium-of-exchange. So too will the U.S. Dollar (..soon perhaps).

Federal debasement of the Dollar
("inflation") 'causes' the 'effect' of a general price level rise.

Cause & Effect is a critical determination in problem solving.

Ron Paul is absolutely correct; Bernake is wrong.

[Gil]

Hey cwurden:

The S.O. has an article has here against the gold standard and the deflation it'd cause as an answer.

http://www.optimist123.com/optimist/2007/05/sound_money_ver.html#comments

But I think the difference is that most people prefer the fiat currency because it's a better measure of value between goods and services and is better for a growing society with ongoing transactions. Goldbugs/Libertarians prefer gold because it's a greater store of value and better for a steady-state society with slow to nil growth.

But by the way why would someone prefer paper money that claims to redeemable for gold necessarily as more sound than fiat currency? Especially as you're still holding paper which still came out of a printer? History has shown that gold isn't actually always redeemable after all just as some have hyperinflated fiat currency. Yet ironically it'd be hard to maintain modern society based on transact gold (and silver) coinage, especially for international trade.

[ghamal]

Mr. Paul's heart is in a good place, but he's wrong. Money supply should grow to accommodate population growth. The problem is that, unless we all find a way to stop needing a car, an A/C unit, and bread, it's easy for a layman to ridicule the current measures of inflation when they don't include necessities like food & energy.

[JorgXMcKie]

Geez, I've seen that argument about the cost of bread before, but I didn't think anyone here would be silly enough to bring it up.

First, a major, major shift in human history was busy occurring in the 19th century. The Industrial Revolution meant, simply, that productivity was no longer tied directly to the efforts of single human beings.

I don't care if the cost of bread today is 100 times the cost in 1850 if I can by 500 times as much bread with a week's worth of wages as a worker could in 1650.

It's not just that the quality of the items we produce is better (although in just about every way it is), but that we can trade our 'labor' for more of the same, or other, products.

Get a grip, people. Money is a place-keeper. A marker. A medium of exchange. Or, perhaps one of you Paulites (Paulines?) can explain to me how everyone is going to figure out how much items cost in terms of fractions of ounces of gold and who is going to weigh it all out. If you say it doesn't actually get weighed out, then I say you're back to the original 'medium of exchange' and the essential valueness of money as anything else. Gold is shiny, pretty, extremely malleable, and so on, but as an actual medium of exchange it's worth much, much less than 'fiat' paper money.

In fact, most money is now merely a set of 1s and 0s on computers anyway.

The current measures of 'inflation' is somewhere between stupid and ridiculous in real terms because it can't even come close to addressing the problem above of how to measure the price of bread compared to 'constant dollars' and labor value.

Hey, CPI and such are more like mnemonics or rules of thumb or such in that they give us a kind of practical, quick and dirty way of measuring the above combinatorial problem.

'Money' needs to be: predictable (more or less) and thus trustworthy for people to use; reliably available to those using/earning it; transparent at a medium of exchange; and widely recognized as all of the above. That's it. Gold fails most of those.

[JorgXMcKie]

Geez, I've seen that argument about the cost of bread before, but I didn't think anyone here would be silly enough to bring it up.

First, a major, major shift in human history was busy occurring in the 19th century. The Industrial Revolution meant, simply, that productivity was no longer tied directly to the efforts of single human beings.

I don't care if the cost of bread today is 100 times the cost in 1850 if I can by 500 times as much bread with a week's worth of wages as a worker could in 1650.

It's not just that the quality of the items we produce is better (although in just about every way it is), but that we can trade our 'labor' for more of the same, or other, products.

Get a grip, people. Money is a place-keeper. A marker. A medium of exchange. Or, perhaps one of you Paulites (Paulines?) can explain to me how everyone is going to figure out how much items cost in terms of fractions of ounces of gold and who is going to weigh it all out. If you say it doesn't actually get weighed out, then I say you're back to the original 'medium of exchange' and the essential valueness of money as anything else. Gold is shiny, pretty, extremely malleable, and so on, but as an actual medium of exchange it's worth much, much less than 'fiat' paper money.

In fact, most money is now merely a set of 1s and 0s on computers anyway.

The current measures of 'inflation' is somewhere between stupid and ridiculous in real terms because it can't even come close to addressing the problem above of how to measure the price of bread compared to 'constant dollars' and labor value.

