Sunday, February 22, 2009

The Hyperinflation Myth

Below is a graph that shows the increase of the Base Money supply of the USA. Base Money (M1) is the fiat money that is created by the Federal Reserve. As you can see, the Fed has been going crazy “printing” money. (Most money is now electronic, not paper - hence the word printing is somewhat of an anachronism.)

Based on this graph, you probably think that we should be experiencing hyper-inflation. Many people of the Austrian Monetary theory (such as Lew Rockwell, Peter Schiff and Ron Paul) have consistently predicted hyperinflation. And, yet, we have not seen a radical increase of prices. Why not?

The reason we have not seen hyperinflation is that most of our money is created by banks through loans. The government creates very little fiat money compared to the credit money created by the banks. And the credit money has been dramatically collapsing over the past year.

The increase of fiat money by the Federal Reserve is like pushing on a string. The banks are not lending this money because businesses are not expanding and current loans are defaulting. And without lending, money cannot increase under our current monetary system.

1 comment:

  1. It seems to me that the distinction between fiat money and money created by the fractional reserve mechanism is a distinction without a difference so far as the ultimate effect on inflation. For in either form, there is that much additional money chasing the aggregate goods that are out there.

    We might ask, what if all the cascading loans were, say, earmarked as building loans. So they are only bidding the price up on 2x4's, concrete, masonry, land services, etc. Nevertheless, every dollar "freed up" by these loans to chase those goods frees up a dollar in the cash part of the economy that would have been earmarked for that, but now can chase shoes and food. So in aggregate, it seems like both forms contribute more or less equally to inflation.

    Only if you could argue that whole new areas of activity were opened up by the loan process that would not be the case otherwise, could one argue differently it seems to me. But this seems implausible.