Money and Inflation: The Tendency to Deny Reality
Can the Phillips Curve be revived? Some mainstream economists are doing their best. They discuss price changes without acknowledging any role that money might have had in these changes. The entire framework is based on dubious black-box, time-series analysis. While the research paper mentions extensively the word "inflation," it never even attempts to define this term. Covering undefined terms with mathematical dressing cannot make the analysis more meaningful if the object of the analysis is not clearly identified. FULL ARTICLE
Comments (219)
Dan Stenabaugh
Dear Sir,
I read all of your Mises submissions with great interest, and especially those that treat the subject of inflation. As simple as this subject appears even to a lay person such as me, I have to wonder about the mental capacity of the members of the central banks. Certainly they cannot be so obtuse as to not see exactly what your article details. Can they? Who is kidding who? Maybe this globalization game has much more far reaching implications than meets the eye.
Thank you for all your writings.
Published: March 27, 2007 2:06 PM
Brad Young
I very much enjoyed your article "Money and Inflation: The Tendency to Deny Reality" and had one question for clarification. It seems to me there are actually two ways more money can get into circulation. Debasement of the currency by the king is certainly the most common, but another is the discovery of more gold. Since we have from time immemorial found gold, it seems there is some natural and reasonable expansion of the money supply. Further, it seems that as productivity increases the buying power of the original gold coin that was the historical measure of exchange, we are forced to either find a new and finer division of the original coin, something we did see with the ha'penny and the farthing, or a new coinage to facilitate efficient exchange of money for goods and services. People in power being what they are, one should not be surprised to see the re-issuance of new coinage paired with debasement of the coinage. On the other hand, could it not be something analogous to the phenomenon of advertising, an irrational cost of trading happily borne by suppliers and consumers?
Published: March 27, 2007 2:29 PM
Michael A. Clem
Excellent article! Especially this:
Please note we don't say as monetarists are saying that the increase in the money supply causes inflation. What we are saying is that inflation is the increase in the money supply.
Why do they have to make it so hard?
Published: March 27, 2007 2:41 PM
Bruce Koerber
Dear Frank Shostak,
'But if the Fed were to acknowledge that inflation is actually printing money, then it would mean that the US central bank is not an inflation fighter but is itself the key source of inflation.'
I doubt the that the Fed will declare itself criminal but someday enough people will.
http://divineeconomyconsulting.blogspot.com/2007/03/divine-economy-theory-labels-inflation.html
With warm regards,
Bruce Koerber
Published: March 27, 2007 3:40 PM
David White
Inflation? WHAT inflation?
http://www.csamerican.com/stuff.asp?k=25
Published: March 27, 2007 3:50 PM
Camden McConnell
Dear Mr. Shostak:
I am thoroughly enjoying your article, “Money and Inflation: The Tendency to Deny Reality.”
At one point you nudge up against the question of whether increases in production and increases in money supply resulting in constant prices are a condition of inflation. I am only an amateur economist myself, but would like to add this observation.
It seems to me that in an environment with a constant “value” to money, as in a true gold standard, the natural trend of prices of goods and services should be downward as producers, in competition with each other, find ever better ways to produce what they sell at lower costs. A perfect example is gasoline, which is virtually the same product today as it was in 1965-67, when I was at graduate school near here at U.C. Berkeley. At that time, gasoline sold for about $0.32 per gallon. If I use gold as a reference, that gasoline cost me, in 2007 terms, about $6.40 per gallon. Thus, the question the public should be asking is not “Why is gasoline up to $3.25 per gallon?” but rather “How can the oil companies sell me $6.40 gasoline for only $3.25?” Or, to look at it the other way, if we had had and maintained a true gold standard, the $0.32 gasoline would sell today for $0.18!
We are deceived because many of the goods and services we buy are not the same. A typical automobile today is much more complicated that a typical automobile of 1965.
Similarly, inflation allows us to receive “increases” in our pay rates that do not keep up with inflation and to fail to realize that we are actually losing purchasing power at the same time that our additional experience makes us more valuable.
So, I absolutely agree with you that inflation is simply the increase in money supply without increase in value. A true gold standard along with an end to government protection of banks against the risk of being caught out at fractional reserve banking would change our economies (in the world) for the better. The only losers would be the big spenders of government around the world.
Thank you for an excellent article.
Published: March 27, 2007 3:56 PM
Camden McConnell
A previous commenter asked about the creation of new money by production of more gold. It is a valid observation.
What we can imagine is that, in a free market, gold will be produced in accordance with demand. There is plenty of unmined gold, but it costs (uses resources) to mine and refine it. As with any other commodity, that will be done in accordance with the relative rewards. The money supply will thus increase naturally, which does not imply any particular price stability for any other commodity.
It is also true that the natural decrease in prices of goods and services as competition increases efficiency may require the development of smaller subordinate coinage. If we were to return to gold and set the rate for dollars arbitrarily and permanently at the old rate of $20 per ounce, prices would be very low, and cents would have a lot of purchasing power.
Mils, now a term used only in taxation, could be an answer to that problem for the United States. My daily newspaper, now at $0.25 would be at 7 mils. No wonder the papers are going out of business.
What a true gold standard will do for us is to take away the power of government to finance itself by stealing value from our money without the appearance of doing so.
Published: March 27, 2007 4:07 PM
RogerM
While I'm all for a gold standard, we should keep in mind that the primary method for pumping the money supply is credit expansion via fractional banking. This happened extensively under the gold standards of the past and destroyed wealth as much as fiat money has.
As several people have mentioned, prices would decline at the rate of economic growth under a fixed money supply. So if production increased, either through population growth, increased savings, or technology at a 3% annual rate, then prices would fall by 3% annually. But as Dr. Reisman points out, gold production would probably increase at 2-3%/per year, thus increasing the money supply by that amount and eliminating the price reductions.
Greenspan's big mistake was think low price increases in the 1990's signaled that he could inflate the money supply at higher rates. Price indexes didn't rise much in the 1990's because of huge productivity increases. But the damage Greenspan did with his inflationary monetary policies caused the stock market bubble and crash and the recession of 2001.
It's strange that so few mainstream economists recognize the connection between the money supply and price inflation, because I have a mainstream macro text book from the mid-1980's with a lagged regression example showing that money supply increases result in price rises between 12 and 18 months after the increase in money.
Published: March 27, 2007 5:28 PM
Juan Garofalo
There is no longer any word available to signify the phenomenon that has been, up to now, called inflation.
counterfeiting ?
Published: March 27, 2007 7:21 PM
Alex MacMillan
I don't think there are many (if any) economists who do not understand that long run increases in prices in general are caused ONLY by increases in the money supply. The central banks generally acknowledge this fact. I think the differences in opinion deal with the short run.
It appears, from what I read, that Austrians believe that there can be no short run increases in the CPI (or any other measure of a general price level) other than those caused by monetary expansions? Am I correct in this belief or not?
Published: March 28, 2007 1:46 PM
RogerM
Alex: "It appears, from what I read, that Austrians believe that there can be no short run increases in the CPI (or any other measure of a general price level) other than those caused by monetary expansions?"
I think that's correct. Supply and demand changes with affect prices of individual products, but a general price rise across the board, such as would affect a price index, has to come about via monetary or credit expansion.
Published: March 28, 2007 8:57 PM
Mike Sproul
Consider for a moment that the quantity theory of money just might be wrong. No dollar is ever issued except in exchange for a dollar's worth of assets, so the issuing bank's assets must rise and fall in step with the quantity of money. This is the point of the real bills doctrine: as long as new money is only issued for equally valuable assets, the issue of new money will not increase the price level.
Published: March 28, 2007 10:57 PM
billwald
If the country reverted to a gold standard would credit cards be permitted and if so on what basis?
Published: March 28, 2007 11:09 PM
Mark Brabson
billwald:
If we went to a true commodity money AND a 100% reserve banking system, the whole credit structure as we know it would be fundamentally altered.
My view is that credit cards would essentially disappear. You would still have non-revolving charge cards for those with top notch credit. For most people, credit would be limited to mortgages and car loans and other large ticket loans. Total credit would have a finite limit and as with all scarce things, would have to be parcelled out most efficiently by banks.
This would be a good thing, as it would keep people out of the huge debt trap. It would also limit bad loans, since scarce credit means that those people actually getting the credit have the best risk profile. No subprime disasters in a scarce credit regime.
Published: March 28, 2007 11:28 PM
Alex MacMillan
Mark,
I would also presume if fractional deposit reserve banking were outlawed, the creation of innovative instruments such as "demand debentures" (debentures repayable on demand with no fixed maturity date) would also have to be outlawed, since such instruments could be used to create credit out of thin air in a similar fashion to fractional reserve deposit banking. This brings up the question: Why? If people want to enter into free market transactions involving such things as demand debentures, why would libertarians seek to prohibit this?
If such things as demand debentures are outlawed, then bank financing would be by normal bond, debenture, and equity routes. I would think that the banks would have an incentive to have this money "parcelled out" most profitably rather than, in some other sense, "most efficiently". Therefore, wouldn't this mean that credit card finance certainly would exist?
Published: March 29, 2007 9:31 AM
Alex MacMillan
RogerM:
Suppose the U.S. money supply is constant and there is no production growth, so that the price level is constant.
Next suppose the government, thinking that its current army of civil servants are all overworked, embarks upon a huge and immediate debt-financed spending program involving a salary increase across the board for all of its over worked civil servants. Would the explanation below roughly coincide with your logic as to why the price level would be unaffected by the government's action?
The increased government financing in the bond market would raise U.S. interest rates, reducing some domestic spending, while increasing foreign buying of U.S. debt securities. This would cause a boost to the value of the U.S. dollar and a resulting reduction in U.S. exports and increase in U.S. imports. The current account would fall. Supposing the increased government spending were $50 billion, the reduction in domestic private spending plus the reduction in the current account would total exactly $50 billion. Hence, there would be no net $ spending on U.S. goods and services from the government's action, and hence no U.S. price level effect.
Published: March 29, 2007 10:01 AM
RogerM
Alex,
I think your reasoning makes sense, but the answer may be simpler: If consumers and businesses buy the bonds the gov sells, then real savings falls by that amount and interest rates go up because people aren't willing to save more. Higher interest rates reduce spending on durable goods, but also investment in business. Lower business investment means fewer people working and lower salaries, so consumption falls an amount equal to what the government spends on wages increases for its workers. So the government has merely transferred money from the wages of private industry workers to those of gov workers.
However, that's all hypothetical. In reality, with a fractional reserve banking, banks would purchase a lot of the gov's bonds through credit expansion, that is, with money created out of thin air. Also, some of the increased wages for the gov's workers would go into banks in checking and demand deposits which the banks would use to further expand the money supply. The increased money supply would then cause a general rise in prices. So the gov's spending by issuing bonds is quite harmful all the way around.
Published: March 29, 2007 11:51 AM
RogerM
Alex: "I would also presume if fractional deposit reserve banking were outlawed, the creation of innovative instruments such as "demand debentures" (debentures repayable on demand with no fixed maturity date) would also have to be outlawed, since such instruments could be used to create credit out of thin air in a similar fashion to fractional reserve deposit banking."
I don't see why demand debentures would have to be outlawed. The problem with FR banking isn't that the money can be demanded at any time. The problem is with having two people claming and having the rights to the same money. If the money for the demand debenture came from the money deposited in a 1-yr CD, for example, it wouldn't increase the money supply, because the purchaser of the CD has given up clame to his money for 1 year while the borrower of money using the demand debenture has taken clame to it. The only twist is that the bank can call in the loan at any time. On the other hand, if the money loaned in the demand debenture came from checking or demand deposit accounts, then it would increase the money supply artificially.
Published: March 29, 2007 11:58 AM
RogerM
Mike: "Consider for a moment that the quantity theory of money just might be wrong."
The first half of the 20th century was an experiment in the real bills doctrine and proof of its failure. The evidence for the quantity theory of money is just too great to dismiss.
Published: March 29, 2007 12:01 PM
RogerM
billwald: "If the country reverted to a gold standard would credit cards be permitted and if so on what basis?"
I don't see why credit cards would be eliminated. The problems isn't the ease of credit, although lax credit standards can cause problems. The problem is with two people claming the same dollar bills in the bank. With gold and 100% reserve banking, the money loaned on credit cards would be the same thing as short term credit. All of the funds for those loans would come from timed deposit accounts so that the savers and the borrowers wouldn't both be claming the same dollars. Credit card loans increase the money supply only if the funds loaned out come from checking and bankd demand deposits. If the money comes from a deposit of savings with a time limit on withdrawal and a penalty for early withdrawal, then credit cards don't increase the money supply.
However, with the money in checking accounts and demand deposits withdrawn from lending, there would be a shortage of loanable funds and interest rates would rise.
Published: March 29, 2007 12:09 PM
Alex MacMillan
RogerM:
Suppose the banking system's balance sheet shows $100 gold and $100 deposits in a 100% reserve system. The banks now sell $100 of demand debentures to people who write checks on the banks to pay for them. The banks now have a balance sheet with $100 gold (asset) and $100 demand debenture (liabil). The banks now make $100 in loans by crediting the borrowers' deposit accounts by $100. The banks' balance sheet now show $100 gold (asset)+$100 loans (asset) and $100 deposits (liabils) + $100 demand debentures (liabil). They have just created $100 of loans out of thin air. They, of course, could do this over and over again, and we're back in a system that is equivalent to fractional reserve banking.
Published: March 29, 2007 2:50 PM
RogerM
Alex: "The banks now make $100 in loans by crediting the borrowers' deposit accounts by $100."
That's the definition of fractional reserve banking. For it to not be fractional, the bank would have to loan out the $100 in gold and thereby reduce its assets. In other words, someone has to give up use of money in a 100% reserve bank. The bank can only loan money that it has received from someone else as a timed deposit. The timed deposit is required so that the depositor gives up use of the money for a specific period of time. If the bank simply credits someone's account, then it is practicing fractional reserve banking and artificially expanding the money supply through credit creation out of nothing.
Published: March 29, 2007 9:43 PM
Mike Sproul
RogerM
"The first half of the 20th century was an experiment in the real bills doctrine and proof of its failure. The evidence for the quantity theory of money is just too great to dismiss."
The quantity theory says that when the quantity of money rises relative to the quantity of goods, inflation will result. The RBD says that when the quantity of money rises relative to the backing held by the issuing bank, inflation will result. The inflations you're referring to could be explained by either model. In "The Ends of 4 Big Inflations", Thomas Sargent observed that the European hyperinflations ended BEFORE the growth of money was restricted, but after fiscal reforms were enacted. That evidence favors the real bills view. See Thomas Cunningham "Some Real Evidence in Favor of the Real Bills Doctrine" for similar evidence from Taiwan.
Published: March 29, 2007 10:13 PM
adi
Mike,
It's true that in the empirical economics there is often no way to identify underlying structure when just observing financial time series. Same data set can support different conclusions.
I have thought few times what you have often written here in Mises blog. Somehow I know that monetary theory in economics is very far from complete and different institutional arrangements affect that more than in any other field of economics.
Still I have many reservations concerning your theory. In your monetary theory there is an asset demand element, but we often hear that money is demanded because we plan to use it in the future for transactions (it's desired cash balance view of money demand).
Also very early many statisticians and economists found out that money supply leads prices, so that increase in the money supply will after some lag increase prices. And asset prices are also affected by these developments.
Do you think that central banks purchases of governments bonds are inflationary when money received is used to purchase goods and services for government?
Published: March 30, 2007 1:02 AM
adi
Alex,
There is an error in your post concerning exchange rate reaction after government makes huge bond financed expenditure increases. Even if the nominal interest rate in US is increased it's not necessarily true that fxrate will appreciate since you must take Fisher equation into account. Returns on assets in foreign interest rate and US interest rate will move in line because interest rate differential is same as the expected depreciation of US fxrate with respect to foreign country.
In Mishkin's book it's said that only rise of real interest rate will appreciate fxrate. Rise of expected inflation rate will depreciate fxrate.
Published: March 30, 2007 5:14 AM
Mike Sproul
adi:
See my paper "There's No Such Thing as Fiat Money", for an explanation of how money demand can affect the value of backed money.
My earliest example of a statistician looking at money and prices is Thomas Tooke, (around 1820-1840) and he concluded that prices lead money, not the other way around. He was also an early real bills advocate, though for the wrong reasons.
As long as new money is issued for equally-valued government bonds, there will be no inflation. Of course if the government starts overspending, its bonds will drop, and since those bonds back the money, the money will drop too.
Published: March 30, 2007 9:59 AM
Alex MacMillan
RogerM and adi: If in today's fractional reserve banking, every loan granted meant the same $ loss in bank reserves, you would effectively have 100% reserve banking. The point is that there is less than 100% leakage of reserves for each loan made. I assumed zero leakage for numerical simplicity, but you can choose any other percentage you like as long as it's less than 100% and, even with a system of 100% reserves against deposit liabilities, demand debentures such as I have described will lead to multiple loan expansion possibilities for the banking system. E.g. Suppose there is 50% gold leakage when the $100 loan is made. The second balance sheet of the banking system would be gold $50 (asset) + loans $100 (asset) = deposits $50 (liabil) + $100 demand debenture (liabil).
Adi: I don't believe the analysis I gave RogerM is necessarily correct short run analysis. I asked him if Austrians thought there would be no short run price level effect of any event other than an increase in the money supply. RogerM said, "yes" or at least he thought as much. So then I gave him a significant event (the large increase in government spending on civil servant salaries) and asked him if the resulting short run story (analysis) I wrote would by why he would think that there would be no effect on nominal spending in the short run and hence no short run price level effect. In that scenario, RogerM doesn't believe that my event would have any effect on the price level, and therefore he wouldn't think there would be any effect on inflationary expectations. Therefore, he would argue that any increase in nominal interest rates under my event would also mean an increase in real interest rates, which would therefore affect the exchange rate.
Published: March 30, 2007 1:50 PM
adi
Mike,
My examples concerning relations of financial time series are from vector autoregressive models. It's often difficult to identify theoretical relations just by looking what kind of coefficients one finds in AR part when estimating these kind of models. Also impulse response functions of different variables on change of other variable are sometimes not easy to analyze (I could claim that positive monetary innovation causes permanent increase in the price level but it's equally valid to object that reason was just ordering of these variables). Your example about Tooke's findings are not very convincing since in those days econometrics was not known and lag relation of these variables might be very significant thing.
Now for the theoretical part of your paper: "There’s No Such Thing as Fiat Money". Your money demand explanation is very weird. As if money is just another asset which has no original/special role in economy. And even when I understood your call option analogy to position of second bank customers there was something wrong in that. Why on earth should customers put their money in the bank where their notes are just lottery tickets to first bank notes? Bank will get much higher rate of return on their loans to businesses and customers will get much less or not at all if bank goes bankrupt. And your GM stock analogy sounds incorrect too; company cannot sell extra shares in the same price if future expectations on return of these stock wont rise.
My conclusion is that even if I cant prove that you have wrong theory, I wont accept that since it's based on very strange foundation. Several years of mainstream economic schooling has already affected my ability to agree with heretical ideas...
Mike, you seem to work in some university in US. Could I ask how academic economists have reacted to your ideas? Perhaps in the same friendly way as we Austrians are welcomed... :)
Published: March 30, 2007 2:27 PM
RogerM
Mike: "The inflations you're referring to could be explained by either model."
I wasn't talking about just the inflations, but the Great Depression as well. According to Rothbard and other historians, the gov's Fed were following real bills doctrine from the formation of the Fed until WWII with disastrous results.
Published: March 30, 2007 2:30 PM
RogerM
Alex: "...even with a system of 100% reserves against deposit liabilities, demand debentures such as I have described will lead to multiple loan expansion possibilities for the banking system."
Other people may have different views of what honest banking (100% reserves) looks like, but I base my understanding on de Soto's book. In it, de Soto insists that for banking to be honest, someone must give up use of money, usually through a time deposit, before anyone else can use it by borrowing it. But the problem isn't with the instrument, demand debentures, it's with the choice of loaning money that doesn't exist. In your example, no one gives up the use of money so that someone else can use it; your banker just issues credit and that is the definition of fractional reserve banking.
Published: March 30, 2007 3:07 PM
Alex MacMillan
RogerM:
Suppose I borrow $100 fiat money (or gold) by issuing a demand I.O.U. on the basis of my good name. Then suppose I turn around and lend this $100 to someone else, who, because of my good name is willing to take another $100 I.O.U., that he trades someone, who also knows my financial reputation, for produce. I'm sure you agree that that Austrian libertarians would not seek force to prevent the foregoing transactions. At this point, my balance sheet for this venture would show $100 fiat money or gold (asset)+ $100 loans = $200 demand I.O.U.s (liabils).
In fact, I can't see how Austrian libertarians would see anything wrong with these transactions, all being voluntary. But, you seem to be saying that if I go too far in this venture, at some point Austrian libertarians would seek to prevent my so doing. What would be a libertarian justification for that?
Published: March 30, 2007 3:56 PM
rtr
Nobel Prize #7: "Money" can be created at whim as promises in a free market. Let's say I discover an oil field buried underneath my land but I have no capital with which to extract that oil. I could go to a bank and borrow gold to pay for equipment and workers. Or I could issue stock grants to buy equipment and options to pay for workers. All money(s) (even fiat), all goods and services, are subjectively valued. My mere promise could be more subjectively valuable than your gold. That's why "money" is just like any other subjectively valued good or service. "Money" is just the most commonly exchanged good in trade. Nothing more.
This is a good thing. More subjective value than could otherwise be produced by a limited 100% reserve system is thus able to be produced.
You libertarians going to use State violence to enforce your "gold standard"?
Published: March 30, 2007 4:16 PM
Alex MacMillan
Any libertarian: Do you have an answer for my previous question, which is is similar to rtr's last question?
Published: March 30, 2007 5:44 PM
Mark Brabson
The objections to fractional reserve banking are simply that of fraud. Nothing more. When additional fraudulent warehouse claims are issued, they dilute the value of real warehouse claims, robbing legitimate owners of value.
I have no opinions as to what the market should choose as its medium of exchange. The market would likely choose gold. It might choose marijuana. That is up to the market to determine. I am not out to enforce a gold standard or any other standard.
If people will loan you money on the basis of your good name, more power to you. That is not an instance of fraud, but of good credit building.
Remember, a bank can always accept your commodity on a NON DEMAND basis, i.e. timed deposit. No warehouse receipts would circulate against it, so no inflationary damage done.
If we MUST end up accepting free, fractional reserve banking, I would demand the caveat that if as so much as one demand draft is refused due to insufficient funds, that bank be instantly liquidated. That would at least provide a sword over bankers head of fear, to keep their inflationist ways to a minimum.
Published: March 30, 2007 6:01 PM
billwald
Mark:
"This would be a good thing, as it would keep people out of the huge debt trap."
Agree 100%. But are Libertarians supposed to have personal concern about ignorant people doing foolish things? Are not Libertarians supposed to profit from others trapping themselves in debt?
Published: March 30, 2007 9:52 PM
billwald
When I use a credit card does not the process generate an IOU that the bank posts as an asset? Is not an IOU an asset?
Published: March 30, 2007 9:57 PM
Michael A. Clem
I'm sure there are more economically-savvy people than me who can answer your question. But it's not clear to me that in either example, rtr's or Alex's, that new money has been created. Money is not merely an IOU. I don't see anything particularly wrong with the examples otherwise, as long as the participants agree to it.
Like Mark, I have no particular desire for a gold standard, merely that currency is issued privately, not by the government. Let the market decide what are the best forms of money, and how it should be backed. I suspect that the market will tend to prefer gold- or silver-backing, but in a true free market for currency, there may be a variety of currencies, including some with limited or restricted uses that may well be fiat money.
If there's any question about fraud involving currency, well, that's what arbitration and mediation is for, since we'd be talking about private issuers, not government, along with any attendant publicity that may affect the issuer's reputation.
Published: March 30, 2007 10:14 PM
Michael A. Clem
But are Libertarians supposed to have personal concern about ignorant people doing foolish things? Are not Libertarians supposed to profit from others trapping themselves in debt?
Last I checked, libertarianism was a political philosophy that specifically didn't tell people what their PERSONAL concerns should be, but left it up to the individual to decide. However, given that libertarians are people too, I imagine most of them would be concerned about people doing foolish things, especially if said people happened to be friends or relatives.
Furthermore, good sales and business sense tells me that "trapping" people into bad or foolish decisions is not necessarily a good business plan, the moreso if such people tend to do desperate things on top of foolish things. As I like to say, a good salesman isn't the one who can sell refrigerators to Eskimos, but the one who has truly helped someone buy what they need and want, at a price they can afford.
Published: March 30, 2007 10:30 PM
Mike Sproul
adi:
Tooke was an eminent economist in his time, and the fact that econometrics wasn't developed doesn't diminish my confidence in the simple statement that price changes tended to lead money supply changes. Thomas Sargent found the same thing in "The Ends of 4 Big Inflations", around 1982 or so.
My paper shows a downward-sloping demand for money, which results from peoples' demand for liquidity. Nothing weird so far.
As for money being a call option: People put paper dollars in banks all the time in exchange for checking account dollars, merely for conveniance. Nothing weird here either.
My point about GM stock was that if GM issues new stock in exchange for equal-valued assets then the stock will not change in value. That, of course, presupposes that GM can put those assets to good use, but then GM wouldn't have issued the new stock if it didn't have a good use for new capital. In any case, this is not a controversial point among economists.
Yes; I'm an American econ prof., and as you guessed, my colleaugues have mostly ignored the RBD. The prof's I have lunch with both say they can't find a flaw in the RBD but they still teach the QT anyway. My favorite journal rejection (from the JPE) was (paraphrasing) "Your defense of the RBD appears to be correct, but I don't care to re-open this controversy in the JPE."
As to the weirdness of the RBD: The RBD says that money has value because of backing--exactly the same as any other security. The QT says that money has value for reasons entirely different from any other security. I find the QT much more weird than the RBD.
Published: March 30, 2007 10:37 PM
Mike Sproul
"According to Rothbard and other historians, the gov's Fed were following real bills doctrine from the formation of the Fed until WWII with disastrous results."
They might have been following Rothbard's idea of the RBD, but they certainly weren't following the simple RBD rule of "issuing new money in exchange for assets of adequate value". If they had, the money supply would not have dropped in the depression, since tightness in the money market would have created lines of people at the Fed, eager to trade their securities for paper dollars.
Published: March 30, 2007 10:42 PM
Sasha Radeta
RTR said:
You have a valid hope for these Nobel Prizes, since those fake Nobel Prizes in economics were mostly handed out to unintelligent individuals, with only few exceptions....Now back to your ridiculous statement. If you sell stocks of your company, you are selling part of your ownership, which is a real asset -- for some gold (asset as well). Nothing is created out of thin air there. If bank loans you the money, it loans you a real asset, holding you liable for that loan and some interest... So what does that have to do with printing money out of thin air????
Your "mere promise" cannot be valued, since legally you can break your mere promise (oh, I forgot you are also ignorant when it comes to basic law). Your contractual promise can be valued -- since it involves exchanges of property titles, or uses of some real property in exchange for some real assets... again, nothing there is "out of thin air."
RTR asks:
Where did you get that silly idea? We can use common law against people who use fraud in order to make money. If you are issuing mere promises your notes must have a syntagma "mere promise" written on those certificates. You can't issue some "mere promises" under false pretenses, and you must be strictly held accountable with all your property for any borrowing you ever make.
Published: March 30, 2007 10:44 PM
RogerM
Alex: "At this point, my balance sheet for this venture would show $100 fiat money or gold (asset)+ $100 loans = $200 demand I.O.U.s (liabils)."
I don't follow your example. In the second sentence you wrote "Then suppose I turn around and lend this $100 to someone else,.." If you loaned the gold to someone, how does it show up in you balance sheet? My reading of your example has you finishing with an asset of a $100 loan and a liability of a $100 loan.
Your example doesn't appear to be one of fractional banking at all, just several people loaning each other money.
Published: March 30, 2007 10:45 PM
Sasha Radeta
Alex said:
In fact, I can't see how Austrian libertarians would see anything wrong with these transactions, all being voluntary. But, you seem to be saying that if I go too far in this venture, at some point Austrian libertarians would seek to prevent my so doing. What would be a libertarian justification for that?
Actually, you are not aware that many Austrians (Mises included) are supporters of fiduciary media, while others would constrict it with formal contracts and full disclosure of Ponzi-scheme nature of such loans (I.O.U. is a joke in legal terms) - in order to fight boom-bust mechanisms, which clearly falsify market signals.
But I thought that you will get the fraud part when you mentioned "recording assets and liabilities"... If you issue certificates claiming they are $100 in your gold and you don't own that money -- you are fraudulently overstating your assets. As George Gaskell noted here once, the concern over the fraud of fractional reserve banking is not limited to the agreement between the bank and its customer, but between the customer and the person the customer pays with that bank's "money." And the person he pays with it. And so on.
Published: March 30, 2007 11:09 PM
Sasha Radeta
Alex said:
Actually, you are not aware that many Austrians (Mises included) are supporters of fiduciary media, while others would constrict it with formal contracts and full disclosure of Ponzi-scheme nature of such loans (I.O.U. is a joke in legal terms) - in order to fight boom-bust mechanisms, which clearly falsify market signals.
But I thought that you will get the fraud part when you mentioned "recording assets and liabilities"... If you issue certificates claiming they are $100 in your gold and you don't own that money -- you are fraudulently overstating your assets. As George Gaskell noted here once, the concern over the fraud of fractional reserve banking is not limited to the agreement between the bank and its customer, but between the customer and the person the customer pays with that bank's "money." And the person he pays with it. And so on.
Published: March 30, 2007 11:11 PM
Sasha Radeta
I managed to drop this part (still George):
“You can't legally sell junk bonds while claiming that they are AAA-rated. So, you shouldn't be able to pass 8%-backed banknotes as though they are deposit-backed money substitutes* (*or "warehouse receipts" on physically existing money).
In every other area of commercial life, disclosure of important facts concerning the risk of default is required to avoid fraud. Banks, for some reason, are allowed to pretend that their negotiable instruments are backs by "deposits," when in fact they are backed only by a shell game of loans from customers and to borrowers.”
Published: March 30, 2007 11:32 PM
RogerM
Alex, As I think about it more, your example was one of the velocity of money, or how quickly money changes hands, not the creation of money from nothing. In times of high inflation, velocity increases and acts very much like money creation. Fortunately, velocity is pretty stable most of the time and nothing to worry about.
rtr: "Money" can be created at whim as promises in a free market." You example doesn't show money creation at all, just simple loans.
Let me give an example of real FR banking: Suppose I had $100 worth of gold and I had 10 friends who want to borrow it. Let's also assume that no other bank exists in my town. So I establish a bank where they can deposit the loans I give them and write checks on the accounts. I also know that since I have the only bank in town, any merchant that receives a check drawn on my bank will open an account with my bank and deposit the check. Knowing all of this, I will loan the $100 I have to all ten friends so each has $100 in his account to spend as he wishes when he wishes. I can do that because I know from reading about FR banking that in any given day, I need only $100 in cash to meet the town's demand for cash. I've taken $100 and turned it into $1100 with nothing more than a pen and paper. That's how FR banking works and why it should be illegal.
Now if someone else opens a bank, things get more complicated and I may need to hold more cash in reserves, but the principle is the same.
Published: March 30, 2007 11:48 PM
RogerM
Mike:"They might have been following Rothbard's idea of the RBD, but they certainly weren't following the simple RBD rule of "issuing new money in exchange for assets of adequate value".
Now you sound like all socialists: "Stalin and Mao weren't true socialists; they didn't do it right." Only you're saying the Fed wasn't following the RBD correctly. Funny, they sure thought they were.
Published: March 30, 2007 11:59 PM
rtr
RogerM: "Your example doesn't show money creation at all, just simple loans."
What's being just "loaned"?
New subjective value is created in the discovery of oil underneath my land. I buy equipment to drill that oil by offering a percentage of future oil production. I pay workers to work the equipment by giving them stock options. There's nothing to pay back if the operation fails or it turns out the size of the oil deposit was vastly over estimated. I own the equipment and had labor traded to me. What's to prevent those workers from immediately trading all or some of those options for other goods? What's to prevent those equipment manufacturers from immediately trading all or some of those promised percentage of future oil production for other goods?
If someone trades a song for a dance how is that any different then digging up more gold in the hills, or any different then selling limited edition celebrity autographed paper bills with their pictures and numbers printed upon them?
Published: March 31, 2007 4:35 AM
Alex MacMillan
Sashda and RogerM: When I lend out $100 and someone is willing to take the demand loan proceeds in the form of my note (my demand I.O.U., which has, written on the front, "Backed ONLY by Alex's good name"), this obviously involves no fraud of any kind. The borrower takes my note with the faith that he can buy produce with it. If he can't, I'm sure he'll be back on my doorstep and either simply pay off his loan with my note or demand fiat money, gold or what-have-you, instead of my I.O.U. When the borrower trades my note for produce, there is no fraud as the seller of the produce knows me and is willing to accept my note (my demand I.O.U.). If the seller of the produce wants to, he can come to me and demand that I give him fiat money, gold, or what-have-you. If I am short of gold or fiat money in my company to redeem my note, I can either borrow or demand that my borrower pay his demand loan. If my I.O.U.s will not circulate, then so be it, I have to shut down my banking venture. Otherwise, I can continue operating in the fashion I have described, with each borrower and seller of produce completely aware that they are accepting my notes (my demand I.O.U.s) purely on the basis of my promise to pay if someone wants to redeem them. There is no theft and no fraud of any kind here.
If my business grows and all holders of my demand I.O.U.s choose at the same time to try and redeem them for fiat money or gold, I shall have to call in all the demand loans that I have made. But I am very wealthy and very prudent and will redeem my I.O.U.s promptly with my own funds, while I wait to collect my demand loans. I may end up having to close my venture, but I doubt it because when people see my smiling face as I willingly redeem the first batch of my I.O.U.s the redemption flow will probably dry up. If it doesn't then I'll have to close my venture and I may take a loss on it. But I am very wealthy and very prudent, so I would never expand my venture to the point that the loss I may take from liquidating all my demand loans and redeeming my I.O.U.s would eat that much into my wealth.
I may have forgotten to mention this, but my I.O.U.s pay interest. This is one of the features that holders of my I.O.U.s like. In fact, some people prefer my I.O.U.s for this reason over fiat currency.
By the way, holders of my I.O.U.s can, if they wish, deposit them with me. In return, I give them credit and debit cards and checkbooks.
What's the Austrian libertarian argument for stopping all my borrowers, holders of my I.O.U.s, sellers of produce, acceptors of my credit cards, etc. from voluntarily so doing?
Published: March 31, 2007 10:03 AM
RogerM
rtr: "New subjective value is created in the discovery of oil underneath my land."
That doesn't make any sense. No one can create subjective value. Subjective value means nothing more than that the value of a thing is determined by each individual's assessment of it. In your example, nothing has been created. You discovered oil; you didn't create it. Then you borrowed someone else's money with the oil as collateral. If you lied about the oil, and none really exists, you still will have to pay back the loan. I can't see how you get the creation of money out of that example. It simply doesn't exist!
Alex: "What's the Austrian libertarian argument for stopping all my borrowers, holders of my I.O.U.s, sellers of produce, acceptors of my credit cards, etc. from voluntarily so doing?"
Because you're committing fraud! No one would ever accept your IOU's as payment unless they believed that you had the ability to convert the IOU's into real money. If you actually have the money, fine. But if you just keep a fraction of it in reserve, as I described in my example, then you're lying to everyone you give an IOU to. In addition, each person who has one of your IOU's has a claim to the same small reserves you set aside. That's fraud in the most obvious case. Just try to go to several banks and borrow the full amount of your home equity from each one. You'll end up in jail because you're committing fraud.
If you don't understand this, then you don't understand the most basic message of Austrian economics: money loaned must come from savings which result from the reduction of consumption.
Published: March 31, 2007 11:06 AM
Alex MacMillan
RogerM:
But I explained to you that I was very wealthy. I had lots of T-bills, stocks, real estate, you- name-it, besides the loan assets of my venture. Everyone knew that I was very wealthy. Please explain the very first transaction that I made that was fraudulent and why it was fraudulent. Whenever I gave out an I.O.U., I stated that it was backed by my good name. Everyone knew that I had much wealth in addition to my little banking venture so that no one would ever lose from my I.O.U.s. Where's the fraud? You seem to keep saying it's fraud because you wish it were so.
Published: March 31, 2007 11:27 AM
Mike Sproul
RogerM
"Now you sound like all socialists: "Stalin and Mao weren't true socialists; they didn't do it right." Only you're saying the Fed wasn't following the RBD correctly. Funny, they sure thought they were."
The difference is that I'm right and socialists are wrong. Critics of the RBD usually attack the idea that money must only be created in exchange for "productive" assets (e.g., a farmer's IOU which will be paid off when he sells his crops). The RBD advocates that I know of (Law, Clement, Bosanquet, Tooke, Fullarton) never phrased the RBD in that way. They only said that money must only be issued in exchange for "good security" (i.e., assets of adequate value). This misunderstanding was a major factor in the mistaken rejection of the RBD, and a major reason why people at the Fed made a mess of it.
Published: March 31, 2007 11:37 AM
RogerM
Alex: "You seem to keep saying it's fraud because you wish it were so."
You're not reading my posts well. I said if you had the money to back up the loans, then there is no problem. Only if you don't have the funds to back up every dollar loaned are you practicing FR banking and fraud by creating money out of nothing.
If your wealth can cover all of the loans, then no one would care that you make such loans. However, you'll have to convert some of those assets to cash when the people you loan to quit loaning to each other and actually buy something. At some point, someone will bring one of your IOU's to you and demand cash, at which point you'll have to sell an asset to make the IOU good. I don't see anything wrong with that and I don't know of any Austrians who have condemned such activity.
Published: March 31, 2007 11:39 AM
RogerM
Mike: "The difference is that I'm right and socialists are wrong."
I see no reason to think that you know more about RBD than did the Fed Board members.
Mike: "This misunderstanding was a major factor in the mistaken rejection of the RBD, and a major reason why people at the Fed made a mess of it."
I imagine the main reason for rejecting RBD is that it's nothing more than a defense of fractional reserve banking. If money should be created to satisfy every businessman who has sufficient collateral, without regard to savings, then there is almost no limit on the ability to inflate the money supply. But if the money available to loan to businessmen is limited by what others save, then the money supply won't grow.
Any money loaned to businessmen, regardless of the collateral, that doesn't come from savings due to reduced consumption, is money created out of nothing, in other words, countefeiting. It doesn't matter that you say the money is backed by an asset. The money loaned did not belong to someone else who decided to forego consumption and save it; it was simply printed.
Countefeit money, regardless of what asset backs it, inflates the money supply artificially and according to the quantity theory of money causes prices increases. If you don't accept the quantity theory of money, then there's nothing more to discuss. I'll just include you with other cranks like Al Gore and his global warming nuts.
In addition to the price increases caused by money inflation, Austrian econ shows that money inflatin also causes entrepreneurs to make serious mistakes in investments, which they would not have otherwise made, and the destruction of wealth as a result. History has shown the the RBD causes all of the above.
Published: March 31, 2007 12:21 PM
adi
RogerM, your attack against Sproul was not very polite. And it was also wrong in it's substance since prof. Allen Dalton has also said something about Fed's policy in those times being at variance with the RBD theory. Mr Dalton has posted few times at this blog.
But why there ever should be a central bank in existence if the RBD is right monetary theory? RBD advocates have spoken about real bills being "self-liquidating" and that reflux principle should remove excess money if situation would be such that there is extra paper money circulating.
Specie convertibility has been suspended often when this principle has threatened whole monetary system (also during war times governments have done that).
Mike, why should anyone who receives notes from the second bank in your paper accept those in their nominal value since they are just options to lottery tickets (remember that notes from the first bank are not backed with 100% commodity money)? Option is usually valued very much less than the market price of underlying security, since it only gives chance to use it if profitable.
RogerM, I think that you have followed De Soto's definitions too closely since there exists alternative theories about what are deposits. De Soto thinks that deposit is same as warehousing contract. Selgin and White have challenged this view.
Many Austrians here have stated that they would accept FR banking if proper information is given to the customer concerning nature of this banking practise. So then there would not be fraud. I support this view.
Published: March 31, 2007 12:51 PM
Alex MacMillan
RogerM: Accoring to Adi, "Many Austrians here have stated that they would accept FR banking if proper information is given to the customer concerning the nature of this banking practise. So then there would not be fraud."
If this is the case, then let's eliminate the ranting against fractional reserve banking per se. Of course, anyone would agree that information that is untrue that gives rise to a transaction is fraudulent. That's why I was careful that in my example that everyone knew that it was my good name and the fact that I had lots of equity that backed my I.O.U.s. I repeat: All my I.O.U.s were backed by demand loan assets that I had. On top of that I had lots of equity. A sound fractional reserve banking system would operate the same way, and there is no fraud in such a system.
Published: March 31, 2007 2:10 PM
Björn Lundahl
My view is that fractional reserve banking should be considered fraudulent because of the reason that bankers cannot fulfil their obligations against all their depositors. This is a logical proof by itself.
It does not matter if bank depositors are well educated in fraudulent banking procedures or not. Reality and logic sets the limit and real laws should be in accordance with reality. Otherwise they are destructive and wrong. No contracts can invalidate reality and logics.
A true monetary loan is an exchange of present goods for future goods, whereby “the future” is defined as an agreed upon time between the parties when the loan expires.
If a “depositor” really wants to lend out his money, he should also comply with what a true loan is and “not try to eat his cake and still try to keep it.”
An Austrian economist has all the reason in the world to be against fractional reserve banking as he wants the economy to correspond to a true voluntarily saving ratio and not to a vague (and therefore fraudulent) one. Because of the fact that fractional reserve banking is relied upon this vagueness and therefore swindle, he also knows that this very vagueness and swindle are the really causes of horrible and anti social depressions and business cycles, which he therefore wants to end once and for all.
Apart from mentioned logical proof of why fractional reserve banking is fraudulent, another logical proof should also be mentioned and that is that the Austrian business cycle theory by itself proves that “savings” through fractional reserve banking does not harmonize with true voluntarily saving ratios of individuals as business cycles are still existent in a fractional reserve economy and are, also, the very cause of them. The Austrian business cycle theory teaches “that recessions and depressions are caused by initially lowering of the rate of interest which do not correspond to true saving ratios, but by increases of the money supply. When the economy adjusts to true saving ratios, malinvestments are liquidated.”
In other words the depositors have been deluded that is being exposed of fraudulent actions by the banks.
We could say that slave contracts should not, in a libertarian society, be allowed for the same reason i.e. they are contradictory and not in accordance with reality and logics as;
“A man cannot renounce his right to self-ownership, since a man in his very nature controls his own mind and body (natural disposition), that is, he is a natural self-owner of his own will and person (having a free will) and he will still be so even if he has “tried” o renounce his natural self-ownership to another person. He cannot renounce something which is a biological and physical fact of his very own life and which will never, as long as he lives, leave him.”
Björn Lundahl
Göteborg, Sweden
Published: March 31, 2007 3:23 PM
Björn Lundahl
Recessions and The Great Depression were caused by Government Interventions!
In a purely free market (without Government intervention), the rate of interest is determined by people’s “willingness to save and invest” (which is called people’s time preferences) for future use, as compared to how much they are “willingly to consume now”. If people change their “willingness to save” (time preferences) and want to save more, the additional savings will cause the rate of interest to fall (increased supply of savings), and businesses will borrow and invest these additional savings. When the Central Bank (for example The Federal Reserve) increases the money supply and expands bank credit (which Central Banks does everywhere and all the time and always “out of thin air”), it initially lowers the rate of interest and thereby misleads businessmen to act in a manner as if true savings have increased, which in turn leads businessmen to invests those supposed savings in capital goods. New projects that were not profitable before, will now suddenly with this lower interest rate, be profitable. While this process is working, the economy is in an inflationary boom phase (expansion). Capital goods such as stocks, real estate etc, will be more demanded and invested in, and prices of those will rise faster and more intensely in relation to consumption goods. As these supposed savings have worked their way through the economy, prices of goods, services and wages have generally increased to a height which prices for them would have not reached without these supposed savings.
As mentioned, people’s “willingness to save and invest” have not changed (people’s time preferences have not changed) for it was only the Central Bank that increased, out of thin air, additional “savings”. When supposed savings have worked their way through the economy and are received, finally, in increased wages, people still spend their real wages in the same manner as before. They save/ consume in real terms and in same proportion to each other, as before mentioned increase in supposed savings. Because of this, a lack of savings will occur and the rate of interest will rise. Projects that businessmen have invested in and that seemed to be profitable when the rate of interest was lowered are now revealed to be unprofitable. All those investments are revealed to be malinvestments. Businessmen will stop investing in those projects and lay off workers. Prices of capital goods, real estate, stocks etc, will fall sharply and relatively to the fall in prices of consumer goods. The economy is in a depression phase. When those investments are liquidated, the economy is adjusted to people’s “willingness to save and invest” and to consume. The economic structure corresponds to the ratio which people want to save and consume. The economy is now healthy again.
Now then, in the 1920s the Federal Reserve, in the US, increased the money supply and bank credit, which in the 30s resulted in The Great Depression. The same story goes with Japan during the 1980s, which during the 90s, resulted in a depression, go to; http://en.wikipedia.org/wiki/Japanese_asset_price_bubble
In Sweden we had banks lending out heavily during the late 80s, which also, led to a depression in the 90s.
All business cycles are caused by the same phenomenon. Economic crisis can occur because of other factors such as wars, boycotts, oil prices etc, but pure business cycles have in common the same cause.
I have tried, in a very few words and in a easy manner, to explain Ludwig von Mises business cycle theory, which is also called the Austrian theory of the business cycle. All faults are mine. Friedrich August von Hayek elaborated this theory and received in 1974 the Nobel Prize* for this. Go to;
http://nobelprize.org/nobel_prizes/economics/laureates/1974/
If you want to know more about this theory, go to;
http://mises.org/rothbard/agd/contents.asp
And to;
http://mises.org/money.asp
Björn Lundahl
Göteborg Sweden
* Information about the Nobel Prize in Economics, go to;
http://cepa.newschool.edu/het/schools/nobel.htm
Published: March 31, 2007 3:59 PM
Björn Lundahl
Any great and sudden change in the economy that is not anticipated such as increased or decreased savings, increased hoarding etc can cause crises and problems. Rothbard has also mentioned this.
But those are rather economic fluctuations, and are they anticipated, the business community can easily cope with them without causing any problems at all.
There is a time lag between increases of the supply of money and prices.
If monetary authorities anticipate that aggregate demand will fall in the future, and therefore increases the supply of money today, there is a time lag between those actions and their impact of aggregate demand.
Changes in aggregate demand can be anticipated by the market. Businessmen are trained specialists in their capability to anticipate changes in the market place and anticipated changes of market prices in the future cause immediate changes of prices today and the necessary adjustments.
If there is a fall in aggregate demand, monetary authorities cannot offset this by increasing the supply of money without causing a business cycle.
Increases of the money supply can not be neutralized even if they are anticipated because there is no way to distinguish them from real savings. They are borrowed funds and as they are borrowed, businessmen are deluded to act as if savings have increased.
Consumers can allocate their economic recourses in two ways: consumption versus savings.
The fact is that during recessions and depressions price falls are extremely much more severe in the capital goods markets than in consumer goods markets.
In Sweden during the early 90s we had an economic depression and only in one year we had an increase of the purchasing power of money of 1% while real estate prices decreased around 50%!
Stocks are titles of capital goods and prices of them fell extremely too.
The same story goes in the U.S. during the late 20s and early 30s and Japan during the very early 90s.
It is true that during depressions prices of some capital intensive consumer goods fall a lot too (durable consumer goods) but they are comparable to capital goods as they render services over a longer term of time and can be regarded as part of a economy’s fixed capital.
To put an end to business cycles fractional reserve banking must be rejected and a 100% commodity money reserve standard adopted (such as gold and silver).
Björn Lundahl
Göteborg, Sweden
Published: March 31, 2007 4:06 PM
Sasha Radeta
Alex,
Please research a little bit about enforceability of I.O.U.s and you'll hopefully understand what kind of nationwide demand you'll have for those legally non-binding certificates. I.O.U.s cannot be promisary notes, but only acknowledgment of a debt, and taken as evidence thereof.
Anyway, your example is irrelevant since banks are not loaning any actual I.O.U.s, but they are actually overstating their assets, claiming they are borrowing non-existing money, and not disclosing true nature of their certificates (fraud).
Published: March 31, 2007 4:07 PM
RogerM
Bjorn and Sasha have made excellent points and I don't have much else to add.
Alex, your last example, in which you are very rich and issue IOU's is not an example of fractional reserve banking. It's 100% reserve banking because all of your IOU's could be paid at once.
As for the Austrians who think FR banking is OK as long as everyone understands what's going on, I would say that might be fine if the banks made it clear to depositors that the bank would lend out their money and there was a good chance they would not get it back, and if the gov didn't guarantee deposits and if there were no central bank. But then, as de Soto argues, the temptation to counterfeit would be too great and depositors would be lulled into complacency after a few years. Eventually, credit would expand again and set off boom/bust cycles. Then citizens would require the government to step in a regulate banking. It's all happened multiple times in history. We can either learn from it or repeat it.
If all that matters to Austrians is liberty, then by all means, allow FR banking. But if we care about prosperity and honesty, we won't allow it.
adi, You thought I was rude to Mike in my last post responding to him. I assume you mean the part about him being a crank if denies the quantity theory of money, which he has already done and which RBD does. Do you think denying the quantity theory is good economics?
Published: March 31, 2007 5:01 PM
Alex MacMillan
Sasha: O.K., Sasha, make them demand promissory notes then. The example remains as and there is not one iota of fraud in any of the transactions. Just to review the transactions briefly: (1) I give a loan of $100 to Ms. A, the proceeds of which are my personal demand promissory note. Ms. A knows how wealthy I am and knows my reputation as one who always pays his debts. She voluntarily enters into the transaction. Where's the fraud?
(2) Ms. A trades my demand promissory note to Mr. B for some goods. Mr. B also knows of me, of my wealth, of my debt payment record and so to make the sale of his goods readily accepts my demand promissory note as payment. Where's the fraud?
I keep a balance sheet for my loan venture. I call it Alexloanventure. Just to take it to the limit, I shall now assume I keep zero fiat money or gold in my venture (I could easily pay out of personal assets if anyone wanted to liquidate one of my promissory notes before I could call in sufficient demand loans).
So after transaction (1) and (2), the balance sheet of Alexloanventure is $100 loans (assets)= $100 demand promissory notes (liabilities). I have created credit out of thin air (actually out of my wealthy, honest and prudent reputation). Ms. A, my borrower is better off for having transacted with me; Mr. B is better off for Ms. A having transacted with me and then transacting with him. What true libertarian would dare prevent such voluntary transactions that benefit all parties involved?
Published: March 31, 2007 5:12 PM
Alex MacMillan
Sasha: Oh, I forgot your last comment about my example being irrelevant "since banks are not loaning out any I.O.U.s, but they are actually overstating their assets, claiming they are borrowing non-existing money, and not disclosing the true nature of their certificates (fraud)."
A bank's balance sheet looks like this:
Assets: $10 cash in vaults & deps. at Fed., + $90 loans of various kinds from securities to direct business and personal loans
Liabilities: $85 deposits + $15 equity
These balance sheets are PUBLISHED so what is the nature of banking fraud. Just because some people are stupid enough not to think for a second or two, and who actually believe that for every dollar of deposit liabilities the bank will have a dollar on reserve, doesn't make it fraud. It makes the people who believe this stupid. Plenty of people do not understand all aspects of well published information on economic transactions. That does not in any way make those transactions fraudulent.
Published: March 31, 2007 5:28 PM
Björn Lundahl
What Has Government Done to Our Money? By Murray Rothbard:
“Defenders of banks reply as follows: the banks are simply functioning like other businesses—they take risks. Admittedly, if all the depositors presented their claims, the banks would be bankrupt, since outstanding receipts exceed gold in the vaults. But, banks simply take the chance—usually justified—that not everyone will ask for his gold*. The great difference, however, between the "fractional reserve" bank and all other business is this: other businessmen use their own or borrowed capital in ventures, and if they borrow credit, they promise to pay at a future date, taking care to have enough money at hand on that date to meet their obligation. If Smith borrows 100 gold ounces for a year, he will arrange to have 100 gold ounces available on that future date. But the bank isn't borrowing from its depositors; it doesn't pledge to pay back gold at a certain date in the future. Instead, it pledges to pay the receipt in gold at any time, on demand. In short, the bank note or deposit is not an IOU, or debt; it is a warehouse receipt for other people's property. Further, when a businessman borrows or lends money, he does not add to the money supply. The loaned funds are saved funds, part of the existing money supply being transferred from saver to borrower. Bank issues, on the other hand, artificially increase the money supply since pseudo-receipts are injected into the market.
A bank, then, is not taking the usual business risk. It does not, like all businessmen, arrange the time pattern of its assets proportionately to the time pattern of liabilities, i.e., see to it that it will have enough money, on due dates, to pay its bills. Instead, most of its liabilities are instantaneous, but its assets are not.
The bank creates new money out of thin air, and does not, like everyone else, have to acquire money by producing and selling its services. In short, the bank is already and at all times bankrupt; but its bankruptcy is only revealed when customers get suspicious and precipitate "bank runs." No other business experiences a phenomenon like a "run." No other business can be plunged into bankruptcy overnight simply because its customers decide to repossess their own property. No other business creates fictitious new money, which will evaporate when truly gauged.
The dire economic effects of fractional bank money will be explored in the next chapter. Here we conclude that, morally, such banking would have no more right to exist in a truly free market than any other form of implicit theft. It is true that the note or deposit does not actually say on its face that the warehouse guarantees to keep a full backing of gold on hand at all times. But the bank does promise to redeem on demand, and so when it issues any fake receipts, it is already committing fraud, since it immediately becomes impossible for the bank to keep its pledge and redeem all of its notes and deposits. [15] Fraud, therefore, is immediately being committed when the act of issuing pseudo-receipts takes place. Which particular receipts are fraudulent can only be discovered after a run on the bank has occurred (since all the receipts look alike), and the late coming claimants are left high and dry. [16]”
http://mises.org/money/2s12.asp
Björn Lundahl
Göteborg, Sweden
Published: March 31, 2007 6:00 PM
Alex MacMillan
RogerM: Sorry Roger I forgot to respond to you. Look at my last example. I have no reserves at all in Alexloanventure. Because I am wealthy I can always eliminate any cash flow (liquidity) problem that might arise from people wanting their promissory notes cashed. Ultimately, if I have to liquidate my entire operation, I may take a loss.
In the case of a bank, as you know, being prudent would mean that the equity of the bank (owners' investment in the banking operation) should be large enough to provide for any cashflow problems that may arise from deposit liquidation. Published information about banks give the public enough tools to judge this or be told by others which banks are less risky than others.
You want to protect the public who are uniformed about bank risk. To be consistent, there must be other things then that you think the state should protect the public from? I'm not saying this is not good thinking; I'm just asking how it is libertarian?
Published: March 31, 2007 6:03 PM
Björn Lundahl
We should also be aware of the fact that fractional reserve banking by itself causes business cycles and, therefore, during recessions or depressions this also causes bank runs as banks are in trouble during this phase of the business cycle.
Björn Lundahl
Published: March 31, 2007 6:33 PM
Björn Lundahl
Milton Friedman blamed the Federal Reserve for not “doing their job properly” during the depression, but if his monetary “theory” was correct it was, really, the market that was to blame for the great depression as it was a need for a Federal Reserve “doing its job properly” in the first place.
Well, a pure free market would be a 100 percent gold reserve money standard:
I quote from America’s Great Depression, by Murray Rothbard:
Preventing Depressions
“Private banks, it is true, can themselves inflate the money supply by issuing more claims to standard money (whether gold or government paper) than they could possibly redeem. A bank deposit is equivalent to a warehouse receipt for cash, a receipt which the bank pledges to redeem at any time the customer wishes to take his money out of the bank's vaults. The whole system of "fractional-reserve banking" involves the issuance of receipts which cannot possibly be redeemed”.
And:
“But a 100 percent gold reserve requirement would not be just another administrative control by government; it would be part and parcel of the general libertarian legal prohibition against fraud. Everyone except absolute pacifists concedes that violence against person and property should be outlawed, and that agencies, operating under this general law, should defend person and property against attack. Libertarians, advocates of laissez-faire, believe that "governments" should confine themselves to being defense agencies only. Fraud is equivalent to theft, for fraud is committed when one part of an exchange contract is deliberately not fulfilled after the other's property has been taken. Banks that issue receipts to non-existent gold are really committing fraud, because it is then impossible for all property owners (of claims to gold) to claim their rightful property. Therefore, prohibition of such practices would not be an act of government intervention in the free market; it would be part of the general legal defense of property against attack which a free market requires.[28], [29] .”
http://mises.org/rothbard/agd/chapter1.asp#preventing_depressions
In other words, if there would be bank runs (which, naturally, would be extremely unlikely as the public knows that the gold is deposited in bank vaults under 100% gold reserve money standard), the banks could meet any claims of the depositors.
We should also be aware of the fact that fractional reserve banking by itself causes business cycles and, therefore, during recessions or depressions this also causes bank runs as banks are in trouble during this phase of the business cycle.
Some consequences of not having a 100% gold reserve money standard:
• Panic of 1819 http://www.answers.com/topic/panic-of-1819
• Panic of 1837 http://www.answers.com/topic/panic-of-1837
• Panic of 1857 http://www.answers.com/topic/panic-of-1857
• Panic of 1873 http://www.answers.com/topic/panic-of-1873
• Panic of 1884 http://www.answers.com/topic/panic-of-1884
• Panic of 1890 http://www.answers.com/topic/panic-of-1890
• Panic of 1893 http://www.answers.com/topic/panic-of-1893
• Panic of 1896 http://www.answers.com/topic/panic-of-1896
• Panic of 1901 http://www.answers.com/topic/panic-of-1901
• Panic of 1907 http://www.answers.com/topic/panic-of-1907
Why should we have central banks and fractional reserve banks that mess things up in the first place? Why should we have business cycles and malinvestments just for the sake to please some perversive lust for power and fraudulent money? Do we really want to have malinvestments? Is unemployment that good? What is the justification?
Björn Lundahl
Published: March 31, 2007 6:44 PM
Björn Lundahl
Mr 007 (License to Steal)
“If I borrow money from you and pay you interest (or not) and agree that I shall repay you on demand, why should that be illegal? Do you believe all demand loans should be illegal? If so, why?”
I might claim my money the next second, minute, day, week, month, year etc.
All demand “loans” should be illegal as they are demand deposits, this because they are redeemable on demand and whenever the depositors claims their monies. The “borrowers” would not be able to use them as they must have the deposits available for any rightful claims of the depositors. This is also why they should not pay any interest and are a contradiction in terms.
A true loan has a maturity date.
If we fool each other greatly enough we shall pay through experiencing another great depression.
Björn Lundahl
Published: March 31, 2007 6:54 PM
Mike Sroul
adi:
"why should anyone who receives notes from the second bank in your paper accept those in their nominal value since they are just options to lottery tickets"
A dollar in a checking account is just an American style (i.e., convertible) call option on a paper dollar, and people accept checking account dollars in preference to paper dollars merely for convenience. Meanwhile, a paper dollar is a european style (i.e., inconvertible) call option on the Fed's gold, and people accept dollars instead of gold for convenience. Note that there are two kinds of convertibility: physical convertibility, where the issuing bank will pay a physical amount of gold for a dollar, and financial convertibility, where the issuing bank will pay a dollar's worth of its assets for a dollar that it issued. When a bank maintains financial convertibility (i.e., conducts ordinary open market operations to maintain the value of the dollar), physical convertibility is irrelevant. Furthermore, convertibility can be immediate or it can be delayed. It is too simplistic to say that the dollar is inconvertible. It might become physically convertible in the future, and it has always been financially convertible. Hence my claim that there is no such thing as fiat money.
Published: March 31, 2007 7:51 PM
Björn Lundahl
The Ethics of Liberty, by Murray Rothbard:
“Unfortunately, many libertarians, devoted to the right to make contracts, hold the contract itself to be an absolute, and therefore maintain that any voluntary contract whatever must be legally enforceable in the free society. Their error is a failure to realize that the right to contract is strictly derivable from the right of private property, and therefore that the only enforceable contracts (i.e., those backed by the sanction of legal coercion) should be those where the failure of one party to abide by the contract implies the theft of property from the other party. In short, a contract should only be enforceable when the failure to fulfill it is an implicit theft of property. But this can only be true if we hold that validly enforceable contracts only exist where title to property has already been transferred, and therefore where the failure to abide by the contract means that the other party’s property is retained by the delinquent party, without the consent of the former (implicit theft). Hence, this proper libertarian theory of enforceable contracts has been termed the “title-transfer” theory of contracts.”
http://mises.org/rothbard/ethics/nineteen.asp#_ftn1
Björn Lundahl
Published: March 31, 2007 7:52 PM
Sasha Radeta
Alex said:
Alex, your statement reminds me of those strange people who always blame rape victims. It seems that you learned your legal theory form RTR. I don't care what bank publishes and I'm not legally bound to research bank owners' assets before I take a simple loan - it should be other way around...
As far as law is concerned, the only thing that matters is the certificate that the bank issues to me. If that certificat states that bank is lending me $100 of their money, that must be the case, otherwise it is a fraud.
If bank is issuing a "mere promise" of $100 it needs to state that on a certificate! Customers should know that mere promises are not legally enforceable - only if bank loans actual, physically existing money, we can talk about exchanges in property titles and enforceable contracts. If someone masks a mere promise of a loan - by stating its actually loaning you (nonexistant) money, that contract is fraudulent and void.
Published: March 31, 2007 11:12 PM
Sasha Radeta
Now check this out Alex -- I will assume something that was never the case in fractional reserve banking -- that banks are complying with contractual law:
People would be free to take someone's "promise" of a loan, and actually pay real money to pay back that promise (do you see how absurd that sounds) -- but they should know that mere promises of something that didn't actually occur are not legally enforceable and that bank can lawfully break a promise.
When a bank loans you a promise of a loan -- and you go and buy some capital with that promise, the only thing between the bank and that seller of capital is a mere promise. Since bank has not received any property from this seller -- there is no basis for enforceable contract. For example if I state here that I will give you a $1 million -- that is not an enforceable contract, since I didn't get any property in exchange from you and my default (change of heart) does not imply any theft.
If I promise you to give you $1 million(which I don't really have) you may be stupid enough to accept my promise and to start paying me for the satisfaction of having my empty promise. But if I change my mind and decide to break that promise, I will not owe a dime to sellers who accepted my promissory note from you.
Basically, sellers gave you their real goods and service in exchange for a promise, which I don't really have to keep. Basically, they relinquished their fortune for free -- and now it is in my discretion whether they will get a single dime. Do you now understand how absurd this scenario is when it comes to national economy -- and why fractional reserve banking must be based on fraud (which is the case right now)!?
Fractional reserve banking based on mere promises could only function in small villages and we would not have bank panics or recessions as its result. Life for most of us is very different. We just don't go into a supermarket and get anything we want based on a promise that our daddies will pick up the tab. That's why perfectly free market would always choose 100% reserve gold standard -- and that's not something that we would have to impose by law if we abolished the FED and government's monopoly in legal tenders.
I hope this makes the case for 100% reserve banking clear, once and for all.
Published: March 31, 2007 11:53 PM
Björn Lundahl
Apart from the fact that a true monetary loan contract has a maturity date, the availability of the money is also transferred from the lender to the borrower (until the loan expires).
When someone deposits a sum of money in a demand deposit the depositor still has the full availability of an equal amount of money.
Björn Lundahl
Published: April 1, 2007 2:23 AM
Alex MacMillan
Sasha: When a bank accepts a demand deposit, a legal and, hence, enforecable contract has been created. For its part, the bank agrees to repay its deposit liability on demand of the depositor. (Just as Alexloanventure contracts to repay its promissory notes with fiat money or gold on demand.) A prudent, well managed fractional reserve bank will always be able to repay its demand deposits on demand as well as its time deposits.
Consider VeryprudentBank. It has $25 fiat currency reserves (asset) + $50 demand loans (asset) + $50 fixed maturity loans (asset) = $45 demand deposits (liabil) + $50 time deposits (liabil) + $125 shareholders' equity. The fixed maturity loans are matched in terms of maturities to the time deposits.
Explain to me how VeryprudentBank will break any of its contracts. Suppose a most unlikely event occurs: the bank loses all its $45 demand deposits at once. It only has $25 of fiat reserves. So it's $20 short. VeryprudentBank calls in $20 of its demand loans. If they are slow in coming relative to the demand deposit withdrawals, VeryprudentBank borrows in the interim. Do you not think that VeryprudentBank could not borrow sufficient funds to manage even the most extreme cash flow problem that we have just imposed upon it? Of course, in practise, VeryprudentBank would not have such a demand deposit run.
If you argue that VeryprudentBank is not the typical fractional reserve bank in terms of its liquidity, I agree. But then we are talking about liquidity requirements for banks, not banning fractional reserve banking.
Published: April 1, 2007 8:04 AM
Alex MacMillan
Whoops, too many "nots" in my sentence beginning: "Do you not think that..." Sorry.
Published: April 1, 2007 9:01 AM
adi
RogerM, Quantity Theory in it's aggregate form is actually misleading theory. It depends on too many assumptions and actually to QT to work we must have situation where dichotomy of real and nominal variables is broken which is something that QT actually says cannot be true!
Look this: MV=PQ where M is nominal money supply (stock), V is velocity of money, P is general price level and Q is an index for real economic activity.
Now we can manipulate this definition in few ways;
M/P=1/V * Q = M/P = kQ which is Cambridge cash balance equation if k=1/V and V is supposed to be constant. Now we suppose that Q and V are constant. Then we can say that increase of money supply must increase price level. But actual transmission mechanism from the money supply to prices is difficult to describe. At least all relations which Friedman has postulated have been found faulty (no constant velocity or stable money demand form and no exogenous money).
Monetary theory must be build on some other foundation and not use QT. There are few attempts; Walras, Mises, Pigou & Keynes, Hicks, Patinkin, Clower, Leijonhufvud, Wallace and Lucas. In Austrian theory there is good thing that money demand is based on individual marginalistic foundation and not to any aggregative analysis.
Published: April 1, 2007 9:27 AM
Alex MacMillan
Adi: It seems to me I remember Friedman saying something like, "Inflation is always and everywhere a monetary phenomenon." Now, I'm notorious for not remembering exact quotes, because I don't try. What's important to me is logic. It's either good or bad, and I don't care who originates it, though I understand that particular individual contributions to good logic may be very important, as are those of Friedman and others you mentioned are.
By "inflation", Friedman meant general increases in the prices of most goods and services. And he believed that such inflation wouldn't otherwise occur in the long run but for increases in the supply of money and credit. Now, I am learning that by "inflation" Austrians mean increases in the money supply. But Austrians, along with Friedman (and correct me if I'm wrong, as I'm sure you will) believe that increases in the money supply cause temporary decision errors and general price increases of goods and services. I don't think Friedman would argue with Austrians concerning the mechansims by which increases in the supply of money and credit cause increases in the prices of goods and services.
Friedman held that the velocity of money was not constant and that it would be difficult to predict how much prices would rise following a particular increase in the money supply.
Published: April 1, 2007 10:46 AM
Björn Lundahl
“If all that matters to Austrians is liberty, then by all means, allow FR banking. But if we care about prosperity and honesty, we won't allow it.”
As I see it, this is based on a misunderstanding. The truth is instead that if it is only liberty that matters, fractional reserve banking should not be allowed. That is also why such libertarian “extremists” as Murray Rothbard and Hans-Hermann Hoppe are against it.
A pure free market (and a pure libertarian society) is based upon the axiomatic principle "that no man or group of men may aggress against the person or property of anyone else".
Well then, fraud is equivalent to theft so this is the reason why fractional reserve banking should not be allowed in a pure libertarian society.
Because of this, fractional reserve banking is based on a government privilege.
Contracts in a libertarian society that are interpreted to have terms that are totally contradictory should not be allowed. For how would it be possible to enforce such contracts? No one would know what to enforce. It is quite obvious.
I have already given several reasons why fractional reserve banking is based on fraud and there is no meaning to write about it again.
I also want to emphasize this: Liberty and Justice are only two labels of the same thing.
Austrian economics goes hand in hand with libertarian ethics.
As Hans-Hermann Hoppe wrote in his book “The Economics and Ethics of Private Property”, pages 234-235:
“Austrians have reason to believe, then, that the time has come when they may succeed in bringing about a fundamental change in public opinion, by reclaiming ethics and economics from the hands of the positivists and the engineering powerful and restoring public recognition of private property rights and free markets based on such rights as ultimate, absolute principles of ethics and economics.”
Björn Lundahl
Published: April 1, 2007 12:33 PM
Björn Lundahl
” Friedman held that the velocity of money was not constant and that it would be difficult to predict how much prices would rise following a particular increase in the money supply.”
This is another misunderstanding. Friedman maintained that there is a close and stable link between inflation and the money supply and, therefore, the velocity of money was stable.
This is also why Friedman advocated a "constant monetary rule" whereby the nation's money supply would grow by a fixed percentage each year, thereby avoiding overexpansion and inflation.
http://www.answers.com/milton+friedman?gwp=11&ver=2.0.1.458&method=3
Björn Lundahl
Published: April 1, 2007 1:13 PM
Alex MacMillan
Bjorn: You say that demand deposits not backed 100% by fiat money (or gold, if you like) are fraudulent. Demand deposits are a contractual arrangement that say (1) that if the depositor wishes his funds, at a moment's notice such funds will be paid out. That's the contract. The contract is not (2) that the funds will be paid out on a moment's notice and also for each dollar on deposit the bank shall have a dollar of fiat money on reserve. You and others keep saying demand deposits are contracts of type (2) when they are not. That's how you are able to claim fraud. If they are of type (1), which they in fact are, then they do not involve fraud.
You may argue that for various reasons (economic stability, etc.) fractional reserve banking should not be permitted, but you cannot validly say that bank demand deposits are anything but type (1) contracts.
Published: April 1, 2007 1:15 PM
Alex MacMillan
Bjorn: Friedman knew that the velocity of money was anything but constant. He knew that technological changes in payment methods, interest rates, and inflationary expectations for example influenced the velocity of money. He also realized that one could not estimate the velocity of money function or, therefore, use it to predict how changes in the money supply would affect nominal spending. This is why he, instead, advocated simple monetary rules for a central bank, rather than having central banks fiddle around trying to influence the real economy in the short run.
Published: April 1, 2007 1:23 PM
Sasha Radeta
Alex,
If sellers know that your wealthy “daddy” is actually a Mafioso who gives empty promises to the entire nation -- promises that by far exceed his current assets -- nobody in their right mind would relinquish the ownership over their real property in exchange for his legally non-binding promises.
Actually, you can’t even compare the state (a violent racketeer) to an individual with a “good name.” Anyway, what kind of wealthy person lives off of mere promises, without spending even a penny of his actual money? Any seller will say that a wealthy individual should not live at other people’s expense -- but actually spend more real money than an “average” person. Nobody in their right mind would accept promises of this “daddy,” who “pays” his debt by giving more empty promises, which he produces either by using a printing press, or by extorting old promises from other victims.
The facts that people would not voluntarily accept this crook’s notes is revealed by the fact that the government must force these legally non-binding promises upon us, as the only legal tender. Furthermore, the government changed the nature of its mere promises: they no longer promise a unit of gold in exchange for a unit of promissory notes. Now you will only get some undetermined amount of undetermined G&Ss (which depends on the amount of notes this crook decides to put into circulation).
More importantly, sales based on (fraudulently presented ad forcefully imposed) fiat currency imply that we live under a socialist regime. Aside from inefficient barter, no real trade takes place in America today. People who think they are trading for money today, actually hand-out their goods and services to other people, without getting anything but fraudulent notes that entitle them to some legally non-binding and nonspecific promises. An economy based on fiat currency is a socialist-communal arrangement, without the use of real money, in which the wealth redistribution is based on government’s implied claim on all goods and services traded within the country. The government injects its promissory notes as it pleases, giving the purchasing power to one group at the expense of another. At the same time, a private cartel that actually issues those promissory notes for the government (the FED) makes the privileged class even more wealthy by feeding it with the artificial credit (fraudulent promises of government promissory notes!), which causes boom-bust cycles that hut the poor the most.
It’s a matter of a simple tautology: The 100 percent gold standard is the logical consequence of the free market’s natural selection and any other system implies fraud and/or socialism.
Published: April 1, 2007 2:41 PM
Björn Lundahl
Friedman believed that the velocity of money was "fairly stable" as he propagated that constant increases of the money supply in agreement with increases of total output would lead to a "stable price level" and unchanged purchasing power of money. This would only be possible if the velocity of money was "fairly stable".
I have a lot of economics books written by Milton Friedman and all of them include statistics which "proves" the relationship between increases of the money supply and decreases of the purchasing power of money.
I myself do believe that logic by itself prove the relationship as economics teaches us that if the supply of marketable commodities increases, the price of each unit will fall.
As this is true, it is also true that if the supply of money-commodities increases, the price of each unit will fall.
If the demand for money increases? Well that is another story.
Björn Lundahl
Published: April 1, 2007 2:41 PM
Sasha Radeta
Alex,
Your VeryprudentBank. shows that you are not reading very carefully, and I can tell that by the fact that you actually posted something other than: "O.K. Sasha, I understand now."
I am forced to repeat this one more time (unfortunately):
"When a bank loans you a promise of a loan and not an actual money -- and you go and buy some capital with that promise, the only thing between the bank and that seller of capital is a mere promise. Since bank has not received any property from this seller -- there is no basis for enforceable contract. For example if I state here that I will give you a $1 million -- that is not an enforceable contract, since I didn't get any property in exchange from you and my default (change of heart) does not imply any theft."
That situation does not make any sense and banks know it. That's why they fraudulently claim they are loaning actual money to people (which really does not exist) -- instead of being straightforward with people and telling them they are actually receiving legally non-binding promises of a loan.
Don’t confuse yourself with numbers and trying to pretend you know anything about accounting. You showed you “knowledge” in our trade deficit discussion, when you showed that you don’t even know what is the “capital account.”
Published: April 1, 2007 2:50 PM
Björn Lundahl
“You say that demand deposits not backed 100% by fiat money (or gold, if you like) are fraudulent. Demand deposits are a contractual arrangement that say (1) that if the depositor wishes his funds, at a moment's notice such funds will be paid out. That's the contract.”
Yes that is the contract and nothing else.
If you read my comments you can understand that there exist several reasons why fractional reserve banking is based on fraud. Each of them is good enough.
A summarization:
A/ Fractional reserve banking should be considered fraudulent because of the reason that bankers cannot fulfil their obligations against all their depositors. This is a logical proof by itself.
B/ Demand deposits are not true savings as Austrian business cycle theory by itself proves that “savings” through fractional reserve banking does not harmonize with true voluntarily saving ratios of individuals as business cycles are still existent in a fractional reserve economy and are, also, the very cause of them. Well, if they are not true savings they cannot be true loans.
C/ Fractional reserve banking by itself causes business cycles and, therefore, during recessions or depressions this also causes bank runs as banks are in trouble during this phase of the business cycle. This also means that during recessions or depression fractional reserve bank’s assets have plummeted in value.
This is also why history is full of bank failures such as these:
• Panic of 1819 http://www.answers.com/topic/panic-of-1819
• Panic of 1837 http://www.answers.com/topic/panic-of-1837
• Panic of 1857 http://www.answers.com/topic/panic-of-1857
• Panic of 1873 http://www.answers.com/topic/panic-of-1873
• Panic of 1884 http://www.answers.com/topic/panic-of-1884
• Panic of 1890 http://www.answers.com/topic/panic-of-1890
• Panic of 1893 http://www.answers.com/topic/panic-of-1893
• Panic of 1896 http://www.answers.com/topic/panic-of-1896
• Panic of 1901 http://www.answers.com/topic/panic-of-1901
• Panic of 1907 http://www.answers.com/topic/panic-of-1907
D/ Demand “loans” are demand deposits, this because they are redeemable on demand and whenever the depositors claims their monies.
E/ A true loan has a maturity date.
F/ Apart from the fact that a true monetary loan contract has a maturity date, the availability of the money is also transferred from the lender to the borrower (until the loan expires).
When someone deposits a sum of money in a demand deposit the depositor still has the full availability of an equal amount of money.
Björn Lundahl
Published: April 1, 2007 3:15 PM
Alex MacMillan
O.k. Sasha I guess I understand now: All those accounting exams I set for people getting their certified management accounting certificates should be recalled. Look, where did I say that I thought the government should issue fiat money and control the money supply?
Bjorn: My last example of VeryprudentBank showed that your A. reason for fractional reserve banking was wrong, so there's no sense in my repeating that. We're just going to disagree on the fraud thing with regard to demand deposits and demand loans.
So to further my understanding of your logic, would you consider a bank that issues only time deposits and perfectly matches the maturities of such time deposits to loans as committing any fraud? My guess is that you would say no, since the depositor has effectively, via the bank, simply transferred his savings to the bank's borrower.
What if a bank had all the maturities of its deposits perfectly matched with its loan portfolio except for a $100 deposit due in 2 years with the bank having loaned the funds out for 2 1/2 years? My guess is that you would argue that the $100 time deposit acceptance involved some fraud.
Are these last two contentions here correct?
Published: April 1, 2007 5:53 PM
Sam
Isn't the grump between fractional reserve banking and fiat currency the same? That is a great many of you fear to be one day holding just a piece of paper? Three things keep bugging me:
1. Why would anyone corrupt the system causing hyperinflation? Everyone's out to make money right?
2. Isn't this a question of risk-taking and forward momentum? Yes credit is riskier than gold currency but it allow people to access funding for building enterprises when it is needed, no? The big problem with gold was that people tended to have to find more gold to get any funding? Was this problem with gold was why Williams Jenning Bryan wanted silver currency as well?
3. And a question I asked before: rather than worry about 1929 what of 1989? Why didn't the stock market crash of 1989 cause a great depression? Especially the 1929 economy was much closer to laissez faire than 1989? Two possible reasons I can think of: a) laissez-faire doesn't provide much solution for a crash, or b) people are far more reliant on the economy than in 1929, when something goes wrong, people are nowadays going to quickly reinvest in society than bother going 'back to the land'.
I probably opt for the second answer with a tinge of the first. Since few of us live 'off the land'. We all have a huge stake in the banking system and currency being decent. Whereas I get a sense that a couple hundred of years ago people did live off the land and got burned from speculators and bank runs went back to simple living and simple equity-based trading.
Published: April 1, 2007 7:46 PM
Björn Lundahl
Alex
I have given you several reasons why demand deposits are not savings. Because of this, I do not believe that your example has any relevance.
Time deposits
Please read the chapter “The Definition of the Money supply” from the book “America’s Great Depression”, by Murray Rothbard.
http://mises.org/rothbard/agd/chapter4.asp#definition
The definition of the money supply is a logical conclusion and is not an empirical conclusion.
As time deposits can be withdrawn at once, they too should consist of 100% reserves.
The principle is that anything that could add to the money supply should be ended by being composed of 100% fiat reserves (or gold reserves in a 100% gold reserve money standard).
Frank Shostak is the expert in defining the money supply. Please read his article of money AMS (Austrian Money Supply).
http://mises.org/daily/1397
Björn Lundahl
Published: April 1, 2007 9:50 PM
Sasha Radeta
Alex,
In your example you mentioned fiat currency as an asset...
I attacked the idea that an entity with a "good name" could ever legally issue a false statement of assets - and that's what fractional reserve banking does, as well as government when it issues fiat currency...
You are just confusing yourself with time deposits... Of course that you may have an agreement with your customers to borrow their money to others and they would ask a higher return on that... But that must be disclosed in contracts with your depositors -- and more importantly, you cannot issue legally enforceable loan certificates if they are not backed 100% by the real assets you are actually loaning. Otherwise, it would be a fraud to mask a legally non-enforceable promissory note in a guise of a real loan.
Published: April 1, 2007 10:13 PM
Alex MacMillan
Bjorn: Time deposits are those with particular maturity dates and cannot be withdrawn on demand. Suppose a bank issues a $100, 365-day time deposit and lends the funds out for 365 days. In this instance there is no creation of credit "out of thin air" by the bank. The depositor is 'saving' $100 for a year, and via the bank, these savings are being borrowed for a year. The effect is exactly the same as if a person had directly lent $100 to another individual, without the bank as intermediary. If, as you seem to say, 100% reserves need be kept against every loan obtained, why would anyone ever borrow?
Sasha: Change fiat currency to gold then, if you like. I am not enamored with fiat money.
Published: April 2, 2007 9:13 AM
RogerM
Alex: "I'm not saying this is not good thinking; I'm just asking how it is libertarian?"
That's a good question. I don't know if it's consistent with libertarianism or not. I can see the argument for it as a libertarian. After all, throughout the 19th and early 20th century, everyone knew very well that banks were likely to fail, yet they placed their money in them anyway and frequently lost it all.
Maybe FR banking is libertarian, because even when people are very well informed about the risks of a particular behavior, they will go ahead and do it anyway. Examples include smoking, taking heroine, gambling and many very risky investments. We shouldn't protect people from their own stupidity.
But de Soto makes an interesting point near the end of his book when he argues for laws that would allow businessmen to sue banks when the businessmen go broke after a bubble. He reasons that many businessmen don't borrow from banks to expand, but use retained earnings. However, the lower interest rates caused by credit expansion signal to the businessman that his project will be viable when in fact it isn't. The collapse after the bubble hurts a lot of innocent people, workers for example.
If we lived in a purely libertarian society, so that no chance existed of people calling for government intervention, then maybe FR banking would work. We'd still have the business cycles and destruction of wealth, possibly even hyperinflation. That would be the price of liberty. But in a mixed society that's always looking for excuses for government to intervene, I think allowing FR banking just guarantess more socialism.
Published: April 2, 2007 10:05 AM
Björn Lundahl
America’s Great Depression, by Murray Rothbard, chapter 4:
The Definition of the Money Supply:
“In recent years, more and more economists have begun to include time deposits in banks in their definition of the money supply. For a time deposit is also convertible into money at par on demand, and is therefore worthy of the status of money. Opponents argue (1) that a bank may legally require a thirty-day wait before redeeming the deposit in cash, and therefore the deposit is not strictly convertible on demand, and (2) that a time deposit is not a true means of payment, because it is not easily transferred: a check cannot be written on it, and the owner must present his passbook to make a withdrawal. Yet, these are unimportant considerations. For, in reality, the thirty-day notice is a dead letter; it is practically never imposed, and, if it were, there would undoubtedly be a prompt and devastating run on the bank.[2] Everyone acts as if his time deposits were redeemable on demand, and the banks pay out their deposits in the same way they redeem demand deposits. The necessity for personal withdrawal is merely a technicality; it may take a little longer to go down to the bank and withdraw the cash than to pay by check, but the essence of the process is the same. In both cases, a deposit at the bank is the source of monetary payment.[3]”
http://mises.org/rothbard/agd/chapter4.asp#definition
Björn Lundahl
Published: April 2, 2007 10:11 AM
rtr
RogerM: "That doesn't make any sense. No one can create subjective value. Subjective value means nothing more than that the value of a thing is determined by each individual's assessment of it."
That means subjective value is *created* by each individual. "Created", "Discovered", "Determined" ... it's the same thing. After computers were invented and built, *new* subjective value for computers was created.
RogerM: "In your example, nothing has been created. You discovered oil; you didn't create it."
Discovered, created, whatever. New subjective value exists for something, oil under my land, that did not exist before, because it wasn't known before that there was oil under my land.
RogerM: "Then you borrowed someone else's money with the oil as collateral."
Nope, that was the point, nothing was "borrowed". That newly discovered oil was *traded* for stuff, equipment and labor. That's "money", i.e. subjective value, being created at whim, in this case, something newly subjectively valued.
That's the point. Everything which is traded by definition means someone subjectively values that which is traded. Doesn't matter if it's oil, doesn't matter if it's gold, doesn't matter if it's paper dollars. All that matters is it has subjective value for whatever reason(s).
RogerM: "If you lied about the oil, and none really exists, you still will have to pay back the loan. I can't see how you get the creation of money out of that example. It simply doesn't exist!"
Nobody lied about the oil. The oil exists. The size of the oil could be estimated, but those that traded equipment and labor for stock and options knew that the oil deposit was estimated, but still materially benefitted by definition of trade, given the risk of the oil deposit estimate, given the risk of future subjective value price changes in oil. There's no fraud at all in the example.
RogerM: "If you don't understand this, then you don't understand the most basic message of Austrian economics: money loaned must come from savings which result from the reduction of consumption."
We just saw a simple example of new stuff being discovered/created. There's no reduction of consumption. There's new goods to be consumed.
And thus as I wrote:
rtr: "If someone trades a song for a dance how is that any different then digging up more gold in the hills, or any different then selling limited edition celebrity autographed paper bills with their pictures and numbers printed upon them?"
Published: April 2, 2007 10:24 AM
RogerM
adi: "Quantity Theory in it's aggregate form is actually misleading theory."
I agree with your points about the modern expression of the quantity theory. I had in mind the older, more general concept which says simply that if the money supply increases and everything else remains the same, prices will increase. Also, if other things change, such as the level of production, then an increase in the money supply will cause prices to be higher than they would have been otherwise. Included in the theory is the idea that an increase in money lowers interest rates, because lower interest rates translate into price increases for capital goods since their NPV is now greater. If this version of the theory doesn't hold, then much of the ABCT is simply wrong. I'm sorry, but I don't have any patience with people who deny the general version of the quantity theory. The historical evidence for it goes back hundreds of years. Mike argues that RBD would not cause price inflation, even though it increases the money supply. In one post above he asks that we assume the quantity theory to be wrong. Doing so would set back economic theory about 400 years.
I don't remember the specific work, but I recently read Mises' account of hyperinflation in Germany. If I remember correctly, Mises said that the German central bankers were following the RBD and constantly assuring people that their activities were not creating the price inflation; they were simply meeting the demands for money of the business community.
So you have two important examples of the failure of RBD: 1) the US Great Depression, for which Rothbard and the Fed governors at the time thought they were following RBD. 2) the German experience with hyperinflation for which Mises and the German central bankers thought they were following the RBD. Now it's always possible that all of the above were wrong and Mike is right, but I doubt it. Could there have been disagreements over what true RBD was? That's liekly, too. But who represented the real RBD? At best, all Mike can say is that some RBD writers disagreed with the Fed's and the German's view of RBD. So he asks us to give it another try, this time with a few minor modifications that would not change the results.
If Mises and Rothbard are correct, then the Germans and Americans suffered from the disastrous effects of RBD. It's not a coincidence that Germany and the US suffered deaper depressions that lasted longer than those of any other country. At this point, Mike should provide a example of somewhere sometime when the RBD actually worked.
Am I being rude in pointing these things out? Maybe so, but I find no virtue in politeness before either socialism or the RBD, both of which have caused so much human suffering in history.
Published: April 2, 2007 10:32 AM
Alex MacMillan
Bjorn: I seem to by using the term "time deposit" in a different sense than you are, and that Rothbard was. I apologize as this no doubt causes confusion. Perhaps if I change my term to "term deposit", that is a deposit contracted to be withrawn only after a specific term (e.g. 30 days, 365 days, 5 years). Suppose a bank accepts a $100, 365 day, term deposit and lends the $100 out for 365 days, there would be no need for reserves against such a deposit until it matures. This would be all right by you, wouldn't it? When a person lends another $100 for 365 days, the lender never expects the borrower to hold the $100 as reserves. So, in this case, the fact that the deposit borrower happens to be a bank would be no different, right?
Published: April 2, 2007 10:53 AM
Alex MacMillan
Roger: I think that intentional missinformation leading to a contract should always be considered fraud. I'm for the free flow of information. I agree that, under the current system, the central bank can create missinformation to the extent that they hide any information concerning their transactions. I'm not sure we should have central banks or fiat money at all, either. I've only started to think about such things since I've begun to participate in the forums on this great website.
I'm learning quite a lot by my challenging people's statements and people challenging my numerical examples. In economics, I tend to think in terms of short, simple numerical examples. I think simple numerical examples are useful for demonstrating economic logic and are easy for people to challenge.
Published: April 2, 2007 11:08 AM
Björn Lundahl
There exist, naturally, all sorts of things people will do if they are allowed to, but that doesn’t prove that those actions are in accordance with libertarian principles.
Some people might make contracts about slavery if they were allowed to and if they were enforceable.
As I wrote above:
“It does not matter if bank depositors are well educated in fraudulent banking procedures when entering fractional reserve banks or not. Reality and logic sets the limit and real laws should be in accordance with reality. Otherwise they are destructive and wrong. No contracts can invalidate reality and logics.
We could say that slave contracts should not, in a libertarian society, be allowed for the same reason i.e. they are contradictory and not in accordance with reality and logics as;
“A man cannot renounce his right to self-ownership, since a man in his very nature controls his own mind and body (natural disposition), that is, he is a natural self-owner of his own will and person (having a free will) and he will still be so even if he has “tried” to renounce his natural self-ownership to another person. He cannot renounce something which is a biological and physical fact of his very own life and which will never, as long as he lives, leave him.””
It would be irrational to believe that reality and logics are something that is wrong.
None libertarian principles are, of course, those that violate property rights and property rights are principles that are discovered by reason.
Björn Lundahl
Published: April 2, 2007 11:29 AM
Björn Lundahl
I want to add and emphasize this:
Monetary demand loans are, of course, not regarded as demand deposits, but as they lack maturity dates and are payable at any time, they could, logically, be regarded as such and that the “borrower” should therefore be obliged to safeguard the money and have them available for the depositor. I might be wrong here as I, I must honestly admit, have not given much thought about demand loans.
Demand loans should, then, have maturity dates to be regarded as true loans. Those loans, though, could fall due in a very short period of time or, even, on a short notice. In those cases demand loans are not, logically, demand deposits, but real monetary loans.
