Does it matter who gets the money first?

by on December 5, 2012 at 1:29 pm in Economics | Permalink

Here is Scott Sumner, gently poking Richard Cantillon and the Austrians:

This is a good example of the fallacy of composition.  In aggregate, the total level of nominal purchases is constrained by the amount of currency in circulation.  But not at the individual level.  Hence being the first to get the new money doesn’t confer any advantage at all–as the new money has no more purchasing power than the existing money.  A dollar is a dollar—and a $100 bill is a $100 bill.

Read the whole thing, there is much more, and here Scott follows up.

Andrew December 5, 2012 at 1:45 pm

“So the government gains a profit of $100 million, which economists call “seignorage.””

Ummm…and it’s the banks that print the money, right?

Andrew December 5, 2012 at 2:10 pm

“Bonds are purchased at market prices.”

Greg Ransom December 5, 2012 at 9:47 pm

What Scott has written has nothing to do with Richard Cantillon and ‘the Austrians’. And it didn’t have anything to do what what Sheldon Richman wrote either, which can be in read context here:

http://www.theamericanconservative.com/articles/how-the-rich-rule/

Who is pulling who’s leg, Tyler?

Whatever Sheldon Richman is saying, is certainly is NOT what Scott Sumner has uncharitably accused him of saying.

prior_approval December 5, 2012 at 1:57 pm

‘In aggregate, the total level of nominal purchases is constrained by the amount of currency in circulation.’

So credit doesn’t count? And what about bank transfers – or does Monsanto or IBM or Boeing pay their suppliers in cash?

Such would be the implication of ‘currency in circulation’ – almost as if SWIFT has no meaning in an economist’s world.

(‘The Society for Worldwide Interbank Financial Telecommunication (SWIFT) provides a network that enables financial institutions worldwide to send and receive information about financial transactions in a secure, standardized and reliable environment. SWIFT also markets software and services to financial institutions, much of it for use on the SWIFTNet Network, and ISO 9362 bank identifier codes (BICs) are popularly known as “SWIFT codes”.

The chairman of SWIFT is Yawar Shah, and the CEO is Gottfried Leibbrandt, who is from the Netherlands.

The majority of international interbank messages use the SWIFT network. As of September 2010[update], SWIFT linked more than 9,000 financial institutions in 209 countries and territories, who were exchanging an average of over 15 million messages per day (compared to an average of 2.4 million daily messages in 1995).[1] SWIFT transports financial messages in a highly secure way but does not hold accounts for its members and does not perform any form of clearing or settlement.

SWIFT does not facilitate funds transfer; rather, it sends payment orders, which must be settled by correspondent accounts that the institutions have with each other. Each financial institution, to exchange banking transactions, must have a banking relationship by either being a bank or affiliating itself with one (or more) so as to enjoy those particular business features. – http://en.wikipedia.org/wiki/Society_for_Worldwide_Interbank_Financial_Telecommunication )

cthorm December 5, 2012 at 3:33 pm

Really, are you getting obsessed over SWIFT? What a joke. There is almost nothing more dull, it’s effectively a telephone number. All it does is speed along interbank transfers by custodian banks, which is a critical but mundane requirement for modern investment management.

Sigivald December 5, 2012 at 4:26 pm

I think you’re making a mountain of a molehill.

Credit is currency – while there is a meaning of “currency” that means “things like coins and banknotes”, it also means “any form of money”, where “money” again does not mean only “coins and banknotes and the like”, but “anything you can exchange for goods and services”.

For these purposes the pool of credit has been and is expanding circulation, whether it be my credit card, or my bank’s fractional reserve policy, in exactly the same way that banknotes do.

The confusion arises, I imagine, because the words have so much overlap in use and the two sets of meanings are so similar; we speak of banknotes in circulation, after all – but that doesn’t mean that “currency in circulation” is therefore limited to banknotes and doesn’t involve the entire credit system.

Isn’t the latter fundamental to monetary policy? Hell, I seem to recall Mises pointing out the integration back in the ’20s.

Eorr December 5, 2012 at 5:57 pm

Credit is the creation of currency which is endogenous when there is an inflation target so your point makes no sense.

malcom digest December 5, 2012 at 2:06 pm

Seems to me that if you give a $100 billion to JPMorgan and they lend it out at some nominal interest rate, they end up making a profit for merely doing clerical work. Additionally some portion of the total cash in circulation is being shifted to them, again just because the money goes to them first.

I’ve been thinking that it would be worthwhile to require that any new money created by the Fed must be inserted into circulation only through banks that are below the top 100. Or maybe only the 10th largest (or smaller) bank in each state. Let the big boys actually create value, not just scrape profit off by virtue of being the future employers of the current individual sitting on the regulator’s chair.

dirk December 5, 2012 at 2:24 pm

“Seems to me that if you give a $100 billion to JPMorgan and they lend it out at some nominal interest rate, they end up making a profit for merely doing clerical work.”