Hey, CPI and such are more like mnemonics or rules of thumb or such in that they give us a kind of practical, quick and dirty way of measuring the above combinatorial problem.

'Money' needs to be: predictable (more or less) and thus trustworthy for people to use; reliably available to those using/earning it; transparent at a medium of exchange; and widely recognized as all of the above. That's it. Gold fails most of those.

[John Henry]

Seems to me that a couple of points are in order:

1) If Ron Paul is saying that he opposes any increase in the monetary supply as inflationary, then I don't think he knows what he is talking about. I've not paid that much attention to him on this but had always assumed that he meant an increase in money supply releative to the siaze of the economy. If the economy grows 3% ie; 3% more activity/value creation, and the money supply grows 3%, then there should be no inflation or deflation.

I agree that it is difficult to impossible to measure either money supply or level of economic activity with a great deal of precision.

2) The US underwent tremendous economic growth between 1800 and 1940. Except for the period 1862 to 1875 (years from memory) there was no inflation. See http://www.pbs.org/teachers/mathline/concepts/president/activity1.shtm
for example. This graph appears in a number of basic econ texts I have used over the years.

What happened in the 1930'S? Well, first Roosevelt devalued the dollar from about 1/20th oz of gold to 1/35 and he basically took America off the gold standard and onto fiat money.

I am not a big fan of gold. I think it is too easily manipulated. OTOH, I am even less a fan of fiat money.

John Henry

[cwurden]

.

" Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

{-- John Maynard Keynes}

________

" Monetary inflation is the preferred solution of politicians for new funding. The real cause of the public's increased cost of living can be hidden from most voters, who are economically ignorant, naive, and trusting. "

{-- Gary North}

________

" It is well enough that the people of the nation do not understand our banking and monetary system for, if they did, I believe there would be a revolution before tomorrow morning. "

{-- Henry Ford, Sr}

[Kevin]

cwurden is quoting GARY NORTH?!?

And you all thought I was joking when I referred to goldbugs still having a closet full of beans and gold coins stockpiled for Y2K. I give you exhibit A.

[Kevin]

John Henry, to your post I'd add that the growth from 1800 to 1929 (not 1940) was marked by periodic hellish depressions worse than anything we moderns have seen.

And there is a reason Roosevelt began to delink money from gold in the 1930s. Recall what was going on about that time? The grand culmination of the world's economies using a gold standard was, indeed, the contagious Great Depression.

[Kevin]

One more thing, I keep seeing this reference to "inherent value". That is a nonsense term. Neither gold nor anything else possesses inherent value. Value is always projected into things by people.

Gold, paper bills, or anything else posses value if and only if humans value them (for whatever reason). In the absence of human society, value is meaningless, like division by zero. There is nothing inherent about it.

Fiat money is valued by people just as legitimately as gold is, and so its value is just as legitimate.

Personally, I value $100 of cash FAR more than $100 market value of gold. I have no use for gold. I cannot eat it and I cannot spend gold, because gold is not money. I cannot use gold to pay for things at any store I know of. There is not a slot in cash registers to hold lumps of gold.

And to convert gold into money I'd suffer a transaction cost -- probably a large one, probably I'd get totally ripped off, since a pawn shop is the only place I can think of to sell gold anyway.

[john Henry]

Kevin,

I spoke of 1800 to 1940 because we have price data going back to 1800 and it is where most graphs I have seen of US inflation begin. I ended with 1940 because that is when the graph goes from being pretty flat (no inflation) to trending consistently and steeply upward.

Even with the depression, we saw no inflation. At least compared to 1940 to present.

re depressions, you are right, they did occur and were somewhat, in your word, "Hellish".

The gold standard was not the cause of the Great Depression of the 30's. The main cause was the Smoot-Hawley tariffs.

For a good book on the great depression, see Amity Schlaes "The Forgotten Man"

John Henry

[Gil]

Isn't comparing 'prices' to 'purchasing power' the same as the 'Total Debt' to 'Total Debt to GDP Ratio' at the top of this web page? Which is to say goldbugs like seeing low dollar values and hate seeing high dollar values, yet the average person's weekly earnings buy more goods and services than someone a century ago? The only issue seems to be that of sticking currency in a shoe box and forgetting about it for 50 years and its purchasing power thereof. Yet if people can easily convert their cash into something that appreciates with the overall price increases so what? If people doing a 40-hour week get more purchasing power who cares? As long as society as a whole is growing and people are getting wealthier what's there not to like?

