Have you ever seen people at a store or shopping mall with "too much money" in their pockets and "too few goods" to spend it on?
Me neither.
Yet I continually hear well-meaning people parrot the Austrian School myth that, anytime a new paper dollar is added to the money supply, the dollars already in existence automatically become worth less, resulting in
inflation ("too much money chasing too few goods").
This is misleading at best. Allow me to explain why.
If, over the course of a given year, economic output increases 3%, yet the money supply increases only 1%, then that 1% increase will be
deflationary, not inflationary, because there will consequently be
less money in circulation relative to the amount of goods and services available for sale.
If the expansion rate of the money supply merely keeps pace with economic output, then there is neither inflation nor deflation.
It's only when money creation dramatically outpaces the production of new goods and services that one has inflation, and even then only if there isn't an offsetting decrease in
money velocity (such as we've seen since 2008 due to plummeting
consumer confidence).
And the above applies merely to overhyped "demand-pull" inflation.
What almost never gets talked about is
cost-push inflation; and even when it
is talked about, virtually no one ever mentions the primary causative roles that are played by (a)
interest on bank loans, and (b)
land speculation.
For a better understanding of what I mean, consider the following three excerpts (the first from Ellen Brown's
Web of Debt, the second from
The Truth In Money Book, the third from the web site henrygeorge.org):
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The
gold standard and the inflation argument that was used to justify it were based on the classical "quantity theory of money." The foundation of classical monetary theory, it held that inflation is caused by "too much money chasing too few goods." When "demand" (the money available to buy goods) increases faster than "supply" (goods and services), prices are forced up. If the government were allowed to simply issue all the Greenback dollars it needed, the money supply would increase faster than goods and services, and price inflation would result. If paper money were tied to
gold, a commodity in limited and fixed supply, the money supply would remain stable and price inflation would be avoided.
A corollary to that theory was the classical maxim that the government should
balance its budget at all costs. If it ran short of money, it was supposed to borrow from the bankers rather than print the money it needed, in order to keep from inflating the money supply. The argument was a "straw man" argument -- one easily knocked down because it contained a logical fallacy -- but the fallacy was not immediately obvious, because the bankers were concealing their hand. The fallacy lay in the assumption that the money the government borrowed from the banks already existed and was merely being recycled. If the bankers themselves were creating the money they lent, the argument collapsed in a heap of straw. The money supply would obviously increase just as much from bank-created money as from government-created money. In either case, it was money pulled out of an empty hat. Money created by the government had the advantage that it would not plunge the taxpayers into debt; and it provided a
permanent money supply, one not dependent on higher and higher levels of borrowing to stay afloat.
The quantity theory of money contained another logical fallacy, which was pointed out later by British economist John Maynard Keynes. Adding money ("demand") to the economy would drive up prices only if the "supply" side of the equation remained fixed. If new Greenbacks were issued to create new goods and services, supply would increase along with demand, and prices would remain stable. When a shoe salesmen with many unsold shoes on his shelves suddenly got more customers, he did not raise his prices. He sold more shoes. If he ran out of shoes, he ordered more from the factory, which produced more. If he were to raise his prices, his customers would go to the shop down the street, where shoes were still being sold at the lower price. Adding more money to the economy would inflate prices
only when the producers ran out of the labor and materials needed to make more goods. Before that, supply and demand would increase together, leaving prices as they were before.
Inflation in a debt-dominant money system, such as the system administered by the Federal Reserve, is correctly defined as: debt-induced currency devaluation. In fact, it is
only in a debt-dominant money system that inflation has ever occurred, from the first recorded inflation that destroyed ancient Babylonia over 4,000 years ago, to the present day.
Inflation is characterized by the loss of purchasing power of the dollar (or any other monetary unit). Steadily rising prices are a
symptom of this loss of purchasing power. It is the devaluation of the dollar that forces general price increases.
The dollar's devaluation, in turn, is caused by the inherent flaw in the debt-dominant money system, namely, the creation of most money as debt. This locks the system into a vicious cycle of escalating borrowing in a futile effort to pay both interest and principal. A debt-dominant money system is naturally deflationary, due to the built-in shortage of money to pay interest. The shortage forces continually increasing borrowing, which requires continually increasing prices to cover the cost of business borrowing.
The devaluation of the dollar leads to a valid demand for growth of the money supply. More money is borrowed into existence to meet this demand, but the amounts are never enough to keep pace with the growing cost of debt which triggered the cycle in the first place.
The growth of the money supply which occurs during times of inflation is simply the result of businesses and individuals escalating their borrowing. They do this in order to pay higher interest costs, either their own or their own plus the higher interest costs reflected in the rising prices of goods, services, and overhead. The primary cause of this escalation is a chronic shortage of money. The money shortage is equal to the uncreated, unpayable interest due on the escalating debt.
This growth of the money supply is widely mistaken to be the cause of inflation, whereas in fact it is only
another symptom of inflation. The mistake of calling an increase in the money supply the cause of inflation is based on the belief that money is like a commodity which becomes more valuable when it is scarce and less valuable when the quantity available increases.
If inflation really is a condition of too much money in the system, it would be reasonable to ask every citizen to burn a $20 bill daily in order to bring down the money supply.
Also, if the theory that money is like a commodity is true, money borrowed at high rates of interest ought to be very valuable and buy more goods than money borrowed at low interest. However, recent experience has shown that money borrowed at 20% interest bought far less in 1981 than money borrowed at 8% interest several years earlier.
In the debt-dominant money system, prices increase as a reflection of the escalating interest charges being incurred by producers. The term "price inflation" clearly identifies the process of rising prices. However, the term "inflation," when applied to the economy as a whole, fails to identify the phenomenon in operation which causes prices to rise, and is therefore misleading. The more accurate and descriptive term for the mis-called "inflation" phenomenon is
debt-induced currency devaluation.
http://www.henrygeorge.org/bust.htm
A theory of economic boom and crash is one of
Henry George's two great purposes in
Progress and Poverty. What is the root cause of the "paroxysms of industrial depression"?
The root cause, says Henry George, is the speculative rise of land prices, which cuts into the earnings of
labor and
capital. Land rents and prices rise at a faster rate than general economic growth, because of two unavoidable facts:
- Land is fixed in supply.
- Land is needed for all production.
When sufficient numbers of workers and capitalists cannot afford to produce at the higher
rents brought about by growth and
speculation, production begins to stop.
Let us examine some of the implications of this fact for modern economies:
New Construction is Limited. If builders must pay too much for building sites, it takes from their profit by raising their costs. Their profit on investing in the building itself is what stimulates investing, which in turn is what makes jobs and incomes.
Business Costs Go Up. Businesses that rent their premises also get squeezed by rising rents. Here's an example: A merchant goes into a new shopping center with a long term lease. His rent is often too high, but he pays it to hold his position for the later term when he hopes the rent will be a bargain. Landlords writing long-term leases get used to this, and hold out for high rentals.
Nonproductive Investments Become More Profitable than Productive Ones. Let’s say that you own some land, which you might decide to improve. But, you have the option of selling the land to a speculator. Why improve the land if the profits on your improvements would yield little more than merely collecting the speculation-hyped value of the vacant site? Landowners will "site-sit" and wait, if they believe future development will be much more gainful than development for the current market. When the workaday facts of today begin looking dull and prosaic next to the gleaming expectations of tomorrow, look out.
Banking and Credit is Destabilized. Builders needing land borrow to buy it, even though the price is too high, gambling that future rises in rents will let them repay the loan. If these rent rises fail to happen, they go bankrupt. Their buildings are not destroyed, but the capital they used to build on them was misdirected, so much of it is economically lost: the buildings lose their market value.
Unlike items of wealth, which are priced according to their cost of reproduction at the present time, land is not produced -- so it has no cost of production. Yet it is bought and sold, like articles of wealth. The selling price of land is determined by comparing its income potential with that of an equivalent value of wealth, through a process called
capitalization.
Here's how that works. However, the capitalization of current rent is only the beginning. With land, there is nearly always an added premium reflecting expected price increases in the future.