JPMorgan isn’t given $100 billion, $100 billion worth of bonds is purchased from JPMorgan. Yes, they can turn around and lend the money out at interest, but perhaps for no more than the yield on the bonds they just sold to the Fed.

Andrew December 5, 2012 at 2:41 pm

What if The Fed purchased $100 Trillion worth of bonds? How many bonds would they get?

Yancey Ward December 5, 2012 at 2:51 pm

Bingo.

Eorr December 5, 2012 at 6:03 pm

The fed doesn’t create the bonds, the treasury does. So if the fed bought $100 trillion in bonds probably at a 0% interest rate the national debt just increased by almost 10 fold and we all wouldn’t have to pay taxes but would be really unhappy when the hyper inflation hits, or the fed would have to respond to the creation of the money by increasing its interest rate target and refused to make the market until the banks are buying the bonds with yields in the hundreds of percent. That would be decision for elected officials in congress and is effectively fiscal policy.

Andrew' December 6, 2012 at 9:01 am

The Fed gave money primarily to the government (because of the huge number they have to create more) but also to anyone able to sell them Treasurys. The drop in interest rates is the increase in the value of previously existing bonds relative to everything else in the economy. The question is what exactly is the mechanism that this translates into instantly higher prices.

Andrew' December 6, 2012 at 9:02 am

Oh, and since deficits mean we don’t pay taxes, tell the government I’d like a 52″ Plasma for Christmas ;)

Rahul December 5, 2012 at 2:30 pm

Isn’t the argument that the one who gets the $$ first, gets to spend it before the wave of inflation spreads and hikes up prices? So he has higher purchasing power?

What’s wrong with that naive picture?

Andrew Edwards December 5, 2012 at 2:57 pm

What wave of inflation?

Also – T-bills can be exchanged for money any time you want. There’s a super-liquid market. If you want to go buy stuff with cash but hold T-bills, that’s a really really easy problem to solve.

That’s probably one of the reasons why T-Bills and not, say, put options on wildcat gold companies.

The Anti-Gnostic December 5, 2012 at 2:58 pm

Your instinct is correct. The earlier recipients get to bid on resources before downstream recipients of the new dollars. That’s one of the reasons a dollar today is worth more than a dollar tomorrow. Hell’s bells this is obvious; that’s why we tack interest on it!

Extremely smart people often educate themselves right out of common sense.

Andrew Edwards December 5, 2012 at 3:10 pm

Just out of curiosity – how do you think this impacts the macro effect of the money? Is the economy materially less stimulated than if the government had introduced money to the economy in some different way? What assumptions are needed (velocity of money, level of inflation) for the inflationary impact to outweigh the transaction costs and cause those early recipients to actually go over-bid for downstream resources?

How would you increase the money supply, by the way? Either the government buys valuable, liquid assets or it does not.

If the government buys valuable liquid assets then it doesn’t matter – if you hold a valuable liquid asset and want cash, you can get cash whether or not you get it from the government.

If you are arguing for “not”, how would the money be distributed? Free gifts can’t be better.

The Anti-Gnostic December 5, 2012 at 3:25 pm

If you instantly doubled every checking account balance, prices would rise in unison. If you print up money and give it to the primary dealers’ network first, and so on and so on, those recipients get to bid on resources first, the prices ripple out thru the economy and the money quickly becomes untraceable but the end result is the same.

IOW, monetary policy is just a nominal tool. It’s cargo-cult economics.

Ian December 5, 2012 at 6:03 pm

It would likely have different effects. The composition of those with checking accounts is quite different from the composition of the population involved in high finance. People with checking accounts include lots of average people who sell their labor and earn wages and spend mainly on mundane goods and services. Increasing their checking accounts may serve to synthesize a larger middle class market than can greater support and justify technological innovation in goods and services that end up lowering the prices of goods and services. High finance will use the money to bid up relatively inelastic supply assets like land, real estate, and make more loans and buy luxury items and Giffen goods.

Andrew Edwards December 5, 2012 at 6:47 pm

I don’t think I follow – who is proposing “giving” money to anyone?

The Anti-Gnostic December 5, 2012 at 7:13 pm

who is proposing “giving” money to anyone?

The Fed prints up money and buys stuff with it. Doesn’t matter what: UST’s, cheap chalupas, mortgage-backed securities, apartment complexes, gold ingots, whatever. It’s a “give” rather than a “purchase” because it’s an exchange that didn’t cost the Fed anything, unlike when you or I have use FRN’s to purchase chalupas, UST’s, gold ingots, whores, etc.

Andrew Edwards December 6, 2012 at 6:28 am

Odd, and I think confusing usage of the word “give” – customarily it is the recipient who a “gift” costs nothing, not the giver.

I wouldn’t raise it except that I think it is confusing your thinking. All the banks are doing when the government buys their bonds is exchanging a liquid asset for cash. They aren’t better off than anyone else because anyone can exchange a liquid asset for cash at any time – that’s what it means to have a liquid asset.

That it cost the GOVERNMENT nothing doesn’t make the BANKS better off than they would have been had they just sold the bonds into the open market.

