Heavyweights Kohn,Volcker Spar Over Inflation Goal notes that:
Federal Reserve Vice Chairman Donald Kohn’s question-and-answer session at a Vanderbilt University conference Saturday was going as countless others surely have in his years as a top policy maker. … Until Paul Volcker raised his hand.”
Former Fed Chairman Volcker … questioned how the Fed can talk about both 2% inflation and price stability. … In the minutes of its January policy meeting, the Fed said … 2% inflation would be … price stability. “I don’t get it,” Volcker said … By setting 2% as an inflation objective, the Fed is “telling people in a generation they’re going to be losing half their purchasing power,” Volcker said. … Kohn responded that by aiming at 2%, “you have a little more room in nominal interest rates … to react to an adverse shock to the economy.” “Your problem is 2[%] becomes 3 becomes 4,” Kohn told Volcker. But other central banks with a roughly 2% target haven’t had that problem, Kohn said.
A friend observed that at least Volcker deserves credit here for somewhat favoring low inflation. I disagree. What the mainstreamers fail to realize is that even zero percent “targeted” (price) inflation is horrible. They do not get this. This is because they mean absolute price inflation in dollar terms. They don’t mean money-supply inflation. With a relatively fixed 100%-standard money supply (say, gold), prices would continually, gradually fall, to everyone’s benefit. Let’s say there would be 5% price deflation every year. Well, if you inflate the money supply at about 5% to achieve 0% price inflation, you are still taxing the populace at about 5%.
In other words, a 2% (price) inflation is thus really like 7%. So the danger is not only that it rises to 3 or 4 or 5%–which would really be 8 or 9 or 10%–it’s that there’s a hidden tax for this reason.
Moreover, not only is central-bank caused price inflation a redistribution of wealth–it’s a redistribution from the average and poor into the pockets of bankers and friends of the state. It is Robin Hood in reverse. It’s a regressive tax; yet the left is all in favor of this, since they do not favor a gold standard.
In addition to this wealth-redistribution, any central inflation of a fiat money supply gives rise to the business cycle, which destroys wealth overall; thus adding yet another overall tax to everyone. This is another tax–10%? 20%? Who knows.
And of course another problem with a targeted price inflation is that price stability itself isn’t even a well defined concept, and depends on an arbitrary (and ever-shifting) basket of prices; and it ignores the Austrian subjectivist approach to value, which shows that value is not only ordinal as opposed to cardinal, it’s not only interpersonally incomparable–it’s intertemporally incomparable even for the “same” individual (or to put it another way, me now is not the same as me later, since only me-now can make judgments in the present, and so on; and value is only coherent in terms of demonstrated preference).
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“He forgot that you can’t afford to tell people in advance that you are planning to cheat them. A government can’t plan a “gradual” increase in prices, be- cause if people \now that prices will be 3 per cent higher, say, next year, they will bid prices up nearly that much right away. If creditors \now that the purchasing power of the money they are asked to lend today is going to depreciate 3 per cent within a year, they will add 3 per cent to what- ever interest rate they would otherwise demand; so that instead of lending at 5 per cent, say, they will ask 8.”
-Hazlitt, “What You Should Know About Inflation”
For money lenders: Deflation = THE DEBIL!
The FED was created for the banksters after all…
The Austrian view of money implies that every central bank gets a free lunch when it issues paper money. Furthermore, every country would earn a further free lunch if its currency could circulate in foreign countries. International competition between various currencies would then continue until the value of each currency was forced down to the value of the assets backing that currency. Thus the value of each country’s money is equal to the value of the assets held by that country as backing, as implied by the real bills doctrine.
Mike,
I’ve seen a few of your posts here on Mises and I just want to ask you a question…
We know the Fed completely terminated the convertibility of the US dollar into gold in ’71. We also know that the Fed loves to run the printing presses, creating more US dollars in staggering amounts. The Fed’s supply of gold (the supposed backing), however, has definitely NOT been increasing with the amount of US currency in circulation. In fact, I’d bet with some diligent research one would discover the Fed has actually been selling it’s reserves!
Why then are you trying to advocate that the Fed still has the assets to back the ridiculous amounts of fiat currency they are sending out into the market (and yes, the US dollar is indeed a fiat currency)? I get the sense you understand that an un-backed currency is technically worthless (barring all intangibles like trust and confidence), so why do you think the US dollar is not traveling down the road of devaluation and consequently extreme inflation?
MB221
The dollar is backed not just by the fed’s gold, but also by the fed’s bonds. If the fed issues another dollar, while acquiring another dollar’s worth of bonds at the same time, then the fed’s assets move in step with its liabilities, and the dollar’s value is unchanged. On the other hand, if the fed issues a trillion dollars, while getting mortgages worth only 700 billion in exchange, then the loss of assets creates pressure for price inflation. However, it is possible that the fed started with sufficient net worth to cover the loss on its mortgage purchases, in which case price inflation might be avoided.
What a joke! In a perfect world there should be neither deflation nor inflation, i.e. no one gets a free ride from the money supply. But, by the same token, if everyone used gold coins then gold mining ought to be banned then as new finds are ‘found’ money, cause unexpected inflation and start a business cycle. Inflation has its winners and losers and so does deflation. Austrians-types must see the winners of deflation as the ‘good’ guys and the losers as the ‘bad’ guys.
Tell someone there can be falling prices and inflation at the same time to make their head spin.
Gil,
That’s right, in a perfect world there would be neither deflation nor inflation of the money supply, beyond a small amount from mining. There are few instances in history where a discovery of new gold and silver has caused a business cycle, although it has happened.
In an ideal world there would be price deflation – what is wrong with this reward to savers? You would rather any extra price deflation be eliminated through a central bank? Why does the gov’t or whoever gets to spend the new money get a free ride instead of the rightful owners of the money?
Mike,
So the fact that gold used to cost $35 an ounce and now costs $850 an ounce doesn’t conflict with your idea that the Federal Reserve’s actions are not inflationary?
Then what causes the massive inflation in prices of commodities when priced in dollars, but not in gold?
One major difference between Federal Reserve Note inflation and gold inflation is that no one is forced to use gold as money by his government.
Mike last year it was estimated that the fed lent out 20-50 trillion dollars.
Are we to assume that there is an equal amount of tangible capital goods out there? Consider inflation. Based off prices in 1913 how much tangible goods would the Fed have to own to equate to the amount of dollars lent last year.
Also, what are bonds backed by? What kind of tangible goods? How do owners of bonds get interest returns on their investment? Where does the money to repay a bond + interest come from?
I understand your theory. I’ve read your site. It’s filled with slippery slope concepts and the belief that a single organization, whether it be government or not, is responsible enough to manage such things. The assumption that we can escape the slippery slope problem with organizations who have no accountability.
Truth is no matter what you try to argue here about 5 minutes worth of googling will prove you wrong.
Gil, if such a motherload of gold existed that was large enough to cause a business cycle on the gold standard I imagine it would have been found. Also, if this is not yet the case then I think geologists will confirm that the odds of finding such a motherload is slim to none. Point being, its doubtful that minor influxes of gold will cause a business cycle. If a business cycle was caused on the gold standard its probably going to be much less frequently and much less harmful as people won’t have their manipulative hands in it.
Mike is advocating a more intelligent approach to Keynesian economics, or rather an approach that John Keynes would have advocated. I sincerely doubt even Keynes would have advocated creating bonds backed by junk securities — which is what we are doing now. He advocates if we print money that is backed by a sufficient security inflation will not be a problem.
I still hold that even if we had the most intelligent and benevolent Fed chairman ever that he could not calculate resources with the precision required to keep inflation at 0%; or better than that, create deflation through ‘super’ securities.
I can see that the real bills doctrine might hold true if we assume the backing indeed is well-done. But that has yet to be proven with the case of the Fed. Also, isn’t there the possibility that bonds’ price might go down, which would be the same as the feds holding mortgages? It doesn’t seem to me that the Feds would follow the real bills doctrine since it seems to have been discredited by the vast majority of economists (Although it is possible that they feel it prevents them to spend without worrying about the consequences). The Feds could be following the real bills doctrine unintentionally. But I find out hard to imagine.
Jeremy:
The real bills doctrine does not imply that the fed’s actions are not inflationary. It implies that inflation, when it happens, happens when the fed’s issue of money outruns its assets. This contrasts with the quantity theory, which says price inflation happens when the issue of money outruns the quantity of goods produced in the economy.
filc:
Most banks–even the fed–will normally only issue a dollar to someone who hands over a dollar’s worth of bonds, gold, etc. in exchange. When this occurs, the bank’s assets move in step with the issue of money, and money holds its value. When the bank fails to get adequate assets in return, the money loses value because of a loss of backing. This past year saw the fed’s outstanding liabilities rise from under 1 trillion to over 2 trillion. Maybe you are speaking of the total amount of bonds passing through the fed over the year, as opposed to the amount held at any given time.
