Saturday, January 16, 2010

Price Control

I've argued before that government spending, even excessive spending, does not increase money supply, but rather shifts money from taxpayer interests to politician's interests. The government acrues revenues by collecting taxes or selling bonds; either way, the money it spends is money that is taken elsewhere from the system. Treasury bonds behave as a voluntary tax that is paid back over time with interest.

Government spending has no effect one way or the other on money supply, but it can and does affect prices. This I would like to discuss today in light of the cash-inventory equivalency.

Previously, I equated money supply with the sum of the prices of all things for sale. In a fractional reserve system overseen by a central bank, the economy could be represented as:

P + C = sum[I(x)]

Where P is printed currency, or cash; C is credit that originates through franctional reserve lending and thus augments the money supply; I is the inventory of items for sale, and x is each general category of saleable goods.

Everything for sale added up is "sum[I(x)]." Say we were to subdivide salable good into: labor (l), energy (e), food (f), commodities (c), houses (h), medical supplies (m), retail goods (r), and investments like stocks and bonds (i). We could subdivide the economy further, but let's keep these broad categories for simplicities sake. The equation becomes:

P + C = sum[I(l) + I(e) + I(f) + I(c) + I(h) + I(m) + I(r) + I(i)]

The cash-inventory equivalency states that prices will self-regulate to equal the money supply. Now it is not the inventory of all houses that would be counted here, but just the ones for sale. If prices of all saleable goods were set greatly higher than the money supply, then velocity would slow and inventory would build to a point where sellers would be profit motivated to cut their prices. Conversely, if money supply greatly exceeded inventories, then money is in abundance and sales velocity would be brisk and prices would tend to rise. These opposing market forces converge on the "cash-inventory equivalency." So goes the theory.

Now, like you, me, hot dog stands, non-profits, and major corporations, the federal government is one economic entity amid the broader U.S. economy with a balance sheet of income (mentioned above) and expenditures. But it is a big player and it can use tax money to affect prices in the different sub-categories in one direction or the other.

To be clear, here I am excluding the Fed. Though the Federal Government and the Federal Reserve Bank are related, their economies are separate. The government's money comes from taxes and bonds, the Fed's money comes from printing it. Fed spending would be inflationary if that money were just given away, but generally it is disbursed in the form of a loan, which is only a temporary increase in money supply for the duration of the loan.

So, if it wants to, Congress can keep prices low. It can buy food at market rates and give it to the poor for free or at reduced prices. Or it can subsidize food producers with the agreement they will sell their product at reduced rates.

It can elevate prices in certain categories too. It could buy houses and keep them unoccupied to shrink the inventory, creating a scarcity of those houses still for sale. Or, it could subsidize banks so they can delay forclosures on delinquent loans, which also restricts inventory. In this way prices can be increased beyond market rates. Also, the government could make malinvestments in overpriced stock, or buy bonds in companies such that its stock will rise. I'm not saying it is doing that, but it could if it wanted to.

While these actions can affect prices in focal market segments, this does not alter money supply, so it does not cause inflation or deflation in the Austrian sense of the term.

No comments: