# Why does printing more money cause inflation?



## archilles (1 September 2009)

Hey all, 
I’m having trouble getting my head around inflation, and I can’t seem to find any credible answers on the internet. I’m tying to find out exactly why printing more money causes inflation !  
Perhaps I’m thick, you see I can’t stand the stock standard response I get “ too much money chasing too few goods blah blah blah “ - I need more depth. 

So this is what I’ve done, I’ve pasted in a standard example of how printing more money causes inflation off the net - picked it apart and have raised a few questions of my own.

Stock standard example I found on the net :

*How Printing more money causes inflation*

Rather than delving deep into the quantity theory of money. 

Let’s think about a simple example.

•	Suppose the economy produces a 1,000 units of output. 
•	Suppose the money supply (number of notes and coins) = $10,000 
•	This means that the average price of the output produced will be $10 (10,000/1000) 

Suppose then that the government prints an extra $5,000 notes creating a 
total money supply of $15,000; but, the output of the economy stays at 1,000 units. 
Effectively, people have more cash, but, the number of goods is the same.
Because people have more cash, they are willing to spend more to buy the goods 
in the economy. The price of the 1,000 units will increase to $15 (15,000/1000). 
The price has increased, but, the quantity of output stays the same people 
are not better off, and the value of money has decreased; 

e.g. A $10 note buys less goods than previously.

*My questions :*

Point/Question 1 :

So who are the people who now have MORE CASH , buying the same number of goods ? 
And how is that extra money circulating in their hands causing prices to go up ? 


Point/Question 2 :


Last time the government increased the money supply, I don’t remember getting 
$ 10,000 or more in my account ? 

True, cheap credit has been available over the past few years , 
allowing us to loan more than we could earn, but what about now ? 
It’s only getting tougher to get loans , so I don’t see how your average Tom , Dick 
and Harry gets even a trickle of that excess money supply ? 

So if the general public isn’t getting access to the excess money injection, 
then how are we “ willing to spend more to buy the goods in the economy “ ?

Anddd if it’s not us who’s doing the spending or receiving the excess money supply   - WHO IS ? 


Going back to point/question 1, this excess money supply seems invisible to me because 
I can’t see who has it or who is getting it, In fact I don’t even roughly know what 
they/we/ he /she is doing with it. Who are these people with the money chasing too few goods, 

how come we can’t physically see them or notice them pushing prices up with 
their new found wads of cash ? 




Point/Question 3:



Also, the reaction doesn’t seem as automatic as described in the example above

For Example: Government injects $200 billion ( of money printed out of thing air ) into the economy

Then BAMB, BOOM , KABOOM – Bread that costs $ 4 a loaf  has now risen to $ 10 a loaf.




Forgive me if I’m missing a point or two here, I havn’t studied economics and left school 
early so don’t judge me lol

Any explanations or thoughts would be greatly appreciated


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## investorpaul (1 September 2009)

> Point/Question 1 :
> 
> So who are the people who now have MORE CASH , buying the same number of goods ?
> And how is that extra money circulating in their hands causing prices to go up ?




to answer your question, people dont just magically get more money what happens is the government prints more money and then buys bonds back from investors or as is the case in amercia at the moment buys new preference shares in companies. These people/companies then end up with more money. They buy goods, pay people, etc which distributes this money through the economy. If the number of goods produced does not increase by the same amount then more money is chasing the same amount of goods thus forcing up prices.



> Point/Question 2 :
> 
> 
> Last time the government increased the money supply, I don’t remember getting
> $ 10,000 or more in my account ?




See above answer, no one magically gets more money for nothing. (unless of course rudd prints money and hands it out as stimulus payments lol)



> True, cheap credit has been available over the past few years ,
> allowing us to loan more than we could earn, but what about now ?
> It’s only getting tougher to get loans , so I don’t see how your average Tom , Dick
> and Harry gets even a trickle of that excess money supply ?




They get the money indirectly, the increased money in the system to companies and individuals means that they spend that money on goods, this creates demand for goods which creates empolyment in that area. If you keep (instead of losing) or get a job then you have more money. 




> Point/Question 3:
> 
> 
> Also, the reaction doesn’t seem as automatic as described in the example above
> ...




As per my answers above the money takes time to work its way through the system. Also most examples are simplistic ie double the money suppy but keep the number of goods the same and the price doubles. In reality however we are probably talking about percentage moves of 1-5% so the difference is less noticable.


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## boofhead (1 September 2009)

I'm not well educated on the matter.

In an abundance of money people are less restrictive on spending. Everyone feels better about the world and their own security. They spend it.

All through the system every part wants more of the money. Retailers, producers, workers. 

Initial workers and companies to benefit have more money to spend. So it gradually spreads throughout the economy. We all want income rises too - there are domestic finance pressures and international pressures. Generally people want to get to a better financial situation.

If you have more money then you have a greater ability to spend money. Some people will be less frugal. Money moves through the economy although not smooth or evenly distributed. Some sections will grow more than others.

This can be added in with the low interest rates which reduces incentives to save - for those in a reasonable financial situation. If they aren't saving then they're more likely to be spending. This is a part of the discussion where the GFC is looking like it is slowing. So some are looking at a later phase of withdrawing stimulus.

Later Howard years shows the opposite. Govt throwing money in to the economy while unemployment is low and growth is strong. Including their middle class welfare. So inflation was higher so RBA pushes rates higher to encourage saving (cost of borrowing also increases.) Some deposits were about 8% - good luck to those that locked them in for a couple of years.


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## Struzball (1 September 2009)

archilles said:


> Point/Question 1 :
> 
> So who are the people who now have MORE CASH , buying the same number of goods ?
> And how is that extra money circulating in their hands causing prices to go up ?