The Anti-Gnostic December 6, 2012 at 8:05 am

I think the word I’m looking for is “print.” Or “digitize”

Andrew' December 6, 2012 at 9:05 am

Then why would they do anything they’ve done?

Why would they buy distressed mortgage securities?

TylerR December 5, 2012 at 3:12 pm

What about the fact that the government bought the security gives the bank the ability to “bid on resources before downstream recipients of the new dollars”? What makes this dollar a magical golden ticket to profit land? This point is addressed in the link.

The Anti-Gnostic December 5, 2012 at 7:54 pm

First, the government didn’t buy the securities, the FRB did. And it does so by ginning dollars up out of thin air and depositing them in the sellers’ accounts, who then turn around and pay bonuses, salaries, office supplies, cocaine dealers, more toilet-paper student loans and bundled mortgages for the FRB to turn around and buy at book value again, etc. The effect is inevitably inflationary. If it were not, the government wouldn’t care if I just decided to start printing my own FRN’s and buying things with them.

Incidentally, is not the Fed being inflationary every time it honors a check drawn on the US Treasury’s account, which has a minus $1trillion balance? Does the Treasury really sell a trillion dollars worth of its own debt every year? And doesn’t the Fed just backstop Wall Street for half or more of it with, again, fiat dollars? Maybe I’m missing something embarassingly obvious but I’ve asked this in lots of other places and never really got an answer.

DocMerlin December 5, 2012 at 9:37 pm

“Does the Treasury really sell a trillion dollars worth of its own debt every year? And doesn’t the Fed just backstop Wall Street for half or more of it with, again, fiat dollars? Maybe I’m missing something embarassingly obvious but I’ve asked this in lots of other places and never really got an answer.”

yes.

TylerR December 5, 2012 at 2:59 pm

“Obviously for auction style asset markets there’s no advantage in getting the money first, as prices respond instantly to the news. But let’s say I was wrong; let’s say the price of gold rises slowly in response to an injection of new currency. The claim would still be wrong, as holding newly injected money doesn’t give anyone any sort of unfair advantage. If I heard about the Fed’s new OMO, and thought gold prices would rise gradually in response, I’d simply call up my broker and buy some gold. What if I don’t have any currency? I’d charge the purchase on my credit card.”

In response to the second question: A dollar today is worth more than a dollar tomorrow especially with inflation but he is talking comparing current dollars. He could have said: the dollar in your pocket right now can buy the same things as the one in mine right now. The value may change over time but that is irrelevant for this comparison.

The Anti-Gnostic December 5, 2012 at 3:11 pm

Except the new dollars don’t all enter the economy simultaneously. Monetary inflation is a slow, steady transfer of purchasing power upstream from later recipients to early recipients. That’s why debtor governments, their creditors and the economists they employ love it. It’s like the best tax ever invented.

j r December 5, 2012 at 3:39 pm

The new dollars “enter the economy” at the moment they are created. If you want to argue differently, then you have to address Sumner’s point that market’s react on the news of the money creation and not on the actual transfer to whomever gets it first.

TylerR December 5, 2012 at 3:50 pm

I went back and forth about making this same reply, but in the end I decided this guy is a troll with no interest in calm consideration. Most likely wrote these comments before reading the arguments presented in Sumner’s posts.

The Anti-Gnostic December 5, 2012 at 4:23 pm

Somebody is going to have their hands on that money before others and get to be the early bidders on existing supply. To say that the whole economy reacts instantaneously and with perfect prescience to a Ben Bernanke press conference is just handwaving. Even if the actors in the economy could do that, then all we’ve done, again, is just re-denominate everybody’s bank balance. (I don’t think it’s benign like that at all, actually. But that’s another topic.)

Andrew' December 5, 2012 at 4:29 pm

It seems like that is if everyone can sell their treasurys. I’m fresh out of treasurys.

John December 5, 2012 at 4:32 pm

How do people tell whose money is new and whose money is old, so that they can be charged different prices?

The Anti-Gnostic December 5, 2012 at 4:52 pm

That’s not what is happening. What is happening is that early bids are being submitted on existing supply and, perforce, later bidders are bidding on less supply. The money itself is untraceable. Economies are fluid, which is why they can’t really be modeled.

John December 5, 2012 at 5:09 pm

You’re begging the question. What stops everyone else from bidding in the earlier auction? Because only those who get the money first have inflated purchasing power?–well then, why do those who get the money first have higher purchasing power? And we’re right back where we started: why are their new dollars worth more than everyone else’s dollars?

The Anti-Gnostic December 5, 2012 at 5:22 pm

well then, why do those who get the money first have higher purchasing power? And we’re right back where we started: why are their new dollars worth more than everyone else’s dollars?

Because there’s more supply when they place their bids than at the point later in time when the downstream recipients place their bids.

If this wasn’t what was happening, then Sumner wouldn’t even have to argue the point. The perfectly prescient market actors would just re-denominate prices based on Bernanke’s utterances. And if that’s really what’s happening, then just what IS monetary policy accomplishing?

