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NOTE Money and Prices

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Good morning, everyone. The lecture this morning is on money and prices.

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Monetary theory is a very interesting compartment of economics.

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It really ultimately addresses the question and answers the question of why anyone should routinely and universally

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accept pieces of paper with ink on them in exchange for very, very valuable goods and services.

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How did it come about in history, and how is it explained by theory, that today, as I said, people all over the world are willing to accept little tickets or bits of paper which intrinsically have very, very little value, or their materials, their inputs have very little value on the market, and yet exchange for these pieces of paper with a stamp with various symbols, very valuable goods and services?

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That's really the function of monetary theory, to explain that phenomenon.

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So let's start at the point at which money originates.

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There are, as we know, a number of problems with barter.

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Whether or not there was ever an extended developed barter economy, we really don't know.

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But theoretically we know there are strict limits to how much development,

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how much accumulation of capital can take place under barter.

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Because there are various inefficiencies involved in what we call direct exchange, which is another name for border.

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The first problem, which you see in all textbooks, is that of the lack of coincidence of wants.

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That is, for any exchange to take place, there must be a double coincidence of wants.

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Not only must you find someone who has what you want, but they themselves must want what you're willing to exchange for that good.

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So one example might be a situation in which you have a person A who wishes to, he specializes in, let's say, producing berries or picking berries and wishes to obtain shoes somewhere, okay, so he prefers a pair of shoes above the berries that he owns.

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So he approaches a shoemaker, let's call it B, who indeed possesses shoes, but does not want the berries.

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Let's say he's allergic to the berries, he breaks out in rashes and so on, so he doesn't want berries at all.

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And especially if the shoemaker was one of the few in the area, and there were few and far between shoemakers,

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This person, A, would be at a loss. He wouldn't know how to complete his exchange.

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Unless he was ingenious and perceived that, in fact, there are goods out there that everyone pretty much accepts in a given society.

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In which case he would then approach people who specialize in producing that good,

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sell the berries for a quantity of that good, even though he did not intend to use that good directly.

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But intended to re-exchange it for the good that he ultimately desired, the pair of shoes.

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And let's say that there's someone who sells wheat out there, C.

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And people in the society use wheat for various food products and so on.

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So he goes and exchanges the berries for the wheat.

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There are numerous, let's say, farmers that sell wheat out there.

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And some of them want berries.

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In exchange, he gets wheat, which he values sort of indirectly more than the berries,

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but only because he knows he can then turn around and exchange the wheat for the shoes that he ultimately wants, so the wheat goes to B.

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That is the solution of the lack of divisibility of wants.

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And that results in the emergence, not yet of money, but of a medium of exchange.

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The key in that example functions as a medium of exchange, meaning that it is purchased or is exchanged for in order to be re-exchanged for something else.

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So this more roundabout process of exchange actually brings about the solution to the problem.

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There's a second problem with barter, and that is that there are indivisibilities in goods.

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If he wishes to sell a horse and wants to get some shoes and eggs and let's say legal advice and a suit,

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he would have to, with that single horse, somehow break it up.

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But in breaking it up, in dividing it up, it would lose its value.

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So he again would confront the problem in obtaining the various goods that he desires from these different specialists.

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So what would he do? He would, again, go and sell the horse for a quantity of a good that is widely used in the society, let's say it's wheat again,

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maybe for a hundred bushels of wheat he would exchange the horse, and then he would use certain quantities of that wheat to buy shoes, legal advice, eggs, and so on.

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And this then would solve the problem of indivisibility that arises on the border.

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So, this occurred in various societies, independently, that people hit upon a medium of exchange, and over time, in fact, over the millennia, there was a self-reinforcing process that took place, in which people began to recognize that other people were more successful in their exchange activities when they used a medium of exchange,

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exchange so the new group of people would would then emulate those people who

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were using the medium of exchange and that would increase the demand for the

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medium of exchange okay whether it's wheat or whether it's salt as it was in

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Africa and we'll go through some of the different types of media of exchange in

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any case as the demand for the medium exchange rose it made it even more

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generally acceptable more and more groups were drawn into to this this

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Indirect exchange economy. And as more people demanded the medium of exchange to eat, its value rose even more.

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And it became even more generally acceptable. Until, over the centuries, and throughout various areas of the world,

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one or two media of exchange emerged as the general medium of exchange. And that's how we define money, as a general medium of exchange.

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Exchange.

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So that by, certainly the Middle Ages in Europe, gold and silver had emerged as the general

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medium of exchange.

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But as I mentioned, there are various media of exchange that were used in human history.

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Again, you can see this in textbooks.

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There were cattle in ancient Greece, leather in ancient Rome, animal pelts, whiskey and

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tobacco leaves were used in the American colonies.

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Wampum, which were strings of beads, were used by American Indians.

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dried fish were used in the Canadian maritime colonies,

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maize, which is corn, was used in Mexico,

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and salt and iron farming implements were used in Africa,

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wives were actually exchanged in ancient Egypt,

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but they were not politically correct,

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and cigarettes in the famous German POW example were used.

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Now, one other point about money, as money becomes a general medium of exchange,

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promotes tremendous efficiency in the economy.

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Not only by reducing transactions costs and trying to find someone to exchange with,

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but more importantly by expanding the market and allowing people to specialize in one good,

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with full confidence that they could exchange that good for the medium of exchange

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and therefore purchase all the other things that they needed.

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So it tremendously expanded the division of labor and specialization

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and allowed the accumulation of capital.

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Just a few qualities that are important for a good medium of exchange.

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First, it must be, obviously, what? Generally acceptable, right?

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For it to even start off as a medium of exchange, it must be generally acceptable.

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It must be widely demanded for non-monetary employment.

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Certainly this was true of gold and silver, which were used for ornamentation,

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We use it in meditation, we use it in religious rituals, we use it for plate and so on, even on military outfits.

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It must be easily portable. For example, as I mentioned, iron was used in Africa.

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But iron isn't easily portable. That is, it has a low value to weight ratio.

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Gold and silver have a very high value to weight ratio.

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So, if today you were to take a, if you wanted to buy, let's say, a high-definition television set, let's say for $2,000, and we were on a gold standard, you might only have to bring two and a half ounces of gold to purchase the television set.

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On the other hand, if we were on an iron standard, that would, you know, let's say iron is $300 a ton or something like that, you might have to take six or seven tons of iron.

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Iron dropped out as a competitor in the emergence of a medium of exchange.

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They must be homogeneous. All units are identical to one another.

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That's certainly true of gold.

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Every unit of gold is chemically exactly alike every other unit of gold.

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Now, it's not true, for example, of precious metals, precious gems,

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I mean, diamonds and emeralds, they could also be used.

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But it would take tremendous amount of time and effort for each exchange in order to find out their value, because each diamond, of course, that's its charm, right?

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Each diamond is unlike every other diamond, sort of like a snowflake, right?

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And so that's good for someone you want to become betrothed to.

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They're special, they have a unique diamond, the expression of your love and so on, but it's not good for exchange.

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Must be highly divisible. Again, precious gems, if you divide them up, they lose their value.

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But if you divide gold and silver up, even the very, very small coins and so on, they maintain the proportional share of their value.

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And finally must be highly durable. Certainly gold and silver are highly durable.

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There is still gold in the world that was dug out of the mines during the Roman Empire, for example, or even before that.

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The only gold that has really perished is gold that has perished in fires or gold that has been lost beneath the sea when ships were sunk.

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But pretty much all the gold that has ever been mined in the world is still in the world.

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So that's why you couldn't use dried fish, you couldn't use hostess twinkies.

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I just noticed today that they introduced for the first time the original Hostess Twinkie, which is a little pastry, which originally had banana cream in it.

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This is a little off topic, but what happened was they had to remove the banana cream during World War II when bananas became scarce because they were sent over to the troops and ever since they've had vanilla cream.

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Well, now they've reintroduced after these many years the original Hostess Twinkie.

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This is Twinkie. But even they wouldn't be good. They would go stale, okay, as you held them.

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One of the primary functions of a medium of exchange is to be held so that you can make your anticipated exchanges over time, okay?

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Okay, let's mention one other important function of a medium of exchange, and that is it does begin to serve as a unit of account, again, in a spontaneous manner.

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Businessmen begin to use it in order to calculate their costs and revenues, profits and losses.

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It makes things easier also for comparing prices.

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If all goods and services in an economy are compared or are priced in gold or silver, well then it's easy to comparison shop to compare prices.

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Think about a barter economy.

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Even a barter economy with only 1,000 goods would generate 499,500 prices.

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So almost 500,000 prices.

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Because each good under barter would have a price in terms of the other 999 goods.

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A typical supermarket has 70,000 items in its inventory on display in the store.

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Imagine how many different prices there would be if you had a barter system, okay?

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Also, not only would the entrepreneurs be unable to calculate which lines of production were the most profitable,

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but they also wouldn't be able to pay the workers.

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What if you were producing cars?

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How would you pay your workers with part of the car, okay?

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and how many cars would they want if you could give them one a year or something like that.

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So you wouldn't get the ability to accumulate capital as you do in a money economy.