Banks should function as financial intermediaries between borrowers and lenders and the demand loans that the banks have received or borrowed and later granted or lent should have the same maturity dates.
In those cases the money supply has not changed and the banks have not committed any fraud.
Björn Lundahl
Published: April 2, 2007 11:58 AM
adi
RogerM, I dont believe in QT if it's expressed in it's Anglo-American form (Fisher, Friedman etc).
But I do believe in Austro-Swedish monetary theory which in the long-run produces same effects. So increase in the money supply via ..... increases price level (... fill this mechanism yourself).
Many things which Sproul presented in his paper "There is no such thing as a fiat money" seemed to be very weird like I have already said.
But I dont know if society based on libertarian principles can restrict freedom to make any kind of contracts as participants like to have. And definition of deposit is not so clear as Björn and Sasha have said it to be.
Published: April 2, 2007 1:16 PM
Alex MacMillan
Bjorn: In my last example, I didn't have any loans payable on demand. I had only term deposits and term loans. The word "term" meaning there were fixed maturity dates to the loans and deposits.
Can any Austrian answer my 10:53 AM question?
Published: April 2, 2007 1:47 PM
Björn Lundahl
Sam,
”And a question I asked before: rather than worry about 1929 what of 1989? Why didn't the stock market crash of 1989 cause a great depression?”
What causes recessions or depressions are not stock market crashes, but increases of the money supply through the system of fractional reserve banking, increases that are extremely encouraged by the Federal Reserve.
When the money supply initially increases, the economy will boom (speculative mania in stocks, real estate etc) until it later on will end with a bust. The difference between 1929 and 1989 is that in 1989 the Federal Reserve kept doping the horse that is; it did not let the money supply contract. During the 20s (1921 - June 30 to 1929 - June 30) the money supply grew by 7.7% per annum (per 12 month period). The 20s was the boom phase. From June 1929 to the end of 1932 the money supply contracted by 11.6%.
If the U.S. in the 20s had established a 100% gold reserve money standard, the stock market crash and the following depression would have been totally avoided as all stock market crashes recessions/depressions thereafter.
Björn Lundahl
Published: April 2, 2007 1:49 PM
Björn Lundahl
Alex
Sorry, my post was not supposed to be an answer to your last question.
Those “term deposits” that you mentioned are acceptable.
Björn Lundahl
Published: April 2, 2007 1:57 PM
rtr
Björn Lundahl: "In a purely free market (without Government intervention), the rate of interest is determined by people’s “willingness to save and invest” (which is called people’s time preferences) for future use, as compared to how much they are “willingly to consume now”. If people change their “willingness to save” (time preferences) and want to save more, the additional savings will cause the rate of interest to fall (increased supply of savings), and businesses will borrow and invest these additional savings."
This is false because it does not account for demand for savings. There's a hidden constant demand assumption.
You can save all you want, but if nobody wants what you save, nobody is going to borrow what you save and pay you interest.
Björn Lundahl: "When the Central Bank (for example The Federal Reserve) increases the money supply and expands bank credit (which Central Banks does everywhere and all the time and always “out of thin air”), it initially lowers the rate of interest and thereby misleads businessmen to act in a manner as if true savings have increased, which in turn leads businessmen to invests those supposed savings in capital goods. New projects that were not profitable before, will now suddenly with this lower interest rate, be profitable."
All subjective value for all goods and services is created "out of thin air". That's the *definition* of subjective value. I can't believe Austrians weren't called out on this decades ago.
People assign value to violence as well. As long as government has the violent power to enforce acceptance of its fiat currency, the market will subjectively value that fiat currency no differently then they value any other good or service. In increase in fiat currency is thus no different then in an increase in automobiles.
Drop a $100 fiat note on the ground and observe if anybody picks it up.
No businessman will be mislead by that change in fiat currency supply any more than any businessman would be mislead by an increase in ethanol production plants. Changes in fiat currency supply are broadcasted as market signals through trade in exactly the same way changes in the supply and subjective value of any good or service is broadcast as market signals through trade. Thus, the Austrian Business Cycle Theory is proved false.
You can't on the one hand maintain markets work, and then claim markets don't work when it comes to the supply of fiat currency.
It's unbelievable how wrong current economic theory is, almost the whole way up and down from A to Z, all because of a few simple key mistakes in the foundation. Luckily I'm here to prove things right, and greedily rack up all the Nobel Prizes for the next century, right in the faces of those who thought they were the best with proof that was right under everyone's noses. Alas, to first elucidator go the spoils.
There's no more effect on interest rates from an increase in fiat money supply then there is an effect on interest rates from increasing the supply of any other good or service. The only thing that's going on is subjective valuation of those fiat notes is not constant, just as it isn't constant for any other subjectively valued thing. Thus, "savings" can vanish into thin air EVEN IF NOTHING WAS CONSUMED! Rack it, Nobel Prize #8.
Björn Lundahl: "As mentioned, people’s “willingness to save and invest” have not changed (people’s time preferences have not changed) for it was only the Central Bank that increased, out of thin air, additional “savings”."
This statement is correct. You just have to remember the value for everything else is also created out of thin air. That's subjective valuation.
Björn Lundahl: "When supposed savings have worked their way through the economy and are received, finally, in increased wages, people still spend their real wages in the same manner as before."
There's nothing "supposed" about real 'this' things that are traded for real 'that' things. By definition of trade, all those things are subjectively valued at the time of trade.
Your critique of fiat paper when it comes to subjective valuation is no better then a critique of pet rocks people subjectively valued before.
Björn Lundahl: "They save/ consume in real terms and in same proportion to each other, as before mentioned increase in supposed savings. Because of this, a lack of savings will occur and the rate of interest will rise. Projects that businessmen have invested in and that seemed to be profitable when the rate of interest was lowered are now revealed to be unprofitable. All those investments are revealed to be malinvestments. Businessmen will stop investing in those projects and lay off workers."
This is no different than the invention of the automobile leading to the bankruptcy of the buggy whip industry. Changing subjective valuations issue STOP LOSS orders to production. You have to get over the fact that after government violently forces trade for it's paper fiat currency (by definition a loss for those originally forced to accept them or prevented from copying/counterfeitting or creating fiat money of their own), that paper fiat currency still has subjective value to people when they trade for it.
Björn Lundahl: "I have tried, in a very few words and in a easy manner, to explain Ludwig von Mises business cycle theory, which is also called the Austrian theory of the business cycle. All faults are mine. Friedrich August von Hayek elaborated this theory and received in 1974 the Nobel Prize* for this."
And it's hereby ripped to shreds, proved false. I think that was my claimed Nobel Prize #4 or #5, I forget.
Björn Lundahl: "There is a time lag between increases of the supply of money and prices."
Just as there is a time lag with changes in supply of any good or service and changes in subjective valuation of any good or service.
Why am I being so cocky? Because I was making essentially the same points here 2-3 years ago. I doubt they'll be unnoticed this time, as I'm *proving* them without doubt this time around.
Published: April 2, 2007 2:49 PM
Sasha Radeta
Alex said:
Some sentences are kind of confusing, but in your example we are not talking about money printing. You are referring to a voluntary arrangement in which a depositor allows the bank to use his money as a borrower for a specified period of time. Banks in this case are the actual borrowers or facilitators of further borrowing, which channel people's real savings toward businessmen in need of additional funds.
This is perfectly consistent with 100 percent reserve banking, since loans that banks make from these term-deposits are backed by real savings and they are not produced out of thin air.
Why is this distinction about the nature of borrowed money so important? First and foremost, I already explained why masking your mere promises of a loan by overstating your assets is fraudulent. But there is also another issue that deals with economic consequences of issuing an artificially produced credit:
In your term-deposit example, when people increase their term-deposits, they are actually communicating that started to value their future consumption more - compared to their valuation of present consumption. Maybe these people are insecure about their retirement benefits and want to have more funds at their old age... whatever. When the quantity of these term-deposits go up, we have an increase in loanable funds that banks can facilitate to businesses -- which mean that interest rates go down!
In other words, interest rates in your example will serve as a correct market signal which will guide producers to invest in capital-intensive projects that will satisfy the projected increase in future consumption -- and to correctly move their funds away from satisfying present consumption. In other words, under normal circumstances there is no "cluster of error" among entrepreneurs or epidemics of malinvestments.
On the other hand, when banks artificially create credit, we also have an increase in loans and consequent drop in interest rate. However, this interest rate is not a genuine market signal about consumers' time preference. There is no real increase in savings (future consumption), so consumers are actually more oriented toward present consumption, especially on credit, as the interest rate in their banks goes down. The decision to move investments toward capital for projects finalizing farther away in future, dereases the domestic production of present goods and foreign goods must take their place (current account deficits and a some lay-offs as the result of economy's fatal restructuring). When all these capital intensive projects finalize, producer's supply is by far greater than people's willingness and ability to consume. We have a large surplus and downward pressure on prices and additional lay-offs... we got ourselves a recession.
Tampering with market signals such as prices and interest rates always create harmful distortions. Ask the former Soviets. The specific thing about "fixing" the interest rate (time preference) is that the effects naturally occur with a time lag. Malinvestements don't look terrible at the time they occur, at least not to general public. Remember how George W. Bush glorified the housing bubble in his last campaign...
Anyway, I hope this clears any of your dilemmas about the Austrian attitude toward term-deposits.
Published: April 2, 2007 3:19 PM
Sasha Radeta
Bjorn nicely summarized the origin of interest rate by saying:
To which poor RTR responded: "This is false because it does not account for demand for savings. There's a hidden constant demand assumption... You can save all you want, but if nobody wants what you save, nobody is going to borrow what you save and pay you interest."
LOL!
You just discovered that if people have no demand for money -- there would be no saving and no interest rates. DUH! Since we engage in market exchanges instead of just consuming what we produce -- there is a demand for money and loans. And if the supply of available loans from savings (future consumption) goes up -- the interest rate goes down.
Why do you feel a need of making up a stupid and meaningless attempts of disagreements?
RTR ALSO SAID: All subjective value for all goods and services is created "out of thin air". That's the *definition* of subjective value. I can't believe Austrians weren't called out on this decades ago.
Poor cretin. Subjective value is not created out of "thin air." It is created in human minds and their preferences are reflected in prices and interest rates.
When credit is not based on real saving -- but on "thin air" -- the artificially lower interest rate is falsely communicating people's time preference. Even those of us who understand what FED is doing are not much better off, since we also don't have a natural interest rate that would guide our production.
FINALLY, RTR CULMINATES: "This is no different than the invention of the automobile leading to the bankruptcy of the buggy whip industry. Changing subjective valuations issue STOP LOSS orders to production."
RTR tried to compare the invention of false market signals with the invention of automobile. Ha ha ha ha ha ha ha ha ha. I feel bad, but retarded people like RTR are amusing.
When the invention of the automobile leads to bankruptcy of a buggy whip industry, we have one group of producers (and their workers) who benefit from this invention, we have one industry who is not benefiting -- and finally we have consumers that benefit from this glorious new invention.
On the other hand, when we have malinvestments from artificially lower interest rates, most of our industries become victims of fraudulent credit which overstated real assets of our banking systems -- we have benefits to sellers in Mexico and China who stepped in when our investments incorrectly moved away from projects less remote in time (current consumption) -- and we have customers who are more likely to be laid-off, indebted (they also got cheep credit) and are not benefiting from any new revolutionary product like automobile :)
By the way, you don't understand that subjective valuation of FIAT currency is irrelevant. As long as people are forced to trade with these papers as a substitute for real money, they will be actually valued for the goods and services they can be obtained. Austrian objections to fiat currency are completely different and I outlined them in my response to Alex at April 1, 2007 2:41 PM
You are not a unique case. There are even textbooks written about your psychopathology...
http://en.wikipedia.org/wiki/Megalomania
Published: April 2, 2007 4:25 PM
Alex MacMillan
Without fractional reserve demand deposit banking, surely the rate of interest would not just be determined by people's rate of time preference but also by the profitability of investment. Suppose people wanted (required) a 25% annual return on their money to be encouraged to postpone consumption, but no one could invest to produce such a low-risk return. Then the interest rate would not be 25%.
Published: April 2, 2007 5:25 PM
Sasha Radeta
Alex,
Uh... what?
The required rate of return of my loan is determined by the supply of loanable funds and demand for it. A lower interest rate can either suggests that people's time preference shifted toward future consumption (more saving)-- or it can suggest that we have a serious decrease in demand for loans (people running away from this economy)... During a boom, the latter is clearly not occurring (and the boom should put an upward pressure on the interest rate, ceteris paribus), so the consequence of artificially low interest rate is badly misinterpreting people's real time preference
Published: April 2, 2007 5:36 PM
rtr
Sasha Radeta: "LOL!
You just discovered that if people have no demand for money -- there would be no saving and no interest rates. DUH!"
I didn't use the word "money" dummy. I used the word "savings", of any good, not just money. If you were to assume a constant gold standard money supply, money savings in your ridiculous defintion of savings could never globally increase, by definition, stupid. Money gold standard savings could only be transferred. People save more than "money". Never had any food in your refrigerator to be eaten at a later time?
Sasha Radeta: "Subjective value is not created out of "thin air." It is created in human minds and their preferences are reflected in prices and interest rates."
That's created by whim out of thin air. Humans can value something one moment, then not value it all the next moment, can not have valued something one moment then value it the next moment, not to mention changes in degree of valuations for things. But of course Sasha Radeta must pollute threads with ever more stupid thoughts.
Sasha Radeta: "When credit is not based on real saving"
Nothing can be given unless it exists.
Sasha Radeta: "By the way, you don't understand that subjective valuation of FIAT currency is irrelevant. As long as people are forced to trade with these papers as a substitute for real money, they will be actually valued for the goods and services they can be obtained."
Drop a $100 fiat note on the ground and see if anybody picks it up. Nobody would forcing you to drop it, and nobody would be forcing someone to pick it up, stupid. If you still didn't get it, keep dropping $100 fiat notes until you do dummy.
Published: April 2, 2007 7:07 PM
Sasha Radeta
LOL!
RTR got even funnier and made up more meaningless "disagreements."
Check this out:
Published: April 2, 2007 8:29 PM
Sasha Radeta
LOL!
RTR got even funnier and made up more meaningless "disagreements."
Check this out:
I didn't use the word "money" dummy. I used the word "savings", of any good, not just money. If you were to assume a constant gold standard money supply, money savings in your ridiculous defintion of savings could never globally increase, by definition, stupid.
You poor retard - Bjorn talked about the origin of interest rates that result from saving of money (future consumption). Only money yields interest rate, because it is a "loose joint" (as Hayek called it) between the present and future consumption of any kind of good. Sorry I overestimated your intelligence for a moment.
By the way you poor retard, I don't assume a constant gold supply. Gold supply can go up, just like supply of all other goods, but without a creation of fraudulent credit (one that is based on non-existent assets, false asset statements) there would be no malinvestment issues.
RTR gets even more ridiculous. He says: ". Humans can value something one moment, then not value it all the next moment, can not have valued something one moment then value it the next moment, not to mention changes in degree of valuations for things."
You poor retard - nobody disputed subjectivism. It is the core of Austrian economics. The point here is that subjective valuations can be abused by fraud. And fractual reserve banking is fraudulent, because it is based on mere promises of a loan, disguised in false statement of assets.
And RTR keeps his most stupid statement as a punchline:
Drop a $100 fiat note on the ground and see if anybody picks it up. Nobody would forcing you to drop it, and nobody would be forcing someone to pick it up, stupid. If you still didn't get it, keep dropping $100 fiat notes until you do dummy.
You poor retard, nobody ever claimed that fiat notes are valued. They are valued because it is a forced legal tender, which can get goods or services. If we had a perfectly free market, fiat currency could never exist - and that's why the government has to use its force in order to maintain its fiat standard. HOWEVER, major objections to fiat currency regime are not limited to its socialist and violent nature... We talked about many harmful economic consequences of money created out of thin air... which you were not capable of understanding due to your mental disability.
Regards.
Published: April 2, 2007 8:45 PM
Björn Lundahl
Alex,
Why not take the Austrian quiz? It is very good!
http://mises.org/quiz.asp
Regards
Björn
Published: April 3, 2007 1:14 AM
rtr
Sasha Radeta: "Bjorn talked about the origin of interest rates that result from saving of money (future consumption). Only money yields interest rate, because it is a "loose joint" (as Hayek called it) between the present and future consumption of any kind of good."
Any good can be promised in the future, not just one good called "money".
Sasha Radeta: "I don't assume a constant gold supply. Gold supply can go up, just like supply of all other goods, but without a creation of fraudulent credit (one that is based on non-existent assets, false asset statements) there would be no malinvestment issues."
It still stupid to maintain savings can only exist in an increasing gold supply as well. Savings can exist in any good whatsoever that has subjective value. No asset is immune to changes in subjective valuation. You're free to store your valuables, fiat currency included, in safe deposit boxes. Credit has subjective value. There's nothing fraudulent whatsoever about that. You can lend your neighbor a rake with his promise to return it. You can lend anybody fiat currency with their promise to pay you back with interest.
Sasha Radeta: "The point here is that subjective valuations can be abused by fraud. And fractual reserve banking is fraudulent, because it is based on mere promises of a loan, disguised in false statement of assets."
Promises have subjective value. Insurance can be bought to hedge cover promises too, and for no where near the full amount of the promises. Insurance is a promise to pay too. You gonna call insurance fraud? You trade them money and they trade you a promise to pay if certain events occur. If something has subjective value, it's an asset stupid. As usual, Sasha Radeta's posts are thread pollution.
Published: April 3, 2007 9:25 AM
RogerM
Alex:"Suppose people wanted (required) a 25% annual return on their money to be encouraged to postpone consumption, but no one could invest to produce such a low-risk return. Then the interest rate would not be 25%."
The interest rate reflex people's time preferences, assuming no monetary pumping by banks. If a person requires a 25% return on his money, then he has a very high time preference. In other words, he wants to spend his money now, not in the future, and you would have to pay him a 25% return in order to persuade him to give up his current consumption. Young people tend to have high time preferences. The market interest rate is just the average of all individual interest rates, or of all individual time preferences.
Published: April 3, 2007 10:05 AM
RogerM
rtr: "If someone trades a song for a dance how is that any different then digging up more gold in the hills, or any different then selling limited edition celebrity autographed paper bills with their pictures and numbers printed upon them?"
I really don't understand what you're trying to say with your posts, but I'm trying. Are you saying that if you print paper dollars and people value them and will exchange goods for them, then no fraud exists and so people should be allowed to print money as they wish?
Published: April 3, 2007 10:11 AM
rtr
RogerM: "I really don't understand what you're trying to say with your posts, but I'm trying. Are you saying that if you print paper dollars and people value them and will exchange goods for them, then no fraud exists and so people should be allowed to print money as they wish?"
I'm saying they already do. Go to a sporting autograph convention and have celebrity sportsman sign say a baseball card. That card has subjective value which can be traded for other goods. All it is is paper with a photograph and a signature, and it has subjective value voluntarily established by the market. That's no different at all then gold, which similarly has subjective value, and can be traded for other goods. People sing and dance and trade that for other goods and services too.
All of the goods and services which exist are no different than money. Money is just the most commonly traded thing in exchange. That's why it's "money", and for no other reason than that. As soon as you call money a "medium of exchange" you are in error. And since that is a fundamental building block in the foundation of economic science, that error corrupts other economic reasoning based upon it.
Credit is money, promises are money, as long as they have subjective value. An insurance company's promise to pay if an event occurs has subjective value. If you're insuring your house, you don't deposit the full equivalent value in an insurance company vault. Insurance companies employ statistical anlysis and have far less reserves on hand if total disaster struck and all claims came due simultaneously. If insurance companies were forced to have assets at 100% of potential claims, insurance would not exist. And the market would be worse off, as people could not insure their homes against fire, floods, earthquakes, hurricaines, tornados, etc. That's why insurance companies have fluctuating stock prices, that's why bonds have differing ratings, etc. Insurance companies are not immune to bankruptcy. That does not make their actions fraudulent. Risks are pooled, hedged, sold. Those things are each subjectively valued, even though they are not "hard" physical assets like gold.
Published: April 3, 2007 10:45 AM
Alex MacMillan
rtr: Good points.
Roger: Roger suppose the rate of return on all investment were zero, while everyone had a 25% rate of time preference. What would the interest rate be?
Published: April 3, 2007 10:57 AM
RogerM
rtr: "As soon as you call money a "medium of exchange" you are in error."
So every economist who has ever lived is wrong and you're going to set us all straight? Good luck on that Nobel prize!
All you're saying with your constant repetition of subjective value is that people value things differently. That's all! And subjective value is not a thing, it's an action: people place value on things that satisfy some utility. So how does that help us understand price inflation?
Alex:"Roger suppose the rate of return on all investment were zero, while everyone had a 25% rate of time preference. What would the interest rate be?"
That would be impossible under a regime of sound money. However, in times of extreme hyperinflation, no one would want to save money when price inflation destroyed money's value. So under hyperinflation, like that in Germany caused by the adherence to the RBD, the monetary pumping of new money could reduce the market interest rate to zero, or even make it negative. If the inflatin rate is say 1,000% and the market interest rate is zero, then in reality you would have to pay an interest rate of 1,000% for an investor to break even, or 1,025% for the investor to make a 25% return on investment.
Published: April 3, 2007 11:56 AM
Alex MacMillan
Roger: O.k., then what if everyone's rate of time preference were 10% and the rate of return on investment were 8%, what would the interest rate be? The point is: it is the interaction of people's rate of time preference and the possible investment projects available to provide sufficient rates of return to at least satisfy some people's rate of time preference that determines the interest rate and the amount of saving and investment undertaken.
Suppose there were two people: A and B. A would save $100 if A could get a 12% return. B would only save $100 if he could get a 25% return. There are two $100 investment projects possible: one yields 14% and one yields 5%. There would not be $200 saved, but only $100, and the interest rate would be somewhere between %12 and 14%. Individual B's rate of time preference is irrelevant because there is no possibility to earn such a rate through investment.
Published: April 3, 2007 2:04 PM
Sasha Radeta
Alex said: rtr, good points....
what "good points"? You mean this nonsense:
Who said anything about goods promised in future? Interest rate is calculated on savings on money, because they can be used in future exchanges. RTR lost the track of what he was arguing about.
RTR continued with absurdities:
He is completely out of his mind. I never said that savings can exist only in an "increasing gold supply". He is suffering from hallucinations, and Alex is not even reading his nonsense. Only durable goods can be saved for future consumption, but the interest rate is calculated for those goods that can be used for any kind of consumption. We call those goods money.
Published: April 3, 2007 2:40 PM
Sasha Radeta
Alex
Stating that time preference is "irrelevant" in formation of the interest rate -- is like saying that supply is irrelevant in formation of prices.
Time preference explains only a supply side of loanable funds and not all Austrians agree on this issue (ask Dr. Murphy). Nevertheless, your postings are becoming increasingly absurd.
Published: April 3, 2007 2:47 PM
rtr
Sasha Radeta: "Interest rate is calculated on savings on money, because they can be used in future exchanges."
Wrong. Land can't be used in future exchanges? Realestate? Airplanes? Cars? Grapes? Art? Factories? Etc.?
Sasha Radeta: "Only durable goods can be saved for future consumption, but the interest rate is calculated for those goods that can be used for any kind of consumption."
Wrong again. You can't drink milk two days from now instead of tomorrow?
Sasha Radeta: "We call those goods money."
Oh, so now you are saying "money" is more than just gold or more than just fiat notes?
Sasha Radeta: "Terms of insurance are not mere promises. They are enforceable contract which involve exchanges of customers money for conditional services."
Just amazing how the most pertinent points breeze over your dumb head. The point is insurance is sold in a fractional reserve manner. All claims are not likely to come due simultaneously. If they did, the insurance company would be bankrupt many times over. There's no way insurance is being provided to the masses in anything except a fractional reserve manner based on statistical likelihoods of event occurence. It would be incredibly inefficient to force insurance companies to lock in a vault 100% of the assets required (which itself is no guarantee either as those assets could decline in subjective value) to back the total value of all potential claims. You would end up forcing homeowners, for instance, to own homes without insurance against weather damage. Because of fractional reserve holding in the insurance industry, far more people have insurance for a far cheaper cost than would otherwise be possible. Why would it be any different for banking?
Published: April 3, 2007 3:26 PM
rtr
rtr: "Oh, so now you are saying "money" is more than just gold or more than just fiat notes?"
Run for the inflation hills! Build the Austrian Ark!
Published: April 3, 2007 3:29 PM
Kevin B.
Look, now he's suggesting that an insurance offer and fractional reserve banking must be treated as the same thing.
Sasha, what is the point of arguing? Where is the value? Let the deluded have their self-awarded nobel prizes. Even the real ones aren't worth half as much as they used to be anyway.
Published: April 3, 2007 4:04 PM
RogerM
Alex: "Individual B's rate of time preference is irrelevant because there is no possibility to earn such a rate through investment."
I see what you're saying, but I think you miss the close link between the interest rate and profits. Classical economists used to talk about them being the same thing: the rate of profit and the interest rate are opposite sides of the same coin, both being determined by time preference.
Of course, at any time there are a wide range of profit/interest rates, from 2% cash accounts through 12% junk bonds and possibly 15% in the stock market. The saver will match his time preference and risk tolerance to the appropriate investment. If his time preference is a high as that of most teenagers, then he won't save at all and in that sense his time preference is irrelevant. But it also means he's an outlier in terms of time preferences.
Published: April 3, 2007 4:28 PM
RogerM
rtr: "The point is insurance is sold in a fractional reserve manner."
Just the opposite! In fact, Huerta de Soto uses life insurance as an example of savings that is the opposite of FR banking and therefore contributes to the wealth creation of a society. Insurance is not FR banking because they invest their revenues in interest bearing assets so that they can fully fund claims. However, de Soto does offer an example of insurance that works like FR banking: when the insurance company lets the policy holder write checks on the value of the insurance. Mutual funds that let the owners write checks on their accounts are a similar example.
Published: April 3, 2007 4:34 PM
Björn Lundahl
“Suppose people wanted (required) a 25% annual return on their money to be encouraged to postpone consumption, but no one could invest to produce such a low-risk return. Then the interest rate would not be 25%.”
It would. Businessmen would only invest in capital goods if they yield an interest of at least 25%. That means that prices of capital goods would be settled to a level that makes this possible.
Björn Lundahl
Published: April 3, 2007 4:48 PM
rtr
RogerM: "Just the opposite! In fact, Huerta de Soto uses life insurance as an example of savings that is the opposite of FR banking and therefore contributes to the wealth creation of a society. Insurance is not FR banking because they invest their revenues in interest bearing assets so that they can fully fund claims."
There's no way de Soto means insurance comapanies have 100% non-FR assets on hand to cover the event that all people covered died relatively simultaneously. Let's say the the average policy is $250,000. You would have to tie up $250 billion in assets to cover 1 million people under non-FR insurance system. The current market cap of Microsoft is 273 billion. Multiply that by say 100 million people in the US and uhhhh I guess we don't have enough of an economy for any home insurance or anything else as there isn't even enough to cover 100 million people with $250,000 of insurance, 25 Trillion! 25 Trillion sitting in a vault!
There's a statisical model that says X% will die per period of time. Why can insurance companies get away with only needing to cover the X% that die per time period but banks can't get away with only needing to cover the X% that withdraw per time period?
Published: April 3, 2007 5:17 PM
Sasha Radeta
RTR still makes me laugh. Check out these statements:
Poor RTR, land is not universally accepted medium of exchange, just like airplanes, cars, grapes, art -- cannot be used as generally accepted as future mediums of exchanges. That's why only money has interest rate, because it is a joint between present and future consumption.
Not if it expires tomorrow, you poor dummy. I wish you had a clue what we're talking about. Money must have certain characteristics that will make it a generally accepted medium of exchange (durability, divisibility, etc.) - and that's why it can be loaned to other people and used for investments. Without these characteristics, goods cannot serve as money - and loaning goods cars or milk for investments does not make sense.
Published: April 3, 2007 5:30 PM
Sasha Radeta
Oh, I feel sorry for you man. RogerM just answered you. Again, when someone issues false certificates for non-existing assets -- that person is engaging in fraud. Of course that there are fraudulent insurance companies, but that industry is benign compared to fractional reserve banking who completely falsifies the nature of its notes.
------
The difference between insurance companies and fractional reserve banks is in the fact that insurance company does not claim that their notes are redeemable on demand. Insurance companies disclose the nature of their contracts... Fractional reserve banks LIE about their assets. Anyway, if an insurance company can only function as long as nothing bad happens (and they only exists to take money from people) -- they are crooks too.
Published: April 3, 2007 5:36 PM
Alex MacMillan
Sasha: Name calling is used by those who are angry, who have a desire to try and anger others, or as a last refuge for those whose logic has been defeated but don't want to admit it.
Published: April 3, 2007 5:36 PM
Sasha Radeta
Alex,
The fact that you didn't make such comment about RTR's postings only testifies about your lack of honesty and any decency.
If there was something faulty about my logic, so far you were incapable of pointing it out. You tried to be a cheerleader for RTR, but his latest comments are simply ridiculous. I mean -- we started talking about the origin of interest rates, and this guy is trying to prove that milk can be used for future general consumption (i guess he wants to argue that it can be loaned for an interest rate).
Sometimes name calling does not come from anger, but repulsion. Regards.
Published: April 3, 2007 5:44 PM
Björn Lundahl
Human actions that are intentional are not the same as events occurring because of accidents. Accidents are insurable but not events occurring as a result of human intention.
Björn Lundahl
Published: April 3, 2007 5:45 PM
Alex MacMillan
Sasha: I didn't direct these remarks to rtr because he didn't direct derogatory remarks to me. However, to set the record straight, in my opinion there is no cause here for anyone to call anyone "stupid" or "a moron", etc. I think some people may miss someones logic every now or then or plain disagree with it, but I doubt very much whether anyone posting here is either stupid or a moron.
Published: April 3, 2007 5:53 PM
Björn Lundahl
Bank failures as a result of bank runs are, of course, consequences of human intentions and are therefore, also, uninsurable. Fractional reserve banking and insurance companies are, consequently, working under totally different conditions.
Björn Lundahl
Published: April 3, 2007 6:17 PM
RogerM
rtr: "There's no way de Soto means insurance comapanies have 100% non-FR assets on hand to cover the event that all people covered died relatively simultaneously."
You're right! My bad! Life insurance companies don't have the assets to cover all policy holders if they died all at once. But that isn't relevant to the issue of FR banking. Life insurance policies don't inflate the money supply; that's the key difference. The premiums that policy holders pay each month is money taken out of circulation in the sense that the policy holder no longer has a claim to it immediately as he does with a checking or bank deposit account. The premiums are savings, which the insurance company then loans to businesses. The businesses then re-introduce the savings into the money supply. If a policy holder dies, or decides to cash in his policy after the required waiting period, the insurance company must sell assets to make the payments. As a result, only one person has claim to the funds at a time.
In FR banking two or more people have claims to the same money at the same time. In fact, usually 10 people have claim to the same dollar reserves. Another difference between insurance and banks is the odds involved. Insurance companies, especially life insurance ones, rarely go bankrupt because the odds of all of their customers being killed at once are extremely remote. That's why banks failed so often in the past.
On the other hand, FR banks have extremely high odds that all of their customers will demand some cash at the same time.
By the way, are you going to answer my question as to how subjective value causes inflation? After all, that was the topic of the main article.
Published: April 3, 2007 6:34 PM
Paul Edwards
Björn Lundahl,
Your post of March 31, 2007 3:23 PM was nicely put.
I think for some, it takes a very thorough praxeological analysis of the nature of money and time preference, to be convinced that money must necessarily be a present good, or a claim to a present good, and can never an instrument of debt.
Once this is clearly understood, it further becomes clear that a currency that is based on notes that are not immediately redeemable at par to the real underlying money, are necessarily fraudulent.
I.e. money certificates that are not titles of ownership to immediately available physical money must necessarily be fraudulent.
This is the snagging point for those who say "hey, libertarians live and let live". They think if some are voluntarily contracting to violate a praxeological law, then no fraud is possible. But to violate a praxeological law simply and necessarily requires force or fraud to implement it; there is no way around it.
Published: April 3, 2007 7:30 PM
Mike Sproul
Paul Edwards:
Long time no see!
So if a bank issues "dollar bills" that are each a claim to a square foot of land, and if billions are issued, and no square foot is claimed twice, would you call those dollars money? Would you call it inflationary as more are issued?
Published: April 3, 2007 10:50 PM
Paul Edwards
Hi Mike,
Yes, i've been away from the mises blog for a while. It's nice to see some of the old names again, including yours.
In a completely free market, i would call money whatever arose as money from the barter market. Historically, silver and gold, particularly gold has emerged as the best qualified good as the most highly marketable good and media of exchange, or money. Land, on the other hand was, is and would continue to be a most unlikely candidate to ever emerge on the free barter market as money because it is just so difficult to use as a money. It's way too cumbersome. Almost anything would be better except perhaps commodities that spoil quickly and easily.
So since land itself would never emerge as money, so too, on a free market, would claims to land or titles to ownership of land also never emerge as money. It would definitely be some other commodity with the characteristics that gold for instance, possesses. BTW, the characteristics i'm talking about are it's durability, it's recognizability, its divisibility, relative rarity, fungibility and marketability.
This is why i say it is very important for people to understand the nature of money, and also the nature of time preference before embarking on a discussion of the implications of issuing pieces of paper that also pass for money, particularly such paper that passes for money in a market hampered by coercive intervention by state central banking.
In a free market, people would finally settle on one most highly marketable good as money and when this choice was made it would be final, again baring violent intervention. Money would be this good as well as the paper certificates representing present claims to such goods. Because of the nature of acting man, and how he must use and think of money, for these certificates to be anything other than titles to currently accessible real physical money would simply have to be fraudulent. Money has a very specific meaning to people of all levels of economic sophistication: they all expect it to be a present and most marketable good. It's the nature of money and man.
Published: April 4, 2007 12:03 AM
RogerM
Mike: "So if a bank issues "dollar bills" that are each a claim to a square foot of land, and if billions are issued, and no square foot is claimed twice, would you call those dollars money? Would you call it inflationary as more are issued?"
That's a very interesting concept. However, if you think it through, using land as money might be harsher than gold. If you established the value of current dollars in use in the US in terms of all of the land in the US, then obviously the supply of dollars couldn't not grow unless the US conquered Canada and/or Mexico. A fixed money supply such as this would cause prices to fall as production increased.
Of course, as Paul points out, land doesn't make a good money. One reason is that it would be very difficult to divide up the land and give it to people who wanted to trade in their paper money for the real thing. Also, land doesn't have a homogenous value; some of it is very expensive, such as real estate in downtown NY City, and other is not. Gold still looks like the best bet.
Keep in mind, though, that gold can still cause price inflation as mining productivity increases and the amount of gold produced rises. But at increases in gold production of 2-3%, the price inflation would just about offset increases in population and productivity increases, leaving nominal prices increases at around zero.
Published: April 4, 2007 12:44 AM
Björn Lundahl
Paul Edwards
“This is the snagging point for those who say "hey, libertarians live and let live". They think if some are voluntarily contracting to violate a praxeological law, then no fraud is possible. But to violate a praxeological law simply and necessarily requires force or fraud to implement it; there is no way around it.”
Very true and I do also believe that it is not possible to contact terms that are contradictory. For what is contracted if the terms are contradictory? That is essentially my point. Fractional reserve contracts are a contradiction in terms. If you have a “libertarian view” is beside the point: contradictions cannot be contracted. Period!
If, for example, someone rents a commercial facility and the lease stipulates that the landlord should maintain the ceiling, it is not, logically, possible in the same lease to contract that the landlord has no responsibility if he has been careless and the ceiling leaks. That is also a logical contradiction. Maintenance and some minimum responsibility go hand in hand.
Björn Lundahl
Published: April 4, 2007 1:11 AM
Björn Lundahl
The purchasing power of money, the gold standard and fiat money
If the gold supply will, on the average, increase as much as total output in a 100% gold reserve money standard or not, is not a praxeological fact but a speculation. It might be a relatively good speculation, but it still is a speculation. Technological advancements that favour increased gold supplies have, of course, been going on since the beginning of the industrial revolution.
Historically, prices have on the average fallen when economies were on a gold standard and those economies were not even based on a 100% gold reserve money standard.
Deflation defined as increases of the purchasing power of money is not, at all, harmful for the society and the economy.
Rothbard saw falling prices as a natural condition of a market economy, For a New Liberty:
“Thus, falling prices are apparently the normal functioning of a growing market economy.”
“And, indeed, if we look at the world past and present, we find that the money supply has been going up at a rapid pace. It rose in the nineteenth century, too, but at a much slower pace, far slower than the increase of goods and services; but, since World War II, the increase in the money supply—both here and abroad—has been much faster than in the supply of goods. Hence, inflation.”
http://mises.org/rothbard/newliberty9.asp
Now when another masterpiece has been added to the great family of glorious books in Austrian economics with the title “Money, Bank Credit, and Economic Cycles” written by Jesús Huerta De Soto, I am pleased to quote the author’s comment about the purchasing power of money under 100% gold reserve money standard page 776:
“Consequently one aspect we can foresee is that in the proposed model, nominal interest rates would reach historically low level. Indeed, if on average we can predict an increase in productivity of around 3 percent and growth in the world’s gold reserve of 1 percent each year, there would be slight annual “deflation” of approximately 2 percent.”
And on page 777:
“The model of slight, gradual, and continues “deflation” which would appear in a system that rests on a pure gold standard and a 100-percent reserve requirement would not only not prevent sustained, harmonious economic development, but would actively foster it.”
I quote from the book “Democracy The God That Failed”, by Hans-Hermann Hoppe, page 58:
“During the monarchical age with commodity money largely outside of government control, the “level” of prices had generally fallen and the purchasing power of money increased, except during times of war or new gold discoveries. Various prices indices for Britain, for instance, indicate that prices were substantially lower in 1760 than they had been hundred years earlier, and in 1860 they were lower than they had been in 1760. Connected by an international gold standard, the development in other countries was similar. In sharp contrast, during the democratic-republican age, with the world financial center shifted from Britain to the U.S. and the latter in the role of international monetary trend setter, a very different pattern emerged. Before World War I, the U.S. index of wholesale commodity prices had fallen from 125 shortly after the end of the War between the States, in 1868, to below 80 in 1914. It was then lower than it had been in 1800. In contrast, shortly after World War I, in 1921, the U.S. wholesale commodity price index stood at 113. After World War II, in 1948, it had risen to 185. In 1971 it was 255, by 1981 it reached 658 and in 1991 it was near 1,000. During only two decades of irredeemable fiat money, the consumer price index in the U.S. rose from 40 in 1971 to 136 in 1991, in the United Kingdom it climbed from 24 to 157, in France from 30 to 137, and in Germany from 56 to 116.
Similarly, during more than seventy years, from 1845 until the end of World War I in 1918, the British money supply had increased about six-fold. In distinct contrast, during the seventy-three years from 1918 until 1991, the U.S. money supply increased more than sixty-four-fold.”
Björn Lundahl
Göteborg, Sweden
Published: April 4, 2007 1:55 AM
adi
I would like to ask few things from participants of this discussion:
In theory Supply of Loanable Funds there are two kinds of agents; those who demand money and those who supply it from their savings. I got an impression that someone claimed
(Alex?) that time preference explains only supply curve (so that lenders are willing to lend Y amount of money at X rate of interest).
* Is it true that time preference doesnt explain demand for money in the market of loanable funds?
*Is this demand for money explained by the "marginal productivity of capital", so that entrepreneur asks more funds if the return on physical capital is greater than the cost of it?
My explanation is something like this; It's artificial to distinquish agents in this market. There is just one price of loans whether these loands are used for investment or consumption purposes. Same agent can demand money at one rate of interest and supply it at other rate of interest. Higher rate in this market induces some to supply money when otherwise they would just use it for consumption.
Sasha, have you heard of "own rates of interest"?
* I could short my holdings of milk, invest proceeds to one period loan, go long into a futures contract on one period milk.
*At the end of this period I could use my money to close my long position.
Voila, my milk has just earned me X percent return (own rate of interest of milk)!!!
Published: April 4, 2007 2:18 AM
adi
Mike,
You wrote in your paper "There is no such thing as fiat money" that central bank recognizes notes in circulation as its liabilities and government bonds and specie as its assets.
Now think about following scenario;
Initially central banks notes are inconvertible into specie, but they are backed (only in your theory, I wont believe this) by central banks assets. There are also commercial banks which have used notes from the central bank and IOU's from public as assets backing their own notes. Some banks might use notes from the first banks as assets backing their own notes and so on...
Now suppose that central bank proclaims that after time period T there will be change to convert notes into a specie.
What happens?
1) Financial disaster happens, since customers want to have real money not "funny-money" from central bank. All IOU's and notes from the commercial banks will depreciate in value with respect to specie.
2) Nothing happens. Notes have already value because market participants have used this probability of conversion to specie in their valuation.
Published: April 4, 2007 3:00 AM
Sam
Actually, if Libertarianism is about freedom of choice then what's the gripe about money? If people want to accept paper money that isn't backed by gold in return for goods and services rendered then so what? If they one day find themselves holding on to worthless pieces of paper then tough luck to them? I think most of agree that such pretty pieces of paper have no stand-alone value and therefore should be spent or converted to meaningful investments. Saying that money should be gold or be backed by gold is a case of regulating other people's behaviour . . .
Published: April 4, 2007 5:16 AM
Björn Lundahl
Man, Economy, & State, by Murray Rothbard:
”[44]As has been the case with all theorists who have attempted to deny time preference, Clemence and Doody hastily brush consumers’ loans aside. As Frank A. Fetter pointed out years ago, only time preference can integrate interest on consumers’ as well as on producers’ loans into a single unified explanation. Consumers’ loans are clearly unrelated to “productivity” explanations of interest and are obviously due to time preference. Cf. Clemence and Doody, The Schumpeterian System, p. 29 n.”
http://mises.org/rothbard/mes/chap6d.asp#11._Time_Structure_Interest_Rates
Björn Lundahl
Published: April 4, 2007 6:35 AM
Mark Brabson
Sam:
The whole trouble is, I DON'T want to use unbacked paper. I am FORCED to do so by legal tender laws. If I don't accept the government's paper, I go to jail.
As a protest, I use Liberty Dollars at the small number of retailers who accept them. If legal tender laws were repealed, you could be damn sure I would exchange out all my fiat money within the week for REAL money.
Published: April 4, 2007 9:07 AM
Alex MacMillan
Bjorn: I read your Rothbard reference on interest. Still mystified as to how the interest rate can be determined ONLY by time preference. Another one of my simple examples: Suppose there is one good in existence, trees. We can eat wood, we can make our clothing from wood, etc. Further suppose trees grow at 3% per year. That is to say, if we don't consume a tree today, the tree will provide us with 3% more wood a year from today. Suppose when considering harvesting the 100th tree this year, every person's rate of time preference is 5%. The 100th tree will be harvested since people will prefer the present consumption of wood of the tree over 3% more next year. Perhaps for the same reason the 101st, and 102nd trees are also harvested. But greater present consumption leads to a lower rate of time preference. When the 125th tree is considered for present harvesting and consumption, suppose the everyone's marginal rate of time preference is 2.9999%. The 125th tree will not be harvested at the present time but will be saved (invested) for next period's consideration. Wouldn't it be more reasonable to say that the interest rate, which ends up being 3%, is in fact determined by the rate of return on investment (the marginal productivity of tree growth) than by people's rates of time preference?
Published: April 4, 2007 10:02 AM
adi
Alex,
I can even improve your example; suppose that for each tree planted tomorrow you get only one tree in future. Each tree lasts only period. It can be planted for next period or consumed now. But this is just an physical transformation possibility that each agent has.
There can be consumption loan market where owner of a tree can give his tree for return of (1+r) trees in future time period. One who wants to consume more today consumes less tomorrow.
What you are actually saying is that in the stationary economy (growth zero) there cannot be positive interest rate since each production process produces only enought to sustain itself. That can only be true if each individual is indifferent between consumption today and consumption tomorrow.
We could say that r above is determined by the average time preferences of all individual agents who have supplies to trade for.
Published: April 4, 2007 11:30 AM
Alex MacMillan
Adi: In my example there would be no consumer loans since I supposed, for purposes of the example and just to illustrate a point, that everyone has the same rate of time preference. If, for example, you and I have both a 5% rate of time preference I would want a 5% interest rate from you, but at such a rate there would be no welfare incentive for you to borrow from me, nor I from you.
And if the rate of tree growth were still my 3% when considering the 100th tree, it would be consumed, as would all trees up to the 125th, which would be saved and allowed to grow to another year. At this point, the rate of time preference of everyone (everyone has the same rate of time preference in my example, remember) would be 2.9999%, as determined by the tree investment growth rate.
Published: April 4, 2007 12:29 PM
Mike Sproul
adi:
In 1821, the Bank of England resumed convertibility after a 24-year suspension. There was not much demand for redemption in gold, since people saw that the Bank had adequate assets (gold+bonds) to back the pounds issued. So you could say nothing happened. The reason is that the amount of backing behing each pound did not change when convertibility was resumed (or when it was suspended). In those days, many banks issued paper pounds backed by gold+bonds. The paper pounds were convertible during business hours, but convertibiliity was suspended every night and weekend. The paper pounds did not suddenly become fiat money every weekend, and they didn't suddenly become fiat money when convertibility was suspended in 1797. This time period, however, was when economists first popularized the misconception that "You can't get gold for your pound, therefore the pound is unbacked (fiat) money"
Published: April 4, 2007 1:26 PM
Björn Lundahl
Alex
“Wouldn't it be more reasonable to say that the interest rate, which ends up being 3%, is in fact determined by the rate of return on investment (the marginal productivity of tree growth) than by people's rates of time preference?”
No, the value of getting something more valued tomorrow that is “3% more wood a year from today” instead of the value of consuming that tree today and avoiding the disutility of postponing (waiting) is derived from an individual time preference. Marginal productivity theory doesn’t answer the question where the value is derived from and why the action is done.
As Jesús De Soto wrote in his book “Money, Bank Credit, and Economic Cycles”, page 271 and 272:
“Hence it is impossible to imagine a human action to which the principle of time preferences does not apply. A world without time preferences is inconceivable and would be absurd: it would mean people always preferred the future to the present, and objectives would be postponed, one after the other, just before they were reached, and therefore no end would ever be achieved and human action would be senseless”.
Björn Lundahl
Published: April 4, 2007 1:32 PM
adi
Mike,
I thought that UK entered into a deflationary period for almost nine years after resumption of convertibility in 1821. So paper assets owned by banks and individuals depreciated with respect to gold. And this loss of paper wealth also affected industry and commerce.
This would support point 1) in my question what would happen if convertibility to gold is possible after lenghty period.
Published: April 4, 2007 1:54 PM
RogerM
Alex,
You might want to read Dr. Reisman's chapter on profits. I probably can't explain it appropriately here, but he shows that profits in the aggregate, or macro level, can only result from capitalists consuming part of their income. Somebody correct me here if I get this wrong, but here goes: At the macro level, every business's revenue is another business's costs, so no profits should exist because costs and revenue equal each other. But if the owners of production consume some of their income, profits result. The more the owners consume, the higher will be profits. Higher consumption rates indicate a higher time preference, that is, less willingness to wait to consume tomorrow, otherwise businessmen would invest in greater productive capacity and reduce profits. Capitalists will always borrow money at interest rates up to the rate of profit, when tends to make profit rates and interest rates equal. So time preference, consumption, profit rates and interest rates are all just measures of the same phenomenon. Things don't work that way at the micro level, which is where you're drawing your examples from, only at the macro level.
Published: April 4, 2007 2:17 PM
Alex MacMillan
Bjorn: Of course rates of time preference play a part in determining interest rates. They did in my above example. The 125th tree was not consumed because the rate of time preference of the population at the consumption level of 124 trees per year was just marginally below the tree investment rate of return of 3%. But, if the tree investment rate of return in my example had been 4%, this would have been the interest rate (in this case fewer than 124 trees would have been consumed). If the tree investment rate of return had been 2%, this would have been the interest rate (in this case more than 125 trees would have been consumed). So how can one say that the investment rate of return played no part in determining the interest rate in my example?
Published: April 4, 2007 2:19 PM
Alex MacMillan
Roger: You know, as a new comer, I'm trying to understand the Austrian logic. I dream up my little examples not to try and tear someone's logic down but to try and get straight what Austrians are saying. I have read some Rothbard on interest rates, natural interest rate, rate of profit and so on, and I have to admit I am confused by the terminology he uses. So, I'm trying to get straight what the Austrian logic is on this matter of interest rate determination (in the absence of fractional reserve banking). It strikes me that good economic logic should be able to be demonstrated by simple examples since economic transactions are carried out with straight forward trades between average unsophisticated people like myself. And again I argue that if someone's logic is obtuse on any particular economic matter (as it often is in traditional economic theory) then it's likely not correct.
Published: April 4, 2007 3:12 PM
rtr
RogerM: "By the way, are you going to answer my question as to how subjective value causes inflation? After all, that was the topic of the main article."
Sure, there's a multitude of ways subjective value causes inflation. Start with the thing you call "money".
1.) If the subjective value of "money" decreases, while the subjective value of other goods stays the same, all other goods will trade for more money.
2.) Since money is subjectively valued, there is an incentive to produce more money, just as there is an incentive to produce more food because food is subjectively valued.
3.) All wealth is the aggregate of subjective value, including the subjective value of money (even if that's just as a 'likely' good store of subjective value). There is an incentive to increase the aggregate of all subjective value wealth. Thus, subjective value causes inflation of subjective value by definition of subjective value. That's pure inflation. But note subjective value is not constant or linear. It can go up, down, and all around. There's nothing smooth or monotonic about it.
4.) Every action is done because it increases subjective value for the actor. Every action increases subjective value (at the moment of action, even if the subjective value of things other than the specific occuring action are declining or fleeting).
[That's plenty for now. I'll be away in D.C. from Thurs. - Sun.]
Published: April 4, 2007 3:14 PM
Björn Lundahl
Alex
“So how can one say that the investment rate of return played no part in determining the interest rate in my example?”
Naturally, not any investments would be done if there did not exist any investments corresponding to time preferences (as you have also illustrated). The technical means must always exist.
You could also make up a construction of a scenario where not any investment alternatives exist at all, but still a demand for consumer loans. In such a case a market rate of interest would, still, exist.
Time preferences exist, as you have illustrated, independently of the rate of return on investments, but they do also exist independently of any demand for consumers loans.
A market interest is only an observable entity that symbolizes something that does exist independently of it and all the time, in other words, time preferences.
Björn Lundahl
Published: April 4, 2007 5:01 PM
RogerM
rtr: "If the subjective value of "money" decreases,..."
Why would people value money less? The only reason would be that they have produced too much of it.
"Since money is subjectively valued, there is an incentive to produce more money, just as there is an incentive to produce more food because food is subjectively valued."
In other words, people produce more of what society values and less of what it doesn't value. OK
"Thus, subjective value causes inflation of subjective value by definition of subjective value."
So because people value money, they produce more of it. The increased money supply causes prices to rise. You've merely restated Austrian thinking on the cause of inflation, using very weird terminology. But the Austrian Business Cycle Theory describes why such inflation is very damaging to the economy, is fraudulent, and destroys wealth, which is the reason Austrians want to limit the money supply. Many methods have been tried throughout history to limit the creation of money so that it will retain its value as much as possible, but none has worked better than using gold as the only medium of exchange, that is, as money.
Published: April 4, 2007 5:10 PM
Sasha Radeta
Alex,
I’m glad to see that you no longer claim that consumers’ preference is “irrelevant” when it comes to interest rates. Your confusion stems from the fact that you imagine that borrowers must give their entire, uncertain, future return on investment to lenders.
Imagine a more realistic tree example:
You own an edible tree that is not planted yet, but you don't have any fertile land. You have choice to either consume it, or to give it to landowner for plantation and further growth at an unknown rate. Since you are a mortal, you prefer present consumption to future one and you are willing to forego your present consumption only if you get a 2% larger tree in a year. This is your minimal required rate of return.
Now, if the borrower expects a growth rate that is less than 1%, he is not crazy to loan that tree from you and owe you an extra 1%. on the other hand, if he expects this tree to grow by 4% during the next year, he is not crazy to give you all of it... The most he is willing to give up is perhaps 3%. The interest rate will be formed somewhere between your subjective valuations, based on demand and supply conditions.
------
RTR,
Your talk about “subjective value of subjective value of subjective value by definition of subjective value” is very funny. You understanding of subjectivism is incomplete and superficial.
Austrians know a lot more about subjectivism than you, but they also know that gold standard puts natural restrictions on inflation (increase of money supply), while at the same time subjective valuation of gold does not significantly decrease from factors other than increased supply -- since it is used to obtain valued goods and services and it has value in a range of other uses, from fashion to industrial uses.
Of course that people have incentive to produce more money (causing subjective valuation of money to go down), but the gold production is expensive and limited. Those large costs and law of diminishing returns place that gold-standard barrier against large inflation. That’s why fractional reserve banks resort to fraud, in order to cheaply produce false money certificates. Artificial credit formation leads to false interest rate (that has nothing to do with real subjective valuation of borrowers and lenders) and produces malinvestments. This would not occur under a 100 percent gold standard.
Published: April 4, 2007 5:23 PM
Sasha Radeta
Correction: "Now, if the borrower expects a growth rate that is less than 1%, he is not crazy to borrow that tree from you..."
Published: April 4, 2007 5:25 PM
Alex MacMillan
Bjorn: Don't change my example now, Bjorn. I explained why if everyone had identical time preferences (as they do in my example), there would be no consumer loans. I gave everyone identical time preferences, as I told Roger, just to have no consumer loans. So, again, in the context of my example, if the trees grew at 4% what would be the interest rate? If the trees grew at 2% what would be the interest rate. Answers: 4% and 2% respectively, assuming that at low levels of consumption consumers rate of time preference would be higher than 4% and become lower and lower as consumption levels become higher and higher in any given year. Do you agree? If not, show where my example went wrong.
Published: April 4, 2007 5:31 PM
rtr
RogerM: "Life insurance policies don't inflate the money supply; that's the key difference. The premiums that policy holders pay each month is money taken out of circulation in the sense that the policy holder no longer has a claim to it immediately as he does with a checking or bank deposit account."
Still, there is no certainty as to when the claim will be issued. But I don't even need to challenge that. All that matters is the money supply is being affected, and the market is receiving signals of those effects (in the case of insurance, new subjective value in insurance deflating the relative subjective value of "money" ---> same money supply, more goods and services), whether the effects are inflationary or whether the effects are deflationary, just like the market accounts for changes in supply or demand for any other good or service.
The more subjective wealth there is in the aggregate, the more demand there is for forms of subjective wealth that hedge and store subjective value. What's so good about a massive deflationary pressure from a relatively stable money supply in comparison to a massive inflationary pressure from a relatively unstable money supply in regards to avoiding "mal-investments"? There is none. It's merely the flip side of up (more) or down (less) signals.
Not that I need to flatten the Austrian Business Cycle Theory any more than I already have. So I take it everyone agrees, I have proved ABCT false now? We're just talking about inflation versus non-inflation now?
What's wrong with oil as money? What's wrong with oil futures as money?
RogerM: "Why would people value money less? The only reason would be that they have produced too much of it."
Why would people value *anything* less, money included? That's the point. They have, they do, they will, because subjective valuation is not constant for any good or service, money included, whether the money is gold, fiat paper notes, diamonds, whatever.
RogerM: "But the Austrian Business Cycle Theory describes why such inflation is very damaging to the economy, is fraudulent, and destroys wealth, which is the reason Austrians want to limit the money supply."
The ABCT has already been *proved* false by me, above. Using force to limit the money supply would itself be as damaging as forcing anything to be accepted as money.
Published: April 4, 2007 5:49 PM
Paul Edwards
Sam,
"Actually, if Libertarianism is about freedom of choice then what's the gripe about money? If people want to accept paper money that isn't backed by gold in return for goods and services rendered then so what?"
Yes. This is the "other" libertarian view regarding the ethics of FRbanking. My argument is the following: there is a praxeologically based necessary and inescapable meaning of money, and it does and must mean the same to everyone. It is a present good, or a title of ownership to a present good. Money must be a present good: it must be the ultimate present good: it must be the most marketable present good as decided upon by the free market. And this is necessarily and inescapably the case.
By pure logic alone then, the instant that you find yourself recognizing that the "money" that is handed around in an economy is anything other than what i have just described - that it is debt or a duplicate claim to the same money - it must necessarily have achieved this status via force or fraud. This is inescapably the case. It is as Björn Lundahl states: you cannot make a contract for a contradiction.
"If they one day find themselves holding on to worthless pieces of paper then tough luck to them? I think most of agree that such pretty pieces of paper have no stand-alone value and therefore should be spent or converted to meaningful investments. Saying that money should be gold or be backed by gold is a case of regulating other people's behaviour . . ."
I think, rather it is merely observing what praxeological analysis reveals has taken place: fraud.
Published: April 4, 2007 6:17 PM
Björn Lundahl
Alex
“Don't change my example now, Bjorn. I explained why if everyone had identical time preferences (as they do in my example), there would be no consumer loans. I gave everyone identical time preferences, as I told Roger, just to have no consumer loans.”
I know that and this is also why I called it a “made up construction”. I meant by saying so, that it doesn’t really illustrate reality, in other words, the underlying process of time preferences. That is also why I “introduced” the consumer loan market without any investment alternatives. This is also a fabricated construction that I made. We can fabricate as many scenarios as we want but that does not, really, say anything about the fundamental process of time preferences.
“So, again, in the context of my example, if the trees grew at 4% what would be the interest rate? If the trees grew at 2% what would be the interest rate. Answers: 4% and 2% respectively, assuming that at low levels of consumption consumers rate of time preference would be higher than 4% and become lower and lower as consumption levels become higher and higher in any given year. Do you agree? If not, show where my example went wrong.”
Actually, I have answered that by saying “naturally, not any investments would be done if there did not exist any investments corresponding to time preferences (as you have also illustrated). The technical means must always exist.”
It meant by saying so, that in the narrow sense, you are correct.
But, please for your own insight; do not miss the fundamental process. The fundamental process cannot be disqualified by fabricated constructions. As I told you, I made one myself as an alternative to yours, an alternative which you deliberately excluded, which proves that you are aware of the consumer loan market and that it would exist a market interest even if there would not exist any investment alternatives. My alternative construction was only meant to illustrate that something else is working independently.
I think that you thoughts and questions are very good and sophisticated. Not bad at all. I ask myself questions all the time.
Another proof of time preferences
When I was a kid, I waited passionately for Christmas. I loved battery cars and I dreamt about them, especially police cars. I knew that I would receive a few of them as Christmas presents. A few weeks before Christmas Eve, I was lying on my bed and with my head, I repeatedly hit my cushion for hours crying, I want it to be Christmas, I want it to be Christmas, I want it….
That was a practical example of time preferences.
Björn Lundahl
Published: April 4, 2007 6:43 PM
Sasha Radeta
Alex,
You assume again that people who lend money know what kind of rate of return will their loans generate. That makes no sense.
Plus, your tree example is absolutely nonsensical: If there is no borrowing, there is no interest rate. If you want to create a hypothetical example that makes any sense, you'll follow my scenario....
If a tree owner has a choice between:
a) lending his tree for further growth and future consumption
b) presently consuming that tree...
... His required rate of return is going to be his time preference! That is the minimum he asks for in order to forego his present consumption and make a loan to someone else. He is clueless about the future rate of return, and it would make no sense to a borrower to accept such interest rate, even if it was known to the lender.
Just like RTR, you are trying to ignore replies that truly debunk your postings.
Published: April 4, 2007 7:42 PM
Alex MacMillan
Bjorn: Your example of Christmas, etc. I know as well as you do about time preference and that it plays a part in determining interest rates. I know every consumer does not have identical time preferences to every other consumer and that there are consumer loans. Heavens, I had a brief stint in banking early on in my career.