Derek December 5, 2012 at 10:13 pm

I’m surprised this is even asked.

Derek December 5, 2012 at 10:31 pm

Say goldman sells some mbs paper to the fed. The fed is buying them because their value is some what in question. In return goldman gets cash. They can now do things they couldn’t do previously because they have collateral. They can lend against it multiple times.the first advantage is that anyone else down the line gets an encumbered benefit.

Being first allows them to do things today that otherwise they would have had to wait till later to do. Anyone in business will tell you that their costs are dated and anything that brings in revenue in a timely way is worth quite a bit more than the same amount at a later date.

Again I’m surprised that the value of new money is a question. It isn’t that old money wouldn’t do. It simply may not be there at that moment being occupied elsewhere.

Andrew' December 6, 2012 at 9:07 am

“What stops everyone else from bidding in the earlier auction?”

I don’t own any distressed mortgage securities. I don’t possess bank reserves that I can hold at The Fed for interest. Etc.

If this doesn’t work, then why is The Fed rescuing individual institutions, if they can’t because they can’t favor individual institutions?

Root December 5, 2012 at 5:36 pm

What you’re saying doesn’t necessarily happen either. It depends on what goods or assets you’re talking about. Early adopters in some new goods, for example, pay a lot more for the same good which goes down in price for later adopters.

The Anti-Gnostic December 5, 2012 at 6:04 pm

That is true as well, and given that economies are fluid, supply chains get disrupted, consumer preferences turn on a dime, etc., we can never know to what extent or precisely where one or the other phenomenon is being reflected in prices. The only way to know this would be if we were Sumner’s perfectly prescient market actors. And if we were, then like I said we’re just re-denominating everybody’s bank balance and poor old Ben Bernanke is burning the midnight oil for naught.

Sigivald December 5, 2012 at 4:39 pm

That would be true if the increase in money was secret, perhaps.

But isn’t the expectation of inflation from any monetary injection, since they’re not secrets, already priced into the entire economy as a whole, especially the easily-purchased liquid bits like securities? (Not that physical goods don’t get re-priced pretty fast if there’s an expectation of significant inflation…)

(This, I assume, is the core of Mr. Edwards’ first sentence of his reply – what wave? A wave implies that the rest of the economy doesn’t know there’s more money now!)

The Anti-Gnostic December 5, 2012 at 5:02 pm

But isn’t the expectation of inflation from any monetary injection, since they’re not secrets, already priced into the entire economy as a whole, especially the easily-purchased liquid bits like securities?

What amount of the compensation you negotiated with your employer is based on your calculation of the rate of inflation or deflation?

Rahul December 6, 2012 at 1:34 am

Are there any empirical studies supporting this instantaneous price adjustment model under inflation? My impression was that information flows and inflation signals aren’t perfect nor immediate and there’s a lag before the various sectors adjust pricing.

Andrew' December 6, 2012 at 9:09 am

Then prices shouldn’t rise gradually. If a future price is priced in, it should be either instant gap reflecting universally recognized new information or simply discounted by the time value of money.

Rahul December 5, 2012 at 2:32 pm

“A dollar is a dollar—and a $100 bill is a $100 bill.”

Yes, but a dollar today is worth far more than a dollar tomorrow especially in a rapidly inflating market?

Andrew Edwards December 5, 2012 at 3:02 pm

Well.

For $100 today to be worth $101 tomorrow, you’d be looking at a daily inflation rate of 1%. At which point I imagine the fed would stop buying bonds…..

I’m only sort of joking – I’m sure you can construct a scenario where there is massive hyperinflation tomorrow but not today due to a massive injection of money, but the scale of the miscalculation by the Fed that you’re talking about is unfathomable in the real world.

cthorm December 5, 2012 at 3:37 pm

What market is rapidly inflating? Inflation by any measure has been moving sideways (i.e. nowhere) for years now in the West. First mover advantage would only matter in an economy that was just on the brink of rapid inflation, like Weimar Germany, and as such it’s a transient effect at best.

Go Kings Go December 5, 2012 at 4:33 pm

I’ve always wondered how inflation works with dwindling populations like Japan and Russia. If the amount of rubles and yen, however measured, remains constant while population declines, do you have per-capita inflation (for want of a better phrase)?

Moti December 5, 2012 at 5:49 pm

My formulation of inflation has always been the aphorism “More dollars chasing fewer goods”. It implies that inflation is caused by an auction of sorts at stores, where people bid more nominal dollars because they have more nominal dollars, and their increased utility for a particular good can be achieved for less substitution of another good.

If producers adjust the supply of goods downwards with the population, then you would have more dollars chasing fewer goods, albeit with fewer people chasing. (This last bit might be important if people’s utility expectations don’t adjust upwards, but that’s a silly assumption I think). So you would get inflation. Think about your showing up in a world where only 3 people have the total amount of currency in the world and you all want the last tv. You’d bid a lot for it.