We all end up with more cash, every year I typically get a 4% "enterprise bargaining" pay rise, along with a yearlly increment.  
The money I sit in a savings account earns 4% interest.  
On the interest I pay on a loan the bank earns 5% per year.  
Assets appreciate with inflation, meaning if I sell a house in 10 years I've basically earnt the profits due to inflation

With that extra money I/banks etc choose to spend it how they want and further inject it into the economy.




archilles said:


> Point/Question 2 :
> 
> 
> Last time the government increased the money supply, I don’t remember getting $ 10,000 or more in my account ?
> ...




As above. However they're not exactly wads of cash, just increasing with the rate of inflation (currently 2-3% I think?)



archilles said:


> Point/Question 3:
> 
> Also, the reaction doesn’t seem as automatic as described in the example above
> 
> ...




As investorpaul says, rather than a 150% jump due to inflation it's probably more like 1-5%.


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## Mr J (1 September 2009)

archilles said:


> Then BAMB, BOOM , KABOOM – Bread that costs $ 4 a loaf  has now risen to $ 10 a loaf.




Over time, yes. Many goods have a higher price than they did 10 years ago.



			
				Struzball said:
			
		

> meaning if I sell a house in 10 years I've basically earnt the profits due to inflation




To be picky, some of it is a genuine increase due to the increase in value of the land.



> As above. However they're not exactly wads of cash, just increasing with the rate of inflation (currently 2-3% I think?)




The official rate is understated, and my guess is that it's more like 5%, so we only tread water with a savings account.

As for why inflation matters, it's because there are significant effects if the distribution of the injected money does not reflect the distribution of the existing money. This is important because the money is not 'fairly' distributed.


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## joeyr46 (1 September 2009)

To be picky, some of it is a genuine increase due to the increase in value of the land.


I think this comment says it all (no I,m not having a go at you we all say it this way round)
Land has not appreciated just because we pay more dollars for it after all it hasn,t changed (yes some of this is due to expansion of population causing increased demand for some land ) but most is due to dollars losing value not land appreciating And we have a dishonest government to thank for that


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## Early Bird (2 September 2009)

it's simple supply and demand!

if you increase the money supply, it's value will decrease, therefore you need more of it to buy the same goods/services.

in the same way as if the supply of goods increases significantly, (eg apples when they are in season) their individual price will go down. so, if you increase the supply of money, it's "price" will decrease. in the case of money, it's price can be measured as the quantity of goods/services that can be exchanged for each $.

so lets say $1 buys you 1 apple. once the money supply is increased, $1 will now buy only 0.9 apples. of course, you still buy 1 whole apple, so it will cost slightly more than $1. 

usually of course inflation is caused by people's wage increases which is a different dynamic in a way as there is not necessarily more total money in the system, but individuals have more spending power which drives up prices. raising interest rates is the most common way to try and control this as it encourages people to save rather than spend thier wage increases. 

its hard to see how the government could ever eradicate inflation though, short of outlawing wage rises???


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## Beej (2 September 2009)

Early Bird said:


> its hard to see how the government could ever eradicate inflation though, short of outlawing wage rises???




The government has no goal to eliminate inflation. The governments goal is to keep a steady rate of positive low inflation in place consistently (in AU the RBA is currently instructed to attempt maintain a 2-3% CPI rate via monetary policy settings they control). Zero inflation, or deflation (even worse), encourages hoarding rather spending of cash - they want the majority of money to be circulating through the economy - spent, invested, anything, rather than it all being hoarded for long periods of time. A bit of inflation also helps governments through tax bracket creep - increases in taxation by stealth and thus avoids political pain for the incumbent . 

Cheers,

Beej


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## archilles (4 September 2009)

Hey Guys thank you all for your replies, keep them coming ! it's certainly making the definition of inflation and it's affects more understandable. One particular post caught my eye and it was written by Investor Paul ( below ). 

This post has given me good insight, however i have a couple of questions ?

1.  The government prints more money to buy back bonds off investors, but i have to ask where are they getting this money from ? I know it's printed out of thin air but does the government then owe someone this money ? Is it the RBA ? 


2. If government is buying preference shares in companies, then these companies/directors are clearly receiving more money. Essentially, these companies can keep producing what they were producing before and get more money for it ( without producing anything more ) - is this what can trigger inflation ? Is this why directors get golden handshakes worth millions of dollars ? Could it be that they have ties to the government ? 













Investor Paul Quote :

to answer your question, people dont just magically get more money what happens is the government prints more money and then buys bonds back from investors or as is the case in amercia at the moment buys new preference shares in companies. These people/companies then end up with more money. They buy goods, pay people, etc which distributes this money through the economy. If the number of goods produced does not increase by the same amount then more money is chasing the same amount of goods thus forcing up prices.


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## Beej (4 September 2009)

archilles said:


> 1.  The government prints more money to buy back bonds off investors, but i have to ask where are they getting this money from ? I know it's printed out of thin air but does the government then owe someone this money ? Is it the RBA ?




For a start you are talking about the US here when discussing "printing money" and using it to buy bonds etc. Australia is not currently running any "quantitative easing" program of this sort. In Australia new money is created via new lending by the banks, which happens all the time, nothing special there. The rate of creation is in theory controlled indirectly by the RBA via their monetary policy settings (interest rates) which helps stimulate or dampen demand for new credit in the economy.

As for who prints the money in the US case - it's not actually the government, it is the central bank (the Fed in the case of the US). They don't physically print more notes, they just electronically create the money and use it to purchase government bonds, either directly off the government or on the market from existing investors. Either way this puts "newly created" money into circulation into the economy, which is the aim of the QE program. So you see no one is "owed" the money - it has just been created (out of thin air if you like). In effect all new money is created out of thin air - normally through credit creation by banks, but in the QE case it's created directly and used by the central bank.



