What If Governments Had Not Destroyed Money?
Had the gold standard been upheld, world economies had been spared many of the severe fiat-money-induced economic, social and political crises experienced seen in the latest decades, from which resulted the growing disenchantment with the idea of a free market order. A good first step forward: stopping any increase in the money supply. FULL ARTICLE
Comments (38)
Mike Sproul
Would you favor prohibiting stores from issuing gift certificates? Would you prohibit Americans from trading with pounds and pesos if they wanted? Would you prohibit shopkeepers from selling goods on credit, and then using their customers' IOU's to buy supplies? I'm always amazed that people who consider themselves libertarians would favor schemes like freezing the total amount of "money" (however defined) and requiring 100% reserves.
This paper accepts the quantity theory of money without question, and fails to even consider the real bills doctrine. From that point its errors multiply too quickly to count.
Published: July 21, 2006 9:28 AM
Roger M
Very informative! Thanks! It's clear that the solution to a lot of problems, such as the social security and medicare crises, is within reach. We just require the will.
Published: July 21, 2006 9:34 AM
Person
I've noticed that being skeptical of pro-free market predictions of the results of free market policies will tend to get me loaded with a lot of personal attacks here, but I'm going to ask a few questions anyway, merely because I'm interested in the answer.
A fixed-money supply changes a lot of things, so (at least for me) it's hard to think through the full implications. As Polleit notes, if the money supply is fixed, prices will decline over time. However, this seems to also have unfortunate consequences:
Impossibility of borrowing money. In order for someone to pay back a loan, they have to somehow earn revenue despite falling prices, to match the principal, and on top of that, pay interest and risk premium. The borrower, at least for a business loan, will have to make un-heard-of returns to pay this back, and the adverse selection problem alone will make people not want to lend. Also, as Polleit agrees, the nominal (risk-free) interest rate would have to hover around zero. Unfortunately, nominal interest rates cannot fall below zero. Nobody's going to lend out their money when they have more to gain just from hoarding it.
It's hard to contemplate the effect of a fixed money supply, since there never has been one. On a gold standard, more gold can be mined. One thing I think helps in understanding is to consider a money backed by something we already recognize, at least for the near future, as being fixed: real estate. That is, imagine that there is a "land standard" and people trade in notes redeemable for real estate. (Yes, I know this also introduces the intuitive difficulty of why people would trade in a non-fungible currency) Now, I can accept that people might lend out real estate, but to be paid back in more real estate? Any loan necessarily increases the fraction of all "money" you own. Would interest paid in land-money really prevail in such a scenario?
-Along the same lines, what about counterfeiters? As each dollar can secure a claim to more and more valuable things, the incentives can make people make the kinds of investment necessary to counterfeit notes more and more efficiently. Under a gold standard, this isn't as big a problem, since the price-deflation will just drive people to mine more money, but under a deflationary fixed fiat currency, more and more resources would have to be invested in security features for the notes, or encryption for electronic banking transfers.
So, anyway, as a usurer, I love limitations on currency expansion, but wouldn't the above consequences result from a fixed fiat currency?
Published: July 21, 2006 9:43 AM
Jeff Fisher
OK article, but too simplistic, IMO.
Author fails to mention that gold supply has risen every year and that under a gold standard M would be rising at about 2% to 3% a year. How would that effect prices? Who would benefit more and who less? Obviously the gold producers would be in the favored position.
Under our Bretton Woods system, the USA is King because it controls and issues the world's money.
The US Banks reap huge benefits, and the US government does not need to live on taxes. Inflation is crudely controlled by central banks changing their overnight rates. The present system creates many problems, but who is going to change it?
99% of the population don't have a clue and the 1% who understand benefit enormously. A realistic solution is limiting government deficits and then the central banks are not forced to monetize. Peace obviously would help a lot. In the end I endorse everything Mises' advocates in Liberalism, including sound money, however gold standard sounds like an impossible pipe dream.
Best regards
Jeff Fisher
Published: July 21, 2006 10:10 AM
banker
No or much lower monetary expansion would most correspond with higher risk free interest rates. This, obviously, discourages peoople to borrow or consume savings they don't have. Higher interest rates make it more attractive to save money rather than borrow. This is simple supply and demand for capital.
Prices are set by supply and demand. This makes relative prices more important than absolute prices. The primary benefiter from the expansion in the money supply is the first entity to use the newly created money. So, if anything, people will benefit greatly from not having the government screw people out of their wealth. Also, if the government decides to have a huge deficit then interest rates will have to go up significantly. Everyone will notice this.
