Commodity Pricing and Fiat Money

Discussion in 'Economics' started by Smart Money, Nov 6, 2006.

  1. I remember learning in economics class that the price of a commodity decreases over time.

    But last night, I was thinking about a fiat money supply, and realized that with a fiat money supply, the value of the currency decreases over time.

    So what if you take them together? What does the price of a commodity do over the long term valued in fiat money?

    Just curious what ya'll think...

  2. fiat money in some respects is just another type of asset, and gets traded as such. to a large extent, its value relative to other type of assets is:
    A. a function of ppl's confidence in their government & institutions' continuing ability to maintain solvency, peace, social order, proper governance systems and sound & transparent financial management across the economic system (incl gvt, CB/Fed, banks, other industries)
    B. the yield curve
    i.e. risk/reward... nothing new here...

    how about supply & demand for that particular asset then?

    well, without going into the complexities of the Mx aggregates, nor how their meaning and relevance has dramatically changed since the 80's, nor how changes in velocity of money come into play, nor how modern central banking & regulatory practices have dramatically improved accountability & transparency at all levels of the financial system over the last 20 years or so... let's just assume a universal Gvt & universal currency unit for simplicity's sake, and distinguish between a couple straightforward scenarii:

    . A & B being 'stable', if the economy is mildly expanding, money wants to change hands more often or move in larger quantities more frequently therefore money supply needs to increase if rates are going to remain stable, otherwise the relative rarity of money vs velocity-induced demand will cause IRs to go up, which would gradually choke the expansion... reverse applies if economy is mildly contracting

    . similarly shld A & B remain 'stable' over a long enough period of time, money supply wld need to expand in line with demographics for IRs to remain stable... or shld demographics change and life expectancy increase significantly as it has been doing over the last couple of decades, the same applies

    . and if the economy is expanding relatively 'rapidly', eg due to the increased monetization of services, the inclusion of women into the workforce, technology-induced transformations and industry specialization leading to spin-offs, outsourcing etc, access to various forms of disintermediated financing etc, all contributing to an increase in the volume of exchanges as experienced in the last few decades, so should money supply, if IRs are going to remain 'stable'

    well, how about inflation? shldn't these increases in money supply create inflation?

    short answer is no, or rather, they shldn't... just because there is more money flowing into the 'system' as a lubricant doesn't mean that the supply (& suppliability) / demand for such & such product or service has fundamentally nor marginally changed... thats a 'determination' that should be and IS made competitively for the most part, on a product-by-product / service-by-service basis... however when there is a widespread perception that the economy is on an expansion path, buyers typically have less bargaining power, ppl over-reach due an anticipated wealth effect etc etc, resulting in inflationary pressures

    ok then, since ppl know that, when the economy seems to be expanding, they'll form expectations of inflation, and that shld be reinforcing innit? yes, but modern CBs know that too and they'll tweak / increase the ST rates as may be required to choke the system enough, create expectations of slowing growth etc or even shoot growth if they have to, so as to keep inflation within 'acceptable' boundaries... or at least thats their mandate

    anyway, all this to illustrate that, A&B being 'stable', inflation is just NOT a function of money supply, sorry milton...

    now of course should the CB increase the money supply totally unreasonably, then what happens is ppl lose confidence in the CB's ability to manage altogether, and so should they... and then of course the currency's value is going to plunge and ppl will want to hang on to whatever hard assets!

    . ok lets call the above the 'baseline'... NOW, what happens when A or B are not 'stable' enough? (but still within a reasonable range... this is not about tequila economies, ok?)

    well, lets say upfront that if the CBs (central bankers) do their job properly, there is precious little reason, A being stable, for B to start jerking around wildly... therefore its more a case of A going way too volatile and B trying to compensate for that...

    cut a long story short, what does a CB do when there are strong deflationary pressures at play (internet bubble burst, 9/11, enron etc debacle, worsening budget deficit, war & terror...)... spur demand... ie decrease rates significantly and provide liquidity as may THEN be required so as to allow the system to absorb / smooth things over an extended period of time of many years... instead of letting the system go into a death downspike within weeks and take decades to recover from the unnecessary panic sell-offs as in old economy crises... same as what the firemen do...

