Printing more money = inflation - how?

[Beej]

And if people think inflation will make you rich because you own assets like houses, you better think twice. It's a naive thinking.

Just on this comment (seeing as it seems to have become somewhat controversial!) - I personally don't say that owning assets like property make you "rich" in a high inflation environment, but I do say they stop you from getting any poorer..... Ie it's a great inflation hedge due to the fundamental value of property/land in the scheme of things, regardless of the actual number of $ in circulation.

Cheers,

Beej

 

[Uncle Festivus]

Just on this comment (seeing as it seems to have become somewhat controversial!) - I personally don't say that owning assets like property make you "rich" in a high inflation environment, but I do say they stop you from getting any poorer..... Ie it's a great inflation hedge due to the fundamental value of property/land in the scheme of things, regardless of the actual number of $ in circulation.

Cheers,

Beej

I would have thought that, in a high inflation environement, housing is a poor choice, unless it's 'value' is appreciating faster than the rate of inflation, a point some property advocates conveniently leave out when calculating their return?

The number of dollars in circulation is intrinsically bound to inflation (because that's what inflation is - the amount of currency created surplus to organic growth) and thereby to property prices?

 

[waz]

Beej makes a good point.

Lets take an analogy. Lets say we live in an economy with 100 people and the only thing in this economy is 100 houses. If each person owns a house, then each person owns 1% of the scarce resources. They are equally rich.

20 years later, inflation in the economy has casued prices to go up by 1,200,345,765%. There are still 100 houses and 100 people in the economy. Not one person has sold a house and no one has built a house (why would you bother the poplutation isnt increasing), and there is nothing else of value in this economy, so even though they are now all zillionaires, they still all hold 1% each of the available resources.

Relative to each other they are all the same. The only thing that has changed is price.

Now lets say there is one smart chap out of the 100 who wants to become rich. As houses are the only resources in this economy he builds another 10 houses and invites 10 immigrants to live in them and pay rent.

We now have a situation where the economy now has 110 houses.
1 guy has 11 houses
99 have 1 house each
and 10 are renting.

Who is rich?
One guy owns 10% of all the scare resources. (Before he had 1%)
99 own 0.9% each (Before they had 1%)
and 10 own nothing. (And they had nothing to begin with too)

The smart guy who increased his stake of scare resources is now the richest (Assuming all houses are of equal value).
Note, the price of these house is irrelevant to work out who is the richest in this simple economy.

Moral of the storey, if you want to become rich, you need to acquire something which is scarce. Property being a good example.

 

[Beej]

I would have thought that, in a high inflation environement, housing is a poor choice, unless it's 'value' is appreciating faster than the rate of inflation

No - only if your aim is get "richer". To simply not get any poorer, you only need your property to appreciate at a rate equal to the prevailing rate of inflation. That is the nature of a "hedge".

PS: Properly selected property should outpace inflation by a margin in a high or low inflation environment anyway, plus the use of debt to gear into property can really make you a relative winner from high inflation, but that is another discussion

Cheers,

Beej

 

[Uncle Festivus]

No - only if your aim is get "richer". To simply not get any poorer, you only need your property to appreciate at a rate equal to the prevailing rate of inflation. That is the nature of a "hedge".

PS: Properly selected property should outpace inflation by a margin in a high or low inflation environment anyway, plus the use of debt to gear into property can really make you a relative winner from high inflation, but that is another discussion

Cheers,

Beej

Then that would depend on what is inflation? The official figure is not inflation but the effects of inflation - that's the big difference. The estimated growth in money supply has been north of 10% in Aus for a while, so unless your returns, from any investment, are greater than that then you are going backwards?

 

[Beej]

Then that would depend on what is inflation? The official figure is not inflation but the effects of inflation - that's the big difference. The estimated growth in money supply has been north of 10% in Aus for a while, so unless your returns, from any investment, are greater than that then you are going backwards?

Increase in money supply does not automatically equal rate of inflation, as growth in GDP (due to increasing economic capacity from both productivity improvements and increasing working population etc) is reflected in (non inflationary) increased money supply. If real inflation had been running at 10% plus for the last few years it would absolutely be reflected in headline CPI, underlying CPI, PPI and other related inflation tracking index!

Cheers,

Beej

 

[gfresh]

How's mr "smart guy" going to be able to afford to build a 10 properties if the prices for materials and labor now cost 1,200,345,765% more?? If his wages didn't go up an equal amount he has no chance of building one property, never mind 10.

Property guy over 20 years can also rent out his backyard to 10 of those who are unable to afford food and shelter and therefore increase his relative wealth?

Rental guy also being passed on whatever costs are being imposed on landlord guy. Rental guy not necessarily benefiting here either..

 

[waz]

Simple, he built the houses in the first quarter of 2009 before inflation took off.

Its just a simple model. The point im trying to make, is that if you want to become rich, regardless of the inflation/deflation rate, you need to take away resources from other people and make sure there is a demand for it.

So a few options are available to you. You can:
Build houses, then chop of the legs of all builders.
Invade an oil producing country and ban electric cars
Buy every airport around the world and create a monoply
Take over BHP, Rio Tinto and Vale, then force them to merge
Invent something and patent it.