[cheezedawg]

John Henry-

Your analysis seems incomplete for two reasons:

#1- The US economy did not begin to expand significantly until WWII- that is when we became an economic superpower. Real per capita GDP grew on average 1.4% between 1800-1940 (growing from $1237 to $7837 per person in 140 years), but since then it has grown at over 2.5% per year (currently the real per capita GDP is $37807 in 2000 dollars). BTW- I only chose 1940 because this is the inflection point you referred to in your post.

#2- The periods of economic growth prior to 1940 correlate almost perfectly to inflationary periods, while periods of economic contraction correlate to deflationary periods. See:
http://cheezedawg.com/GDP_Growth_vs_Inflation_1790_1913.PNG

By the way, the period from 1862-1875 was actually one of the few times in our economic history where the economy was able to expand with a deflating currency (it was not inflationary). This is the exception- not the rule- in our history.

[john Henry]

Cheezedawg,

I looked at the graph you linked as well as the others on your blog. Do you have larger versions? Or links to where they came from?

The one of GDP vs Inflation I can barely read and the others I can't read at all.

You can send them to me at john@changeover.com if you like

Interesting that GDP growth and inflation tend to track each other fairly closely (as well as I can read it)

But is that not what we would expect? Wouldn't GDP, unless expressed in inflation adjusted dollars do just that?

It would be interesting to have more info.

John Henry

[cheezedawg]

John-

I wouldn't exactly call that a blog :)

The source data for those graphs can be found here:
http://eh.net/hmit/gdp/
http://measuringworth.com/calculators/uscompare/

From there, I just plugged the numbers into excel. I made those graphs for my benefit, so I didn't bother to make them pretty. I guess I'll go back and at least make the images clickable so you can see the full size image.

[The Practical Skeptic]

The “two” definitions of inflation are…

(1983) An increase in the amount of currency in circulation, resulting in a relatively sharp and sudden fall in its value and rise in prices: it may be caused by an increase in the volume of paper money issued or of gold mined, or a relative increase in expenditures as when the supply of goods fails to meet the demand.

(2000) A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services.

The definitions are the same if you read closely.

One definition mentions “an increase in the volume of paper money issued or gold mined” and the other definition says “an increase in available currency and credit beyond the proportion of available goods and services.”

In other words, both definitions say inflation is caused by a manipulation of the money and/or credit supply.

The money supply is controlled by the Federal Reserve, which is why it no longer publishes the M3 figure or the amount of money in circulation.

The Fed knows exactly how much money is in circulation but it wants to keep that figure to itself, which is why it no longer shares that figure with Congress.

Increase the money supply, you devalue the currency, and therefore it requires more and more money to buy more and more goods and services.

All countries, all empires devalue their currency.

History is rife with examples from Rome to France to the present day United States.

Ron Paul frequently points to inflation as one of many examples of how the Federal Reserve manipulates the money supply thus creating a “hidden” tax on the poor and middle classes.

As the money supply is manipulated, the money you save is worth less. And the money in your wallet or pocketbook is worth less and it takes more of it to buy goods and services.

Ron Paul supports a return to the gold standard to prevent the fractional reserve banking system known as the Fed from manipulating the money supply, creating bubbles, and then bursting them.

Central bankers have created every depression and recession from 1913 by manipulating the money supply.

By making “easy” credit available, you create the perception of wealth without having a true wealth.

Wealth without any assets backing it is nothing but an illusion.

“Real” money advocates such as Ron Paul want tangible assets backing fiat money.

America needs to return to real money and real capitalism without central economic planning and without market, money, and credit manipulation by the Federal Reserve.

[Gil]

Who then created the depressions and recessions in the good ol' days prior to 1913?

[Zephyr]

"Who then created the depressions and recessions in the good ol' days prior to 1913?"

The rigid constraints of the commodity-based monetary system (such as gold) greatly inhibited economic flexibility, and exacerbated deflationary declines.

[The Practical Skeptic]

Ron Paul's Statement Before the Joint Economic Committee, November 8, 2007

Mr. Chairman, our economy finds itself in a precarious state. Oil prices are rising, gold is nearing all-time highs, and the dollar is nearing all-time lows. The root of this crisis, as with past financial and economic crises, results from federal government intervention into the economy, not to anything endemic to the market, nor to the actions of market participants.