Government bonds are backed by the government’s ability to collect taxes, just as corporate bonds are backed by the corporation’s earning ability. When the government’s tax revenue is inadequate, the bonds fall in value, and there is inflationary pressure.
Dewind:
I’ve never thought that keynes’ views on fiscal policy were valid, and as near as I can tell keynes was a quantity theorist. I don’t think he ever spoke favorably of the real bills view. I’ll admit I haven’t read much of keynes’ stuff, since the little bits I’ve read don’t inspire me to read more.
Nineteenth-century note-issuing bankers usually claimed that they lost money on the issue of paper currency, and that note issue was done as a form of advertising, in spite of the loss. This lends support to your idea that even the best fed chairman would cause inflation.
Gil
The issue isn’t gold, or that using gold would be a perfect solution. The issue is that “money” should be determined by the market, and not by edict or government controlled monopoly.
With gold, certainly price inflation could occasionally result — and it is possible someone tomorrow could discover a mine that instantly doubles the supply of gold, resulting in both money and price inflation. This could even result in a different commodity taking superiority for a time.
However, I will take those chances against the current system. This system is so blatantly and obviously used to tax the population in a hidden way for the benefit of a few. It is evil at its core. Imagine, you are trading your daily labor for something that can be debased without any effort — in other words, the current system implicitly makes your labor worthless. Additionally, it is a system that rewards spending and penalizes savings — completely perverse.
At least that historic gold strike will take some effort and work (and by the way, hasn’t happened very often in recorded history).
Letting the market determine currency at least gives me a fighting chance.
Gil,
Supposing that prices are functioning, any winners or losers from inflation or deflation (defined as a change in the price level) are deserving. Prices are like signals. Sometimes these signals take on various characteristics when taken together, but these characteristics are not important: they are epiphenomena. What is important is what is whether or not prices are effectively allocating resources.
I might be nitpicking here, but…
“Moreover, not only is central-bank caused price inflation a redistribution of wealth–it’s a redistribution from the average and poor into the pockets of bankers and friends of the state. It is Robin Hood in reverse. It’s a regressive tax; yet the left is all in favor of this, since they do not favor a gold standard.”
This isn’t entirely true. Yes, wages (which aren’t much unlike to futures contracts) are quite affected by price inflation, which favors many businesses. But when it comes down to political incentives (i.e. votes), the average and poor do gain something. Price inflation is caused by monetary inflation, so let’s mention the expansion of credit and welfare, both of which get fueled by taxation through inflation.
It is unfair to mention just one side of the story. This is one of those things where you can’t avoid being non-popular.
The problem with RBD and Keynesian mainstream economics is that they confuse money and capital/credit.
Like many goods, capital and credit is priced in money terms. But they are not the same thing.
A business may need 100 millon dollars in credit, to use as capital for an investment, lets say building a hotel. But this doesnt mean the business needs 100 millions of dollars of money. This demand for capital/credit is not demand for money.
In fact what that business need is the resources that is needed to complete the hotel. The labor, and other resources that go into the completion of the hotel such as steel, glass, marbles, elevators, etc.
The business takes the credit in money terms, because it knows that money represent those real goods that go into the production of the hotel. The business would be just as satisfied if the lender would lend him not the money but the resources, but then it would be hard to calculate the interest so money prices are used for capital/credit.
This means money prices in capital/credit is only meaningful if it represents the real capital goods, and labor in the market. And increasing the supply of money is not the same thing as increasing the supply of capital/credit.
Just wondering – I’ve read that Arthur Burns famously said something like: “If we don’t give the politicians the monetary policy they want, we could lose our independece”.
Did he really say that or is it a false quote? Thanks.
MB221 and others, it is important to remember that when Mike Sproul talks about “Real Bills Doctrine”, he is not talking about, well, Real Bills Doctrine but about something else that he chooses to call that. In particular, he accepts backing by government bonds.
