7% Inflation and What it Means for the PP?

[systemskeptic]

I found this forum through the massive Bogleheads thread on the PP, and proceeded to read through thousands of posts on the massive thread and many here on this forum.  Let me start by saying a big THANK YOU for making me aware of this alternative to the rather horrendous allocations which persist in most investing circles.

It seems there is a big deflation/inflation debate going on which is leading to a lot of talk about TLT/GLD so I thought I would put in my 2 cents.  This may be overly simplistic, but sometimes the K.I.S.S. principle works.

As I see it, there are two primary sources of inflation:
1.  (dollars I have / dollars available). What is the rate of dollars being added to the money supply?.  This to me is the biggest worry as it represents real, measurable devaluation of the dollar.  I don't know the best measure of this, but I am using M2 as an example in the following analysis.

2.  (resources I consume / resources available) Scarcity / rising cost of commodities as the population grows and resources dwindle.  This too, is a simple "how many people are using the resources I use, and how fast are they growing/consuming."  Very difficult to quantify, but either population growth or CPI might be decent measures here.

On the flip side, is deflation which also stems from two sources
3. Dollars being destroyed/debt being paid down.  Given the increases in our national debt and constant printing press, I find this one pretty hard to believe.  De-leveraging I can understand as low-interest margin money vanishes, but I don't really know how that factors into something like the M2 supply.

4. Increases in efficiency/technological development which drives down cost.  Ten years ago you could buy a 20" TV for $500 or a 42" Plasma for $5000.  Today you can buy a 42" Plasma for $500 or a 90" Plasma for $5000 so it appears buying power went up -- the problem is even though the price for TVs dropped, your standard of living rose to counter it.  Nobody is buying 20" tubes anymore.

As someone with net savings vs. net debt,  #3 would be beneficial, and #2 and #4 affect everyone on the planet more or less equally so I think it makes more sense to dismiss them.  In my mind, the only concern (and measurement) of inflation I care about is the devaluation of the currency my savings are denominated in.

I don't know much about M1/M2/M3 etc. but I've seen mention of M2 on here so I just grabbed the M2 data back to 1959 along with the gold and S&P 500 prices.  Here are a couple plots I made, with notes:





These plots seem to indicate that the dollar is being devalued at a rate of 7% per year. Given that the PP has averaged 9-10% over the past 40 years, the real gain is about 2-3%.  Breaking down the components we find that:

From 1959 to to end of 2011:
1.  $1 invested in Gold was up to $45
2.  $1 invested in Stocks was up to $22
3.  $1 in M2 supply had grown to $31

I don't have numbers for LTT prior to 1990 (maybe someone else does?), but I'm guessing the rates very closely match the growth of M2 (7%).  From 1990-2012, LTT rates average 6% which is below the 7% inflation rate.  The rate for short term cash is then 2-3% below inflation depending on the yield curves.  Combining all four components in the PP and you have a vehicle which in terms of NAV, more or less tracks inflation.

This passes a sanity check for me as the people who make money, make it at our expense.  Do you invest your money as a charity?  Probably not so I do not think it is possible to just earn money for free in a market with this much manipulation.  There is no free lunch and I cannot see why anyone would give out free returns (aka cash/bonds being near/above inflation).  So where does the 2-3% real return in the PP come from? 

Possibly the average of:
2-3% boost from dividends
2-3% boost from re-balancing gains (seen quoted on this forum)
2-3% boost from the historical trend of decreasing rates (seen quoted on this forum)

7% inflation also matches my qualitative observations over the last decade.  At 7%, your buying power is cut in half every 8-10 years.  10 years ago I remember a McDonalds cheeseburger was  49 cents.  Now its 99 cents.  Movie tickets from $6 to $12, and so on.

I'm not sure what to do with this information, but 7% inflation doesn't seem to bode well for a private investor. 

[clacy]

Interesting post.  Speaking of inflation/deflation, here is a good Bill Gross article that outlines these two fat tail outcomes that are opposing one another...

http://www.pimco.com/EN/Insights/Pages/ ... -2012.aspx

[moda0306]

Is this really Clive, or am I now going to have to look at even more graphs and analyses that leave me with a headache?

I think we should close this forum to new members for a while.

systemskeptic,

JK and welcome.  Your charts simply seem off... It's hard for me to believe that gold has grown more than stocks since 1959 to the degree that you illustrate, if at all.... could this be due to dividend reinvestment?

I'd also add that as a fellow net saver, I am also very, very concerned with my ability to stay employed, and that has a much larger affect on my pocketbook than the fact that I may have $50k-$80k in net assets.  The expansion of our money supply often is dealt with in terms of making sure there are enough net financial assets (do you follow MMT (modern monetary theory?)) in the economy for it to work with the amount of productive capacity.

Again, welcome, and try to put these things up before I've had 3 glasses of undrank New Years champagne.

[craigr]

Do your stock figures include dividends? They seem off to me at first blush.

[systemskeptic]

Haha, no I am not Clive

But you are both correct, the stock chart is simply S&P 500 closing prices back to 1959 so it doesn't include dividend reinvestment.  Dividends should be good for another 2-3% on that curve, which I assume is part of the reason the PP achieves real gains.

[Gumby]

As I see it, there are two primary sources of inflation: [/u]
1.  (dollars I have / dollars available). What is the rate of dollars being added to the money supply?.  This to me is the biggest worry as it represents real, measurable devaluation of the dollar.  I don't know the best measure of this, but I am using M2 as an example in the following analysis.

Welcome!

What you're referring to is the Quantity Theory of Money, which Keynes refuted about 80 years ago. Even Harry Browne — who constantly worried about inflation — told us many times on his radio show that the increasing money supply itself does not cause inflation, but rather there are other factors, such as the demand for that money. In other words, you're not going to be able to predict inflation by looking at the money supply. You have to factor in employment, private deleveraging, disposable income and the velocity of money for starters.

Right now, unemployment is high, disposable income is low and the private sector is undergoing a massive deleveraging cycle not seen since the Great Depression — these are not ideal conditions for high inflation. If anything, the money supply is too low in the private sector since most people are trying to save and pay down debt. And even if there was a desire to spend, companies could easily hire new workers to generate more supply and absorb the demand from more dollars in the private sector.

[systemskeptic]

You have to factor in employment, private deleveraging, disposable income and the velocity of money for starters.

I haven't read much on these types of issues, but I am familiar enough with keynes/mises to be on one side or the other.  I have a feeling that many authors/minds tend to complicate issues by adding extra variables which may or may not add clarity to what is under investigation. 

You are right that the global juxtaposition of who is earning how much, with what currency, what is being consumed by who all factor into what could be termed "inflation."  These are in my mind, secondary effects which are present regardless of what the government/fed/policy is doing to debase the currency.  When the money supply increases from 4 trillion to 9 trillion in ten years, how is it that someone holding cash in savings didn't directly lose buying power?

The fact that the 7% inflation corresponds to the average LLT rate and trends with the stock and gold NAV also seems like a bit of a coincidence doesn't it?

[craigr]

As I see it, there are two primary sources of inflation: [/u]
1.  (dollars I have / dollars available). What is the rate of dollars being added to the money supply?.  This to me is the biggest worry as it represents real, measurable devaluation of the dollar.  I don't know the best measure of this, but I am using M2 as an example in the following analysis.

Welcome!

What you're referring to is the Quantity Theory of Money, which Keynes refuted about 80 years ago. Even Harry Browne — who constantly worried about inflation — told us many times on his radio show that the increasing money supply itself does not cause inflation, but rather the demand for that money. In other words, you're not going to be able to predict inflation by looking at the money supply. You have to factor in employment, private deleveraging, disposable income and the velocity of money for starters.

And to go one step further, something I brought up with some others about inflation being imminent and/or big spending will fix everything Krugman-types, is that you can't force people to borrow money and spend it. Just because a bank has access to large sums of money doesn't mean it is being circulated. The numbers people see from the Fed are reserves that banks can or have tapped. But that doesn't mean it is being loaned out and used. If it is simply sitting in bank reserves and there is no demand for it then it will not cause inflation.

[Gumby]

When the money supply increases from 4 trillion to 9 trillion in ten years, how is it that someone holding cash in savings didn't directly lose buying power?

