So I was thinking about Steven Landsburg’s argument (from Chapter 7 of the Armchair Economist) that Burning a dollar bill decreases the price level and helps everyone who holds money except the one who’s bill was burned. I’m not sure I agree.
A) I first wanted to claim that when the value of all other non-burned dollars become more valuable the relative usable value to dollar holders doesn’t increase as much as the $1 decrease the burner experienced. Allow me to explain. There are plenty of dollars that still have value but that no-one holds. These are the “lost” dollars of the world. Waiting to be found, similar to the dollar that Landsburg says “would be as good as burned” if he let it blow away. In all reality it isn’t burned. It still holds $1 worth of value to the lucky soul who finds it. If you imagine that scattered throughout this orb we inhabit there are thousands if not millions of dollars “lost” to potential dollar holders. Every-time a dollar is burned, the relative value of these dollars all increase, and the relative value of usable held dollars in the world has decreased. Thus the value to SOCIETY has actually decreased not remained the same.
B) Second why would everyone else’s value increase really? To the world this dollar has just been saved byLandsburg, to be spent another day. The world expects it to still have value, the same as the world has expectations of a probable expected future use for all the “lost” bills I mentioned in part A). Thus the price level will not decrease to the extent Landsburg claims. Thus the world is “worse” off by the burning of a dollar. Unless of course it is broadcast to the world so that everyone would know that it had really been destroyed. But in that case we have to think if the opportunity cost of broadcasting to the world the burning of a dollar bill outweighs the value to the world of watching.
Constrained Optimization 
January 25, 2007 at 6:31 pm |
Money that does not circulate does not contribute to the price level. Its velocity is zero.
January 26, 2007 at 12:39 am |
Money that does not circulate is effectively increasing its scarcity, which increases its value.
January 26, 2007 at 9:49 am |
I would argue that “lost” money is still in circulation and still has a velocity. The velocity is just extremely low. If it is used once in a thousand years that is a velocity. If it has a probability of being found this year and spent then there is an expected amount of velocity of the bill thus it can be expected to contribute to the price level. A burned dollar has 0 expected and 0 real value and velocity. (though it does have a physical velocity as the ashes blow in the wind or fall to the ground. accelerating actually at about 9.8 m/s^2 toward the earth, assuming no air resistance
January 26, 2007 at 10:07 am |
Money contributes to the price level only when it is spent, not when it is held.
January 26, 2007 at 10:48 am |
Scrooge McDuck believes that gold eating weevills are on the loose and he seals off his vault. Those who now hold gold essentially own a much scarcer resource. The relative price has increased because the supply has decreased.
January 26, 2007 at 12:54 pm |
MV the “lost” dollars still make up part of M while not in a freeze frame of this instant adding to velocity, by the same argument all the money in my wallet and bank account are not being spent, If you only looked at the freeze frame dollars being spent the money supply decreases drastically, If you are looking at cash you have to put all cash in the M, even the M that is in my grandma’s mattress as it still has value
January 26, 2007 at 3:48 pm |
No one is saying that lost money is not valuable to the person who finds it. We are saying that it does not contribute to the price level while it is lost.
Let’s say the entire monetary base consists of one dollar bills. Let’s say further that we track how many times each bill is spent in a year (or any other period). For each bill, the velocity equals the number of times that it is spent and we can call that v. MV is the sum of all the little mv’s. Since all m=1, MV is the sum of all the little v’s. Therefore, money that is not spent (v=0) does not contribute to the price level in that year. We can generalize this to say that if a dollar bill is lost, it does not contribute to the price level unless and until it is found and spent.
January 26, 2007 at 3:59 pm |
How would you calculate the velocity of lost money. It’s a moot argument, and fact is that losing hiding or burning money causes deflation because it will lower spending, while spending it causes inflation.
Work all your life, spend nothing, and then burn all the money you’ve earned. You’ll have done the best you can do for your fellow humans. Unless ofcourse you think you know some people who have better use for it than the masses who’ll only get 0.000000001% increase in value.
January 26, 2007 at 4:57 pm |
10 trillion pounds of gold are found, the price of gold decreases. All gold but one ounce is shot into the sun, the price of that one ounce increases.
January 27, 2007 at 2:33 pm |
Lets take the situation of 10 trillion pounds of gold being discovered and being under the gold standard. And lets say that this person holds onto it. I would expect the price to change regardless of whether or not this person spends the gold, wouldn’t you. The knowledge of more gold in the world affects the price. M has gone up whether or not the gold is in ACTIVE circulation. People adjust their expectations and willingness to pay, accept, etc. based on how much gold they know to be around. I agree that once the gold entires active service the price will probably adjust the rest of the way, but i think just the expectation of future use of that gold will move the price as well.