Published: July 21, 2006 10:16 AM
Thorsten Polleit
By stopping any further government money supply incresase, Mises wanted to set the stage for returning to free market money. As such, freezing was just an intermediate step
Published: July 21, 2006 10:19 AM
Thorsten Polleit
By stopping any further government money supply incresase, Mises wanted to set the stage for returning to free market money. As such, freezing was just an intermediate step.
Published: July 21, 2006 10:19 AM
Thorsten Polleit
Loan problems when price level declines? No: market practise would be that principle repayment would be simply lower in nominal terms.
Published: July 21, 2006 10:21 AM
Person
Loan problems when price level declines? No: market practise would be that principle repayment would be simply lower in nominal terms.
Er... what? So, you make a loan for $10,000, and then only require that a "principle" of $8,000 plus interest of $1,000 be paid back? Again, why not just keep the money instead of loaning it out? Remember, just because money increases in value, doesn't mean people would loan money out for negative nominal rates.
Published: July 21, 2006 10:33 AM
adi
Mr Polleit we have here in Europe this glorious institution, European System of Central Banks, which is supposed to correct all the worries which you repsented in your good article.
Since economists Kydland and Prescott wrote about the consistency of optimal plans, ECB is supposed to be institution which has different incentive structure about monetary policy than national central bank which controls national money. European governments do not have monopoly to inflate anymore.
Personally I think that the gold standard has better safeguards againts inflation financing than this current arrangement. Money was originally a good free-market invention and not a tool for governments "white elephants" policies.
Published: July 21, 2006 10:34 AM
Owen
I'm sure many have raised the point by now, but I'm surprised it's not addressed: Keynes predicted that Churchill's Gold Standard return would lead to labour unrest rather than a smooth wage reduction (1925). I had thought that the standard was abandoned after this was proven. Is this your understanding, or do I have it wrong, or do you think those conditions no longer apply, or would ultimately go away?
Isn't money illusion very powerful? For example, isn't it true that house-sale velocity drops dramatically during housing-price deflations?
On another point, this article says that nominal savings rates would fluctuate around zero (presumably going negative even with the risk premium during productivity accelerations). I have to question this prediction: It wouldn't take much or an entrepreneur to realize an arbitrage profit from a negative 20 basis point rate by offering negative 10 bps, and simply hiring a strong box to secure the gold in. Or would it? Are you saying that nominal negative rates can be sustained?
Anyway, an interesting counter-factual conjecture - nice article.
Published: July 21, 2006 10:57 AM
banker
Why would someone invest their savings for a negative return? Especially when they could just do nothing with their savings (keep in mattress types). It is a case of -2% vs 0%. When investing savings there is no need to distinguish between real and nominal. In reality, people only care about nominal returns.
I think, due to the current monetary situation, people are afraid of what will happen if borrowing becomes too expensive. When someone borrows all that is happening is that someone is consumig savings they don't have. Since borrowing would be more expensive without inflating people would have to save their own money rather than borrow somebody else's. If anything this is a much better situation than perpetual debtors.
Published: July 21, 2006 11:17 AM
Dave Weilacher
How about getting rid of the law that only the government can provide money then folks can decide themselves what money should be?
Published: July 21, 2006 12:40 PM
Paul Marks
Being a libertarian does not mean being in favour of fraud.
If a person (or a corporation such as a bank) says "I am lending you one hundred Dollars" they must actually have the hundred Dollars to lend - and when they have lent the money they DO NOT HAVE IT ANY MORE.
Mr Smith (or Smith Incorporated) must actually have one hundred Dollars if he want to lend one hundred Dollars to Mr Jones - and if Mr Smith does lend the money to Mr Jones, Mr Smith does not have it any more (until when AND IF Mr Jones pays him back - in which case Mr Jones does not have it any more).
Anything else is a shell game, and efforts to justify such shell games are a matter of smoke and mirrors.
As the article rightly pointed out, hostility to this fraud is not some strange obsession of Murry Rothbard - it goes back to Mises (and long before Mises).
It is a basic principle of economics that lending must be from REAL SAVINGS (i.e. people choosing not to spend all their income).
Trying to finance borrowing by credit expansion (in order to get "lower interest rates") distorts the capital structure and leads to the boom-bust cycle.
But O.K. let us prented that credit bubble finance is not fraud (after all the government statutes say it is not fraud), people above say they support fractional reserve banking - but want no government support for it.
The test for such people would be the very first bank run (and bank runs go back long before the creation of the Federal Reserve system in 1913).
