Friday, November 14, 2008

They Better Start Teaching Say's Law

Don Surber fields a question about college tuition (via Instapundit):
Question: What fuels college tuition inflation?

Answer: Student loans. From the Chronicle for Higher Education: “The volume of private loans shrank by $173-million, or about 1 percent, to $19.1-billion in 2007-8. That decline reverses years of double-digit growth and does not reflect the recent credit crunch. At the same time, the volume of federal loans rose by 6 percent after inflation.”

You have a volatile mix: Inexperienced borrowers, federally guaranteed lenders and the biggest sharks in capitalism: College presidents. Hence, the double-digit inflation in price.

Say's Law, simply stated, is that supply creates demand. This is why printing money, like the Fed is doing, usually causes inflation: the supply of dollars is larger after the printing but the supply of stuff is not, so the demand for stuff gradually becomes denominated in larger and larger quantities of dollars—prices rise, inflation. But, we have deflation right now, why's that?

The rise in M2 is not as pronounced as what's happened to M0, so the really big measures of our money supply have not moved much. I'm curious what M3 would've shown had it not been discontinued. I think it may have warned of the impending financial mess because, as wikipedia tells us, it includes "institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets." Money-market funds started breaking the buck this past September, so I suspect that M3 data may have indicated the coming storm earlier in the year as it started to decline (well, that's what I think it would've been doing).

Getting back to Say's Law, you have to ask yourself: what is money? The text book answer is that it is a medium of exchange. The greenbacks in your wallet are money. If you've ever rented a car, you've probably learned that credit cards are a better form of money for that transaction. If you've bought a house, then you've learned that reams of legal sized paper signed by several people in triplicate are money.

And why is college tuition going up? Our government, indeed the American people at large based on bond and ballot initiative results, have never seen an educational expense that they do not want. So the supply of money, especially in the form of student loans, for college tuition keeps going up. Many more dollars chasing a few more slots for students, the market clears, inflation.

No comments: