Barrons on Monetary Realism

Nice quote in Barrons this week from a regular reader Stephen W on MR:

“Your editorialist, Thomas G. Donlan, wrote, “People might learn that it’s all funny money.” I suggest we use the more proper term “fiat money,” wherein our nation is an autonomous issuer of its own currency, existing within a floating exchange-rate system.

We must be careful comparing the federal government with a household (or state or business) because Washington has no solvency constraint. The federal government can’t run out of money (unless Congress decides it should), as it can always call on the banks and the Federal Reserve to serve as agents of the government.

The constraint is inflation, not solvency. But given the weakness in our economy, along with high unemployment, I don’t see much risk of inflation anytime soon.”

That’s precisely right.  We need to really hammer this out there.  Although the US government has outsourced the creation of money to the private banking system it still wields incredible power via its ability to tax and essentially bribe banks to do its bidding.  Of course, an autonomous government doesn’t eliminate the risk of hyperinflation occurring, but it does eliminate the risk of running out of money.  So, when we discuss the debt ceiling and other such debates it’s foolish to think of the government like a household.  Unless you have the ability to tax $16 trillion of output then you’re not in the same boat as the government.

Anyhow, thanks to Steve W on helping others better understand the way our monetary system is actually designed.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. Cullen at the hyperbolic far fetched improbable limit isn’t hyperinflation the same as insolvency for an autonomous issuer of their own currency

    • Yeah, but this debate is all about understanding the causes of specific diseases. Insolvency for the autonomous currency issuer doesn’t involve running out of money as most people think. It involves printing massively in excess of productive capacity or other rare exogenous events that I’ve previously discussed. I personally don’t see any risk of hyperinflation in the USA so to conclude that the current environment creates some insolvency risk (of any kind) appears misguided to me….

      • I would argue hyperinflation is not caused by a monetary phenomenon, but a psychological one, i.e., printing money will not cause hyperinflation, a lack of faith in the currency will.

        That lack of faith translates to higher bond rates, which in turn leads to unsustainable interest payments and lower growth, which in turn leads to money printing and hyperinflation.

        The FED has no clue what was about to happen in 2007, you really think they have, in their supposed infinite wisdom, the ability to forecast hyperinflation? Place your bets wisely.

        • The “lack of faith” argument doesn’t fully connect the dots. What causes this “lack of faith”? There needs to be a real fundamental cause. Otherwise, it’s like saying that lack of faith in the stock market causes price declines. No, a lack of faith not backed by a fundamental cause results in fools selling shares at low prices to smart money buyers. Hyperinflation is certainly more than a monetary phenomenon, but these phenomena are very real fundamental events that lead to a hyperinflation. They aren’t mere reductions in faith based on misconception or other non-fundamentally based things. If that were the case QE and all the silly fearmongering over “money printing” would have caused hyperinflation in the USA long ago….Most Americans think we’re bankrupt and printing money like Zimbabwe. If understanding the monetary system is a prerequisite for “faith” in the economy then the USA has been running on empty for a very long time. And the USD is still there with all these same people still clamoring to get their hands on more of them….

          • Lack of faith…sure. You could start with an ever-increasing national debt. Falling incomes. Record high welfare. HFT algos running the stock market, prompting the retail investor to exit due to lack of trust. 9% approval rating of Congress. A promise by the FED to continue to debase your dollar by 2% a year regardless of your salary, food prices, gas prices and rent. Gold / Silver coin sales at record highs. “Doomsday Preppers” highest rated show in NatGeo. Gun / ammo sales through the roof.

            It is cumulative. You cannot predict the event or the date, you only know which season it is, unless you are on CNBC, where it’s always Spring.

            • I don’t think there’s much historical precedent for any of those things causing a hyperinflation. I guess there’s a first for everything, but I still don’t see a sound argument for it. I’ve been debunking hyperinflation arguments for 5 years now and still have yet to see a single one that convincingly connects the dots.