Would they say "the bankers must provide every Dollar their contracts say they must provide - and if they can honour their contracts the bank is bankrupt and all its assets must be sold for whatever price they will fetch".
Or would they say "we must save the economy from depression"
Of course we all know who the "we" is - the government.
Credit bubbles always burst sooner or later and they drag down a lot of honest business enterprises as well as the credit bubble financial institutions (people not being able to pay their debts as the depression spreads out).
A lot of innocent people suffer - and they call out to the government to save them.
The only way to prevent the bust is to prevent the boom in the first place.
Economic development must be based on work - not credit bubble short cuts.
There is nothing wrong with being a money lender - as long as you actually have the money you are lending out, and you do not pretend that you still have the money after you have lent it out.
Published: July 21, 2006 12:53 PM
Paul Marks
The above should read "if they can not honour their contracts the bank is bankrupt"
Published: July 21, 2006 12:55 PM
Vince Daliessio
Dave sez;
"How about getting rid of the law that only the government can provide money then folks can decide themselves what money should be?"
Well put. If money reverted to a naturally-arising means of exchange (which is what it is), I would not care if it were gold, silver, hemp, backrubs, or even "real bills". In the absence of government force, we would very quickly see what the best money would be. And if we had a real property-rights regime, I would suspect that gold would win, but I really don't know, nor does Mike Sproul, ultimately. It will be what it will be.
Government, unfortunately, doesn't like market money, because it is multifarious, e.g., it is not an easily-creatable or easily taxable commodity, therefor it is threatened by market money. ALL of the problems of our government today stem from the divorcement of money from real value in 1913.
Published: July 21, 2006 12:55 PM
Reactionary
Dave and Vince,
Strictly speaking, there is nothing that prevents people from agreeing to exchange gold, silver, auto parts, or cigarettes for goods and services instead of money. Rather, legal tender laws simply say that if somebody insists on paying their debts in FRN's, the other party cannot refuse to accept them. What the other party can do is simply refuse to deal in the first instance with a customer who will only trade in money, which is what inevitably happens when the market loses faith in the currency.
Presumably, this has not happened in the US b/c the rate of inflation of the money supply is still fairly predictable. I guess we won't know what the tipping point is until it happens.
I also find it interesting that no country in modern times that has experienced a currency crisis (Mexico, Russia, Argentina, Weimar Germany) has reverted to a gold standard.
Published: July 21, 2006 1:05 PM
Paul Marks
Churchill and the gold standard.
Firstly Britian was not even on a real gold standard before the First World War (as the Bank of England issued more notes than it had gold in its vaults - although this fraud was on a modest scale by modern standards).
This leaves aside the activites of the fractional reserve banks (which the Bank of England's task was to protect) - although (again) such fraud (in pre 1914 Britian) was on a modest scale by modern standards.
As for what happened in 1925, the government wanted to pretend that World War One inflation had not occured and that the Pound was worth the same (in terms of Gold) as it had been before the First World War.
It was David Ricardo (not a good economist in many ways, but right on this question) who pointed out (a century before - in relation to the inflation during the wars with France)that if a government inflates (i.e. issues more money) it should not pretend that its notes are worth the same after the inflation as they were before.
For example, if the government only has enough gold to cover each of its notes by one thousandth of an ounce - then the note is worth one thousandth of an ounce of gold (however much it used to be worth). This is something that governments never like accepting (as it restricts their ability to play political games).
Alternatively government can try and "deflate" (gradually get the value of the notes more in line with what it used to be) - but this will lead to problems. Although these problems (such as rises as unemployment) will tend to clear in time IF the market is allowed to clear (i.e. if the government has not created any institutional barriers to the market clearing, by imposing regulations).
There was a deflation in Britian in the 1820's and in the late 1920's
As there was in the United States in the 1880's.
Kenyes took one part of Ricardo reasoning - but missed the other bit.
As for the "money illusion" - largely nonsense.
If prices are going up unions will ask for wage increases that take that into account - so Keynes' effort to con them into real wage cuts (in order to reduce unemployment) will tend to fail quite quickly.
Unless (of course) the government controls wages. This was accepted by Kenyes in his introduction to the German edition of the "General Theory of ....." (1936) - not something that Kenyesians like to be reminded of (as the government of Germany that Keynes praises is not popular these days).
Where trade unions are strong (in Britian they were strong because of such things as the Act of Parliament of 1875 and 1906 which protected them from common law tort actions, and allowed them to "picket" private property) wages and conditions will be pushed up to a level that the market (at that time and place) does not justify.