> 2. If government is buying preference shares in companies, then these companies/directors are clearly receiving more money. Essentially, these companies can keep producing what they were producing before and get more money for it ( without producing anything more ) - is this what can trigger inflation ? Is this why directors get golden handshakes worth millions of dollars ? Could it be that they have ties to the government ?




Again you are talking about what is going on in the US here (not Australia). In this case the government is using money they have acquired from various sources, including taxation, direct borrowing, the sale of government bonds etc, to support these organisations via injection of capital in return for equity stakes. Remember a part of this money has come from the QE program (new money), so that's how the 2 things are linked. 

As for the effects of this intervention, it doesn't mean the companies can get more for what they are producing - which is not the right way to look at it as in most cases we are talking about financial institutions anyway (plus maybe GM etc but what they got was a loan, which needs to be paid back anyway, just happens to be from the government). What the companies get is the chance to not go bust, due to the injection of funds where none were available to them from the private sector. So in effect the government takes on risk in return for averting something that they see as far worse than the financial risk they have now taken on.

In terms of inflation, any inflationary effects from all this, if any, come in over time simply due to the increased amount of money flowing into the whole economic system. However, as this has occurred in response to a great destruction of wealth/money through falling share/house prices, loan defaults, bankruptcies etc, the new money may simply (hopefully) keep the status quo by replacing what has been lost at a macro level and therefore averting a deflationary driven downward spiral. The risk is always that it get's over-done, and because the inflationary effects take some time to manifest, by the time they become evident (if they do) it will be too late to turn off the new money tap - that's the key risk here.

Again all this is really talking about the US. In Australia things are more straight-forward right now, all we have is low interest rate settings in an attempt to increase demand for credit to stop the economy from stalling, plus some government fiscal stimulus being funded by actual/directly borrowed money (not money printed by the government). So far this seems to be working here, so we don't face a great inflation risk IMO in AU.

Cheers,

Beej


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## Portfolio (28 September 2009)

There is also a massive difference between money (currency) and credit (promises to deliver money).  Most people dont know the difference.

In a recession the velocity of money (how fast it moves around the economy) decreases so in effect the money supply (if you include credit) decreases.

Thats why inflation isnt going through the roof - we are actually getting deflation or this deflationary effect is offsetting the printing MS increases.


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## jono1887 (28 September 2009)

Portfolio said:


> There is also a massive difference between money (currency) and credit (promises to deliver money).  Most people dont know the difference.
> 
> In a recession the velocity of money (how fast it moves around the economy) decreases so in effect the money supply (if you include credit) decreases.
> 
> Thats why inflation isnt going through the roof - we are actually getting deflation or this deflationary effect is offsetting the printing MS increases.




Are we getting deflation? I thought our inflation around 3% last time I heard.. and I'm sure its not deflation in the US either..


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## ducati916 (29 September 2009)

> As for who prints the money in the US case - it's not actually the government, it is the central bank (the Fed in the case of the US). They don't physically print more notes, they just electronically create the money and use it to purchase government bonds, either directly off the government or on the market from existing investors. Either way this puts "newly created" money into circulation into the economy, which is the aim of the QE program. So you see no one is "owed" the money - it has just been created (out of thin air if you like). In effect all new money is created out of thin air - normally through credit creation by banks, but in the QE case it's created directly and used by the central bank.




Incorrect.

The US Treasury is responsible for _printing money_

The Federal Reserve has as it's mandate low inflation, usually as a target, and price stability. The two mandates were generally implemented via _monetary policy _ which increased/decreased money/credit via control of the short-end interest rate [FFR]

That the banks can create credit via fractional reserve banking is correct. The current credit creation however is not bank mediated, it is government mediated via increases in debt/credit & QE.

jog on
duc


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## Beej (29 September 2009)

ducati916 said:


> Incorrect.
> 
> The US Treasury is responsible for _printing money_
> 
> ...




Yes of course the Treasury (US) is responsible for the printing of physical currency/bank notes. But that's not what I was referring to - as you point out, what I was talking about is how the current QE program is "printing money" (which is what everyone calls it) - and that is not actually being done by printing more bank notes (directly), but via the creation of credit through the purchase of government bonds.

Cheers,

Beej


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## Riddick (29 September 2009)

lots of good information on this thread.

for a great addition check out the Zeitgeist:Addendum movie, released for last year. it's anot for profit production designed to illustrate the immoral functioning of the central banjing system and covers myths of inflation.

I'm pretty sure you can watch it on you tube, as it was released free online last year

www.youtube.com/watch?v=5r6-o1lpJHU

check it out. worth the time if you have a geuine interest.


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## Portfolio (29 September 2009)

There is deflation in some assets and inflation in others but overall there is slight inflation (every asset doesn't go up by the inflation rate).

The best way to understand creation and destruction of money is this.  Suppose you go to your corner store and start up a tab and buy some bread and milk.  You buy it and put it on the tab.  You havent paid for the bread and milk yet (because you havent handed over any money) all you have done is create credit (which spends exactly like money).  The storekeeper hasnt received any money but they think (rightly so) they have an asset (they think you will repay them at some point in the future).

In a recession what happens is that the money supply decreases - there are a whole lot of storekeepers out there that realise that the debts that are owed to them arent able to be paid.  What do they do?  They write the debts off.  So the asset is now gone.  It hasnt gone anywhere - the money supply has just decreased.


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## matty2.0 (29 September 2009)

because a gold rush happens when after you go to the toilet, you can wipe your bum with your dollar bills.


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## Macquack (29 September 2009)

I agree with everything Beej says, except his expectation of a low risk of inflation.

The true definition of inflation is an increase in the money supply. Rising prices is the consequence.