    shld that by itself cause inflation? the resulting excess (against 'baseline') increase in money supply?

    short answer imo, again is no... or rather that the dynamics are of a different nature than what the permabear medias would have it to be... notably, if ppl (in aggregate) are confident enough that the cure is going to work and that the economy is NOT going to collapse after all, therefore that the currency's value over a say 3-year horizon - as opposed to 3 months - is not a material concern, after an initial phase of partial 'flight to security'/non-interest earning hard assets buying just in case, once A has somewhat stabilized again, and ST rates are going back to normal, and money is flowing back into financial instruments vs hard assets thks notably to the attraction of more competitive rates, then the initial excess increase in money supply made possible by low rates over a period of time simply disappears from the system as rates are going back up... and yeah some ppl are going to bleed in the process, thats for sure, but slowly, instead of everybody taking a cut to the jugular... which is better?

    . ok... assuming the above is 'reasonable', aren't the current high levels of debt, gearing, leverage etc employed by all manners of actors - be it gvts, hedgies, individual investors - not a huge risk to the system though?

    well yes they certainly are a risk, now the question is whether this risk is reasonably 'well' managed or not... well, i am in the camp of those who from experience believe it is... not that there won't be accidents of course... but that in case of a default by Russia in 98, LTCM later, the Enron Worldcom Refco etc bankruptcy cases, Amaranth yesterday, the 'system' has enough controls & safeguards in the right places to ensure those are mere hiccups to the overall financial system / the economy...

    . in any case, this was just to illustrate how inflation on the one hand, and properly managed increases in money supply by a competent modern CB on the other, are NOT related, sorry again milton...

    Coming back to, ahemmm, lemme clear me throat, the OP's original question, for those of you i haven't put to sleep yet, let me just say this:

    commodities, apart from temporary supply (supply chain) / demand (hoarding) type tensions, are at the low end of the value chain spectrum, and that won't change... don't expect miracles there...

    (a hundred pages later)

    ...therefore, to a large extent, as our revered central bankers are there to ensure in their infinite wisdom that IRs, leverage, growth and inflation remain within the magic fine-tuning limits of the golden tetrahedron of 21C finance, the OP's question is... irrelevant...

    but thks for asking nonetheless
  3. So you're saying, that effectively, the banks try to set the fiat currency, using the mechanism you outlined, at a level such that the commodities will not increase in price? Got to re-read your post half a dozen more times, but if that is what you are saying, it does make a lot of sense. The value of fiat money is easily changed, and must stay within narrow parameters so people don't lose confidence in it on the one hand, while it retains its usefulness on the other. Hmmmm.....
  4. not commodities or any other asset class in particular, but so that inflation primarily, under its various measures / approximations (CPI, PCE, core & non-core) may remain within a 'reasonable' range YoY...

    as long as there are no material second-round inflationary effects observed, it doesn't matter if a particular asset class inflates... not all bubbles pop, besides no one is ever obliged to own assets in a particular asset class (not even RE, $s etc)... most assets can be loaned leased etc, for ppl who are worried their valuations may be excessive at a particular point in the 'cycle'...
  5. Tuneman


    well I didn't read that entire thing, but I wanted to take issue on the main posters point of a commodities price deteriorates with time.

    However this cant be true, or else there would be no reason for long term speculation.

    Or what about if we are running out of oil but our demand stays the same? we will see a rise in prices.

    Also, if a currency price goes down over time, that would mean another currency you are comparing it to goes up!

    So simply by logic this cant be true. Are you sure you interpreted the lecturer's points correctly?
  6. Oh yeah. It is supposedly an accepted concept in economics...that commodities decrease in price over time. I think they attribute this to the creation of acceptable substitutes, and the subtle pressure to keep prices on substitutes low because that is the only way you can sell them. I know what you are saying about the phenonenon of "running out" of something like oil, but the theory, (explained to me), is that as it gets scarcer, the industry will find new ways of doing things, like solar power.

    Hey, I have no idea if you can buy whale oil cheaper today than you could in the 1800s. I suspect not. I agree that this "accepted" idea doesn't seem right...