So unemployment will result, and (because of the harm done to the industries involved) eventually wages and conditions will actually be worse than if the unions had not existed (but the lost jobs will not return).
This is what W.H. Hutt called the "Strike, Threat System" - it only really works where an employer is either not allowed to have no-union contracts or not allowed to enforce these contracts. And where unions activists are allowed to "picket" (i.e. place guards at - to "picket" is a military term) the entrances to a place of employement in order to try and threaten people going into work in order to inuduce them not to go into work.
Such tactics push up wages and conditions in the short term - at the expense of jobs and also long term wages and conditions.
Printing more money (or issuing it via computers) by Lord Keynes (or anyone else) does not help, in the long term, with any of this.
Lord Keynes replied that "in the long term we are all dead" - which may be true for him (he died in the 1940's) but is of no use for people who are not dead.
In short, yes going back to the gold standard at a new parity (i.e. admitting that the Pound was no longer worth what it had been before the War) would have been a good idea. But the real problem in 1920's Britian (as regards unemployment) was union power in certain basic industries in certain parts of the country - union power that had been created by Acts of Parliament.
These Acts (basically the Acts of 1875 and 1906) should have been repealed. "Friendly society" (what Americans used to call "Fraternity" - in the days before such things just meant drunken college boys)would have continued (more than 80% if industrial workers in Britian were members of Friendly Societies by 1911), but the seperate "strike threat system" would have been greatly weakened (i.e. prices and wages would have been allowed to adust to reality - as they did, for example, in the United States in 1921 and were not allowed to after 1929).
By the way, efforts to maintain the exchange rate between the Pound and the Dollar in the late 1920's (efforts led by Milton Friedman's hero B. Stong of the New York Federal Reserve Bank) created the increase in credit-money which led to the late 1920's American boom - and to the great bust that came after it.
The Bank of England wished to pretend that the Pound was still worth the same number of Dollars it had been before the war - and important people in the United States helped them try and maintain this pretence. At great cost to the United States and the world (including Britian).
All these silly efforts to maintain exchange rates (whether of the Pound to the Dollar or of the Pound to gold) could have been cut through if government people had accepted that it is the gold (or whatever other material people have chosen to use as money) that is the money - not the bits of paper that the government has produced (this production of bits of paper just lays the government open to temptation).
Before the Civil War the United States Treasuary (thanks to the work of men like Martin Van Buren) neither deposited money in a national bank (for it to play fractional reserve with) or with "pet" State banks (as President Jackson had done - the State banks played the same game as the national bank had).
It simply took in tax money (in terms of gold and silver coin) and paid it out for government spending.
This is denounced by establishment historians as a practice fit for "the middle ages" rather tnan the modern age - but it is the only honest way for government to act (if one chooses to ignore how it got the tax money of course).
As for "private currencies" in the sense of private banks producing bits of paper (or computer entries) and declaring them money. I think people need to read Carl Menger on the development of money before they put their faith in such things.
Published: July 21, 2006 1:44 PM
Paul Marks
Of course some people will not accept that the picketing of private property is obstruction, and will claim that pickets stand by an entrance in order to discuss philosophy (or whatever) rather than to threaten people who are trying to go to work.
Such people clearly live in a different universe - I hope it is nice there.
There is no strict need for government to clear pickets. A company could sue the union who put them there (if such tort actions were allowed), or it could just hire men to clear them away from its property (if this was allowed).
In the old days it was a point of honour for the owner or manager of place of business to fight alongside his men if the place of business needed to be protected (although I doubt that the modern M.B.A. crowd would be of any use in either a fist fight or in gun play).
If union activists do not like the way Mr Ford (or whoever) runs his business, they should set up their own (perhaps using the union pension fund as capital).
This is not to say that I support the historical Mr Henry Ford's demands for government credit-money expansion (he was a "Keynesian" before Keynes)or his demands for the government to build free roads.
It is often forgotten that the United States had a vast improvement in wages and conditions before unions were of any importance.
To claim that unions are the cause of the long term improvement of wages and conditions is almost as absurd as to claim that the cause is government regulations (such as mimimum wage laws).
It shows a basic lack of understanding of economics.
What unions can do (if supported by government regulations) is to boost temporary wages and conditions - at the cost of the long term health of basic industries.
In the end not only are there less jobs in these industries - but wages and conditions are actually worse than they would have otherwise been.
Sadly economic understand is at the level of "in year X wages were such and such, now wages are higher and governent is bigger, therefore bigger goverment leads to higher wages".
Published: July 21, 2006 2:11 PM
Paul Marks
Sadly "Reactionary" is mistaken.