Here's how Harry Browne explained it on his investment radio show (recorded on 12/12/04):

Harry Browne: Inflation results from the supply of money increasing faster than the demand for money. Now, mostly what we hear though is that inflation results from the increase supply of money. In other words, an increase in the supply of money is "A" and inflation is "B". When you get "A" then "B" follows. But what happens is periods like the past few years when the money supply has been increasing at a fairly rapid rate, and yet, we do not see any appreciable price inflation whatsoever. So, what we're seeing here is that the money supply has increased, but the consequence has not ensued. And that's because of two things. One of which is timing, and the other is that other factors can be introduced. So, what we do mean to say, really, is that an increase in the supply of money makes the inflation rate greater than it would be without that increase in the supply of money. We also take into account the demand for money — the desire of individuals to hold money in their pocket, to hang on to money, rather than spending, saving, or investing it. And if that is increasing as fast as the supply of money, then there is no increase in the inflation rate. So, all other things being equal, the increase in the supply of money leads to an increase in the price inflation rate. But, there are other things that have to be considered and that case, mostly the demand for money. These other factors always play a part, but we can't always see them.

Source: https://web.archive.org/web/20160324133 ... -12-12.mp3 (skip to 13:20)

[systemskeptic]

I think I agree with you about short term inflation rates (say from year to year).  That is one reason why I did not try to plot such a thing.  I suspect the system is too complex for anyone on earth to model inflation with our present computational power.

However, over the longer horizon -- say 5-10 years, don't you think the quantity theory of money conceptually must hold true?  I for one am not really concerned with what my prices do over the next couple years barring an economic apocalypse.  I am concerned with a 7% siphon per year which results in me waking up 8-10 years later in a world where my money is worth half what it was when I deposited it in the bank.

I did a quick search and found this from wiki:

"While mainstream economists agree that the quantity theory holds true in the long run, there is still disagreement about its applicability in the short run." 

It seems to jive with this discussion.

[Gumby]

over the longer horizon -- say 5-10 years, don't you think the quantity theory of money conceptually must hold true?

Not necessarily. Unemployment is very high right now and disposable income is very low. Real data shows us that there is a very strong correlation between the rate of change in disposable income and the inflation rate.

[align=center][/align]

So, you don't really need to worry about inflation taking hold until everyone feels like they have disposable income again. That's not likely to happen anytime soon. Even if the huge money supply you fear were to start getting spent, companies would simply hire more unemployed workers to increase their supply and keep prices down.

And if for some reason everyone was swimming in cash and had lots of disposable income, the government could just raise taxes to destroy some of that money supply (since everyone could afford to pay taxes at that point).

Now, is it possible that the government screws this up and never taxes that money away as full employment is reached? Absolutely. I'm not saying inflation can't happen. But, the reality is that inflation is unlikely to happen until people feel like they have disposable income again and unemployment is low.

[systemskeptic]

Absolutely. I'm not saying inflation can't happen. But, it's unlikely to happen until people feel like they have disposable income again and unemployment is low.

How does the disposable income of other people affect my buying power if "non-disposable" spending comprises the lions share of peoples wages? 

This "time of propagation" from when the money is printed until it trickles down to impact peoples buying power is one of the most insidious aspects of inflation.  If the fed adds 1 trillion to the supply in some QE and overnight prices jump by 15% people would riot.  When it happens at -3% year 1, 5% year 2, 5% year 3 etc. people don't notice it as much when it trickles in over time. 

You say it cannot take hold because of the current economic conditions such as employment and disposable income.  But it must take hold eventually when the money works its way through to the last recipient -- how can it not?

If 3% inflation is true, it takes 25 years to halve your buying power.  I have a hard time believing that based on prices I've seen in my own lifetime.  At 7% it halves every decade. That seems to fit the data much better in my opinion.  What do you envision the rate at?

[Gumby]

How does the disposable income of other people affect my buying power if "non-disposable" spending comprises the lions share of peoples wages?

Because there is always a desire to save, or pay down debt, when people only have non-disposable income. When disposable income increases, people lose that desire to save and spend their money. Just like Harry Browne said. And the data proves it. We can't have high inflation right now. Any money that gets into people's hands just goes to pay down private debt (i.e. deleveraging) or is saved by people who want to have disposable income someday. And any increase in demand for goods is easily met by hiring new workers.

