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Because the 'simple straight forward explanation' doesn't make much sense. As economies grow and expand, they need more money supply to keep prices stable. If

Because the 'simple straight forward explanation' doesn't make much sense. As economies grow and expand, they need more money supply to keep prices stable. If you're using 100 tons of Gold as your 'fixed money supply' then you run into deflationary problems. Also, if there is a crisis in which people get really anti-liquid and tend to hoard and do other bad things, and/or the system needs to allocate resources somewhere fast or else face destruction - then if you only have a big pot of gold split between owners, you are screwed. Mad Max style. If a country is invaded or has a pandemic, most regular levers may not work. But helicopter money can help. It implies an 'unfair' re-balancing of who owns what, but so long as the community at large accepts that, then it's fine. It means a price adjustment for everyone.

WalterBright 4y ago
Some good questions. The answer isn't simple, but I'll try. It comes down to how banks work with fractional reserve banking. (To keep this post short, I'll refer you to google if you don't know what it is.) Banks loan out a multiple of their deposits. In other words, banks create money when they make loans. Amazing, isn't it? But, banks don't loan money unless there is collateral. The next part is tricky to understand. If I, Picasso, create a painting I create value. I can use the painting as collateral for a bank loan, i.e. because I created value, I also indirectly created money! With me so far? Next, what happens when I repay the loan? The money disappears! If you think about it, you'll see that the money supply, through the blind forces of Supply & Demand, tracks the value in the economy, almost like magic. While the gold it represents can sit buried in a vault somewhere and needn't actually be traded. Inflation happens when the government prints money that has no collateral, and has no correspondence to added value in the economy and so it dilutes the value of the money that is already in circulation.
- jollybean 4y ago
  I think you are misunderstanding fractional lending and collateral. Fractional lending seems a bit odd, but it's not like there is 'no collateral' - rather, there ends up being 'partial collateral'. As it turns out, that 'partial collateral' is enough - it's actually reasonable thing to do, because the vast majority of loans are repaid, it's not necessary to fully collateralize everything on the whole. Banks have to have some capital requirements, which means, if they 'screw up' too badly, then they go bankrupt! So they are acting in a capitalist manner and have to be careful about how they lend, and at what rates. If random bank acts irresponsibly, then random bank will go kaput by regular market forces. Instead of thinking of fractional lending as 'missing money' think of it more like leverage. Basically - the effect of fractional lending is that it's a 'multiplier' to whatever the Central Bank decides to do. So it exacerbates effects in one direction or the other but on the whole, it doesn't change the real nature of the system. The way we manage money is sound. We need money to expand and contract, and we have good ways to measure that. The 'danger' of fiat of course is political intervention, or a failure of controls. We had a broad intervention in 2008 that favoured home owners over others, and there are attempts to use the Central Bank to do 'Social Justice' type things, which I think is very risky. It's a bit like Nuclear Energy: it's very potent, you just have to watch it responsibly. Finally - currency should be a 'current' asset, not a store of value. We just want it as a medium of exchange. So as long as it's not shifting too much one way or another, then it should work. For 'stores of value' there are other things, like real estate etc.. "Inflation happens when the government prints money that has no collateral, and has no correspondence to added value in the economy and so it dilutes the value of the money that is already in circulation. " This is misleading. The 'government' does not print money, the Central Bank does. And as you indicate, the bank ultimately creates credit via fractional lending. 'Inflation' happens when the cost of goods rise faster than the money in circulation. Thus 'inflation' can happen because 'stuff is more costly to make'. Like gas in Europe, is more expensive, not because 'money printing' but 'Russia'. Also, inflation can feasibly happen without money printing or even a rise in inherent cost of goods, if the economy shifts in a way that ends up in excess cash. But ultimately, if during normal course of 'growth' if there is no expansion in the monetary base, then you'll have deflation, which has bad externalizes. So the goal then is to adjust interest rates / print or extract money from the economy so that prices stay roughly flat, with just a tiny bit of inflation. That is a dynamic process, not a static process.
  - WalterBright 4y ago
    Rather bluntly, a central bank is central economic planning. Central economic planning always falls short of what free markets do. The idea that a central bank is able to control the financial markets better than free market forces is shown to be false (with actual data) by Friedman in "Monetary History of the United States". > The 'government' does not print money, the Central Bank does. I said "print money" as a euphemism for what the Fed actually does, which is the same thing, it just doesn't involve doing the old fashioned way. They do it by issuing debt with no collateral.
    - jollybean 4y ago