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Let's talk a little bit about the monetary unit. Assuming that gold and silver emerge,

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because they encompass the important qualities that we talked about in a medium of exchange,

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or they embody those important qualities, they emerge on the market and we call that a commodity money.

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We now have a commodity money and the monetary unit then becomes really a weight of the commodity.

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Gold and silver exchange both before indirect exchange that is under barter and after as or by weight.

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So what we get then is a situation in which the initial monetary units were defined as weights of gold.

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So that the British pound from 1821 to 1931,

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one British pound was defined as one-fourth of an ounce of gold.

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And the US dollar from 1834 to 1933 was defined as one-twentieth of an ounce of gold.

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And the French franc was defined as one hundredth of an ounce of gold, or thereabouts.

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In any case, what you'll note is that, in fact, the pound, the dollar, the franc, the mark, were not different kinds of money.

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In fact, they were all just different weights of the same universal money, which was gold.

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Now, silver tended to be used in the East, in India and China, and up until the 1870s, many countries had bimetallic systems,

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in which the value of gold and silver were fixed by law, but it was basically gold and silver that were used as the main commodity monies.

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Which brings up the question of exchange rates.

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What was the exchange rate for about a hundred years, which never changed by more than one percent, above or below the so-called poor value?

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What was the exchange rate between? It was about five to one. By the laws of arithmetic.

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Dollar and a pound were simply different weights of gold. There was about five times the amount of gold in a pound as it was in a dollar,

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in the dollar so that the exchange rate, the poor value was $4.86 per British pound.

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And that exchange rate was fixed for, as I said, about 100 years.

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Now, it's not really an exchange rate. Would we say that the exchange rate,

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there's an exchange rate between dimes and nickels in the U.S. currency?

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That's not a true exchange rate. No one changes dimes for buys and sells dimes for nickels.

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In fact, a nickel is defined as the 20th part of gold, of a dollar, it's one-twentieth of a dollar.

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And the dime is defined as one-tenth of a dollar.

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So since a dime represents twice as much of a dollar as does a nickel, by the laws of arithmetic, it's two to one, two nickels for a dime.

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True exchange rate involves an exchange on the market, which prices can change.

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So if every monetary unit was really just the weight of gold, then you would have a system like we have today in the U.S. where the dollar is simply money throughout the U.S.

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So the world, or at least the countries that use the gold standard as their currency,

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really want a part of the same currency area.

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Just as everyone who uses the dollar in the U.S. is part of the same dollar area, which is the currency of the U.S.

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Now let's talk a little bit about the supply of money.

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Under a gold standard, it's easy to calculate the supply of money. It's really the total monetary gold in existence.

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Initially, when the gold standard did emerge, it was 100% gold standard. People simply used full-bodied coins and bars, which are called bullion, to make their exchanges.

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Later on, what we call fiduciary media or banknotes arose, which were convertible into gold.

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But initially it's simply the money supply is equal to the total weight of gold.

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So we would add up the money supply in this room if we were on the gold standard by just finding out how many gold coins and gold bars everyone had in terms of weight.

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Now, given those preliminaries, how is it then that the value of money is determined?

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Well, given that we've emphasized that money is a commodity, like any other except in one respect, which I'll get to,

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Every commodity's value or market value, more precisely, or price, is determined by supply and demand, and the same is true of money.

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Supply and demand determines the value of money. But before we get to what the value of money is, we have to talk a little bit about, or rather how it's determined, we have to talk a little bit about exactly what the value of money is.

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Let's introduce the term purchasing power at this point.

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The purchasing power of any item is the amount that it can purchase on the market.

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So if a pizza sells for $10, the pizza has a price of $10, we say that the pizza has a purchasing power of $10.

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You can buy $10 with a pizza.

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We're not used to thinking of buying money, but when we talk about money, you have to now look at the other side of the coin.

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Every exchange or half of every exchange involves money.

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So the person with the money is buying the car or buying the pizza,

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but the person with the pizza or selling the car is purchasing money

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to be held for a longer or shorter period of time, to be demanded

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by the person that's buying the money.

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Right, so if you say then

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that the pizza has the purchasing power

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of $10. You can turn that around and say that in terms of money, $1, if that's the monetary unit, buys one-tenth of a pizza.

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So what we can show then is that the purchasing power of money, and I'll call it the PPM following Murray Rothbard,

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Okay, is the reciprocal or inverse of the money price of different goods, okay?

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So if a high definition TV costs $2,000, then the purchasing power of money in terms of TVs is one two thousandth of a television.

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And Murray Rothbard in his book gives a very simple example of a four good economy, actually it's a five good economy,

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in which there are eggs, butter, shoes and TV sets, all of which are priced in money,

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Because now we know that money is the general medium of account.

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And notice that these are the money prices.

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Now, given that these are the money prices, what would be the price of money?

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Well, we see immediately that unlike all other goods in the economy,

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okay, this is one difference between money and other commodities,

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money does not have one price.

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Every other good has a single price.

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Okay, it's emerged out of barter, it has one price.

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Money has at least four prices in this economy.

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It has a price in terms of eggs, butter, shoes and TV sets.

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So, we can then state the purchasing power or price of money as an array.

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It's not a unitary figure. It's not a single figure.

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It's an array of alternative goods and services that the monetary unit can command or purchase.

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So, a dollar can purchase either two dozen eggs, which are 50 cents a piece,

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or one pound of butter or one-twentieth of a pair of shoes or one-two hundredth of a TV set.

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So money is still in a state of border with all other goods and services, paradoxically enough.

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Or another way of putting that is that money does not have a single market.

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All other goods and services have a single market in which they're exchanged for money.

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Which brings us to the relationship between overall prices, the prices of goods and services,

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and the Purchasing Power of Money

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note something here

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that if

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suddenly

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all prices were to double

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okay let's say due to inflation of the money supply or expansion of the money supply

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we would then have a rough doubling of the price of all goods and services

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as I show you there in the second set of figures

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now in the third set here we see in fact

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as prices go up what happens to the value of money

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What happens to the purchasing power of each monetary unit?

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It falls, because it's the inverse of the money price.

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We simply turn it around, we turn it upside down.

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So now, you can only purchase one dozen eggs

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at a dollar a piece instead of two dozen eggs

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when they're 50 cents a piece, and so on.

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So, inflation causes the dollar to shrink,

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It's purchasing power to shrink. It represents this phenomenon. It causes the dollar to buy less. It's purchasing power to shrink more appropriately.

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So now you can only buy a half a pound of butter, one four hundredth of a TV set, whereas before you could buy twice as much of each of those goods.

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So to sum up, the purchasing power of money moves inversely to the price level.

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So the value of money, which is, again, the inverse of all the prices in the economy, is determined by supply and demand.

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Why do we draw the supply curve vertically? We draw the supply curve vertically because at any given moment in time, there's a fixed amount of money in people's cash balances.

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We use the term cash balances to mean everybody's individual money supply.

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So, if you want to total up the entire money supply, which we symbolize as capital M, it's equal to the sum of all the individual money supplies in the economy, which we call cash balances.

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Now, I'll explain in a moment why the demand curve for money would slope downward and what that means.

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And what that means, it means this, that as money loses its purchasing power, all other

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things equal, people want to hold more of it, all other things equal, including their expectations.

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Now first that seems sort of paradoxical, right? Why would people want to hold more

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money as money's value falls? Well, it's the law of demand. And let me explain that very

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Let's say you wake up tomorrow morning and prices have doubled.

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You wake up and now you have to pay $4 for a McDonald's hamburger instead of $2.

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You have to pay $6 for a gallon of gasoline instead of $3.

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You have to pay $20,000 for a Ford Tours instead of $20,000 and so on.

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But, remember, we're assuming all prices are doubled and the price of labor and wages and salaries are also a price, the price of labor, they've doubled also.

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Now, you have to make anticipated purchases during the course of the week.

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They're going to cost you twice as much. So are you going to hold more or less money? You're going to hold more money.

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And you're able to hold more money because your nominal income has gone up.

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You have more dollars in your pocket because your wages and salaries have doubled.

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So if the money supply doubles and all prices have doubled, including the price of labor,

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people are going to want to hold more money to pay the higher prices.

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Okay? Conversely. Yes, go ahead.

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Have you included the amount in your banking account as having doubled?

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Yes, what we're going to assume is all, well, that might be a sort of a transition problem where that hasn't doubled.

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We're just assuming all prices have doubled.

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And maybe you would include the price of all assets, too, which would mean that you're in a sense that you're saving the account as an asset and that's doubled.

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That's a good question.

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So now, on the other hand, if you wake up and prices have been cut in half, have been halved, including your salaries, of course,

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In the long run, you're going to want to hold less money.

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It's only $1.50 to buy a gallon of gas. Lunch costs you half as much.

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A beer at happy hour costs $1 instead of $2 and so on. Everything is cut in half.

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So what we get then is the downward sloping demand curve.

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So if the purchasing power of money is very low, down here, meaning that prices are very high,

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prices are very high when the purchasing power of money is low, then people are going to want to hold much more money,

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and I'll put figures in in a moment, much more money than they would have if prices were low.