      • Those “rare exogenous events” may be rare on the scale of a single, randomly chosen, human lifetime, but still be guaranteed to occur in the not so distant future from the overall direction of history and our current place on the timeline.

    • Thanks. Cullen should get full credit, but Barron’s edited out my mention of his work.

  2. Anyone who actually pays attention to prices in stores on anything from beef to laundry detergent to apples to motor oil, let alone prices for medical care/insurance to tuition must simply shake their head in AMAZEMENT at the proclamations from anyone claiming inflation is subdued, let alone anything other than not rampant.

    No matter how many “charts” and indexes are thrown at the wall, with ridiculously errant and even intentionally manipulated measures intended to understate the actual rate of inflation, anyone who…you know…actually buys food, gasoline, medical insurance, tuition or just about anything else, can confidently proclaim that inflation is running at a very high annual clip.

    The fastest way to lose all credibility with the American People (those who actually manage the family bills) is to tell them that “inflation is low” as this is pure, unadulterated B.S.

    • i totally agree. do anyone notice that the portion of the entree quietly shrink in the same restaurant that you go to for years? or the “new package” of anything from cereal to chocolate actually means a few oz less for the same price? even in Costco, do you notice that they use to sell shampoo in two-bottle package for 11 but now sell one bottle for 7?

      and don’t get me start on the rental cost.

      inflation is alive and thriving, except for the middle-class paycheck.

      • Inflation measures are not meant to apply specifically to an individual as each person consumes a basket of specific goods that may or may not change prices. It’s important to separate inflation from price changes due to supply and demand. Good case in point. I live in the Midwest and Broccoli prices went from $.99 cents a bushel to $2.49 within a week. This wasn’t inflation but rather the market allocating a scarce amount of goods between indifference levels. Food & Energy are always poor measures of inflation as prices decrease and increase rapidly which makes them poor for trend forecasting. We were not suffering from deflation when oil fell from $130 a barrel to $40 a barrel.

        My consumption pattern shows falling to no inflation for everything over the last year. Low food costs, gas costs, falling clothing costs, eating out is cheap, bowling has gotten more expensive, newspaper more expensive, MMA lessons same, etc. I would say the current CPI accurately measures the change in my costs, however, it is not meant to be a specific measurement for each individual. An 80 yr consumes an entirely different set of goods than someone in their 20′s. Thus they may be more or less affected by price changes between items.

        Changes to portion sizes are not inflation related but driven by a need to increase profits, etc. Those aren’t comparable things. The way inflation is measured is fine and other people utilize different measures. Some place more emphasis on housing prices, medical prices, etc. but it does necessarily mean they are more accurate or less accurate.

        • I partially disagree. A change in portion sizes IS inflation. The Hershey Bar is the classic example cited in economics textbooks. The item has a “customary price”, so the producer makes more $$$ by cutting the size and keeping the price the same. Once the bar got small enough, they started increasing the price as well.

          Food and Energy have both a cyclical component and a systematic component. It is correct to ignore the cyclical component as measure of inflation. But the systematic component should not be ignored. As oil becomes ever scarcer in coming decades, the systematic component should increase, and there should be massive price shocks as geopolitical events cause latent pent-up inflation to be realized.

          The USA has had hyperinflation in the distant past. The Continental Congress issued Fiat money without a tax return path during the Revolutionary War. That experiment failed quickly. The Confederacy also experienced hyperinflation near the end of the Civil War. Instead of pooh-poohing the notion that hyperinflation could happen in the USA, one should instead be discussing realistic scenarios that could produce true hyperinflation in this country. There are some, even if they don’t seem especially likely at the moment.

          • Hyperinflation will not occur in the US unless productive capacity falls close to zero and the US is forced to import all necessary goods using a foreign currency while purchasing that currency through outright fiat creation. If that occurs then the rest of the world will be in an bad situation too. Hyperinflation within the US rests in the same category as monsters under the bed and winning a $300MM Powerball Jackpot.

