11. THE FEDERAL DEFICIT AND INFLATION
One economic controversy centers on the effect of budget deficits by the federal government on the money supply and on inflation. The federal deficit is the money that the government borrows in order to cover the cost of operations that exceeds the amount of collected taxes, borrowing which is financed through either Treasury or Savings Bonds. One can find economists who say that relationship between deficits and inflation is definite, an economists position is possible, or is non-existent. Some findings indicate that the size of deficits doesn't necessarily correlate with inflation, for both Japan and Germany have deficits that are proportionally four to five times greater than our deficit, yet their inflation rates have been only a third to a fourth of ours.
This chapter will explain the quirks of why deficits do or don't produce inflation. This explanation will draw upon how productive deflation, described earlier, occurs more frequently in Japan and Germany through government sponsorship of increased productivity and government curtailment of private speculation. For instance, there are few corporate takeovers in Japan, especially by foreigners, that drain money from capitalizing production. The velocity of money circulating in non-productive activities is not as great in Japan and Germany. Whereas American politicians run deficits to fund programs like milk supports, the Japanese and Germans direct their deficit spending into research and development for increased productivity and lower prices, ergo, productive deflation.
The inflationary impact of deficits, when applicable, occurs foremost in the essential products. Essential refers to the products of human production that are essential to basic human survival, e.g., food, clothing, and housing. This inflation is due to how deficits are inflationary in both the short and long run and involves the de facto currency nature of the Treasury issues used to fund the deficit. If one understands that Treasury bonds are a form of currency, one will realize why the Federal Reserve can't control the money supply as it claims to do in its fight against inflation.
The present (1980) policy-makers in the Federal Reserve are monetarists who believe that inflation is controlled solely through affecting the money supply. Their basic rationale is the classic definition of inflation which simplistically states that inflation is merely a ratio of money to goods and services. As noted before, this definition ignores how the particular use of money today will affect prices tomorrow, in terms of shortages or surpluses of products. If money is counterproductively used by the government and bankers--whether from deficit spending or savings relending--then inflation occurs due to shortages, even if the money supply has not increased.
Even without considering how deficits can inflationarily circulate money away from production, one can show a relationship between deficits and inflation using the monetarists' position that inflation occurs when the money supply increases. This relationship exists because the functional money supply is more than what the monetarists declare it to be. The Treasury bonds, for example, used in financing the deficit are part of the money supply.
When one thinks of currency these days, one usually thinks of a certain scribbled-on paper product that is called money. In addition, there is the coinage of metal currencies. These constitute the official public currencies which, in the United States, are Federal Reserve Notes along with the pennies, nickels, dimes and quarters.
Federal Reserve Notes are printed by the Federal Reserve System to increase or decrease the "money" supply ... in theory. Thus, the money supply increases or decrease when the Federal Reserve System either
lends Reserve Notes through its "discount windows" to banks, or,
The reserve requirement was discussed previously in regards to the "Bankers' Law of Money Multiplication." Changing the reserve requirement affects the money supply by increasing or decreasing the loans in circulation. (The Fed's use of "open market" operations, another of its functions, will not be discussed here.)
Through these functions, the Board of Governors at the Fed believe they can control the money supply and thereby control inflation. But what if they are wrong about what constitutes the money supply? Suppose the Treasury bonds, issued in larger numbers to cover a ballooning National Debt, are in fact a form of money? If so, then the money supply is expanding more rapidly than the simple measures of money indicate.
At one time the Federal Reserve System printed denominations of currency up to the amount of $100,000. If the Fed injected one of these bills into circulation, the money supply would increase by $100,000. The bank receiving this Federal Reserve Note could use it to make many loans, converting it into lower denominations in the process. Does a similar expansion of the money supply occur when the Treasury Department, in order to fuel the deficit spending of the politicians, prints a Treasury bond? Consider the steps involved in selling this paper.
The denominations of Treasury bonds (T-bills) are in units of $10,000, up to $1,000,000. When the Treasury Department prints and sells a $100,000 T-bill, the politicians become owners of dollar bills. The effect on the money supply is the same as if the Treasury Department had printed the dollars and thereby expanded the money supply. The dollars were not previously in active circulation competing for the available goods and services.
This expansion of the money supply is very obvious if the Fed happens to be the purchaser of the T-bill; over the years, the Fed has purchased T-bills to the tune of $150 billion. The effect on the money supply is the same if a bank takes inactive money from its required reserves and lends it out, thereby expanding the money supply. Once converted from a savings account, through bank loans or government borrowing, these dollars become liquid in the everyday economy. The Fed Notes have convertibility--liquidity--with T-bills. This liquidity makes the latter an unofficial public currency printed in higher denominations than the scribbled-on paper products used as the official currency (the Federal Reserve Notes). Liquidity as the basis for determining what is money has been noted by others and has been extended to include a large group of financial instruments, e.g., corporate paper, a credit line, which have been called forms of "near money."
