tisdag, juli 28, 2009
Is the lending of money inflationary?
Some argue that the lending of money is not inflationary. If Adam borrows one ounce of gold from Bruce, Bruce has one ounce less to spend. But that is not the whole truth.
If Adam signs a piece of paper where he obliges himself to pay back what he has borrowed from Bruce and Bruce hands over that piece of paper to Charles in exchange for goods or services, the credit transaction has created additional, inflationary purchasing power.
However, it is of course true that the additional purchasing power will become extinguished once the debt has been paid off. But, as an indisputable matter of fact, the lending of money against the issuance of promissory notes does add purchasing power until the debt has been paid off. I am aware of the fact that the quantity of money proper is not affected, but since the debt of a solvent debtor not seldom can be exchanged for goods and services and sometimes even be used as payments for other debts, the lending of money does create some kind of second-class money.
I have tried to publish comments on Stefan Karlsson's blog where I point out this perfectly obvious fact, but for some reason Stefan Karlsson refuses to publish my comments and insists that the lending of money is not inflationary since the additional purchasing power of the debtor is cancelled out by the decreased purchasing power of the creditor. But, as I have shown here, that is largely incorrect.
A more interesting and puzzling question to be answered is how the lending of money affects gold mining and demand for physical gold under a gold standard. My answer is that the lending of money depresses gold mining and fuels demand for physical gold and that thus the credit expansion under a gold standard ultimately is regulated by the fact that the profitability of gold mining must remain approximately as high as the profitability of other similar businesses in spite of the fact that credit transactions with nominal value in gold do depress the purchasing power of gold.
If Adam signs a piece of paper where he obliges himself to pay back what he has borrowed from Bruce and Bruce hands over that piece of paper to Charles in exchange for goods or services, the credit transaction has created additional, inflationary purchasing power.
However, it is of course true that the additional purchasing power will become extinguished once the debt has been paid off. But, as an indisputable matter of fact, the lending of money against the issuance of promissory notes does add purchasing power until the debt has been paid off. I am aware of the fact that the quantity of money proper is not affected, but since the debt of a solvent debtor not seldom can be exchanged for goods and services and sometimes even be used as payments for other debts, the lending of money does create some kind of second-class money.
I have tried to publish comments on Stefan Karlsson's blog where I point out this perfectly obvious fact, but for some reason Stefan Karlsson refuses to publish my comments and insists that the lending of money is not inflationary since the additional purchasing power of the debtor is cancelled out by the decreased purchasing power of the creditor. But, as I have shown here, that is largely incorrect.
A more interesting and puzzling question to be answered is how the lending of money affects gold mining and demand for physical gold under a gold standard. My answer is that the lending of money depresses gold mining and fuels demand for physical gold and that thus the credit expansion under a gold standard ultimately is regulated by the fact that the profitability of gold mining must remain approximately as high as the profitability of other similar businesses in spite of the fact that credit transactions with nominal value in gold do depress the purchasing power of gold.
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Flavian, we are in almost complete agreement on this matter. You write:
"If Adam signs a piece of paper where he obliges himself to pay back what he has borrowed from Bruce and Bruce hands over that piece of paper to Charles in exchange for goods or services, the credit transaction has created additional... purchasing power."
Of course! Some people seem to be so focused on gold-as-money that then cannot see anything else. But it is often said that Fractional Reserve Banking creates money from nothing. Perhaps even your Stefan Karlsson says it?
"However, it is of course true that the additional purchasing power will become extinguished once the debt has been paid off."
Yes. Under the system of Fractional Reserve Banking, borrowing creates money and paying back what is borrowed again destroys the money. It is very simple, I think.
"But, as an indisputable matter of fact, the lending of money against the issuance of promissory notes does add purchasing power until the debt has been paid off."
Again, yes.
"I am aware of the fact that the quantity of money proper is not affected, but... the lending of money does create some kind of second-class money."
Okay. I do not focus on "proper" money and "second class" money. (Give me a choice and I will take gold. But there is no choice.) Money created by lending is generally not counted in M1 (money in circulation) here in the U.S.A. If it was counted in M1, then the M1 number would be greater than Total Debt. But it is not.
However, economists seem to allow for this bank-created money by saying that "velocity" is faster.
I think this is silly. I think it confuses the issue. I think it is wrong. But that is how it is done.
I think we agree on this topic.
"If Adam signs a piece of paper where he obliges himself to pay back what he has borrowed from Bruce and Bruce hands over that piece of paper to Charles in exchange for goods or services, the credit transaction has created additional... purchasing power."
Of course! Some people seem to be so focused on gold-as-money that then cannot see anything else. But it is often said that Fractional Reserve Banking creates money from nothing. Perhaps even your Stefan Karlsson says it?
"However, it is of course true that the additional purchasing power will become extinguished once the debt has been paid off."
Yes. Under the system of Fractional Reserve Banking, borrowing creates money and paying back what is borrowed again destroys the money. It is very simple, I think.
"But, as an indisputable matter of fact, the lending of money against the issuance of promissory notes does add purchasing power until the debt has been paid off."
Again, yes.
"I am aware of the fact that the quantity of money proper is not affected, but... the lending of money does create some kind of second-class money."
Okay. I do not focus on "proper" money and "second class" money. (Give me a choice and I will take gold. But there is no choice.) Money created by lending is generally not counted in M1 (money in circulation) here in the U.S.A. If it was counted in M1, then the M1 number would be greater than Total Debt. But it is not.
However, economists seem to allow for this bank-created money by saying that "velocity" is faster.
I think this is silly. I think it confuses the issue. I think it is wrong. But that is how it is done.
I think we agree on this topic.
The lending of money creates second-class money. Second class money is not money proper, but the role of money proper under a gold standard is only to regulate the credit expansion.
If somebody deposits gold in the banking sector he thereby creates an inflationary signal. If more gold is deposited banks are encouraged to engage in more daring credit transactions and vice versa.
Credit expansion increases the demand for gold and makes jewelry business withdraw more gold with the result that the credit expansion slows down.
99% of all transactions are paid for through the exchange of debts and only a minor fractrion by payments in money proper. Still money proper plays a very important role since transactions in money proper regulate the credit expansion just like an exchange rate target on behalf of a currency board regulates the credit expansion in a jurisdiction with currency board.
So the role of gold under fractional reserve banking is to function as an exchange rate target.
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If somebody deposits gold in the banking sector he thereby creates an inflationary signal. If more gold is deposited banks are encouraged to engage in more daring credit transactions and vice versa.
Credit expansion increases the demand for gold and makes jewelry business withdraw more gold with the result that the credit expansion slows down.
99% of all transactions are paid for through the exchange of debts and only a minor fractrion by payments in money proper. Still money proper plays a very important role since transactions in money proper regulate the credit expansion just like an exchange rate target on behalf of a currency board regulates the credit expansion in a jurisdiction with currency board.
So the role of gold under fractional reserve banking is to function as an exchange rate target.
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