Speculation raises land prices beyond the sites' current use values. Credit is extended farther in order to accommodate this. That is, banks lend on overpriced land, counting on a further rise. When the rise slows, they extend the loans, sometimes even granting new loans for paying interest on old loans. They use political pressure to get governmental agencies (e.g. the World Bank) to extend or underwrite these risky loans (e.g. in Latin America). When the bubble bursts, the loans are not repaid. This destroys capital. The Savings & Loan fiasco of the 1980s is a case in point, but the basic dynamics are there in every recession.
This is not a new phenomenon.
John Stuart Mill had written (before Henry George) of a tendency of lenders, when legitimate demand for loans dries up, to "lower the quality of credit" by accepting high-risk loans they would have spurned before. Because land value is such a large part of collateral on loans, and land values fluctuate wildly in business cycles, the tendency toward these volatile, high-risk lending practices is very strong.
Why don't capitalists needing land simply join in the speculative game? Couldn't they buy land at speculative prices and use it while it continues to rise in value? Actually, that's what they all do. No one can justify buying and holding land at today's prices without counting the future advance in price or rent as part of his or her gain. Thus everyone is hooked, forced by the market to participate in the speculative game, once it gets started. All become implicated and habituated, emotionally and politically, whether they like the principle or not. Eventually people forget that there could be any other way of doing business.
How do labor and capital resist advances in land value, when they must have land in order to produce? By ceasing production. What does this mean in real life? Labor and capital decline to buy or rent land at the high asking prices. Some will rent or buy less land, and use it more intensively. Some will sleep on the street, or sell from the sidewalk. Some will retreat to little patches of marginal land. Some will buy as much land as ever, but thus use up funds they otherwise would have used to improve it, becoming withholders themselves. Some will organize and pass counterproductive rent-control laws. The economy-wide net result will be less production, more unemployment.
The question that many modern-day economists fail to ask is this: How do investors react to a set of incentives where expected changes in land value are made part of the overall return on investment -- and land price is part of the investment on which return is figured? This has several results:
- Many are screened out by the increased need for credit.
- Rising land value becomes part of the incentive to build. It can't go up forever. When it levels off at a high level, it becomes a serious drag. When it starts falling, it is worse.
- Land value becomes collateral; its wild swings destabilize credit and money.
- A lot of land is unused, (or run down in its present use), as the holder waits for a possible higher use that never materializes. In and after a crash, bid prices for land fall, but asking prices stay high, so sales drop like a stone. This behavior is inconsistent with the premises of the "rational expectations" theorists, but is good history: it has been extensively documented, over several giant cycles of boom and crash.
Land Speculation and Inflation?
There are as many different theories of the basic cause of inflation as there are for depressions. But since today's business cycle seems to involve a constant tension between periods of inflation and periods of unemployment/recession, the two phenomena clearly are linked.
George said almost nothing in
Progress and Poverty about inflation; in his day industrial depression was a much more serious problem. However, inflation was not unheard-of in those days, and a strong connection is implied in George's reasoning. Consider the following statement regarding George's remedy (which this course is soon to consider): "Taxes may be imposed upon the value of land until all rent is taken by the state, without reducing the wages of labor or the reward of capital one iota; without increasing the price of a single commodity, or making production in any way more difficult."
What has this to do with inflation? George identifies
land rent as an income that does not come from production; it is, in effect, a tax on production, the burden of which increases as production increases -- due to rising demand for the fixed supply of land. The tendency of this process is, as we have seen, to raise land rents beyond the marginal ability of labor and capital to pay them -- and depression is the result.
This process can be forestalled, temporarily at least, by increasing the money supply. Remember, the income of landowners increases as overall production increases, even though landowners make no contribution to production! The buying power that landowners gain, laborers and capitalists lose. But the effect of this can be blunted by increasing the money supply. When then supply of money increases faster than the supply of actual wealth, that's called inflation. An increase in the money supply can stimulate demand for goods, for a while -- if people have a certain amount of money to spend, they will try to spend it before it loses its value. Thus, an increase in the money supply, via lowered interest rates, can keep a period of economic growth alive -- at least until after the next election.