Something does prevent people choosing gold or silver (or whatever) as money in the modern world - that something is government.
In 1933 many private contracts clearly stated that payment was to be in gold, but the Administration of President Roosevelt voided those contracts.
The United States government had no power to do that (indeed, under the Constitution of the United States, it was supposed to uphold contracts - of course, under the Constitution no State is supposed to be able to make anything but gold or silver coin legal tender and the Congress has the power to coin money, not to print it or set up another organization to do so), but the Supreme Court just twisted the words of the Constitution to support the government.
What is the point of having a contract that specifies payment in gold if the government can simply rip up this contract?
Nor is this just an American experience. Not content with taxes, governments of many nations have a habit of voiding contracts or just stealing the property of people.
And (as you mention) the government demands that its taxes are paid in its money (and taxes tend to be rather important when government gets to the size it has).
Published: July 21, 2006 2:22 PM
Vince Daliessio
Paul,
Very entertaining posts, and in agreement with what of Rothbard (and Friedman, go figure) that I have read regarding the monetary confidence games of the period.
Published: July 21, 2006 2:51 PM
Reactionary
Paul,
I am aware of that history, but strictly speaking, there is nothing preventing you and your vendors and customers from dealing in gold, vodka, auto parts, or just plain barter. You can set up your own e-gold and barter club any time you want, and people have done so.
The problem as you know is the government's bad money drives out the good money. Why exchange valuable gold and silver for a DVD player when you can just use the paper that everyone else uses? Why make the price calculations necessary with gold and barter when you can just use paper dollars?
Apparently (and, I stress, apparently), so long as the government is merely increasing the currency at a fairly predictable rate and the market is allowed to function more or less freely, paper/digital currency is going to be the money that the market will settle on because it's the easiest to use. (I have yet to hear of a single modern country that reverted to the gold standard after a currency crisis, not even the most infamous example, Weimar Germany.)
Conversely, if the market doesn't trust the currency, then no amount of legal tender laws can dictate otherwise.
Perhaps the experiment in fiat currency just hasn't run its course yet. I honestly don't know.
Published: July 21, 2006 3:42 PM
cynical
Person,
Essentially, you ask: Under deflating prices, why not just keep your money (instead of loaning it out)?
I ask: Under inflating prices, why not spend money instantaneously (or never accept it in the first place)?
Published: July 22, 2006 10:09 AM
cynical
Person,
I should add that your previous question, regarding the alledged in ability to make loans in a fixed money supply environment, ignores that today, under inflationary policies, we see the (positive) interest rate increase above what it would be due to an "inlfation premium". Consider this and I think your dilemna is solved.
Published: July 22, 2006 10:33 AM
Nima Mahdjour
@Person: The theory that people would hoard money deflating prices is a huge fallacy. Money is used in order to exchange it for goods/services that you attach a higher value to. That is its core purpose. All other functions can be traced back to this very function: it is a medium of exchange.
As such, it doesn't help you a bit to hoard it. What would you do with it? Take a bath in it? Chew on it? Throw it up and let it rain on you?
No, you use it in order to purchase goods/services or lend it to someone else who would ultimately do the same.
There is nothing else you can do with money. You would also not delay purchases because you expect falling prices.
If for your business you need a laptop, you won't wait because you know its price will decline in 1 year. What would you do in the meantime?
@Thorsten: Overall your article is well thought out. Just one thing bothered me: That you used the "transaction equation". This equation means absolutely nothing. The variable V is not an independent variable and as such you cannot possible assume a constant velocity of money had we frozen its supply. In fact the whole equation is worthless. As Shostak puts it.
"Velocity = Value of transactions/supply of money. This expression can be summarized as: V = P(T/M) , where V stands for velocity, P stands for average prices, T stands for volume of transactions, and M stands for the supply of money."
and
"Since V is P(T/M), it follows that the equation of exchange is reduced to M(PxT)/M = P(T), which is reduced to P(T) = P(T), and this is not a very interesting truism. It is like stating that $10=$10, and this tautology conveys no new knowledge of economic facts."
Best,
Nima
Published: July 22, 2006 4:30 PM
Michael Robb
The Polleit paper is very interesting because it is the first attempt to put calculation to work on defining what has been called the Pelf effect of fiat money.
If we agree to overlook the velocity question, and take the Cantillon presumption for a standard, we do not need all the wealth in the world to serve as the medium of exchange.