The collapse of the housing market has served as a catalyst for the economy's latest bust. For years the federal government has made it one of its prime aims to encourage homeownership among people who otherwise would not be able to afford homes. Various federal mortgage programs through the FHA, Fannie Mae, and Freddie Mac have distorted the normal workings of the housing market.

The implicit government backing of Fannie Mae and Freddie Mac provides investors an incentive to provide funds to Fannie and Freddie that otherwise would have been put to use in other sectors of the economy. It was this flood of investor capital that helped to fuel the housing bubble.

Legislation such as the Zero Downpayment Act and the misnamed American Dream Downpayment Act made it possible for people who could not afford down payments on houses to receive assistance from the federal government, or even to pay no down payment at all, courtesy of the taxpayers. The requirement of a down payment has always helped to ascertain the ability of a buyer to pay off a mortgage. It requires the buyer to show hard work and thrift, the ability to delay present consumption in order to make a larger acquisition in the future.
When this requirement is minimized or eliminated, you introduce a new class of homebuyers, people who are unable to budget and save for the purchase of a home, or who should wait for a few years until they have saved enough to purchase a home. Federal policies have encouraged investors, lenders, and brokers to cater to these people, so it is no surprise that market actors came up with ever more sophisticated means of bringing these people into the real estate market.

Finally, the Federal Reserve's loose monetary policy and lowering of interest rates were a major spur to the housing boom. Low interest rates influence marginal buyers, those who are sitting on the fence, and encourage them to take on a mortgage that they otherwise would not. Even when interest rates are raised, no one expects them to stay high for long, as there is always pressure from politicians and investors to keep rates low, as no one wants the cheap credit to end.
Thinking that interest rates will cycle from low to higher, back to low, lenders begin to offer adjustable rate mortgages, 2/28's, 3/27's, and other sophisticated mortgages that may trap many unsavvy buyers. Buyers go short, lenders go long, and many people have been burned as a result.
It is time that the federal government get out of the housing business. Through our interventionist legislation we have caused the boom and bust, and any attempts at reform that fail to address the causes of our current problem will only sow the seeds for the next bubble.

[Dan]

http://www.youtube.com/watch?v=XaxdUPNYj2s

[DamnWilcox]

Mike Sproul:

I believe you have it backwards here: if you have 1% of the money supply and all the sudden you have .5% of the money supply you have lost half you money. Why? Because your despite your claim your money does not obtain immediate and automatic backing, instead because there is so much more running around prices are likely to double. Making your money half as useful as it was before 100% more of the supply was printed. ;)

Another way to think of it is in terms of supply and demand. You have 100 dollars, there are 1000 in the world, all the sudden there are 2000 dollars in the world. The supply has increased which affects the cost of the dollars by decreasing their value in proportion to the increase in supply. I'm not an economic junkie but it seems that money isn't special in regards to supply and demand.

-DamnWilcox

WrongPolicy.blogspot.com

[Greg Copenhaver]

Kevin said: "Fiat money is valued by people just as legitimately as gold is, and so its value is just as legitimate."

The only reason fiat money has any value is because it's illegal for the People to print their own dollars. Commodities like gold and silver don't need state laws to give it a value...the value can be determined in a free market by supply and demand without any outside regulation. It's a lot of work to mine for gold and silver. It's not so much work to print off a bunch of worthless pieces of paper and tell people they have value way more than it's real value (had there not been laws enforcing the value)...that's counterfitting. The Federal Reserve System is just a state protected monopoly on counterfitting.

How people can act as though they don't trust the government but then somehow trust them with the ability to print it's own money, I'll never understand. It's a nice way to get money without directly taxing the public, though the people are unwittingly taxed indirectly...especially the people on fixed incomes. Why else would reverse mortgages have become so popular? The elderly on fixed income need to get money somehow, since somehow their purchasing power decreases every check.

Due to the rarity of gold and silver, you won't get the runaway inflation that fiat currencies inevitably have after a while. You can't solve the problems of inflation with more inflation...you just end up creating bigger bubbles and busts, leading to bigger depressions and eventually a worthless currency.

While there may be fluctuations in an economy with hard money, they are much smaller than those ever expanding fluctuations in an economy with a fiat currency.

Government intervening in the lives of people in any pre-emptive way in generally bad, and tends to create more problems than it solves. Intervening to protect rights of the individual people is about the only reason for having government. Just like with anything else, too much government is a bad thing.