"Printing money" is becoming an obsolete term as no actual printing of physical cash is necessary to increase the money supply. Even at the height of the use of the 'cold hard folding stuff' as a means of exchange, cash has never represented more than 10% of the total money supply. The other 90% has been created out of thin air by the private banks.


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## jono1887 (29 September 2009)

Macquack said:


> Even at the height of the use of the 'cold hard folding stuff' as a means of exchange, cash has never represented more than 10% of the total money supply. The other 90% has been created out of thin air by the private banks.




That is quite a scary thought the more you think about it..


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## ducati916 (30 September 2009)

Beej said:


> Yes of course the Treasury (US) is responsible for the printing of physical currency/bank notes. But that's not what I was referring to - as you point out, what I was talking about is how the current QE program is "printing money" (which is what everyone calls it) - and that is not actually being done by printing more bank notes (directly), but via the creation of credit through the purchase of government bonds.
> 
> Cheers,
> 
> Beej




QE is printing [currency] money. It is not credit creation, which is a separate form of money creation.

Simply observe M1


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## Beej (30 September 2009)

ducati916 said:


> QE is printing [currency] money. It is not credit creation, which is a separate form of money creation.
> 
> Simply observe M1




Yes but M1 is likely to increase in response to the "new money" being injected into the system via the QE, low interest rates (increased demand/supply of credit) etc. But it is not increasing because the Fed has physically printed the cash (or directly asked Treasury to) and handed it over to someone. Also, in the US, M1 includes both physical cash/notes in circulation and central bank deposits, so have to remember that when looking at M1 graphs etc.

As Macquack points out, notes in circulation only ever represents a small percentage of the amount of "money" in existence. Cash is "printed" as required based on what people demand (via withdrawals from banks, cash payrolls etc etc).

At the end of the day the point is moot anyway, regardless of the actual mechanism, the result in an increase in the amount of money that exists in that economic system. That creates the *potential* for inflation, both in the short term and the longer term, depending on what else is going on, how the economy reacts to the increased money supply etc etc. Clearly how much and what the risk is can be debated! 

Cheers,

Beej


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## Beej (30 September 2009)

Portfolio said:


> There is deflation in some assets and inflation in others but overall there is slight inflation (every asset doesn't go up by the inflation rate).
> 
> The best way to understand creation and destruction of money is this.  Suppose you go to your corner store and start up a tab and buy some bread and milk.  You buy it and put it on the tab.  You havent paid for the bread and milk yet (because you havent handed over any money) all you have done is create credit (which spends exactly like money).  The storekeeper hasnt received any money but they think (rightly so) they have an asset (they think you will repay them at some point in the future).
> 
> In a recession what happens is that the money supply decreases - there are a whole lot of storekeepers out there that realise that the debts that are owed to them arent able to be paid.  What do they do?  They write the debts off.  So the asset is now gone.  It hasnt gone anywhere - the money supply has just decreased.




That's actually not a bad analogy. I would extend it though - in the shopkeeper example, they don't actually extend the credit, usually a bank does (via a credit card, other loan etc). So the bank takes on the default risk, but in return they get the interest margin "premium" from everyone they extend the credit to. This is in fact the key mechanism normally used to increase the money supply in the economy.

So the shop-keeper get's the money regardless, and keeps it - either spends it again, or banks it, or invests it, or a combination - and remember this is in effect "new" money that is being used now. If the consumer defaults on their loan, the bank carries the "loss" or destruction of money, as they know will not get back the money they lent. However, as long as this doesn't become systemic (and send the bank under, or worse ALL the banks under) it's basically OK, as they have made enough of a buffer through the interest charged on all their loans to handle the loss. 

The banks responsibility is to manage this risk properly, but to "help" them do this properly, we have a central bank that can influence what retail banks do via monetary policy, + prudential regulation which sets broad parameters within which the banks must operate by law. The US banks clearly needed more "help" on this front than they got..... 

BUT, (and this is the key), as a result of increased defaults the bank may now charge more to lend, or else lend less, ie credit tightens, so the next time the consumer cannot use credit at the shop at all, they need cash - but the money supply is now not growing. This causes a sharp drop off in economic demand, a lowing in the velocity of money and the growth of the money supply, and this can bring on a recession (as you point out in the first example). The shopkeeper sells less so has to lay off one assistant, unemployment increases and so on and so on. It starts a negative feedback loop. This is also why in response the central banks try to pump more money into the system in order kick start demand again, however they risk creating inflation if it is over-done.

Cheers,

Beej


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## ducati916 (30 September 2009)

*Beej*



> Also, in the US, M1 includes both physical cash/notes in circulation and central bank deposits, so have to remember that when looking at M1 graphs etc.




I specifically showed the currency component of M1.

Here is the currency + demand deposits. You can see it is circa $1.3 Trillion compared to currency of $800 Billion


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## Beej (30 September 2009)

ducati916 said:


> *Beej*
> 
> 
> 
> ...




Oh yes so you did - apologies; good graphs! 

Cheers,

Beej


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## ducati916 (30 September 2009)

*Beej*



> At the end of the day the point is moot anyway, regardless of the actual mechanism, the result in an increase in the amount of money that exists in that economic system. That creates the *potential* for inflation, both in the short term and the longer term, depending on what else is going on, how the economy reacts to the increased money supply etc etc. Clearly how much and what the risk is can be debated!




Actually I would argue that the mechanism, if you are an active participant in the financial markets is important. The reason that it is important is that inflation in the initial stages favours some sectors/industries preferentially. If you know the mechanism, you know the sectors in which to concentrate your search and analysis.

A bank system mediated inflation or credit expansion, which is a monetary policy expansion, is a very different beast to a fiscal credit expansion. The end result is also likely to be somewhat different.

