Okay, we'll start the lecture on money, or the theory of money.
We have to ask the first question, how did money originate? Where did it come from?
We talked a little bit about barter exchange, and we did assume money when we talked about supply and demand,
but we have to go back now and ask, from whence it came?
Well, we have to go back to barter to answer that question. Barter is direct exchange, where people exchange a good that someone else wants for another good that they themselves intend to use.
So when someone exchanged a horse for a cow, the cow that they received, they intended to use for whatever purpose.
But there are problems with barter. In fact, there are two really insurmountable problems with barter.
And the first is what we might call lack of coincidence of wants.
In other words, there's someone who has a good.
Let's say someone has berries or eggs.
And that person specializes in producing eggs and wants something else.
Let's say he wants to get a pair of shoes.
Well, there might be a problem.
The person who has shoes in this economy may not want eggs.
So, their wants do not coincide. There is not a coincidence of wants.
We can show
this
with the following illustration.
Okay, let's say you have person A. Person A has eggs.
He's specializing to a certain extent.
And he wants to trade for shoes. He knows person B has shoes, yet
Person B does not want eggs. Person B, let's say, is allergic to eggs, breaks out in hives, hates eggs.
Now what is A to do?
Let's say B may be one of the few people in the area who sell shoes, other people may be at a greater distance.
Direct exchange then fails.
There can be no direct exchange of eggs for shoes in this small economy.
So if A is clever,
May very well look around and say to himself, you know what? In this economy, many people are willing to accept wheat, okay? Wheat is used for various baked products, bread and so on, and almost everyone accepts wheat in exchange.
So he'll go to the person who sells wheat, let's say person C, and he'll make an exchange of the eggs for the wheat.
Even if he values the wheat lower than the eggs, he doesn't intend to use the wheat directly to satisfy his own wants.
He intends to turn around and use it to purchase shoes.
So now you have indirect exchange. The wheat is traded once more, is exchanged once again after he gets it, to be for the shoes.
That is known as indirect exchange. Wheat, which facilitates that exchange, the ultimate exchange between shoes and eggs,
Weed is known as the medium of exchange. It's not quite money yet.
There's a second problem, and that's the problem of a lack of divisibility.
Let's say you have person X who has a horse and has many wants that he wants to satisfy.
But the horse is indivisible. It can't be cut up without losing its value.
And to the extent that there's specialization in this economy, that there's a shoemaker and someone makes a shirt, he has to make exchanges with a number of different people.
So what does he need to do? Once again, he looks for a good that's generally acceptable or generally marketable in the economy.
Let's say, again, it's wheat. And he exchanges the horse for, let's say, 50 bushels of wheat.
And then he takes the wheat, which is much more divisible than the horse, that is, it can be divided up and exchanged without losing its value,
exchanges it for the shoes, for wine, for milk and for so on, for other goods and services.
This, again, is an example of an indirect exchange.
But how does money actually grow up out of this?
Money is defined as the general medium of exchange, the good that everyone in society is willing to accept, without second thought.
So, think about when you go to purchase your lunch today or you go to a movie tonight, you have no hesitation at all with taking out these green pieces of paper and handing them over.
And the people that you're exchanging with have no hesitation in accepting them.
So when we say that money is a general medium of exchange, we mean that it's universally and routinely accepted.
That is, everyone accepts it.
Even though these people do not intend to directly use it themselves.
Well, how do we get from a situation of indirect exchange in a small area to one of a general medium of exchange that by the 17th, 18th centuries or even before that was universal?
Universal. Well, what happens is that people recognize these problems and the more ingenious people that begin to solve their problems by trading their goods for more marketable goods and then making further exchanges, they become emulated.
They're successful in satisfying more of their wants by trading their products for more exchangeable goods so that people, as they emulate them, there's a self-reinforcing process.
The process is as follows, people look around for good that's generally acceptable and they increase their demand for that good, so the demand for the good increases, whatever it might be, it might be wheat, it might be, we'll talk about different, it could be dried fish, it could be tobacco leaves, all of these things were used as media of exchange, media being the poor or the medium. Well, that increases the general acceptability. Now, let's say wheat in this society is being demanded
not only for direct consumption, but also as a general medium exchange.
So more and more people are beginning to accept it.
And as that happens, other people who want to satisfy their wants more productively
will increase their demand for it, which in turn makes it even more generally acceptable than groups further away, okay?
You know, people who are undertaking caravans or sailing to various areas will begin to accept a good that is used generally.
So eventually you get a world embracing division of labor based on this general medium of exchange.
Now let's talk first about the important qualities of a good medium of exchange.
By the way, let me just finish this off. Over the centuries, many different media of exchange were used, and I'll name some of them,
but one or two emerged as the general medium of exchange, and they were, of course, the precious metals, as they were called, gold and silver.
Gold by the 19th century was used throughout Europe, the late 19th century.
Silver tended to be used more in the East, that is in India and China.
But they certainly exchanged against one another and silver was still in circulation until the late 19th century in Europe and the United States.
Okay, what were some of the traits that made something a good medium of exchange?
Well, first of all, it has to be generally acceptable. That is, before people can even focus on a particular good as a medium of exchange, they have to recognize that it's widely demanded for non-monetary purposes.
And certainly gold and silver were generally acceptable. They were used in religious rituals, they were used for ornamentation, they were used for ceremonial purposes, they were used in weaponry and so on.
Also the good must be easily portable. It must be easy to carry around. So it must have a high value to weight ratio. So the value to the weight must be high.
Iron for a while was used. Farm implements were used as a medium of exchange in Africa. But think about it today. A ton of iron might cost $300. So let's say you wanted to purchase a $300 lawnmower from somewhere. You'd have to carry a ton of iron, whereas it may only take a half an ounce of gold.
So, iron has other good qualities, as we'll see. It's very durable, okay? So, the good must also be very durable, okay?
It's not good to use fish or ring dings or something that will go, that will spoil or perish over time.
So, those goods, less durable goods dropped out, okay?
So, while iron, for example, was highly durable, it was not very portable.
Also, the good must be highly divisible, that is, it should be able to divide it into small units without it losing its value.
So let's take precious gems, which were used for a while, emeralds and rubies and diamonds and so on, or were used in various places, in a very limited sense, as a media of exchange.
Well, they certainly were generally acceptable, they were easily portable, had a high value to weight ratio, and highly durable, but they weren't really divisible, because if you divided up a diamond, if you tried to cut it up, it lost its value, so eventually precious gems dropped out of the contest.
The good also must be homogeneous. All units should be identical to every other unit.
So you don't have to incur a lot of transactions cost in trying to figure out how much this unit is worth.
Well, every ounce of gold is like every other ounce of gold.
Whereas it's not true of diamonds, it's not true of precious gems and so on.
Yes, Pat?
I think it's been a chance with it, been ruling that rule out diamonds yet.
So there is some wearing of the coins.
For example, some of the gold that was in circulation before Jesus Christ walked the earth is still here.
And it's exceedingly naturally scarce, which keeps its value to weight ratio high.
Which means that the amount of production compared to the stock of gold that's existing in the world is very small on a year-to-year basis, okay?
So the supply of gold doesn't increase very rapidly, it increases quite slowly over time.
So gold and silver then emerge. Some of the items that were used as media of exchange in human history included cattle in ancient Greece, leather in ancient Rome, animal skins or pelts, whiskey and tobacco leaves in the American colonies, so beaver and deer and so on, those skins or pelts of those animals were used.
