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The Janitor

How Does New Money Get To Remain In The Economy?

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Hi,

With so many people citing the Japanese deflationary bust as the most logical outcome of this crisis, I still cannot understand, why and how the new money did manage to stay in circulation in the past, increasing the monetary base, whilst this time, apparently, it won't.

Say, once upon the time a new car could be purchased for £1,000. Now it's £10,000. If all the fiat money is debt, and needs to be paid back, is it not a system of diminishing returns in which inflation becomes impossible past certain point?

The explanation as to why the QE money, or any form of new money won't get into the wider economy is because unions are weak (or non-existent). What I fail to grasp, is how does the presence of unions force the monetary base to increase?

Say that I am a car manufacturer building only ONE car, at a cost of £1000,

of which:

£500 is raw materials

£300 is labour

£150 is OPEX

-----------------

£950

This leaves me with a £50 profit

Say that my unionised workers demand an increase that will take my labour costs to £400 and that because of general inflation, raw materials have gone up by £50.

So now, my total costs are:

£550 is raw materials

£400 is labour

£150 is OPEX

-----------------

£1,100

So, now I need to charge at least £1,160 to get a margin similar to what I used to get when the car was sold for £1,000. So I presume, that repeating this cycle we get to current £10,000 cars. Now, the question is:

a) Where do people find more money to pay for the more expensive car?

B) If the customers are also unionised factory workers elsewhere, then maybe they get a similar salary increase that allows them to afford the more expensive car?

If I follow the sequence of purchases of an economy composed of unionised factory workers getting salary increases, at some point I will hit a point where the new money cannot be assumed to be floated somewhere in the economy, but needs to be brought into existence in an afresh fashion.

Say that the increase to £550 from £500 in terms of raw materials, was due to an increase of iron import costs by some of the suppliers. Say now, that iron has gone up exactly by £50 and that the supplier has decided just to pass the cost to the manufacturer. How has the supplier got hold of the extra £50. Did the supplier borrowed it from the bank? Did the bank in turn got this "new money" through some QE dodgy scheme? Say that the BoE has literately printed the money and lent it to a retail bank. The money needs to be PAID BACK.

So, how the hell does the money get to STAY in the economy leading to a continuous increase in prices?

The only explanation to me is the printing of new money that does NOT NEED to be paid back. I presume that this is what happens in Zimbabwe, the government prints money and SPENDS it straight on.

Can any of the brightest minds on here shed some light?

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Hi,

With so many people citing the Japanese deflationary bust as the most logical outcome of this crisis, I still cannot understand, why and how the new money did manage to stay in circulation in the past, increasing the monetary base, whilst this time, apparently, it won't.

Say, once upon the time a new car could be purchased for £1,000. Now it's £10,000. If all the fiat money is debt, and needs to be paid back, is it not a system of diminishing returns in which inflation becomes impossible past certain point?

The explanation as to why the QE money, or any form of new money won't get into the wider economy is because unions are weak (or non-existent). What I fail to grasp, is how does the presence of unions force the monetary base to increase?

Say that I am a car manufacturer building only ONE car, at a cost of £1000,

of which:

£500 is raw materials

£300 is labour

£150 is OPEX

-----------------

£950

This leaves me with a £50 profit

Say that my unionised workers demand an increase that will take my labour costs to £400 and that because of general inflation, raw materials have gone up by £50.

So now, my total costs are:

£550 is raw materials

£400 is labour

£150 is OPEX

-----------------

£1,100

So, now I need to charge at least £1,160 to get a margin similar to what I used to get when the car was sold for £1,000. So I presume, that repeating this cycle we get to current £10,000 cars. Now, the question is:

a) Where do people find more money to pay for the more expensive car?

B) If the customers are also unionised factory workers elsewhere, then maybe they get a similar salary increase that allows them to afford the more expensive car?

If I follow the sequence of purchases of an economy composed of unionised factory workers getting salary increases, at some point I will hit a point where the new money cannot be assumed to be floated somewhere in the economy, but needs to be brought into existence in an afresh fashion.

Say that the increase to £550 from £500 in terms of raw materials, was due to an increase of iron import costs by some of the suppliers. Say now, that iron has gone up exactly by £50 and that the supplier has decided just to pass the cost to the manufacturer. How has the supplier got hold of the extra £50. Did the supplier borrowed it from the bank? Did the bank in turn got this "new money" through some QE dodgy scheme? Say that the BoE has literately printed the money and lent it to a retail bank. The money needs to be PAID BACK.

So, how the hell does the money get to STAY in the economy leading to a continuous increase in prices?

The only explanation to me is the printing of new money that does NOT NEED to be paid back. I presume that this is what happens in Zimbabwe, the government prints money and SPENDS it straight on.