Inflation happens when there is too much money being spent on goods that are supply-constrained. So, even if everyone starts spending their money, companies will keep prices down by hiring more workers to increase their productive output.

This "time of propagation" from when the money is printed until it trickles down to impact peoples buying power is one of the most insidious aspects of inflation.  If the fed adds 1 trillion to the supply in some QE and overnight prices jump by 15% people would riot.  When it happens at -3% year 1, 5% year 2, 5% year 3 etc. people don't notice it as much when it trickles in over time.

Sorry, but the money printed in QE never makes it into the private sector — it's just an asset swap between the Fed and banks that doesn't do very much. In fact, by law, the Fed isn't allowed to add net financial assets to the private sector. Only the Treasury has the legal authority to add net financial assets to the private sector — as instructed by Congress's budget. So, QE is unlikely to cause any meaningful inflation. It's like using a pea shooter.

You say it cannot take hold because of the current economic conditions such as employment and disposable income.  But it must take hold eventually when the money works its way through to the last recipient -- how can it not?

Well, it can take hold, eventually. But, the last recipient will have a job and a jump in their disposable income. So, it's unlikely to happen anytime soon. And there is plenty of time (i.e. many, many years) for the money supply to be adjusted to the optimum level to match our nation's productive capacity before we're at risk of the last recipient having a good job.

If 3% inflation is true, it takes 25 years to halve your buying power.

Not true. If you're getting 3% from a bank, or T-Bills, your buying power will be the same (less whatever your tax rate is). It's the tax rate that reduces your buying power in that situation — which is one of the tools the government can use to reduce the inflation rate in the first place.

I have a hard time believing that based on prices I've seen in my own lifetime.  At 7% it halves every decade. That seems to fit the data much better in my opinion.  What do you envision the rate at?

It really doesn't matter what the inflation rate is if banks are able to match the inflation rate closely enough. Perhaps you need to take the time to explain how everyone would have enough money to spend to cause inflation in the first place? I'm off to bed. Have a good night!

[gap]

First we should be clear about how we define inflation- through CPI, PPI or the price index of GDP or of all firms(excluding the govt). Some studies have been done (I wish I could get the exact reference) that indicate that for the last definition above, which impacts our daily living considerably,  it depends strongly on the following
Unemployment rate  -ve
Cost of imports +ve
Wage Rate +ve

Over the long run there is also a  small positive trend towards higher inflation.

I ma not surprised that  in spite of the QEs there has not been any significant inflation except in specialized areas, e.g. unfortunately  in health care and education

[MediumTex]

Let's say that the U.S. government prints up $1 trillion in currency and ships it to me with no strings attached.  I can do whatever I want with it.

What I decide to do, however, is to bury it in a gigantic hole in my back yard. 

In such a case, has inflation occurred?  If so, will it show up in prices anywhere in the economy?

I think that people tend to overlook this part of the inflation equation.

If we assume that debt burdened consumers are likely to take any wage gains, tax cuts, or other increases in income and primarily use it to reduce their levels of debt rather than engage in additional consumption, how would "extra" money anywhere in the economy result in price increases? 

In an economy that is in the process of deleveraging, I think that the deleveraging process itself resembles the gigantic hole in my backyard.  You can shovel a near infinite amount of money into it, and until the underlying debts are paid off or liquidated it's hard to see inflation coming out of the process.

One of the most common misconceptions about inflation seems to be that if ANY prices are rising ANYWHERE in the economy that means that there is "inflation."  In a deleveraring environment, however, any time I see pockets of inflation here and there, I think to myself "that's really going to hurt the rest of the economy a lot, because people don't have more money to spend, and if milk and eggs cost more that means that something else either must cost less or something else simply won't be purchased at all."

The un-answered question in the inflation debate always seems to be "where are consumers going to get the money to pay the higher prices?"  If consumers don't have the money to pay higher prices businesses can raise their prices all they want and the only result is going to be demand destruction as their customers simply run out of money.  OTOH, if wages are NOT rising, then it's hard to argue that true inflation is occurring, since inflation suggests that the price of EVERYTHING is going up, and wages are really nothing more than the "price" of labor.