Remember, in order for you to increase your stake of the worlds limited resources, that means somone else is decreasing their stake. So if someone becomes rich, someone becomes poor.

 

[Beej]

Remember, in order for you to increase your stake of the worlds limited resources, that means somone else is decreasing their stake. So if someone becomes rich, someone becomes poor.

That is not entirely true. Eg, if you make something with your own labour and/or enginuity, then you increase your relative wealth without having taken any resources of someone else and made them poorer. Eg, you could have built your own house, you could grow your own food etc. These are simple examples, but they demonstrate how wealth is actually created through productive labour.

Cheers,

Beej

 

[Knobby22]

The US and GBR are printing money.
Not that big a deal as money supply has been increasing for years.

If..if...they get it right and don't print too much, they may stop deflation without getting hyperinflation. As inflation increases they can tighten money supply and if they are the "smartest guys in the room" in reality, it just might work.

 

[Dowdy]

I don't take a hard position on this either way, and don't claim to be an expert, but there is an argument floating around that because of the destruction of value brought about in the US economy by the sub-prime/credit crisis, their "printing of money" will not be inflationary as it is replacing that lost value, and therefore just kind of "canceling out" the real and potential deflation. It would only create inflation if it got out of hand.... which of course it might.

Cheers,

Beej

Sure they're replacing lost value but that 'value' was over inflated and in a massive bubble so to prop up prices that couldn't be sustained in the first place will only lead to destruction of currency.

You don't fight debt by creating more debt and most of the homes (US and here) are 80%++ debt.

 

[Dowdy]

Increase in money supply does not automatically equal rate of inflation, as growth in GDP (due to increasing economic capacity from both productivity improvements and increasing working population etc) is reflected in (non inflationary) increased money supply. If real inflation had been running at 10% plus for the last few years it would absolutely be reflected in headline CPI, underlying CPI, PPI and other related inflation tracking index!

Cheers,

Beej

CPI figures are manipulated. I wouldn't use those as a reference. They just simply change the 'basket of goods' to make it look like everything is fine and dandy


http://www.youtube.com/watch?v=zsNgJVD8KgY&feature=related

 

[Uncle Festivus]

The US and GBR are printing money.
Not that big a deal as money supply has been increasing for years.

If..if...they get it right and don't print too much, they may stop deflation without getting hyperinflation. As inflation increases they can tighten money supply and if they are the "smartest guys in the room" in reality, it just might work.

I think the M agregates figures show a contraction for a few months now, at least for the US.

Sure they're replacing lost value but that 'value' was over inflated and in a massive bubble so to prop up prices that couldn't be sustained in the first place will only lead to destruction of currency.

You don't fight debt by creating more debt and most of the homes (US and here) are 80%++ debt.

$15 trillion of previously printed money 'lost' so far on global equity markets, can't or havn't seen them 'printing' that much money in the priming packages so far?

 

[waz]

This is more in reply to Beej, thanks for making me think harder. hehe

Another analogy. We have an economy with two farmers. Mr Productive and Mr Non productive.
At the moment the economy produces 100 units of food (output) and there are 20 units of resources.

They both make 50 units of output each and they both use 10 units of input each. So they both have the same level of income and access to resources. 50% each.

Mr Productive goes to university and learns a new farming technique which enables him to produce more units of output using the same level of inputs as before.

Mr productive now makes 60 units of output while Mr unproductive still makes his 50. In total the economy is more productive, we are creating 10% more using the same resources.

Both our friends have 50 customers each and sell their units of food for $1 each (Assume there are only 100 people in the world). So both have $50 of income. However, now that Mr Productive has 10 spare units, what does he do? He sells these spare units to Mr Unproductive's customers for 90c (The units of food are exactly the same and the customer do not care about loyalty).

Mr productive sells all his 60 units for an income of $59.
Mr unproductive only sells 40 units for an income of $40. (10 units sit unsold).

Both are using the same amount of resources, one is now more productive than the other and has increased sales and profit, the other has lost sales and profit. The gap between them has widened. One is better off than before, and one is worse off than before.

Ofcourse this model is very simple, Mr unproductive can reduce his price to 80c, Mr Productive customer's can hold out purchasing until he agrees to sell all his units for 90c.

The point is, the person with the productivity gains has the upper hand. Even though they still have access to the same amount of resources as before. The productive person has generated more income and in the future years his relative wealth will increase at a faster rate than the non-productive.

 

[Temjin]

I do not normally wade into the 'tit for tat'...not when online and you are communicating with an unknown audience...but I do take offence when another suggests one might be..or is..naive to think a certain way....

my answer is 'you may also be very naive....to think another way'

....you have no idea of the depth of knowledge I , or other posters /bloggers hold on a certain subject.....so hurling insults around will not get any friends...and on some forums you would be suspended...or put on the ignore list...
one needs to have good manners...and decorum...if you wish to be taken seriously

Wooo, no need to get so "emotional" about this. I certainly don't feel my posts are done so in a bad manner. Anyone who have ventured this forum for a while and have read my posts would know the type of "style" I use to illustrate my points.

