Re: Rolling bubbles
From: Michael Vilkin (mikevilkin_at_mail.com)
Date: 06/28/04
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Date: 27 Jun 2004 21:29:44 -0700
William F Hummel <wfhummel@comcast.net> wrote in message news:<d43ud09kbt1imf7t5u5u8a8q8df8d7pjl9@4ax.com>...
<skip>
> >Increase in money supply as a result of using credit cards
> >will increase aggregate demand in the economy,
> >and it will increase general level of prices.
> >Increase in aggregate supply will reduce general level of prices.
> There is currently about a trillion dollars of credit not actually
> used in credit cards in the US. That doesn't mean there is a trillion
> dollars worth of aggregate demand. Aggregate demand refers to the
> decision to buy, not the means to pay.
I agree, of course, that aggregate demand is increased not because
people have credit cards, but because they use credit cards,
increasing total credit in the economy.
We both agree that availabilty of credit plays a certain role in the
general level of prices. Imagine, for example, that credit cards are
outlawed for whatever reason, and only debit cards are legal. You
don't have money in your bank account? You are out of luck.
This would significantly reduce amount of credit in the economy.
Reduced amount of credit would in turn reduce aggregate demand.
We will, probably, agree on that.
> For example, Japan has suffered from low aggregate demand for over a
> decade in spite of the availability of credit at almost zero interest
> rate. The government has been unable to stimulate much spending there
> in spite of flooding consumers with money.
Japan has experienced a few rolling bubbles. First, it was a stock
market bubble. People got burned in stocks, and they decided that a
shelter was a better investment. So, they created a real estate
bubble. At one point, total price of Japan's real estate was higher
than a total value of the U.S. real estate. When they got burned in
real estate, they decided just to hoard the money.
But what caused deflation in Japan? In part, inflation caused it.
Had there been no inflation in stocks and real estate, there would be
no deflation in the same assets.
It's instability on the upside that causes instability on the
downside.
When people are optimistic, they use available credit, increasing
money supply.
The result is steady increase in prices and economic boom.
When people are not optimistic, they do not use available credit, and
that is why prices go down.
Availability of credit might have been the same both before the
bubble, during the bubble, and after the bubble. It's people's beliefs
about future direction of the economy, it's their desire to invest and
to take risks that affect total amount of credit, change in money
supply and, ultimately, market prices.
I believe that the U.S. is following Japan in footsteps.
But I don't believe that anyone will seriously stimulate household
spending.
I believe that the financial class needs an economic depression to buy
some undervalued assets.
We have gone through equities bubble, debt bubble, real estate bubble,
and now we are going to deflate, Japan style.
If interest rates are going to rise for 15 or 20 years, we are in a
big trouble.
It will make the hangover after the bubble that much worse.
You will, probably, agree on this point.
> During the Great Depression, people hoarded currency out of fear of
> the future. There was a sharp increase in currency relative to bank
> deposits, but aggregate demand suffered badly.
I agree that it's a total amount of credit, not amount of currency,
that determines health of the economy.
A healthy economy needs a reasonably steady credit, not rolling
bubbles that we have seen in Japan and the U.S., and some other
countries are not too far behind.
> >My point is that to fight inflation, we should increase aggregate
> >supply, not interest rates.
> Do you see any shortage of goods and services in the US? Most store
> shelves are bulging with merchandise. We have not had a shortage of
> supply in goods and services since perhaps World War II.
> Price inflation is seldom caused by inadequate supply. Shortages on
> specific items can drive up their prices, but that is not what we mean
> by inflation. And usually those shortages don't last long.
In a free market economy a shortage is not possible. If America stops
production of wheat, there will still be bread available at a higher
price.
There will be no shortage. Just pay $10 for a loaf of bread. No
shortages.
So, technically you are right about absence of shortages. All goods
and services will always be available... at equilibrium price.
Shortages develop only when something is offered at a price below
market.
Like rent-controlled apartments in New York. You have to pay a bribe
to get a rent-controlled apartment. I used to live there, and I've
paid a bribe.