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Prices were low, they don't need the whole of that much money because each purchase absorbs less money.

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So the demand curve slopes downward to the right.

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Now let's talk a little bit about the monetary adjustment process in which we'll explain a little bit more about what happens when the money supply changes

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and how we get to what's called the equilibrium.

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Okay, let's say that initially, for whatever reason, there's more gold in the economy, okay?

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And so, this is the stock of gold, 100 million ounces, let's use dollars, 100 billion dollars of money in the economy.

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And yet people only want to hold, given the demand curve, at that purchasing power, they only need to hold half as much, let's say 50 billion.

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So they have 50 billion excess dollars, not in the sense that they want to throw them away and don't want them.

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If you feel that you're holding more money than you need, let's say if you just hit the lottery and you have 10 million dollars, you just won 10 million dollars.

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You're going to have excess cash balances. What will you do? What's going to be your first thought if you hit the lottery?

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Either invested or either buy financial assets or buy consumers' goods.

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So you're going to rush out. That's how you get rid of excess money. You don't throw it away, obviously, because it's valuable.

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What you do is you allocate it to other goods that are now more desirable than all this money.

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So you might buy a yacht. You might buy an estate. You might, as you pointed out, invest it in stocks or even buy an entire company.

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Company. As you do that though, as money is put in circulation, if this is the economy

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as a whole now where there's excess money in the economy, people rush out and spend

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the money and that does what? Increases the demand for goods and then causes prices to

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go up. That's called the monetary adjustment process. And let me just set it out here for

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Here's what we're going to assume. We're going to assume that people have more money than they demand to hold, because prices are low, they don't need that much money.

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So the money supply is greater than the demand for money.

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Now, using sidewood arrows to mean causes, that excess amount of money, the excess supply of money causes an increase in the demand for goods in the economy.

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Okay, so the demand for goods shoot up. As you pointed out, prices rise. People begin to buy more, more yachts, more hamburgers, more of every item in the economy.

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As prices rise, however, that means that each dollar buys less and less, becomes less powerful.

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So, remember, the purchasing power of money is simply the inverse of the price level.

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Purchasing power of money drops,

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and that leads then to

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people wanting to hold, having to hold a greater

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quantity of money. The quantity demanded of money goes up

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because now people need more money in their pockets as all these prices begin to rise.

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And finally,

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we get a situation where

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The market adjusts the purchasing power of money so that the amount of money in the economy

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equals the demand for money.

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So let me put this up again.

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If you have a surplus of money, eventually, that's not going to last.

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People are going to rush out and spend the money.

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As they spend the money, the prices will rise, the value of money will drop and they'll move

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down along this demand curve to the point where they will want to hold a full $100 billion

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for Anticipated Purchases. They will feel that they have no excess money that they have to rush out and spend immediately.

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Now, the reverse, that's called the monetary adjustment process.

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The market always makes sure that the price level is set at the point at which people will hold the whole amount of money in the economy.

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It sets supply of money equals the demand for money.

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On the other hand, if there's a shortage, if people want $150 billion, but there's only $100 billion in the economy,

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Does that mean the economy is going to go into recession and people be laid off?

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No, not necessarily. What's going to happen is that,

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again, thinking about it on the individual level,

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if you suddenly find that you can go on a cruise for a real bargain,

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and you have to come up with, let's say, $3,000 for you and your spouse

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to go with your friends on a cruise in the Caribbean,

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and you have to come up with that money, let's say, within a month.

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What are you going to do?

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If people then suddenly require more money than they're currently holding,

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you cut back on your spending.

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That's how a monetary shortage is adjusted.

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Now, if everybody wakes up one morning and feels that there's going to be a recession

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and that they're going to face greater prospects of being laid off

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or not getting their bonuses or having their salaries cut,

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they're going to feel that they have a shortage of money.

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They're going to be uncertain about the future.

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and uncertainty about the future is going to cause them to demand more money than they would have.

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So let's assume that the prices are quite high in this economy, the purchasing power of money is low,

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and people want to hold 150 billion dollars instead of 100 billion dollars.

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Well, how are they going to do that? Well, again, it's the monetary adjustment process.

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As everyone cuts their spending, prices are going to fall, all of these arrows are going to be reversed.

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Prices will fall as people demand fewer goods, which means that the price level will go down,

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the purchasing power of money will rise now.

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Each dollar will buy more as prices fall, and people will feel that they don't have to hold as much money as they did before,

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so we will move up this demand curve.

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People will demand less and less money as prices fall.

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So, take a radical example. If prices were one-tenth as high tomorrow, it was cut by 90%, so that an auto bill was $2,000 instead of $20,000, and gasoline was $0.30 instead of $3, and you had the same amount of money in your checking account, what would you do?

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You'd rush out and spend it. Or on the other hand, if prices were to triple tomorrow, you would need more money, so you'd have to cut your spending.

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So what we're saying here, and this is a very important point, is that there is never a need to increase or decrease the supply of money.

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The market will always adjust the price level to a level at which people are satisfied with the amount of money that they are holding.

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Second thing to keep in mind is that, like any other price, the price of money, which we call the purchasing power of money, is determined by the market.

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Now we can talk about inflation and its consequences.

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The original definition of inflation, which I think was used pretty much up until the

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early 20th century, even into the 1930s.

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Inflation means a volume, right?

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You inflate a balloon, a volume that has more than two dimensions.

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It meant initially to increase the supply of money.

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That was what inflation, that's how it was defined as an increase in the supply of money.

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And one of its consequences, but not the only one, was a rise in prices.

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Later on, especially after John Maynard Keynes wrote his famous general theory, his treatise,

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in 1936, but actually even before that, economists began to use inflation as a term denoting

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using the consequence, one consequence of inflation, which was the price level rising.

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But you can see that inflation refers to a volume expanding, which is like the volume

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of money expanding, not to a level going up or down.

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But nonetheless, that word was then applied.

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Now there was a problem with that, using inflation to denote or refer to a change in the price

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level.

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What was this? There are many other consequences of inflation, artificially lowering the rate of interest, or pushing up the prices of real estate and financial assets.

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All of that is ignored when you use inflation to denote a change in consumer prices, which is the way it's used today.

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So, let's just look at a change in the money supply. Let's say that, actually before I do that, let me quickly mention one other thing.

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And that is that over time, people became used to using fiat money, okay? That is paper money.

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And so for that, we'll get to a little bit more detail in a moment, but for now, governments were able to manipulate the supply of money.

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Even when it was convertible into gold, they had some power to manipulate through the banks the supply of money.

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So let's see what happens when you have an increase in the supply of money.

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So now you have a quantity of a hundred million initially, a hundred billion dollars in the economy.

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And here is equilibrium purchasing power. Purchasing power of money is at point A.

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There's a certain level of prices, overall prices for various items are at a certain level.

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And then there's an increase in supply of money by 50 billion dollars.

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People now have 50 billion dollars more than they need.

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So they rush out and they spend the 50 billion.

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Well, that's where the monetary adjustment process comes in, sometimes called the inflation adjustment process.

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What occurs then is that as people rush out to spend that extra money, prices rise to the point where the purchasing power of each dollar falls and we eventually get higher prices and a lower purchasing power of money.

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So we have had inflation. Now, what changes occur as a result of that? Does that benefit society in any way?

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In fact, even though the money supply has increased by 50%, there are no more goods in the economy.

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There's the same amount of goods in the economy. They depend on the available resources, the amount of capital and technology.

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They don't change, assuming those things are constant.

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What happens is simply that prices are pushed up, but the real money supply does not change.

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So, if a central bank increases the money supply, wanting to give people more purchasing power, they don't succeed in doing that.

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All they do is they raise the price level in the same proportion as the money supply.

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So, to give you a simple example here, if pizza is the good that we're talking about in the economy, let's say the representative good,

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when we have $100 billion, let's say that pizza is $10 a piece, so $10 per pizza.

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The real money supply is defined as the money supply divided by the price level in the economy.

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So if we use pizza, we divide this by ten dollars, and it's ten dollars for pizza.

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What we get is a real money supply equal to the amount of pizzas that the hundred billion dollars can buy.

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And that's simply ten billion pizzas.

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So the real money supply is always stated in terms of goods.

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How many goods can the money supply buy?

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It can buy 10 billion pizzas.

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Now let's see if the Fed or the central bank has changed anything by increasing the numerator.

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So it increases the money supply to $150 billion.

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Prices of pizza have gone up to $15 by 50% by about the same proportion as the increase in the money supply.

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What's happened to the real money supply? Has it changed? No, it's still 10 billion pizzas.

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So there is no change in the money supply. People just have to carry around more money and have to pay higher prices.

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They don't have any more purchasing power because there are no more goods in the economy.

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All right, now let's see what happens when we get a change in demand for money.

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Why might the demand for money change?

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Well, people might want to hold more money, as I said before, because they fear a recession in the future.

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Or there might be an increase in the amount of money that people want to buy because there's more goods and services.

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That is, we have economic growth and there are more computers being sold on the market.

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So that exercises an increased demand for money or represents an increased demand for money.

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So let's say we have an increase in the demand for money as a result of economic growth.