One must distinguish between what economists call money or currency and what the nature of currency is within a system of production. Most economists axiomatically reject the equating of Treasury paper with Federal Reserve paper. Within this camp are those who say that if money and Treasury bonds were the same then they would have been called the same thing, and, that without certain boundaries we would not know what money is, let alone know how to measure and control it. Maybe past economists made a conceptual mistake. The nature of what is and what is not money is continually debated,, a fact that the Fed seems to be aware of in its statistics, e.g., it has six different money supplies.
Some economists note certain everyday differences between the Treasury bonds and money which, they argue, justify maintaining a distinction between the two. A writer for the Wall Street Journal, Lindley H. Clark Jr., offers the following "everyday" occurrence as a basis for distinguishing the two: "There are, of course, differences between Treasury securities and money, as anyone would find if he tried to buy a pair of ostriches from Niemann-Marcus with a $10,000 Treasury bill."
Refuting this argument can be done by considering whether it would be easier to "buy a pair of ostriches" with a $10,000 Federal Reserve Note?
According to the Money Museum in the Detroit Renaissance Center, there were in 1980 four hundred $10,000 Reserve Notes in circulation. Would it be any easier to buy something with a $10,000 Reserve Note or a $10,000 Treasury Note? Plausibly, a large denomination Reserve Note would be harder to cash than a Treasury Note at Niemann-Marcus or at a bank, since many, many Treasury Notes are in circulation compared to their Federal Reserve analogs. Bankers and storeowners are going to be more leery of something they have never ever or seldom ever seen, i.e., the more obscure $10,000 Reserve Note.
On the basis of liquidity--the ease of cashing some piece of financial paper into the smaller every day currency that most people experience--the convertibility of a Treasury Note probably exceeds that of a large Reserve Note. Thus, one can argue that Treasury issues are a form of money based on their high degree of liquidity.
Immediate And Long-term Inflation From Federal Deficits
Mr. Clark offered another line of reasoning to justify that Treasury bonds are not money, that they have no affect on the money supply, and that they have little affect on inflation.
If the Treasury finances the deficit by selling securities to the general public, there is little impact on inflation. The transaction merely substitutes public spending for private spending, and there is no increase in the money supply. In the longer run, however, public spending affects prices more than private outlays, since it is less likely to lead to the production of goods and services.
If one accepts financial liquidity as a basis for what is money, then Clark errs in saying that deficit spending does not increase the money supply. Thus, inflation would occur according to the classical definition because the money supply increased.
Clark self-contradicts his claim that deficits have little impact on inflation when he notes that production will not benefit from deficits. Shortage inflation will occur in the future. In the present, inflation will result from the virtual expansion of the money supply without a rise in production, especially in certain products.
Consider who buys Treasury bonds in units of $10,000 up to $1 million dollars and consider the range of people who are supported by deficit spending. Regardless of whether the purchaser of T-bills derives his income from production profits or inflationary returns, he has disposable income which is not in active circulation. On the other hand, the recipients of the dollars borrowed through the Treasury will put the money into active circulation; and, more likely than not, they are engaged in producing nothing or providing national services or goods, e.g., welfared persons or federal workers. This aspect of Treasury borrowing plays a key role in why budget deficits are not only inflationary but especially occurs in essentials.
In the balance, more of the federally-subsidized recipients--whether in defense industries, in bureaucracy, or on welfare--are consumers rather than producers of essential goods and services. Deficit-spending is immediately inflationary in the essential goods and services:
The number of dollars chasing the finite number of essential products increases after the government borrows money from people who are well-off, productively or inflationarily.
Prior to exchange for a Treasury bonds, the excess dollars of the well-off persons were not exerting any inflationary pressure on the essential goods and services, so-called "demand-pull" inflation. However, once exchanged for the T-bill, the number of dollars in circulation inflationarily increases which are competing for a fixed amount of essential production. Thus, the money supply increases without an increase in production which yields inflation.
The amount of production is fixed because the recipients of the dollars in defense or in welfare are not producing any of the essential goods and services which they are consuming. Consequently, deficit-spending through Treasury bonds generates one of the major reasons why inflation of the essential goods and services exceeds the rate of the overall Consumer Price Index.,
Savings Bonds Are Treasury Paper
Unlike Treasury bonds, Savings Bonds are purchased for patriotic reasons more so than financial reasons. The politicians do not allow high interest rates on savings bonds as they do for Treasury bills. As with the larger Treasury paper which also fund deficit-spending, savings bonds fuel inflation of the money supply and of essential product prices.