In fact, I don't build a story completely, but the term the buck for the dollar comes from the skin of the male deer, since that was used in the colonies.
Also, American Indians used wampum, which were strings of beads. You must have heard the famous story of Manhattan being sold for $26 worth of beads from the American Indians.
Dried fish were used in the Canadian maritime colonies. Maze or corn, what we call corn, was used in Mexico. Salt and iron farming tools were used in parts of Africa. Wives were actually exchanged in Egypt.
So instead of getting a divorce, you could just make your wife a medium of exchange. In effect, women were slaves, and slaves were traded also.
But as I said, over the centuries, gold and silver emerged as the general medium of exchange throughout the civilized world.
Let me say a few other things about money before we get to the value of money.
One is the monetary unit.
The monetary unit initially, when money emerged, was simply a unit of weight of gold or of silver.
For example, for 100 years, from approximately 1834 to 1933, when the U.S. devalued and went off the gold standard,
A U.S. dollar was worth or was defined as one-twentieth of an ounce of gold.
And in Great Britain, from 1821, when they went back on the gold standard after the Napoleonic Wars,
Until 1931, when they went off the gold standard, one British pound was equal to one-fourth of an ounce of gold.
So, the pound and the dollar were just different names for the same money, gold.
There were different weights. There were names for different weights of gold.
So, the entire world, Franks and Marks, also were units of weight of gold.
So, for over 100 years, the so-called exchange rate between pounds and dollars were fixed.
And it was fixed at $4.86 per pound.
The reason why you had to pay almost five dollars to get one pound was simply because there was five times the amount of gold, approximately five times the amount of gold in a pound as it was in a dollar.
A pound was defined as five times the amount of gold as a dollar was defined as.
This is not really an exchange rate.
In fact, five nickels trade for one quarter in our monetary system because a nickel is defined as one-twentieth of a dollar and a quarter is defined as one-fourth of a dollar and one-fourth is five times one-twentieth.
So you have, it's an arithmetical relationship. Quarters and nickels are part of the same, or refer to the same money, just as pounds, marks, francs, dollars.
So the various national monies, under the classical gold standard, were not independent currencies.
In fact, they were all part of the same money. They were all names for different weights of gold.
In this system, the government really doesn't have to perform any role, though it did assign the definition.
In 1834, a law defined the dollar as one-twentieth of an ounce of gold, approximately.
But governments never confined themselves to this particular function. They went beyond it.
The kings generally monopolized the mints and drove out the private mints.
That is, they didn't permit entrepreneurs to provide the minting of coins for people.
That is, when you mint coins, you transform gold and silver into shapes that are more convenient to use in everyday transactions.
And the kings charge a monopoly price for this, which they called seigneurage.
The term seigneurage comes from the French term seigneur, which is the master.
And supposedly, seigneurage was initially, you know, in feudal society,
The Lord of the Manor, the Signurage was a practice whereby the vassals, when they got married, they had to permit the Lord of the Manor to spend the first night with the bride.
That never generally happened. What happened was that they paid a fee to get out of that.
So that's where the term seniorage comes from and that's a monopoly price that's charged for minting of coins in government mints.
And in today's world, as we'll see, it refers to the hidden tax of inflation. Seniorage is the amount of real resources that the government is able to drain from the economy by printing money.
So under a paper money standard, seniorage has a different meaning. Kings generally engaged in debasement. They were able to get away with this because they would put a particular name on the coinage, whether it was a pound, originally a pound of silver, or a franc.
Originally they were names for weights of precious metals, as I've mentioned, but once people became used to the name, the kings were able to engage in a practice known as the basement,
in which they either adulterated the coinage, which meant that when they called the coinage back to a recoin it because it was becoming worn down and some of the coins were lighter
What they would do is they would mix the coins with the base metal. So they would give you back, let's say, a one ounce coin, but it wouldn't be all gold. It would only have nine-tenths gold in it and one-tenth ounce of copper.
And what would they do with the extra gold? They would just put it aside and then use it to make their own coins, and that constituted inflation.
inflation. They would then spend these coins on various goods and services that allowed them to run a deficit in a sense, to spend more than they were taking in taxes, and that would cause inflation.
But even though the coin was now only nine-tenths of the previous weight, or contained nine-tenths of the previous weight of the precious metal, it was still called by the same name.
And so they kept doing this over time. The coins kept getting smaller and smaller.
They also used the practice of sweating the coins where they could shake the bag of gold coins and some of the pieces of it would fall off and then they'd use that to make more coins and then spend them.
And there was also clipping where they just clipped around the side of the coin and made it smaller and used the shavings of the coin to produce more coins and to spend them.
Okay, now let's ask the question, what determines the value of money? Money is a good like any other good, but it happens to be the general medium of exchange.
It's the good that's traded on every market and, in fact, money itself, as we'll see, is still in the state of border with all other goods and services.
There was one other point I wanted to make, and that was that money also solves another problem that you find under barter that prevents the development of a division of labor and specialization.
And that is that calculation, the calculation problem is solved. Firms can calculate profits and losses.
Under barter, it's very difficult to calculate profits and losses. It's very difficult to pay your workers.
If someone wants to produce an automobile, how do you pay the workers? In pieces of the automobile or in automobiles?
How do you determine your cost of production in producing an automobile? You're using many different inputs.
There's no money that you're exchanging for these inputs. You might be exchanging many different types of goods to get these inputs.
So you can't find a common denominator which will allow you to compare your total cost, your total revenue, so you will not know if you're earning profit or loss.
Also, in a very simple economy where there's, let's say, 10,000 goods, 10,000 different goods in an economy.
Now, there's 70,000 goods in a typical supermarket.
Where there's 10,000 goods, so it's much more than a supermarket, there's millions of prices, okay?
I think there's 70 million prices or 10 million prices.
I have the figures right here. Let me just look them up for you.
I don't have them here. Okay, but there's over a million prices to be taken account of, even in a simple economy of 10,000 goods when you have water.
So, it's very, very difficult to comparison shop on the border.
It's very, very difficult to compare the prices of different goods and services and to know whether you're getting the best deal for your money, whether you're maximizing your utility.
However, when you have prices coming in, then if there's an economy with 10,000 goods, there's 10,000 prices.
Okay, actually 10,001 prices, okay, and that is because money also has a price, which we'll get to now.
Okay, what determines the price or the value or what we sometimes call the purchasing power of money?
It's determined by supply and demand, okay, the same forces that determine the price on the market of all other goods and services.
Now the price of any good can be called its purchasing power. For example, if a pizza sells for $10, then the purchasing power of a pizza is $10. Each pizza can purchase $10 on the market.
So it's not only the price but it's also the purchasing power.
Really the price is the exchange power or the power in exchange of the good, what the good can bring you in exchange.
Now the price of money is, as we'll see in a moment, the inverse of the price of the good.
So if a pizza sells for $10, then the dollar in that economy will have a price of one-tenth of a pizza.
One dollar has a purchasing power of one-tenth of a pizza.
So if we take a very simple economy, and this economy will have four goods in it, the purchasing power of money, the PPM, is equal to the inverse or the reciprocal of the ratio of the prices of goods in the economy.
So you'll see here in this economy in which there are eggs, butter, shoes and TV sets, that eggs has a price of 50 cents, butter has a price of a dollar per pound, shoes 20 dollars, TV sets 200 dollars.