      Rather bluntly, this is just not true. I think there is an erroneous understanding/implication in your statement, which is likely leading you to erroneous conclusion. The Fed is not 'Central Planning' so much as it is actually trying to make the market more 'neutral' in normal cases. We'll get to the 'crisis' cases in a bit. If we just had a hard currency, like Gold (which 'feels' neutral) we'd get into trouble, because of deflationary issues. People would treat it like Bitcoin, and as prices fell slightly would be oriented a bit towards 'store of value' as opposed to currency. The Fed 'targets' just a 'bit above zero' inflation by policy. That is basically 'neutral'. That is not really 'central planning', it's more like 'central neutralization'. As for 'crisis' situations, i.e. when the Fed does start to 'intervene' and does things which you might argue are 'central planning' - well - the government in many cases can absolutely do it 'better than free markets' because only the government has the scale to do it. For example, 'free markets' could have not have created and executed the Highway road system of the 1950s. It was of a scale and scope far, far beyond any economic actor. That required 'strategic vision' on behalf of the government. Now - private contractors actually did the 'building' - which is how we want it because the government doesn't need to hire individual workers. But it's a government project by virtue of scale and other things. The meltdown of 2008 was a very scary time - if the government did not intervene, the banks would have collapsed, and it would have taken down the entire economy. It would be like a human having a 'heart attack' - the heart stops - everything stops. So the government put together a plan and intervened. A lot of it had to do with 'confidence signals' and other things, extra regulation, but it worked. There is of course the 'Too Big To Fail' argument i.e. moral hazard i.e. banks take on more risk knowing the 'gov will save' us - that said, the worst actors did definitely lose a ton of money. Also - the problem was not just the banks, it was a systemic failure in a number of sectors. Basically - the US had an economic cancer and no individual organization was going to be able to contend with it. So -> intervention. Much like a war, or pandemic. Having a fiat currency allows that opportunity. If it were a 'Gold Based Economy' it would have fallen down like a house of cards. Like a brick building during a rare earhtquake: brick 'feels' strong like Gold, but an earthquake will ravage it, which is why you need steel reinforcement - the steel can bend and absorb different kind of tensions. Milton Friedman is wrong. Yes, when there is hyperinflation, it's probably because some stupid government is printing too much money, but inflation is not just a function of money printing.
- lagrange77 4y ago
  > Banks loan out a multiple of their deposits. In other words, banks create money when they make loans. Amazing, isn't it? I've heard about that, and it's really amazing. If i understand it correctly, the loan interest i have to pay is money that also does not exist yet, at the point of time, when i get the cash. The bank faces the risk of me not being able to generate (get from others, who potentially also take loans) that extra money, so they demand a collateral as an insurance against that risk. > Inflation happens when the government prints money that has no collateral, and has no correspondence to added value in the economy and so it dilutes the value of the money that is already in circulation. What instance decides, if some printed money does or does not have collateral?
  - jollybean 4y ago
    This is kind of a misunderstanding. Banks retain assets for loans they make. They don't print money. But imagine this scenario: you deposit $10 at bank A, they loan that $10 to person B, that person B puts their $10 account at Bank C, thank bank loans out that $10 to person D etc.. You can see all of a sudden, $10 turns into $100! or $1000 in assets! So what we require banks to do is keep a part of the assets they receive. So if they get $100 in deposits, they can only lend out $90 i.e. they have to keep '10% in reserve'. This means that banks are leveraged at 90%. It also means that if there is a calamity, and a 'run on the bank' or it loses 10% of it's assets, the bank is wiped out. So what all of this means is that there is 'leverage' in the system, and it means there is 10x money going into the economy than is released by the Fed. It definitely adds a lot of flexibility to the system. Banks are still responsible for evaluating risk of their loans and paying the price if they fail. "The interest on the loan" is mostly a function of risk and the cost of that bank managing that money i.e. getting the depositors to loan you the money in the first place. The OP's definition of 'inflation' is a bit warped. Inflation is when there's more money than demand for stuff. If stuff is harder to make or is more rare, prices will go up irrespective of money supply. If you throw money in the economy for no reason inflation will happen. But most economies are expanding a bit, and so they need more money in the supply to keep prices stable, which is why we like to have just a bit of money printing. All money loaned out - even given out by the central banks has collateral. The Fed keeps mostly TBills (Government Debt) and real estate as collateral.
landemva 4y ago
> you run into deflationary problems. Deflation means people who save increase their purchasing power without gambling on stonks. The savers mentality is called low time preference. Any problems from less consumerism would be felt by junk producers: plastic spinner toys, yet another streaming service, iGadget yearly upgrades. High time preference people are the market for short-lived trash. A currency with disappearing value encourages such consumption because it does not hold value. Due to technology and manufacturing advances, price decreases (deflation) are natural.