Currently, the credit expansion, being a fiscal expansion is supporting consumer goods, the lower the stage, the greater the margin, and the more likely the expansion of the P/E multiple awarded.

jog on
duc


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## TabJockey (1 October 2009)

Riddick said:


> lots of good information on this thread.
> 
> for a great addition check out the Zeitgeist:Addendum movie, released for last year. it's anot for profit production designed to illustrate the immoral functioning of the central banjing system and covers myths of inflation.
> 
> ...




Ive watched those movies, they are incredibly well done and entertaining, however they are almost entirely made up. Not many people have an indepth understanding about the way that credit creation works within the economy but it works pretty well most of the time especially here in Aus (US is a little dodgier as always). Allot of lay-people dont know that when banks lend money they create money, and its something that those zietgiest movies have really preyed upon painting it as evil, but there isnt anything wrong with it.

There are stacks of those nutjub conspiracy theory movies all over the internet, and they are highly persuasive if you dont know the ins and outs of the content material, but they are all the same. They dont do any REAL scientific research with a scientific method that gives you facts that stand up under a bright light and the only people they reference are other conspiracy theorists.

A really good website to read if you watch one of these movies and are suddenly engulfed by a burning desire to strike out at the oppressive social construct is http://conspiracyscience.com/.

So yeah not recommended to watch Zietgiest if you want any credible learning on inflation


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## ducati916 (1 October 2009)

*TJ*



> Allot of lay-people dont know that when banks lend money they create money, and its something that those zietgiest movies have really preyed upon painting it as evil, *but there isnt anything wrong with it.*




Actually there's plenty wrong with it.

The irregular demand deposit, the obligation to guard and protect the goods deposited is the fundamental element in all deposits.

In the first instance we have an ethical failure on behalf of government who have perverted the law to allow the following.

In an Irregular deposit, the fungability of money in no way mitigates the obligation of having 100% of the tantundem available, *on demand.* Banks in complicity with government, have, essentially committed theft when through fractional reserve banking they create money from nothing - using demand deposits as the initial [and continuing] reserve.

In the second, inflation is simply theft by government, from the people. Inflation is a debasement of the money. When the money is debased, all economic decisions become distorted, leading to periodic crisis.

jog on
duc


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## Macquack (1 October 2009)

ducati916 said:


> Actually I would argue that the mechanism, if you are an active participant in the financial markets is important. The reason that it is important is that *inflation in the initial stages favours some sectors/industries preferentially*. duc




This reality is what really annoys me about government 'controlled inflation'.

Obviously the private banks are the first cab off the rank in profiting from inflation, that is understandable as they create the inflation in the first place!

Other early bird recipients of inflationary gains would include real estate agents (increased commissions on inflated real estate sales), insurance companies (increased commissions on inflated policy values), fund managers (increased commissions on inflated portfolios).

Better to take those gains early in the cycle while they have some value and are not eroded by "inflation." 

Anyone interested in starting up a bank? If you cant beat them, join them.


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## TabJockey (1 October 2009)

The ethics of fractual reserve banking are debatable, just like the ethics of just about anything. Yeah its sort of **** that your deposit may or may not be there if lots of people try to withdraw at the same time, but without it the supply of credit for entrepreneurial progress is really limited isnt it? Not sure if economic growth is possible at rates we are used to without the credit creation process? Im no expert so correct me if im wrong.


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## ducati916 (1 October 2009)

TabJockey said:


> The ethics of fractual reserve banking are debatable, just like the ethics of just about anything. Yeah its sort of **** that your deposit may or may not be there if lots of people try to withdraw at the same time, but without it the supply of credit for entrepreneurial progress is really limited isnt it? Not sure if economic growth is possible at rates we are used to without the credit creation process? Im no expert so correct me if im wrong.




I don't think there's any debate at all. The contract that covers time deposits [mutuum] provides for the legal transference of the deposit [tantundem] for the specified period. Thus demand deposit contracts are violated when they are used to create money via fractional reserves.

Economic growth is enhanced when savings, or, time deposits are used to fund the requirement for loans [credit] This has been demonstrated many times, yet, because government overspend, they require constant inflation to mitigate their profilgate spending and debt.

jog on
duc


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## GumbyLearner (2 October 2009)

ducati916 said:


> QE is printing [currency] money. It is not credit creation, which is a separate form of money creation.
> 
> Simply observe M1




What about MZM?

http://en.wikipedia.org/wiki/Money_with_zero_maturity


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## ducati916 (3 October 2009)

GumbyLearner said:


> What about MZM?
> 
> http://en.wikipedia.org/wiki/Money_with_zero_maturity




Not as useful as it includes demand deposits. Demand deposits are [were] the way banks created credit. With QE we are looking for evidence of money being *printed*

jog on
duc


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## Uncle Festivus (3 October 2009)

So when the banks 'make' money, what do they do with it? Lend it out of course creating price inflation and booms, or getting a little shy of the commercial loan business? A sustainable parabolic trend, or what is the end game? Is this just 'normal'??


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## Beej (4 October 2009)

Uncle Festivus said:


> So when the banks 'make' money, what do they do with it? Lend it out of course creating price inflation and booms, or getting a little shy of the commercial loan business? A sustainable parabolic trend, or what is the end game? Is this just 'normal'??




Looks more exponential than parabolic to me UF  A parabola looks like this: 




Anyway, try plotting your graph with a log scale and it might make more sense 

PS: You know that the human population has grown exponentially for the past several thousand years don't you??

Cheers,

Beej


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## Macquack (4 October 2009)

For a good example of "Why does printing more money cause inflation?", look no further than Indonesia.

The exchange rate determined upon Indonesia's independence in 1949 was *3.8 rupiah to 1 US dollar.* Today the exchange rate is close enough to *10,000 rupiah to 1 US dollar*.