Nevertheless, it is perfectly valid to assume what I did as a way of illustrating that not only does time preference play a part in determining interest rates but so does the technical side of production.
Published: April 4, 2007 8:11 PM
RogerM
rtr: "All that matters is the money supply is being affected, and the market is receiving signals of those effects (in the case of insurance, new subjective value in insurance deflating the relative subjective value of "money" ---> same money supply, more goods and services)..."
Not even close, but you bring up an important difference between money and all other goods. If we produce too much money, the prices of all goods rise across the board. But increasing the production of one good, such as insurance or oil, won't change the value of money; all that changes is the value of insurance or oil in relation to other goods and money. In order to make the value of money rise, you would have to increase the production of all other goods at the same time. Overproduction in a few segments of the economy is common, but general overproduction is impossible according to Say's law. That's why Austrians say that when you see prices of all products rising, you can bet the Fed is pumping up the money supply.
rtr: "What's wrong with oil as money?"
It's awfully hard to put in my wallet. And production is very volatile. And we tend to burn it up in our cars.
rtr: "Why would people value *anything* less, money included? That's the point. They have, they do, they will, because subjective valuation is not constant for any good or service, money included, whether the money is gold, fiat paper notes, diamonds, whatever."
Again, people don't act arbitrarily. They act to improve their lives in some way. The overall price level remains faily constant, as demonstrated by prices during the 19th century in which the overall price level finished in 1900 about where it was in 1800. There were major fluctuations in between, but not because people arbitrarily changed their minds about goods like a Valley girl. Almost all of the volatility came from government intervention or FR banking crises.
You act as though people act arbitrarily, deciding to value one thing today and not the next. They don't. If people cease valuing something, they do so because it produces less utility for them than something else.
rtr: "The ABCT has already been *proved* false by me, above."
It's clear that you don't even understand ABCT.
rtr: "Using force to limit the money supply would itself be as damaging as forcing anything to be accepted as money."
Force is sometimes necessary in order to maintain civil society. We must use force against murderers and rapists as well as against thieves and perps of fraud. FR banking is a type of fraud, so force is justified to prevent it. Limiting the money supply is not at all damaging. Again, you show that you don't understand ABCT. If the money supply were fixed, prices would decline across the board at the rate of the increase in production, which would be fairly small, 2%-3% per year. And there are many advantages to a society with declining prices. On the other hand, money supply inflation causes a great deal of wide spread damage to wealth, but also to morality and civil society. It also increases the reach and power of the state.
Published: April 4, 2007 8:19 PM
RogerM
Alex, Maybe this will help, but you really should read pages 719-743 of Reisman’s book, Capitalism.
The average rate of profit determines the average interest rates, because in order for businesses to borrow money, they will expect to earn a rate of profit equal to or greater than the interest rate they will have to pay. At the same time, businesses are a source of loanable funds in that they often loan out retained earnings, but to do so, they must earn at least as much in interest on the loan as the rate of profit they would make should they invest the funds in their own business.
Obviously, economic profits equal the difference between sales revenues and operating expenses, which are the costs of labor and capital goods such as equipment and plants. This is true for individual businesses as for the macro economy.
However, the determinants of the profit rate for individual businesses is different from that of the whole economy because competitive factors and consumer preferences play the greatest role in how profitable an individual company is. For example, a company that introduces a hot new product will increase its profit, but only at the expense of its competitors so that total sales and profits for the industry may not increase. Competition isn't relevant to the economy as a whole. Also, many companies will lose money while others make enormous profit rates. We're concerned with the average rate of profit for the whole economy.
Now spending for capital goods by one company is an identical amount of sales revenue for the seller of the capital goods. For example, if a car maker purchases steel, the steel is an expense for the auto maker, but an equal amount of revenue for the steel company.
In addition to capital goods, companies will spend money on wages, which workers then spend (for the most part) on consumer goods. So the wage expense of one company becomes the sales revenue of another.
So imagine a two-company economy, in which company A produces capital goods for company B, and B produces consumer goods which the employees of both companies consume. No profits exist because the expenses for capital equipment and wages of both companies equal the revenues of both companies.
Now in this economy the sum of sales of capital goods by A to B and the sale of consumption goods to workers of both A and B equals total revenue for the economy. But B’s purchase of capital goods from A is an expense and A’s spending on wages for its workers is an expense, and the sum of the two expenses is the total expenses for the economy, which is also equal to the revenue for the economy. Mathematically, Reisman expresses this as sc + sb = wb + sb where sc is the spending on consumption; sb is the spending on capital goods; wb is spending on wages. Sc + sb = sales revenue; wb + sb = expenses. For profits to exist, sales revenue (sc + sb) must be greater than expenses (wb + sb), but at this point they’re equal.
Notice that sb exists on both sides of the equation. If we subtract sb from both sides, we end up with sc = wb, or sales of consumption goods equals wages. For profits to exist, spending on consumption must be greater than spending on wages. But if wage earners spend all of their income on consumption, who will provide the extra spending on consumer products? The extra demand will have to come from the capitalists, that is, the owners of businesses and lenders of money. Capitalists will have to spend more on consumption goods than they spend on wages.
How can capitalists spend on consumption? Initially, the spending would have to come out of previous savings. Later, those funds are replenished through profits in the form of dividends and payment of interest.
Now, what determines how much capitalists will consume? Their time preferences. So time preference determines spending on consumption by capitalists, which determines the average rate of profit, which determines the interest rate as mentioned above.
Published: April 4, 2007 10:26 PM
Sasha Radeta
Alex said:
"Nevertheless, it is perfectly valid to assume what I did as a way of illustrating that not only does time preference play a part in determining interest rates but so does the technical side of production."
But that's not what you said. First you claimed that time preference is irrelevant in interest rate determination... but then you changed your mind and stated that the rate of return is actually the interest rate, when it is greater than the rate of time preference. Both of these statements are absurd. Do you even know what you're arguing about?
Published: April 4, 2007 11:06 PM
adi
Alex,
I think that you could understand standard indifference map example better than any previous comments of mine. I continue your example about trees.
First we divide time into two periods; present and future. We suppose that horizontal axis measures present income and vertical axis future income. At first we have a stock of X trees at this time period. If agent consumes all trees in present his income in future time period is zero. Define C as consumption in present period. Then income in future time period is 1.03*(X-C) which agent consumes. "Production possibility frontier" in this example is a straight line from point (X,0) to point (0,1.03*X) and all points in this line are feasible consumption points.
But if you want to have a unique point of consumption then draw standard convex indifference curves and pick the one which touches this budget line.
So your return on physical capital (trees ripe in future period minus trees planted for future consumption) just describes physical transformation possibilities in this "economy" and nothing more. Agents preferences (described by her/his indifference map) with respect to present and future consumption will determine this actual point in budget line where she/he consumes.
Was this any use for you?
Published: April 5, 2007 1:45 AM
Sam
Interestingly an economic observer pointed out that 'currency' is short for 'current money'. Yet who doesn't know the long-term problem of holding money due to inflation? Every economic adviser, big and small, talking about investing has always warned against holding money in the long-term. Hence I simply said that all one had to with spare change is to use paper money to buy into investments that will hold their value over time. But so what if you don't want to use paper money? If I wanted to be paid and to pay bills with diamonds I'd have to live with reality because other people don't want to transact in diamonds.
Interestingly despite what doom-and-gloomers have been saying: U.S. citizens have had the right to privately own gold since 1975. So you may not like fiat currency but you are able to put yourself into a sweet position if the currency goes haywire and gold becomes the darling currency again. To say that the government could ban private gold stores is not much different from a private theif making off with your gold anyway. But then again U.S. citizens have the right to own a great many firearms too . . .
Nevertheless what's the deal with everyday inflation? Inflation: "good news, we're getting paid more, bad news, the cost of living has gone up". Deflation: "good news, the cost of living has gone down, bad news, we're getting paid less". Since business operators pass inflationary rises onto their customers why won't they pass deflationary falls onto their employees' paychecks? I'd say it's the standard of living that we have versus how much time and effort it takes to maintain it rather than worrying about what the purchasing power of each little piece of money has.
Published: April 5, 2007 7:44 AM
Alex MacMillan
Roger: Let me deal with your 2 paragraphs beginning, "So imagine a two-company economy...". And, I realize you are giving me Reisman's example here. I take note that in the example the entire amount of capital goods acquired by B from A is treated as an expense of A and that any use of capital goods by A is neglected. That implies 100% depreciation of the capital goods A acquires in the period under question and 0% depreciation of any capital goods A may use. That's fine with me for purposes of the example. But let's use simple numbers for the quantities sc, sb, etc.
Suppose: the sales of A=10; the wages of A's employees are 7; A's profit is 3. The sales of B are 15; the wages of B's employees are 4; B's profit is 1. Total revenue of A and B=10+25, but total expenses of A and B are only 21. This does not jibe with remaining part of Reisman's example. For no profits to exist in the aggregate one has to assume profits away at the micro level. Apparently Reisman would say that wages of A must be 10 and that wages of B must be 5. But why would this necessarily be so?
Published: April 5, 2007 8:39 AM
Alex MacMillan
Adi: Your production possibilities/indifference curve example is absolutely fine with me. Peoples' rates of time preference are, of course, reflected in the shape of the indifference curves. Now, take a look at your example again. What is the interest rate, and what determines that interest rate in your example? What do the indifference curves determine in your example? (Answers: The interest rate is 3%, determined by the production possibilities of present and future output. The indifference curves in your example only determine how much is presently consumed and how much is invested. Right?)
In general, the production possibilities curve would have curvature, in which case (as I've said) the interest rate and the amount saved and invested would be determined by both the production possibilities between present and future production and people's rates of time preference as embodied within the indifference curves.
Published: April 5, 2007 8:49 AM
Mike Sproul
adi:
"I thought that UK entered into a deflationary period for almost nine years after resumption of convertibility in 1821. So paper assets owned by banks and individuals depreciated with respect to gold. And this loss of paper wealth also affected industry and commerce."
Deflation would result in a rise in value of paper assets, not depreciation.
In any case, this ignores the more important point: that a suspension of convertibility does not mean the currency is no longer backed.
Published: April 5, 2007 9:00 AM
RogerM
Alex: "...the entire amount of capital goods acquired by B from A is treated as an expense of A..."
Actually, A is a capital good producer, so the goods A produces are both an expense and revenue. Reisman deals with depreciation in a separate section. Depreciation can be a source of profits, too, but it's small and diminishing over time, so Reisman left it out of the main discussion.
"For no profits to exist in the aggregate one has to assume profits away at the micro level."
Reisman sort of works the problem backwards. We know that revenues must be greater than expenses in order for profits to exist. Now let's assume workers spend all of their wages on consumption (This isn't true in reality because workers save some of their wages, but those savings make them capitalists as well as workers. It simplifies the problem to assume they consume all of their wages.) Then the wages of workers at A plus the wages of workers at B equal the total sales of B, the consumer goods maker. But for profits to exist, someone has to add to the spending. Workers can't spend more than they earn (assuming away consumer debt for simplification). The only ones left to increase spending are the capitalists (owners of businesses, stocks, bonds, etc.) So for profits to exist, capitalists must spend some of their saved up capital initially, then some of what they receive as profits. In other words, the only way company B, the consumer goods maker, will see a profit is if the capitalists spend some of their profits or savings.
Now company A, the capital goods maker, must earn a profit also and its situation is similar to B's. (We assume that A is vertically integrated and so doesn't need to purchase capital goods, that is, it makes everything it needs for production.) Wage earners can spend more than they earn in our example, so it's up to the capitalists at B to spend some of their savings on the purchase of capital equipment from A in order for A to earn a profit.
In both cases, spending on consumer goods and spending on capital goods, the capitalists must spend some of their capital in order for either company to earn profits. Initially, either in the beginning of time or at the start of a new business, that spending by capitalists must come from their savings. Afterwards, that spending comes back to the capitalists as profits and the capitalists spend some of it.
Reisman points out some interesting implications of this. High profit rates are a sign of high levels of consumption on the part of capitalists, not a good thing for the long run. Also, some capitalists will spend more than their profits and some less. Those who spend more will diminish their capital reserves and may go broke.
But the main point is that consumption by capitalists out of their saved up capital causes profits to exist in the first place. Time preference determines how much capitalists will spend. Profits determine interest rates, so time preference of capitalists also determines interest rates.
Published: April 5, 2007 9:40 AM
RogerM
Sam: "Nevertheless what's the deal with everyday inflation?"
That was Milton Friedman's view. He was a great thinker, but was wrong on that point. The whole intent of the ABCT is to show why inflation is dangerous. In a nut shell, it's because new money isn't spread evenly across the economy; if it were, there would be no problem. New money enters the economy at specific points, such as through the government or through financial institutions. The first people to receive the new money can use it to purchase things at the current price, but as they spend the new money, prices rise. The first receivers of the new money get a great deal because they could purchase things at pre-inflated prices, while the rest of us are stuck with the same income but spending it after prices have risen.
But the greater danger is not with the increase in prices, which is a symptom, but with the expansion of the money supply that precedes price inflation. The increased money lowers interest rates and encourages businesses to make capital investments. However, because the new money doesn't represent increased savings, a lot of those investments must fail.
Published: April 5, 2007 10:01 AM
Alex MacMillan
Roger: Sorry, Roger, wouldn't you know it I screwed up a couple of A's and B's in my example. I meant to say, "I take note that in the example the entire amount of capital goods acquired by B from A is treated as an expense of B (I said "A" in error)and that any use of capital by A is neglected. That implies 100% depreciation of the capital goods B (I said "A" in error. Aaargh.) acquires in the period in question and 0% depreciation of any capital goods A may use." As I say, these assumptions are fine by me for purposes of Reisman's example. But the rest of my example (the numbers part) stands. In my example, I have for A: sales to B=10; wages=7; profit=3. And for B, I have: sales to consumers=15; cost of capital goods used=10; wages=4; profits=1. What's wrong with these numbers? In this case, the consumer goods sales of B (15) are purchased by employees with their income of 11 (7+4) and by the owners of firms' A and B, whose incomes=consumption spending (in Reisman's terms, with zero saving)=4 (3+1).
If we want to add some saving and investment to the example, suppose of Firm B's purchase of 10 capital goods from A, only 9 units were used up in the production of consumer goods. Then consumer goods production would have been 1 unit less, at 14, purchased by employees incomes of 11 (as before) and 3 of the 4 units of profits of the business owners. The business owners of Firm B would therefore have financed the 1 unit of investment in unused capital goods from their profit income.
Do you see anything wrong with my numbers? If so, which numbers are not possible? And therefore show me why my 4 units of profit can't exist?
Published: April 5, 2007 10:36 AM
adi
Alex,
Actually in your example there was no such thing as an interest rate since you and I only presented model where from the present stock of original factor one could produce income (=consumption) stream in future time period. This production possibility frontier describes what consumption levels are possible in the present and future. It's of course true that the equilibrium point (assuming standard well-behaved convex indifference curves) is described by the tangency condition between production possibility frontier and one indifference curve. This means that marginal rate of substitution between present and future consumption is same as technical trade-off between present and future consumption...
But by this example you cannot claim that "marginal productivity of physical capital" determines interest rate.
And Austrian theory can escape Cambridge capital controversy if time preference is taken to be only determinant of interest rate.
Published: April 5, 2007 11:09 AM
adi
Mike,
Of course those papers depreciated in value after resumption of convertibility. If all assets and goods lost their value with respect to gold how could not that happen?
Quantity of paper money had increased after suspension of convertibility and had bid up prices of assets and goods when gold stock was more stable. So after convertibility was resumed, there was too much paper chasing too few gold coins...
Published: April 5, 2007 11:23 AM
Alex MacMillan
Adi: As I said a number of times now, BOTH peoples' time preferences AND the profitability of investment (or, if you wish, the rate at which present saving (investment) can be physically converted into future consumption) (jointly) determine the interest rate. However, in your diagrammatic example (and personally I don't like diagrams in economics, but that's just me), with the straight line production possibility curve and normally shaped indifference curve, it was the slope of the production possibility curve ONLY that determined the interest rate. One more time. In general (agains using your diagrammatic approach), with a curved production possibility curve, both the production possibility curve and the indifference curve would determine the interest rate. Not just the production possibility curve and not just the indifference curve.
Published: April 5, 2007 11:35 AM
Björn Lundahl
Alex
“Your example of Christmas, etc. I know as well as you do about time preference and that it plays a part in determining interest rates. I know every consumer does not have identical time preferences to every other consumer and that there are consumer loans. Heavens, I had a brief stint in banking early on in my career.
Nevertheless, it is perfectly valid to assume what I did as a way of illustrating that not only does time preference play a part in determining interest rates but so does the technical side of production.”
Well, I cannot know what you know. I have to answer as thoroughly as I can. Someone else that read the comments might not know.
If I go down to a bank and ask a banker about money supplies, fractional reserve banking and time preferences, I won’t get many valid answers. They are usually unaware of the economics aspects of their business.
You should understand, then, that time preferences are given and the technical sides of production are adjusted to correspond to the market rate of interest and time preferences and not the other way around.
If, for example, Robinson Crusoe made himself a fishnet he would have made the size and quality of it in accordance with his time preferences.
If the technical side is given as it might be in your example and the tree would, by nature, provide us with 3% more wood in a year only by waiting, this only illustrates that the capital good “fortunately” and “accidentally”, by nature, corresponded to people’s time preferences. It does not prove anything and it was this correspondence to people’s time preferences that I said was correct.
You by focusing in constructing a technical side that is given and by finding such a fabricated case, you believe that you have proved something, is utterly wrong. You by doing so ignore the fact that it does not explain the market rate of interest for consumer loans and it does not explain all those cases when capital goods are made by man to correspond to people’s time preferences (and that is nearly all cases). The theory of time preferences fits handsomely with all occasions and proves by doing so that it is only time preferences that explain the existence of a market rate of interest.
There is no “middle way”.
All values are something which exists within us and time is not, happily, excluded.
Björn Lundahl
Published: April 5, 2007 11:54 AM
RogerM
Alex, There's nothing wrong with you numbers. Your example is fine. The question is how are those profits possible? Revenues must be greater than expenses, but total revenues equal total consumption and expenses boil down to just wages. Wage earners can't spend more than they earn. Who's doing the extra spending so that the profit figures you quote are possible? It's the owners of capital.
Put another way, the profits you calculate for each firm don't just happen. They result from capitalists consuming some of their capital. I realize this sounds weird, but that's macro econ for you. Micro is very intuitive, but macro tends to be weird. At the micro level, I can increase profits by cutting costs, raising prices or a myriad of other ways. But essentially, what you're doing is taking business away from your competition, or reducing the revenue of suppliers by cutting costs.
However, at the macro level, all of those efforts cancel each other out. If I cut costs at my business by using less capital or fewer workers, I don't change the total amount of income in the country; I merely rearrange it; my company gets more while others get less. All of the efforts of businessmen to enhance profits merely shuffles chairs; some businesses prosper but at the expense of others, either competitors or suppliers or workers. (That's not necessarily so for technical advances.)
So at the macro level, all that matters is that total revenues in the economy must be greater than total expenses in the economy. If owners of capital didn't consume any of their capital, then the only people consuming are wage earners. But what is income to wages earners is an expense for every business and they equal each other. So without the spending on consumption of capitalists, there would be no profits.
I know this seems weird, but macro often requires a different way of looking at things. Most econ students do fine in their first micro class, but they get lost in macro because things get weird with all of the aggragation.
Published: April 5, 2007 11:56 AM
Alex MacMillan
Roger: In the example, we had 2 firms in the entire economy (let's say) A and B. So when I aggregated, I arrived at the numbers for the entire economy (i.e., the macro numbers). A's revenue was 10. B's revenue was 15. That totals 25. A's wage expenses were 7 (there were no other expenses for A). B's capital goods' usage expenses were 10; B's wage expenses were 4 (there were no other expenses for B). Total revenues in a macro sense were 10+15=25. Total expenses in a macro sense were 10 (capital usage) + (7+4) (wage expenses)=21. In a macro sense, therefore, profit totaled 25-21=4.
By assuming consumption goods production was 15, we are essentially assuming saving and investment is zero. As I showed in my last post, we could assume there was some saving and investment and perhaps the wage earners saved some and the business owners did too. But, sticking to a zero saving and investment assumption, who consumed the consumption goods totaling 15? The wage earners would have spent all their income of 11 on consumption goods and the business owners would have spent their income (profit) of 4 on consumption goods. That's how it would have worked in a macro sense.
I could also go through the macro aspects of this example in a national accounting manner but I know Reisman doesn't like that approach. So, I won't unless you want me to. Oh, what the heck! From a national accounting standpoint, (again assuming no saving or investment) the GDP would be 15 (the consumer goods) and the national income would be 15 (wages=11; profits=4).
Published: April 5, 2007 12:36 PM
Björn Lundahl
Sam
“Actually, if Libertarianism is about freedom of choice then what's the gripe about money? If people want to accept paper money that isn't backed by gold in return for goods and services rendered then so what?”
Fiat money is a result of government fraud and intervention and is not chosen freely by individuals.
“Saying that money should be gold or be backed by gold is a case of regulating other people's behaviour . . . “
It is the government that is regulating when it is imposing fiat money. Gold as a medium of exchange has been the choice people freely has done without government intervention. If people in a free market would want other commodities serving as money, no libertarian would object. Libertarians, generally, only assumes that people would choose gold again if they were allowed as it has been so historically. They need not, though, say it every time and remind people about it when they speak about government’s fraudulent money. It is only a waste of time. In a free market, no one would choose paper money which couldn’t be converted into gold, silver etc. I can tell you that!
Björn Lundahl
Published: April 5, 2007 12:56 PM
Adrian
My contentions with that article are based on this statement:
Then the matter relates more to definitions than actual things.
We can call inflation "purple" and the increase in the money supply "pink." Then, in our small framework, it is correct to say that "pink causes purple."
The word "inflation" is only a label, it has no intrinsic meaning. If for Austrians it means "an increase in the money supply" and for others -- "an increase in prices" then we're really not talking about the same things here.
Words don't mean anything in and of themselves. Once separated from their objects, they are mere arrangement of letters. It stands of no importance if "inflation" means ore thing or the other, or indeed if it would mean "four-legged animal" because it's just a label. If we use the same word to mean two different things then we cannot make ourselves understood.
So I propose instead of just "inflation" we speak of "price inflation" and "monetary inflation," respectively, as to be more precise.
Otherwise, I enjoy reading mises.org and hope to see many more good articles in the future. Excellent job so far!
Adrian
Published: April 5, 2007 7:15 PM
RogerM
Alex:"By assuming consumption goods production was 15, we are essentially assuming saving and investment is zero."
Good job! I think you've got it! You're right that we assumed no savings and investment on the part of wage earners. If wage earners save, which they do in reality, that makes the capitalists as well. They have a dual role as wage earners and capitalists. Reisman assumes they don't save in his analysis because giving them the dual role complicates the example without adding insight.
Published: April 5, 2007 7:25 PM
Alex MacMillan
Roger: The point was to show that profit exists at the micro and macro level, whether there is savings and investment or not. Though I have already done this, if you insist I'll show you again that savings and investment do not change the fact that profit exists at the micro and macro level.
Let's suppose saving and investment is 2 units in Reisman's model with firm A and B. Here we go then. Firm A sells 10 units of capital goods to B. B only needs 9 units of capital goods to produce their 14 units of consumer goods. The extra unit of capital goods is saved and invested so that B can produce more consumer goods next period. A's rev=10; A's wages=7; A's profit=3. B's rev=14; B's wages=4; B's capital input=9; B's profit=1. Suppose the saving is done by the wage earners. Consumption=14, employee consumption=10 (their income was 11); business owners' consumption=4 (they spend all their profit on consumption. On the other hand, they could have done the saving. It doesn't matter.)
Published: April 6, 2007 7:56 AM
RogerM
Alex: "The point was to show that profit exists at the micro and macro level, whether there is savings and investment or not."
I agree completely. Savings and investment have little to do with profits at the macro level. That's Reisman's point, too. Consumption by capitalists (whether workers who own assets like stocks and bonds or business owners) is the key to profits. Profits determine interest rates. Time preference determines capitalist consumption, therefore time preference determines interest rates through profits. My point in presenting Reisman's discussion of profits was to show that profits are the connecting link between time preference and interest rates, which I think is what began this whole discussion.
Published: April 6, 2007 9:37 AM
RogerM
I just realized that profits and interest rates are even more closely connected: profits return to capitalists as dividends, retained earnings, and interest paid on notes, bonds etc. So interest rates are one manifestation of profits.
Published: April 6, 2007 11:59 AM
Björn Lundahl
I have not read this book:
Where do interest rates come from?
Mises.org Updates
Frank Fetter was the great American Austrian who devoted a fantastic part of his professional life to arguing on behalf of the pure time preference theory of interest. His work is lucid and powerful, and largely would have been forgotten if Murray Rothbard had not assembled this excellent volume of his writings. It supports the Misesian case in every detail, and set it against the productivity theory and other false notions of interest.
Capital, Interest, and Rent is now available for free download or print on demand.
Download PDF:
http://mises.org/books/capital-fetter.pdf
Björn Lundahl
Published: April 6, 2007 1:56 PM
Björn Lundahl
On page 259 of the book Capital, Interest, & Rent, by Frank Fetter, I just found this which I believe confirms my above statement:
“The semblance of a rate of physical productivity which Dr. Brown discovers, appears only when, side by side, two methods of production are in use, one new and the other old. As long as the two methods so continue, a unit of labor has equal value
whether applied to present fruit or to trees; but how long can this continue?
Only so long as the rate of time-preference HAPPENS to COINCIDE with this so-called rate of productivity. Timepreference existed before the new method was discovered; it continues to exist afterward.
If when the new technical method is discovered in the assumed case, time-preference happens to be over ten percent, the new method is uneconomic and can not be adopted; if it happens to be under ten per cent then the old method is uneconomic and must be abandoned as fast as the shift can be made.”
Björn Lundahl
Published: April 6, 2007 3:23 PM
Alex MacMillan
Roger and Bjorn: I've been away for a couple of days. I'll download Frank Fetter's book, as you suggest, and look for the material. I am quite willing to be convinced that only time preference determines interest rates, but as of yet I am not. If I do become convinced, I'll try to conjure up a simple numerical example to demonstrate it.
Published: April 8, 2007 9:31 AM
Björn Lundahl
Alex
Nice hearing from you and I hope you have had a splendid time!
We all are different from each other and we think differently and this despite of the fact that human basic logic is the same.
I think the main thing is to find or, at least, try to find the truth.
When I find ideas that I feel are important to me but they seems to be built upon contradictions or paradoxes, I feel very uncomfortable until I have solved them. If I am unable to solve them, I won’t accept them until I have.
I have not felt so about the pure time preferences theory of interest as I have received the insight that time preferences are a part of human nature and cannot because of this be discarded in any situation involving human action and time. Very simple examples prove that.
Human nature is not, either, something which sometimes exists and sometimes does not.
If anyone would try to dismiss time preferences in any given situation by illustrating different examples, I would rather feel: go back to the drawing board and get it right. You have obviously done something wrong.
For me Frank Fetter’s explanation is good enough. This by coincidence was the same as mine. I do not feel the need, in other words, to complicate things by drawing up different examples. It is only a waste of time and also the wrong way to do it as it is rather a philosophical or praxeological insight than a mathematical one. This in a way as Frank Fetter already has illustrated as he in a few words proved what he just said. Because of this it is not either possible to produce any better answer.
In the search for truth, I think this rule should always be followed:
Occam's razor
William of Ockham
Occam's razor (also spelled Ockham's razor) is a principle attributed to the 14th-century English logician and Franciscan friar William of Ockham. The principle states that the explanation of any phenomenon should make as few assumptions as possible, eliminating, or "shaving off", those that make no difference in the observable predictions of the explanatory hypothesis or theory. The principle is often expressed in Latin as the lex parsimoniae (law of succinctness or parsimony).
http://www.answers.com/topic/occam-s-razor?method=26&initiator=answertip:more
That is also the rule that Rothbard often referred to and always followed.
I have read Human Action once and I have read Man, Economy, and State twice. I will read them again and probably several times further away in time (woops time preferences). It was a very long time ago I read those books.
My way of studying is to think about the problems and to look them up in mentioned books and then think over them again. It is a process which takes quite a long time.
I wish you good luck in trying to convince yourself, whichever the direction!
Björn Lundahl
Published: April 8, 2007 1:32 PM
Björn Lundahl
Another way to explain the pure time preferences theory of interest is that time preferences are value judgments and value judgments are derived from individuals. All human actions are done to satisfy values. Time as, I wrote, is not excluded.
To deny time preferences as the only determining factor of the rate of interest to the advantage of the productivity theory of capital, would be analogues with the proposition that the marginal utility of a consumer good is determined by the technical possibility to make it. Without the technical means to produce the good, the consumption of it would not be possible and not, therefore, any price of it.
The fallacy with mentioned reasoning is that the marginal utility, that is the value of a consumer good and therefore its price are value judgments.
If an investment is productive is, also, derived from people’s value judgments.
Physical productivity of capital is only a technical term and not a value judgment. Physical productivity can increase dramatically but will not be brought about if it isn’t in value terms “productive” and doesn’t therefore correspond to people’s values, or to state the matter differently, will not be brought about if it doesn’t correspond to people’s time preferences.*
To put it differently, if an investment is productive and yields a market rate of interest is ultimate derived from value judgements, in other words the existence of time preferences.
Björn Lundahl
* The costs of labour and land are here excluded, but are of course also market prices or values.
Published: April 8, 2007 6:20 PM
rtr
Back from D.C., catching up on replies.
RogerM: "Not even close, but you bring up an important difference between money and all other goods. If we produce too much money, the prices of all goods rise across the board."
False. That's exactly how I meant defining "money" as the medium of exchange causes massive errors. What holds true in strct economic praxelogical reasoning for money, must hold true for any good or service. So let's substitute milk for money into your statement:
"If we produce too much milk, the prices of all goods rise across the board." See how absurd that sounds?
Economics is about ratios of value between this and that. Claiming price is only measured by "money" is false. There are two prices for every trade. If you trade an apple for an orange, the price of apples is 1 orange, *OR* the price of oranges is 1 apple. Everytime somebody trades one good for another good called "money", the person accepting money is by definition increasing their wealth at the moment of exchange, *NOT* trading a good of equal value to the amount of money exchanged.
