Major policy changes usually start out as trial balloons, ideas placed with sympathetic media outlets that float around and draw reactions from the affected parties. This gives policymakers a risk-free look at what would happen if they claim credit for a given idea. So the article that appears in today’s Wall Street Journal under the headline Low Inflation Always Best? Some Urge a Policy Rethink is pretty much what you’d expect to see as the U.S. searches for a way out of History’s Biggest Credit Collapse. Still, it’s worth reading closely:
For the past quarter century, inflation has been a bogeyman that eats wealth and causes instability. But lately some smart people—including the chief economist at the International Monetary Fund and a senior Federal Reserve researcher—have been wondering aloud if a little more of it might actually be a good thing.
For several reasons, however, the idea isn’t likely to gain traction any time soon.
The new argument for inflation goes like this: Low inflation and the low interest rates that accompany it leave central banks little room to maneuver when shocks hit. After Lehman Brothers collapsed in 2008, for example, the Federal Reserve quickly cut interest rates to near zero, but couldn’t go lower even though the economy needed more stimulus.
Economists call this the “zero bound” problem. If inflation were a little higher to begin with, and thus interest rates were a little higher, the argument goes, the Fed would have had more room to cut interest rates and provided more juice to the economy.
Right now, the Fed and other big central banks have their sights set on inflation of around 2%. Economists had used a “Three Bears” approach to come up with this number—for a long time it seemed like it was not too hot and not too cold. But low and stable inflation could in theory mean something steady at a slightly higher rate.
IMF chief economist Olivier Blanchard, in a recent paper, said maybe the U.S. central bank’s future inflation goal should be 4%. John Williams, head of the San Francisco Fed’s research department, argued last year that higher targets might be needed to provide a cushion for future crises.
The proposals underscore a broader rethink that is rumbling through the economics profession in the wake of the financial crisis. Many of the things economists thought they knew turned out to be wrong.
It’s a timely conversation. On Friday, the Labor Department said consumer prices excluding food and energy fell in January, the first monthly decline since 1982. Neither Mr. Blanchard nor Mr. Williams was calling for higher inflation now, but their argument opened the door to that discussion.
There are other reasons some would welcome a little more inflation now. Governments in the U.S. and elsewhere, and many U.S. households, are sitting on mountains of debt. A little more inflation could in theory reduce the burden of servicing and paying that off, because while debt payments are often fixed, the revenue and income that households and governments generate to pay it off would rise with inflation.
But there are problems with the welcome-more-inflation argument.
The first is that it isn’t yet clear that the “zero bound” on interest rates that Mr. Blanchard worries about is the economy’s biggest problem. Thus addressing it might not be worth the costs that would be associated with higher inflation.
After the Fed pushed interest rates to near zero in December 2008, Chairman Ben Bernanke found alternatives to more interest-rate cuts: buying mortgage-backed securities and Treasury bonds and funneling credit to auto-loan, student-loan and credit-card markets. Those additional steps were no panacea, but they helped end the recession even if they didn’t produce growth fast enough to bring unemployment down quickly.
“Is that the stuff of a zero-bound disaster?” the Atlanta Fed’s top economist, David Altig, recently wrote on his blog. “Put me down on the petition to not experiment with higher inflation to avoid a problem that was not so clearly a problem.”
There is also a thornier problem. Suppose for a moment that Mr. Blanchard is right, and central banks around the world would be better prepared to fight future crises with a little higher inflation.
Getting from 2% to 4% could be a very messy process. Investors, businesses and households might well conclude a one-time shift to a higher inflation target actually means less commitment to stable inflation. Expectations of higher inflation could become a self-fulfilling prophecy. Instead of getting 4% inflation, central banks could end up with 5%, or 6% or 7%.
A higher inflation goal “would have a fairly immediate and disruptive effect” on markets, said Bruce Kasman, chief economist at J.P. Morgan Chase.
Mr. Bernanke has acknowledged the allure of a higher inflation goal. In written answers to lawmakers in December, he said a higher inflation target could in theory make it possible for the Fed to push inflation-adjusted interest rates lower, stimulating borrowing and economic growth.
But the opposite could happen, too. The prospect of higher inflation could cause interest rates to shoot up and make the burden of future borrowing even heavier. This is a particular problem for countries, like the U.S., that issue a lot of short-term debt and for people with adjustable-rate mortgages.