The Central Bank just keeps pumping up the numbers. Their political aim is to make the people feel better off because they have more money (in terms of the numbers printed on the currency). In reality, the people become worse off in real terms because of the reduced purchasing power of the 'inflated' money.


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## GumbyLearner (4 October 2009)

There is also one example where the distribution of gold to the poor has caused rising inflation. Unlike today though the IMF will sell a chunk of it's gold, usurp 3rd world balance sheets with it and it will be quickly purchased by excessive net US dollar holders.  

http://ezinearticles.com/?Gold-And-Mansa-Musa&id=1189523

In the Mali Empire all gold nuggets belonged exclusively to the king. It was required that all gold nuggets be turned into the imperial treasury in return for an equal amount of gold dust. The value of the gold dust varied throughout the region, but was used all over as a form of currency. While there was no set currency, gold was usually measured in units called mithqals. A mithqal is about 4.5 grams of gold and the term dinar was often also used. It is not clear as to whether coined currency was used in this time though.

By the time Mansa Musa took control of the Mali Empire it was an extremely wealthy and very powerful nation. They had firm control of most of the trade routes in Africa. On his pilgrimage to Mecca he was accompanied by 60,000 men. He took with him more than 2 tons of gold. *This gold was distributed to the poor along his way, which drew attention to the great wealth of the Mali Empire and also cemented his respect among the Arab world. Mansa Musa distributed so much gold that it caused inflation in Cairo. The value of gold dropped and did not recover for many years.*


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## Uncle Festivus (5 October 2009)

Beej said:


> Looks more exponential than parabolic to me UF  A parabola looks like this:
> 
> Anyway, try plotting your graph with a log scale and it might make more sense
> 
> ...




Half a parabola then?

Whatever the scale used, the data shows that residential lending increased from $50B in 1989 to $860B in 2009. 

Now if you want to link that to population growth then it doesn't compute as Australias population has not increased at the same rate over 20 years (16.8m to 22m) . 

Which means to me that money supply inflation via fractional reserve banking has been a large factor in asset price appreciation, probably more so than supply/demand fundamentals? 

Imbalances get corrected eventually over time...even if they are artificially sustained in the short term?

Now someone who's smarter than me and knows a bit about the banking system might be able to explain to me if having $170Billion more in loans (assets) than deposits (liabilities) in the banking system is a good thing? (As well as bumping up their impaired charges to $32B from $4B 2 years ago??)

(RBA Tables B02 & B03)


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## Beej (5 October 2009)

Uncle Festivus said:


> Whatever the scale used, the data shows that residential lending increased from $50B in 1989 to $860B in 2009.
> 
> Now if you want to link that to population growth then it doesn't compute as Australias population has not increased at the same rate over 20 years (16.8m to 22m) .
> 
> ...




OK I like this post, you have made me think! It's an interesting set of numbers. The current figures can also be found here (http://www.apra.gov.au/Statistics/Monthly-Banking-Statistics.cfm) and seem to match up pretty well. Let's look at it like this:

First, over the last 20 years, we would expect money supply growth generally to at least increase with GDP growth + CPI inflation right? The average of those 2 would be somewhere around 10% for the past 20 years (remember we had double digit inflation alone for the first few years of this period).

OK now let's scale up the initial $50B by the population growth (as we would expect lending to increase with population growth at least, even though this is kind of accounted for in GDP growth as well). That gives us a base of $65B. Compound it by 10% for 20 years and we get to about $500B.

So that still leaves "pure monetary inflation" of $390B. A part of this may be accounted for by the rise in the amount of property investment loans as a proportion of total investment loans since 1989, due to the deliberate policy of not building public housing, and relying on private investors to provide growth in rental accommodation (with NG incentives etc etc). This has resulted in a shift in the balance sheet of public to private debt. Also add to that figure the systemic lowering of interest rates (meaning of course people can afford to borrow more), plus the increased use of equity manager loans, redraw facilities etc etc that probably adds some more credit growth in there as well.

Still probably still leaves some pure monetary supply growth (and you could argue the last 2 factors above are the cause of this anyway), so yes I would agree this would still be a factor in asset price growth seen over the period. But I am also not sure you can divorce that factor from the supply/demand argument? At the end of the day, nobody forces people to borrow - they do it because they want/need the money for whatever reason, (ie demand). The price of what they want may grow due to lack of supply and too many people chasing it (because we haven't built enough houses where people want to live or haven't provided jobs where houses can be built cheaply etc etc). 

So I would argue the "inflationary" credit growth component can still be seen to have been driven by demand. But above I also think I demonstrate that this component of credit growth may not be as large as the raw numbers when presented on their own with no other context suggest.



> Now someone who's smarter than me and knows a bit about the banking system might be able to explain to me if having $170Billion more in loans (assets) than deposits (liabilities) in the banking system is a good thing? (As well as bumping up their impaired charges to $32B from $4B 2 years ago??)
> 
> (RBA Tables B02 & B03)




I don't claim to be an expert, but I'll have a go:

Again the APRA tables also seem to confirm this situation (Total loans $1,483B, total deposits $1.243B). But if you download the spreadsheet at the link I posted, you will see that "Total Resident Assets" of all banks in Australia is $2.324B, which includes cash and liquid assets held, trading securities, investments (+ all loans) and so on. Ie, if you take the loans out, there are still another $900M of other non loan assets held in the system. So by that measure the banks appear to be well capitalised relative to the size of their loan/deposit books to me?

Cheers,

Beej


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## Macquack (5 October 2009)

Uncle Festivus said:


> Which means to me that money supply inflation via fractional reserve banking has been a large factor in asset price appreciation, probably *more so *than supply/demand fundamentals?