But yet we're missing the price of money there. Now the price of money is not going to be a unitary figure. It's not going to be a single quantity of another good.
In the case of all the other prices, they're simply a single quantity of dollars, that's what they are, they can be stated in one quantity.
But in the case of money, things are a little bit different.
You'll note here that the price of money is either two dozen eggs, because that's the reciprocal of 50 cents per dozen eggs.
If you turn that ratio over, you'll find that's two dozen eggs.
Or it can buy one pound of butter, because it's a dollar a pound, or one 20th of a pair of shoes, or one PB set.
So the price of money is an array of the quantities of other goods.
An array is a list of the quantities of other goods that money can exchange for.
Now, let's say the price level doubles, how does the price or the purchasing power of money move in relation to the price of goods and services?
If it doubles, what you'll find is that all prices then rise, so now eggs are doubled in price, their price is a dollar a dozen, shoes are $40 a pair and so on, everything is doubled in price.
What has happened then to the purchasing power of money?
Well, since it's reciprocal, it's fallen. Now money can buy less.
As prices go up, it turns out that money can now buy not two dozen eggs, but only one dozen eggs.
Not one full pound of butter, but only a half a pound of butter.
So, inflation or price inflation brings about what people call a shrinking of the dollar.
And that's based on this analysis.
That in fact, the higher prices are, the less the unit of money can purchase on the market.
So we get then a diagram which illustrates how the price level or the purchasing power of money, which is the other side of the coin, is simultaneously determined by supply.
The supply of money is fixed at any given moment in time. In a modern economy, it's fixed by the Fed.
Under the gold standard, it's fixed by the quantity of monetary gold in existence.
It can change over time under a gold standard as more gold comes onto the market, or as people melt down their jewelry and other non-monetary forms of gold, they can do that and have them transform into coins and bars that are used for money exchange.
So we have to ask ourselves a question about the supply and demand. Let's first look at demand.
Why is the demand for money downward sloping?
Now what that means is this. Let me zoom in a little bit. Zoom out rather.
On the left axis, we have the purchasing power of money. That is, as prices fall, money is able to purchase more and more.
So at lower prices, money can purchase more. So when the price of a dozen eggs, we'll use eggs here, is $2, obviously the dollar is worth only a half a dozen eggs on the market.
As prices fall, let's say eggs become 50 cents, then the purchasing power of money rises.
So on the left axis we have the purchasing power of money going from low to high.
On the right axis we have the dollar price of goods and services going from high to low.
The lower down we are on the right axis, the higher the price is.
Now that shows us that money, the purchasing power of money moves inversely with prices.
So let's, now we're not interested yet in the determination of prices.
What I want to explain to you right now is why does the demand for money slope downward?
Which means why do people want to hold more money, if this is billions of dollars,
why do they want to hold two billion dollars when money purchases very little, a half a dozen eggs,
and a dozen eggs, compared to only 50 billion dollars when a dollar can purchase much more.
Well, the question is then why do people hold money in general?
People hold money because they have anticipated exchanges in the future that they want to make.
They're not certain about when these exchanges are going to be exactly or how large these exchanges are going to be,
But they have some idea about these transactions they're going to make before their next paycheck, let's say.
Also, people know that there's certain unforeseen events that could occur.
Things that would not be required or that they would not generally purchase.
For example, if there's a medical emergency, if their car breaks down, or if they find a great sale,
or if suddenly they find that there's a good deal on a cruise that they always wanted to go on.
So they want some money on hand, take advantage of those things, or to prevent, or to meet an emergency.
So for these reasons people want to hold money.
Well why is it the case that when prices are higher people want to hold more money?
Well obviously if prices, if we wake up tomorrow and prices have doubled, including our wages and salaries,
because labor is also a good which has a price on the market, so if all prices doubled you would want to hold twice as much money.
Because lunch would be twice as much, McDonald's hamburger would sell for twice as much, gasoline would sell for double the price as it is now, if you can believe that, all rents would be twice as high and so on.
Well, certain things would be fixed for a while, but after a while, everything would pretty much double in price.
So, the higher the prices of goods are, the more money you want to hold. That's why the demand curve is downward sloping.
On the other hand, if we woke up tomorrow and prices were only 25% of what they were today, we'd have a lot of extra money on hand.
We wouldn't have to hold all that money for our everyday transactions or to meet emergencies.
Doctor's visits would only be 25% as high. McDonald's hamburger would be 50 cents or whatever or less.
A ticket to a movie might be $1.50 or $2.00, one quarter of what it is today. So you'd need much less money.
So, the rule then is, the quantity demanded of money is greater, the lower the purchasing power of money is.
The less each unit purchases, the more people have to hold, and the more they will desire to hold.
That's why the demand for money is downward sloping.
Now, we're using eggs as a representative good, but of course, all goods are rising in price as we move down this axis,
which means that money is purchasing less and less as we move downward.
So as money purchases less, people want to hold more.
So when eggs are 50 cents a dozen, people have to hold or want to hold 50 billion dollars.
But when the price of eggs and all other goods quadruples, people want to hold approximately four times as much money.
It's never an exact relationship, but we know it's a qualitative law, it's a law of demand.
The lower the price of anything or the lower the market value or purchasing power of money, the more of it that people want to hold.
Now keeping in mind again that when the value of money falls, it also means that labor purchases more money, that everybody's wages, if money, if price is quadruple, your salaries and your wages are all quadruple.
Okay, now let's talk about supply and demand and how that does determine the value of money.
That is why the price level is at a certain level and no higher or no lower.
So let's take this example here.
Let's say initially that prices are lower, which means the money purchase is more.
So people are here. Let's say we have a price level up here.
So prices are low. People want to hold $50 billion.
But let's say that the Fed has created $100 billion.
So there's surplus money, there's excess money.
People have $50 billion more than they need to hold. What's the first inclination when you have more money than you realize you need to hold?
And let me give you an extreme example. Let's say tomorrow you were to win a $10 million lottery.
Would you hold all of that cash in your checking accounts or in currency in your wallets and purses?
People would rush out and begin to do what? Spend it. It's called the monetary adjustment process.
As people spent this surplus money, however, something would happen.
The demands for all goods and services would rise, and prices would begin to rise.
As prices rose, each dollar would buy less and less.
So as this process continued throughout society, as the surplus money was spent and re-spent throughout the economy,
Prices will be driven up to the point where the quantity of money in existence, the full $100 million, in this case a billion dollars, excuse me,
the full $100 billion would just be sufficient to meet people's desires to hold money.
In other words, prices, if there was excess money, prices would rise to the point where it absorbs all the excess money,
Meaning that people were willing to hold that money and use it for their usual anticipated purchases and hold it for any, you know, unanticipated or unforeseen emergencies.
Now, what about a money shortage? Let's say prices were very high, which means the purchasing power was low, and there was $100 billion in the economy, and yet people needed $150 billion because prices were so high.
How would they react to this and how would their reactions result in an adjustment process that would allow the money supply that exists to meet their demands?
Well, once again, if you suddenly find that there's a good deal on a cruise and that you and a number of your friends would want to go on this cruise in a month or two and you have to come up with $2,000,
how would you go about accumulating that amount that you needed? You cut back on your spending, okay? You cut back on your spending.
So, in cutting back on your spending, what you're doing is you're reducing, if everyone in society reacts this way because it's a shortage of money,
everyone cuts back on their spending, that reduces the demand curves for various goods and services, prices fall.
