For a while, I've been wanting to better understand how money works in our world. This article is my attempt at organizing my thoughts on the subject, with the hope that others will read it and help guide my knowledgeable. So if I get anything wrong, please feel free to correct me in the comments as well as share any new insights that might be useful. Mostly I'm hoping to start a discussion on these issues so that we can all better understand the implications of inflation versus deflation, centralization versus decentralization.
In the US, the total amount of money that exists as hard currency, or sits in checking and saving accounts, or is held in certificate of deposits, is known as the M2 money supply. As of March 2020, the M2 money supply was valued at approximately $16 trillion. This would exclude anything like real estate, stocks, debt, etc.
The reason I'm focusing on the M2 is because I feel it gives us the best approximation of all the "money" that exists in the US. For the purposes of this article, I'm ignoring other assets because they are not money in and of themselves, but can be exchanged for money. For example, if you own a house and want to sell it, you must find someone with the dollars to buy it from you. I suppose you could barter your house for another person's house, but let's ignore that possibility for now. Another way of looking at it is to ask if anything can be worth more than $16 trillion if that is the total dollars available in the system? It would be impossible to sell something for $32 trillion when there are only $16 trillion in existence, right?
I'd say yes, unless of course the fed prints another $32 trillion and uses that to buy this magical $32 trillion item.
Earlier this month with the CARES act, the US Federal Reserve printed an additional $2 trillion, or 12.5% of the M2 money supply, and I wondered to myself, what does that mean for our economy?
According to my research, about $1 trillion will end up in the hands of individuals, either through stimulus checks/deposits, or unemployment benefits, or continued wages through small business loans granted to their employer. Another $500 billion is being given to the government to help fight covid-19, as well as for various government services and public works. And the last $500 billion is going to large corporations as loans that they supposedly will have to pay back, though I'm not sure about that.
Bottom line is all of this money ends up in someone's account. Whether it's a private sector employee, a government employee, or a corporate bank account, the money exists and is under the control of these individuals.
So with this additional $2 trillion distributed to millions of bank accounts throughout the country, now what?
Are prices going to go up? Are we heading towards hyperinflation?
With most of the US under some kind of lock down, the country's economy has ground to a halt. So despite the fact that there has been a 12.5% increase in the M2 money supply, the demand for goods and services is way down as people have stopped consuming all but the most essential items. Does this mean prices will crash since demand is down?
Let's imagine there was no pandemic but the government suddenly decided to double the amount of money people had in their wallets, in their checking or savings accounts, or in CDs. What would happen? Prices would inevitably go up because the supply of money has doubled while the supply of all other goods and services has not. Chances are prices wouldn't just double overnight, however. It would happen over some period of time until a new equilibrium is found.
Going back to our real life example, I think a similar process is playing out. While we adapt to the new normal, price discovery is happening in real time. But whether that means lower or higher prices in the near term is hard to gauge because both supply and demand are changing congruently.
Let's take a family of four who live paycheck to paycheck and have little or no savings. Both parents have lost their jobs and are now collecting unemployment. They also received a stimulus check and they use this money to pay for their monthly bills and other essentials like food. That money goes to the electric company, and to the grocery store, and to the grocery store suppliers, etc. The money moves from our family of four to the companies up the supply chain and the people who work for them. Those people then use the money they've just earned to pay for their own needs. The money goes around and around, and with each transaction, there is someone there to take a % as profit or as tax. Business owners and shareholders of publicly traded companies eventually benefit from the profits, while government employees benefit from the taxes.
I'm no economist, but I'm guessing what's going to happen when all this shakes out is that the poorest of us will suffer the most. The problem to me isn't so much that we operate under an inflationary model, because theoretically it's possible in such a model that even with new money being pumped into the market, so long as that money is evenly distributed, no one need suffer as wages should rise at the same rate prices rise. To me, the problem is that any new money isn't distributed evenly. With the government holding the purse strings, the bureaucrats will use every opportunity to enrich themselves and their friends in big corporations. This is just just a hunch, but I suspect that by intervening in the economy, and not letting the free markets reign, our government is using the guise of stimulus checks for the citizenry to disproportionately bail out their friends in industry (i.e. airlines, banking). Eventually, as more and more money is pumped into the system, I can see a situation where everyone suffers but those in Washington and their friends. While your average joe is getting a $1200 check, just enough to get by, the largest shareholders of these huge corporations and hedge funds will get millions. Let's say $300 billion is divided between 300 million Americans with each getting $1000. Compare that to 1 million Americans dividing $400 billion to keep their businesses afloat and maintaining their status in the .1%.
So does this mean the problem is having a central authority control our money? I believe it does.
Bitcoin Cash solves this by using a system that doesn't allow a central authority to capture the network and inflate the money supply according to its whim. There are checks and balances in place to insure this doesn't happen. But in addition, the model behind Bitcoin Cash is a deflationary one where there will never be more than 21 million coins that ever exist.
This leads to a new question. Is the answer to our problems a decentralized economic system based on math and computer science where new money can only be produced through proof of work? If the world economy was running on Bitcoin Cash, with the inability to print money haphazardly, how would we have dealt with a situation like coronavirus?
I will try to investigate that in the next article.
Meant to read this article a week, but just read it finally. A few things to add: first of all, the world right now scrambles to get US dollars, because their local economies are going down the drain. So that creates a buying pressure on US Dollar. Google "1 USD to EUR", "1 USD to INR", "1USD to MXN" and click "1Y" - you'll see the US Dollar getting more and more expensive. So, it makes sense in this situation to print more Dollars, because as long as you're printing slower than the demand - you're maintaining the status quo.
The second thing you got exactly right - inflation isn't immediate. Remember 2008's stimulus? What was it like 800b? I remember reading that years later most of this money is still in the same accounts. It didn't really move into the economy. So it never created the inflation. There's a lot of hidden pressure that will be released if a panic sets in. Luckily the US dollar is the currency to buy in a panic right now. Nowhere to run. It might change, but not at the moment. Realistically.
Anyway, great read, as usual!