RogerM: "But increasing the production of one good, such as insurance or oil, won't change the value of money;"
False. All the total things which can be exchanged for all the total "money" is greater, thus *by definition* the relative scracity value of "money" is effected. That's why people say "real wages" increase if you are paid the same nominal amount or even a lesser nominal amount but can trade for more stuff with that lesser nominal amount.
RogerM: "all that changes is the value of insurance or oil in relation to other goods and money."
Thus, *by definition* the value of money changes, because the quantity or subjective value of anything else changes.
RogerM: "In order to make the value of money rise, you would have to increase the production of all other goods at the same time."
False. The slightest marginal decrease in the quantity of subjective value "all other goods" or even the the slightest marginal subjective value decline in the same quantity "of all other goods" will increase the value of money. Thus, if you drink a glass of milk, you increase the value of money because there is less "all other goods" which can be traded for money. If you milk a cow in the morning, you decrease the value of money, because there are more "all other goods" which can be traded for the same money.
RogerM: "That's why Austrians say that when you see prices of all products rising, you can bet the Fed is pumping up the money supply."
Well sure, if there's a massive increase in money, more money will trade for those same "all other things".
RogerM: "The overall price level remains faily constant, as demonstrated by prices during the 19th century in which the overall price level finished in 1900 about where it was in 1800."
There's no such thing as an "overall price level". Specific things trade for specific other things at specific moments in time. Subjective value is not constant for anything. That is all. That statement of yours is not only unproved, but it would be extremely easy to prove it false merely by examing population in 1800 and population in 1900.
RogerM: "You act as though people act arbitrarily, deciding to value one thing today and not the next. They don't. If people cease valuing something, they do so because it produces less utility for them than something else."
That's the definition of subjective value not being constant but always being in flux. Of course, subjective value of things like money doesn't swing from max to min value with off the chart volatility. But there's still a pulse fluxing as value changes constantly for all things for all people. Sometimes when a fiat money supply collapses, you see gargantuan changes in subjective valuation.
RogerM: "It's clear that you don't even understand ABCT."
Of course I don't understand that which I proved false. It's false, doesn't make sense, does not describe reality, by definition.
RogerM: "Limiting the money supply is not at all damaging."
It's violent. By definition that creates poverty. If people voluntarily subjectively value celebrity autographed pieces of paper there's nothing you can do about it.
RogerM: "Again, you show that you don't understand ABCT."
Of course I don't. I already proved it false. Nobody challenged any aspect of my proof. It's done.
RogerM: "If the money supply were fixed, prices would decline across the board at the rate of the increase in production, which would be fairly small, 2%-3% per year."
You can only attempt to "fix" the money supply, the same way you can attempt to "fix" anything else, by using violence. Nobody's talking about fraud. If you want to lend your neighbor your rake for a promise of it's return and the goodwill of borrowing some of his stuff in the future, there's no fraud generated. Credit is not fraud.
Published: April 9, 2007 9:46 AM
billwald
If a person trades his dollar for an apple then the apple must be more valuable to him than the dollar.
Published: April 9, 2007 10:39 AM
Paul Edwards
Bill:
"If a person trades his dollar for an apple then the apple must be more valuable to him than the dollar."
Excellent! He's certainly not going to voluntarily trade if he valued them in reverse. He wouldn't even bother to trade if he valued them perfectly equally.
And the further observation is the person he traded the dollar for the apple, must have valued the dollar over the apple; an opposite valuation.
In short, both sides of a voluntary trade necessarily expect to benefit. This is why the coercive measures of the state necessarily reduce net social utility between non-aggressors in contrast with the free market which guarantees maximum ex ante utility.
Published: April 9, 2007 12:20 PM
Dan Coleman
rtr, you write:
Of course that sounds absurd, but only because using the term "money" presupposes that it is a medium of exchange, and by removing that presupposition you remove meaning from the statement.
Speaking in terms of praxeology, it so happens that some things on a free market will be valued by actors insofar as they can be exchanged for something else. Hence, a medium of exchange; hence, money.
If milk was generally accepted as the medium of exchange in a given society, your "absurd" sentence makes perfect sense. If the milk supply doubles, "the prices of all goods rise across the board," insofar as milk is used as a medium of exchange for these goods. That is because 'price' is defined (in this society) as how much milk it takes to purchase something. Historically, 'prices' have been expressed in gold, the preferred commodity for money.
There is fraud with the government intervention, of course, because the government has taken media of exchange and replaced it with their own paper tokens -- and forced the population to accept them as legal tender (at gunpoint). They've hijacked a market process that used physical commodities and can now "create" wealth out of nothing. Without intervention, the production of additional "money" requires increasing the physical good in question, a business that was no more profitable in the long run than any other.
People may still benefit from each exchange that they have, but it is woefully negligent as an economist to ignore how they would act otherwise, which certainly shows how much poorer we are due to interference.
Published: April 9, 2007 1:11 PM
Björn Lundahl
I haven’t read much of George Reisman’s writings. I have just downloaded a PDF file of Reisman’s essay “The Goal of Monetary Reform”
At a first glance I, surprisingly, read that Reisman writes the following:
“The essential reason that a 100-percent-reserve gold standard should be the ultimate goal of monetary reform is that it would secure the
economic system against the evils both of inflation and of deflation–depression.”
“The essential propositions I want to establish are: (1) Falling prices caused by increases in production and supply are not deflation. (2) Deflation is a decrease in the quantity of money and/or volume of spending in the economic system. This, not falling prices per se, is what causes the symptoms of depression.”
So Reisman suggests that deflation or falling prices caused by increased demand for money (hoarding), or decreased aggregate spending, is a bad thing. This is what surprises me.
In Man, Economy, and State Murray Rothbard writes the following, pages 776-853:
“The very word “hoarding” is a most inappropriate one to use in economics, since it is laden with connotations of vicious antisocial action. But there is nothing at all antisocial about either “hoarding” or “dishoarding.” “Hoarding” is simply an increase in the demand for money, and the result of this change in valuations is that people get what they desire, i.e., an increase in the real value of their cash balances and of the monetary unit.11 Conversely, if the people desire a lowering of their real cash balances or in the value of the monetary unit, they may accomplish this through “dishoarding.” No other significant economic relation—real income, capital structure, etc.—need be changed at all.”
“Forgotten is the truth that money is desired and demanded as a useful commodity, even when this use is only as a medium of exchange. When a man holds money in his cash balance, he is deriving utility
from it. Those who neglect this fact scoff at the gold standard as a primitive anachronism and fail to realize that “hoarding” performs a useful social function.”
“No businessman in the real world is equipped with perfect Foresight; all make errors. But the free-market process precisely rewards those businessmen who are equipped to make a minimum
number of errors.”
“Sometimes sharp changes, such as a sudden burst of hoarding or a sudden raising of time preferences and hence a decrease in saving, may arrive unanticipated, with a resulting crisis of
error.”
In America’s Great Depression Murray Rothbard, pages 39-42, writes the following:
“The Keynesian doctrine artificially assumes that any increase (or decrease) in hoards will be matched by a corresponding fall (or rise)
in invested funds. But this is not correct. The demand for money is completely unrelated to the time-preference proportions people might adopt; increased hoarding, therefore, could just as easily come out of reduced consumption as out of reduced investment.”
“In a brilliant article on Keynesianism and price-wage flexibility, Professor Hutt points out that:
No condition which even distinctly resembles infinite elasticity of demand for money assets has even been recognized, I believe, because general expectations have always envisaged either (a) the attainment in the not too gradual a decline of prices that no cumulative postponement of expenditure has seemed profitable.
But even if such an unlikely demand arose: If one can seriously imagine [this situation] . . . with the aggregate real value of money assets being inflated, and prices being driven down catastrophically, then one may equally legitimately (and equally extravagantly) imagine
continuous price coordination accompanying the emergence of such a position. We can conceive, that is, of prices falling rapidly, keeping pace with expectations of price changes, but never reaching zero, with full utilization of resources persisting all the way.”
So in other words, if prices in a free market economy are expected to fall, no anti social effects will be brought about. With regard to economic stability, it does not matter if falling prices are caused by increased demand for money or increased productivity.
Sudden and sharp changes such as an unanticipated burst of hoarding or higher time preferences and decreased saving will cause a crisis.
So I imagine that any sharp, sudden and unanticipated change of great magnitude will cause problems and crises and is not especially related to hoarding and the demand for money.
Naturally, businessmen or entrepreneurs are trained specialists in their ability to anticipate change. They are not perfect, but neither is anyone.
Björn Lundahl
Man, Economy, and State:
http://mises.org/rothbard/mes/chap11b.asp
America’s Great Depression:
http://mises.org/rothbard/agd/chapter2.asp#wage_rates
Published: April 9, 2007 1:55 PM
RogerM
Bjorn: "So Reisman suggests that deflation or falling prices caused by increased demand for money (hoarding), or decreased aggregate spending, is a bad thing."
Having read a lot of Reisman's writings, I think you'll find that's not what he meant if you keep reading. He agrees pretty much with the ABCT. He argues that monetary inflation/deflation, not price inflation/deflation, causes booms and busts. He argues against the mainstream econ idea that price deflation causes depressions. He asserts that price deflation caused by limiting the money supply is a good and natural 210634thing and increases wealth.
Published: April 9, 2007 2:36 PM
rtr
Dan Coleman: "Of course that sounds absurd, but only because using the term "money" presupposes that it is a medium of exchange."
And that "presupposition" is absurd, leads to massive errors in economic reasoning. Trade never occurs because people value things equally. Trade occurs because that which is received is valued more than that which is given away in exchange. Hence why I get the Nobel Prize and have made the biggest contribution to economic science of all time, so far. :P
Dan Coleman: "Speaking in terms of praxeology, it so happens that some things on a free market will be valued by actors insofar as they can be exchanged for something else. Hence, a medium of exchange; hence, money."
Everything which has subjective value will be valued by actors insofar as they can be exchanged for everything else. That's part of another Nobel point; everything which has value is in a sense "money". Money, properly defined, is *just* the thing which is most commonly traded for in exchange. Yup, it's even simpler than marginal utility, but the implications are far more revolutionary and profound. Sure, "convenience", "liquidity" are aspects of subjective value.
Dan Coleman: "If milk was generally accepted as the medium of exchange in a given society, your "absurd" sentence makes perfect sense."
There is no "medium" of exchange. There's just exchange. That's my irrefutable Nobel Prize point. The conception of "money" makes no sense at all otherwise, explains nothing about why people at certain points of time are holding money, and others are holding things other than money.
Dan Coleman: "There is fraud with the government intervention, of course, because the government has taken media of exchange and replaced it with their own paper tokens -- and forced the population to accept them as legal tender (at gunpoint)."
That's theft, not fraud. Paper tokens can still have subjective value. How do you pretend to analyze a fiat currency collapse? With some business cycle myth that claims it's inevitable? Or with economic science that observes a massive change in subjective valuation of something from one moment in time compared to another moment in time?
Dan Coleman: "They've hijacked a market process that used physical commodities and can now "create" wealth out of nothing."
Be careful about confusing the economic analysis of events. Wealth is always created out of nothing, is determined by non-constant subjective value. Thus a more accurate description is government compels a transfer of wealth to itself. It's robbery, plain and simple. But if you steal someone's jewels, that act of theft doesn't cause the jewels to lose subjective value. No doubt that rage against theft caused the stagnation of economic science for the last 140 years, as government runs the "money machines". Mises was a titan of epistemology (as he had to be, to make his brilliant points against socialism), but there haven't been any breakthrough advances in economics since Menger. How do you price actions like promises? People trade things for promises all the time. Markets for risk exist.
Dan Coleman: "Without intervention, the production of additional "money" requires increasing the physical good in question, a business that was no more profitable in the long run than any other."
False. Money does not have to be a physical good. Subjective value is not limited to physical goods. You're just causing the stagnation of economic understanding by claiming money must be a physical good. It could be a physical good. It could be something other than a physical good. Gold may have less volatility than credit, but that doesn't mean credit isn't currently the "money" which is the most commonly traded thing in exchange. And past volatility says nothing about future volatility.
Dan Coleman: "People may still benefit from each exchange that they have, but it is woefully negligent as an economist to ignore how they would act otherwise, which certainly shows how much poorer we are due to interference."
People "may"? No, people *must*, by definition of trade, in every single instance. Of course people would act differently if fiat currency wasn't forced into existence by government. But that's no excuse for creating myths like the Austrian Business Cycle Theory. Unfortunately, the whole of economic science cannot be in violation of the law of trade, and wherever exchange occurs, the theory needs to be rechecked from the foundational ground up. It's not like it would take more than a few weeks to go through the entire field and say this is proven true, that is proven false, by testing it against the law of trade. Most of the claimed economic knowledge is anything but. But you need to wipe away the fog of errors to see further, to see more clearly. That means money as a "medium" of exchange is out. Money as the most commonly traded thing in exchange is in.
You can also try understanding why people act in spite of interference. My theory, no theory is the wrong word, my demonstration is applicable to all exchange, not just "gold money". It's silly for anyone to maintain a dropped $100 fiat currency note would sit on the ground and not be picked up by anyone, which is what current Austrian Theory comes off as maintaining. Better to describe what happens in reality.
Showing how much poorer we are due to interference is exactly what I've been doing with this thread and the other trade thread. Every act of trade by definition creates profit for both parties to the exchange. Compeling transferance of wealth through violence does not create profit for both parties. The compelled lose, *at the expense* of those who employ violence. So how much less wealthy is society through time because of violence? What would living standards, what would health care, what would life spans, be like, if there wasn't the massive violent compulsion and violent "intellectual property" protectionism of the last decades and centuries? To even begin to answer that question you must start at the foundation that trade is mutually *profitable*, in the economic sense of the word profit (no revenues minuses expenses bs at all). The division of labor exists because it's "fun"?
Published: April 9, 2007 2:50 PM
Paul Edwards
rtr,
"...Gold may have less volatility than credit, but that doesn't mean credit isn't currently the "money" which is the most commonly traded thing in exchange. And past volatility says nothing about future volatility."
Me, In a free market, money cannot be credit because money must be the most marketable good, and a present good is always more marketable than its corresponding future good – we know this by observing the fact of interest due to time preference. Therefore, in a free market, money substitutes also must be titles of ownership to a present good.
Because of time preference - the time discount we also call originary interest - we know that present goods are more marketable than claims to future goods. Therefore, credit can never be as marketable as the most marketable current good. Therefore, credit can never be money.
Published: April 9, 2007 4:35 PM
Björn Lundahl
Hi RogerM,
Yes I have noticed that you often refer to Reisman and think that he has a lot of good ideas. I do not know much I am afraid, about his ideas.
I do know, though, that he is an Austrian economist and believes in the Austrian business cycle theory, but that alone does not exclude that he also might believe that increased hoarding is a bad thing.
For he writes that “(2) Deflation is a decrease in the quantity of money and/or volume of spending in the economic system,” notice the last sentence “or volume of spending in the economic system”. What he is relating to in this last sentence is increased hoarding (increased demand for money).
In other words, Reisman defines deflation as a decrease in the quantity of money and/or an increase in demand for money.
Falling prices because of increased production he does not define as deflation as he writes:
“(1) Falling prices caused by increases in production and supply are not deflation.”
If I keep reading as you have recommended I will, for example, find this:
“I will now elaborate on my first proposition, i.e., that falling prices caused by increases in production and supply are not deflation. Such falling prices are not deflation, because they result neither in a reduction in the average nominal rate of profit on capital in the economic system nor in any generally greater difficulty in repaying debts, which are two essential symptoms of any genuine deflation. In a genuine deflation, profits are sharply reduced, perhaps even wiped out altogether, and, at the same time, debt repayment becomes so difficult that widespread insolvencies and bankruptcies occur. Neither of these phenomena occur as the result of falling prices under a 100-percent-reserve gold standard.”
What he is saying here is that in a genuine deflation, (as he defines it which is decrease in the quantity of money and/or an increase in demand for money):
“profits are sharply reduced, perhaps even wiped out altogether, and, at the same time, debt repayment becomes so difficult that widespread insolvencies and bankruptcies occur. Neither of these phenomena occur as the result of falling prices under a 100-percent-reserve gold standard.”
He obviously sees an increase in demand for money as a bad thing. He does not believe that there will be any “problem” with that under a 100% gold reserve money standard as he believes that there will be increases in the supply of gold money:
“(3) A 100-percent-reserve gold standard is the best possible guarantee against deflation thus understood, because once new and additional gold money comes into existence, it does not, for all practical purposes, go out of existence. Instead, its quantity tends continually to increase, at a modest rate. Moreover, its modest rate of increase serves to avoid situations of an artificially induced decline in the demand for money for holding, which then set the stage for a sudden need to rebuild cash holdings later on, with an ensuing contraction of spending.”
The interpretation must be, I believe and as I have said, that Reisman sees increases in demand for money as a bad thing. This in sharp contrast with what Rothbard believed.
Best regards
Björn Lundahl
Published: April 9, 2007 4:47 PM
Sasha Radeta
Dan Coleman:
"Of course that sounds absurd, but only because using the term "money" presupposes that it is a medium of exchange."
To which RTR responds:
"And that "presupposition" is absurd, leads to massive errors in economic reasoning. Trade never occurs because people value things equally. Trade occurs because that which is received is valued more than that which is given away in exchange. Hence why I get the Nobel Prize and have made the biggest contribution to economic science of all time, so far. :P"
RTR also added:
"There is no "medium" of exchange. There's just exchange. That's my irrefutable Nobel Prize point. The conception of "money" makes no sense at all otherwise, explains nothing about why people at certain points of time are holding money, and others are holding things other than money."
==================================================
Claiming that money is a medium of exchange does not presuppose that people value things equally. Quite the contrary - sellers place a higher value on money they receive compared to their own goods, simply because they place a higher value on consumption of goods other than their own (one person cannot produce everything he needs and he cannot efficiently fulfill those needs through barter... that's why he values some widely accepted medium of exchange). So the fist RTR's statement I quoted is completely absurd.
The claim that "there is no medium of exchange... because people hold goods other than money in their possession" is also nonsensical. The fact that I hold some sugar, flour, oil, sauerkraut, etc., in my possession does not deny the fact that money is my medium of exchange, by which I can easily exchange my goods for some other goods I desire to consumer -- either now or later. I may hold these items for my future consumption or even for some barter -- but these items are not universally accepted goods that I could use for purchases of other goods -- i.e. money.
Also, I may hold some quasi-money, such as jewelry, but they do not have the same properties as the real money (gold, for example). http://mises.org/rothbard/mes/chap11d.asp
When it comes to RTR's statement that money does not have to be a physical good, it only shows that economics is seldom thought at our schools. Money is always a physical good that is high in value-to-weight ratio (hence transportable), durable, relatively difficult to inflate or counterfeit... http://mises.org/rothbard/mes/chap3a.asp#2._Emergence_of_Indirect
Anything that does not have these properties was never historically selected as money. RTR tried to suggest that "credit" is money, but that's just his misunderstanding of definitions of "money" and "credit," as Paul Edwards nicely explained.
PS
Austrian business cycle theory is a wonderful piece of tautology, in which people's subjective valuation always emerge, by restoring the true interest rate or time preference (investment/consumption proportions and price differentials between stages of production). Unfortunately, it is far beyond RTR's cognitive capabilities.
Published: April 9, 2007 6:19 PM
RogerM
Bjorn: "For he writes that “(2) Deflation is a decrease in the quantity of money and/or volume of spending in the economic system,” notice the last sentence “or volume of spending in the economic system”. What he is relating to in this last sentence is increased hoarding (increased demand for money)."
I searched for "hoarding" in the PDF version of Capitalism and found that about half of the instances refer to hoarding of goods because people fear further price increases. The other half he uses the term "hoarding" to respond to the error of Keynesians that saving is hoarding (see page 691).
Then on page 692 he has a section on "The Hoarding doctrine as an instance of the fallacy of composition" where he shows that while individuals can hoard, the macro economy can not.
On 693 he writes "The fact that 'hoarding', or, more correctly, the desire to increase cash holdings, operates to reduce savings no less than consumption, does not mean that it is an evil or should be prevented in any way. What the attempt to hold more cash does succeed in doing is to increase the buying power of the stock of money, whatever the stock of money may be...To say the same thing in somewhat different words, it operates to increase the so-called quick ratios of corporations and all other businesses and to place them and everyone else in a financially stronger position, in which their cash reserves stand in a higher ratio to their current liabilities, and in which, therefore, the general state of financial solvency is better assured."
I stumbled upon something that might have prompted Alex's questions about time preference and interest rates: Reisman writes on page 837 "That cash hoarding does serve in the long run to raise the rate of profit provides an answer to the pretended fear of the Keynesians that in a free economy the rate of profit will be too low to make investment worthwhile and will thus lead to a limitless rise is 'liquidity preference'--viz., cash hoarding. The answer is that if the rate of profit ever were too low to make investment worthwhile and thus did resort in cash hoarding, the effect of such cash hoarding, as we have just seen, would be to restore the rate of profit to a point high enough to make investment worthwhile."
When Reisman writes "Moreover, its modest rate of increase serves to avoid situations of an artificially induced decline in the demand for money for holding, which then set the stage for a sudden need to rebuild cash holdings later on, with an ensuing contraction of spending," maybe the emphasis should be placed on "an artificially induced decline" which then causes a "sudden need to rebuild cash holdings." The rebuilding of cash holdings is correcting the distortions of the artificial decline. But Reisman doesn't see this as bad, because above he writes that it restores the profit margin and encourages people to invest again.
Published: April 9, 2007 6:34 PM
rtr
Paul Edwards: "In a free market, money cannot be credit because money must be the most marketable good, and a present good is always more marketable than its corresponding future good"
So credit cards are a mirage? Home loans don't exist? Credit scores are the same for all individuals?
Paul Edwards: "we know this by observing the fact of interest due to time preference."
"Time preference" might be another casualty of the correct definition of money. What does "time preference" have to do with trading something today for the promise of that something back plus something more tomorrow, especially if that something is just sitting there in storage for future use anyway? Both parties by definition profit from that exchange at the moment of that exchange.
Paul Edwards: "Therefore, in a free market, money substitutes also must be titles of ownership to a present good."
Title to ownership of future goods are traded all the time in a free market. You can pre-order a DVD of a Hollywood movie before it's manufactured. You can trade title to future pay checks or title to future revenues for a house or business capital today.
Paul Edwards: "Because of time preference - the time discount we also call originary interest - we know that present goods are more marketable than claims to future goods."
I don't know what "marketable" means. I doubt there's a precise praxeological definition of it. Homes and condominiums not yet built are capable of being marketed and sold before ground is broken in construction. Thus, all sorts of things are capable of being marketed before they are built. Thus, they are "marketable". I don't know how you can prove one thing is "more" marketable than another thing.
Paul Edwards: "Therefore, credit can never be as marketable as the most marketable current good. Therefore, credit can never be money."
Whoa that's a huge leap in logic, especially given that credit cards can pay for all sorts of goods daily. Even a debit card is a credit card that transfers numbers, the promise of payment, or the promise of money being there to be withdrawn.
It's just silly to maintain credit cards and debit cards wouldn't exist in a free market economy. They already do exist voluntarily in a not so free market economy. And free market credit already *dwarfs* fiat currency. There's no limit to promises in a free market if somebody is voluntarily willing to accept them as subjectively valued money. That's why markets for rating and hedging credit risks exist.
Published: April 9, 2007 6:58 PM
Björn Lundahl
RogerM,
I will not make any more statements about Reisman’s ideas regarding hoarding as I have read only a few sentences about them.
I believe that I have given Alex the correct answers concerning the pure time preferences theory of interest, as I think it to be true that he does not seem to see the difference between productivity as a value judgment and pure physical productivity (mechanical).
If Alex himself thinks that I have given him the correct answers is, of course, another story.
Regards
Björn
Published: April 9, 2007 7:29 PM
Paul Edwards
rtr,
“So credit cards are a mirage? Home loans don't exist? Credit scores are the same for all individuals?”
I’m not sure I follow your point. Loans and credit cards would seem likely to arise in a free market. But this has nothing to do with the nature of money in such an economy. Money would still be a present good regardless of the fact that credit transactions would take place all the time.
“"Time preference" might be another casualty of the correct definition of money. What does "time preference" have to do with trading something today for the promise of that something back plus something more tomorrow, especially if that something is just sitting there in storage for future use anyway? Both parties by definition profit from that exchange at the moment of that exchange.”
Well, time preference is the fact that people necessarily value something more today than they value it a year from today. It is why we have originary interest. Why this is important in the context of analyzing money is that it shows us that all present goods, including the most marketable one – money - are necessarily more marketable (are valued more highly) than corresponding present claims to such goods in the future - the interest rate proves this. As we all know through study of Mises’s regression theorem, money is the market’s most marketable commodity: and whatever that commodity is, to be the most marketable, it must necessarily be a present good.
Take for instance ten ounces of gold. If you were to lend it out, you might expect to get in consideration of interest and time preference, 11 ounces back in a year or two. Therefore ten ounces today is worth 11 in the future. Obviously today’s ounce of gold is worth more today than the one you expect to get back two years from today. The corollary to this fact is also that an ounce of gold is more marketable today than a claim to an ounce two years from today. Hence, if gold is the most marketable present commodity, it is also the most marketable commodity period. Credit cannot ever emerge on the free market as money.
“Title to ownership of future goods are traded all the time in a free market. You can pre-order a DVD of a Hollywood movie before it's manufactured. You can trade title to future pay checks or title to future revenues for a house or business capital today.”
This is true, but while credit transactions can and will occur, it does not make credit money. You will borrow money from a bank, and pay money to the house seller, but the seller is taking money, and the bank is lending money. In the end, it is money – the present good – which is the medium of exchange. It is not credit.
“I don't know what "marketable" means.”
You need to know this in order to discuss this subject properly. Without knowing this concept, you can’t follow Mises’s money regression theorem. And if you don’t understand that, you can’t understand why money must be a present good. Most marketable means generally valued by the most people. In the context of money, it means that people will accept it just for its value as a medium of exchange: for indirect monetary exchange, to sell later for what they really want.
“I doubt there's a precise praxeological definition of it.”
Well, there’s a precise praxeological definition of money, and the concept of “marketable” is part of that definition.
“Homes and condominiums not yet built are capable of being marketed and sold before ground is broken in construction.”
But people do not and cannot use homes and condos as media of exchange. They cannot use them as money for quite a host of reasons, including their lack of marketability.
“Thus, all sorts of things are capable of being marketed before they are built. Thus, they are "marketable". I don't know how you can prove one thing is "more" marketable than another thing.””
The way you know that a good is more marketable than others is when the market will accept that good for the purpose of indirect exchange whereas it won’t accept any other commodity for this purpose. Until then, in a barter market such a question remains yet to be resolved.
“Whoa that's a huge leap in logic, especially given that credit cards can pay for all sorts of goods daily.”
But what are the units we pay in with these credit cards? In the U.S, they are dollars. What units of currency is it that is written on the good or service you wish to buy? In the states, it is “dollar”. You pay in dollars. The merchant does not care if you borrowed the dollars from a credit card company, the bank, or your mother. It wants dollars, and that in fact is what gets transferred very quickly to his bank account. It is not a credit transaction from the merchant’s perspective. To him, he is getting paid essentially in cash.
“Even a debit card is a credit card that transfers numbers, the promise of payment, or the promise of money being there to be withdrawn.”
Actually a debit card is not a credit card. Using it is definitely a cash transaction. The promise you are talking about is quite like the promise that the cash dollars you hand over are not counterfeit.
“It's just silly to maintain credit cards and debit cards wouldn't exist in a free market economy.”
I agree. But neither of us is making this claim.
“They already do exist voluntarily in a not so free market economy.”
Not that what happens in the hampered market that we live in today is any clear sign of what would happen in an unhampered market, but I agree they would likely exist in a free market.
“And free market credit already *dwarfs* fiat currency. There's no limit to promises in a free market if somebody is voluntarily willing to accept them as subjectively valued money. That's why markets for rating and hedging credit risks exist.”
I think this is confused. Money is what the market chooses as a universal media of exchange. In a free market there can only be one such commodity that fulfils this role. It must be the most marketable of all commodities such that people will recognize it as being easy to sell when the right opportunity arises to buy what one wishes. That’s all money is.
Published: April 9, 2007 8:35 PM
rtr
Sasha Radeta: "Claiming that money is a medium of exchange does not presuppose that people value things equally."
It presupposes people value money *only* as a medium of exchange, which is absurd, which is "F" "A" "L" "S" "E". Why would anybody accept money in trade if it was only a "medium" of exchange? It would be a "hot potato" to be instantly traded for something else that wasn't money. Trade occurs because that which is received is valued more than that which is given away. If you were really just trading for a "medium of exchange" you would never hold money long term, bury it in the backyard, hide it under the mattress, or put it in a bank vault.
Sasha Radeta: "Quite the contrary - sellers place a higher value on money they receive compared to their own goods, simply because they place a higher value on consumption of goods other than their own (one person cannot produce everything he needs and he cannot efficiently fulfill those needs through barter... that's why he values some widely accepted medium of exchange)."
Good, it's amazing, truly, just how much garbage is out there as claimed economic theory. Add consumption to that list. Trade is not "consumption". Not everything which is traded for is "consumed" afterwards, and certainly not consumed at the moment of trade.
Sasha Radeta: "The fact that I hold some sugar, flour, oil, sauerkraut, etc., in my possession does not deny the fact that money is my medium of exchange, by which I can easily exchange my goods for some other goods I desire to consumer -- either now or later."
Money is just another good, that happens to be the most commonly exchanged thing in trade. How many times do I have to repeat myself? If money is a medium, then nobody wants money except just as a medium, which means nobody would accept money in the first place. It would be completely pointless to have money. It's no wonder Austrians (and well I guess everyone else too) are clueless as to why fiat currency is picked up off the ground and voluntarily exchanged for other things in trade.
Sasha Radeta: "I may hold these items for my future consumption or even for some barter -- but these items are not universally accepted goods that I could use for purchases of other goods -- i.e. money."