Mr. Bernanke concluded he didn’t want to mess with people’s fragile expectations. He said switching to a higher target would risk causing “the public to lose confidence in the central bank’s willingness to resist further upward shifts in inflation, and so undermine the effectiveness of monetary policy.”
The 2% inflation goal that is so popular with central bankers around the world might not have been the ideal target in retrospect.
But it looks like everybody is tied to it, for better or worse, for the foreseeable future.
A few thoughts:
- The hubris of economists and policymakers who think they actually have the power to tether a system as complex as a modern economy to a specific inflation rate would be funny if it wasn’t so terrifying. Presumably they’ve been targeting an inflation rate all along, and the results have deviated just a bit, in both directions, during the past couple of decades. Raising the target rate would simply raise the amplitude of the fluctuations.
- It’s interesting that the writer recognizes the risks the U.S. runs by financing its deficit with short term borrowing, even comparing us to a homeowner who takes out an adjustable rate mortgage. Yes, we are a subprime nation.
- This is a dance with very predictable steps. A few semi-obscure economists toss out the idea that we need to inflate aggressively, not just as a reaction to a crisis but as a matter of ongoing policy. The U.S., in the person of Ben Bernanke, demurs, citing potential problems and appearing to care about the value of the dollar. Then, as events deteriorate a growing chorus of legislators and economists (look for Paul Krugman to weigh in soon) starts making panicky noises. And finally, Bernanke and the other Fed governors allow themselves, reluctantly, to be convinced of the painful necessity of further debasing the dollar. Which is, of course, what they’ve wanted to do since they aced their first college economics class.
- Now all that’s left is the timing. When will things get so bad that the Fed is forced to swallow its fake reservations and really go for it? That’s unknowable, of course, because it depends on when the next black swan lands. But it probably won’t be long.
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{ 25 comments… read them below or add one }
I agree but faith in the USD is still very strong such that for the moment the effect of most Black Swans will be the usual outa “risk” (Asia, resource stocks & resource currencies) into the Dollar and short term Treasuries.
The Black Swan event needs to be something that is perceived bad for the US but not as bad (or even good) for much of the rest of the world.
As Peter Schiff often points out it may just be a slow realisation on the part of the rest of the world that the US isn’t good for its promises and that there may be better places to preserve and grow wealth.
In the rest of the world everyone is intimately familiar with the problems in their own countries (I’m from New Zealand where our household debt:disposable income ratio is second worst in the world – housing bubble ready to burst) and assumes that Uncle Sam can’t quite be in as bad a shape as the naysayers proclaim.
Last March, IIRC, Mr. Bernanke appeared before the House and Senate and disclosed that the plan was to re-inflate the economy and bring it back down in an orderly manner. Using the inflated balloon metaphor, Mr. Bernanke eloquently explained that there is no recovery from a crash. The economy needed to be re-inflated and brought back down to a natural bottom.
The reason we haven’t seen hyperinflation yet is because all that newly created money hasn’t circulated through the economy. The banks are holding their TARP chits to increase their capital reserves. Why should the banks lend money when they get it for free from the Fed and can buy treasury paper paying 3-5%?
There’s never been a better time than now to be a banker.
During and following the Great Depression, things didn’t improve much for the little guy until the late 1940′s – early 1950′s. Granted there was a war to kind of take peoples attention off their poverty.
Much better we send our angry young men to fight in Europe or Asia than for them to turn their guns on Washington. Where will it be this time?
The USD and all other FIAT currencies will be consumed in time. The wild currency swings, capital flight, sovereign default, and central bank “Cures”. Will be so eye popping that even the most brain dead of the sheeple will eventually wake up that all is not well. Gold will be steadily rising all the time, as people get up from their couches and buy an ounce here and an ounce there. The globalists will fight back with everything they have, (money and and lots of it) which only makes the problem worse. As well we will see grand plans pushed onto the people by their increasingly desperate elected officials, and still Gold will be getting more valuable. Eventually a trigger event will jolt people awake and the gold rush will begin in earnest. Then a year or so later the entire facade of what constitutes money will be changed. There will be no going back. Just like waking from a nightmare the whole failed fiat money experiment will seem surreal and unimaginable. There is a saying for this “This too shall pass”.