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That is, we had initially, let's say, the $100 billion, but now let's just make this a 50% increase.

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Let's say there's a tremendous amount of economic growth in a given year, this wouldn't happen, but 50%.

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50% there's 50% more goods and services on the market because of growth so those sellers want to sell those extra 50% of goods and services how can they sell it those extra goods and services with the same money supply doesn't the Fed need to step in and increase the money supply out to this point here they move this whole line out here so that now at the same prices they can sell the additional computers and other things that have increased in supply

394
00:41:36.020 --> 00:41:49.020
No, not at all. In fact, what happens is that as the demand for money increases, people suddenly, or the people that have the extra goods and services, realize that they have to do what?

395
00:41:49.020 --> 00:41:58.020
They have to lower the prices. They have to lower the prices. As has happened as we talked about in the high-tech industries.

396
00:41:58.020 --> 00:42:05.020
Even if this is a demand to hold more money and not to sell more goods but to just hold more money because people are fearful of recession,

397
00:42:05.020 --> 00:42:07.020
What will people do?

398
00:42:07.020 --> 00:42:13.420
Even with the same amount of goods in the economy, they'll cut back on the amount of money they're spending on goods and services and that will lower prices.

399
00:42:13.420 --> 00:42:17.520
In either case, the increase in demand for money will result in lower prices.

400
00:42:17.520 --> 00:42:20.520
So let's say prices are cut in half to make it simple.

401
00:42:20.520 --> 00:42:25.920
Okay, now the market does increase the real money supply.

402
00:42:25.920 --> 00:42:29.220
So an increase in demand for money will increase the real money supply.

403
00:42:29.220 --> 00:42:32.520
That increase in demand emanates from private people.

404
00:42:32.520 --> 00:42:43.520
So let's say that the money supply remains at $100 billion, but demand more or less has doubled, let's say, to make it a simple calculation.

405
00:42:43.520 --> 00:42:53.520
If demand doubles, what happens is that price of pizza are cut in half, right? Price of pizzas are cut in half.

406
00:42:53.520 --> 00:42:58.520
What's that? Okay, let me move it up, thank you.

407
00:42:58.520 --> 00:43:05.520
Price of pizza is cut in half and calculating the real money supply here, M over P.

408
00:43:05.520 --> 00:43:17.520
How much that $100 billion can now buy? With prices lowered, that $100 billion can now buy 20 billion pizzas.

409
00:43:17.520 --> 00:43:22.520
What has happened to the real money supply? It's increased. The market has increased the real money supply.

410
00:43:22.520 --> 00:43:27.520
Money Supply, why? Because people wanted to hold more money, or they had more goods that they wanted to sell for money.

411
00:43:27.520 --> 00:43:37.520
In either case, prices have adjusted. They've come down so that people now, with the same amount of dollars, each dollar is worth twice as much, right?

412
00:43:37.520 --> 00:43:48.520
So if each dollar is worth twice as much, then by holding, let's say you hold $1,000 in your bank account on average, that $1,000 now does what? Buys twice as much.

413
00:43:48.520 --> 00:43:56.520
So, every part of that money supply has doubled in value, every dollar of that 100 billion, as prices have come down.

414
00:43:56.520 --> 00:44:06.520
So, in contrast to an increase in the supply of money by the government, which does not increase the real money supply, does not give people any more satisfaction,

415
00:44:06.520 --> 00:44:15.520
an increase in the demand for money which lowers prices does make people better off, because it makes their cash balances more powerful.

416
00:44:15.520 --> 00:44:44.520
Okay, now we come to an important question, and that question is this. What is the optimal supply of money? Economists use that term optimal, okay, or another way of putting it is what should the supply of money be, given the analysis that we just went through? Is there ever a reason to increase the supply of money, or to change it?

417
00:44:44.520 --> 00:44:52.520
Okay, that's the main objection.

418
00:44:52.520 --> 00:44:56.520
Certainly in the case of economic growth, we need more dollars to buy these extra goods.

419
00:44:56.520 --> 00:45:02.520
But if you look again at areas or sectors of the economy that are growing,

420
00:45:02.520 --> 00:45:06.520
they adjust fine without big increases in the supply of money.

421
00:45:06.520 --> 00:45:11.520
As I mentioned, when personal computers were first introduced, they were $20,000.

422
00:45:11.520 --> 00:45:30.520
$500. Now they're $500. When hand calculators were first introduced in 69, they were $350. Now they're $5. So growth in any sector is no different than growth in the economy as a whole, because the economy as a whole is composed of all the various industries and sectors.

423
00:45:30.520 --> 00:45:42.520
So, you don't need an increased supply of money to accommodate economic growth, because in fact, the demand for money will change in such a way that it will lower prices, okay?

424
00:45:42.520 --> 00:45:56.520
Now, here's a way of approaching this, and it's as follows. Here's where money is different from the other classes of commodities, okay?

425
00:45:56.520 --> 00:46:07.520
Think about a consumer's good. The function of a consumer good is to yield direct satisfaction to consumers.

426
00:46:07.520 --> 00:46:17.520
Now, in functioning as a consumer good, a thing is generally either used up immediately, in the case of a meal, or used up over time, in the case of a normal meal.

427
00:46:17.520 --> 00:46:22.520
In either case, in performing its function as a consumer good, things are used up.

428
00:46:22.520 --> 00:46:24.520
Same thing with capital goods.

429
00:46:24.520 --> 00:46:30.520
Almost all capital goods, whether it's a factory or it's a raw material, it's used up in the process of production.

430
00:46:32.520 --> 00:46:34.520
But what about money?

431
00:46:34.520 --> 00:46:38.520
Money is neither a consumer good or a producer good.

432
00:46:38.520 --> 00:46:42.520
Producer good yields indirect satisfaction, consumer good yields direct satisfaction.

433
00:46:42.520 --> 00:46:49.520
The function of money is to be obtained and then re-exchanged for something that you desire more.

434
00:46:49.520 --> 00:46:55.520
So the function of money is to be re-exchanged. It's like a hot potato. It's passed throughout the economy.

435
00:46:55.520 --> 00:47:09.520
In performing this function, do either fiat dollars or silver or gold, is it part of that function to be used up?

436
00:47:09.520 --> 00:47:14.520
No, it's not part of it. There might be some wear and tear. There is wear and tear on gold and silver.

437
00:47:14.520 --> 00:47:18.520
and the paper dollars do have to be replaced every five years or whatever it is

438
00:47:18.520 --> 00:47:23.520
but that's not an inherent part of the function of a medium of exchange.

439
00:47:23.520 --> 00:47:25.520
It's just to be re-exchanged.

440
00:47:25.520 --> 00:47:31.520
It's not to be consumed either in producing consumer goods or in satisfying directly human wants.

441
00:47:31.520 --> 00:47:39.520
So given that, we can then use what Murray Rothbard calls the Angel Gabriel model

442
00:47:39.520 --> 00:47:43.520
to show why you don't need an increase in the money supply.

443
00:47:43.520 --> 00:48:13.520
Supply. And Milton Friedman calls it the helicopter model. Basically what happens is that there's an angel up there who wants to benefit humanity but is economically ignorant and decides that since a given person, when their money income increases, he observes that a given person is better off. Well, he's going to make everybody better off by doubling their cash balances. So when you wake up tomorrow morning, you're going to have twice as much money in your wallets, purses, and in your

444
00:48:13.520 --> 00:48:43.520
Bank Accounts. So he does that. He doubles the money supply. Everyone wakes up. First, let's assume everybody wakes up at the same time, for simplicity. And what do they do? At the same price level, they now have more money than they want to hold. They don't need to hold twice as much. They already adjusted their cash balances to what they needed to hold. Everybody rushes out and spends it, and almost immediately, what happens to prices? They rise and you get inflation. The angel has not benefited anyone. All that has happened is that we have twice as

445
00:48:43.520 --> 00:48:58.520
The real money supply is not changed, okay. So there is no social benefit conferred by an increase in the money supply, okay.

446
00:48:58.520 --> 00:49:04.520
Any quantity of money, this is sort of Ricardo's law, one of the first economists to recognize it, David Ricardo.

447
00:49:04.520 --> 00:49:10.520
Any quantity of money is sufficient to perform the function of a medium of exchange.

448
00:49:10.520 --> 00:49:16.520
Exchange. If there are $50 billion in the economy, let's take three economies. Economy

449
00:49:16.520 --> 00:49:21.520
number one has $50 billion, number two has $100 billion, number three has $150 billion.

450
00:49:21.520 --> 00:49:29.520
And everything else is the same. They have the same consumers, labors, goods, technology.

451
00:49:29.520 --> 00:49:34.520
Everything is exactly the same. Is the economy with $150 billion better off than the economy

452
00:49:34.520 --> 00:49:44.520
with 50 billion? No. The only difference is that prices are three times as high in the economy with the greater supply of money. That's the only difference.

453
00:49:44.520 --> 00:49:58.520
There is no increased satisfaction of human wants. Now, if the angel had known some economics, he'd come to this seminar and paid close attention to the Salerno part of the seminar,

454
00:49:58.520 --> 00:50:06.520
He would have realized that the way to benefit humanity was to do what?

455
00:50:06.520 --> 00:50:08.520
Not to increase the supply of money, but to increase the what?

456
00:50:08.520 --> 00:50:09.520
Goods.

457
00:50:09.520 --> 00:50:12.520
Well, if you woke up and you had a second car in your driveway,

458
00:50:12.520 --> 00:50:14.520
or if you had two and you had four cars in your driveway,

459
00:50:14.520 --> 00:50:18.520
everybody had twice the amount of goods and you had a second home and so on,

460
00:50:18.520 --> 00:50:22.520
everybody would be better off because more human wants would be satisfied.

461
00:50:22.520 --> 00:50:26.520
The same thing is true if he decided to double the amount of producer goods,

462
00:50:26.520 --> 00:50:34.520
The amount of capital goods in the economy, the amount of factories, the amount of software programs, the amount of computers and so on, trucks.

463
00:50:34.520 --> 00:50:43.520
Eventually, those things would allow the fixed amount of labor to produce more goods and services and the economy would again be better off.

464
00:50:43.520 --> 00:50:52.520
So that is another way in which the commodity of money differs from producers' goods and consumer goods.

465
00:50:52.520 --> 00:50:59.520
Okay, now let's talk a little bit about, oh, let me introduce a twist into the Angel Gabriel scenario.

466
00:50:59.520 --> 00:51:02.520
Let's say some people are early risers, okay.

467
00:51:02.520 --> 00:51:06.520
Some people get up early. I know Lew Rockwell gets up very early.

468
00:51:06.520 --> 00:51:11.520
He has to have his page up, lewrockwell.com.

469
00:51:11.520 --> 00:51:17.520
So he gets up very early, and he finds that his money supply has doubled.

470
00:51:17.520 --> 00:51:25.520
Okay, now Peter Klein lays around, kind of slothful, lays around in bed, reads the papers, doesn't venture out until 11 o'clock.

471
00:51:25.520 --> 00:51:27.520
He's a typical college professor.

472
00:51:31.520 --> 00:51:37.520
Okay, now what happens? Lew Rockwell and others like him rush out and spend the new money.

473
00:51:37.520 --> 00:51:42.520
What happens to prices? Well, they buy when prices are still at their old level, okay?

474
00:51:42.520 --> 00:51:48.520
And so prices begin to rise. The people who get up a little bit later have to face slightly higher prices.

475
00:51:48.520 --> 00:51:54.320
However, when Peter Klein gets up and goes out, he finds out that prices have increased tremendously.

476
00:51:54.320 --> 00:52:03.920
So, in effect, what has happened is that wealth has been transferred from Peter Klein to Lew Rockwell.

477
00:52:03.920 --> 00:52:09.720
That increases social welfare, in my estimation.

478
00:52:09.720 --> 00:52:18.520
So, what happens is that the people who receive the new money late are victimized by the inflationary process,

479
00:52:18.520 --> 00:52:22.520
and the people who receive the new money first are the ones who gain, okay?

480
00:52:22.520 --> 00:52:26.520
Because they buy before prices have risen, so the purchasing power of their dollar is still high,

481
00:52:26.520 --> 00:52:36.320
whereas Peter Klein buys after the prices have risen, and so the purchasing power of his dollars have already declined, okay?

482
00:52:36.320 --> 00:52:38.320
We're going to come back to that point again.

483
00:52:38.320 --> 00:52:49.320
Now let's talk a little bit more about government paper money and how it came about because I want to get to the case of hyperinflation here.

484
00:52:49.320 --> 00:52:58.320
Initially the kings monopolized the mining of gold and silver coins and they charged their subjects a monopoly price.

485
00:52:58.320 --> 00:53:05.320
They banned private minting of coins which had existed in various parts of Europe.

486
00:53:05.320 --> 00:53:11.320
And they charge a monopoly price, and that monopoly price, if you want information, was called seigneurage.

487
00:53:11.320 --> 00:53:32.320
The right, representing the right of the lord, or the prerogative of the lord of the manor or of the king to monopolize the process of minting coins.

488
00:53:32.320 --> 00:53:39.320
Okay, and Signorage would also, now I don't know how apocryphal this story is, but it's interesting, so I'm going to tell it.

489
00:53:39.320 --> 00:53:50.320
It also referred to the right of the feudal lord to spend the first night with the bride of his vassals.

490
00:53:50.320 --> 00:54:03.320
Now, that was never actually enforced. What they would do is that the vassal would have to pay him a sum of money so that he would renounce that right.

491
00:54:03.320 --> 00:54:15.320
So, supposedly, this is where the terms and yourage comes from. I've heard that story and other people have said it's apocryphal, that it's a made-up story.

492
00:54:15.320 --> 00:54:31.320
It has no basis in fact, but it's a good story to tell, because the government basically screws you when it's minting money or at monopoly prices or producing paper money.

493
00:54:31.320 --> 00:54:45.320
So, now the important point here is that when you have the king monopolizing the mint, they can engage in what's called debasing the coinage.

494
00:54:45.320 --> 00:54:51.320
They can do it in a number of different ways. There's something called sweating the coins, where they call the coins back.

495
00:54:51.320 --> 00:54:58.320
When a new king comes in, let's say King Nitwit now ascends to the throne.

496
00:54:58.320 --> 00:55:02.820
Okay, so King Knit would now ascend to the throne, and he wants his picture on the coins, okay?

497
00:55:02.820 --> 00:55:12.320
So, he calls the coinage back, and he'll put his own picture on the coin, you know, and he'll name it the Knit, okay?

498
00:55:12.320 --> 00:55:17.820
And let's say the Knit was initially one, okay.

499
00:55:17.820 --> 00:55:21.320
Does it look like Peter? The nose in here. Okay.

500
00:55:21.320 --> 00:55:24.320
The Knit was initially one full ounce of gold, let's say.

501
00:55:24.320 --> 00:55:32.920
What he'll do is he'll reduce the gold content to, let's say, nine-tenths and he'll debase it by adulterating it maybe with a copper, okay,

502
00:55:32.920 --> 00:55:40.920
recoin it with some copper in it, which is a base metal, or he'll sweat the coinage, that is, he'll put the coins in a bag,

503
00:55:40.920 --> 00:55:48.120
he'll have his lackey shake the bag and the loose piece of gold will fall off the coins and then he'll give the coins back,

504
00:55:48.120 --> 00:56:00.120
In fact, he'll be lighter weight and he'll use, obviously, the residue and coin that into coins and use them himself, as he would if he clipped the coins. Clipping the coins is just shaving off the outer edge, okay?

505
00:56:00.120 --> 00:56:12.120
In any case, the amount of the precious metal becomes less, but yet the name Knit sticks, okay? And he now has more revenue, okay?

506
00:56:12.120 --> 00:56:16.440
And so the kings can only get away with this, you know, once or twice during their reign, all right.

507
00:56:16.440 --> 00:56:27.360
Sometimes they'll call back the coinage because it's becoming lightweight, okay, and they want to re-coin because it's becoming, the face of it is becoming sort of, it's becoming defaced as it's being used.

508
00:56:27.360 --> 00:56:34.360
So you might call it back for that reason. And again, he debases it, okay. Over time, coins have been tremendously debased.

509
00:56:34.360 --> 00:56:46.360
For example, I don't have it here, but in Spain, the coinage was the base of the point where the coins had become so small that they couldn't even, you know, they were too small to even circulate, okay?

510
00:56:46.360 --> 00:56:57.360
The key point, however, is that people begin to think of the monetary unit not as an ounce of gold because now it's a half an ounce of gold or a quarter of an ounce of gold, it keeps getting smaller and smaller.

511
00:56:57.360 --> 00:57:08.360
they think of it as the knit, okay? So they accept the name as the monetary unit and not the weight, alright?

512
00:57:08.360 --> 00:57:14.760
Now, in order to gain general acceptance, okay, for paper money, once the printing press was invented,

513
00:57:14.760 --> 00:57:20.860
the government saw that, you know, you can only debase the coinage so far, okay, there is a limit, obviously.

514
00:57:20.860 --> 00:57:26.260
So inflation can't extend very far under the gold standard, but if you can print paper, then it will.

515
00:57:26.260 --> 00:57:43.260
So, how did they get paper into circulation? Well, given that people were now accepting the names, like Frank, Mark, Dollar, rather than the weight, as the monetary unit, the kings then guaranteed redeemability on demand initially.

516
00:57:43.260 --> 00:57:51.260
They would say, look, you accept the paper money we issue, we will pay you the full amount in gold if you come back with it. And the paper money is more convenient, and so on.

517
00:57:51.260 --> 00:58:12.260
They also said that they would accept the paper money in payment of taxes, due, and they imposed legal tender laws that forced people to accept the paper dollars in full discharge of debts incurred in the gold dollars at par, or gold nits, or whatever it is.

518
00:58:12.260 --> 00:58:26.260
So, for all these reasons, paper money got into circulation, which then allowed the kings to pay for their wars and building palaces, basically that's the two things they spent their budgets on.