As prices fall, people need to hold less money.
And as the adjustment process proceeds through society, you find that the quantity demand of money is less and less,
until prices fall to the point at which, once again, people, in total, want to hold $100 billion.
So, there's an automatic adjustment mechanism that is always operating in the economy
to adjust the supply of money to the demand for money.
and it does it through adjusting the purchasing power of money.
So the purchasing power of money is adjusted like any other price
to get rid of surpluses and shortages of money.
So you don't need the Fed to increase the supply of money to 150 billion dollars.
The market increases it.
So if prices, for example, are very,
The prices of pizza fall, or any other good in the economy falls, falls by 50 percent.
Well, each dollar in the economy falls by 50 percent.
So, if you divide it by 15 into 150 billion, people would be purchasing, let's say, 150 million pizzas.
So, the money supply, they would like to have that much in the money supply.
But now, the prices of pizza fall, or any other good in the economy falls, falls by 50 percent.
or any other good in the economy falls, falls by 50 percent.
Well, each dollar purchases 50 percent more.
So, let's take an example.
Let's say you wake up tomorrow and all prices have been cut in half.
Well, the reason why you don't need as much money tomorrow as you did today is because each dollar purchases twice as much.
The real money supply has increased.
So whenever prices fall and each dollar becomes greater in its purchasing power, we say that the real money supply has increased.
And I'll talk about that again when we talk about economic growth and how you can finance economic growth
or how any given money supply is sufficient to finance an increased amount of goods and services.
Now we're going to ask the question, how and why do prices of money change?
And actually before I do that, let me just show you in symbolic form the adjustment process here.
Okay, let me zoom in on that. Okay, notice if money is in excess, if there's too much money out there, more than people want to hold, so that the supply of money, M, is greater than the demand for money, that leads to an increase in the demand for goods.
And once the demand for goods increases, prices in general begin to increase, which means that the dollar begins to lose purchasing power as prices increase.
As it loses purchasing power, people want to hold a greater quantity of dollars.
And that's going to continue until the purchasing power of money is adjusted to the point where the amount of money in the economy is equal to the demand for money.
Demand for Money, okay? And to look at the reverse case, where people don't have enough money, when the money supply is less than the demand for money, people will postpone or withhold spending, withhold their cash balances, they won't spend as much, that will drive down demand for goods, prices will fall, the purchasing power of each dollar will rise, okay? And once that happens, there'll be a decrease in the amount of money that people desire to hold, and you'll get equilibrium again, okay?
Obviously, long-term, it's a bad strategy that this is closer to the logic behind when central banks lower interest rates thanks for it and on the growth. Do you think it will increase the density?
Now the Fed is going to print more money. That's what happens before interest rates are lower.
The Fed injects money into credit markets, expands supplies of funds that banks have to loan out by expanding their reserves, we'll talk about that tomorrow, and that drives down interest rates.
You don't need that additional money to allow economic growth.
The drop in interest rates, as we'll see, will in fact distort economic growth and cause it to become unsustainable, or at least a part of it.
Okay, now let's look at the increase in the money supply.
That's one reason why you'll have a change in the purchasing power of money.
So let's say the Fed creates 50 billion new dollars.
And we show that, we illustrate that by having the supply curve of money shift to the right, so M shifts to the right.
People have not changed their demand for money.
The price of eggs is a dollar and the purchasing power of the dollar then is one dozen eggs.
and likewise for all the goods. But suddenly people have excess money, prices haven't changed, they don't need that extra money, so what do they do? They rush out and spend that new money.
As it comes into the, it's injected into the economy, they then run out and they spend it, and as they spend it, the monetary adjustment process kicks in and the price level rises from a dollar to a dollar fifty in this case for eggs, or a dozen eggs, and then the purchasing power of money is cut.
It's cut by one-third. Now you can only buy two-thirds of a dozen eggs with a dollar because each dozen costs $1.50.
So all the Fed has succeeded in doing in this case is raising the price level by 50 percent.
Okay, now let's look at what happens. Now, by the way, the real money supply has not changed, okay, because the real money supply is defined as the M, the amount of money in the economy, divided by the price level.
We'll use the price of eggs in this example. So, notice that before the Fed injected money, there was $100 billion in the economy and eggs were $1 apiece.
So, in effect, the entire money supply, in real terms, was equal to 100 billion dozens of eggs.
Now, what happens? We have a higher price of eggs, but there's more money in the economy.
There's 150 billion dollars in the economy, price of eggs is $1.50.
What's the entire money supply worth in terms of the amount of eggs it can buy?
Still, 100 billion. So the Fed is incapable of changing the real money supply.
All it's done is raise prices and cause people to have to hold more money and to spend more money on a given good.
But it hasn't changed the real money supply, and that's what people are interested in, the real money supply.
That is, they're interested in holding a certain amount of purchasing power in their cash balances.
So the Fed is not able to directly change the real money supply.
Now, what about change in demand for money?
Well, if people need more money or less money, as the case may be, and actually before I show you that, let me just show you the opposite.
I won't talk too much about it.
That is when the money supply decreases, we get the opposite happening.
When this is happening, you have a decrease in the money supply, a rise in purchasing power of money, which implies the prices are falling.
Now, getting to demand.
Let's say that there's an increase in the demand for money.
Let's say there's economic growth, and that there's a 10% increase in supply of goods and services in the economy.
So let's assume that this difference between the demand curve at A, which is the purchasing power of money, that's where the initial equilibrium point is, at A.
So at the initial price level, people suddenly demand more money because there has been economic growth.
That is, supplies of goods and services in the economy has grown.
Well, the demand for money goes up.
Let's assume the Fed does not increase the supply of money.
How are those additional goods and services that have been produced,
how are they sold if there's no more money in the economy?
Well, how are all the additional computers sold when they were produced?
produced as we had the the the massive increases in supply over time due to
technological improvement from the 1980s until you know through the present how
were the additional computers sold their prices dropped all economic growth means
is that the supplies of some goods and services in the economy are shifting to
the right in order to sell them prices must fall to get rid of the surplus as
As prices of these goods fall due to economic growth, what happens to the purchasing power of money?
It increases.
So people do have sufficient dollars because prices are going to fall sufficiently, okay,
so that supply and demand in each particular market is equilibrated.
They're going to fall so that the real quantity of money has now gone up, okay.
The purchasing power of each dollar is more and there's the same amount of dollars in the economy,
which must mean then that each dollar buys more and therefore the total money stock buys more.
So, the market itself is able to adjust the purchasing power to, let's say, an increase in the demand for money.
And when that occurs, you get an increase in the real demand for money, or I'm sorry, an increase in the real stock of money.
Each dollar is worth more, you have the same number of dollars in the economy, they can buy more.
So if you just think about computers, each dollar or the money supplied in terms of computers has increased in real terms in our economy.
And on the other hand, if for some reason people are less uncertain about the future and therefore they demand less money,
And I won't even really show you this. They are able to decrease their demand for money and what you'll find is prices rising as people decrease their demand for money.
Okay, well let's now go to the question of what the demand for money should be. What should the demand for money be in the economy?
This is a question that's debated by economists today.
Did I say demand for money? I meant the optimal supply.
What is the optimal supply of money? That is, what should the supply of money be?
Is there an optimal supply? Well, first of all, this is a strange question for economists to ask and to debate about.
Because no one asks the question, what's the optimal supply of pizzas or oranges or automobiles or Big Macs?