We are witnessing history being written, sit back and enjoy the show!
How do you “enjoy the show” when you are starving to death?
Dear Mr. Rubino,
We’ve disagreed some here on your site but I hope you will treat this question with the sincerity with which I ask.
Is it possible that we will avoid hyperinflation here in the USA because we export inflation in the form of our debt instruments?
All the Best,
Thrash
Personally, I have never quite believed that hyper-inflation will occur in the US mainly because of globalization. The global-market prices for goods and services are still much lower than in the US. There are plenty of people in the world who will work for much less than what goes for normal pay in the US, from medical specialists to laborers. (I used to be surprised that construction workers in the US – and not just laborers – would do just about anything for $50 a day, until I encountered many, many people in other countries who would do the same work for $5. Engineers are also about ten times cheaper, and I’ve read that similar ratios apply for doctors and hospitals (the basis of medical tourism), lawyers, and even economists – haha.) Interestingly, goods are often more expensive globally than in the US, and thus are less available (i.e., have lower demand), or are not available at all (i.e., luxury items). Stated differently, inflation in the US may take the form of reduced availability, lower quality, slower innovations, etc.
More to the article’s point, however, is the notion that by talking up inflation now as being a good thing will lessen the political blow-back when prices start rising. That’s a stretch in my opinion, but maybe not since many people still believe in this administration and that it’s all George Bush’s fault.
Hey Bruce C,
Anybody who buys oil, gas, petrochemical products, food (whoops food is a petrochemical product, sorry for being redundant), gold, silver, nickel, bauxite or any other commodity and pays for them in USD’s would disagree with you.
But thanks for answering my question.
All the Best,
Thrash
@ Brad,
Hope you don’t mind if I jump in with my own thoughts. The global appetite for our debt instruments is not limitless and is beginning to dwindle, so I think you’re talking about the past, not the future. Yeah, we’ve been exporting our inflation by dumping dollars and dollar-denominated debts onto other countries, which we could get away with partly because our currency is the world’s reserve currency. But that very status is also why there are so very many dollars (as cash or Treasuries) sitting out there in foreign banks, just doing nothing. About $7 trillion available to be dumped, according to John Williams. That sets us up for a very sudden hyperinflation if there’s ever a global panic out of dollars.
Professor Antel Fekete has stated that risk-free bond speculation will keep interest rates low and commodities from shooting skyward. So, do we get a Japanese experience plus structurally high unemployment for the next decade? I’m not so sure the Professor is correct. It’s just difficult for me to believe base money supply can be doubled or more without the common folk being punished by rising prices of necessities within the next 10 years. Plus, some believe we’ve turned the corner and started a new interest-rate hiking cycle for the next two or three decades. And since all currencies are directly or indirectly anchored to the dollar, wouldn’t a quick disintegration of the dollar lead to a hyperinflationary event worldwide followed by a deflationary collapse worldwide?
Hey PIP (paper is poverty)
Hope you don’t mind the nick. It was my paternal grandad’s nick so it is with respect and affection I abbreviate.
I totally agree that our current economic model is not sustainable. We could well be already bankrupt. Estimates of our debt and unfunded liabilities (public and private) are reaching a breathtaking $100 trillion or more than 7x’s annual GDP.
So let’s say Pip, the world does get the jitters and sells off their current holdings and refuses to buy anymore of our paper. Really we’re not talking the world but rather the exporting nations of OPEC, Canada (our largest trading partner) Japan, China and the Four Tigers.
First, they lose their largest trading partner. Second, they have $7 trillion in worthless paper themselves. That money has to return here. It is, at the end of the day, our money.
Last week everybody had the beejeebers scared out of them because the Chinese sold about $38 billion more in US paper than it bought. What happened? The Fed raised an interest rate and the price of a bbl of oil went up to near $80 USD.
China IIRC, is now the world’s largest importer of oil. The Chinese are caught between a rock and a hard place of their own making. Do they continue to divest themselves of USD’s and pay higher prices for oil? Where will they find new customers to replace the USA?
Even at current growth rates, if you believe China’s numbers, it won’t have domestic consumption to replace the USA for at least 40 years.
So yeah PIP, the world could suddenly divest itself of USD’s. I just don’t think they’re that stupid. At the end of the day the world still needs the USA far more than we need the rest of world.