            Portion size changes are not inflation as they cannot be accurately measured nor do they fit within the definition. That is a relative measurement and the only evidence I can find for portion changes is a 2011 article that covers a couple of processed products. The amount of items covered in the CPI calculation is substantial and available to view, even if we accept that some goods had portion changes the effect on the overall measurement is nil. Billion prices project covers an incredible amount of goods and their numbers come close to matching US CPI numbers.

            Systematic Components are difficult to identify in energy markets with all the noise but Saudi Output is a good indicator and it has been falling lately. All non-renewable inputs will rise overtime until adequate substitutes are introduced.

            • Sorry, but you’re flat wrong on portion sizes.
              If 12 ounces of peanut butter costs $3, but the new jar still costs $3 but has 10 ounces, there has been a 17 percent price hike. The kids aren’t going to eat less because the jar is smaller.
              Again, sorry, but it’s amazing the number of people who can tell us we’re not spending more each month on our monthly bills.

          • you’re not seriously comparing the confederacy hyperinflation to today, are you? that is the perfect example of a collapse in productive capacity being the problem. meanwhile, the little I’ve read of the Revolutionary money printing it was counterfeiting by the British in an attempt to destroy the American economy, and it largely backfired as it led to higher production. calling hyperinflation ONLY a money printing problem can only come from not doing your homework. you either have a production collapse like the confederacy and Zimbabwe, or you owe debts in a currency other than your own, like gold. And you “solve” that problem not by becoming more productive, but my printing along with no other constructive changes.

            • Meanwhile, US corporations are meaner and leaner than ever before. I don’t think our productive capacity’s in any danger any time soon.

              The hyperinflationistas forget one of the definitions of inflation: “too much money chasing too few goods”. If your production is always increasing, it’s hard to have hyperinflation.

      • I notice that the flat screen TVs on sale at Costco are now about a $1000 less, and they’re thinner and lighter and have a bigger viewing area than the one I paid for 4 years ago.

        I have three renters. I have not raised the rent on them for more than 4 years. I’m just glad they all still rent. The cost of a mortgage for a similar property to the one I rent out is about 2/3 of what I charge in rent.

        Speaking of which my mortgages have all done nothing but go down. When I purchased my primary residence in 1999 I had 7 3/4. Now I’m paying 4 1/8. I could go lower still.

        Pizza place still send out coupons for $5 large pizzas. It still costs about $12 for an all you can eat lunch at the Mongolian BBQ (which I take FULL advantage of). Two tacos at Jack in the Box for $.99 still… still that mysterious orange semi-meat like filling. I get a strange craving for those once in a great while. I haven’t noticed that they’ve gotten EVEN WORSE! (but perhaps they have).

        Gas prices all over the map.

        I don’t know. I don’t see a clear trend.

        • Gas is at a record high now for this time of year.

          Residential electric rates hit an all time high last October, in spite of shale gas etc.

          I tried one of those $5 large pizzas and it was awful – fake cheese, crust like gooey cardboard, etc.

          There are also many similar items I could quote that have gone up in price and/or down in size or quality.

          • if you’re electric is from formerly cheap unregulated coal, then you’re electric bill has and/or will be going up. that has nothing to do with money printing.

        • Tom, you are a good landlord, and I guess you are not in the SF bay area. My landlord already paid off the house but she would still adjust (increase) the rent based on the market, and the rent is the largest part of the living cost.

          In SFBay many have so-called 6-figure income but can barely save money, if any at all.

    • Why is tuition/education going up – you can largely thank “free market” ideology – cut taxes, cut gov spending – which may not have happened on the natl level, but has at State/Local. California is the perfect example – Prop 13 destroyed property tax revenue which destroyed free/cheap education.

