Peter G. Klein's speech about the Fed

[ubernerd]

Originally Posted by independent

I believe we're using "inflation" two different ways. I'm talking about the average increase in consumer prices (e.g. hot dogs). You may be talking about the increase in the money supply. They are related by not identical.

The original discussion:

Quote:
Originally Posted by FormLetter
It is rather convenient [ ] that the income tax was made legal in the same year the Federal Reserve (inflationary by design) was created.

From that point forward, you get taxed on inflation. Say you buy a freeze dried hot dog last year for $1. This year you sell it for $1.05 because prices have gone up due to the inflation induced by the Fed. You get taxed on the $0.05. So even though the real wealth is the same, the income tax takes a piece. It's brilliant really.
[/quote]

Originally Posted by independent

The way I do the math, the inflation tax is based on the amount of currency I hold, or the balance in zero-interest (or near zero) accounts.* If I bought the hot dog with a dollar bill that I hid in my mattress, then I'd agree with your calculation. But I don't hide currency in mattresses.

I don't know about you, I hold maybe 1-2% of my annual income in currency or checking accounts. So 5% inflation costs me .05 x [.01,.02] = 0.05% to 0.10% of my annual income. That's a pretty small tax.


* Long term interest rates have inflation expectations embedded in them. Equity or real estate investments ride up with long term inflation because revenue goes up with inflation. So I don't see any inflation tax on those investments.

It should be pretty clear that when we referred to inflation we were talking about activities of the central bank (Fed), in other words an increase in money supply. This is the cause of the inflation you are talking about. And it's effect is not uniform on consumer prices either. In fact, the effect of inflation is not uniform on all consumers. It has the greatest effect on the people who get the new money last. Bankers and government and some of the contractors they purchase from get the benefit.

[ShebaPoe]

Inflation.

Its impact is not uniform. Gas prices up, food up, TVs down, wages stable.

There is a high correlation between people who think inflation is good and idiots. In general, they seem to have a hard time with this: inflation up, interest rates up, cost of capital up, wages stable, inflation up further, rates higher, cost of capital still higher, you get laid off.

Independent, despite his lack of understanding of this issue, does make a good point about the ineffectiveness of storing money in your mattress. Why, do you think, the USG wants to discourage this behavior? It's only stupid to store cash, not to "store" stocks or commodities.

[independent]

Originally Posted by ubernerd

It should be pretty clear that when we referred to inflation we were talking about activities of the central bank (Fed), in other words an increase in money supply. This is the cause of the inflation you are talking about. And it's effect is not uniform on consumer prices either. In fact, the effect of inflation is not uniform on all consumers. It has the greatest effect on the people who get the new money last. Bankers and government and some of the contractors they purchase from get the benefit.

Who gets "new money last"? Money is fungible. It seems that if the gov't pays me or a contractor or a bank with "new money", that looks the same as if it pays us with "old money".

(I've seem this comment before and, as you can see, it doesn't make sense to me. If it's a well-known economic fact, I'm fine with reading about it in some standard reference instead of asking you to explain it. I just don't know where to look.)

[ShebaPoe]

The only winners in inflation are banks (creators of money) and the federal government (the entity that can command the creation of money).

Everyone else loses, though some may see nominal asset appreciation, while others may see wage increases. The key word, of course, is "some". When you see that, it means the government is picking winners and losers.

[ubernerd]

Originally Posted by independent

Who gets "new money last"? Money is fungible. It seems that if the gov't pays me or a contractor or a bank with "new money", that looks the same as if it pays us with "old money".

(I've seem this comment before and, as you can see, it doesn't make sense to me. If it's a well-known economic fact, I'm fine with reading about it in some standard reference instead of asking you to explain it. I just don't know where to look.)

Only banks and the treasury have the privelege of creating US dollars. When they spend the newly created money prices are adjusted to the old money supply. Only after they spend it do prices adjust to the new demand. This process takes time to filter through the whole economy. The fact that money is fungible is exactly what makes this work. As a seller, you don't know that you are getting new money.

Compare this to a scenario in which I produce counterfeit money. I go into your store and buy a bunch of stuff from you. I spend some more of the phony bills at other stores in your town. I got the merchandise free (minus the trivial cost of counterfeiting). If you can successfully pass the phony bills in another store, you will also benefit but not as much since I also bought stuff there causing prices to adjust slightly and of course because you gave up some merchandise to get the money. After you spend your money, prices might adjust upward again. After a couple hundred rounds of this prices have adjusted to the new money supply but some people are just out of luck while I have reaped a huge benefit.