WalterBright 4y ago

Some good questions. The answer isn't simple, but I'll try. It comes down to how banks work with fractional reserve banking. (To keep this post short, I'll refer you to google if you don't know what it is.) Banks loan out a multiple of their deposits. In other words, banks create money when they make loans. Amazing, isn't it? But, banks don't loan money unless there is collateral. The next part is tricky to understand. If I, Picasso, create a painting I create value. I can use the painting as collateral for a bank loan, i.e. because I created value, I also indirectly created money! With me so far? Next, what happens when I repay the loan? The money disappears! If you think about it, you'll see that the money supply, through the blind forces of Supply & Demand, tracks the value in the economy, almost like magic. While the gold it represents can sit buried in a vault somewhere and needn't actually be traded. Inflation happens when the government prints money that has no collateral, and has no correspondence to added value in the economy and so it dilutes the value of the money that is already in circulation.

jollybean 4y ago
I think you are misunderstanding fractional lending and collateral. Fractional lending seems a bit odd, but it's not like there is 'no collateral' - rather, there ends up being 'partial collateral'. As it turns out, that 'partial collateral' is enough - it's actually reasonable thing to do, because the vast majority of loans are repaid, it's not necessary to fully collateralize everything on the whole. Banks have to have some capital requirements, which means, if they 'screw up' too badly, then they go bankrupt! So they are acting in a capitalist manner and have to be careful about how they lend, and at what rates. If random bank acts irresponsibly, then random bank will go kaput by regular market forces. Instead of thinking of fractional lending as 'missing money' think of it more like leverage. Basically - the effect of fractional lending is that it's a 'multiplier' to whatever the Central Bank decides to do. So it exacerbates effects in one direction or the other but on the whole, it doesn't change the real nature of the system. The way we manage money is sound. We need money to expand and contract, and we have good ways to measure that. The 'danger' of fiat of course is political intervention, or a failure of controls. We had a broad intervention in 2008 that favoured home owners over others, and there are attempts to use the Central Bank to do 'Social Justice' type things, which I think is very risky. It's a bit like Nuclear Energy: it's very potent, you just have to watch it responsibly. Finally - currency should be a 'current' asset, not a store of value. We just want it as a medium of exchange. So as long as it's not shifting too much one way or another, then it should work. For 'stores of value' there are other things, like real estate etc.. "Inflation happens when the government prints money that has no collateral, and has no correspondence to added value in the economy and so it dilutes the value of the money that is already in circulation. " This is misleading. The 'government' does not print money, the Central Bank does. And as you indicate, the bank ultimately creates credit via fractional lending. 'Inflation' happens when the cost of goods rise faster than the money in circulation. Thus 'inflation' can happen because 'stuff is more costly to make'. Like gas in Europe, is more expensive, not because 'money printing' but 'Russia'. Also, inflation can feasibly happen without money printing or even a rise in inherent cost of goods, if the economy shifts in a way that ends up in excess cash. But ultimately, if during normal course of 'growth' if there is no expansion in the monetary base, then you'll have deflation, which has bad externalizes. So the goal then is to adjust interest rates / print or extract money from the economy so that prices stay roughly flat, with just a tiny bit of inflation. That is a dynamic process, not a static process.
- WalterBright 4y ago
  Rather bluntly, a central bank is central economic planning. Central economic planning always falls short of what free markets do. The idea that a central bank is able to control the financial markets better than free market forces is shown to be false (with actual data) by Friedman in "Monetary History of the United States". > The 'government' does not print money, the Central Bank does. I said "print money" as a euphemism for what the Fed actually does, which is the same thing, it just doesn't involve doing the old fashioned way. They do it by issuing debt with no collateral.
  - jollybean 4y ago