519
00:58:26.260 --> 00:58:39.260
It allowed them to issue or to get banks, the banks, to loan them paper money and to use that paper money to pay for the wars and to pay for the palace building and other boondoggles.

520
00:58:39.260 --> 00:58:52.260
So the government then began inflating through paper money and secretly redistributed money from the populace, from the citizens to itself.

521
00:58:52.260 --> 00:58:59.260
And they were able to run budget deficits because they could finance it by paper money.

522
00:58:59.260 --> 00:59:05.260
Under a full gold standard it was very difficult, you really couldn't run budget deficits unless you get somebody to lend you the gold.

523
00:59:05.260 --> 00:59:10.260
and so it was a narrow limit on the amount of deficits you could run

524
00:59:10.260 --> 00:59:14.260
and in fact there are stories of armies just leaving the battlefield

525
00:59:14.260 --> 00:59:18.260
because the kings could no longer pay the wages for the soldiers.

526
00:59:21.260 --> 00:59:25.260
Now, eventually, and I don't want to go through the whole historical process,

527
00:59:25.260 --> 00:59:30.260
but by 1914, well generally during wars all countries went off the gold standard,

528
00:59:30.260 --> 00:59:44.260
off the gold standard. That is, they suspended the redeemability of the paper money for the period of the war, promising that they would go back after the war and redeem the paper money again in gold and silver at par.

529
00:59:44.260 --> 00:59:54.260
But during wartime, they went off the gold standard. The United States did during the Civil War. Great Britain did during the wars with Napoleon in the early 19th century.

530
00:59:54.260 --> 01:00:00.260
Every belligerent did in 1914 and stayed off the gold standard until well after the war ended.

531
01:00:00.260 --> 01:00:13.260
And finally, in the 1930s, 31 Great Britain went off, 1933 the US went off, 1936 France and a number of others in a monetary block with France went off the gold standard.

532
01:00:13.260 --> 01:00:19.260
So that really after World War II we didn't have, we went back to a very watered down phony type of gold standard.

533
01:00:19.260 --> 01:00:26.260
We pretty much had paper money. But during wartime, even earlier, as I said, nations went off the gold standard.

534
01:00:26.260 --> 01:00:32.260
This allowed governments to print money without any limit to finance the wars.

535
01:00:32.260 --> 01:00:44.260
And we got the phenomenon of hyperinflation. The phenomenon of hyperinflation arose.

536
01:00:44.260 --> 01:00:55.260
The most famous incident of hyperinflation was that of Germany after World War II.

537
01:00:55.260 --> 01:01:00.260
I'm sorry, World War I, excuse me, in the early 1920s.

538
01:01:00.260 --> 01:01:13.260
Basically, Germany had, if you take 1913 as a base year and take the price level as equal to one,

539
01:01:13.260 --> 01:01:19.260
The price level rose one trillion times by 1923 in Germany.

540
01:01:19.260 --> 01:01:21.260
Let me just read you some of the interesting...

541
01:01:21.260 --> 01:01:25.260
What happens is the government, of course, kept printing money, especially...

542
01:01:25.260 --> 01:01:28.260
It had to pay reparations by the Treaty of Versailles.

543
01:01:28.260 --> 01:01:34.260
The German government had to pay reparations, as well as the other members of the alliance,

544
01:01:34.260 --> 01:01:41.260
had to pay to the French, British, for the damage allegedly caused by the war.

545
01:01:41.260 --> 01:01:52.220
and some interesting stories about how bad this inflation got and what I want

546
01:01:52.220 --> 01:01:58.100
to first do is show you the price of a German newspaper very good way of

547
01:01:58.100 --> 01:02:04.980
getting a feel for the magnitude of the inflation okay rather than just using a

548
01:02:04.980 --> 01:02:09.820
price index something like a newspaper is an everyday item its quality doesn't

549
01:02:09.820 --> 01:02:14.940
can change much, pretty much the same over time, so it gives you a good idea of the magnitude

550
01:02:14.940 --> 01:02:19.340
of the price increases, you know, when those price increases are large.

551
01:02:19.340 --> 01:02:26.060
So if you take 1921, January 1921, start of the hyperinflation, there was a lot of inflation

552
01:02:26.060 --> 01:02:30.860
during the war but nothing, it wasn't a hyperinflation at that point, it was about one-third of a

553
01:02:30.860 --> 01:02:38.900
mark, then by May 1922, a little bit more than a year later, it had tripled, so the

554
01:02:38.900 --> 01:02:43.900
The price level had tripled in 14, 15 months.

555
01:02:43.900 --> 01:02:50.900
That's as if 15 months from now the price of a Ford Tourist would be $60,000 instead of $20,000.

556
01:02:50.900 --> 01:02:56.900
Then from May to October, so from the fifth month to the tenth month of that calendar year,

557
01:02:56.900 --> 01:03:00.900
the price level went up eight times.

558
01:03:00.900 --> 01:03:06.900
By February 1923, the price of a newspaper was 100 marks.

559
01:03:06.900 --> 01:03:10.900
So from the beginning, comparing to the beginning, it went up 300 times about.

560
01:03:10.900 --> 01:03:17.100
Then it went up to 1,000 marks about 7 or 8 months later.

561
01:03:17.100 --> 01:03:23.600
Then from September 1923 to October 1st, within a month, it doubled.

562
01:03:23.600 --> 01:03:26.900
And then within 14 days, it went up 10 times.

563
01:03:26.900 --> 01:03:32.600
Now 20,000 marks to buy a German newspaper.

564
01:03:32.600 --> 01:03:38.320
Two weeks later, it was now one million marks to buy the newspaper.

565
01:03:38.320 --> 01:03:41.440
Then 10 or 11 days later, it was $15 million.

566
01:03:41.440 --> 01:03:46.120
Eight days later, it was $70 million, 70 million marks.

567
01:03:46.120 --> 01:03:52.220
That's as if you go for a haircut when it's $10.

568
01:03:52.220 --> 01:03:57.560
And then in, let's say, two years, pretty much it, a little bit more than two years, two and a half years,

569
01:03:57.560 --> 01:04:05.960
The haircut is now 70 million times that, or 700 million dollars, okay?

570
01:04:05.960 --> 01:04:12.160
So that's the magnitude of the inflation, which caused a lot of behavioral changes in people, obviously,

571
01:04:12.160 --> 01:04:16.360
especially as prices were going up hour by hour, okay?

572
01:04:16.360 --> 01:04:23.660
You all, or you've heard of, or maybe have seen the picture of, or the, yeah, it's a picture or photo,

573
01:04:23.660 --> 01:04:37.660
of the German worker with a whole wheelbarrow full of marked notes and pushing them into a grocery store to exchange them for just like a pound of butter.

574
01:04:37.660 --> 01:04:43.660
Also, what began to happen was that people began to demand to get paid more frequently.

575
01:04:43.660 --> 01:04:51.660
So workers were getting paid every two weeks, they demanded every week because they didn't want to hold money for a very long time because the purchasing power was declining so rapidly.

576
01:04:51.660 --> 01:05:08.660
Then they were getting paid every day and then two and three times a day and their families would show up at the factory gates, the grandfather, the wife, the children, and he would bring out the notes and they would give them to the family and the family would rush out and spend it on anything at that point.

577
01:05:08.660 --> 01:05:14.660
You couldn't even comparison shop because prices were going up minute by minute or hour by hour.

578
01:05:14.660 --> 01:05:20.660
Even if no one in your family played a piano, if there was a piano for sale you would just buy it right then.

579
01:05:20.660 --> 01:05:25.260
This was the flight into real values, it was called, all right?

580
01:05:25.260 --> 01:05:29.780
There was also another sort of behavioral change that occurred.

581
01:05:29.780 --> 01:05:37.060
Women would begin to bring their laundry baskets full of marked notes to the stores, okay?

582
01:05:37.060 --> 01:05:43.180
But you couldn't fit them down the aisles, so they would leave them outside, you know, with the notes in them.

583
01:05:43.180 --> 01:05:47.420
And thieves would come by and dump the notes out and steal the baskets,

584
01:05:47.420 --> 01:05:51.340
Because the basket was more valuable than the notes, okay?

585
01:05:55.260 --> 01:05:59.340
College professors, civil servants,

586
01:05:59.340 --> 01:06:00.780
they began to quit their jobs

587
01:06:00.780 --> 01:06:03.420
because they were being paid every two weeks or every month

588
01:06:03.420 --> 01:06:05.780
and they couldn't afford to wait to get their income

589
01:06:05.780 --> 01:06:08.740
because it was declining value so rapidly.

590
01:06:08.740 --> 01:06:13.340
So they became waiters and taxi drivers, okay?

591
01:06:13.340 --> 01:06:15.940
Or another service people that got paid immediately.

592
01:06:15.940 --> 01:06:21.940
So you had that occurring. Of course now the government claimed that we had nothing to do with it, they claim.

593
01:06:21.940 --> 01:06:27.940
Because if you looked at the statistics, what you saw was that prices were rising more rapidly than the money supply.

594
01:06:27.940 --> 01:06:31.940
That's very interesting. Prices were going up much more rapidly than the money supply.

