Economic Magic (Musical Tribute)

Greenspan: Don't use Fed as a 'magical piggy bank'

Greenspan, 82, who ran the Fed for 18 1/2 years and was the second-longest serving chief, says he is concerned that Capitol Hill will look to the Fed's actions "as a wondrous new font of seemingly costless federal funding -- a magical piggy bank."

The "magical piggy bank" reminds me of a little parable that Ben Bernanke offered in 2002, well before Greenspan retired.

Deflation: Making Sure "It" Doesn't Happen Here

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

Today an ounce of gold sells for $800, more or less. That's a 167% increase in price. I think it is safe to say that alchemists have not been able to produce unlimited amounts of gold at essentially no cost yet.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But 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. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Meanwhile, our government's monetary alchemists do have a proven "magical" technology which allows them to produce as many U.S. dollars as they wish at essentially no cost. Unfortunately, they've been dabbling in the black arts for nearly 30 years (as seen here). I'm not sure they know how to stop. In fact, they must summon more dollars into existence just to pay the interest on the dollars they have previously summoned. Further, investors are a fickle lot. They don't just want interest. They want a real return above inflation. That requires even more summoned dollars. Without the extra reward, investors are no doubt tempted to hoard hard goods instead.



You have to believe we are magic
Nothin' can stand in our way
You have to believe we are magic
Don't let your aim ever stray
And if all your hopes survive...