In support of my original point that we aren’t seeing hyperinflation yet because all the new money is moving within a tight little circle of Fed-bailed out banks-Treasury; Bernanke has announced a new Fed program:
Among the Fed’s options, he said, are transactions that would drain excess money from the financial system. One such program, a “term deposit facility” that would give banks the incentive to park their money at the central bank, could be operational shortly after being tested this spring, the Fed said in its semiannual report.
http://www.reuters.com/article/idUSN2315353620100224?feedType=nl&feedName=usdai
The Fed is creating more tools than just interest rates to draw money out of the system.
The Fed may turn out to be the “bad bank” as I’ve suggested. Maybe one day we’ll have an honest dollar but not before we stop the policy of privatizing profit and socializing loss.
Hi Brad T.,
Thanks for your response. I actually think there is/will-be inflation in goods and deflation for labor. I also think that if/when people begin (again) to view gold and silver as money and not just another commodity, those two metals will disengage from currency values and become ultimate assets. I agree that oil and food will go up because of supply- demand fundamentals, Asia not having the same monetary problems as the West does.
This inflation-hyperinflation argument is a little confusing to me because neither word is well defined, at least not operationally. First of all, they’re both relative. Is 10% annual inflation “hyper” or does it need to be more like 100% or higher? Or, is the RATE of change of inflation the issue? Practically speaking I don’t think it matters that much because all such scenarios would be disastrous.
That said, I’m not sure I understand your argument. I believe you’re saying that the FED dollars have not yet made their way into the economy, but then also say the FED is developing many ways to mop up that same liquidity before it has leached out. Are you just hoping that is the case but not so convinced?
There is an article that you may find interesting that claims there actually are no such bank reserves as such, that banks are capital restrained. I actually didn’t understand it, but you might. It is at:
http://globaleconomicanalysis.blogspot.com/2009/12/fictional-reserve-lending-and-myth-of.html
Just for fun, consider this scenario: To remove liquidity from the system the FED commands all banks to send all of their physical currency (dollars) to the nearest Fed Bank, and that currency is then destroyed (say burned). What do you think would happen when the word of that gets out? Would you hoard your dollars and consider them more valuable? Remember, 80% (about $800 billion, I believe) of all dollar currency resides outside the US.
What would do you think a foreigner do?
Hey Bruce C.,
Sadder days ahead for sure when labor is continually devalued. I guess what the moneyed elites are really saying is that people aren’t worth much or worse, that we’re just a bunch of useless eaters.
I disagree with Shedlock, on most things. He gets some of his facts right but his conclusions seem agenda driven rather than the result of cool, impartial analysis.
I more than skimmed but less than read the link you provided. Shedlock misses or conveniently leaves out the salient point. The new money given to the BOBS (Bailed Out Banks) mitigates or offsets the losses on their books. That is no fiction. The Fed printed the money and gave it to them.
Additionally, the Fed is also buying bad paper at the discount window, further relieving the banks of losses.
Our monetary and fiscal model is “privatize profit – socialize loss.” Those who advance this silliness, like Shedlock, are anything but the lower case conservatives they claim to be.
Shedlock’s second point, that banks aren’t lending for lack of credit worthy borrowers doesn’t pass the laugh test. Banks are getting money for free or less than free when factor in inflation. They then buy government debt paying 3-5%.
Why lend to useless eaters when you can buy gubbment notes and bonds with free money from gubbment?
Bruce, there has never been a better time to be a banker than now.
Brad,
I understand what you’re saying and basically agree (that BOBs received essentially free money and simply bought essentially risk-free gov. bonds that pay 3-5% interest instead of lending it out to potentially risky customers.) However, it is also true that most businesses and individuals either don’t want to borrow or have too much debt/bad credit/insufficient income to be able to borrow more. And, yes, ironically it is a good time to be a banker considering that most of the big banks would have gone bankrupt had not the Treasury and Fed saved them. It is really outrageous what happened. I so wanted McCain to grow some balls (and brain cells) at that last “debate” and denounce the bail out program as an unprecedented level of fraud and theft. He either didn’t understand that, didn’t care/wanted the largess, or really didn’t want to be president.