Right now, talking about deleveraging in the U.S. is sort of like playing a western swing ballad to someone who has only ever listened to speed metal.  I think that the whole structure and form of the deleveraging process has not yet fully registered with many consumers, businesses and politicians.  Once it does, I think that people will have a more measured view of how large a risk inflation really is. 

Ironically, I think that Ben Bernanke probably has a pretty good feel for what I am talking about, and that's what has been driving the Fed's policies since 2008.  As much heat as the Fed has taken for its policies, I would say they have been largely successful in that the U.S. economy basically went through a Depression-inducing financial crisis and only had to endure a very severe recession in its wake.  Of course, the best policy would have been to have prevented the buildup of un-repayable debt in the economy in the first place, but that's probably asking too much of the average politician, policymaker or central banker.

Bernanke is sort of like a surgeon who is able to keep a person from dying after being involved in a severe car wreck while riding in a car being driven by Alan Greenspan.  When the patient wakes up from surgery and asks whether he will fully recover, the surgeon would say: "Of course not, but that was never an option.  We were just trying to keep you from dying."  The surgeon has not failed; in fact, he has succeeded.  You just have to grasp the nature of the overall situation to see that beyond a certain point economic crises go from being "rescue missions" to "salvage operations."

Would the economy be in better shape today if the Fed had done nothing in 2008?  I doubt it.  Financial crises throughout history have often taken decades to recover from, and are often followed by wars, so sitting here today three years later I can imagine things being a LOT worse, but I can't imagine things being a whole lot better, given that wholesale debt liquidation in a world more or less controlled by financial interests is probably not realistic, even though that's what is REALLY needed.

[moda0306]

MT,

Great post.

I'd add that Ben Bernanke is severely limited with his options.  "Printing money," given the rules the fed has to go by, involves pulling almost near-identical assets at the same value out of the economy.  Until one finally realizes that the treasury bonds that Ben buys back gave the holders the exact same purchasing power as the cash he's just given them in return, hearing things like "$1 trillion of QE" can scare the crap out of someone.

It's the treasury, not the fed, that can truly enact the "helecopter drop."

If Ben Bernanke and Tim Geithner were sitting around deciding whether a $1 Trillion in stimulus (think $5,000 per adult about), or whether to do $1 Trillion in QE, buying up more Short-term bonds, they'd have to come to the conclusion that the deficit spending, not the QE would have hands-down the greater affect on the economy.  Why is this?  How can $1 Trillion in money printing NOT have an affect, but increased deficit spending has a HUGE affect?  This is exactly what MMT answers.  Deficit spending, not QE, is what truly increases the purchasing power of the American public.  It's what can truly lead to inflation.  It's what increases the number of pieces of paper out there that the government says has value.

It would be roundly accepted by way too many pundits that $1 Trillion of QE is "printing $1 Trillion dollars," but you haven't changed the purchasing power of anyone.  You've traded every one of those dollars for a short-term bond out there of equal value.  On the other hand, when you deficit-spend $5,000 into the hands of each adult American, they now have an increased $5,000 in savings, and if the treasury issued $1 Trillion in new bonds to "pay for" the stimulus, those savers still have $1 Trillion in purchasing power on their balance sheets in highly liquid instruments.  So you've literally improved balance sheets of the country by $1 Trillion.

Even then, I think most people would use much of the $5k to pay down debt... which in my book is just fine.

Increased deficit spending has a MUCH greater affect, dollar for dollar, than QE, because it increases the number of net financial assets out in the economy that can be used to improve balance sheets and/or buy stuff.  

[systemskeptic]

There are valid concerns here, but isn't inflation a much more personal issue?  Specifically, with regards to the following:

Wage Rate
If I have a job, save very little compared to my income, and my wages are market adjusted up or down -- why would I care about inflation?  How does this situation change if I am retired and living on a fixed income?  Second, establishing causation is no easy task -- though it is my opinion that wages follow inflation rather than cause or prevent it.