      Why are health care costs going up? demand from an aging and increasingly obese society is probably the biggest factor. we are so much less healthy than we used to be, yet we are living longer. there are, of course other reasons too

      and for food prices – oil inflation (a worldwide commodity with increasing demand) impact it, climate change effecting supply, growing demand from the world and from our ever growing US population and waste lines, etc, etc.

      Lastly, lack of wage inflation makes the purchase inflation you’re experiencing seem far worse. Too many people point fingers at Fed “money printing” which means they are unaware of the real causes. Without knowing what the actual problems are we’re never going to fix them.

  3. Cullen, regarding inflation, if the central bank, acting alone, wanted to raise the rate of inflation… say to 4%, starting from where we are now (inflation, economy, everything), what do you suppose it would try? How successful would it be do you think?


    They say that time is money.* What they don’t say is that money may be running out of time.

    But Banking and central banks carried within them an inherent instability that required the perpetual creation of more and more credit to stay alive. Those initial loans from that first deposit? They were made most certainly at yields close to the rate of real growth and creation of real wealth in the economy. Lenders demanded that yield because of their risk, and borrowers were speculating that the profit on their fledgling enterprises would exceed the interest expense on those loans. In many cases, they succeeded. But the economy as a whole could not logically grow faster than the real interest rates required to pay creditors, in combination with the near double-digit returns that equity holders demanded to support the initial leverage – unless – unless – it was supplied with additional credit to pay the tab. In a sense this was a “Sixteen Tons” metaphor: Another day older and deeper in debt, except few within the credit system itself understood the implications.

    Not only is more and more anemic credit created by lenders as its “sixteen tons” becomes “thirty-two,” then “sixty-four,” but in the process, today’s near zero bound interest rates cripple savers and business models previously constructed on the basis of positive real yields and wider margins for loans. Net interest margins at banks compress; liabilities at insurance companies threaten their levered equity; and underfunded pension plans require greater contributions from their corporate funders unless regulatory agencies intervene. What has followed has been a gradual erosion of real growth as layoffs, bank branch closings and business consolidations create less of a need for labor and physical plant expansion. In effect, the initial magic of credit creation turns less magical, in some cases even destructive and begins to consume credit markets at the margin as well as portions of the real economy it has created. For readers demanding a more model-driven, historical example of the negative impact of zero based interest rates, they have only to witness the modern day example of Japan. With interest rates close to zero for the last decade or more, a sharply declining rate of investment in productive plants and equipment, shown in Chart 2, is the best evidence. A Japanese credit market supernova, exploding and then contracting onto itself. Money and credit may be losing heat and running out of time in other developed economies as well, including the U.S.

  5. I personally think that politicians and the FED take care there won’t be a hyperinflation. They target a high inflation (say 4…6 percent range) for a prolongued period of time instead. This would reduce public debt. Oh, and partially dispossess retirees, savers and so on, but nobody cares about them anyway.

    • I believe targeting inflation at 4% would be nearly identical to the Market Monetarist position right now (of course their implicit inflation target changes as GDP changes… it’s the sum they advocate targeting, or NGDP).

      Also, since they explicitly target NGDP rather than inflation, I think they’d say that’s an advantage in several ways (having to do with measuring it, “targeting the forecast,” and communicating to the markets what you are doing more clearly).

      Also, they would claim that it does more than just make life easier for debtors… (I think!) they’d say that it would tend to boost GDP because raising the price of ALL financial assets tends to push money instead into “goods and services” (which they define pretty broadly) “at the margin.”

      Looking at their position more clearly, I’m wondering why the Austrians main boogeyman is still Krugman… I think they should be just as concerned about their “libertarian” brethren in the MM crowd!

      I just finished a long interchange over there with a commenter named “dtoh” who I think is pretty well informed. I think his ideas might even conform to the MR framework regarding the mechanics of how the system works…. but of course he’s a big advocate for an MM position which is nearly identical to Sumner’s.

      My big question (for Cullen or anybody that knows) is that the MMers claim that there’s never been a central bank in history that couldn’t raise inflation to whatever they wanted. Is that really true?