If the money supply was not continuously increased by the private banks there would be a saturation point in terms of asset values. 

I think there is a misconceived belief that people are competing against each other for a limited pool of money available for loans.  



Uncle Festivus said:


> Now someone who's smarter than me and knows a bit about the banking system might be able to explain to me if having $170Billion *more in loans (assets) than deposits (liabilities)* in the banking system is a good thing?




How can there be more loans than deposits in the banking system as a whole?

When a loan is issued, a deposit is created somewhere in the system. 

Bad loans reduce a banks assets, however the corresponding deposit in the system does not disappear.


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## alter1217 (5 October 2009)

Macquack said:


> How can there be more loans than deposits in the banking system as a whole?




In a country with no bank, there is $1 mill of currency. you and a group of entrepreneurs pool your money together and start up a bank with $100k of capital.

Your first customer takes out a loan of $10k with 10% interest per annum.

Total Loans are greater than total deposits by $100,000, unless you count the 100k of capital as deposit.


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## Beej (6 October 2009)

Beej said:


> I don't claim to be an expert, but I'll have a go:
> 
> Again the APRA tables also seem to confirm this situation (Total loans *$1,483B*, total deposits *$1,243B*). But if you download the spreadsheet at the link I posted, you will see that "Total Resident Assets" of all banks in Australia is *$2,324B*, which includes cash and liquid assets held, trading securities, investments (+ all loans) and so on. Ie, if you take the loans out, there are still another *$900B* of other non loan assets held in the system. So by that measure the banks appear to be well capitalised relative to the size of their loan/deposit books to me?




Just wanted to correct some typo's above - where my original post states $900M I of course meant $900B. Additionally I used decimal points in some of the other numbers where I meant to use comma's! Corrections in the quote above.



alter1217 said:


> In a country with no bank, there is $1 mill of currency. you and a group of entrepreneurs pool your money together and start up a bank with $100k of capital.
> 
> Your first customer takes out a loan of $10k with 10% interest per annum.
> 
> Total Loans are greater than total deposits by $100,000, unless you count the 100k of capital as deposit.




Excellent example, and I think that's very much the situation with Australian banks, as this shows where the "extra" $900B in resident assets has probably come from (share-holder equity + retained earnings/cash-flow etc).

PS: Thinking about this some more, if we presume an average interest rate margin of say 2% on all outstanding loans, that generates some $30B a year in net cash-flow (ie after paying all funding costs, interest to depositors etc etc), equals 2.5% of the total deposit book pa. We haven't added in cash-flow from bank fee's yet either, which is a similar amount from memory. I would reckon all this cash-flow, plus the non loan related $900B worth of other liquid assets mentioned above, would be more than enough for the banks to cover any deposit withdrawals that might arise under any "normal" circumstances. Does that show how the situation is quite sustainable?

PPS: Looking at all this,  it's no wonder the banks have such high earnings and high dividend yields in Australia.

Cheers,

Beej


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## ducati916 (6 October 2009)

From Mish

http://globaleconomicanalysis.blogspot.com/2009/10/fractional-reserve-lending-constitutes.html



> Fannie Mae makes a loan of $1,000,000. Let's be more than reasonably fair and assume Fannie Mae issued bonds for the entire amount, not borrowing a single cent into existence. So far there is no fraud.
> 
> $1,000,000 goes to the home builder. That home builder deposits $1,000,000 into a Bank of America checking account. Ignoring sweeps that would allow Bank of America to loan out every cent, let's assume BofA keeps 10% in reserves and lends out $900,000 to a new furniture store on the corner strip mall.
> 
> ...




jog on
duc


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## Macquack (6 October 2009)

alter1217 said:


> In a country with no bank, there is $1 mill of currency. you and a group of entrepreneurs pool your money together and start up a bank with $100k of capital.
> 
> Your first customer takes out a loan of $10k with 10% interest per annum.
> 
> *Total Loans are greater than total deposits by $100,000*, unless you count the 100k of capital as deposit.




Dont you mean "Total Loans are greater than total deposits by *$10,000*"

My take.

The Banana Republic Bank lends out $10,000 to their first customer, Fred Blogs to buy a piece of land. A bank cheque is made payable to Mr Keating the land holder.

Surprise, suprise Mr Keating turns up the very next day at the Banana Republic Bank and deposits his cheque and decides to open a savings account (paying 8 % interest).

Total loans (asset) = $10,000 , Total deposits (liability) = $10,000.

The Bank collects the 10% interest from Fred Blogs, but has to pay Mr Keating 8% on his deposit. The Bank makes the 2% spread so long as Fred keeps up his repayments.

Also, no cash changed hands. The bank still has the $100,000 cash in the vault. The bank must have created the $10,000 loan out of thin air!


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## alter1217 (7 October 2009)

In a country with no bank, there is $1 mill of currency. you and a group of entrepreneurs pool your money together and start up a bank with $100k of capital.

Your first customer takes out a loan of $10k with 10% interest per annum.

Total Loans are greater than total deposits by $10,000, unless you count the 100k of capital as deposit.

Fixed. 



Macquack said:


> Dont you mean "Total Loans are greater than total deposits by *$10,000*"
> 
> My take.
> 
> ...




Well, yeah, that's what usually happens... Until the government implements a piece of regulation called "reserve requirements"... there could potentially be unlimited money created (until a bank run occurs, lol)?


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## Macquack (8 October 2009)

alter1217 said:


> Well, yeah, that's what usually happens... Until the government implements a piece of regulation called *"reserve requirements"... *there could potentially be unlimited money created (until a bank run occurs, lol)?







> "Unlike central banks in a number of other countries, the RBA imposes *no reserve requirements"*
> http://www.rba.gov.au/MarketOperations/Domestic/open_market_operations.html




Reserve requirements/ratios are old school.