Now, the Mike Sproul system is internally consistent, but that backing is not being done by Real Bills, which are defined as paper issued on the back of work in progress or goods that are “real”, meaning they will come to market in short order and that there is a sound market for them to come to, with the bills matching that value, so the bills always have something waiting to catch them, as it were. If the music stopped when the goods came through and no new production got under way, all would be well – the circle would be closed. In practice, new production keeps going and the currency keeps being rolled over – but something always stands ready to catch it if anything goes wrong. That means Mike Sproul is quite wrong to write “The real bills doctrine does not imply that the fed’s actions are not inflationary. It implies that inflation, when it happens, happens when the fed’s issue of money outruns its assets. This contrasts with the quantity theory, which says price inflation happens when the issue of money outruns the quantity of goods produced in the economy.” Genuine Real Bills Doctrine does imply that last sentence of his; it’s actually equivalent, apart from quantity theory not requiring a solid connection between the cash generation and the goods. That is, the quantity theory also works out the same even when fiat money or whatever is in use, provided only it is made to track the levels and values that Real Bills would produce. The contrast is only with the Mike Sproul system, not with genuine Real Bills Doctrine.
Now, the only thing wrong with genuine Real Bills Doctrine – a very serious thing – is the tendency to make wrong estimates about what is “real” in that sense, so the system leaks by allowing gaps to build up. It’s rather like having a Balance Sheet with things on it valued on estimates rather than by a mark to market rule.
But Mike Sproul takes that leaking even further, and even makes it part of his system; he deliberately and inaccurately calls those financial instruments “real”. To be sure, they can and do back a currency, sort of, but look at how. Eventually the only value for things like government bonds comes from the cash paid out on them. It is circular, and provides no support in itself. The whole thing only works to the extent that the currency is being supported in a Chartalist way, by the government imposing taxes and then being willing to accept the currency in payment (as he admits), or by some hidden component like bullion or genuine Real Bills. The “backing”, then, is just another layer which confuses the unwary, although it does have a sort of shock absorber effect. But it can no more carry the currency than a car’s shock absorbers can carry the car in mid air; there has to be something underneath them connecting with the road. And you would get just the same fundamental support even if that “backing” weren’t involved; for our purposes it’s just a red herring, and we might as well treat the whole thing as just another fiat currency backed by government force in the form of taxes.
The thing is, when genuine Real Bills are issued, the linking process that should make them real (but which is unreliable) would automatically ensure that wealth gets created to match. But when the government does something under the Mike Sproul system, the most it can do is jack up taxes to match – diverting wealth towards it, not creating wealth to head off the price inflation that would ensue from just printing money.
Excellent post… as always.
One question about your analysis though. Under a true Au standard, miners would still have an incentive to extract more of the metal from the mines. As the supply of Au increases, some of the deflation would be offset just as increasing the fiat supply would. Do you consider an increase in the supply of Au to be an inflationary tax under the Au standard.
*Note: I know that the tone sounds a bit argumentative but that was unintentional. Just looking for clarification.
kinsella says:
“In addition to this wealth-redistribution, any central inflation of a fiat money supply gives rise to the business cycle…”
i disagree that fiat money creation necessarily generates the business cycle. were fiat money used to pay for government expenses, then only (covert) redistribution would occur. (in other words, counterfeiting is parasitic but not destabilizing). only when the fractional reserve banking system is the conduit for the inflation does the boom/bust business cycle occur. bill barnett goes over this in this podcast:
http://media.mises.org/mp3/interviews/Interview-11-20-2005.mp3
PM Lawrence:
The RBD has been around long enough to have been stated in many different ways. What you call the ‘genuine’ RBD is more a creation of RBD critics than of its advocates, but of course even the RBD advocates have often stated it in illogical ways.
It sometimes helps to restate my version of the RBD as the ‘backing theory’: The value of currency issued by some institution is equal to the value of the assets that institution holds as backing for its currency.
As you observe, those assets need not be ‘real’. They only need to have value. That means assets can include government bonds, future taxes receivable, corporate bonds, land, lottery tickets, etc.
Example:
Suppose a landowner buys a loaf of bread by handing the grocer his IOU, which promises to pay 1 oz. of silver. The grocer accepts that IOU because he knows the baker will accept it. The baker accepts it because the miller will accept it, who accepts it because the farmer will accept it, who accepts it because he rents land from the landowner, and the landowner will accept it in payment of rent. These IOU’s could circulate widely without ever being redeemed in actual silver. They just get retired every time someone pays rent with them. The IOU’s will hold their value as long as the landowner’s property is sufficient to back the IOU’s.
Replace ‘landowner’ with ‘government’, and ‘rent’ with ‘taxes’, and you have reasonable description of how our system of so-called ‘fiat money’ works.
I think there’s a misconception about gold in the hard-money community. Gold supplies are constantly increasing, it is being mined every day, the current production is about 400 tons a year. Some of that gold goes towards jewelry and trinkets of course, but you can’t attribute that all of it does, some of it is coined and some of it goes into the vaults of central banks in the form of bullion.
There is however a cost of mining, which puts a natural dampening effect on “inflation” of gold. (Price of gold rises, more is mined; price falls, less or even nothing is mined.)
If you were to believe that the supply of monetary gold is constant, then as economic production of all sorts of goods expands over the millenia, the price of let’s say a loaf of bread would be MUCH cheaper today than it was 2000 years ago. But actually, one ounce of gold buys about 370 loaves of bread today, as it did about 2000 years ago.
So it seems to me that gold is the ultimate currency of “price stability” and NOT of “money supply stability”.
Inherent in this description is the assumed claim by the government upon every bit of property and productivity within the economy by way of confiscation (taxes).
Government fiat money precludes private property.
It would be a very interesting thing to see in a truly free market with free banking, no Fed and legal tender laws, competition between issuers of fiat currency based on Mike’s ideas and minters of gold and silver coin.
Perhaps without government’s ultimate backing of force as a ‘lender of last resort’ such a currency might rein in the inflationary trend of the existing monopoly.
Objections can still be raised on the grounds of 100% vs fractional reserve banking, fraud and the actual backing of the coin, though.
Any thoughts?
Jason:
Government ‘fiat’ money only requires that the government has a claim on enough private property to back the money it has issued. Whether the government has a legitimate claim to that property is a separate issue. Money issued by pirates could be valued just the same as money issued by a church. The important thing to recognize is that there is no such thing as fiat money, where I interpret ‘fiat’ to mean ‘unbacked’.
Marco:
The US Free Banking era, from 1836-1861, was a pretty good approximation of what you describe. Private banks issued paper money–some good, some bad. Almost all banks chose fractional reserves. Critics of the period like to say that there were 8000 different kinds of paper money circulating in the country, and they claim it led to all kinds of chaos. They neglect to mention that there were about 5000 towns in the country, and the paper money of each town was generally issued by a handful of local banks.
Well.. the first (possibly irrelevent) thing to point out is that if we’re to honestly represent ourselves as believers in subjective value, we cannot in good conscience dismiss bonds as valueless. For as long as there exist people who derive a percieved and subjective benefit from them, they represent value.
The gold standard as “ideal” seems to be largely incidental. It is superior to fiat currency only in that in addition to its subjective “money” value, it has some intrinsic value as a factor of production. Fiat currency, generally speaking, does not. This does not make it valueless.
It does, however, make the cost of creating new money significantly lower… converging on completely insignificant as money becomes increasingly represented simply electronically.
Lowering the cost of creating money makes it an ever-more appealing “short term” patch.
But these points are not vital to the discussion.
What is vital is that inflation can happen in a variety of ways. I think Mike’s description is accurate of what really does happen. For as long as people believe in the value of the assets held by the Fed, the currency will have value. Once those “IOUs” are called, though, the problems become manifest.
The description just doesn’t carry things out far enough is all. Dollar represents bond, but what does bond represent? future tax income? What does that represent? future resource reassignment from productive sources. So… as more money is printed, more bonds are needed, which means more needs to be taken from the most productive arms of the economy, which means increasing disincentive to produce…which means that at the time that the currency actually does have to be backed by assets, you will kick off a downward spiral of wealth and productivity destruction.
That’s the problem. The theory inherently removes the accountability of the monetary unit to the economy’s output and places it on less-stable ground– a government balance sheet. Governments are accountable to peoples’ words; economies are accountable to their actions. The comparison to IOUs is apt — it’s just another “credit” bubble taking its jolly good time in forming.
It has to do with physics – entropy. Backing a currency with anything other than a very stable element is pointless. “Assets” cost money to maintain their inherent marketability. The cost of maintaining a currency that was backed by IOUs of things that aren’t intrinsically stable would be folly. Mining an element has a cost, but think of the costs you incur in just maintaining a home. Forget it. These are recurring. Once you have gold or silver in a vault someplace, you’re set. It ain’t changing!
Newson:
I think you may be right. I stand corrected.
@Mike:
Since all value is arguably subjective, I think the assertion that ‘backed’ currency not really being fiat currency (with the corresponding piggybacking suspicion) is flawed.
