Another Keynesian Meme Dragged Up

A recent Fed paper reports that the Fed's wild money printing orgy has failed to produce much CPI inflation because “consumers are hoarding money”. It is said that this explains why so-called “money velocity” is low.

The whole argument revolves around the Fisherian “equation of exchange”, as you can see here. Now, it may be true that the society-wide demand for money (i.e., for holding cash balances) has increased. Rising demand for money can indeed cancel some of the effects of an increasing money supply. However, it should be obvious that there is 1. no way of “measuring” the demand for money and 2. the “equation of exchange” is a useless tautology.

Consider for instance this part of the argument:

 

“Though American consumers might dispute the notion that inflation has been low, the indicators the Fed follows show it to be running well below the target rate of 2 percent that would have to come before interest rates would get pushed higher.

That has happened despite nearly six years of a zero interest rate policy and as the Fed has pushed its balance sheet to nearly $4.5 trillion.

Much of that liquidity, however, has sat fallow. Banks have put away close to $2.8 trillion in reserves, and households are sitting on $2.15 trillion in savings-about a 50 percent increase over the past five years.”

 

(emphasis added)

First of all, banks have not “put away” $2.8 trillion in reserves; in reality, they have no control whatsoever over the level of excess reserves. They are solely a function of quantitative easing: when the Fed buys securities with money from thin air, bank reserves are invariably created as a side effect. Credit can be pyramided atop them, or for they can be used for interbank lending of reserves, or they can be paid out as cash currency when customers withdraw money from their accounts. That's basically it.

 

Now imagine that a consumer who holds $1,000 in a savings account spends this money. Would it disappear? No, it would most likely simply end up in someone else's account. So the aggregate amount of money held in accounts is per se definitely not indicative of the demand for money either – it wouldn't change even if people were spending like crazy. Someone would always end up holding the money. Money, in short, is not really “circulating” – it is always held by someone.

This also shows why so-called velocity is not really telling us anything: all we see when looking at a chart of money velocity is that the rate of money printing has exceeded the rate of GDP growth (given that money printing harms the economy, this should not be overly surprising).

In Fisher's “equation of exchange”, V is simply a fudge factor. As Rothbard noted with regard to the equation, it suffers from a significant flaw:

 

Things, whether pieces of money or pieces of sugar or pieces of anything else, can never act; they cannot set prices or supply and demand schedules. All this can be done only by human action: only individual actors can decide whether or not to buy; only their value scales determine prices.

It is this profound mistake that lies at the root of the fallacies of the Fisher equation of exchange: human action is abstracted out of the picture, and things are assumed to be in control of economic life. Thus, either the equation of exchange is a trivial truism— in which case, it is no better than a million other such truistic equations, and has no place in science, which rests on simplicity and economy of methods—or else it is supposed to convey some important truths about economics and the determination of prices.

In that case, it makes the profound error of substituting for correct logical analysis of causes based on human action, misleading assumptions based on action by things. At best, the Fisher equation is superfluous and trivial; at worst, it is wrong and misleading, although Fisher himself believed that it conveyed important causal truths.”

(italics in original)

 

V“Velocity” of M2 – click to enlarge.

 

It is of course true that prices in the economy adjust to the supply of and the demand for money. However, low consumer price inflation by itself does also not really mean that one can infer that the demand for money must be exceptionally high.

What if e.g. the supply of goods increases at a strong rate? Then we would ceteris paribus have to expect the prices of goods to decline – if they instead remain “stable”, it is actually indicative of inflationary effects making themselves felt.

Moreover, prices never rise or fall at uniform rates. In today's economy, some prices rise at astonishing rates of change, such as for instance securities prices. These are not part of the consumer price index, but they are nevertheless prices. Their huge rise in recent years is an effect of monetary inflation – and if we were to attempt to infer the demand for money solely from their rates of change, we would have to say that the demand for money cannot have increased a whole lot. So you can see that things are evidently not as simple as “MV=PT” would have it.

 

In fact, the most pernicious effect of monetary inflation is precisely that relative prices in the economy shift and in the process paint a distorted picture that falsifies economic calculation and leads to capital malinvestment. Money always enters the economy at discrete points, and therefore changes in prices are like the ripples in a pond after a stone has been thrown in. First the goods demanded by the earliest recipients of newly created money rise…then the prices of goods  demanded by the receivers who are second in line, and so forth. The earlier in the chain of exchanges one resides, the more likely one is going to be a winner of the process, the later, the more likely one is going to lose out (as more and more prices rise before the late receivers get their hands on the new money). Needless to say, the number of losers tends to be much greater than the number of winners.

Lastly, a sharper rise consumer price inflation may yet strike with a large time lag. There is no way of knowing for certain, but it wouldn't be the first time it has happened.

 

TMS-2 with memo-itemsMoney TMS-2. Obviously, the rate of monetary inflation has been vast. Economic growth meanwhile hasn't been much to write home about (hence “decreasing velocity”) – click to enlarge.

 

Why Hoarding Isn't “Bad”

Such reports is however do as a rule not merely attempt to explain why  consumer price inflation is apparently low in the face of huge money supply growth (let us leave aside here that the “general price level” is in any event a fiction and cannot be measured. Let us also leave aside that the calculation of CPI such as it is seems highly questionable on other grounds as well). We may for the sake of argument concede that the demand for money (i.e., for holding cash balances) has risen on a society-wide basis after the 2008 crisis. Indeed, it seems quite a reasonable supposition.

The underlying theme of such studies is however invariably that this alleged hoarding somehow harms the economy, because economic growth is assumed to be the result of spending and consumption. This is a bit like arguing that the best way to stay warm is by burning one's furniture. In fact, this is a very good analogy, as burning the furniture will keep one warm for a while, just as people wasting their savings on consumption will for a while make aggregate economic statistics look better. That there might be a problem only becomes evident once all the furniture has been burned. Then it is cold, and there is nothing left to sit on.

Obviously, the argument that consumption drives economic growth is putting the cart before the horse: one can only consume what has been produced after all, so production must come first. If production must come before consumption, then investment must come before production and saving must come before investment. When people save money, nothing is miraculously “lost” to the economy. By saving more, people are merely indicating that their time preferences are lower  – that they prefer consuming more later to consuming less in the present. Their savings can be employed to increase production, so as to enable this later, larger rate of consumption they desire. All that changes is the pattern of spending in the economy – more will tend to be spent on producer's goods and wages instead of on consumer goods.

What about genuine “hoarding” though? What if money is not kept in savings accounts, but instead stuffed under a mattress where nobody has access to it? Isn't that harming the economy?

The answer is actually no.

Let us assume a lone miser takes all the money he earns and stuffs it under his mattress. Given that this money is held in his cash balance and not being spent, prices in the economy must ceteris paribus adjust downward (assuming that no-one else's demand for money changes and that its supply remains fixed). However, all of this continues to fully agree with an expansion in production.

After all, our miser must have earned his money somehow, and he can only have earned it by producing a good or a service. The contribution he has made to the economy's pool of real funding remains “out there”. The fact that he subsequently hoards his money does not alter this fact. He could use his money to exercise a claim on other goods or services, and so consume the portion of the economy's pool of real funding he is entitled to on account of his preceding production. If he doesn't, then whatever he has contributed can be employed to expand production.  The point here is: money is merely a medium of exchange. It is a sine qua non for the modern complex economy as there can be no economic calculation without money and money prices, but money is not what ultimately funds economic activity.

Just think about it: if one is stranded on an island without any real capital – i.e., without concrete capital goods – one can have suitcases full of money and will still be unable to fund even the tiniest bit of production with it.

 

Conclusion

In short, “hoarding” cannot possibly harm the economy. The same, alas and alack, cannot be said of money printing.

 

scroogeNope, he doesn't harm the economy …

 

Charts by: Saint Louis Federal Reserve Research

 

 

 

Emigrate While You Can... Learn More

 


 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

2 Responses to “Are US Consumers Evil Hoarders?”

  • No6:

    Nicely explained. Alas Politicians and their crooked mouthpieces prefer to blame the responsible savers amongst us.

  • Doug_B:

    The bottom 80% – 85% of us have no real wealth (other than IRA’s / homes – in which we live – so they are not an asset until we are dead.) Most Americans have had their incomes decline – even myself, who has two STEM degrees. Who needs to buy more knock-off junk made in China?

    We are well on the way to reaching a critical mass. Most every communication from “the” government (not “our” government) is either an outright lie, or twisted statistic. No inflation – well disregard the price of gasoline, disregard the price of electricity, disregard the price of food – and poof – no inflation. I guess necessities of life are not that important.

    The government constructs / manipulates our economy – and then blames the people for not responding to their manipulations!

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • America Goes Full Imbecile
      Credit has a wicked way of magnifying a person’s defects.  Even the most cautious man, with unlimited credit, can make mistakes that in retrospect seem absurd.  But an average man, with unlimited credit, is preeminently disposed to going full imbecile.   Let us not forget about this important skill...  [PT]   Several weeks ago we came across a woeful tale of Mike Meru.  Somehow, this special fellow, while of apparent sound mine and worthy intent, racked up...
  • Retail Capitulation – Precious Metals Supply and Demand
      Small Crowds, Shrinking Premiums The prices of gold and silver rose five bucks and 37 cents respectively last week. Is this the blast off to da moon for the silver rocket of halcyon days, in other words 2010-2011?   Various gold bars. Coin and bar premiums have been shrinking steadily (as have coin sales of the US Mint by the way), a sign that retail investors have lost interest in gold. There are even more signs of this actually, and this loss of interest stands in stark...
  • Credit Spreads: Polly is Twitching Again - in Europe
      Junk Bond Spread Breakout The famous dead parrot is coming back to life... in an unexpected place. With its QE operations, which included inter alia corporate bonds, the ECB has managed to suppress credit spreads in Europe to truly ludicrous levels. From there, the effect propagated through arbitrage to other developed markets. And yes, this does “support the economy” - mainly by triggering an avalanche of capital malinvestment and creating the associated boom conditions, while...
  • Gold Divergences Emerge
      Bad Hair Day Produces Positive Divergences On Friday the ongoing trade dispute between the US and China was apparently escalated by a notch to the next level, at least verbally. The Trump administration announced a list of tariffs that are supposed to come into force in three week's time and China clicked back by announcing retaliatory action. In effect, the US government said: take that China, we will now really hurt our own consumers!  - and China's mandarins replied: just you wait, we...
  • Industrial Commodities vs. Gold - Precious Metals Supply and Demand
      Oil is Different Last week, we showed a graph of rising open interest in crude oil futures. From this, we inferred — incorrectly as it turns out — that the basis must be rising. Why else, we asked, would market makers carry more and more oil?   Crude oil acts differently from gold – and so do all other industrial commodities. What makes them different is that the supply of industrial commodities held in storage as a rule suffices to satisfy industrial demand only for a...
  • Chasing the Wind
      Futility with Purpose Plebeians generally ignore the tact of their economic central planners.  They care more that their meatloaf is hot and their suds are cold, than about any plans being hatched in the capital city.  Nonetheless, the central planners know an angry mob, with torches and pitchforks, are only a few empty bellies away.  Hence, they must always stay on point.   Watch for those pitchfork bearers – they can get real nasty and then heads often roll quite literally....
  • Lift-Off Not (Yet) - Precious Metals Supply and Demand
      Wrong-Way Event Last week we said something that turned out to be prescient:   This is not an environment for a Lift Off Event.   An unfortunate technical mishap interrupted the latest moon-flight of the gold rocket. Fear not true believers, a few positive tracks were left behind. [PT]   The price of gold didn’t move much Mon-Thu last week, though the price of silver did seem to be blasting off. Then on Friday, it reversed hard. We will provide a forensic...
  • Merger Mania and the Kings of Debt
      Another Early Warning Siren Goes Off Our friend Jonathan Tepper of research house Variant Perception (check out their blog to see some of their excellent work) recently pointed out to us that the volume of mergers and acquisitions has increased rather noticeably lately. Some color on this was provided in an article published by Reuters in late May, “Global M&A hits record $2 trillion in the year to date”, which inter alia contained the following chart illustrating the...
  • Cryptocurrency Technicals – Navigating the Bear Market
      A Purely Technical Market Long time readers may recall that we regard Bitcoin and other liquid big cap cryptocurrencies as secondary media of exchange from a monetary theory perspective for the time being. The wave of speculative demand that has propelled them to astonishing heights was triggered by market participants realizing that they have the potential to become money. The process of achieving more widespread adoption of these currencies as a means of payment and establishing...
  • The Fed's “Inflation Target” is Impoverishing American Workers
      Redefined Terms and Absurd Targets At one time, the Federal Reserve's sole mandate was to maintain stable prices and to “fight inflation.”  To the Fed, the financial press, and most everyone else “inflation” means rising prices instead of its original and true definition as an increase in the money supply.  Rising prices are a consequence – a very painful consequence – of money printing.   Fed Chair Jerome Powell apparently does not see the pernicious effects...

Support Acting Man

Item Guides

j9TJzzN

The Review Insider

Dog Blow

Austrian Theory and Investment

Archive

350x200

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

Mish Talk

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com