Can any of the brightest minds on here shed some light?

It is very simple.

"new" money stays in the economy because the total outstanding debt of a nation, public and private, is always growing.

Edited by dom

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all those costs you just cited as going up, are in fact labour costs in the end. The cost of mining those materials, or paying tax to the government who use that money to pay the labour costs of running the government. Therefore, all those employed people dont mind spending a bit extra on stuff, because their wages are also going up.

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all those costs you just cited as going up, are in fact labour costs in the end. The cost of mining those materials, or paying tax to the government who use that money to pay the labour costs of running the government. Therefore, all those employed people dont mind spending a bit extra on stuff, because their wages are also going up.

Yes, but all that's happening is a growth in the total pool of money (which is debt) allowing prices to be "bid up".

Restrict credit and wages are negotiated down, shops mark down prices and asset prices fall.

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I asked some similar questions a while back.

It's a mixture of increased leverage in the banking system, plus a small drip feed of the narrow money supply.

To take your example:

When a car cost 1000, then narrow money supply might have been 100 and the leverage x10 = 1000

Now the narrow money supply might be 250 and the leverage x40 = 10000

In theory the credit crunch reduces the leverage and the broad money supply.

The QE doubles the narrow money supply, so takes the average leverage instantly from x40 to x20. Distributing

that is not so easy. Control of inflation if it starts to get leveraged out will be very hard.

.... removing it ... impossible!

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Yes, but all that's happening is a growth in the total pool of money (which is debt) allowing prices to be "bid up".

Restrict credit and wages are negotiated down, shops mark down prices and asset prices fall.

OR, the money supply has stayed constant, the cars are NOT sold and we have layoffs.

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OR, the money supply has stayed constant, the cars are NOT sold and we have layoffs.

Don't forget the drip feed of interest and debt redemption. Credit must grow. Look at the figures for M4 during the 90s recession, credit continued to grow, it was the rate of growth that slowed.

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I think all the OP has done is describe a wage-price spiral. One of the reasons that won't happen this time IMHO is the lack of any strong unions to force wages up.

If we don't have a wage-price spiral then, again, IMHO the only alternative is deflation.

Interestingly, Merv pointed out yesterday that the BoE will only engage in QE once the Chancellor has given the Bank a full indemnity for the whole amount of the proposed new purchases. There will come a point where the Bank thinks further QE is necessary but the Chancellor will be unable to give the indemnity because of the parlous state of the public finances. At the point things might get very interesting.

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I think all the OP has done is describe a wage-price spiral. One of the reasons that won't happen this time IMHO is the lack of any strong unions to force wages up.

If we don't have a wage-price spiral then, again, IMHO the only alternative is deflation.

Interestingly, Merv pointed out yesterday that the BoE will only engage in QE once the Chancellor has given the Bank a full indemnity for the whole amount of the proposed new purchases. There will come a point where the Bank thinks further QE is necessary but the Chancellor will be unable to give the indemnity because of the parlous state of the public finances. At the point things might get very interesting.

At this points money is created/printed directly at no debt cost and handed directly to citizens.

Edited by moosetea

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At this points money is created/printed directly at no debt cost and handed directly to citizens.

That will never happen (IMHO, of course). Zimbabwe has proved that that approach is utterly futile.

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One of the reasons that won't happen this time IMHO is the lack of any strong unions to force wages up.

If we don't have a wage-price spiral then, again, IMHO the only alternative is deflation.

At the moment the new money is moving between institutions, not between institutions and the real economy. To see the same kind of nominal increases in asset prices, lending will have to return to unsustainable levels. The alternative is to wait until the tide of credit rises slowly to meet asset prices. It could take ten years.

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That will never happen (IMHO, of course). Zimbabwe has proved that that approach is utterly futile.

But isn't that what's happening now. They're hiding behind secondary gilt markets and forced lending by govt backed banks, but effectively the BoE hold 125bn in gilts, the govt and the banks have 125bn of new narrow money to give/lend/leverage out to the people.

There's an illusion that at some point this will be reversed, but I can't see how! If it's not then it's exactly what Zimbabwe did. For now on a smaller scale (doubling of narrow money), but where will it end?

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But isn't that what's happening now. They're hiding behind secondary gilt markets and forced lending by govt backed banks, but effectively the BoE hold 125bn in gilts, the govt and the banks have 125bn of new narrow money to give/lend/leverage out to the people.

There's an illusion that at some point this will be reversed, but I can't see how! If it's not then it's exactly what Zimbabwe did. For now on a smaller scale (doubling of narrow money), but where will it end?