Lastly, I think I agree with you about Shedlock. He does have his interests and points of view (but so does every other blogger) and tries to substantiate them. What stands out is that he is a staunch deflationist. It’s amazing to me how there can be such a wide range of opinions on the inflation/deflation issue. No wonder economics is called the dismal science.
Obviously a smart bunch here. But don’t miss the crux. The FED is the problem and needs elimination. The FED only exists because Treasury traded its monetary oversight responsiblily to the conspirators on Jekll Island.
Perpetual inflation is not sustainable. Inflation is inevitable unless something changes. Alas, nothing changes as long as the FED exists.
The FED keeps screwing things up. Easing & tightening… why do we need this or put up with it?
It’s always boom or bust. Never something in the middle. Like a phrase from the ’80s, it’s the FED, stupid.
Next on the agenda: let the dollar become toast. Is that the FED’s policy or Treasury’s policy? We may never know. They both speak with forked tongues.
Kill the FED and let Treasury speak with one voice. Having two monetary masters isn’t working so well, it it?
Madman,
Good point. I totally agree. Our current FED bank is the third one in this country. Andrew Jackson broke the second one, as you may recall from a previous article at this site. There is always a desire by some to gain control and leverage over others/institutions etc. However, there is also always a large group of people who believe that top down management is necessary or desirable (and possible). Both sides share beliefs in the unsavory and untrustworthy Self, and thus the free market and individualism by extension. Greenspan is faulted for his belief in the self-regulatory ability of the free market. That is the spin intended to deflect attention away from the actual fraud and self-serving regulations that exist. Considering that Congress is wrapping up another financial reform bill shows that people are still not getting it. As Ron Paul and others have said, Capitalism has not failed – we haven’t had real capitalism for decades. We’ve all grown up in an increasingly mixed economy, and it is very difficult to discern or prove that top-down gov. fiat actions via tariffs, regulations, subsidies, taxes, stimuli, etc. are what cause the imbalances and instabilities, and not the other way around which is what the “monetary elitists”, career politicians, and everyone else who gains an advantage by that system want you to think. Things ARE changing but your guess is as good as mine as to how it’s going to play out. In the meantime, enjoy your “ringside seat for the global financial crisis.”
If the Fed is a privately owned bank as Madman and others suggest, why is it that 100% of the Federal Reserve Bank profit is credited to the Treasury annually?
Madman,
What difference would it make if the FED is eliminated and Treasury is given (or resumes) the same powers that the FED has now? Fiat money is problematic no matter where it’s created. And do you think that the Department of the Treasury would be a better controller of interest rates than the heads of the Federal Reserve Banks? The free market should determine the price of money as it (ideally) does for everything else. Is transparency want you want? What good is that if the whole framework is fatally flawed anyway? Ron Paul wants the FED to open its books and be audited not as an end in itself, but as a first step to reveal its clandestine nature and hopefully gain more support for its complete elimination. Treasury likes the FED precisely because it is not transparent and not accountable and can be used to surreptitiously carry out its desires. I doubt Tim and Ben disagree on much.
Well,
A couple of thoughts… about where we are…
The Depression was Great because it ground out the “Hope” and “Changed” the prosperity of our nation, and the world. We are only in the second or third inning, (year) in my estimation… and another significant leg down is just around the corner.
The lists of things that are over valued on paper, is incredibly long, and unless you are a “Chosen” bank (ieBoB), you and I, WE the PEOPLE, will discover, brutally and painfully, the true value of the things we think we own, over the coming decade, or two.
This is Deflation… and it is as inevitable as the sun rising tomorrow,
It’s likely, in my view, that we could have monetary inflation in the things we use and consume…(during the Depression… 75% OF THE POPULATION SPENT 100% of their income on food and rent).
Prices look as though they are falling by Government (Falsified) indicators… but not by the REAL experiences of consumers.
Wages (and taxes withheld) have fallen SIGNIFICANTLY, and will continue to fall for the foreseeable future. Even Greenspan acknowledged recently the financial problems now were/are worse than the Great Dep.
So it’s early in that game.
The mountain of Derivatives stand ready steal all the accumulated (IMAGINARY) wealth of a generation. Look at Goldman… helping Greece to HIDE it’s true problems, and betting against them!!!