January 27, 2007 at 3:21 pm |
Unlikely, but maybe, given your assumptions. However, note that you are entirely refuting your earlier argument. When you say that the gold will affect the price level after it is found, you are also saying that it will not affect the price level while it is lost. After all, the gold was there all along.
I think appealing to expectations doesn’t make much sense because very few people have any sense of how big the monetary base is. We have no expectations about it at all. Without looking it up online, could you tell me how big it is?
So, by making an unrealistic assumption to try to salvage your argument, you have completely refuted it. Say uncle!
January 27, 2007 at 3:51 pm |
There is no fundamental difference between the forms that money takes; whether it be green paper or yellow metal. Scarcity increases purchasing power. Reduce it to the level of barter if you must. If your oranges are the ones that escaped the frost, you are better off because every other farmer in California lost.
January 27, 2007 at 7:45 pm |
No my whole point is that if you vaporized the gold it ceases to add anything to price. just because the gold isn’t in criculation doesn’t mean it ads nothing. To relate to earlier if you “lose” the money it still has an impact on society “lost” money isn’t the same as burned has been my whole point all along. and because of this if you were to vaporize a gold nugget in circulation, you are increasing the relative strength of gold out of circulation and weaking the realtive strength of gold in circulation. regardless of the form of money in circulation, destroying part of the money in circulation weakens all the rest of the money in circulation Relative to the “lost” money out of circulation. The value of spendable money has gone down relative to the value of lost money. I’ll say uncle if i refute myself, I have not
January 27, 2007 at 8:02 pm |
Lets have an example, my last post upon rereading looks kind of ramblely. Lets say there is 100 dollars in circulation and 100 lost dollars. Now lets say that there is a 2% chance that it will be found and spent this year. the EXPECTED money supply is $102 which is used in the MV, thus the 100 lost dollars has the potential to affect price as much as the money in circulation but because it is lost, people expect it to have only a small effect.
Now lets say that someone actually finds the lost money, and announces it to the world. People will update their expectations and think of expected money supply being 200 dollars. A much bigger impact in circulation than it had out of circulation.
Or we could think of someone finding the money but nottelling anyone about it. The rest of the world still expects only 102 dollars, but only gradually as the finder spends the money will the world realize that the money has been found. E(>102)
Now lets look and Landsburg’s burning a dollar. 100 in circulation 100 lost. Holding a bill people will believe it is 1 out of an expected 102 bills that make up the money supply. by burning the dollar the exected money supply drops to 101 dollars. the lost money is still adding a 2 dollars to the expected money supply while true circulation is adding 99. The price increase caused by expectation of possible inflation from finding the money has gone up. The value to the world of that actually money in circulation makes up is now only 99/101 instead of 100/102 it has gone up, but not as much as the expected value of “lost money” that has gone from making up only 2/102 to 2/101. Money in circulation makes up a relatively smaller portion of total value than does “lost money”.
January 28, 2007 at 12:47 am |
Going back to the gold example, let’s look at a before and after. Before the gold is discovered, there is some price level, P1. After the gold is discovered, you are arguing that there is a price level P2. The gold was there all along, and since P1 is not equal to P2, that means that the gold that had been lost did not affect the price level until it wasn’t lost any more. I still think you are refuting your own argument here.
Trying another tack: let’s examine how prices are set in real life. They are set by someone calculating what the money supply is and then figuring out what fraction is spent on their commodity. NOT. They are really set by someone setting a starting price, seeing how much of the commodity they sell, and making adjustments. Prices go up when merchants see their product flying off the shelves. They go down when their product is sitting on the shelves. Only money that circulates, by definition, can contribute to the purchase of the products. Therefore, it is only spent money, not the stock of money, that affects prices.
January 28, 2007 at 1:31 pm |
Pamela, I still love you! NOT!
January 28, 2007 at 6:11 pm |
P1 is is a price level affected by the expected lost money being found. P2 is after the amount found is realized. thus “lost” gold affects before its found and after. I’m still not certain how I have refuted myself.
January 28, 2007 at 7:11 pm |
You have worn me down. I refuse to argue with you further about this.
March 24, 2008 at 5:57 am |
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Jane.
October 27, 2008 at 5:15 am |
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Burning Money | Constrained Optimization
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