Personally, I find the term ‘fiat’ highly appropriate, because the face value is asserted by ‘someone’ (in case the Federal Reserve or perhaps Treasury) ‘saying it is so’ with no auditable regard to the ephemeral and dubiously amorphous series of things the State could argue ‘backs’ a Federal Reserve Note.
Perhaps if say HR 1207 Passes and the Fed has to reveal the money supply’s guts, that would be remedied.
Is a FRN not ultimately under this logic just as despicable a beast as a Collateralized Debt Obligation?
“This is because they mean absolute price inflation in dollar terms. They don’t mean money-supply inflation.”
Bam! Inflation is an increase in the supply of money; the resulting rise in price is not inflation, but the result of inflation. If this fact is not hammered home to the masses, they will willingly (and sheepishly) accept the further depreciation of their earnings. If we can drive this important point home, it will draw the ire of the masses when the government or some talking-head begins to discuss more stimulus and bailouts; the people will be empowered to see it for what it is and know exactly what the end will look like.
if such a motherload of gold existed that was large enough to cause a business cycle on the gold standard I imagine it would have been found. Also, if this is not yet the case then I think geologists will confirm that the odds of finding such a motherload is slim to none. Point being, its doubtful that minor influxes of gold will cause a business cycle. If a business cycle was caused on the gold standard its probably going to be much less frequently and much less harmful as people won’t have their manipulative hands in it.
Actually, technology could make gold mining much cheaper — I have a few ideas how this could happen and I’d even expect this to happen eventually. However, keep in mind that similar
technology would make many other things cheaper also…
Boy oh boy would I love to be able to question a Fed economist!
Me: Economics is a Science is that correct?
Fed: Why Yes, of course.
Me: And in order for a scientist to conduct scientific study, he must take accurate measurements, correct?
Fed: Yes.
Me: What do you measure?
Fed:Value. Worth.
Me: What do you measure with? What is the unit of value?
Fed: Uh, The Dollar!
Me: What’s it worth? What will it be worth tomorrow? Next Year?
Fed: I don’t know, It changes over time.
Me: How do you know it changes?
Fed: Because the prices for things vary from day to day.
Me: Then why do you conduct science with a measure that is unstable? Why don’t you use gold for instance?
Fed: Because there isn’t enough gold for an economy as large as ours, for one.
Me: I see you are wearing a gold ring. There seems to be at least enough to go around for that. What’s it worth?
Fed: It’s priceless.
Me: You mean it’s worthless?
Fed: No. It’s priceless. It’s my wedding ring.
Me: Will it still be “priceless” tomorrow? The next day?
Fed: Yes, of course.
Me: Then why don’t you measure with that?
Let Me at em! I’ll moyda da bums! It would be sooooo much fun to philosophically disassemble their logic, measurement, value, trust. I know I could turn any one of them on their heads just by concentrating on the fundamentals of value, trust, and measurement. That is the Achillies Heal of Keynesian Econ.
Keynesians can be destroyed in any argument, because their “Science” says one thing, but they themselves, personally, will say the opposite. Keep this truth in mind when engaging them. Take the argument back to their own personal experience of the world, their reality, and they must argue in your favor, as an objective observer and participant in the same reality. Go to the fundamentals of measurement, value, and trust. Make the scenario under dispute, personal, and they fall like so many tin soldiers.
Keyne’s theory is the theory of a gaffe. A ruse. It’s the workings of an Illusionist. It’s the secret behind a cup and ball trick. When arguing with them, don’t assume they have a ball in a cup! Don’t assume the deck is not shaved, or the dice are fair. Prove the gaffe! Pull the rug out from the very start. All the other arguments they make depend on YOUR assumption of initial conditions. Establish a common stable measure. Make it personal.
Gold is the measure, even if you only have a half ounce in a ring.
Personal feelings, Personal value, Personal evaluation, can only be measured by comparison to a stable standard of value. You MUST always measure the unknown, the potential, the probability against a stable, real, actuality, or you only have a guess, not a measurement.
Dollars, Euros, Yen etc. are not measures. They are Ordinal Placeholders, like the numbers on a tape measure. They are NOT the tape itself! The measurement of them is in the price of a thing of real value. The price does not measure the thing, the thing measures the MONEY. This is what “priceless” means. It is when the money can’t measure up to the actual subjective value.
Subjectives must be measured by Objective comparison. Comparing subjectives to subjectives and getting a result does NOT make the result Objective. So comparing a Subjective value currency, to the Subjective Personal value, yields a Subjective measurement, which is not objective.