[independent]

Originally Posted by ubernerd

Only banks and the treasury have the privelege of creating US dollars. When they spend the newly created money prices are adjusted to the old money supply. Only after they spend it do prices adjust to the new demand. This process takes time to filter through the whole economy. The fact that money is fungible is exactly what makes this work. As a seller, you don't know that you are getting new money.

Compare this to a scenario in which I produce counterfeit money. I go into your store and buy a bunch of stuff from you. I spend some more of the phony bills at other stores in your town. I got the merchandise free (minus the trivial cost of counterfeiting). If you can successfully pass the phony bills in another store, you will also benefit but not as much since I also bought stuff there causing prices to adjust slightly and of course because you gave up some merchandise to get the money. After you spend your money, prices might adjust upward again. After a couple hundred rounds of this prices have adjusted to the new money supply but some people are just out of luck while I have reaped a huge benefit.

It's clear to me that the Treasury (or the gov't in general) makes money - that's traditional seigniorage in my world. The Treasury can pay defense contractors with new bills that didn't come from taxes.

But, I don't see how the contractors get any special benefit. In your counterfeit money example, the first store owner that accepted the fake money gave up real goods in exchange for fake money. Assuming he successfully passes it on to somebody else, he's in exactly the same position as if he had sold the goods for real dollars. There's no advantage to him being paid in counterfeit.

I don't see any advantage to banks, either. Banks get involved in "creating money" in a couple ways. They accept new bills from the Fed in exchange for their existing reserves. They also do fractional reserve banking. But I can't see where either of those gives them some special deal.

[FormLetter]

The person using the new (or fake in the counterfeiting example) money first gets to spend that money without having produced anything, and they spend it before prices adjust to this new additional money. Somewhere along the line all the new money chasing real goods will lead to higher prices. People who never get any of this new money still face higher prices, so their same initial amount of work yields them less goods. Compare that to the first spender who was able to buy things at the old prices before they went up, without having produced anything to get that new money. The defense contractor is just the second holder of that money. They get to spend it early in the process. The citizen in Des Moines that works in a restaurant just faces the higher prices.

[Standtall]

Originally Posted by ShebaPoe

The only winners in inflation are banks (creators of money) and the federal government (the entity that can command the creation of money).

Everyone else loses, though some may see nominal asset appreciation, while others may see wage increases. The key word, of course, is "some". When you see that, it means the government is picking winners and losers.

I think inflation will help younger people with very little savings, as future earnings and savings will be higher if the inflation happens early, i.e. before their prime earning years.

Older people and people with large amounts of wealth with less future earning years will get hurt more.

When it comes to competing for goods in the market later on, eroding the wealth of those older than me, with more money saved than me is probably good for me.

[ShebaPoe]

Your post is too speculative to evaluate.

You also don't contemplate the possibility that inflation could lead to the production of fewer goods, long term, at which point your wealth has lower utility.

Finally, your post makes it clear that centralized dominance of monetary policy is antithetical to individual liberty. You're saying, roughly, "if the central money planners do something which favors me". In short you (and all of us) are herded around by central planners.

Sound money is as important to individual liberty as free speech or the right to keep and bear arms.

[independent]

Originally Posted by FormLetter

The person using the new (or fake in the counterfeiting example) money first gets to spend that money without having produced anything, and they spend it before prices adjust to this new additional money. Somewhere along the line all the new money chasing real goods will lead to higher prices. People who never get any of this new money still face higher prices, so their same initial amount of work yields them less goods. Compare that to the first spender who was able to buy things at the old prices before they went up, without having produced anything to get that new money. The defense contractor is just the second holder of that money. They get to spend it early in the process. The citizen in Des Moines that works in a restaurant just faces the higher prices.

I agree with the bold. In the case of gov't printed money, the first person is the gov't -- really the politicians, in the sense that they get credit for spending money without blame for raising taxes.

The rest of the people don't know if they are getting new money or old money. Anybody who spends before prices go up, regardless of where they got their money, "saves" in the sense that they got rid of their currency before prices went up.

For example, I don't see how SS beneficiaries are better off if their benefits are paid with newly printed currency rather than with money collected in taxes.