    Rather bluntly, this is just not true. I think there is an erroneous understanding/implication in your statement, which is likely leading you to erroneous conclusion. The Fed is not 'Central Planning' so much as it is actually trying to make the market more 'neutral' in normal cases. We'll get to the 'crisis' cases in a bit. If we just had a hard currency, like Gold (which 'feels' neutral) we'd get into trouble, because of deflationary issues. People would treat it like Bitcoin, and as prices fell slightly would be oriented a bit towards 'store of value' as opposed to currency. The Fed 'targets' just a 'bit above zero' inflation by policy. That is basically 'neutral'. That is not really 'central planning', it's more like 'central neutralization'. As for 'crisis' situations, i.e. when the Fed does start to 'intervene' and does things which you might argue are 'central planning' - well - the government in many cases can absolutely do it 'better than free markets' because only the government has the scale to do it. For example, 'free markets' could have not have created and executed the Highway road system of the 1950s. It was of a scale and scope far, far beyond any economic actor. That required 'strategic vision' on behalf of the government. Now - private contractors actually did the 'building' - which is how we want it because the government doesn't need to hire individual workers. But it's a government project by virtue of scale and other things. The meltdown of 2008 was a very scary time - if the government did not intervene, the banks would have collapsed, and it would have taken down the entire economy. It would be like a human having a 'heart attack' - the heart stops - everything stops. So the government put together a plan and intervened. A lot of it had to do with 'confidence signals' and other things, extra regulation, but it worked. There is of course the 'Too Big To Fail' argument i.e. moral hazard i.e. banks take on more risk knowing the 'gov will save' us - that said, the worst actors did definitely lose a ton of money. Also - the problem was not just the banks, it was a systemic failure in a number of sectors. Basically - the US had an economic cancer and no individual organization was going to be able to contend with it. So -> intervention. Much like a war, or pandemic. Having a fiat currency allows that opportunity. If it were a 'Gold Based Economy' it would have fallen down like a house of cards. Like a brick building during a rare earhtquake: brick 'feels' strong like Gold, but an earthquake will ravage it, which is why you need steel reinforcement - the steel can bend and absorb different kind of tensions. Milton Friedman is wrong. Yes, when there is hyperinflation, it's probably because some stupid government is printing too much money, but inflation is not just a function of money printing.
lagrange77 4y ago
> Banks loan out a multiple of their deposits. In other words, banks create money when they make loans. Amazing, isn't it? I've heard about that, and it's really amazing. If i understand it correctly, the loan interest i have to pay is money that also does not exist yet, at the point of time, when i get the cash. The bank faces the risk of me not being able to generate (get from others, who potentially also take loans) that extra money, so they demand a collateral as an insurance against that risk. > Inflation happens when the government prints money that has no collateral, and has no correspondence to added value in the economy and so it dilutes the value of the money that is already in circulation. What instance decides, if some printed money does or does not have collateral?
- jollybean 4y ago
  This is kind of a misunderstanding. Banks retain assets for loans they make. They don't print money. But imagine this scenario: you deposit $10 at bank A, they loan that $10 to person B, that person B puts their $10 account at Bank C, thank bank loans out that $10 to person D etc.. You can see all of a sudden, $10 turns into $100! or $1000 in assets! So what we require banks to do is keep a part of the assets they receive. So if they get $100 in deposits, they can only lend out $90 i.e. they have to keep '10% in reserve'. This means that banks are leveraged at 90%. It also means that if there is a calamity, and a 'run on the bank' or it loses 10% of it's assets, the bank is wiped out. So what all of this means is that there is 'leverage' in the system, and it means there is 10x money going into the economy than is released by the Fed. It definitely adds a lot of flexibility to the system. Banks are still responsible for evaluating risk of their loans and paying the price if they fail. "The interest on the loan" is mostly a function of risk and the cost of that bank managing that money i.e. getting the depositors to loan you the money in the first place. The OP's definition of 'inflation' is a bit warped. Inflation is when there's more money than demand for stuff. If stuff is harder to make or is more rare, prices will go up irrespective of money supply. If you throw money in the economy for no reason inflation will happen. But most economies are expanding a bit, and so they need more money in the supply to keep prices stable, which is why we like to have just a bit of money printing. All money loaned out - even given out by the central banks has collateral. The Fed keeps mostly TBills (Government Debt) and real estate as collateral.

landemva 4y ago

> you run into deflationary problems. Deflation means people who save increase their purchasing power without gambling on stonks. The savers mentality is called low time preference. Any problems from less consumerism would be felt by junk producers: plastic spinner toys, yet another streaming service, iGadget yearly upgrades. High time preference people are the market for short-lived trash. A currency with disappearing value encourages such consumption because it does not hold value. Due to technology and manufacturing advances, price decreases (deflation) are natural.