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Money Multiplier
What is the Money Multiplier?
In a fractional reserve system like we have here in the United States money is loaned out by banks and by law they are only required to have a fraction of the amount they loan out. For example they might be required to keep 10% in reserves. In other words, they may have $10 million dollars in deposits but because not everyone will come in to claim their dollars at once the bank may loan out $9 million dollars. But the multiplication doesn’t end there the $9 million will be deposited at another bank and that bank can loan out 90% of that or $8.1 million and that will be deposited in another bank who can loan out another 90% and so on.
In our article, How Wealth Can Simply Evaporate Bob Stokes gives the following example: “…a lender starts with a million dollars and the borrower starts with zero. Upon extending the loan, the borrower possesses the million dollars, yet the lender feels that he still owns the million dollars that he lent out. If anyone asks the lender what he is worth, he says, ‘a million dollars,’ and shows the note to prove it. Because of this conviction, there is, in the minds of the debtor and the creditor combined, two million dollars worth of value where before there was only one.” This is the perfect example of Continue reading
Velocity of Money
What is the velocity of money?
Simply defined the velocity of money is the turnover in the money supply. A shop owner can measure how fast his inventory is selling by calculating “inventory turnover.” To do that he simply calculates Total Sales ÷ Average Inventory for the period in question. See: Inventory TurnOver for more information.
But if you expand the idea of turnover to the entire country you get the “Velocity of Money”.
Strictly speaking all the velocity of money tells us is how long people hold onto their money. But from that we can infer their motives and perceptions of the economy in general…
Velocity of Money Calculation
To Calculate the Velocity of Money you simply divide Gross Domestic Product (GDP) which is the total of everything sold in the country by the Money Supply. Thus Velocity of Money= GDP ÷ Money Supply. Now there is some debate about the proper measurement of the money supply. The most most restrictive measure of money supply is M1 which basically includes short term money i.e. money that is available immediately. So that would be cash and checking accounts, NOW accounts and demand deposits i.e. money you can get your hands on immediately.
There is a good argument that this is the best measure of velocity of money because you want to look for an increase in the cash people are looking to hold. If people are Continue reading
Agflation- What is it?
Agflation, is a relatively new term coined by analysts at Merrill Lynch in 2007. Back then rising demand for agricultural products started driving up prices. Agflation is simply a combining of the words agriculture as in “agricultural commodities” and the word inflation. Inflation is commonly used to mean an increase in prices (although it originally meant an increase in the money supply which eventually resulted in an increase in prices). So agflation is simply an increase in the prices of agricultural products.
But agflation is not the result of an increase in the money supply like typical inflation, but rather it is simply a result of supply and demand factors. In 2000, the world wide population was 6,057,000,000 and by the end of 2010 it had increased to 6,900,000,000 or an increase of 843 million. With 843 million more mouths to feed you would expect food prices to increase but during the first five years (through 2005) that had not happened.
In the year 2000, the Economist magazine’s Commodity Price Index of global food prices was set to equal 100. Five years later the index stood at slightly under 100 a net change over five years of zero (actually a slight decline). As the world population increases the long-term demand for food supplies also increases but as long as the supply of food increases proportionally the price can be expected to remain relatively level as this example shows.
So what happened since 2005 to drive the price of food up 135% over the following five years? Continue reading
Inflation and Velocity of Money
How do you define inflation? In some ways it’s a slippery thing, like trying to nail Jell-O to a tree. One common definition amounts to “a general and sustained rise in the price of goods and services.” Another is “a persistent decline in the purchasing power of money.”
Others argue that inflation is directly tied to the money supply. That is to say, they believe a substantial rise in the money supply is the same thing as inflation. (This is one small step removed from Milton Friedman’s old assertion: “Inflation is always and everywhere a monetary phenomenon.”)
Why is the debate important? Because of the infamous chart you see below (courtesy of hedge fund QB Partners and the St. Louis Fed) and all the investing implications that stem from it.
Chances are high you’ve seen that chart before. It’s been referenced countless times (including more than once in these pages). Continue reading
What is the Federal Reserve – Part 3
Money, Credit and the Federal Reserve Banking System
Conquer the Crash, Chapter 10
By Robert Prechter
How the Federal Reserve Has Encouraged the Growth of Credit
Congress authorized the Fed not only to create money for the government but also to “smooth out” the economy by manipulating credit (which also happens to be a re-election tool for incumbents). Politics being what they are, this manipulation has been almost exclusively in the direction of making credit easy to obtain. The Fed used to make more credit available to the banking system by monetizing federal debt, that is, by creating money. Under the structure of our “fractional reserve” system, banks were authorized to employ that new money as “reserves” against which they could make new loans. Thus, new money meant new credit.
It meant a lot of new credit because banks were allowed by regulation to lend out 90 percent of their deposits, which meant that banks had to keep 10 percent of deposits on hand (“in reserve”) to cover withdrawals. When the Fed increased a bank’s reserves, that bank could lend 90 percent of those new dollars. Those dollars, in turn, would make their way to other banks as new deposits. Those other banks could lend 90 percent of those deposits, and so on. The expansion of reserves and deposits throughout the banking system this way is called the “multiplier effect.” This process expanded the supply of credit well beyond the supply of money. Continue reading
What is Debtflation?
By David Galland, Managing Editor, The Casey Report
We recently received the following comment in our Q&A Knowledge Base.
- Investors should be prepared to sell gold as either increased inflation expectations or doubts around debt sustainability force a sharp increase in US Treasury bond yields. Simply put, in an environment of high real interest rates, the allure of gold could disappear as quickly as it did in the early 1980s when Paul Volcker took control of the Federal Reserve.
My response…
First off, I want to congratulate the reader for trying to anticipate the conditions that might mark the end of the gold bull market. Because, make no mistake, the gold bull market will come to an end – and when it does, it’s not going to be pretty for those who stubbornly stay too long at the party. Continue reading
How Do I Calculate the Inflation Rate?
The following article explains how to calculate the current inflation rate, if you know the Consumer Price Index. If you don’t know it, you can find it here.
If you don’t care about the mechanics and just want the answer, use our Inflation Calculator.
The Formula For Calculating Inflation
The formula for calculating the Inflation Rate using the Consumer Price Index is relatively simple. Every month the Bureau of Labor Statistics (BLS) surveys prices and generates the current Consumer Price Index (CPI). Let us assume for the sake of simplicity that the index consists of one item and that one item cost $1.00 in 1984. The BLS published the index in 1984 at 100. If today that same item costs $1.85 the index would stand at 185.0 Continue reading
What is the Real Definition of Inflation?
By Tim McMahon
Webster’s 1983 Definition of Inflation
According to Webster’s New Universal Unabridged Dictionary published in 1983 the second definition of “inflation” after “the act of inflating or the condition of being inflated” is:
“An increase in the amount of currency in circulation, resulting in a relatively sharp and sudden fall in its value and rise in prices: it may be caused by an increase in the volume of paper money issued or of gold mined, or a relative increase in expenditures as when the supply of goods fails to meet the demand.
This definition includes some of the basic economics of inflation and would seem to indicate that inflation is not defined as the increase in prices but as the increase in the supply of money that causes the increase in prices i.e. inflation is a cause rather than an effect. But… Continue reading
Velocity of Money and Money Multiplier- Why Deflation is Possible
By Tim McMahon
Back in 1924, John Maynard Keynes called gold a barbarous relic. There is a thought prevalent these days that deflation is the new barbarous relic.
In a speech in November of 2002, Federal Reserve chairman Ben Bernanke said, “I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small… I am confident that the Fed would take whatever means necessary to prevent significant deflation… the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities.” He went on to say, “the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”
He also referred to “Milton Friedman’s famous helicopter drop of money” as a figurative method of fighting deflation, which earned him the nickname “helicopter Ben”. Continue reading
Which is Better: High or Low Inflation?
It would seem obvious that low inflation is good for consumers, because costs are not rising faster than their paychecks. But recently commentators have been saying that “Low inflation introduces uncertainty”. This is nonsense.
Deflation benefits low debt consumers and those on fixed incomes, because they receive a fixed number of dollars but can buy more with each dollar
During the high inflation “Eighties” I remember commentators saying “High Inflation introduces uncertainty”. This is not quite true either. The truth is that steady inflation, if it can be relied upon to remain steady, does not introduce uncertainty. Changing (fluctuating) inflation rates is what introduces uncertainty.
Eliminate Uncertainty
But there is no guarantee that if inflation is high it will not go higher… or lower. So there is the uncertainty. The only sure way to eliminate uncertainty is to have no inflation at all and that can only be accomplished by a “Gold Standard”.
Under a Gold Standard, the government owns a set number of ounces of Gold and issues currency for that amount of money. The only way to increase the money supply is to increase their holdings of Gold. This forces fiscal responsibility on the Government. Continue reading