Zimbabwe dollars are a minor currency. Their economy operates mainly in cash. They have no major bond market. All very similar to Wiemar and very different to the UK. My cousin is an "economist" working in Zimbabwe. At the moment he is negotiating with doctors to try and get the hospitals working again in return for USD. USD and gold are all that's accepted, apparently.

Edited by dom

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If we don't have a wage-price spiral then, again, IMHO the only alternative is deflation.

The term "wage-price spiral" is a trick used by bankers and their politician paeons to blame

the ordinary workers for monetary inflation.

Monetary inflation eventually leads to price inflation, and labour is something to be

purchased like commodities and finished products.

---------------------------------------------------------------------------------

About Zimbabwe and the dreaded yellow metal see the first video in my signature.

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Exponentially increasing monetary velocity helps.

If you lend out out £100 and expect back £110 there doesn't need to be an extra £10 in the system. It just means that £10 of whatever you are paid back has to re-enter the system from your own activities and come back to you a second time.

This is why l don't believe interest doesn't necessitate inflation in itself.

How about this:

Given sufficient velocity (impossible outside of theory l agree) a single pound coin could act as base money supply upon which all other credit rested. No?

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Exponentially increasing monetary velocity helps.

If you lend out out £100 and expect back £110 there doesn't need to be an extra £10 in the system.

Err, yes there does otherwise your £ won't work as a means of exchange.

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You have mentioned "leverage"; my point is that it is mathematically impossible to get past a certain point based on the proverbial fractional reserve principle. That's almost like monetary alchemy; I put £100 in the banking system, sit back 200 years and when I come back I find a huge economy measured in trillions.

As long as money is lent at positive interest rate, and has to paid back, the monetary base can only grow so much.

From all the posts, the basic two responses have been

a) leverage

B) growing debt

Both involve money that needs to be paid back. If the money has to be paid back (and in greater quantities due to interest), then if all money is paid back, we would be left with say, perhaps the £100 quid I created 200 years ago.

This doesn't make sense. It is not the unionised workers that drive inflation, it is the fact that the factory owners can AFFORD to pay their inflated wages, and that consumers can AFFORD the resulting inflated prices attached to the newly priced products. The wage spiral is nonsense. It's a by-product, a by-consequence that stems from the availability of more monetary units that can be distributed.

Another poster mentioned that inflation is very difficult without wage inflation. But it is perfectly possible to have the equivalent of price-controls applied to wages. In essence, there could be trillions of monetary units floating around but in the hand of a few individuals or institutions. Unless the said money moves through the economic actors (people), then velocity will be low and there would not be tangible inflation in spite of an latent inflated money supply. But who stops institutions to use the money to speculate on the commodity markets?

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You have mentioned "leverage"; my point is that it is mathematically impossible to get past a certain point based on the proverbial fractional reserve principle. That's almost like monetary alchemy; I put £100 in the banking system, sit back 200 years and when I come back I find a huge economy measured in trillions.

As long as money is lent at positive interest rate, and has to paid back, the monetary base can only grow so much.

From all the posts, the basic two responses have been

a) leverage

B) growing debt

Both involve money that needs to be paid back. If the money has to be paid back (and in greater quantities due to interest), then if all money is paid back, we would be left with say, perhaps the £100 quid I created 200 years ago.

This doesn't make sense. It is not the unionised workers that drive inflation, it is the fact that the factory owners can AFFORD to pay their inflated wages, and that consumers can AFFORD the resulting inflated prices attached to the newly priced products. The wage spiral is nonsense. It's a by-product, a by-consequence that stems from the availability of more monetary units that can be distributed.

Another poster mentioned that inflation is very difficult without wage inflation. But it is perfectly possible to have the equivalent of price-controls applied to wages. In essence, there could be trillions of monetary units floating around but in the hand of a few individuals or institutions. Unless the said money moves through the economic actors (people), then velocity will be low and there would not be tangible inflation in spite of an latent inflated money supply. But who stops institutions to use the money to speculate on the commodity markets?

"monetary alchemy"

That's exactly what the Elite City Financiers 'Occultly' practise.

Useless de-based alloys (think Old Alchemical common as muck 'lead') and paper 'promises' are used to enrich themselves for their Class 1 'Gold-en' lifestyles!

Philosopher's stone time?

apis(THE Egyptian BEES AGAIN!) philosophorum is a legendary alchemical tool, supposedly capable of turning base(crap-alloys) metals into gold.

Trouble is, the uber-greed has got out of hand and the Elite factions are fighting amongst themselves to keep their own greedy vested interests intact!Which has revealed 'them' to anyone who is 'awake'

The latest one is they way they have tapped into the Exchanges/stock markets utilising fraction of second bids(with supercomputers) against ordinary punters.

I bet this has been going on as long as exchanges were computerised!