Money isn't "universally" accepted either. Money isn't involved in every trade. The only one who is employing universal economic law is me, as I'm talking about trade, which includes all things which are exchanged, even the non physical.
Sasha Radeta: "When it comes to RTR's statement that money does not have to be a physical good, it only shows that economics is seldom thought at our schools. Money is always a physical good that is high in value-to-weight ratio (hence transportable), durable, relatively difficult to inflate or counterfeit..."
Lol, what's higher in value-to-weight ratio than credit promises? That sounds like something out of a communist handbook: "money is always a physical good that is high in value-to-weight ratio ..." How do you explain then the number of transactions that occur with no physical good traded? Some whacko conspiracy theory about invisible men with guns forcing them to?
Sasha Radeta: "Austrian business cycle theory is a wonderful piece of tautology, in which people's subjective valuation always emerge, by restoring the true interest rate or time preference (investment/consumption proportions and price differentials between stages of production). Unfortunately, it is far beyond RTR's cognitive capabilities."
You can demonstrate proof and they bury their heads in the sand. Sash Radeta ain't the sharpest knife in the drawer around here by far, but wow, if that's the best left holding up the Austrian Business Cycle Theory it makes one wonder if Rothbard was nothing but a hack all along.
"Peoples subjective valuations always emerge"? What is this, Snow White and the Seven Dwarves?
"by restoring the true interest rate or time preference"? The magic land fairy tale of the Austrian Business Cycle Theory is "O" "V" "E" "R", thanks to me. Deal with it.
Published: April 9, 2007 10:25 PM
Sasha Radeta
RTR,
Like I said, Austrian business cycle theory is far beyond your grasp. Trying to explain it to you would be inhumane and cruel (almost like trying to tech a paraplegic how to ride a bicycle). I’ll try to explain the theory of money (you obviously skipped that with Menger):
First of all, you obviously have a problem with reading or an ADD that makes you jump to wrong conclusions. I never claimed that “trade is a consumption” as you incorrectly impute. I only stated some facts that stem from the fact that the goal of every trade is the present or future consumption! That’s why money is accepted as a medium of exchange -- it can serve as a store of value by which we can postpone the finalization of desired exchanges. For example, imagine if sauerkraut was my only good and I want to obtain grapes with my neighbor, who does not want any kraut. Selling sauerkraut not only provides me with a generally accepted medium of exchange - but I can also hold the gold and get those grapes at a later date, when they become ripe (I can’t believe I have to explain the basic functions of money to a human being - o tempora, o mores!)
By the way, I never said that people take money “only” as a medium of exchange (first of all, money as physical good always has its basic practical purpose, like in jewelry or industry). “Medium of exchange” is the basic function of money that makes it generally accepted… but since it allows the postponement of desired exchanges, as well as the purchase of future goods (either through interest-yielding loans or through the purchase of capital and factors of productions that will later be transformed into present goods) - the money gets its other functions as a store of value…
By the way, empty blabbing against Austrian business cycle theory do not prove anything more than your mental retardation. In order to say anything meaningful about this theory, you would first have to read it and understand it. Unfortunately, you are incapable of doing that (actually, I think that you are trying to tease us into explaining this theory to you, and you will create a disagreement along the way : )
Published: April 9, 2007 11:48 PM
rtr
Paul Edwards: "Money would still be a present good regardless of the fact that credit transactions would take place all the time."
All sorts of goods are "present" goods. Milk is a present good. Gold is a present good. Credit is a present good. Reputation is a present good. Celebrity is a present good.
Paul Edwards: "Well, time preference is the fact that people necessarily value something more today than they value it a year from today."
You mean like a 5 year old bottle of Scotch tends to be more valuable than a 20 year old bottle of Scotch? Whoops, there goes the "necessarily".
Paul Edwards: "Why this is important in the context of analyzing money is that it shows us that all present goods, including the most marketable one – money - are necessarily more marketable (are valued more highly) than corresponding present claims to such goods in the future - the interest rate proves this."
False. If that was true for all people, nobody would save. Nobody would invest. By definition of the act of saving, one values it more in the future than in the present. If you choose to eat your dessert after your vegetables you value eating your dessert after eating your vegetable more than you value eating your dessert before your vegetables. It's amazing all the stuff I'm *proving* false with a clear understanding of trade, isn't it? That's why I'm the best, EVER, so far.
Paul Edwards: "Take for instance ten ounces of gold. If you were to lend it out, you might expect to get in consideration of interest and time preference, 11 ounces back in a year or two. Therefore ten ounces today is worth 11 in the future."
If that were true, put options (the right, but not the responsibility, to sell something in the future for the present price) would never have positive value. You might choose to sell a $500,000 house a year ago, and rent, expecting to repurchase that same house for $250,000 two years from now. The same expectations, individual subjective valuations, can exist for gold. Ten ounces of gold today can be worth more than 12 ounces of gold next year.
Paul Edwards: "The corollary to this fact is also that an ounce of gold is more marketable today than a claim to an ounce two years from today."
Add up the subjective value of futures and derivatives contracts as expressed in the most recent trade prices.
Paul Edwards: "Credit cannot ever emerge on the free market as money."
It already has. Anything whatsoever that has subjective value can emerge as the most commonly exchanged thing in trade.
Paul Edwards: "You will borrow money from a bank, and pay money to the house seller, but the seller is taking money, and the bank is lending money. In the end, it is money – the present good – which is the medium of exchange. It is not credit."
How is someone trading for a house with no money down and only the promise of future money payments? How is someone trading for present money with only the promise of future money payments? No matter how you slice it, credit has subjective value, promises have subjective value.
Paul Edwards: "Without knowing this concept, you can’t follow Mises’s money regression theorem. And if you don’t understand that, you can’t understand why money must be a present good."
As soon as the Austrians started talking about money, I said "BS". As soon as the Chicago School started talking about money, I said "BS".
Paul Edwards: "Most marketable means generally valued by the most people. In the context of money, it means that people will accept it just for its value as a medium of exchange: for indirect monetary exchange, to sell later for what they really want."
If it only has value as a medium of exchange, why bother with the "middle good"? See? That's why labeling money a "medium" of exchange is false. You've just admitted people don't "really want" money, and that is in direct contradiction with the law of trade. The error was subtle, but gargantuan. But hey, that's why I get the Nobel Prize trophy case, right?
Paul Edwards: "But people do not and cannot use homes and condos as media of exchange."
It takes two to tango, and there are (at least) two things involved in every trade. It would be absurd for two people to trade in the present differing amounts of the same thing, as in one person trading 5 gold pieces for 10 gold pieces.
Paul Edwards: "The way you know that a good is more marketable than others is when the market will accept that good for the purpose of indirect exchange"
False. "Indirect" exchange would be hampering the profit which must be occurring from for all parties from every voluntary transaction. If it's "indirect", it means "you don't want it".
Paul Edwards: "But what are the units we pay in with these credit cards? In the U.S, they are dollars. What units of currency is it that is written on the good or service you wish to buy? In the states, it is “dollar”. You pay in dollars."
You pay in promises to pay dollars when you swipe a plastic card.
Paul Edwards: "The merchant does not care if you borrowed the dollars from a credit card company, the bank, or your mother. It wants dollars, and that in fact is what gets transferred very quickly to his bank account. It is not a credit transaction from the merchant’s perspective. To him, he is getting paid essentially in cash."
False. The merchant is paying a percentage transaction fee to credit merchants. He very much cares about the form of payment.
Paul Edwards: "Actually a debit card is not a credit card. Using it is definitely a cash transaction. The promise you are talking about is quite like the promise that the cash dollars you hand over are not counterfeit."
Or like the promise that the "gold" you hand over is not counterfeit? Or like the Picasso being auctioned by the auction house is not counterfeit? Or that the diamond you are purchasing is really of a certain "grade" and "quality"?
Paul Edwards: "Money is what the market chooses as a universal media of exchange."
There is no such thing as a "universal" media of exchange, unless it's strictly limited to subjective value. Money is just the (doesn't have to be "one" thing either, or one "class", like a multitude of "precious metals") most commonly exchanged thing of subjective value in trade.
Published: April 9, 2007 11:53 PM
Björn Lundahl
RogerM
I forgot to thank you for the quotes of Reisman’s position regarding hoarding. I think they are valid.
I will have to read more about Riesman’s ideas before I can make up my mind concerning his position on hoarding.
Björn Lundahl
Published: April 10, 2007 2:39 AM
Paul Edwards
rtr,
“All sorts of goods are "present" goods. Milk is a present good. Gold is a present good. Credit is a present good. Reputation is a present good. Celebrity is a present good.”
Well, I’ll not dispute with you the question of the nature of credit. But I will say that while gold and milk are both present goods, only one of the two have the physical characteristics needed to become money. Not every present good has a chance at being money; and in the end, only one commodity can and will emerge as money.
“You mean like a 5 year old bottle of Scotch tends to be more valuable than a 20 year old bottle of Scotch? Whoops, there goes the "necessarily".”
This is a common misunderstanding of time preference. The 5 and the 20 year old bottles of scotch are not the same good, so they are not comparable. The way to think about it so you grasp it is this: a 5 year old bottle of scotch is worth more today than a 5 year old bottle of scotch if it is delivered 5 years from now, is worth today. Does that help?
“False. If that was true for all people, nobody would save. Nobody would invest. By definition of the act of saving, one values it more in the future than in the present. If you choose to eat your dessert after your vegetables you value eating your dessert after eating your vegetable more than you value eating your dessert before your vegetables. It's amazing all the stuff I'm *proving* false with a clear understanding of trade, isn't it? That's why I'm the best, EVER, so far.”
You are very impressive. However, you would be an even greater giant if you were to stand on the shoulders of other giants such as Mises and Rothbard from time to time. Have you ever noticed that those who save and invest today’s resources, without exception, expect to be paid in the future with both principle and interest or profit? I’m saying, without exception. People save, but only if the borrowers, or the investment shows some promise of paying a return on this savings and investment. I think the scotch example also answers the veggies/dessert question.
“If that were true, put options (the right, but not the responsibility, to sell something in the future for the present price) would never have positive value. You might choose to sell a $500,000 house a year ago, and rent, expecting to repurchase that same house for $250,000 two years from now. The same expectations, individual subjective valuations, can exist for gold. Ten ounces of gold today can be worth more than 12 ounces of gold next year.”
Sure, but this is accounting for peoples expectations and speculations that there will either be an excessive supply of the good, or a depression in the demand for the good in the future, severely depressing its price at that time. The purchasing power of the money commodity can be influenced by similar considerations, although the nature of the commodity chosen as money tends to be far less under such influences. The increase in the supply of gold in the market, for instance, if it were money in a free market, is fairly steady and is fairly small in comparison to its present supply. And the increasing uses of gold and demand for it can be accounted for by speculators and these influences flattened out. But nevertheless, all things being equal, people prefer a thing that they desire more now than later, as Riesman puts it, because desiring a thing means to want it sooner than later.
Paul Edwards: "The corollary to this fact is also that an ounce of gold is more marketable today than a claim to an ounce two years from today."
“Add up the subjective value of futures and derivatives contracts as expressed in the most recent trade prices.”
There is lots of speculation about how ravaged the US dollar, the world’s reserve currency, may be in the future and how much the world market will dump the dollar in preference for gold as a safer haven for their cash holdings, as the fed inflates the dollar into the ground. This is not related to time preference. It is an artifact mainly of the uncertainty the federal reserve and the banking industry has injected into the world markets via vast amounts of monetary inflation of the US dollar, again, the world’s reserve currency.
Paul Edwards: "Credit cannot ever emerge on the free market as money."
“It already has. Anything whatsoever that has subjective value can emerge as the most commonly exchanged thing in trade.”
Credit did not emerge as money on any free market. It was the outcome of coercive state interference with a gold commodity money via the state favored banking industry and central banking. It is a mistake to confuse today’s markets with free markets. They are vastly different.
Paul Edwards: "You will borrow money from a bank, and pay money to the house seller, but the seller is taking money, and the bank is lending money. In the end, it is money – the present good – which is the medium of exchange. It is not credit."
“How is someone trading for a house with no money down and only the promise of future money payments? How is someone trading for present money with only the promise of future money payments? No matter how you slice it, credit has subjective value, promises have subjective value.”
I’m not disputing that credit is subjectively valued. I’m just saying credit isn’t money. People subjectively value horses and donkeys as well as mortgages and credit. And yet, horses and donkeys also are not money.
Paul Edwards: "Without knowing this concept, you can’t follow Mises’s money regression theorem. And if you don’t understand that, you can’t understand why money must be a present good."
“As soon as the Austrians started talking about money, I said "BS". As soon as the Chicago School started talking about money, I said "BS".
I see. You are very impressive indeed. You will probably write a tome – or have you already - to rival and render obsolete both Human Action and Man Economy and State. I salute you in advance.
Paul Edwards: "Most marketable means generally valued by the most people. In the context of money, it means that people will accept it just for its value as a medium of exchange: for indirect monetary exchange, to sell later for what they really want."
“If it only has value as a medium of exchange, why bother with the "middle good"? See? That's why labeling money a "medium" of exchange is false. You've just admitted people don't "really want" money, and that is in direct contradiction with the law of trade. The error was subtle, but gargantuan. But hey, that's why I get the Nobel Prize trophy case, right?”
Yes. You deserve the Nobel Prize indeed. Is it really your contention that there is no such thing as money as described by Mises? If you are saying this, then the rest of your argument makes more sense, in that it is clear from where your confusion is rooted.
Paul Edwards: "But people do not and cannot use homes and condos as media of exchange."
“It takes two to tango, and there are (at least) two things involved in every trade. It would be absurd for two people to trade in the present differing amounts of the same thing, as in one person trading 5 gold pieces for 10 gold pieces.”
I do not see the connection between my comment, and your response.
Paul Edwards: "The way you know that a good is more marketable than others is when the market will accept that good for the purpose of indirect exchange"
“False. "Indirect" exchange would be hampering the profit which must be occurring from for all parties from every voluntary transaction. If it's "indirect", it means "you don't want it".”
Your comments are getting further and further out there, dude. I think it is time for you to be nominated for that nobel prize.
Paul Edwards: "But what are the units we pay in with these credit cards? In the U.S, they are dollars. What units of currency is it that is written on the good or service you wish to buy? In the states, it is “dollar”. You pay in dollars."
“You pay in promises to pay dollars when you swipe a plastic card.”
Correct. Wow. These promises are that the dollars will be deposited the next business day. It’s not a loan to you. It’s a cash transaction limited in swiftness of technology and banking hours.
Paul Edwards: "The merchant does not care if you borrowed the dollars from a credit card company, the bank, or your mother. It wants dollars, and that in fact is what gets transferred very quickly to his bank account. It is not a credit transaction from the merchant’s perspective. To him, he is getting paid essentially in cash."
“False. The merchant is paying a percentage transaction fee to credit merchants. He very much cares about the form of payment.”
His whole business is founded on paying a series of fees to get a product or service in the hands of a paying customer. His goal is to pay less in total fees than he charges his customers. That is how he turns a profit. Paying a fee to a credit card company is just another cost of doing business. He still gets paid in cashy money – dollars - when you swipe that card.
Paul Edwards: "Actually a debit card is not a credit card. Using it is definitely a cash transaction. The promise you are talking about is quite like the promise that the cash dollars you hand over are not counterfeit."
“Or like the promise that the "gold" you hand over is not counterfeit? Or like the Picasso being auctioned by the auction house is not counterfeit? Or that the diamond you are purchasing is really of a certain "grade" and "quality"?”
Yup.
Paul Edwards: "Money is what the market chooses as a universal media of exchange."
“There is no such thing as a "universal" media of exchange, unless it's strictly limited to subjective value. Money is just the (doesn't have to be "one" thing either, or one "class", like a multitude of "precious metals") most commonly exchanged thing of subjective value in trade.”
Your definition of money is next to useless. For every exchange there are two commodities involved, usually, one of those commodities is money. Money is used because barter is too cumbersome. People suffer too often from a lack of a coincidence of wants in barter. A monetary economy overcomes this. When people can participate in indirect exchange through some medium of exchange, they can take money for what they sell today, safe in the knowledge that there is a general demand for this money so that they can buy with it what they want tomorrow.
Published: April 10, 2007 4:34 AM
Björn Lundahl
In my bookshelf I just found an old book and looked into it “Dollars and Deficits, Inflation, Monetary Policy and the Balance of Payments”, by Dr. Milton Friedman published in 1968, chapter two, page 76:
“I cannot forbear a minor digression at this point. For a long time I have been a proponent of 100% reserve banking. Under this system, the depositary activities of banks would be separated from their lending and investing activities, and the depositary institutions would serve as pure warehouses of funds. For every dollar of deposits, they would be required to hold a dollar currency or its equivalent. Those of us who favour this scheme are accustomed to being labelled “unrealistic”; to being told that we are proposing a reform that has no chance of adoption and would require utterly impractical changes in the banking system if it were adopted.”
It seems that Milton Friedman gave up this idea of 100% fiat money reserve standard and instead proposed a monetary rule as this standpoint was more politically feasible.
Björn Lundahl
Published: April 10, 2007 6:07 AM
rtr
Paul Edwards: "The 5 and the 20 year old bottles of scotch are not the same good, so they are not comparable. The way to think about it so you grasp it is this: a 5 year old bottle of scotch is worth more today than a 5 year old bottle of scotch if it is delivered 5 years from now, is worth today."
You are correct that they are different goods. I realized that after reading my post.
Paul Edwards: "Have you ever noticed that those who save and invest today’s resources, without exception, expect to be paid in the future with both principle and interest or profit?"
True. You save because your savings are worth more in the future then they are worth in the present. Seven years of feast followed by seven years of famine.
Paul Edwards: "People save, but only if the borrowers, or the investment shows some promise of paying a return on this savings and investment. I think the scotch example also answers the veggies/dessert question."
People will save even if there are no borrowers, for instance as insurance for a rainy day. That act itself is profitable with no interest being paid by another. The scotch example does not answer the veggies/dessert example. You are free to eat your vegetables first or free to eat your dessert first. That's a time preference choice which shows eating your dessert in the future after eating your vegetables in the present is more profitable than the reverse.
Paul Edwards: "The increase in the supply of gold in the market, for instance, if it were money in a free market, is fairly steady and is fairly small in comparison to its present supply."
Sure, and that's likely a big part of the reason people subjectively value gold as a store of subjective value.
Paul Edwards: "But nevertheless, all things being equal, people prefer a thing that they desire more now than later, as Riesman puts it, because desiring a thing means to want it sooner than later."
Sure, all action occurs in the present. Becoming conscious of desiring in the future, man sets aside in the present. Imagining more, or better use, in the future, man employs in the present.
Paul Edwards: "Credit did not emerge as money on any free market. It was the outcome of coercive state interference with a gold commodity money via the state favored banking industry and central banking."
In every single instance where credit is voluntarily offered and credit is voluntarily traded for is an instance of credit emerging on the free market.
Paul Edwards: "Is it really your contention that there is no such thing as money as described by Mises?"
It is my contention that money is not a medium of exchange. It is my contention that money is simply the most commonly exchanged thing(s) in trade. It's also my contention that defining money as a "medium" of exchange has led to gargantuan errors in economic reasoning throughout the field of economics.
Paul Edwards: "These promises are that the dollars will be deposited the next business day. It’s not a loan to you. It’s a cash transaction limited in swiftness of technology and banking hours."
It's a short-term loan. But it's still a loan.
Paul Edwards: "Paying a fee to a credit card company is just another cost of doing business. He still gets paid in cashy money – dollars - when you swipe that card."
The merchant gets less than if the customer had actually traded cash dollars directly to the merchant instead of swiping the card and trading the promises of future cash dollars being deposited to his account. The reputation and routine of the transaction is of such a high quality that it's generally considered "as good as" cash, even though technically, it's the promise of future cash. Again, as we both agreed, there are fraud risks faced by the merchant and the credit company, just as there are fraud risks for any good being traded for.
Paul Edwards: "Your definition of money is next to useless. For every exchange there are two commodities involved, usually, one of those commodities is money. Money is used because barter is too cumbersome."
Defining money as a medium of exchange is false. Barter is not "too cumbersome". There are general merchants like Wal Mart, malls, marketplaces, grocery stores, where are a variety of goods are bought and sold. It's been the way for centuries through many different forms of particular "money". People by definition profit by the act of trading completely unrelated this for that things, because that's what they want. Money, as the most commonly exchanged thing in trade, a common store of value, helps measure how much of this for how much of that. But the profit cannot ever be precisely objectively measured, because by definition of trading money for a good you are profiting from that action. The good is worth more than the money traded away in exchange.
Paul Edwards: "People suffer too often from a lack of a coincidence of wants in barter. A monetary economy overcomes this."
Absolutely true.
Paul Edwards: "When people can participate in indirect exchange through some medium of exchange, they can take money for what they sell today, safe in the knowledge that there is a general demand for this money so that they can buy with it what they want tomorrow."
There is no possible example of an indirect exchange. All exchange is done with the purpose of receiving something of more value than that which is given away. Of course that creates incentives to produce and gather what others want. The only thing which occurs in reality is direct exchange of this for that. Money is not a medium of exchange either. The rest of that paragraph is absolutely correct though. But because you leave out the word "trade" you miss the profting which is occuring in every exchange. You also neglect that "money" is not the only good which is valued because of "general demand". All goods are subjectively valued which are in "general demand".
That's why people specialize in the division of labor and produce surpluses beyond what they themselves are going to use because their surplus is in "general demand", whether that surplus is the manufacture of "money" or the production of any other good or service whatsoever. It's absurd to call money a medium of exchange (and false) without also calling every individual's surplus production of other goods and services for trade a medium of exchange. Thus, not only is calling money a medium of exchange false, but it wouldn't be uniquely applicable either.
Published: April 10, 2007 10:14 AM
Sasha Radeta
Yes, the reason behind every trade is consumption, either present or future one (including the consumption of next generations). Since people normally don’t desire money to consume it (for industrial use, jewelry, etc) -- it normally serves only to be exchanged for some other desired goods or services -- either now or in the future.
RTR’s insane comments about “medium of exchange” show that anti-Austrian “brains” are incapable of applying the factor of time in the basic economic analysis. That’s why RTR is stuck in the economics of present goods (he never got beyond the high-school “economics”). He doesn’t understand that people can exchange present goods for future goods even at the present time and that money serves as a medium of exchange in those transactions (whether in forms of the interest-yielding loans that are aimed for future consumption -- or in the form of purchases of capital and production-factors that will become present goods at the future date)
Since the factor of time forms the basis of Austrian business cycle theory, it is not strange that RTR is incapable of understanding it. As I pointed out, money serves as a medium of exchange between present and future goods and due to the time preference, people place a higher value on present good and they purchase capital goods and factors of production at a discount (plus the factors of risk). Higher saving (I.e. higher future consumption) reduces the consumption of present goods and it increases investments in higher stages of production. As the result, prices of factors of production go up, while prices of final goods go down. Increased supply of future goods satisfies higher demand and we have no malinvestments.
Since the interest rate is ratio of prices between different stages of production (showing the return on investment from lower to higher stage, similar to return on loans) -- when the central bank falsifies the interest rate it is basically misinforming entrepreneurs about the prices of future goods sold today in form of capital and factors of production, as well as loans. As you know from economics 101, the basic role of prices is to direct resources to their most valued use. Increase in prices attract resources toward these higher stages of production and people invest heavily into these future goods. However, people’s consumption of present goods did not go down (they just switched to imported goods) and they don’t have savings (future consumption) to support this massive increase in future goods. As the result, we have a large surplus of goods unsold and many firms go bankrupt. When people’s true preferences reveal malinvestmets we call this a “recession…”
Trying to deny the Austrian business cycle theory is like trying to deny self-evident facts noticeable to anyone who cares to use his brain. One basic role of prices is to guide production (higher prices attract supply) and when central bank falsifies the interest rate it in facts sends a wrong signal regarding the prices of future goods. That is the only reason for the epidemics of bad decision that occurs cyclically after every fraudulent (not supported by real savings) credit expansion.
Published: April 10, 2007 11:20 AM
rtr
Sasha Radeta: "I only stated some facts that stem from the fact that the goal of every trade is the present or future consumption!"
That's wrong moron. Land isn't consumed. Music isn't consumed. Words and ideas aren't consumed. You don't know what you are talking about as usual. But what an idiot that completely ignores the reason action occurs, to profit, to increase utility. Your statement "the goal of every trade is the present or future consumption" shows utter indifference between the present and the future.
Sasha Radeta: "That’s why money is accepted as a medium of exchange -- it can serve as a store of value by which we can postpone the finalization of desired exchanges."
Money is accepted *in* exchange.
Sasha Radeta: "Selling sauerkraut not only provides me with a generally accepted medium of exchange"
Selling it for money means you trade it for money you retard. That's an exchange, ONE THING FOR ANOTHER. Calling one the "medium" is idiotic. You prefer one or the other if you exchange for it.
Sasha Radeta: "I can also hold the gold and get those grapes at a later date, when they become ripe (I can’t believe I have to explain the basic functions of money to a human being - o tempora, o mores!)"
You can hold anything of subjective value to a later date for the purpose of holding subjective value, not just one item you call "money" dummy. People invest in art, in coins, buidlings, etc. Your basic functions are not unique to gold or money stupid. People save grain in case of famine too.
Sasha Radeta: "By the way, I never said that people take money “only” as a medium of exchange"
Then money isn't the medium of exchange, idiot, by definition of other subjectively valued purposes, moron.
Sasha Radeta: "(first of all, money as physical good always has its basic practical purpose, like in jewelry or industry)."
Your Marxist "use-value" artificially alleged a priori defined purposes are tiresome.
Sasha Radeta: "“Medium of exchange” is the basic function of money that makes it generally accepted"
And that's unique from every single other good or service which is traded how .... MORON? Everything which is traded is accepted, and not just generally. If nobody wants it, it doesn't get traded. And lot's of things are "generally accepted" too, like food and labor.
Sasha Radeta: "but since it allows the postponement of desired exchanges,"
What an utterly absurd contraciction, an exchange to postpone exchange ... Try thinking stupid. Not to mention, *waiting* to exchange has the effect of delaying exchange to the future.
Sasha Radeta: "RTR’s insane comments about “medium of exchange” show that anti-Austrian “brains” are incapable of applying the factor of time in the basic economic analysis. That’s why RTR is stuck in the economics of present goods (he never got beyond the high-school “economics”). He doesn’t understand that people can exchange present goods for future goods even at the present time and that money serves as a medium of exchange in those transactions (whether in forms of the interest-yielding loans that are aimed for future consumption -- or in the form of purchases of capital and production-factors that will become present goods at the future date)"
wtf are blabbering about moron? Seriosuly, why don't you take your mental pollution to another thread. I don't have time to dissect new paragraphs of your garbage.
Sasha Radeta: "Since the factor of time forms...satisfies higher demand and we have no malinvestments."
Talking to your delusional self?
Sasha Radeta: "people’s consumption of present goods did not go down (they just switched to imported goods)"
Oh how convenient. It's another magical fairy tale world from which the imports are made. @@
Really, the ABCT coffin is nailed in my posts above. I'm not copying and pasting, or constructing new examples from scratch, for you anymore. All you do is spew unproved tiresome garbage and ignore things which are proved to you. Have fun talking to yourself or others.
Published: April 10, 2007 2:05 PM
Björn Lundahl
I don’t know if this one is clearer:
Another way to explain the pure time preferences theory of interest is that time preferences are value judgments and value judgments are derived from individuals. All human actions are done to satisfy values. Time as, I wrote, is not excluded.
To deny time preferences as the only determining factor of the rate of interest to the advantage of the productivity theory of capital, would be analogues with the proposition that the marginal utility of a consumer good is determined by the physical and technical possibility to make it. Without the physical and technical means to produce the good, the consumption of it would not be possible and not, therefore, any price of it.
The fallacy with mentioned reasoning is that the marginal utility, that is the market value of a consumer good and therefore its price are value judgments.
If an investment is productive is, also, derived from people’s value judgments.
Physical productivity of capital is only a technological or a mechanical term and not a value judgment. Physical productivity can increase dramatically but will not be brought about if it isn’t expected to be in market value terms “productive” and profitable and therefore correspond to people’s values.
To put it differently, if an investment is productive and yields a market rate of interest is ultimately derived from value judgements.
Time preferences are intrinsically value judgements as they answer the question why consumers will place premiums on enjoyments nearer in time over more remote enjoyments.
Björn Lundahl
Published: April 10, 2007 3:52 PM
Sasha Radeta
RTR is eager to call someone a "moron," but that still does not hide his severe mental retardation and lack of any common sense when it comes to economics.
He said: “That's wrong moron. Land isn't consumed. Music isn't consumed. Words and ideas aren't consumed.”
Poor guy does not see that I never said that “music, words or ideas” are “consumed” in economic sense. He is incapable of seeing that music, words and ideas are not exchanged in market transactions (instead, we buy physical items such as book or C.D.s, or we pay for services of someone else’s scarce goods)
The reason behind every trade is some use (OR CONSUMPTION) of scarce consumers goods. When people buy factors of productions, such as land or labor, they actually purchase future goods that can be produced from these factors. When people accept money, they normally don’t take it as their desired end. Money is only a medium of desired exchange that will help us to get a desired consumption. In my sauerkraut example, I accept money only to get some desired grapes (without having to go around the world looking for a grapes-seller that also needs sauerkraut)…
RTR goes simply out of his mind, and starts barking and foaming when I mentioned that money is generally accepted medium of exchange. He does not realize that money is different in that regards than other goods. For example, RTR probably highly values a rectal plugs -- but these toys are not generally accepted by other people. RTR may sell his labor services for this plug -- but he will suffer from the inefficiency of barter when he tries to exchange that item in the supermarket…. However, if he accepts gold for his services, he will have no difficulty of obtaining any desired (present or future) consumer goods. That’s why gold historically served as money, and RTR’s favorite toys did not…
Since RTR is incapable of applying the factor of time and he is oblivious to the exchanges of present for future goods (with money as their medium of exchange), Austrian business cycle or any basic economics leads him to an incredible amount of frustration. That’s why he could not use single coherent argument and he keeps blabbing about “fairytales.” It is sad to see him so deranged and angry.
Published: April 10, 2007 4:30 PM