595
01:06:31.940 --> 01:06:34.940
The key is what we call inflationary expectations though.

596
01:06:34.940 --> 01:06:42.940
And that means this, that if people expect inflation, prices to rise to a great extent at a period in the future,

597
01:06:42.940 --> 01:06:52.940
the period in the future. Let's say we expect prices of, let's say, automobiles and various adorable goods to double next year.

598
01:06:52.940 --> 01:06:58.940
What will people rush out and do? They'll buy them. They'll buy them this year.

599
01:06:58.940 --> 01:07:04.940
That occurred when we had the first sort of housing boom in the 1970s where young couples were rushing out.

600
01:07:04.940 --> 01:07:09.940
When young couples, instead of waiting two or three years and saving for a down payment to buy a house,

601
01:07:09.940 --> 01:07:14.940
were borrowing from their families and putting down payments on their homes.

602
01:07:14.940 --> 01:07:21.940
As the inflation rate increased to the point where, I think in 1980, it was about 16% per year in the U.S.,

603
01:07:21.940 --> 01:07:25.940
you saw more of this anticipatory buying, which means that people are trying to get rid of money.

604
01:07:25.940 --> 01:07:30.940
The demand for money is falling to the left. The demand for money is going down.

605
01:07:30.940 --> 01:07:35.940
People don't want to hold money, or as much money as they did before. They want to get rid of it almost as soon as they get it.

606
01:07:35.940 --> 01:07:40.940
At the end, of course, at the end of hyperinflation, no one really wants the whole money.

607
01:07:40.940 --> 01:07:50.940
That is to say that everyone who has anything real will sell, or another type of commodity, will sell the commodity for money.

608
01:07:50.940 --> 01:07:54.940
But let's look at some of the other things that happened during the German hyperinflation.

609
01:07:54.940 --> 01:08:02.940
As I said, the German government pointed to this phenomenon and said, look, it's not us, it's the speculators.

610
01:08:02.940 --> 01:08:19.940
They're selling the mark very cheaply or they're short selling the mark on the foreign exchange market and that's pushing down the value of the market and causing import prices because the mark then needed more marks to buy foreign imports to explode.

611
01:08:19.940 --> 01:08:23.940
So they blamed on speculators but of course it was this inflationary expectations.

612
01:08:23.940 --> 01:08:30.940
Not only were they increasing the money supply but people were spending money faster so prices were going up for two different reasons.

613
01:08:30.940 --> 01:08:34.940
but all related to the increase in the money supply.

614
01:08:34.940 --> 01:08:39.940
So the government made the argument that we're just increasing the money supply rapidly

615
01:08:39.940 --> 01:08:42.940
so that people have more money to pay the higher prices.

616
01:08:42.940 --> 01:08:49.940
In fact, prices were becoming so high that they actually developed sort of a shortage of money during this hyperinflation.

617
01:08:49.940 --> 01:08:53.940
Because sales were raising the price in anticipation of a much higher price the next day.

618
01:08:53.940 --> 01:08:56.940
So it was a hyperinflationary spiral.

619
01:08:56.940 --> 01:09:01.940
So to meet this, the government began to, at one point in the Weimar Republic,

620
01:09:01.940 --> 01:09:11.940
2,000 printing houses were working 24-hour shifts to keep worthless paper flowing to banks that didn't count it, but waited on butcher scales,

621
01:09:11.940 --> 01:09:17.940
because they were all like one million mark denominations, and I'll show you some of these.

622
01:09:17.940 --> 01:09:44.940
There were other, as I pointed out, many of the people who traditionally, like teachers and professors and civil servants, who were traditionally paid once a month, had to quit their jobs as a rate of inflation sword in order to take jobs as taxi drivers or waiters.

623
01:09:44.940 --> 01:09:51.940
Okay, a couple other points I want to make here that are interesting rather.

624
01:09:51.940 --> 01:10:00.940
Okay, by the middle of 1923, the price of a full dinner on Friday night would not cover the cost of a cup of coffee on Saturday morning.

625
01:10:00.940 --> 01:10:06.940
So that's how rapidly prices were rising, okay.

626
01:10:06.940 --> 01:10:13.940
Yeah, by the height of the inflation in 1923, an egg that had cost 25 fennigs in 1918, which is much less than a mark,

627
01:10:13.940 --> 01:10:21.940
In currency already inflated by four years of war, so there already had been inflation through the four years of war, cost 80 billion marks.

628
01:10:21.940 --> 01:10:24.940
So one egg went from, you know, like a quarter of a mark to 80 billion marks.

629
01:10:24.940 --> 01:10:30.940
A glass of beer priced at 17 phoenix in 1918 cost 150 billion marks.

630
01:10:36.940 --> 01:10:39.940
So, what did the government do?

631
01:10:39.940 --> 01:10:49.540
Well, it was running the printing presses 24 hours a day, as I mentioned, and it ran out of paper to print the money.

632
01:10:49.540 --> 01:10:58.240
So what it did was, now this is a 1,000 mark note, 1,000 marks, but you see the red stamp across here?

633
01:10:58.240 --> 01:11:04.640
When the notes came back to the banks, what the government did was to take a stamp and stamp 1,000,000,000 marks.

634
01:11:04.640 --> 01:11:07.440
That's 1,000,000,000.

635
01:11:07.440 --> 01:11:14.840
So, they were just issuing these, just stamping the old notes, the 1,000 mark notes, and they stamped them with 1 billion, okay?

636
01:11:14.840 --> 01:11:17.140
And so prices continued to rise.

637
01:11:17.140 --> 01:11:28.540
Eventually, the government stopped the inflation call by promising to, by introducing a new mark, okay?

638
01:11:28.540 --> 01:11:32.540
And setting an exchange rate of 1 trillion old marks.

639
01:11:32.540 --> 01:11:37.540
If you brought one trillion old marks in, you could get one new mark.

640
01:11:37.540 --> 01:11:42.540
And they claimed that they would not inflate this, that it would be backed up by the land, and so on.

641
01:11:42.540 --> 01:11:49.540
They didn't really go back to the gold standard immediately, but they did make a credible effort to stop the increase in the money supply,

642
01:11:49.540 --> 01:11:53.540
so that the hyperinflation stopped cold.

643
01:11:53.540 --> 01:12:01.540
Very interestingly, there's a story. Again, this may be apocryphal, I'm not sure, but Austria also suffered a hyperinflation.

644
01:12:01.540 --> 01:12:19.540
In 1920, Ludwig von Mises, the world-renowned economist, was called upon by frantic government officials to give his remedy for the ever-worsening Austrian inflation.

645
01:12:19.540 --> 01:12:24.540
He agreed to meet with them on one condition, that it was to be at midnight on a certain street corner in Vienna.

646
01:12:24.540 --> 01:12:37.540
Let me just insert here the following. Most German economists, or economists in the German-speaking world, did not recognize the link between money and prices.

647
01:12:37.540 --> 01:12:45.540
They claimed that prices were going up because of speculation on the foreign exchange market and the government was just trying to keep up with it by printing more money.

648
01:12:45.540 --> 01:12:57.540
A very famous economist who wrote actually a good book on inflation or rather on money, Carl Helfrich, had become the head of the German Central Bank and made this argument.

649
01:12:57.540 --> 01:13:09.540
Mises was one of the few economists and his students or some of his colleagues who had read his book that understood the link at that point between money and prices.

650
01:13:09.540 --> 01:13:16.540
So, to go on, he agreed to meet them on one condition that it was to be at midnight on a certain street corner in Vienna.

651
01:13:16.540 --> 01:13:20.540
Although government officials were baffled by the request, they nevertheless agreed.

652
01:13:20.540 --> 01:13:25.540
When they met, it was quiet except for the continuous noise of the machinery in the adjacent building.

653
01:13:25.540 --> 01:13:32.540
When officials asked von Mises how to solve their foremost economic problem, he simply pointed to the noisy building and said,

654
01:13:32.540 --> 01:13:36.540
The building and said, first and foremost, you must stop that noise.

655
01:13:36.540 --> 01:13:46.540
Well, what was the noise? The noise, of course, was the building, was the government printing plant, and the sound was the printing of money 24 hours a day, which was literally happening.

656
01:13:46.540 --> 01:13:53.540
So we know economically it's easy to stop inflation. You stop printing money. Politically it's difficult.

657
01:13:53.540 --> 01:13:59.540
Because once you've printed money, as we'll see in the next lecture, you set off a chain of effects,

658
01:13:59.540 --> 01:14:06.640
beginning with an artificial reduction of the interest rate, which causes certain industries to over-expand,

659
01:14:06.640 --> 01:14:15.540
and when the increase in money supply ceases, that expansion is reversed and we have a bust or recession.

660
01:14:15.540 --> 01:14:24.840
So politically, it takes a lot of will to stop an inflation, but economically, it's very, very simple, just as Mises said, stop printing the new dollars.

661
01:14:24.840 --> 01:14:38.840
Now, again, as we'll see in the next lecture, in today's world, the money supply is not increased by literally printing new dollars, but through the banking system, by adding reserves to the banking system, which are then lent out and turned into bank deposits.