Their buddies (in Govt/Military) get chips (eg from Intel) 6-12 months ahead of the rest of us (please correct me) plebs.

Which if passed secretly to certain banks/etc enables them to be one (fraudulant) step ahead all the time!

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Exponentially increasing monetary velocity helps.

If you lend out out £100 and expect back £110 there doesn't need to be an extra £10 in the system. It just means that £10 of whatever you are paid back has to re-enter the system from your own activities and come back to you a second time.

This is why l don't believe interest doesn't necessitate inflation in itself.

How about this:

Given sufficient velocity (impossible outside of theory l agree) a single pound coin could act as base money supply upon which all other credit rested. No?

doesnt work when the total repayment required exceeds the total cash in the system,, ie, the banks repayment is higher than your £100.

they cant physically lend you £110 for the next loan.

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....then if all money is paid back, we would be left with say, perhaps the £100 quid I created 200 years ago.

This doesn't make sense.

Another poster mentioned that inflation is very difficult without wage inflation. But it is perfectly possible to have the equivalent of price-controls applied to wages. In essence, there could be trillions of monetary units floating around but in the hand of a few individuals or institutions.

But who stops institutions to use the money to speculate on the commodity markets?

It makes perfect sense. Study history and you will see numerous examples of misguided governments attempting to repay the national debt - the result is always poverty.

Thatcher tried a different strategy. She shifted debt (money) creation away from government and encouraged the public to create the money supply instead. She called it "the home owning democracy". Even by selling our national assets, cutting public services and the explosion in household debt, the Thatcher government only managed a budget surplus once in nineteen years.

You must remember what we call money is actually debt - nothing more.

Edit to add:

Now, if you consider that mortgages account for 60% of money creation and take into account your own observations, for example, why must both parents work full time to provide the same size home as your parents enjoyed on one salary, it really does start to make perverse sense.

Edited by dom

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The money that is issued by the central bank is permanent money, if it is "loaned into existence" it is temporary as a consequence of it disappearing when the loan gets paid back. To make it very simple, imagine the bank lends money to someone who puts it directly back into the bank... assume no interest, then when the year is up and the loan must be repaid, suddenly the bank cancels the deposit account and wipes away the debt. So then the money (or credit, whatever you want to call it) which existed as a bank account is no longer there and we are back to the beginning.

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I think what many people don't understand is that there are two types of money, not one.

I only found this out last week reading on Wikipedia.

The basic idea is that the banks themselves have an account with the central bank (Bank of England) and the bank of England deposits into that account, say, £1billion.

(Although this is electronic money they can also if they want to exchange it for £1billion in physical notes and coins, or something along those lines. I expect the bank has to post collateral to claim this money as well)

What happens then is that the practice of "fractional reserve banking" operates. This is where the bank is allowed to offer loans to customers (home buyers for example). But the loan isn't given to a customer, customerA, as cash itself, but rather as a credit and debt pair in the customer's own account with that bank.

The customer then uses the credit to pay the credit into the account of another customer, customerB at the same bank, as payment for a house that customerB owns and wants to sell. This leaves the customerA with a "debt" to the bank, and customerB with a big credit in their account. (and the ownership of the house has moved from customerA to customerB)

This can operate on a large scale with many customers (as things balance out between the banks).

The difference in the interest rate provides "profit" to the bank.

But the point is that in this system is that there is nothing to prevent the banks from providing these credit/debt pairs well in excess of the £1billion that they have in their central bank's account. In fact it can go up to around 10 times this, or £10 billion.

And the point is that as long as not everyone asks for their money at the same time, any individual can ask for their credit to be cancelled and the bank pay them the money in notes and coins. And this CAN be done because the bank has up to £1billion in notes and coins to pay them.

So this makes it APPEAR to customers that the credits in their accounts with the bank are equivalent to actual money in cash.

Which in ordinary operating circumstances it is, because any customer individually can go into their bank and ask for cash from their account.

However if everyone does this, then the bank will run out of notes and coins, and will go bust - a bank run.

What happens in an economic boom is that the banks get more and more confident. They create these debt-credit pairs more and more, so causing the total amount of debt, and the total amount of credit in the economy to increase.

People start to feel richer.

But it reaches a limit when the ratio between the amount of credit/debit, and the amount of base money gets too high. Then banks become vulnerable if for some reason people start pulling their money out in cash. So they start getting worried and stop offering debt/credit pairs (otherwise known as "loans") and the remaining ones start to get paid off. So as this process, called "deflation" occurs, you get a cancellation of these pairs, but people feel poorer.

Sorry I've forgotton what the OP's question was, but I'm not going to delete this after all this typing.

Good night all. Hope I haven't bored you too much...

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