Know the difference between Future and Past. Future is probabilistic. Past is actual.
Future is measured statistically. Past is measured Objectively.
Debt is in the future. A job done is in the past. Only the job done has Objective Value. Debt is still not done, and so is a probability.
Material is Actual and therefore Objective. Future material is unknown, and so is Probabilistic.
Stick to your fundamentals, and there is no valid argument from the Keynesians on damn near anything!
Remember that Trust can only be given. It cannot be “Legalized” or “Decreed”. Trust is gained or lost through objective evaluation over time, compared to your personal experience. Only Objectives that are consistent can be trusted holders of value. You can only trust the measurements of Objectives.
If they show you a chart, convert the values on that chart to gold. Use the market spot price. If the chart is over time, convert each daily value to the spot price of gold that day. Bubbles suddenly expand before your eyes! The true measure of the chart will be revealed. Don’t worry about the variance in the “market”. The Market is a superposition of subjective value. It is much closer to you and your reality than a pretend measurement like the dollar. Trust the market price as a true reflection of perceived value, and then measure the money against that!
Keynesian arguments always stand in a canoe of subjective-subjective measurement. All you have to do to win the argument is tip the canoe from the firmament of the objective ground you stand on.
I’ve seen this argument floating around that there is no such thing as “fiat” money and the US dollar is backed by assets because the dollar represents those assets.
I think it’s just trying to argue semantics. There is commodity money (for example gold coins), fiduciary money (paper dollars redeemable by gold coins), and fiat (paper dollars, no gold coins).
The dollars in the US are indeed unbacked and completely fiat. But that isn’t to say the dollars don’t represent something. They do; they always do. $3 will get you a loaf of bread in this country. Does that mean our currency is backed by bread? No, it just means that $3 represents the price of a loaf of bread. It is the confidence and trust in those dollars that they are able to buy that bread. Print enough of them and no one will trust in them any longer; the value of the paper dollars will be destroyed. However, the bread the dollars represented will still has value.
Your example of the “landowner” and “silver” is an example of a fiduciary money system. The â€Real Bills Doctrine†is of the same concept from what I gather, but instead of choosing a commodity to back the currency, it believes anything can be purchased as an asset. Even something that can be produced in mass amount with little to no work, like bonds.
At any point during those landowner / silver transactions the paper dollar could be redeemed in silver. The fact that silver cannot be fabricated is the key. A bond is not an asset in the same way precious metals or land are assets. A government can print up a billion dollars worth of bond IOUs and the fed can then print up a billion dollar money IOUs.
That new money will then circulate through the economy causing a rise in prices. “Backed” by bonds or not, the quantity of money has increased, thus devaluing the money already in existence. Now take a snapshot of the economy. The new money issued by the Fed represents the same goods and services, though they are now at a higher price. All dollars are accounted for; all dollars represent something in the economy. Where a house cost $100k before, it is now $150k. That $3 loaf of bread might now be $5.
What I’m not seeing is how the “Real Bills Doctrine†addresses value. I get the impression it assumes value is calculated by the market and the only time inflation occurs is when the Fed “overpays†for something. But it doesn’t seem to take into consideration the quantity of money plays a central role in the value of “assetsâ€.
If a central bank is issuing currency based on the price of a fluctuating asset, they will never get the ratio correct. And even if they “underpay†for an item, they are still creating new money which is inflation and does devalue the currency. As they issue more currency to buy the same assets each time around, that act will drive up the cost of the assets, so they’ll need to create more money to buy the same assets the next time around, which will drive up the costs of the assets, and on and on.
The point is fiat currency obtains its value based on trust. It has no direct link to the good it represents other than a central bank or government saying “this money will be used as a medium for exchangeâ€. This is in contrast to a commodity based currency in which the medium of exchange in itself has value.
Kevek:
For the US dollar to be a true ‘fiat’ money, the Fed would have to hold no assets. That is not the case for the fed, or for any other central bank. If money can have value even when the issuing institution have no assets, then where are such institutions?
People who believe the dollar is fiat money are confusing ‘unbacked’ with ‘inconvertible’. The US dollar is physically inconvertible, meaning that the fed will not buy it back with gold. Even in gold standard days, every gold-convertible note became inconvertible every weekend when the bank closed, but nobody called those notes fiat money, because they knew the gold and other assets were still there in the vault of the issuing bank. Many central banks have suspended convertibility for years instead of days, and people started calling the money “fiat money”–until convertibility was restored a few years later. Note that convertibility could not have been restored if the bank held no assets.