We allow entrepreneurship on the market and supply and demand to determine what the stock or what the quantity of the good produced is.
In other words, the government doesn't try to second-guess the market on this.
No one talks about what the optimal amounts of Big Macs are.
The optimal amount is determined by profitability, and the profitability drives entrepreneurs to provide the amount that best serves consumer wants, given their demands for other goods and services in the economy.
So production is pushed by profits to being adjusted to consumer value scales and to technology and cost and so on.
Why is that the case with money?
Well, in the case of money,
you have to keep in mind that money is really different in a very important sense
from both consumer goods and producer goods.
Consumer goods are used up in fulfilling their function.
That is, they directly serve human wants and they're used up.
They're used up either immediately, for example, a Big Mac is eaten immediately,
Or they used up over time, automobiles and even houses deteriorate.
What about producer goods?
In performing their function of being transformed into consumer goods, they're also used up more or less slowly.
But now money, in performing its function, which is simply a medium of exchange,
which is simply being exchanged and re-exchanged again and again, money need not be used up.
That's not necessary in the performance of its function.
So keeping that in mind, that money is a medium of exchange and that a medium of exchange is different in its function from consumer and producer's goods,
we can make the statement that any supply of money that exists will yield the full benefits of a medium of exchange.
If the supply of money is smaller, then prices will be lower for goods, but all the goods that people want to exchange in the economy will be exchanged.
If the supply of money is larger in a certain economy, then let's compare, in fact, two economies.
One in which the supply of money is larger, the other in which it's smaller, but the economy is the same in all other dimensions.
The same labor, the same technology, same quantities of goods produced, same value scales.
Is the economy with the largest supply of money better off than the economy with the smaller supply of money?
In fact, no. The only difference is a difference in the purchasing power of money.
Where there's more money, there'll be higher prices.
And let me give an example that Murray Rothbard likes to give, or used to give.
He called the Angel Gabriel model. Milton Friedman used a similar example. He called it the helicopter model.
But let's say there's an angel who has very, very good intentions, benevolent, wants to benefit mankind or humankind, and yet is economically ignorant.
So one night he doubles everybody's cash balances. We wake up tomorrow morning, there's twice the amount of money in our checking accounts,
and banking accounts, twice the amount of money in our purses and wallets and so on.
What do we do as we find this? We rush out and spend it.
Supply curve shifts to the right and prices rise.
They rise rapidly. So the angel has not benefited human beings.
Now, what if the angel had doubled the stock of consumer goods?
You got up in the morning, you have twice as many cars in your driveway.
If you had one, you now have two, okay?
You have twice the square footage in your houses, all other goods on the markets, on the shelves
and supermarkets and so on, all of those goods have been doubled.
Are human beings better off?
Is there a social benefit to doubling the amount of consumer goods?
Yeah, there sure is.
More human wants are satisfied, okay?
What about the angel doubling the amount of factories, capital goods, producers' goods in general, natural resources, all that?
Yes, once again. Eventually that will result in an increase in consumer goods and more human wants satisfied.
But in the case of doubling supply of money, there are no benefits.
An increase in supply of money yields no social benefit.
Now, it will redistribute wealth, okay?
What about people who get up early and find out about this doubled supply of money first?
They'll rush out and spend the money before prices rise. Other people who sleep late or who work the night shift and get up later on, they're going to find that they're hurt because they're now paying higher prices for those goods.
Whereas the people that had gotten up first, they spent the money before prices rose, they got more of the real goods that exist in society, the consumer goods, and these other people get less than they had gotten before, so they're hurt.
So, the only thing that happens when there's an increase in supply of money, since it really isn't, you know, the angel Gabriel, Fed is not the angel Gabriel in the sense that it doubles everybody's cash balances.
The only thing that happens is a redistribution of wealth, which we can show through the counterfeiting process, which I want to just outline.
Let's assume there's a group of counterfeiters that work in Auburn and they're able to produce counterfeit dollar bills that are completely undetectable as counterfeits.
They've outsmarted the U.S. Treasury and they figured out a way to exactly duplicate current dollars.
Well, what happens? Certainly they're better off. They're the first ones to get this new money.
And now they begin spending it in Auburn. They begin spending it at retail shops.
They begin buying houses in Auburn, purchasing new automobiles.
Well, the next group of people who get that new money, they find that their incomes have gone up
before prices of the things they buy have gone up.
So now they begin spending money. They go on more vacations. The people that have received this new income,
They go on more and better vacations, they order more things from catalogs, so on and so forth.
They buy more wine, more beer and so on, so the prices of wine and beer begins to go up.
And other people, the people in the, let's say, in the breweries in Milwaukee have higher wages
and stockholders have higher dividends, and the same thing in vineyards.
So now prices begin to go step-up, step-by-step throughout the area and throughout the country.
Okay, now, let's say, me living in New York, I don't have any of the new money yet,
and yet I'm paying higher prices for, let's say, wine and beer and, let's say, steak,
because people are buying more steak here and so on. So there's a ripple effect.
The new money is rippling out. The people who receive the new money early in the process,
in this inflation process are the ones that spend the money when prices are still low or at their old levels, they benefit.
The people get that money last, eventually the money is spread out throughout the US and people now begin to take more, let's say vacations in New York,
they begin to use more financial services in New York, so incomes in New York begin to go up, people in those industries begin to have higher incomes.
So, some of them increase their demand for a PACE university MBA degree, when I teach an MBA program.
So, 18 months later, if this money has been created, my salary goes up.
But in the 18 months, I've been paying higher prices.
So, my real income has decreased during that period of time, and it's only caught up after 18 months.
So, my real wealth and income is redistributed to those people who have gotten the new money first.
They have new and better houses, cars and so on, and my income has fallen, so I've maintained my car less well than I would have.
I've been eating steak, I've been eating hamburger and so on.
So that, putting the ethics aside, the counterfeiting process is no different than the money creation process that's undertaken by any government central bank.
If you're lucky enough to be the people that receive that new money first, if you're at the injection point, for example, if the government runs a deficit in order to purchase more, let's say, guidance systems, computer guidance systems for its missiles in Iraq, the demand for the computers go up, so people in Silicon Valley benefit.
And let's say they also purchase or spend some of this deficit on subsidizing farmers because Republicans have an election coming up and they want to get re-elected.
So you want to appeal, let's say, to the electorate in the Republican area, so you subsidize farmers.
Now the farmers are better off. So these two groups of people begin spending that money.
They're spending that money, they buy more automobiles, they go to Disney World more, they buy more steak and wine and so on.
People who do not get that money initially, in other areas of the country, find that they're paying higher prices for these things.
So their real income is effectively shrinking.
And they may catch up later on, and they will catch up later on, as the money percolates throughout the economy.
In fact, there's one group that never catches up.
Those are people on fixed income, people living on insurance policies or on pensions and so on.
And they never receive any of this new money, so their real incomes shrink.
Okay, I want to jump to the...
I want to mention before I actually jump to demand for money, that government eventually broke the link
between gold and paper money. Actually, in every war, governments pretty much went off the gold standard. Wars are enormously expensive. In order to finance the wars, they would do so by printing money to finance a deficit, because once people see how costly wars are by having the cost reflected in higher taxes, wars become very, very unpopular.
So a great proportion of any war is financed by deficit spending that is financed in turn by the creation of new money.
So for example, almost all belligerents within two weeks of the outbreak of World War I in 1914 went off the gold standard.