Maybe someone smarter than me can correct me, but I think that’s right.

chuck martel December 6, 2012 at 11:29 am

The other day I asked a butcher why lamb was so expensive. He said, “We keep raising the price but people still keep buying it. It’ll probably get more expensive”.

gabe December 6, 2012 at 12:42 pm

What market is rapidly inflating? School tuition and health care services.

Bruce Cleaver December 5, 2012 at 2:50 pm

Same question as Rahul…..

Ray Lopez December 5, 2012 at 3:02 pm

Greg Ransom is a vicious street fighter of the Austrian camp in the Sumner thread–he hits hard, boy! I see he likes to mix it up too, see this May 2011 post by B. DeLong “Greg Ransom vs. Larry White and Tyler Cowen on Hayek”. Let the flames begin!

Andrew' December 5, 2012 at 4:43 pm

I would question whether the green grocer knows exactly how to price his tangelos based on recent credible Fed announcements.

D. F. Linton December 5, 2012 at 3:04 pm

Tyler shame on you. You are endorsing the view that increased demand does not affect prices since everyone always pays the market price. Prices rise to restore equilibrium and those who purchased first enjoyed a greater consumers surplus than those who bought at the new higher prices. Additions to the stock of fiat money (real or digital) always benefit somebody first and the diffusion of new money is not instantaneous.

Yancey Ward December 5, 2012 at 3:26 pm

“We continue to anticipate what the Fed is buying,” Gross said. “They’ve told us they will buy $40 billion to $70 billion of agency mortgages every month until the cows come home. It pays to own these mortgages even though they’re overvalued.”

That Bill Gross is a loon.

Yancey Ward December 5, 2012 at 3:31 pm

Seriously, if the government decided to inject, let’s say, $2 trillion next year by paying government employees a surprise bonus on January 1, no one should care?

Sumner December 5, 2012 at 3:44 pm

That is right Yancey. This would benefit EVERYONE exactly the same.

Labor prices would be bid up across the board…so even if some of us don’t work for the government we would ALL benefit exactly the same.

Rahul December 5, 2012 at 3:50 pm

How about a surprise tax refund?

D. F. Linton December 5, 2012 at 4:55 pm

So if instead of paying out the $2 trillion to government employees checks were written to 2 million randomly chosen taxpayers, you would be completely indifferent whether you were one of those who got the $1 million check or not? I for one would want the check and would rush out and spend it. If you truly would not care (if you really believe that everyone would benefit exactly the same), you would be equally indifferent if 2 million randomly chosen taxpayers were given the right to run off $1 million of legal tender notes on their color copiers, wouldn’t you? Would it be any different if those two million guys each produced $1 million in perfect counterfeit notes?

Cliff December 5, 2012 at 5:26 pm

That is just batshit insane. If your theory leads you to that conclusion, you’ve got to look long and hard at your theory.

The Anti-Gnostic December 5, 2012 at 5:32 pm

It’s “Sumner” channeling Sumner. (And it’s not me, btw.)

(Sometimes my /sarcasm detector is a little slow too.)

Darren December 5, 2012 at 8:24 pm

Labor prices would be bid up across the board…

This all takes time and that time varies depending on what is being ‘bid up’. This doesn’t all happen simultaneously or at once. The effects are not all the same.

DocMerlin December 5, 2012 at 9:40 pm

Are you assuming that everyone has exactly the same amount of knowledge?
thats a pretty massive claim.

kebko December 5, 2012 at 5:37 pm

In your example, the employees are receiving something of value that they didn’t have. The Fed is exchanging one thing of value for another thing of value. There might be some very small effect of the Fed’s operations, but I think your analogy probably misses the mark.

Yancey Ward December 5, 2012 at 6:10 pm

Then see Andrew’s question about $100 trillion in bonds above.

Gabe December 6, 2012 at 12:26 pm

“In your example, the employees are receiving something of value that they didn’t have. ”

No the employees already had a asset..their time…they are just now exchanging it for something of equal value. Sumner’s logic is foolproof.

andy December 5, 2012 at 5:59 pm

I think the point is that the money gets somehow loaned at market prices. Or, alternatively, if you were the recipient of the ‘new dollars’, than the point is that you are exactly the same way better off as anyone else who was paid ‘old dollars’.

Moti December 5, 2012 at 6:06 pm

Yeah they’re buying bonds in the gov’t’s case, not air-dropping bills. In that case it certainly would matter who gets it.

Yancey Ward December 5, 2012 at 6:14 pm

Again, see Andrew’s question about $100 trillion in bonds being bought by the Fed.

Go Kings, Go! December 6, 2012 at 1:55 am

Can you explain his point for me? It seems like the Fed cannot sell $100 trillion because there is not $100 trillion in buyers, at least until Congress raises the debt limit. I could buy it if they would accept the Z$100 trillion I bought on Ebay for $5.

Andrew' December 6, 2012 at 9:18 am

My point (which I barely understand myself, and certainly don’t understand what Dr. Sumner is saying) is to use a number that neutralizes the “market prices” point. $100T makes bonds scarce enough that they have to rise in price. It also illustrates that the government receives the money first and if you have an ounce of public choice in you then you understand that of course that matters. And while the bond market may be huge and liquid it is not everything nor instant. This is one reason why the government does NOT do this proposal and spreads what could be single purchases over days, weeks and months.

But my point is not really a point. I don’t know, that’s why it’s a question. If I were to make a point it would be that we are like this probably because it used to be worse. It’s probably better now, and I don’t understand it which is why I don’t make a big deal, but then again they make transactions every day and just a little rent on ALL our money could go a long way. However, I’m more concerned about fixing that when we aren’t in a depression.

Carl the EconGuy December 5, 2012 at 3:40 pm

“In aggregate, the total level of nominal purchases is constrained by the amount of currency in circulation.”
This is true only under two implicit assumptions. One, velocity is constant. Two, demand deposits and various derivative monies (M2, M3, M4) are constant multipliers of currency.
Neither assumption is necessarily warranted. Inflationary expectations change, velocity changes. Expected real interest changes, velocity changes. Bank risk aversion changes, currency multiplier changes.
Obvious, right?

Gabe December 5, 2012 at 4:15 pm

I think that is an obvious point Carl. I thought everyone assumed that the velocity of money was NOT constant.

I don’t understand why Sumner would say what he did, but I am not a PHD in economics and I don’t understand why he thinks primary dealers earn trivial commissions and bid/ask spreads in the bond markets.

It seems to me that financial market jobs that are peripheral to the huge profits earned at primary dealers have been by far the best jobs/careers since I have gotten out of college in 1996…everything else seems to have been in a 20 year long depression. It seems silly to me to say their aren’t winners and losers created by any tiny changesto the way the Fed decides to inject trilllions of dollars into the economy.

Anthony December 5, 2012 at 5:04 pm

Sumner’s point seems to be that the velocity of money is infinite.

Either that, or he’s hiding the ball. The claim he’s arguing against is “The first people to get the new money benefit the most.” Sumner’s example says that the Federal Reserve “prints a million $100 bills” and buys government bonds, presumably from private sellers (rather than directly from the treasury). He then says So the government gains a profit of $100 million, which economists call “seignorage.” So in one sense, Sumner has already given up his argument – he says that the government, who “got” the new money first, benefits the most.

Sumner also ignores that by choosing what is done with the money, the Fed is bidding up the price of something. By buying U.S. Treasury bonds in large quantities, the Fed is slightly pushing up the price of those bonds (else the sellers wouldn’t sell). That benefits not only the sellers (who were content, up to the point of the sale to the Fed to hold their bonds) but other holders of treasury bonds, especially those who sell to non-Fed buyers shortly thereafter. If, instead, the Fed were to give the money to the Treasury for the purpose of giving a supplemental $100 bonus to all food-stamp recipients, who would then have to go out and buy food with the money, one would see a small rise in the price of food, making grocers slightly better off, before the food processors raised their prices.

Sumner claims “Indeed if you really thought that asset prices would rise with a lag, then holders of the new money would actually see a loss of purchasing power due to inflation.” He’s (probably deliberately) confusing the issue. If I have $10,000, and am given $1,000 as a result of a Fed operation which reduces the purchasing power of each of those dollars by 0.01%, my initial stock of cash is now only worth $9,999, and my new cash is only worth $999.90, but I have gone from $10,000 to $10,998.90, which is an increase in my purchasing power of $998.90, nothing to sneeze at. Even if Sumner’s claim that the response of prices to money-supply is effectively instantaneous were true, the initial recipient of the money gets something. Sumner seems to be saying that the initial recipient is effectively the government. That’s a reasonable-sounding factual claim, but all he’s really shown then is that “the first people to get the money” isn’t quite who the Austrians think it is, rather than disprove the claim “The first people to get the new money benefit the most.”.

Eorr December 5, 2012 at 6:13 pm

I think that is right to a certain extent. Look at Nick Rowe’s comments on his blog which basically reduces the argument that the Austrians are saying that fiscal policy matters. The first movers are not the primary dealers but the government and since it is all cycled back to the fed that any downstream effects are negligible at best. Also that assumes that the people who have money do not react to the expected future policy of the fed which seems ridiculous.

Desolation Jones December 6, 2012 at 12:52 am

“If I have $10,000, and am given $1,000 as a result of a Fed operation which reduces the purchasing power of each of those dollars by 0.01%, my initial stock of cash is now only worth $9,999, and my new cash is only worth $999.90, but I have gone from $10,000 to $10,998.90, which is an increase in my purchasing power of $998.90, nothing to sneeze at.”

But you give up your bonds in return for cash. You gain 1k in cash, but you lose 1k in bonds. Your wealth hasn’t changed. You could have have sold your bonds even if the Fed wasn’t buying What’s the difference?

The Anti-Gnostic December 6, 2012 at 10:01 am

“Your wealth hasn’t changed.”

Actually it has, since there’s now $1K in cash floating around that didn’t previously exist.

“You could have have sold your bonds even if the Fed wasn’t buying.”

Could you? And at what price?

