Friday, September 30, 2016

On Hyperinflation

Previously, we asserted that the standard definition of money was in error.  Money does not constitute a store of value.   Money, fiat money, has no intrinsic value.   It only constitutes a store of demand.  In particular, it is demand on the real production of goods and services of the society whose government recognizes the money as ‘tender.’  (Money has various forms, which may also be exchanged for each other. This distorts its actual exchange value.)  Even more exactly, money is a token offered in exchange for either other tokens, other ‘forms of money,’ or for goods and services produced by the economy, or needed or used by the economy.  (We will call any of these things, or any combination of these things, (real) resources.)  Its current value is roughly determined by the ratio of the flows of goods and services to the (opposite directed) flow of money. The flow of money is nominal, in the sense that, for a given rate of flow of goods and services, the greater number of units of money in the countervailing flow of money, the lower the value of each unit. Thus, the value of the unit, the dollar, is determined by the ‘physical quantity’ of goods and services exchanged in the economy divided by the number of units, of dollars, those goods and services are exchanged for.    Money’s value is not directly affected by the amount which is exchanged for other forms of money, nor the (lesser) amount of goods and services exchanged in barter.

Aside from the flow of money, there is a stock of money, just like there is a stock of real resources and assets, which, at any given moment, are not being actively exchanged. The standard definition of money implies that this stock of money constitutes an asset, a 'financial' asset. And therefore, according to the standard definition, the value of all this money should be added to the stock of real goods, services and real assets in the economy when calculating the total 'value' of capital in the economy.  

However, money is only an 'asset' to the individual.  The total value of a society, of all its assets and production, is independent of the total quantity of money.  Money is not an ‘asset’ to society, in the sense that the ‘value’ of the total quantity of money in a society is added to the total value of society.  It is only an asset in the sense that it enables certain forms of exchange.  In this sense, it acts as a multiplier of value. (Multiplication of value I discuss elsewhere.  I only mention here that its value as a multiplicative factor depends on its distribution, and not its nominal quantity.)

Invert the usual definition.  Money has value in terms of the things it is buying. In traditional macroeconomics, money's value is given by the so called "Equation of Exchange:"  M= P x Q/V.  In this equation, M is the stock of money, the total number of dollars, P is the Price level of things, sort of  the 'average' number of dollars exchanged for each thing, Q the quantity of  things exchanged, and V the average velocity of the total amount of money.  Now this equation is usually used to evaluate the total quantity of money M in an economy, so V can change. But really, the velocity of the money in circulation does not change, so when the V of the equation changes, what it is showing is the percentage of the total money supply which is actually in circulation in the real economy, and what share of the total money supply is in savings or bonds or other financial instruments. It shows the proportions that M is divided between circulation in the real economy, and the churn, where different forms of money, bonds and other instruments of debt, are traded among themselves.  Thus, when V goes down, money is being taken out of circulation in the real economy and 'invested' in the churn.  When V goes up, money is being taken out of the churn, and put into the real economy.  

With this understanding, we can simplify the equation to:  M = P x Q,  where the terms are as described above. This can be understood in either macroeconomic terms, in terms of average price level times some quantity measure of all things exchanged, or in terms of microeconomics, as the average price of any particular good, times the quantity of that good, giving the total quantity of money, the number of dollars, (or in general the number of units that P is expressed in. which need not be dollars.) that is being exchanged for that particular good. It can be visualized as the flow of money, and the opposing flow of the good or service, in its own particular channel.

 If we rearrange, then the price of any particular good, or of the price level of all goods if we are talking about the economy as a whole, can both be expressed as:  P = M/Q.   If M increases, and/or if Q declines, the price or a good, or the price level of an economy, goes up.
We have talked about what we call the churn.  The stock of money experiences activity separate from its motion in the real economy. It is not kept in mattresses, (although in a sense it might as well be,( churning:  Forms of money are exchanged for other forms of money.  However, this ‘churn’ usually has no immediate effect on the value of money in the real economy, as long as it does not affect the movement of money out of the churn and into the real economy, or out of the real economy and into the churn.)  Similarly, barter, the direct exchange of goods,  does not affect the value of money, although changes in the amount of barter, where they alter the amount of goods exchanged for money, would change the value of money in the opposite direction.  That is, if a greater percentage of goods were being exchanged in barter, then the money in circulation would be chasing fewer goods.  This would result in inflation.  (This analysis ignores the effect of the expectations of participants, which may indeed alter the value of money in the real economy.)

