Men spin myths as spiders spin webs…
Eve and Adam munched the apple, Zeus kinged Earth, Washington axed the cherry tree.
To these fantastic fictions we must add another:
Money and wealth are synonyms. Money is wealth and wealth is money.
This myth — this deathless myth — commands our attention today.
Murdered and buried 1,000 times, 1,001 times it has stormed from its tomb. The very gods envy its immortality.
Man chased these gods down from Olympus aeons ago. Yet the money myth lives, breathes, prospers in A.D. 2020.
Inflation: The Birth of a Thousand Illusions
Explains Henry Hazlitt in his masterly Economics in One Lesson (1946):
The most obvious and yet the oldest and most stubborn error on which the appeal of inflation rests is that of confusing “money” with “wealth”… So powerful is the verbal ambiguity that confuses money with wealth, that even those who at times recognize the confusion will slide back into it in the course of their reasoning…
Yet the ardor for inflation never dies. It would almost seem as if no country is capable of profiting from the experience of another and no generation of learning from the sufferings of its forebears. Each generation and country follows the same mirage. Each grasps for the same Dead Sea fruit that turns to dust and ashes in its mouth. For it is the nature of inflation to give birth to a thousand illusions.
China first went chasing after this false fruit in the ninth century CE.
The results were… predictable.
By 1448 CE currency — face-valued at 1,000 — was trading for 3.
By 1455 China turned to silver to jam inflation back in its cage. It did not revisit paper until the late 19th century.
Meantime, Rome clipped coins, famously.
Kings, princes, prime ministers and presidents throughout history have bitten the same Dead Sea fruit.
In each instance it turned to dust and ashes in their mouths.
A Thought Experiment
Money does not create wealth. Money no more creates wealth than yardsticks create yards.
Please direct your attention to 18th-century philosopher David Hume…
Imagine, said Hume, that a benevolent fairy drops money into every pocket overnight. Instantly the money supply doubles.
But is this society doubly rich?
Alas… it is not.
The money supply has doubled, yes. But no additional goods have entered existence.
The new money will simply chase existing goods. Thus we can expect prices to roughly double as the fresh money runs them down.
The late economist Murray Rothbard:
What makes us rich is an abundance of goods, and what limits that abundance is a scarcity of resources: namely land, labor and capital. Multiplying coin will not whisk these resources into being. We may feel twice as rich for the moment, but clearly all we are doing is diluting the money supply. As the public rushes out to spend its newfound wealth, prices will, very roughly, double — or at least rise until the demand is satisfied, and money no longer bids against itself for the existing goods.
And so we come to this question: What then is the proper money supply?
Money and “Price Stability”
Should the money supply increase each year to match that year’s increase of goods?
That is, if the stock of goods increases 2%… should the money supply increase 2%?
Many would argue yes. It is the way to “price stability,” they would say.
They concede that an overproduction of money relative to goods will yield inflation. That is, if money production increases 4% while goods production increases 2%.
But they will likely tell you that gentle inflation is tolerable — even healthy. It spurs the consumer to spend… which adds a figure to the gross domestic product.
That is because consumers will purchase goods today knowing their dollar will fetch them less tomorrow.
A little inflation can therefore keep an economy on the jump… and business in funds.
Conversely, an undersupply of money relative to goods works the opposite effect. That is, if money production increases 2% while goods production increases 4%.
Deflation means people will delay today’s purchases. That is because they expect lower prices tomorrow. And so tomorrow’s dollar packs more oomph than today’s dollar.
What is the ultimate result, the evil result?
Goods will wallow upon shelves, stockrooms will overflow… and the wheels of commerce will slow to a standstill.
Under extreme deflation they may stop entirely.
Thus is deflation the ultimate bugaboo, the ultimate fee-fi-fo-fum, the ultimate devil of monetary economics.
The money supply must therefore increase continually — lest deflation menace.
That is the theory as it generally runs. Do you question it?
As well question the reality of Noah’s Ark… or Russian sabotage of American elections… or of gravity itself.
But is it true? Is deflation really the supreme monetary evil?
Why Do People Keep Buying Computers and Large-Screen Televisions?
Consider, if you will, computers. Consider large-screen televisions.
Their prices slide lower year after year.
Yet computers and large-screen televisions do a very brisk trade — despite consumer expectations of falling prices to come.
Where then is Armageddon?
If deflation was so vicious… why do consumers continue purchasing this gadgetry… rather than waiting for next year’s prices?
Thus we revisit this question: What is the proper money supply? Is there one?
Could the economy even rub along without any increase in the money supply whatsoever?
That is, if the money supply was eternally frozen in place.
Paul Krugman would denounce you as an agent of darkness if you suggested it. But consider…
The Mystery of Prices
In an economy of fixed money, all goods and services must bid against the existing money stock.
Some prices would rise on supply and demand. Others would fall on that same supply and demand.
Consumers may prefer product X to product Y this year — for example.
The price of X will rise. And the price of Y will fall… all else being equal.
The maker of X will therefore profit, even in a world of fixed money. His purchasing power would in turn increase.
But what about the maker of Y?
He must lower his prices. But the consumer is the beneficiary. He can purchase Y at a reduced price. His purchasing power has therefore increased.
And so it goes, back and forth, forth and back.
We are led then to this throttling conclusion: The argument that the money supply must constantly expand finds little excuse in the facts.
If prices are free to seek their own equilibrium, changes to the money stock are unnecessary.
Any amount of money will do the duty of any other.
“We Come to the Startling Truth That It Doesn’t Matter What the Supply of Money Is”
Explains the grandee of “Austrian” economics, Ludwig von Mises:
As the operation of the market tends to determine the final state of money’s purchasing power at a height at which the supply of and the demand for money coincide, there can never be an excess or deficiency of money. Each individual and all individuals together always enjoy fully the advantages which they can derive from… the use of money, no matter whether the total quantity of money is great or small… The services which money renders can be neither improved nor repaired by changing the supply of money… The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.
Here the aforesaid Murray Rothbard — who learned at Mises’ elbow — affirms:
We come to the startling truth that it doesn’t matter what the supply of money is. Any supply will do as well as any other supply. The free market will simply adjust by changing the purchasing power, or effectiveness of [money]. There is no need to tamper with the market in order to alter the money supply that it determines.
To repeat — for emphasis:
Any amount of money is as good as any other. And there is no screaming need to add more.
Thus we declare ourself heretic today, raise our infidel flag… and train our cannons on the castle walls of the economics profession.
In conclusion, we petition the government to shutter the Federal Reserve — and to point its members toward productive employment in private industry.
Their services are not required. They never were…
Managing Editor, The Daily Reckoning