Desolation Jones December 6, 2012 at 10:48 am

“Actually it has, since there’s now $1K in cash floating around that didn’t previously exist”
Since when is wealth define as how much cash you have? If own a billion dollars is assets, and only have around $100 in cash (including my bank deposits), does that mean I’m poor? Selling $1k in bonds is just exchanging 1 type of liquid asset for the ultimate liquid asset (money). My decisions on how much to spend would be based on how much wealth I have, not on how much cash I have.

You can say perhaps the primary dealers are making a killing by selling their bonds at a higher price (when the fed lower interest rates), but they could do that even if the Fed wasn’t buying bonds from them directly.

“Could you? And at what price?”
Demand for safe and liquid assets are at an old time high. Interest rates would have fallen even if the Fed wasn’t buying because the economy was weak. I’d have no trouble selling bonds. The US government certainly isn’t having any trouble.

GiT December 5, 2012 at 6:47 pm

All I know is that I’d much prefer it if I got all the money first.

Gabe December 6, 2012 at 12:34 pm

It seems to me that JP Morgan and Goldman Sachs prefer to keep the system similar to the way it is. I am not exactly sure of all the ways that it helps them to have new money channeled through primary dealers…but I bet they aren’t just supporting the current methods of monetary injection because they are so good naturedly watching out for my best interests.

Is that the postion of those in favor of the current systems of monetary injection…that the primary dealers and Fed want to keep the system as is because they care about us so much?

You guys are supposed to be smart? December 5, 2012 at 8:24 pm

Only in academia wonderland could clowns proclaim that it does not matter if the money supply rises and who gets that money first.

sovathana sokhom December 6, 2012 at 12:33 am

Yes, you are right! Sad…if you are a single mother….!!

DocMerlin December 5, 2012 at 9:08 pm

“In aggregate, the total level of nominal purchases is constrained by the amount of currency in circulation.”
No its not.
A purchase is an event, money is an object.
Scott is confusing stocks and flows.

Tyler Cowen December 5, 2012 at 9:48 pm

Blah, blah, blah. Empirically seigniorage income is relatively small.

The Anti-Gnostic December 5, 2012 at 10:07 pm

That’s good news. Since it’s so small, the government won’t mind when my neighbors and I get some plates engraved and start printing our own.

As long as December 5, 2012 at 10:40 pm

Yours is backed by T-bills, then sure.

The Anti-Gnostic December 5, 2012 at 11:14 pm

The T-bills backed by the money the Fed and the central banks of OPEC and southeast Asia print to buy them? You think that’s never been tried before?

D. F. Linton December 6, 2012 at 8:07 am

Empirically, by revealed preferences, the income from counterfeiting is relatively large.

prior_approval December 6, 2012 at 8:59 am

The Bundesbank considered it a signifcant enough source of revenue that it impacted its budget by the conversion to the euro. But then, it was never a German that said ‘a billion here, a billion there, at some point it becomes real money.’ That includes the East German physics Ph.d. currently in charge of the German government. And she has never been heard to say ‘blah, blah,’ either.

But on the other hand, she doesn’t blog.

Steve Sailer December 5, 2012 at 10:22 pm

Okay, I’ll take the money first. You can have it later.

Rahul December 6, 2012 at 1:37 am

+1

Goldman Sachs December 6, 2012 at 12:36 pm

We like the money to flow through us first. Keep things as they are. We derive no benefit from being a primary dealer, we promise.

dirk December 6, 2012 at 3:36 pm

If you got the money first, it would have to be in exchange for something whose market value was already equal to the money you were receiving. Why is this so hard to understand?

The Anti-Gnostic December 6, 2012 at 4:03 pm

Because it’s a real stretch to call this a market exchange when you get together with your buddies and peg the price for the asset based on political considerations, and then just print up whatever money you need to make the purchase.

T December 6, 2012 at 10:38 pm

Why is everyone in this thread missing Scott’s very simple point? Its *information* (that money has been issued) that counts not the actual banknote. In an open market operation, everybody gets the information (although not everyone will act on it).
Suppose Fed use fresh money to buy a bond secretly. from Bank A (by pretending to be a non-government entity) but reveals the information exclusively to Bank B. It is Bank B that has the advantage even though the new notes are actually held by Bank A. Bank B knows that prices will rise in the future and can benefit from the info(say by buying commodities with dollars).
This is similar to insider trading problem. When a company issues new shares, the people who hold the new shares dont have an advantage. But the insider who knows about this can benefit if he is allowed to act.
Even if the inflation hits in gradually, it is the people who include the information in their models first, who benefit, not the people who have initial access to the new money.

The Anti-Gnostic December 7, 2012 at 12:35 am

It’s arid theorizing on paper. The real world doesn’t work like a linear equation. You can find EMT academics who will demonstrate why nobody makes profits on Wall Street as well.

T December 7, 2012 at 2:39 am

I am not invoking the EMH at all. Simple question for you – if a counterfeiter injects cash into the economy by buying goods from person A, but reveals that he has done this only to person B. From a monetary persepctive, which position would you prefer to be in A or B?