Demand as debt.

Many have heard about instances on hyperinflation, and tales of wheelbarrows of money being exchanged for loaves of bread.  During the Weimar hyperinflation in Germany in 1923, before computerized money, they couldn’t print the money as fast as it was being inflated.  Bills printed with already outrageous denominations had to be restamped with denominations hundreds and thousands of times higher, before they could actually be issued, because the original denominations were already to small to be useful.

What we don’t hear about, however, are busloads of money being exchanged for houses. It would be rare, one would think, but surely, if it happened, it would be memorable.  But no one sells houses during periods of hyperinflation. Or automobiles, or appliances, or many of the more ‘advanced,’ but in the end, less immediately essential  products of an economy.

For what happens is that the monetary economy collapses onto essential goods, the most essential being food and fuel.  But the circulation of these goods, in the modern economy, and the quantity of money exchanged for them, takes up only a small portion of the market of the entire economy.  So the total quantity of money in circulation, whose value (as tokens of demand) was originally based on fact that things demanded consisted of the entire quantity of goods and services in the whole economy, is nominally much greater than the nominal value of the circulation of essential goods and services like food and fuel.  The supply of valuable goods contracts to only those which are essential.  Demand is now concentrated on a much smaller portion of the economy.  Meanwhile, the value of non-essential goods crashes

In our equation:  P = M/Q, then, what first happens is that M increases, not as a result of government printing, but as money is taken out of the churn, and put into the real economy. This is mostly rich people panicking, although ordinary people are also taking their money out of the banks.   As this process progresses, the economy begins to contract onto essential goods. Thus the quantity Q of goods exchanged for money decreases.  

Imagine that suddenly, all that anybody wanted to buy in the economy was bread.  With over $!.4 trillion of dollars cash in circulation, M0,  M2 the larger measure of less liquid money is over $13 Trillion, M3, still money but no longer counted, we may estimate, from recent trends at at least $19 Trillion. If M2 tells us the amount of money in mattresses, the difference between M2 and M3 we might consider money buried in backyards.  It will all come out.  With the market for bread at the outset about 1 billion dollars the price of that bread would become extremely high extremely fast.  Of course, there are other forms of food, which may be regarded as equally essential, (although high priced foods might also be priced out of the market.)  The size of the retail food market in the US is around $50 Billion per week, or  $2.5 Trillion per year.

 And this is what happens at the outset of the progression of hyperinflation.  The government doesn’t have to print money.  The money is already out there. Some of it is just being used for ordinary business in ordinary ways. Much, perhaps even most of it, is in the churn:  Ordinary savings accounts for ordinary people, high powered financial instruments for the wealthy.  But as runaway inflation, and then hyperinflation begin to take hold, people increasingly see money as overvalued.  Durable goods and fixed assets also begin to be seen as overvalued, at least in terms of money.  And they see other people seeing that, too. Therefore everyone wants to exchange their money for (basic) goods as fast as possible. As the demand becomes ever more concentrated on essential goods, the velocity of money also increases.

 As inflation progresses, increasingly goods become sorted into their essential value. The value of non-essential goods and assets decreases, relative to essential commodities.  Money becomes preferentially spent on those of greatest essential value, and the prices of these increase the most as demand becomes concentrated on them.   Those holding money in savings and other financial instruments, withdraw and liquefy them, and bring them into the real economy, where they add to the already increasing forces of inflation.    

The government faces a choice:  Either to take money out of circulation  as fast as possible, or to print money.

The proper response of government is not to print money in an attempt to stay ahead of it. This merely aggravates the problem and drives the accelerating inflation.   While initially, government issued money is not the problem, as the government issues money at an ever greater rate, the entire nominal value of money in circulation does becomes government issued.

The proper response of government is to take money out of circulation as fast as possible.   One way is a high sales tax. However, this will not prevent the entry of money into the circulation of the real economy from the churn, the stock of money circulating in banking and finance. Therefore, the liquid assets of the wealthy, and foreign holdings, must also be frozen, and offshore financial assets prevented from repatriating.  So far as the wealthy control the government, this is resisted. 

When the wealthy become aware, not only that the stock of money is too greatly over valued, but aware that others also know,  we may expect a rush into more tangible assets, with ordinary people, by which I mean basically the entire 99%, priced out of essential goods and services.