Exported Inflation

[Watchman]

What Is Money?
Part 13: Exported Inflation

If you think people are confused about monetary affairs inside the borders of the nation they live in, you should listen to their explanations of money outside the country, beginning with the idea of "money outside the country."

If you read the financial press, you will run across this phrase: "exported inflation." We never hear the terms "imported deflation" or "exported deflation."

Think about "exported inflation." Except for Keynesians, most people see general price inflation as a bad thing. How is it that the free market leads to a situation in which something that is bad for the entire world takes place, and the sole beneficiary is the United States? Why isn't a free market arrangement – international trade – beneficial for all parties?

My suggestion: let us look for something that is not free market or else stop talking about "exported inflation."

PAPER DOLLARS

If someone hires an illegal immigrant – referred to these days as an "undocumented resident alien" – and pays him in cash, the immigrant may send some of this currency back home. He inserts paper money into an envelope, addresses it, sticks a stamp on it, and mails it to someone living in a foreign country. Paper money leaves the United States.

The person who receives this paper money probably does not report this to the tax collectors in her country. If she deposited it, she would have to report it, so she does not deposit it. She may not even have a bank account. So, she spends it.

She can spend it locally because, in her country, the U.S. dollar functions as an alternative currency to the depreciating monopoly money printed by the socialist plutocrats or generals who run her country. All over the third world, paper U.S. dollars function as a shadow currency.

Question: Whenever an illegal immigrant mails money home, does he export America's inflation? Think about this. The answer is not intuitive. That is because fractional reserve banking is not intuitive. The function of currency in a fractional reserve banking system is not intuitive. It is counter-intuitive. What seems logical isn't.


To pay the immigrant, a consumer of "services with an accent" goes to an ATM and withdraws a few hundred dollars. He then pays the worker. Let us call the worker "Manuel." That's short for Manuel Labor [lahBOHR].

Manuel spends most of this money locally. He sends some of it back home.

Let us follow the money. Manuel spends some of it for rent to his "cousin," who rents him and seven other "cousins" two bedrooms. This rental arrangement is legal because it's all in the family. Zoning laws against renting do not apply to families.

The home-buying, mortgage-paying "cousin" spends this money locally. The money winds up in cash registers. At the end of the day, the businesses deposit this currency into their bank accounts. The paper money re-enters the fractional reserve banking system. The total money supply does not change for long.


In contrast, the money sent abroad is not re-deposited into the American banking system. It is not immediately deposited into the foreign banking system, either. It circulates as currency – untaxed, barely depreciating, and highly appreciated by recipients. The foreign spender wins, the foreign seller wins, and the tax collectors on both sides of the border lose. This is surely productive from the private citizens' point of view. So, the arrangement continues, decade after decade.

For every dollar in currency withdrawn from the U.S. banking system that is not redeposited by a local business, at least nine dollars disappear through the contraction of money inside the fractional reserve banking process. This outcome is deflationary with a vengeance. Think of it as burning money – digital money. The lower the reserve ratio for the local banks inside the United States, the more powerful the deflationary process.

A good mini-book on this process is Modern Money Mechanics. It was published by the Federal Reserve Bank of Chicago over 30 years ago.


Do not forget this: when currency is withdrawn and not redeposited, the digital money supply shrinks dramatically.

The "foreign nation" imports physical dollars. This really means that either Manuel's wife or his father spends extra dollars. The fall in the digital money supply in America is much greater than the increase of the physical money supply abroad.

The dollar's international value rises because the supply of digital dollars has decreased. It will cost foreign importers of American goods – agricultural goods, for example – more in their local currency. The paper dollars coming in may raise dollar-denominated black market prices a little. They have an even greater effect on imports from America. Because they shrink the supply of digital dollars in American banks, they raise the price of digital dollars. They raise import prices. Meanwhile, America has lower prices because of the shrinking of its digital money supply. This is exported inflation. Because of millions of decisions, made mainly by illegal immigrants, America has sent a lot of its inflated money supply abroad. But it has done so only because of a non-market institutional arrangement: a government-licensed fractional reserve banking system that is protected by a government-licensed monopoly over money, a central bank. America does not have a free market in money.

This has been a major factor in holding down prices in the United States. A huge amount of currency is involved. This has been true for a generation. The Federal Reserve Bank of St. Louis provides an up-to-date graph of this.

The figure is approaching one trillion dollars. As the Federal Reserve Bank of New York says, the majority of this money is held outside the United States.

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