Think it can’t happen here? The US is a debt junkie, moving, being forced, or choosing? to bet the house on shorter and shorter term bonds. WHEN the rates rise, and they will. that house of cards will make some of the BoB’s RICH. Uh, RICHER! The process is much closer to the edge of the cliff than most think.
That’s the PLAN. Guaranteed!
Now how about the ULTIMATE plan? Is it possible that when paper currencies fail… and they all do… that the bank runs will REQUIRE a new global currency? That currency will be all electronic… no runs on the banks. They might convert your countries currency (savings account) to the new currency, at a discount. INVISIBLE control. REAL inflation coming to the world, and the chosen banks running it all. Can’t buy or sell without the electronic money in your account. Hmmm… maybe
MOST of the Industrialized world is nearly there NOW! The structure is in place for when the failure occurs. Which bank, Government, will be the CHOSEN ONE? Hmmm… who created and sold the whole world this mountain of worthless debt and worthless paper treasuries? Who has the most derivatives? Who stands to gain? Might it be the US BoB’s? Hmmm?
Buffet called them weapons of mass financial destruction… and we know that weapons are made to be used… so it’s certain that they will.
A thousand TRILLION$ of derivatives. It’s gonna get real UGLY! Me Thinks!
I honestly think that our problems are not the result of too much inflation, but too little inflation. There is this silent and unquestioned assumption that money should ideally maintain its purchasing power over time. I honestly believe this is a great fallacy. Let me explain.
Money is created in order to compensate for the creation of products and services. The truth is that all products and services lose their value over time. Every house erected will fall apart within 30 to 50 years unless constantly maintained. Every food produced will expire within days or weeks due to natural decay. Every car produced, even if preserved in mint condition, will become worthless in time due to technological progress. Even oil, once refined into gasoline or diesel, will spoil in time and become useless.
So if the overwhelming majority of products and services produced by the economy has a finite life span, why should the money earned in producing these products and services keep its purchasing power forever? There is a contradiction here which nobody likes to talk about. Clearly, we would like to live forever and for that reason we would like our savings to last forever. But I believe this wishful thinking is a great fallacy which is the main reason for our present problems.
A huge accumulation of debts is nothing else than a huge accumulation of monetary and financial claims. Where did all this money come from? Where are the real products and services which gave value to these huge accumulations of money? The truth is, that while money accumulates exponentially, the underlying real assets (housing, bridges, highways etc) decay exponentially.
The only solution to this dilemma is to inflate the value of money away over time. The inflation rate should match the natural decay rate of real products and services. Money should not and can not be gold. There is a huge intellectual dishonesty among all those who criticize the Fed for deflating the value of the Dollar by more than 90% since the creation of the Fed in 1913. In truth, the mistake the Fed made is that it did not deflate the Dollar by 99.9% as it should have done in order to keep the economy healthy and to keep the financial sector subservant to the manufacturing sector and not the other way around as it is today.
The great fallacy of money whose worth is independent of time must come to an end one day. That will happen at the latest when all the oil fields are exhausted and all the metal mines are depleted. Only then will people start to understand that the quadrillions of Dollars held in various bank accounts are only an illusion – a reflection of our desire to life forever in a world governed by entropy and the laws of thermodynamics.
Robert,
With all due respect what you’re saying is preposterous. But, rather than try to unwind your various qualitative arguments, I suggest you try to pin down just what rate of inflation is the proper one, quantitatively. If the proper rate of inflation cannot be calculated then your theory is not practical. Basically, you’re implying that the inflation rates/interest rates for the last 100 years or so have been wrong, and too low. In my opinion, this another example of top-down control not worjing out as hoped.
Bruce C., I think the notion of inflation is not the right notion for what I have in mind. Inflation usually refers to the increase in the money supply beyond the increase of goods and services produced by the real economy. That increase in the money supply leads to rising prices, at least in the long run. In my understanding, there should not be any price increases of consumer goods as the result of monetary policy. (Prices might increase due to other factors like growing scarcity of certain commodities etc)
In reality, the economy constantly produces new goods. However, the number of goods does not increase to infinity simply because old goods fall apart or become obsolete in time. A perfect monetary system must have the same property. Money created a long time ago must depreciate in value steadily in such a way that there is always a balance between the total amount of goods and services in existence and the total amount of money in bank accounts.