But ok, if my post offended you, I will apologise for making the "naive" comment.

I will rephrase that last sentance and add in a few more words that I forgot to mention.

Anyone who believes holding a property purchased on credit and expect it to provide a hedge against hyperinflation should really think twice about it.

Can you explain why this is so?

Now I will get to the point.

No doubt that in a hyperinflation (or high, not necessary million % per year) scenario, prices for everything will raise, including property. But is it the perfect hedge against it? No, I don't think so because it does not satisfy certain criteria that I believe to be crucial for a good inflation hedge.

- It is not liquid enough enough and not easily diversible. This make property a difficult asset to sell when one needs the inflated money to purchase the corresponding increased value of everyday needed goods. In theory, if purchased in cash, it may "perserve" your net wealth, but it serve no purpose in maintaining your lifestyle because you cannot sell 1% of it to pay for anything you need. Wage rate and cash rate generally don't raise fast enough to counter the inflation effect on general goods. This explains why most countries that experienced a hyperinflation (or near) scenario tend to suffer a rapid decrease in living standards. (i.e. Germany in 1920s and of course, Zimbabwe)
- Interest rate will raise rapidly during high inflation because banks will move extremely quickly to protect their underlying profit. In fact, they will most likely to raise borrowing rate far above underlying inflation rate because it is almost impossible to predict the growth in money supply fast enough to adjust the changes needed. It's a risky business for banks during these periods if they underestimated the inflation rate. Thus, those who hold properties on credit will get crushed by the rapidly increased debt servicing burden. Combined it with a rapid rise in unemployment, you get a double punch on the value of your property.
- Again, wages rarely raise fast enough to catch up with high inflation. Look at Zimbabwe as a perfect example. This is why there is a 90% unemployment rate over there because their q And if wages don't raise fast enough, the ability for a person to service a new mortgage debt based on high interest is severely reduced. No demand = no raise in price.
- I also highly doubt properties will maintain their value during a hyperinflation scenario, especially if it is a stagflationary one where there is a rising price PLUS rising unemployment. No one would be able to afford these "hyperinflated" houses.

Regardless, I'm not saying property cannot be used as a hedge against inflation. It's just that it cannot be used in a practical way to act as a perfect hedge in a realistic world.

If you have a fully paid house, then it may retain your overall net wealth but it serves little practical hedging purpose if you cannot afford to maintain it and/or to feed your family due to job lost or your cash reserve was deflated too rapidly.

 

[robots]

hello,

great work, who cares about inflation, deflation, hyperinflation its all irrelevant

if twisties drop to $0.50/packet can i get more today?

look at the doctor just recently who had council revalue from 1mil up to 6mil, wouldnt be too concerned about any of that

spot on Beej, add value at the moment is the way to go

thankyou
robots

 

[Dowdy]

hello,

great work, who cares about inflation, deflation, hyperinflation its all irrelevant

if twisties drop to $0.50/packet can i get more today?

look at the doctor just recently who had council revalue from 1mil up to 6mil, wouldnt be too concerned about any of that

spot on Beej, add value at the moment is the way to go

thankyou
robots

So now we're using some doctor who done a council revalue as the benchmark and everything else is irrelevant. Keep up the good work robots

 

[robots]

So now we're using some doctor who done a council revalue as the benchmark and everything else is irrelevant. Keep up the good work robots

hello,

will do

thankyou
robots

 

[juw177]

The causes of inflation during the boom and subsequent deflation are little to do with printing money par se. It is to do with fraudulent credit creation by the banks.

In order for a bank to lend money, it only needs to hold a fraction of the loan amount, not the entire amount. When a loan is made, the bank has created money that was not there before, which is effectively the same as printing money.

Credit creation without the GDP means to back it up is inflationary. During the credit boom, there was a lot of money (credit) available which caused high inflation. No stop was put to the increasing of leverage and the intentional mis pricing of high risk loans.

But, we now find that the credit were bad loans. The defaults start happening. No more credit is issued because everyone is overcapacity in debt and there is not enough reserve to support any more loans. Now have deflation.

 

[Beej]

The causes of inflation during the boom and subsequent deflation are little to do with printing money par se. It is to do with fraudulent credit creation by the banks.

In order for a bank to lend money, it only needs to hold a fraction of the loan amount, not the entire amount. When a loan is made, the bank has created money that was not there before, which is effectively the same as printing money.

Credit creation without the GDP means to back it up is inflationary. During the credit boom, there was a lot of money (credit) available which caused high inflation. No stop was put to the increasing of leverage and the intentional mis pricing of high risk loans.

But, we now find that the credit were bad loans. The defaults start happening. No more credit is issued because everyone is overcapacity in debt and there is not enough reserve to support any more loans. Now have deflation.

Yes that was the story in the US. In Australia, the creation of credit (and thus the money supply) was throttled slowly through higher and increasing interest rates over the past 5 years. Hence we are in a much better position here in this regard than the US is.

Cheers,

Beej