662
01:14:38.840 --> 01:14:49.840
One last point I want to make, and that is the German hyperinflation wasn't the greatest in history. It's the most famous, but it was not the greatest.

663
01:14:49.840 --> 01:15:03.840
The greatest one occurred in Hungary after World War II, and after World War II, or rather before World War II in 1939, the Hungarian currency known as the Pengo,

664
01:15:03.840 --> 01:15:22.840
So, the Pengo had a value in terms of dollars of 3.39 equals $1.

665
01:15:22.840 --> 01:15:39.840
Now by 1946, in July of 1946, the same dollar was worth 500 million trillion pengos, that's a 5 and 21 zeroes.

666
01:15:39.840 --> 01:15:50.840
So after the war, rural Hungarians quickly abandoned money in favor of primitive barter, but people in Budapest,

667
01:15:50.840 --> 01:15:54.840
The people in Budapest, the capital, had to cope with the monetary system.

668
01:15:54.840 --> 01:16:00.840
Wages were raised daily, prices rose by the hour, shoppers carried their money in large bags,

669
01:16:00.840 --> 01:16:05.840
high-speed presses raced to turn out more currency.

670
01:16:05.840 --> 01:16:11.840
The upshot was that if you had deposited $100,000 worth of pengos in a bank in 1939,

671
01:16:11.840 --> 01:16:17.840
let's say you couldn't get to it during the war, you couldn't get it out during the war,

672
01:16:17.840 --> 01:16:23.240
They weren't worth the trouble, that $100,000 worth of pengos, to withdraw in 1946

673
01:16:23.240 --> 01:16:28.940
because the haircut now cost $800 trillion pengos in Budapest, okay?

674
01:16:28.940 --> 01:16:35.940
And the average annual income there would buy only about $50 worth of merchandise on the black market, okay?

675
01:16:35.940 --> 01:16:39.940
So, that was the greatest hyperinflation.

676
01:16:39.940 --> 01:16:49.940
There was also one, let me just give you a short summary of the Bolivian hyperinflation in 1985.

677
01:16:49.940 --> 01:16:54.940
In one six-month period, prices soared at an annual rate of $38,000.

678
01:16:54.940 --> 01:17:00.940
I'm sorry, 38,000 percent, excuse me.

679
01:17:00.940 --> 01:17:04.940
And so they take the example of an individual, Mr. Miranda.

680
01:17:04.940 --> 01:17:10.580
If he doesn't quickly change his pay into dollars, it evaporates.

681
01:17:10.580 --> 01:17:16.700
The day he was paid 25 million pesos, a dollar costs 500,000 pesos.

682
01:17:16.700 --> 01:17:20.140
So he received just $50.

683
01:17:20.140 --> 01:17:24.420
A few days later, the rate was 900,000 pesos.

684
01:17:24.420 --> 01:17:27.940
So his pay was now $27 a few days later.

685
01:17:27.940 --> 01:17:30.740
It was cut in half in a few days' time.

686
01:17:30.740 --> 01:17:32.460
So that's what hyperinflation does.

687
01:17:32.460 --> 01:17:34.740
It's the worst enemy of the market economy.

688
01:17:34.740 --> 01:17:39.620
it thrusts the economy back or catapults the economy back into barter

689
01:17:39.620 --> 01:17:43.980
and that means a breakdown of the industrial economy

690
01:17:43.980 --> 01:17:47.480
so I will stop here and take any questions

691
01:17:47.480 --> 01:17:55.540
yes, Ron

692
01:17:55.540 --> 01:18:02.540
yeah, the civil servants quitting their jobs, absolutely

693
01:18:04.740 --> 01:18:29.740
There was a lot of speculation in the sense that people stopped producing and what they were doing was trying to buy and resell factories.

694
01:18:29.740 --> 01:18:45.740
So what they would do, or one guy would, they mentioned this article, would buy houses and then they would wait, they wouldn't pay right away, they would wait for a few weeks and then pay.

695
01:18:45.740 --> 01:18:52.740
So the sharper people realized that, you know, if you bought something on time, you did better, right?

696
01:18:52.740 --> 01:18:59.440
Because the real value of the nominal amount of marks was decreasing.

697
01:18:59.440 --> 01:19:07.740
So a lot of people made out very, very well during the hyperinflation by speculating, okay, on prices continuing to go up.

698
01:19:07.740 --> 01:19:25.740
I was never in a prisoner of war camp, but the war was winding me down, and I had my laundry down with a free cigarette. I offered to march or anything like that, but they refused.

699
01:19:25.740 --> 01:19:33.740
I forget how many cigarettes they told me they had to pay to get a pair of shoes.

700
01:19:33.740 --> 01:19:41.740
No, cigarettes actually circulated after the war outside the prison of war camps too.

701
01:19:41.740 --> 01:19:49.740
I don't know what sort of inflation there was with Marx, but people lose confidence when a country loses the war,

702
01:19:49.740 --> 01:19:56.740
the value of the currency goes down, demand for the currency goes down because they think it's going to be replaced by another currency and they don't want to be caught holding it.

703
01:19:56.740 --> 01:19:58.740
So everybody tries to spend it.

704
01:19:58.740 --> 01:20:05.740
When the war ended and the government inflated the cigarette money supply, every month I'd get a carton.

705
01:20:28.740 --> 01:20:44.740
The night before people expected the US to land, what happened was that everyone rushed out and spent the Japanese-issued currency, and prices just became astronomical.

706
01:20:44.740 --> 01:20:50.740
Because they just wanted to get rid of it. They knew it wouldn't be worth anything once US forces occupied the islands.

707
01:20:50.740 --> 01:20:52.740
Any other questions? You had a question?

708
01:20:52.740 --> 01:21:17.740
In Germany during that period, there were US dollars, there were coins and so on, gold and silver, contrasting that with today, if we had a hyperinflation here in the US, we wouldn't have the same recourses as they did to foreign currencies and so on.

709
01:21:17.740 --> 01:21:24.740
Gary North gave a great example, an actual case example, of the hyperinflation in Germany.

710
01:21:24.740 --> 01:21:32.740
It always impressed me. A German bought a farm, a potato farm, on a mortgage, with a mortgage in.

711
01:21:32.740 --> 01:21:38.740
When his first potato crop came in, to proceed from that potato crop, he was able to buy one potato crop.

712
01:21:38.740 --> 01:21:39.740
To pay off the whole thing.

713
01:21:39.740 --> 01:21:43.740
Had he waited one year, he could have paid it off with one potato.

714
01:21:43.740 --> 01:21:49.540
that's great that's great well that type of thing see see this is a little bit

715
01:21:49.540 --> 01:21:53.820
more technical but but but people don't have the same expectations okay Mises

716
01:21:53.820 --> 01:21:57.820
pointed that out in today's economic models everyone's assumed to have

717
01:21:57.820 --> 01:22:02.220
adaptive expectations that is based on what's happened in the past or rational

718
01:22:02.220 --> 01:22:07.860
expectations based on full information about what is currently going on and

719
01:22:07.860 --> 01:22:13.580
what's likely to happen in the future but but Mises recognized that people in

720
01:22:13.580 --> 01:22:43.580
developed inflationary expectations before the farmers, for example, so people would go out to the farms and buy the eggs and sell them very cheap, but then the farmers caught on, you know, and then even the dullest person would catch on, okay, and then everybody would develop inflationary expectations, but during that period, okay, as expectations were adjusting, you could make a lot of money, or let's put it this way, you could acquire a lot of valuable assets, as you've just pointed out. Yes?

721
01:22:43.580 --> 01:22:55.580
Is there a difference of hyperinflation with a massive bubble in that both are creatures of expectations that are ahead of the reality at that moment?

722
01:22:55.580 --> 01:23:04.580
And the analogy is working really well the way the one, the hyperinflation ended in Germany. That is, the bubble burst.

723
01:23:04.580 --> 01:23:08.580
So do you think that model might work or do you think it's just far-fetched?

724
01:23:08.580 --> 01:23:16.180
Well, no, it's not far-fetched, but I would say it's not exactly analogous because a market bubble,

725
01:23:16.180 --> 01:23:22.780
well, to the extent that there are market bubbles, and there probably are,

726
01:23:22.780 --> 01:23:30.880
yeah, that's self-limiting in some sense, whereas the government, in the case of hyperinflation,

727
01:23:30.880 --> 01:23:37.080
sets off the spot, in other words, there's something else, another factor, and that is to increase the money supply,

728
01:23:37.080 --> 01:23:42.520
which is a real factor and that then causes people eventually to develop expectations

729
01:23:42.520 --> 01:23:46.080
which then intensifies the hyperinflation.

730
01:23:46.080 --> 01:23:52.160
And the government, if this other factor stops and it's credibly stopped, then you can stop that hyperinflation.

731
01:23:52.160 --> 01:23:57.800
But I guess in some sense a market bubble is also self-limiting when people see the underlying realities.

732
01:23:57.800 --> 01:24:03.640
But I guess that's the point with the hyperinflation, there is an underlying reality driving everything

733
01:24:03.640 --> 01:24:09.640
and that's the increase in the money supply, okay? Any other questions? Okay, thank you.