To achieve this equilibrium, we only need to introduce a second parameter to money in addition to the nominal amount. That second piece of data should be the date of the creation of that money. Since most of the money today is simply a piece of computer data, it would be very easy to track the date of the creation of that money. The nominal amount of that money would than depreciate over time according to a formula set by the Treasury or by the Fed.
Let’s consider an example. Suppose you apply for a bank loan (mortgage) in order to build a house. According to the IRS, buildings and houses can be depreciated for tax purposes over a period of 27.5 years (if I remember correctly). The same time period (27.5 years) can be incorporated into the bank loan which you took out and which the bank created out of thin air. The money you spent will circulate in the economy as it travels from one checking account to another account. However, after 27.5 years that money must depreciate to zero in order to reflect the fact that the house which gave value to the money you spent has reached the end of its useful life (assuming no repairs and additional improvements were done to the original house). Properly implemented, such a system could achieve various desirable objectives:
1) very little price inflation at the consumer level, that is, the price of bread or clothes would stay more or less constant.
2) a genuine scarcity of money which would prevent the rise of monster financial institutions which are too big to fail.
3) It would make it impossible that somebody could live forever from the interest generated by his earnings during 20 years of work. In particular, the dream of living in retirement for 40 years would be only a dream – not a possible reality. In particular, we would not have any Social Security problems.
4) Most importantly, it would prevent the rise of the money class over the real part of the economy. In such a type of monetary system, the people in the manufacturing sector would be always more important that the people sitting behind an office computer (bankers and politicians).
5) Such a monetary system would encourage the production of long lasting goods. The production of low quality products with a short useful life span would not be rewarding.
I could go on, but I think you got the main idea, so I better stop here.
Thanks for responding to my post.
Robert
I forgot to mention the most important advantage of this type of “self liquidating money”. The purpose of interest charges on loans of regular fiat money is to exercise pressure on the borrower to pay back the loan. That pressure is necessary in order to prevent hyperinflation if loans are not paid back on time. In the type of money I described in my previous post there would not be any need for excessive interest charges since the loans would be self liquidating due to the constant depreciation of money. In other words, interest charges on loans could be very low, perhaps only a fraction of one percent.
Robert,
I’m sorry to say that I simply flat out do not understand what your proposing, and on many levels. Your example concerning the value of the money received for a real estate loan is bizarre. First of all, the depreciation schedule for real estate an arbitrary contrivance and wouldn’t even exist in a sane and sound financial system (or is old land really worth less to you than “new” land? – whatever that is.) I’m no genius, but if I’m not getting your theory here then you better not count on the the Fed or Treasury getting it either. Having them determine the time value of money by a formula? Are you kidding me? They can’t handle their current responsibilities. Again, it’s not intellectually honest to promote a quantitative theory on qualitative grounds alone. I challenge you to derive the formula the Fed or Treasury is to use (because they ain’t gonna do it.). A complicated system like you’re proposing (and many others) is akin to wanting one’s conscious mind to control the involuntary system of one’s body.
Bruce C., you are right, land does not depreciate. For that reason, land should not be sold. Land should only be leased from the local government on renewable terms, say every 100 years. The lease rate should be identical to property taxes. In fact, our present property taxes are nothing else than a rental fee for the land we use. We are kidding ourselves believing that we own a piece of land. At best, we only have a right to use the land as long we pay usage fees (called property taxes).
There are zillions possible formulas which could be used in order to depreciate money. Here is a very simple one: Suppose we all agree that the value of freshly created money out of thin air should depreciate to 36% after Y years (Y could 27.5, but it could be equally well 50 years – that is a matter of expert adjustment by people who design monetary policy). Assume further that N is the number of years passed since the creation of that money (N could be a fraction changing every day). Then the present value of one Dollar created N years ago would be simply
( 1 – 1/Y )^N
You may notice that this is the formula we use to calculate the present value of future cash flows. So the formula is nothing new. People use it all the time. If we take Y=27.5 and N = 100, the value of one Dollar 100 years after its creation would be worth only 2.46 cents. I think this is pretty realistic. It more or less corresponds to what the Fed has accomplished by using inflation. However, inflation leads to rising prices, while the model I propose would keep present prices constant. It would instead depreciate the value of money held in the bank for the long run.