However, even this expediency is thwarted by the process of land speculation. As we
explained here, land prices are arrived at via the process of capitalization. Essentially, the annual rent of a site is divided by the current rate of interest, and this capitalized rent is the basis for the selling price (most often a speculative premium will be added). Now, if the central bank lowers interest rates to free up the money supply, this means that the divisor, the capitalization rate, is a lower figure -- and therefore land prices will increase!
Many analysts, for example, note that the persistently low interest rates maintained by Alan Greenspan's Federal Reserve in the early 2000s played a key role in the "housing boom" that followed. Of course, in the real world a great many factors influence financial markets, and particular market situations are extremely complex. However, this by no means denies the pivotal, fundamental role played by land rent and land speculation. Eventually, in a growing economy (even if the growth is only a short-term blip brought about by fiscal stimulus), increased rents will consume the extra buying power. Then, one of two things must happen: either the money supply must be increased further, risking runaway inflation -- or there must be a recession.
[
Continued...]
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Thus, contrary to what the monetary flat-earthers and economic snake-oil salesmen from the Austrian School would have everyone believe, inflation -- under the current system -- is
not caused by "government printing too much money."
First of all, the bulk of our money supply isn't even paper, but mere numeric entries on the books of some bank.
Second, the government doesn't print "money," otherwise it wouldn't have to
borrow it all the time. What the government "prints" is
currency. But that currency does not become "money" (legal tender) until it's been
issued by the private banking system, which does so by
lending it at interest.
It is thus
private banks who've been causing inflation all these decades, and they've done so by (a) loaning out trillions of dollars they
didn't even have, and (b) never creating the money needed to pay the usurious interest on all these inherently fraudulent loans -- thereby forcing indebted business owners, as a whole, to silently incorporate the
cost of this
unpayable interest debt into the selling price of virtually everything we buy (a form of "cost-push" inflation one never hears about from news anchors, media pundits, or either Austrian or Keynesian ideologues); and
consumers, as a whole, to continually
borrow more in order to afford the usury-induced price increases.
Land speculation then makes matters worse by driving up the location values of a fixed supply of land, and hence the
cost of either renting or purchasing that land (another form of cost-push inflation one never hears about). And since land isn't a product of human labor, and since the increased cost of renting or purchasing it forces the cash-strapped masses to borrow
still more, this has the effect of (a) delinking money creation increasingly further from the production of new goods and services, and thus of (b) increasing the amount of money there is in circulation relative to the amount of goods and services available for sale, thereby triggering eventual demand-pull inflation as well -- though not as much as one might think, since this is
offset to a significant degree by both
* the fact that money vanishes from the money supply whenever the principal of a bank loan is repaid; and
* the deflationary impact that mortage loan defaults have on the money supply, due to the fact that pledged collateral usually sells for much less than what the bankrupted homeowner or business owner owed on it, and how this in turn forces the bank to offset the unpaid principal dollar for dollar from its capital assets. The more this happens
nationwide, the less banks as a whole can lend. The less banks can lend, the more the
gap between (a) the overall indebtedness of the economy (principal-plus-interest) and (b) the amount of money there is in circulation to pay it off
increases (since interest debt continues to increase at a compounding rate regardless of whether the money supply increases along with it). And as that gap increases, more and more people are consequently forced into bankruptcy, thus creating a vicious, self-perpetuating cycle of bankruptcies, increased money shortages, followed by still further bankruptcies.
(The above two factors, coupled with the dramatic decrease in the velocity of money brought on by record lows in consumer confidence, are why -- in mid-2010 -- we have yet to experience the runaway
hyperinflation that many were insisting as far back as late 2008 was just around the corner.)
Thus, while there is undoubtedly a certain degree of inflation that may be accurately classified as "demand-pull," much if not most of it is actually
cost-push inflation (for the reasons explained above). And whatever demand-pull inflation we do have is driven primarily by land speculation and the consequent delinking of money creation from wealth production.