The U.S. and the Union and the Confederacy went off the gold standard during the Civil War.
During the American Revolution, paper money was printed by the Continental Congress.
The British went off the gold standard from 1797 until 1821 during the Napoleonic Wars
and of course during World War II, we all were off the gold standard, all belligerents.
But in fact, we went off the gold standard before that.
In 1931, Britain went off. In 1933, the US went off. In 1936, a group of other countries, including France, went off.
And we returned to a phony gold standard in 1946 at Bretton Woods.
By 1971, the last link to gold, which was the dollar that the U.S. government had promised solemnly at Bretton Woods that they would redeem any dollar presented by a foreign official institution, a government or a central bank, at the rate of $35 per ounce.
So other governments were willing to hold U.S. dollars to back their own currency because they felt that U.S. dollars were as good as gold.
And after World War II, we had most of the gold in the world.
And while there may have been something like 12 billion dollars worth of our dollars outstanding, we had 25 billion dollars of gold.
So much more gold than was necessary to redeem all the foreign dollars.
You and I, our parents and grandparents, as citizens of the United States, were not permitted to redeem their dollars in gold.
In fact, it was illegal to own gold from 1933 until 1976. It was illegal for an American citizen that was not licensed, such as a dentist or a jeweler who could get a license, to own any gold. Even to own gold in a foreign country, believe it or not.
Okay? So there was more than enough gold to go around.
Now, the incentive that that created for the U.S. government during the 1960s when the Vietnam War heated up,
and also at the same time when President Johnson declared his war on poverty and enormously expanded the welfare state,
the incentive was, look, everyone throughout the world will accept our dollars as good as gold.
Okay, so let's run deficits. So deficits were run so that we could have both guns and butter, as they said, so that we could expand the war in Vietnam and at the same time expand the war on poverty, okay, and not raise taxes.
had taxes been raised to pay for the war in Vietnam and the war in poverty,
you can bet your bottom dollar, your bottom paper dollar,
that the Vietnam War would have ended much more quickly.
So the US ran these enormous deficits beginning in the mid-60s
and what happened, prices in the US shot up,
so we exported less to foreign countries because our products were more expensive,
imported more, and to make a long story short,
In short, dollars began to flow out of the country. We got real goods and services from Europe.
In effect, they financed the war in real terms, or part of the war, and what did they get in return? Our dollars.
By the late 60s, by 1968, there was something like $80 billion held by foreign official institutions.
And our gold stock had shrunk from $25 billion to $12 billion.
The Germans and French wanted to redeem their dollars. They now didn't trust the dollar to be as good as gold.
They didn't believe that the US could redeem the dollars.
And the US government responded by, in a sense, blackmailing these countries.
They said, well, okay, if you force us to redeem these dollars, we might have to remove our nuclear umbrella that's protecting you against the Russians.
So the Germans backed down. The French didn't.
The French didn't, the French left NATO, the French built up their own nuclear force, okay?
And so gold was still falling out because there were many, many, in London and Zurich there were private gold markets
and people were able to buy gold with those dollars in those markets and the price of gold began to rise
and when the price of gold rose the government, the US government which had the gold would then sell the gold
The goal is to keep the price down at the level of $35 an ounce.
By 1968, it couldn't do that any longer, and it said,
well, we don't care what happens to the private price of gold or the price of gold in the private market.
We're just going to trade between governments at the rate of $35 per ounce.
So basically, those dollars now are losing value in gold that the foreigners are holding.
And so we had a gold run in 1971.
The U.S. stock shrunk further from $12 billion to $9 billion.
Within two weeks, at the rate that we were losing gold, our whole gold stock would have been gone.
And so President Nixon in August closed the gold window. That was the last link to gold.
All money is now fiat money. Every country's monetary unit is a pure name.
That's what a fiat currency is. It's a pure name.
The US government can take the dollar, the named dollar, and it can put on anything it wants.
Anything it wants. It can take his bottle of Powerade and stamp it $1 or $20, and that would pass. It wouldn't be very convenient, but that would pass as money.
So you can put, the dollar is a pure name. You can put it on anything. It doesn't have to be green ink on a piece of paper.
A dollar is simply a name that is now monopolized by the government. It can be stamped on anything.
Now, what's one of the likely outcomes of a fiat system, or one of the outcomes?
Well, one is hyperinflation, and I want to just talk a little bit about hyperinflation and give you the classic example of Germany.
Let's just let me outline what had happened in Germany from 1913 to 1923 when the hyperinflation ended.
The hyperinflation is a very, very rapid increase in prices and a precipitous drop in the value of the monetary unit.
In this case, it was the mark.
So from 1913 to 1923, the prices increased by about one trillion times.
So think about that. In ten years, if a haircut cost $10 in 1913, or right now, let's say we had the same sort of thing happening,
a haircut cost $10 now, it would cost $10 trillion ten years from now.
So it was an extremely rapid increase in prices.
and it was brought about by a continual increase in the supply of money
which then caused people to lose confidence in the money and therefore decrease their demand for money.
So one important determinant of the demand for money, why it would move, why it would fall,
is that people do not trust money to maintain its value in the future.
So let's look at how the various stages of inflation, an inflation, okay? The first stage, when the government first starts printing money, let's say it shifts the money supply out tremendously to pay for a war, as the German government did, and then later on, after the war, they were increasing the money supply even more to pay for reparations that were imposed on Germany by the Treaty of Vienna.
Germany by the Treaty of Versailles. So let's say they increase the money supply. It's an emergency situation. People say to themselves, you know what? This fall in the value of money, which occurs along this demand curve here, this lower demand curve, so the value of money falls from A down to C, and prices rise accordingly. People say to themselves, this is an emergency situation. Prices are abnormally high. After the war ends or after the emergency is over, prices are going to return to their old level.
So people do not spend the new money or all of the new money. They hold some of it.
Because if you believe, for example, that six months from now that automobile that you want to buy is going to be 20% lower,
let's say because Bush is going to take all tariffs off of goods into the U.S.
He's going to introduce unilateral free trade.
So many, many prices, many, many goods would drop. What would we all do?
Many of us, or most of us, would hold back on purchasing durable goods that we know will have a lower price in six months.
So the demand for money actually increases at the beginning of an inflation.
So the demand for money goes up and it moderates the fall in the value of money.
Prices don't rise as quickly.
Now the government thinks that this is a great thing.
You know what? We increase the money supply tremendously, we've got a lot of real resources, and yet prices have risen very little, okay?
The value of money has only fallen from A to B.
That's because people are holding a lot of this new money, speculating on prices going back to their old level.
Now, of course, the government then begins to increase the money supply at a rapid rate, and people begin to catch on, okay?
and we get into phase two of the inflation.
So the U.S. had phase one of our inflation in the early sixties.
The new economists that took over under Kennedy
were pushing for an increase in the supply of money, we were getting increases in the supply of money,
yet prices weren't rising very rapidly leading up to the Vietnam War in the mid-sixties or even for a while after it began to heat up.
but then as we continue to increase the money supply and we jump back between the US and Germany
two things happened, the money supply shifted out even more, this is the
increased money supply, now we're shifting out even more to M double prime
okay so that the value of money fell now from B to D
but at the same time people began to lose confidence, by the late sixties people were saying to themselves, you know what
this inflation isn't going to stop
The price of houses are only going to be higher next year, the price of automobiles are only going to be higher.