Unemployment
Anyone would prefer to have a job earning dollars that are being devalued at 7% a year if the alternative is unemployment and homelessness.  But what if you are someone who saves 50% a year and is preparing an early retirement?  Like wages, unemployment trends with inflation but I do not think it has much power to cause or prevent it. 

Import rate
Doesn't this depend on what you consume and where you live?  If you are a U.S. citizen buying foreign cars and electronics, yes maybe this is a big source of stress in your life. If you live a simple life, commute by bicycle, and shop at the local farmers market, how does the trade balance affect the majority of your finances?  You can't outsource housing, food, and local entertainment...

These three do not pass the test for things that I care about with regards for inflation, but I can certainly see the perspective of others.  Don't you think, too, it depends whether you're planning to rely on your wages rising to match inflation?  Whether you hoping for high inflation to keep unemployment low so you have a job at all?

This ideas are not valid for someone who doesn't have a job and is living on a fixed income -- either at home or abroad.

[moda0306]

systemskeptic,

I really think you need to re-figure whether an increase in the money supply is inflation.

In 1800, we had X supply of gold out of the ground, and it was far and away the worlds most used currency.

By 1900, we had suffered almost no inflation, if not deflation, but the gold supply had increased considerably.

Why is that?  Our productive capacity was significantly higher.... more money chasing more goods (as long as more=more) equals no inflation.

Money is simply a tool with which buyers of real goods and services can more efficiently meet sellers of different goods and services.  It's a medium of exchange to prevent the inefficiencies of bartaring.  That's all it is.  It holds no other purpose.  If we have more goods and services to offer each other after 100 years, we'll need more money on our balance sheets if we want to be able to do it smoothly and efficiently, with confidence.  Your piece of green paper hasn't been devalued in 100 years if the money supply has simply kept up with productive capacity.

I'm starting to develop a theory that older people tend to look at money differently than young people (not in the sense that your Grandpa from the depression values it more, etc).  Older people are much less affected by unemployment, but are often obsessed with their nest egg retaining its value... They think of dollars and bonds as these precious things that should not be debased in any way shape or form.  Young people, especially the ones like Gumby, melveyr, and myself, can much more easily absorb the idea of money as no more than a medium of exchange to prevent the inefficiencies of bartaring, and that it's truly unemployment and our economic potential going to waste that we have to worry about... conveniently, Gumby, melveyr and myself are MUCH more dependent on future employment prospects than our measly savings.

I still think we're right, though.

[systemskeptic]

QE does not directly inflate the M2 supply, but why does that change the validity of the quantity theory of money?  It is not fair to say that someone with $1 trillion in interest free money puts it in a hole in the ground.  They are not doing that, they are investing it for profit.  When they pay back the $1 trillion loan, do they return the interest as well?  No. 

That is how the money makes its way into the economy -- not through direct QE, but through the profit people make on that "free" money.

From my chart, the M2 supply was $7815 billion in 2008 and $9211 billion in 2011.  A change of $1.4 trillion or just about 18%.  18% corresponds to...you guessed it, nearly 6% inflation the last three years.

I have heard numbers from the Fed audit thrown around about $13 trillion being lent out in all the QE.  I don't know if those numbers are accurate, but if they are it would only require a 3% return over 3 years to generate the $1.4 trillion profits which are now locked into the economy.

These profits are being made at the expense of every dollar currently in savings.  How is that not true?

[Indices]

What inflation?

[moda0306]

I don't think "lent out" is the term that should apply to QE... they're buying back bonds that the treasury issues, but didn't have to.

If during the biggest boom of the 1800's 18% more gold had been mined out of the ground than previously existed over a few year period, would you call that 6% inflation?

Once again, money is simply a medium of exchange.  One of the MAJOR reasons the gov't is even in the business of providing it is for the purposes of efficiency (all one currency) and stability, both short and long-term (able to counter shocks and grow with the economy).  So, yes, the gov't could simply quit supplying the economy with financial assets, so your financial asset increases in value relative to the productive capacity of the nation while people who can provide real goods and services don't have enough medium of exchange to meet each other efficiently, and have to resort to sitting around unemployed, or, if their lucky, finding someone to bartar with.  But this isn't the purpose of common fiat currency, nor should it be.