Fiat money is currency by decree, whose value is set by decree (Fed Funds, open market operations, etc), and unredeemable. You’re saying the dollar is backed by the assets the Fed holds. But what you are considering to be assets, aren’t necessarily assets. Like I mentioned before, the government can print up a bunch of IOUs which the Fed can buy and call them “assets”. Paper IOUs paying for paper IOUs. There is no real value there, no backing.
Let’s go to the dictionary:
Fiat money – irredeemable paper currency, not resting on a specie basis, but deriving its purchasing power from the declaratory fiat of the government issuing it.
Unlike commodity based money, in which the commodity money actually has value, paper fiat money has no value and the reason it is being used is because the government says that’s what we use.
How does the real bills doctrine explain something like hyper-inflation?
The problem I have with the cursory analysis in this blog post is the imprecision. What’s the explicit model? Where are the numbers? Where’s the evidence?
Economics is not about accounting identities. It’s about science and science must be empirical.
Okay, some statements of the obvious here:
1.) The dollar is fiat, because the government decrees that dollars are legal tender all debts public and private. Judgements, wages, etc. all have to be monetized if the person owed requests it. Also, the use of private currencies in the public domain is illegal in most circumstances.
2.) Inflation can occur for reasons other than changes in the Fed’s balance sheet, such as relative commodity shortages or reductions of productive efficiency if the money supply remains constant.
3.) Gold or other commodity standards don’t work. Politicians can and have either diluted the redemption rate for gold or have simply scrapped gold standards altogether when it suited their interests.
4.) Economic bubbles are a natural feature of free markets. This is because almost everyone has an incentive to create them and feed them. Bankers and insurance companies love them because they increase profits and bonuses. Stock and Bondholders love them, because they earn capital appreciation. Consumers love them because jobs become more plentiful, sometimes with higher wages and looser credit, politicians love them because they get credit for what seems like a great economy, and retaliers, service providers, and manufacturers love bubbles, because they increase consumption of their products and services.
Even in the case of competing private currencies with transparent disclosure from issuing institutions, speculators looking for arbitrage opportunities would deive up demand for currencies, leading to self-feeding, hyper-valuations, and hence an expanded money supply and lower interest rates to further fuel the bubble. Consumers would want the most bubbliscious currencies for their deposits, as they stand to realize currency appreciation. Then, either there’s inflation due to the increased consumption outstripping the deflation of prices due to monetary appreciation or deflation that could begin to suppress demand (consumers wait to see if they can get it cheaper later and this can spiral), which can cause retialers, commerical real estate owners, and manufacturers and service providers to begin defaulting on loans, which could bring the whole system down.
Mike Sandifer:
If you want evidence, see the works of Smith, Sargent, Calomiris, Siklos, and Bomberger & Makinen, which are all cited in my paper entitled “There’s No Such Thing as Fiat Money”, which you can find by clicking my name above.
Legal tender laws were in effect during the hyperinflations of the Continental dollar and the Assignats. They were ineffective then, as now.
On private currencies: Have you ever bought goods using a gift certificate?
MIke Sproul,
Your comments demonstrate a lack of understanding of money and monetary policy. For example, you posted, “On private currencies: Have you ever bought goods using a gift certificate?”
Well, gift certificates are denominated in dollars, in case you didn’t notice. They are bought with dollars and usually are exchanged for items priced in dollars. Dollar inflation or deflation would affect the purchasing power of those gift certificates.
And how can you say the dollar isn’t fiat when issuing competing currencies for general, economy-wide public exchange is illegal? Also, court judgements must be monetized in dollars if requested by a successful plaintiff in a lawsuit. Before I look up the references of someone who hasn’t demonstrated an understanding of the nature of money, why not answer that question?
Here’s a question: What if, for the last 97 years, we’ve used our two big tools of monetary regulation — namely, the FED and the IRS — backwards…and no one realizes it?
Imagine looking at this whole economy from above, let’s put focus on the four main points of “money” — creation, recirculation, and collection, and destruction.
First…instead of looking at the economic cycle as a 2-D closed circle, imagine it instead as a COIL, spiraling through time. From where we’ve been visualizing it before, IT APPEARS like a closed circle, but NOW imagining it from 3-D spatial, it looks like a SLKINY… where some of the sections are larger, and some smaller.
Hold on…have to go for the moment…be back soon
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