I'm going to increase my demand and buy those things now.
So the demand for money fell.
So what happened was that you got an even greater increase in prices and decrease in the value of money.
That's phase two.
By the end of the 70s, now during the 70s, we had a huge real estate boom, or not a boom, but people were buying houses and pushing prices up.
Young couples that would have preferred to save for two, three, four years for a house for a down payment were borrowing from their families and so on, buying homes, people were buying automobiles rather than waiting another year.
So you began to get a run-up in prices that was fueled not only by the increased money supply, but by the loss in confidence in what we call the inflationary expectations.
So people begin to develop inflationary expectations in phase two.
That is, they believe prices will be higher tomorrow than they were today.
Their mentality then is, buy what I was going to buy tomorrow, buy that today because its prices will only be higher.
So not only is there more money in the economy, they're spending it more rapidly.
They're holding less money and that drives prices up even further.
By the end of the 1980s, we got to the point where, I'm sorry, by the end of the 1970s,
prices in the U.S. were rising at unprecedented levels outside of the Civil War and the Revolutionary War.
They were rising at around 16% on an annual basis, very, very rapidly, at the end of the Carter administration.
At that point, the Fed stepped on the brakes and Paul Falker was hired,
was brought in, appointed as Fed Chair, and he began to reduce the rate of growth in the money supply.
However, in Germany, actually the reverse happened.
The government saw the prices rising extremely rapidly, and they were trying to keep up with the rising prices.
So they continued to increase the money supply, and what happened was that prices began to, the demand for money began to fall even more,
And we began to get a race with the printing presses, okay?
So you've got the money supply shifting over to the right and demand shifting to the left or falling.
Now let me give you some of the statistics on this.
Let's see the extent to which this inflation proceeded.
Let's just take a newspaper, a daily newspaper in Germany. In January of 1931, and this is in terms of Deutschmarks, a newspaper cost about one-third of a mark.
And a newspaper is a good proxy for the price level because it's something that many people buy on a daily basis.
So by less than a year later, or a little more than a year later, the prices had tripled, the prices had gone up three times.
From May to October, the price level went up eight times, the price was eight times as high in five months.
So if an automobile today cost $20,000, in five months that same automobile cost $160,000.
So what's your mentality? If I want to buy an automobile, I'm not going to wait at all. I'm just going to buy it.
So as people begin to buy things more quickly, you start to move into phase three.
At that point, people's mentality is buy anything as soon as you can.
If there's a piano out there that's being sold, even if no one in your family plays the piano, buy it and get rid of the money.
I'll go into some of the implications of that.
Then by 1923 of September, I'm sorry, in February, prices had increased by more than ten times from October.
And then just about eight months later, they were ten times as high.
And then they doubled in one month from September of 1923 to October.
Prices of newspapers were now 2,000 marks compared to one-third of a mark less than two years before.
And then it began increasing at an incredibly rapid rate. Prices were going up by thousands of percent every day, by hundreds of percent every hour, so prices increased from the price of a newspaper increased to 20,000 marks, and then 14 days later it was a million marks, then a few weeks later it was 15 million marks, then eight days later it was 70 million marks, okay? Prices were increasing so fast that the amount of money that you spent to buy a whole dinner
Tonight, wouldn't even buy you a cup of coffee tomorrow morning.
Now, what were some of the implications of this?
Well, workers didn't want to hold money. They wanted to spend it as soon as possible.
So workers began to demand, factory workers in Germany, began to demand you get paid first every week,
from two weeks to weekly, then every day, then three times a day.
They would have their families, their fiancés, their wives, their children, meet them at the factory gates.
They'd run out with their pay packets. They would get bills, not paychecks. Paychecks didn't come in until after World War II.
And these people, their families would run out and buy anything they could get their hands on, okay? Pianos, eggs, whatever it was, okay?
Anything that would hold its value. Professors, civil servants, people that had jobs and who were salaried, paid on a monthly basis or every two weeks,
They began to quit and become waiters and taxi drivers, because they were getting paid right away.
You get your tips right away so you can spend it right away.
So you began to have that happening.
The amount of money that people had to pay for things was just mind-boggling.
So there's a famous picture of a German worker with a wheelbarrow, and it's full of German marked notes.
And he's pushing the wheelbarrow to the market to buy a pound of butter.
Women used to take laundry baskets to go shopping.
Not to bring the food back, but to bring the money there.
You wouldn't get much for the money.
So they'd bring these laundry baskets full of paper-marked notes, of the Deutsch marks,
and they would leave them out in the front of the store.
They'd put them out there, and they'd go and try to bargain and get whatever they could for the amount of money they had.
And thieves would come by and dump the notes out and steal the baskets,
because the laundry baskets were worth more than all the notes in the baskets, okay?
Yeah, you could burn the notes. Yeah, this was cheaper than firewood.
Then there were some other interesting...
The other thing was the government's reaction, which was just unbelievable.
The government claimed that the initial increase in prices would do these evil speculators
drove the value of the German mark down, so all imports had higher prices, but of course the value of the mark was falling because it couldn't buy much, prices were rising, so they claimed it was the other way around, that prices started rising first and people didn't have enough money to pay the high prices, and after a while that was true, but what they did was then they tried to increase, they said we're just increasing the money supply so people can pay these enormously high prices, but of course in doing that they kept the whole vicious cycle
The more they increase the money supply, the more prices rose, and the more confidence people had in the money, the more inflationary expectations they developed, and therefore the faster prices rose.
So by the end of this, the German government had almost every printing house in the country, it had taken over almost every printing house.
At one point there were 2,000 printing houses working 24-hour shifts to keep worthless money flowing to banks.
Now the banks, they weighed the money on butcher scales because all the money was, I'll show you in a moment, was denominated 1 billion marks.
The government ran out of paper after a while in increasing the money supply.
So what they did, and I can show you this, was they took mark notes when they came back to the banks and they just stamped them 1 billion.
It was a one mark or a thousand mark note, and here's an example, I think I can show it on here.
Okay, now that note is initially one thousand, you can see the one thousand in the corner there.
Now, notice that you can't see, it's red, but you'll see ein, milliard, ein, milliard marks, okay?
Okay, that's stamped across it.
Million is billion, so they took a 1,000 mark note and they were just stamping them 1 billion and then reissuing them.
Okay, so you can get these, there's so many of them, you can get them at flea markets.
I got these for a quarter a piece or something like that.
All right, so that's what they were doing.
And of course, that was making things worse.
And of course, a few other interesting examples, by the end, even the farmers were sort of slow to pick up on this, they wouldn't even sell you one egg for the whole German money supply.
So in other words, what happened to the real value of money? What happened to the real money supply?
If at the end you can take the whole money supply and not get one real good for it, the real money supply has fallen to zero.
So not only can the government not increase the real money supply, that is the amount of goods and services the total money supply can purchase,
but what it can do is destroy the value or reduce the real money supply and it can reduce it to zero.
Now, this all stopped in early December when the government of Germany declared that it was no longer going to increase the money supply, it was going to introduce a new currency called the Reichsmark and they claimed they were going to back it up with land.
They didn't back it up with gold, but they did stop the inflation and they stopped it. It's always simple to stop an inflation, you just stop printing money.
So people brought back one trillion marks, and for every one trillion old marks they got one new gold mark, or one new mark, what wasn't at that point backed by gold.