This is great for those retired or with a boat load of savings that don't have to work productively to earn money... but that's not the purpose of money... the purpose of money is to provide a medium of exchange that works for the REAL economy... people DESIRE to save in that medium of exchange in the hopes that it will hold its value relative to the CURRENT product/service mix of the economy, not be able to buy ever more simply by stuffing it in their mattress.  The true evil would be issuing a fixed amount of a currency, letting it get into the hands of the wealthy and retired or near-retired, and then tell everyone "you have to use this as currency, and pay taxes in this currency, but good luck trying to expand GDP, because this is all we're done making."  

This defeats a main purpose of the sovereign fiat currency in the first place. Even Milton Friedman didn't call for a fixed money supply.  Think of a world where all people have is goods and services and skills to offer.  Any "financial asset" is a promise to give something of value in the future, and in this world there is no money so people promise goods & services.  The purpose of a growing, fiat currency is to offer this imaginary world a stable, common medium of exchange, not to allow old men who hold bonds to hold the productive economy hostage with a fixed money supply, while people with real skills and services are forced to resort to bartaring.

[moda0306]

I'd also add that M2 is a product, partially, of private-sector lending.  This means, using your logic, that simply by loaning someone money a bank can steal from you.  Banks interact freely with free citizens, just like you and I... a loan can hardly be described as stealing from those with the hard stuff.

So since that makes little sense, we need to scale it back.

So that brings us to M1, cash reserves... and if we consider this inflation we're really in a pickle, because this thing goes all over the place.  This is truly, according to your definition, what decides if the gov't is stealing from you.

None of this really makes sense...  to simply use different variations of the quantity theory of money without looking at the real economy it should be used to support is a tough sell IMO.

[systemskeptic]

Your piece of green paper hasn't been devalued in 100 years if the money supply has simply kept up with productive capacity.

...conveniently, Gumby, melveyr and myself are MUCH more dependent on future employment prospects than our measly savings.

moda,

I realize that economic theory is so complex that there are proponents on both sides that strongly believe in their position.  We will probably have to agree to disagree on whether the money supply must keep up with productive capacity.  As you said yourself, "money is a medium for barter" why does the medium need to keep up with what is being bartered, so long as it is sufficiently divisible?  If production drops prices would rise, if production booms, prices would fall.  Really this is bordering on philosophy and the abstract more than anything either of us can prove or disprove.

To play devils advocate for a bit,

Most young people are relying on 10% returns to propel them into retirement.  If the real rates on such an investment are only 2-3% as opposed to 6-7%, isn't that going to throw a massive wrench in most retirement plans?

When investing vs. consuming becomes impossible/impractical due to inflation, the only choice is remaining employed.  Wouldn't this mean that you are destined to work for the rest of your life, well into your 60s or even 70s depending on how long you expect to live?  Tell me this, the powers that be, would they prefer you employed (for them) or living off static investments drinking beers on a beach?

It sounds like you are simply "putting off" the problem of inflation for your future self.

[Gumby]

systemskeptic, your understanding of QE is incorrect. QE does not create new net financial assets in the private sector. The Fed doesn't have that authority. Only the Treasury can increase net financial assets in the private sector.

Even Benanke has admitted that QE is not inflationary...

http://pragcap.com/ben-bernanke-explains-fed-qe

All QE does is provide more liquidity (swapping Treasuries for Cash) to banks. And since Treasuries are already one of the world's most liquid assets, the swap is pretty much irrelevant — particularly when those Treasuries don't yield very much.

[Gumby]

I realize that economic theory is so complex that there are proponents on both sides that strongly believe in their position.  We will probably have to agree to disagree on whether the money supply must keep up with productive capacity.

systemskeptic, there are virtually no well-regarded economists who believe in the Quantity of Money Theory anymore. Pundits yes. Economists, no. Everyone knows that inflation is more complex than simply counting up the number of dollars in the world.

As investopedia points out...

John Maynard Keynes challenged the theory in the 1930s, saying that increases in money supply lead to a decrease in the velocity of circulation and that real income, the flow of money to the factors of production, increased. Therefore, velocity could change in response to changes in money supply. It was conceded by many economists after him that Keynes’ idea was accurate.