And this brings us to the concept I'd really like to discuss.
Standard of living, which may be defined as affordability of goods and
services, without price controls.
A big part of the population has a low standard of living.
How can we increase it? What is the easiest way?
Since we both live in Southern California, we both know price of
housing here.
You are right, there is no shortage of housing here... at equilibrium
price.
But how to make housing more affordable? I believe that higher
affordability of housing would increase standard of living, if you
agree with me.
In my opinion, the best way to increase affordability of housing is to
increase supply of housing. There are hundreds of thousands of young
bums in Los Angeles. Why not put them to work in construction?
First, abolish welfare, so that the bums apply for work... at a market
price.
Would you agree that a shift in supply of real estate would reduce
real estate prices?
> > What is your opinion about interest rates?
> >Do we need higher interest rates?
> >Increase in interest rates will discourage production, reduce
> >aggregate supply, and in the long run will result in inflation caused
> >by shortage of goods.
> We need somewhat higher interest rates, mainly to slow the rate of
> increase in asset prices, particularly real estate prices.
I agree. A small increase over time, to 2 or 3 percent would not hurt.
> >First, let's discuss if we agree about the direction of equilibrium
> >price when there is a shift in either aggregate demand or aggregate
> >demand.
> Yes, but not aggregate demand as you are using that term.
I've offered an equation P = M / G,
which says that general level of prices P is directly proportional to
the
amount of Money chasing Goods, and inversely proportional to the
amount of Goods chasing Money.
This is basically a crude version of quantity theory of money, which
is correct in one - and only one - version, when velocity of money is
constant. That is why velocity has no place in this equation.
Suppose now, with velocity not changing, we decided that all Americans
need just two times higher wages and salaries to buy twice more
goodies.
So, we increased minimum wages by 100%. Over time, all wages increased
100% percent. Labor costs will increase 100%, and prices will increase
100%.
In this case the quantity theory of money is correct.
But M in this case not only quantity of money, but also an aggregate
of income, because we increased monetary income. This monetary income
is not an equivalent of higher productivity. It's simply 100% more
claims on the same amount of goods produced, and those claims are
durable, because wages are increased forever. Demand here is stable,
and prices will increase 100% and stay there.
Suppose now, M was increased 100% as a result of increase in credit,
and wages stay the same. In this case, general level of prices will
increase initially, but later supply will increase and push prices
down. Because wages are low, production costs are relatively low, and
higher prices mean high profits which encourage more production.
Now let's assume that M is amount of money chasing real estate in the
Southern California market, and G is real estate Goods.
At any given moment there is equilibrium price P, which is directly
affected by supply G and demand M.
In this case a shift in supply of real estate Goods will cause an
inverce change in equilibrium price P, but it may not be proportional.
It might not be a linearly proportional change, but there will be a
change in prices.
The change will depend on psychology of the market participents.
Psychological factors like optimism and beliefs about future direction
of the economy are difficult to quantify, but they ultimately
determine demand.
In the first case quantity theory of money was at work.
Monetary income increased 100%, supply did not change,
and prices increased 100%. Pure inflation.
In the second case monetary income is assumed to be constant.
A change in either supply or demand will cause a nonlinearly
proportional change in general level of prices.
Say, 10% increase in supply might cause 15% drop in prices, a factor
of 1.5,
and 20% increase in supply might cause 35% drop in prices, a factor
of 1.75.
What is your opinion?
> >Then if we agree that new purchasing power created by increased line
> >of credit will increase aggregate demand.
> Increasing the line of credit will not have much effect on aggregate
> demand. As noted above, there is an enormous unused line of credit in
> people's wallets today.
> >After that we can discuss if "In fact the money supply as usually
> >defined grows as a function of prices rather than vice versa."
> See my article http://wfhummel.cnchost.com/inflation.html
I've visited you Web site, and I do like it, and I do agree with you.
I think we have very little differences so far... unless you hate
quantity theory of money.
--Michael Vilkin
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