      • In layman’s terms, why would raising inflation be a good thing?
        Your last question is a good one. In the summer of 2006, people believed the Fed had solved the boom-bust cycle and ushered in the so-called Great Moderation. Do we still ascribe these healing powers to the Fed?

        • Inflation is not a “good thing,” but a travesty of a misnomer spread by the monolithic economic establishment that now has a near monopoly in educational institutions and within governmental and quasi-governmental agencies.

          Inflation destroys purchasing power and typically encourages consumption to the point of indebtedness, which inevitably leads to the collapse of any fiat currency (I challenge anyone to provide an example of a major nation where that has not played out; Britain is arguably on the road to fiat currency collapse again, after being bailed out by the IMF back in 1976).

          Keynesians argue that deflation is dangerous as it encourages the hoarding of fiat currency (i.e. saving), while nearly exclusively dismissing the far more adverse risk behavior encouraged by inflationary policy (leading to increasing indebtedness, and then inevitable insolvency, without historical exception).

          The irony is that Keynes himself gave grave warnings about the dangers of inflation (i.e. debasement of the currency) in his ‘The Economic Consequences of the Peace’ [pp. 235-236], yet neo-Keynesians such as Krugman have bastardized much of what Keynes taught.

          As far as the “inflation targeting,” it’s being done to kick the can, since without an inflation rate that exceeds real economic output,real productivity gains, or real GDP growth, there’s no way for the government to service the interest payments on its national debt, let alone come close to being able to actually pay down the aggregate amount of debt it has already accumulated.

          One can prove this truth via a simple mathematical equation.

          • How about you challenge yourself to show us a non-fiat currency system that even exists today, and how they’re doing??? Thanks, I’ll take the US, UK, Japan, etc. We’re all going to die eventually…. you and me well before there’s a currency collapse in any of the above 3 nations.

            Meanwhile if we experience wage and price inflation we have a net zero on your household’s balance sheet, yet the society as a whole is productive and improving everyone’s standard of living. This is why I’ll take today’s dollar over the 1913 dollar. I have a crap load more of them, and a FAR superior lifestyle.

            Sorry, your inflation thesis is just ideology and nothing more

        • Short answer to “why would raising inflation be a good thing?”:

          In and of itself, it’s not. That’s why, according to MM, you want to target the growth rate of NGDP = inflation + GDP. Since GDP growth is low right now, targeting NGDP may result in inflation. MMers tend to like numbers like 5% for the NGDP growth rate. Thus if GDP grows 1%, inflation should be 4%.

          Now why is that good? The only reason I can think of is the “helps debtors” reason and that they (MMers) must think it improves GDP in the long run. So perhaps if GDP is 5% then inflation is only targeted to be 0%. I don’t fully understand the mechanism through which this 5% gets re-apportioned between GDP and inflation, but it must have something to do with making “real goods and services” (broad definition) more attractive to buy than “financial assets.” My discussion w/ dtoh was more focused on “Won’t the market have to invent safe equivalents to Treasuries if the Fed buys them all” and “Do MMers believe that paper bills and coins have some special significance?” dtoh did a good job of dispelling this last notion, however, and agreed that’s a confusing aspect of the way MM is usually presented. I like the way he presents it better than Rowe, Sumner, Christensen, Munes, or Glanser actually. Here’s the link to our conversation:

  6. Did Barrons wrote that or just copied from one of your posts at Pragcap Cullen?

  7. Thanks for posting, Cullen, as always, yet another message that’s intended to challenge us to think for ourselves and to move us all forward.

    I guess one way of knowing that you’re on the right track is when all the opposition can do is raise their voices to a shrill level and wave sacred texts in your face.

    So, bravo for doing your persistence in keeping the debate open, for maintaining dignity, and for trusting in truth.

  8. The usual MR claptrap.

    The biggest constraint for ANY government is DEFLATION and and a lack of liquidity, not Inflation or Solvency.