The Anti-Gnostic December 7, 2012 at 8:19 am

So now B can counter A’s next move, and A has lost his advantage. Again, if that’s what’s happening, I question what monetary policy is accomplishing in real terms. Actually, I do know: it’s propping up nominal asset values by diluting the money stock. All the transparency in the world can’t stop the distortions from happening.

MikeDC December 7, 2012 at 10:21 am

This is partly true, but…
… there’s also the issue of gains from trade and opportunity cost. Sumner makes the ludicrous statement that since the bank and Fed are making a market exchange (eg, $100 value bonds for $100 cash), each side is no better off.

Of course, the truth in any market exchange is that both sides are better off. The exchange has to hold enough gains to overcome our indifference.

Well, I say both sides, but in this case, only one side of the trade is engaging in a market exchange. The Fed is trading a good for which it faces no scarcity and receiving a good for which it has no use (except to prop up banks and the government).

Ray Lopez December 5, 2012 at 10:54 pm

Economics is rich with ironies, and the Austrians, if they adopt the position that money is not neutral (which seems to me rather bogus), are in fact agreeing with Keynes “money illusion”, meaning doubling the money supply will not double prices immediately, but there will be a lag, and this lag that could make people who get the money first to spend more, precisely what Keynes suggests for increasing AD by printing money. Hence Austrians = Keynesians. I love it. Relevant passage below from “How the Rich Rule”: http://www.theamericanconservative.com/articles/how-the-rich-rule/

“But the Austrian school of economics has long stressed two overlooked aspects of inflation. First, the new money enters the economy at specific points, rather than being distributed evenly through the textbook “helicopter effect.” Second, money is non-neutral.
Since Fed-created money reaches particular privileged interests before it filters through the economy, early recipients—banks, securities dealers, government contractors—have the benefit of increased purchasing power before prices rise. Most wage earners and people on fixed incomes, on the other hand, see higher prices before they receive higher nominal incomes or Social Security benefits. Pensioners without cost-of-living adjustments are out of luck.”

The Anti-Gnostic December 5, 2012 at 11:46 pm

But it’s not the same thing. Consumption in the Keynesian model is not supported by prior production. Rather, it’s bringing future production forward to spend it in the present. Granted, Steve Jobs presumably justified his business plan to his creditors but that’s players betting with their own money. Are central bankers playing with fiat dollars as perspicacious? I guess we’ll find out.

Mark December 6, 2012 at 1:34 am

The Austrian model erroneously assumes that saving leads to future production.

andy December 6, 2012 at 4:19 am

Doesn’t it correctly assume that non-saving does lead to future non-production?

Ray Lopez December 6, 2012 at 5:03 am

Thanks Anti-Gnostic. The blue link means you’re almost famous ;-). But I was referring to the ‘money illusion’ aspect of Keynesianism, not the ‘no Say’s Law’ / Demand-creates-Supply aspect of Keynesianism. Though I’m sure somebody will find a nexus between the two, I don’t think they are one and the same thing.

Ray Lopez December 6, 2012 at 5:07 am

So, while I can see a nexus between money illusion and anti-Say’s Law, I think the Keynesians and Austrians are one and the same with respect to this limited question: Austrians think it matters as to who gets money first for purchasing power, and Keynesians believe in money illusion (dropped money from a helicopter will make people feel richer, when in theory–if they logically thought it through–it should not change demand but only raise prices).

The Anti-Gnostic December 6, 2012 at 10:12 pm

Feel free to stop by. Thanks for your comment.

Joe in Morgantown December 6, 2012 at 11:39 am

This experiment has been done, in an extreme form. In the German and Austrian hyperinflations, the people who got the money first did rather well. It only the less well connected who were obliterated.

Why is it different this time?

Gabe December 6, 2012 at 12:40 pm

Because our government loves us and the Fed is run by men who are looking out for the best interest of the little people. /sarc off

bmcburney December 6, 2012 at 3:40 pm

But if the Fed’s goal is to get money into the economy by buying Treasury bonds then, necessarily, there must be a distortion of demand for that asset by the fact that a very significant buyer has entered the market for reasons having nothing to do with the investment prospects of the asset. So, in fact, the Fed does not buy $100 million in bonds for $100 million in new money but only, let’s say, $99.97 million in bonds temorarily marked up for the occasion. As soon as the Fed acts, sellers of the asset they are buying obtain better prices then otherwise. Unless the Fed buys all assets classes simultaneously the owners of the asset class which they do buy must obtain a windfall. A small windfall in a liquid market compared to the volume of the buying but the Fed cannot obtain the desired macro effect of lower interest rates unless it distorts the market. And, in fact, even as to the market for US Treasury Bonds, Fed buying does move the market and owners of the asset before the buying begins obtain a windfall.

Salvatore December 18, 2012 at 12:34 am

I don’t even know how I ended up here, but I thought this post was good. I don’t know who you
are but certainly you’re going to a famous blogger if you are not already ;) Cheers!

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