And then there's an interesting story about Ludwig von Mises, I'll just tell you that and then I'll show you the biggest inflation, which wasn't Germany, it was Hungary, I'll indicate how big that was.
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.
He agreed to meet with them on one condition, that it was to be at midnight on a certain street corner in Vienna.
Although government officials were baffled by his request, they nevertheless agreed.
When they met, it was quiet, except for the continuous noise of machinery in an adjacent building.
When officials asked von Mises how to solve their foremost economic problem, he simply pointed to the noisy building and said,
first and foremost, you must stop that noise.
The building, of course, was the government printing plant, and the sound was the printing of money 24 hours a day.
And I didn't know if the story was true or not, but I don't know where I read.
I recently read a similar story about Mises by an economist that was a friend of his.
I think it's in The Raven of Zurich by Felix.
I don't remember his last name now, but it's probably in the library.
He actually tells this story and he was in Vienna at the time.
The worst hyperinflation occurred in Hungary after World War II.
And let me give you the dimensions of this hyperinflation. In 1939, just before World War II, one American dollar bought 3.38 Hungarian pengos, so the exchange rate was one dollar equal to 3.38 pengos.
In July 1946, seven years later, the same dollar was worth 21 zeros.
So it's 500, so you have to spend, keeps going, and one more, that's 50 or 500 million trillion pengos, never before or since has so much been sold worth so little.
So if someone before the war put in $100,000 worth of pengos in a bank and that's like 338,000 pengos at that exchange rate,
And let's say that they couldn't access those pengos during the war because you couldn't withdraw your money.
By the end of the war, it wasn't worth even withdrawing 238,000 pengos.
The reason? A haircut cost 800 trillion pengos in Budapest.
So this was the largest recorded hyperinflation.
That's the all-time record.
and that's caused simply by increasing the money supply. So I'll stop here and I'll take any questions if there are any. Alex?
Germany was off the gold standard, like every other country, from 1914, from the outbreak of World War I, so I don't know what he or she is talking about.
But that's a knee-jerk Keynesian response. Something must have been the gold standard.
Yes, Curtis? Go ahead. You were first. Nick, go ahead.
You were talking about the optimal prime loans, and it became bolder in 2001 than it was in 2009, but that's just a fooling of the state, right?
A meal is cold in both countries.
So the only difference is the supply of money.
So what I was trying to show is that there's no difference.
As long as all technology, labor and so on is the same, you're going to have the same output of goods and services.
It's not meant to be a model for international trade. I'd have to think that through.
No, same dollars. We're talking about the exact same country. Everything is exactly the same.
Let's say closed economy. So they don't trade by definition.
Exact same closed economy with different amounts of money.
There's a confusion with the word devalue and depreciate. Usually the word devalue is used under the gold standard, meaning that the gold content of the
of the currency is lowered, or to put it another way, the price of gold goes up. So we devalued
in 1933, Roosevelt devalued the U.S. dollar, changed the price from $20 per ounce to $35
per ounce. So each dollar contained less gold. That's a devaluation. And that allows them
to inflate more. It was a technique for permitting inflation. Depreciation, if a country wants
When you depreciate its currency consciously, what it does is it goes, it prints up money and it goes into the market, into the foreign exchange market, and it buys other currencies.
It increases the supply of its currencies. That drives the price of other currencies up and drives the value of your currency down.
Right? Because it takes more dollars to buy the same amount of francs or pounds and so on, or yen and euros.
So depreciation does cause inflation in the, actually to get back, you would ask if it...
Well, you know, a number of years ago I had Argentina, so I devalued their money.
Oh, okay, they devalued because Argentina had a fixed exchange rate with the U.S. dollar, with one peso to one dollar, okay.
So, in fact, they had a currency board, and under that system, they could only increase the supply of peso currency, dollar per dollar.
In other words, only when dollars came into the country and were turned into the central bank, could they expand their money supply.
So, if they wanted to issue one peso, the central bank or the currency board had to have an additional dollar.
Now, what they did then was devalue by making, going for, let's say, three pesos to one dollar.
So, if a dollar comes in, now they can issue three pesos instead of issuing only one.
The peso is now worth less.
And that will be reflected on the foreign exchange market also.
Yeah, Pat and then Mike.
Right, the question is, would, under the gold standard, would a war be
much more difficult to undertake and to sustain?
And the answer to that is absolutely yes.
In fact, that's why governments, modern governments, have all gone off the gold
standards
when they've gotten involved in major wars because otherwise they would have to raise taxes
okay they couldn't run very large deficits
okay without printing money and so taxes would have to rise
to a much greater degree and people would then
realize the high cost of the war
the money would be coming out of their pockets and be very visible to them
and also in the days of the gold standard when we didn't have paper money
Wars ended because kings ran out of money to pay the troops with.
Yes, Mike?
So, you're talking about if the state is in place, if the supply is constant, will it have an effect on the purchasing power of money?
No, there is an effect on the purchasing power of money.
The question is if...
Go ahead.
There's no change in the real value.
The question is, what would happen if the state wanted to reduce the money supply by destroying 25% of the money supply?
The question is what would happen if the state wanted to reduce the money supply by destroying 25% of the money supply?
Would there be a redistribution of wealth? Now, there would be a redistribution of wealth if the money that they destroyed would have been spent by the state on certain goods and services.
In other words, if the state reduces its spending, that is, it takes in a surplus of tax dollars and reduces its spending and destroys a certain amount of those tax dollars, it actually just burns them.
What would happen is that there would be redistribution from the people who were being paid by the state to sell them things or who were getting subsidies from the state, redistribution to the people who were not being subsidized by the state.
Because their incomes would fall first, so in other words, let's say they now spend less on computers from Silicon Valley, they now cut their subsidies to farmers.
And if they did that, those groups would suffer, their money incomes would fall first, and they would have less to spend on other goods and services.
So demands would go down, prices would go down. You and I, we would have the same incomes initially.
And we have lower prices. So you and I would be able then to benefit at least until the lower prices reached us because we'd be paying lower prices for a while while our incomes were still at their old levels.
So the deflationary process redistributes it to people who have their money destroyed or have lower prices later on from the people who experience lower prices early.
early and actually this is a good I've written something on this they call
seniorage the seniorage is applied to a situation which the government creates
new money and spends it okay and gets real resources there's the opposite
effect might be called a rabatage or a rebate okay if the government takes some
of its tax dollars and actually destroys those tax dollars and spends less then
Then there's, in effect, a hidden rebate of taxes.
Scenurage is a hidden tax, a rabatage, which in French means rebate, and I use that term,
I coined that term, or I appropriated that term.
Deflation does, in a sense, benefit, in a rough sense, the people that were hurt by
inflation.
It benefits those people who are not being subsidized by the state.
So deflation has good effects.
So in Canada, a lot of governments, provincial and federal governments have big surpluses.
So it would make sense for them if your concerns for the tax came last, to just have that money destroyed.
Yes. Those surpluses now, as it stands, Mike pointed out that in Canada, the provincial governments run surpluses.
Those surpluses now are used to pay off bonds. They're not just held as money, okay, somewhere.
They use the payoff bonds so they get back into circulation to pay off the bondholders and so on.
Yeah, they're paying off debt with those surpluses.
If they were just to repudiate their debt, let's say, to the bondholders and destroy that money, then that would benefit the taxpayers.
The net taxpayers in the economy would be benefited.
They'd have real resources redirected to them.
See, that's been left out of the analysis of deflation.
We have to stop here because we're a little over time.