The patriotic purchaser of Savings Bonds is naively destructive of America and humanity. Through bonds, people underwrite the politicians' pork barrel projects and wasteful makeshift work. Foolishly, such naivete is fueling the collapse of production by corrupt and/or incompetent politicians. If people did not fund politicians, perhaps the pols would start being productive problem-solvers. As noted before, people who fund deficits through bonds, banks or money funds are hypocrites if they blame the politicians solely for the growing National Debt; without the buyers of bonds, there would be no National Debt or imbalanced budgets.
Velocity Of Circulation: Quantity vs. Quality
Monetary economists are chastised, herein, for failing to realize both the currency nature of Treasury issues and the effect of deficit spending on the prices of essential goods and services. The latter failure is a result of monetarists' naive or ignoble use of "velocity of circulation" in analyzing how fast and where money exchanges hands in the economy.
In assessing the velocity of circulation, the monetarists content themselves with mere quantitative measures. They measure the amount of money with little or no regard for which hands are handling the money. They assess money circulation without regards to the qualitative impact on product or production impact of the money, that is, whether needed or unneeded business is stimulated.
The monetarists do not distinguish whether the money is circulating in the essential or non-essential businesses, in the businesses of production profit or of inflationary returns. Consequently, an economy could be on the brink of catastrophic collapse due to cash-starved essential production, and the monetarists would still be seeing a strong economy. This monetary blindness would be amusing if the collapse were not approaching and if the great monetarists and the modern politicians were not exaggerating the state of the economy. In 1982, there was a marked shift by bond buyers toward short-term securities which means an increase in the amount of money shifting hands for manipulating paper, yet the monetarist chairman of the Federal Reserve (Volcker) saw no need for concern.
A nation cannot survive without production profits, especially essential production profits. Record yields on short-term bonds does not grow corn. For a given velocity of circulation, which economy is healthier:
An economy in which the money is circulating solely within the businesses that pursue inflationary returns, or,
The monetarists do not make this qualitative distinction as to the nature of a given quantity of money or a given velocity of circulation. The number one monetarist--Milton Friedman--would strenuously object to clarifying the nature of money circulation so as to maintain productivity in essential needs because of the implied loss of freedom for investors.
Velocity of circulation will only be balanced when there is democratic control of policy-making. Democratic tuning is needed not only in federal monetary policy but in private savings. Democratic tuning will promote productive deflation as a replacement for necronomic shortage inflation by maintaining optimal circulation.
Any kind of federal budget deficit using some form of Treasury Issue (bills, notes, or Savings Bonds) exerts an inflationary effect upon the money supply. The effect is the same as if the Federal Reserve System had printed an amount of money equal to the Treasury issue and injected it into the money supply. The extent of inflationary impact is whether the money is used in productive, non-productive or counterproductive programs. If the money is not used to improve production per capita, then inflation will be immediate and long lasting, especially in essentials.
Public borrowing is like private borrowing. If a person borrows so as to increase his production or productivity, his standard of living is going to improve. However, if he merely borrows for non-productive spending, his standard of living will only temporarily increase with an eventual day of reckoning. The politicians abuse of the federal deficits to grease their reelection has given America, and themselves, a temporary period of bliss.
People are incorrect to think that the Federal Government doesn't print large denominations of currency anymore. True, the Fed no longer prints and circulates denominations of Federal Reserve Notes above $100 into which the lower common denominations could be easily converted. However, the role of high denomination currency exists in the form of the much higher T-bill denominations "in units of $10,000 to $1 million", denominations in which the lower denominations of the Federal Reserve Notes can be easily and quickly converted.
A unity exists between the "scribbled on paper products" of the Fed and the Treasury presses. This unity is based on the ease of mutual convertibility, and it underlines the futility of the Fed in attempting to control inflation. Its monetary policy is predicated on an inaccurate assessment of what composes currency. The issuing of a million dollar T-bill by the Treasury has the effect on the money supplies as if the Fed had itself issued one million single dollar bills.
The Federal Reserve chairman fools himself and the nation when he states that he can control the money supply without recognizing the paper from the Treasury bond presses as money. A fifteen billion dollar federal deficit expands the money supply as if the Fed printed that many fresh greenbacks; only these greenbacks come out of hiding or from places that aren't considered to be part of the active money supply, e.g., rolled over T-bill purchases. The Fed and the Treasury are monetary siamese twins trying to go two ways at once: tight money and loose budgets. Through their respective printing presses, both cause inflation by counterproductively expanding the money supply. Schizoid economic monetarism is a testament to the incompetence of the politicians and to the people they have hired to advise them--the necronomists.
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