Capital adequacy is the new buzz word used by central bwankers. What does it mean? It means that private banks can create more money out of thin air than they could when there where minimum cash reserve ratios in place.



> "Removing controls on banks will almost certainly result in a *surge in credit growth*...A regulated financial system often tends to result in credit rationing, so there is unsatisfied demand for credit in the community; *this is able to be meet once the controls are removed*."
> 
> "Australia's Experience with Financial Deregulation"
> Rick Battellino
> ...


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## jono1887 (8 October 2009)

Macquack said:


> Reserve requirements/ratios are old school.
> 
> Capital adequacy is the new buzz word used by central bwankers. What does it mean? It means that private banks can create more money out of thin air than they could when there where minimum cash reserve ratios in place.




There aren't any specified capital adequacy ratio in Australia isn't there.. its up to the banks choice on what their capital adequacy ratio's are..


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## JimmyJones (9 October 2009)

jono1887 said:


> There aren't any specified capital adequacy ratio in Australia isn't there.. its up to the banks choice on what their capital adequacy ratio's are..




From wikipedia:

"Australia, through its Australian Prudential Regulation Authority, implemented the Basel II Framework on 1 January 2008"

Also:

http://www.riskmanagementmagazine.com.au/articles/74/0c03eb74.asp
http://www.apra.gov.au/ADI/Basel-II-implementation-in-Australia.cfm

I thought the Basel rules were voluntary for the countries signing up to them. If that's the case why didn't the U.S. government lower the capital requirements for their own banks thus negating the need for the taxpayer-funded bailouts??


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## Macquack (9 October 2009)

JimmyJones said:


> I thought the Basel rules were voluntary for the countries signing up to them. If that's the case *why didn't the U.S. government lower the capital requirements* for their own banks thus negating the need for the taxpayer-funded bailouts??




Wasn't that the problem, US private bank reserves were already too low.



> America’s Federal Reserve””maintained them (reserve requirements), but had such loopholes in them that they became *basically irrelevant*. Thus the US Federal Reserve sets a Required Reserve Ratio of 10%, but applies this only to  deposits by individuals; *banks have no reserve requirement at all for deposits by companies.*
> Yueh-Yun C. OBrien, 2007. “Reserve Requirement Systems in OECD Countries”


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## jono1887 (10 October 2009)

JimmyJones said:


> From wikipedia:
> 
> I thought the Basel rules were voluntary for the countries signing up to them. If that's the case why didn't the U.S. government lower the capital requirements for their own banks thus negating the need for the taxpayer-funded bailouts??




I think considering the state of the financial system.. reducing the requirements would have no effect. The banks were all scared of bank-runs, and by reducing their own capital reserves, they would be increasing this risk. Didn't the US govt find that even with the injection of the billions of dollars.. the banks were simply unwilling to hand out any more credit, hence the credit crisis and they were preferring to sure up their balance sheets and minimise risks by increasing their own capital reserves above the specified rate.


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## Sean K (16 October 2009)

Good You Tube on Inflation I think;


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## Macquack (16 October 2009)

kennas said:


> Good You Tube on Inflation I think;




In reference to Mugabe cutting loose with the printing presses.


> By July 2008, it cost 100 billion Zimbabwean Dollars to buy three eggs.






> In April of 2009, the Zimbabwean currency was officially declared dead and completely worthless.
> 
> Zimbabweans were forced to transact in gold.




Is there a message in this for the rest of the world?


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## boofhead (16 October 2009)

Many in Zimbabwe trade in neighbouring currencies and the South African Rand is popular.


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## Timmy (30 January 2010)

ducati916 - if you are around - or any others, of course, thoughts on money velocity in the US?

First tick up in a while, possible foreshadowing of the inflation you were looking for?  

Graph below, from: http://research.stlouisfed.org/publications/mt/page12.pdf
(Red oval mine)


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## GumbyLearner (1 February 2010)

I've tried to track stats on IMF Special Drawing Rights. Who borrowed, how much and when?

Can anyone on ASF please point me in the right direction?

Here's a great informative article by Joe Stiglitz.

This is the paragraph that got me thinking!!! 

*Thanks to the Deficit, the Buck Stops Here*
August 30, 2009

http://www.washingtonpost.com/wp-dyn/content/article/2009/08/28/AR2009082802111.html

In its interim report in June, the commission described a number of alternatives. Some involve building on the International Monetary Fund's "special drawing rights," or SDRs -- a kind of "IMF money" -- but making the issuance of this global reserve money annual and more predictable. *(Currently, issuances of SDRs are small and episodic.)* Other proposed reforms are more complex and ambitious, such as issuing new global reserves in ways and amounts that could be used to stabilize the world's economy or to invest in "global public goods," such as helping developing nations reduce greenhouse gas emissions.

So what are these small and episodic events?


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## paulhood (3 February 2010)

simple defintion of inflation is: an increase in the supply of money......therefore more money in the system reduces the purchasing power of existing dollars that are already in the system......hope this helps.....


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## Timmy (3 February 2010)

Gumby - the IMF website has info on SDRs and the 4 times they have been allocated ... hope that helps.  (It appears one of the allocations was after Stiglitz's article appeared in August '09)

http://www.imf.org/external/about/sdr.htm


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## Wysiwyg (12 June 2011)

*So is Australia currently experiencing the effects of inflation due to USA printing more paper money?*


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## tothemax6 (13 June 2011)

Wysiwyg said:


> *So is Australia currently experiencing the effects of inflation due to USA printing more paper money?*



What other countries do to their currency should have no effect. The only thing that effects inflation in Australia is the Australian money and credit supply. Note the appreciation of AUD against USD since the US started printing away.


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