But an interesting point arises in a gold standard due to the natural permanancy of the metal. We have all heard how all the gold ever mined is still above ground. A gold firm even tells us how much there is, -- about four billion ounces. Yet 10% of wealth was Cantillon's outside estimate of the amount of money needed to accomodate the exchanges between buyers and sellers.
However, this is not to say that 90% of the gold is ignored. How could it be? Rather, it seems far more likely that all four billion ounces (less some valuable artifacts) would always be more or less available for use as money; at least potentially. Thus it may not be the case that new production could actually increase this total supply by an amount the size of the 2% or 3% stated above.
It is an interesting question what amount of production would be the result of public preference for gold payment mechanisms. This is an especially appriate quesiton today because of the phenomenal popularity of electronic gold instantaneous transaction payment mechanisms which are now easily operated on the internet for online purchases.
With the latest advances in cell phone technology announced just a few weeks ago electronic gold payment is not at the point of being available to virtually everyone, anywhere on earth.
With new low priced card reading chips the small denomination cash card, backed by milligrams of metal in secure and encrypted gold vaults in friendly free countries, -- having constitutional guarantees of privacy, and freedom from intrusion or cost, can make sound money available to the smallest, most informal merchant for the tiniest transaction.
How could this be? Communication technology coupled with the power of the computer and the existence of money changers capable of accumulating and accounting for large numbers of small transactions communicated to the electronic payment mechanism at the vault. If this is not an idea whose time has come, what would one be?
TP's estimate of continued 3.3% economic growth should be considered a mere benchmark. It was generated during a lengthy period of fiat foolishness combining intense capital misallocation in addition to the separate destructive effects of bubble and burst, on a number of occasions.
Agreeing that all or most of these deleterious effects may be avoided in the sound money world, a rate of increase in one or two multiples of such an amount should be within the realm of continual possibility.
It is extremely heartening to hear TP assert that the purchasing power of the coin will increase at the rate of economic growth. It seems that this is arithmetic, but perhaps verbal logic could express the validity just as well.
All in all, the best economic article of the year, and very apropos for its originality.
Published: July 23, 2006 11:42 AM
Michael Robb
Correction: ...electronic gold payment is NOW at the point of being available to virtually everyone,
Published: July 23, 2006 11:52 AM
(8?»
I fail to understand the purpose of this article, as its underlying assumption creates a contradiction that cannot be overcome (at least from a "libertarian view").
This fiction could just as easily be titled, What if Theives Decided Not to Steal?
Besides it also gives life to the lie that "governments" or more accurately, the people who wear the alter-ego of "civil servants," took it upon themselves to destroy the money, when truth is, they were either largely ignorant of the what was happening, or were already thoroughly compromised by their true owners, the bankers.
It is sad to see writers on this website fall victim to such falsehoods by giving the imaginary creation of "the State" credit for the actions of power hungry individuals who hide deep behind it. It's almost as if Human Action had never been written.
Published: July 24, 2006 10:29 AM
Paul Edwards
When i see an article make use of Fisher's MV = PT, it reminds me of a section of Rothbard's MES titled "The Fallacy of the Equation of Exchange".
There Rothbard spends several pages refuting and ridiculing the equation.
Using terminology as "fallacious", "flagrant non sequitur", "misleading fiction", "a tangle of fallacy and irrelevance", "delusion", "uninteresting truism" which "conveys no knowledge of economic fact whatsoever", "an identity and not an equation", "not very enlightening", "pernicious", "triviality", "erroneous", "mythical", "meaningless", "illegitimate", and compounded "absurdity", Rothbard inflicts a particularly scathing refutation on the MV = PT equation.
I would not mind reading an article that makes a good attempt at rebutting Rothbard’s attack against Fisher’s equation, although this seems unlikely to be possible, but until I see one that succeeds, I would argue that it is counterproductive to attempt to use the equation to illustrate economic principles from an Austrian perspective.
Published: July 24, 2006 12:01 PM
Person
Alright, good to see I finally got some responses. Nima and cynical essentially responded to a claim I never made, that people would "just hoard their money and never spend it." (I've noticed it's SOP for people on the Mises blog to respond to things I never said, and steadfastly refuse to stop strawmanning my positions. Let's see if we can move past that, guys.) However, that's not what I said at all. My question was about people who want to save to have more later. Under the current regime, or even a gold standard, you can lend out your money for more money later. If the money supply were rigidly fixed, however, money necessarily gains in value. In order for someone to pay it back, they would have to produce more in the future, just to pay back the principle, and then, on top of that, pay the interest and risk premiums. It's unlikely anyone could generate that rate of return, so from the perspective of someone saving money for a future date, it would make more sense just to hold it. Make sense now?
As to cynic's other point:
I should add that your previous question, regarding the alledged in ability to make loans in a fixed money supply environment, ignores that today, under inflationary policies, we see the (positive) interest rate increase above what it would be due to an "inlfation premium". Consider this and I think your dilemna is solved.
Unfortunately, the dilemma is not resolved. Again, I will remind you nominal interest rates *cannot* fall below zero (assuming some kind of stability and respect for property rights). If you can only lend at a negative nominal rate, you would just "lend" to yourself (at zero nominal rate), and capture the gain in money's value rather than give it away. If the marginal dollar is more valued, this will push real interest rates down, and if the real rate of growth increases too much, the deflation would make the nominal rate have to be less than zero.
Published: July 24, 2006 12:46 PM
Mike Sproul
Paul Edwards:
We finally agree on something! The equation MV=PT only says the amount of money spent equals the amount received--about as useful as saying the amount of rain falling from the sky equals the amount hitting the earth.
Published: July 24, 2006 3:35 PM
Paul Marks
Reactionary is correct - people do tend to cling to a currency (and not just because the government demands its taxes are paid in it).
The currency used to be a commodity (normally either gold or silver) or replaced one that had once been - so there is a vague feeling that it is something real (even long after it is just fiat - just the command of the state people).
It takes a great deal of inflation before most people give up using a fiat currency.
On the point (I think it was Cynical's point) about people not lending out money if prices are falling (falling in the sense of economic growth - not a sudden bust) - well the reply to this is empircial THEY DO.
In all periods of gradually falling prices people were still willing to lend out money (although, of course, borrowers were upset at having to pay interest).
As a supporter of the Austrian school I hold that economics is a logical (not an empirical) subject - but sometimes "but people did do this" does save time.
As for Fisher: The continuation of the popularity of his stuff casts doubt on whether "empircal" establishment economists are really emirical types at all.
When I was young Fisher type "monetarists" (led at the time by Milton Friedman - who later changed his opinions to some extent) were presented as the great alternative to the followers of Lord Keynes.
Yet, time and again, periods of a "stable price level" have been followed by a great bust.
Fisher's basic error (in which he is followed so many people) is define "inflation" as a rise in the "price level" - rather than a increase in money.
Saying to the Fed (or whoever) that their objective is to "keep the price level stable" may be better than to tell them "your objective is to keep down unemployment" (if they try that they will have both rising inflation [however defined] AND eventually RISING unemployment), but it is still terrible folly.
The Fed will perhaps deliver this "stable price level" but the very act of trying to deliver this (by increasing the supply of money in line with economic growth) will create a boom-bust cycle.
So what should be the objective of the Fed people?
To clear their desks and get out.
"But the financial institutions and politically connected corportations are dependent on the workings of the Fed".
Oh dear, how sad, never mind.
If such enterprises do not reform themselves so they are not dependent on the slush fund of credit expansion, they will eventually go bust (even if the Fed continues in existance).
What is sad is that such enterprises drag down honest ones when they go bust (unpaid bills and so on).
Things may get a lot worse before they get better.
But IF enough people understand the principles of honest business (inculding honest finance) reconstruction is possible.
Published: July 25, 2006 12:09 PM
Person
Paul: the argument is not that "people won't lend if money gains in value". The argument is that people won't lend if the money supply is rigidly fixed as described in the essay. If there's minor inflation, as there is with even a gold standard, the rate of GDP growth can still be such that nominal rates remain positive -- this is what we saw historically. But if GDP increases, year after year, while money supply literally does not budge, it's hard to see how someone could get a rate of return that would justify borrowing money, so from the perspective of the lender, you're best off holding.
(Again, this does not mean no one will spend. It means that savers won't lend.)
There could still conceivably be consumptions loans, since the borrower does not use the loaned capital to generate revenues to pay it back, but rather has some other source they can draw on, such as labor income. Actually, this sort of helps to understand the anti-interest mentality prevalent in the late 19th century (known for its deflation). Since merely paying back the principle means paying something more valuable, it's understandable why some people would conclude that that's "enough". Note to Stephan Kinsella, Curt Howland, quasibill, Fred Mann, and everyone else who habitually misreads my posts: I did not just agree with the arguments against usury; I'm just saying I have a better understanding of where they're coming from.
Published: July 25, 2006 12:36 PM
quasibill
Person, I'm touched. I'm mentioned in a thread I haven't even participated in yet!
Regardless, I was about to post that I agree with you. In a system where money supply is artificially suppressed, I agree with you that lending will become negligible. I actually see that as a generally good thing, especially considering the social effects compared to what we have now (self reliance versus the current collectivized conception of success - the difference in realizing that you've got to go out and be of service in the market to make your dreams come true vs. realizing that you've got to suck up to the right people to make your dreams come true). Not that I'm in favor of forcibly suppressing the money supply, of course.
However, I think that it would be nearly impossible to completely constrain growth in money supply. Even if we hit the natural limit of accessible gold, other commodities would supplement the money supply (most likely candidate would be silver in smaller denominations). And even a state couldn't really achieve complete steady state, as a black market would seem to be the natural outcome of state enforced suppression of the money supply.
Published: July 25, 2006 1:51 PM
Paul Edwards
There is an article by PHILIPP BAGUS titled "DEFLATION: WHEN AUSTRIANS BECOME INTERVENTIONISTS" at http://mises.org/journals/qjae/pdf/qjae6_4_3.pdf , which makes the argument that when it comes to deflation, the Austrians are not radical enough. That is, even Rothbard appears to come out looking like a kind of wishy washy interventionist.
I think i'm going to have to give this article several thorough reading as soon as possible because it is a concern i have had before. Can not divesting the Federal Reserve of its security holdings be justified on ethical or economic grounds?
Published: July 25, 2006 3:13 PM
Nima
@Person:
Could you please provide a little more about the following statement:
"If the money supply were rigidly fixed, however, money necessarily gains in value. In order for someone to pay it back, they would have to produce more in the future, just to pay back the principle, and then, on top of that, pay the interest and risk premiums. It's unlikely anyone could generate that rate of return,"
I will try to take it apart and comment on its main pieces as far as I understand what you mean:
- "If the money supply were rigidly fixed, however, money necessarily gains in value."
Makes sense. More products, same money supply, money value goes up.
- "In order for someone to pay it back, they would have to produce more in the future,"
What do you mean by "more"? Do you mean more than they are producing right now? That I would agree to. Regardless, someone always needs to "produce more" in the future than right now in order to pay back a loan they took on. They should be borrowing for that very purpose, shouldn't they? If they had enough right now, then they would not need to borrow money in the first place.
- "just to pay back the principle, and then, on top of that, pay the interest and risk premiums."
Yes that is always what you need to pay when borrowing money.
- "It's unlikely anyone could generate that rate of return,"
What precisely are you referring to by "that".
If you could reply to my questions I could get a better understanding of your reasoning and add my thoughts accordingly.
On another note: It seems like some people here are mistaking the temporary means of freezing money supply for an end.
Freezing the money supply is only the first step to get back to a free gold money system.
I think what Thorsten missed in his article was also the importance of legal tender laws that force people to accept fiat money.
I don't understand why freezing money supply should be unlibertarian. The whole process of printing money is controlled by government and ultimately paid for from tax money which can only be obtained by applying force and coercion.
All we are asking is for this procedure to end. It is by no means unlibertarian to force someone in order to prevent him/her from forcing others.
Best,
Nima
Published: July 29, 2006 6:22 PM
Mike Sproul
Nima:
"On another note: It seems like some people here are mistaking the temporary means of freezing money supply for an end.
Freezing the money supply is only the first step to get back to a free gold money system."
Some problems:
1) There is no reason to freeze the quantity of green paper dollars. People should just be free to introduce new forms of money and use them if they want.
2) You are assuming the correctness of the quantity theory, which says that as more money is issued, its value will fall. If money is backed by something of value, then as long as the amount of backing moves in step with the quantity of money, the value of the money will be constant even as its quantity changes. Freezing the quantity of "money" (however defined) would only lead to shortages of money during busy periods (e.g., xmas shopping season). That's the whole reason the Federal Reserve's founders gave it the duty of providing an "elastic currency". The US had plenty of bad experience with an inelastic currency following the civil war.
Published: July 30, 2006 8:51 AM
Nima
@Mike:
1) I think there is still a lot of confusion about this freezing issue. By freezing the money supply I basically mean that government stops printing money and abolished legal tender laws. I agree, everybody should be allowed to produce money and the best money shall prevail. (As it did when money was first invented)
2) Money is not backed by anything anymore. Paper dollars were taken off gold in the 70s, and even back then we merely had a "Gold Exchange Standard" and not a true gold standard. On the rediculous myth of inelasticity as a reason for the establishment of a central bank, read Rothbard, "A History of Money and Banking in the United States".
Best regards,
Nima
Published: August 7, 2006 8:59 PM