How to Ruin an Economy in One Easy Step
Chris McGreal reports from Harare:
Zimbabweans are shopping like there's no tomorrow. With police patrolling the aisles of Harare's electrical shops to enforce massive government-ordered price cuts, the widescreen TVs were the first things to go, for as little as £20. Across the country, shoes, clothes, toiletries and different kinds of food were all swept from the shelves as a nation with the world's fastest shrinking economy gorged itself on one last spending spree.Car dealers said officials were trying to force them to sell vehicles at the official exchange rate, effectively meaning that a car costing £15,000 could be had for £30 by changing money on the blackmarket. The owners of several dealerships have been arrested.
President Robert Mugabe's order that all shop prices be cut by at least half, and sometimes several times more, has forced stores to open to hordes of customers waving thick blocks of near worthless money given new value by the price cuts. The police and groups of ruling party supporters could be seen leading the charge for a bargain.
Comments (98)
The police and groups of ruling party supporters could be seen leading the charge for a bargain...and then apparently selling everything again at the inflated prices in shops that miraculously don't get raided until they're empty!
Published: July 16, 2007 5:19 PM
Here's the Real Bills Doctrine at work right before our eyes!
Published: July 16, 2007 9:45 PM
Sigh.
RogerM, this is not "the Real Bills Doctrine at work right before our eyes". It's actually something far subtler than that.
The only thing wrong with the Real Bills Doctrine is human nature; they aren't really Real Bills, once people start putting their own spin on things. Real Bills are those that really will close off in the near term and return a real value, intrinsically retiring the bills. Unfortunately people always put their thumbs on the scales, saying in effect "who do you think you are, claiming that you aren't too sure about this bill of mine?", and so a whole load of UNreal bills get in too. Then things degenerate into a Ponzi scheme as newer bills get thrown in to sweeten the pot, and so on.
Getting back to Zimbabwe, look at those banknotes. Those - as everybody knows - never will automatically retire themselves. The trouble with Real Bills Doctrine is that the bills end up not real.
By the way, the better way to print money for fun and profit, ruining an economy, is to put a proportion of the new issues into piecemeal acquisition of assets with a revenue stream, high value urban rental land say, and apply some of that revenue stream to retiring the money over time, sinking fund fashion (thus extending the life of the scheme). This is what the
French did to occupied countries during the revolutionary wars, after they had learned their own lesson the hard way, and it is roughly what the Dutch did in the East Indies to set up their "Culture System" (with variations).
Published: July 16, 2007 11:59 PM
Unbelievable. Economic suicide. Hopefully the people pushing price controls in the US will pay attention to what happens next. Unfortunately, though, the disaster will probably be blamed on something else and their will be a new country for the US to send money to.
Published: July 17, 2007 12:49 AM
> Hopefully the people pushing price controls in
> the US will pay attention to what happens next.
Alas, this is wishful thinking. They really never learn -- there was plenty of opportunity to see what price controls do in US and outside during the miserable 20th century.
The more I live, the more I get convinced that the only proper place for a collectivist is a mental institution.
Published: July 17, 2007 1:47 AM
If he wants to cling on to power why is he doing this? Does he really not understand what happens if you arbitrarily lowers prices?
Published: July 17, 2007 3:25 AM
"If he wants to cling on to power why is he doing this? Does he really not understand what happens if you arbitrarily lowers prices?"
Mugabe probably knows what is happening better than you do, Simon. The winners in this are those he has given special privileges, like access to foreign currency at statutory levels. The losers are all his enemies anyway, for tribal and party reasons, so he has nothing to lose there. And when all this leads to a close of international trade, it will be the foreigners who actually do the deed, not him - and he has already started blaming them. "Princes deal rewards by their own hands, death and punishment at the hands of others" (quoting Webster from memory).
Published: July 17, 2007 4:33 AM
P.M."The only thing wrong with the Real Bills Doctrine is human nature."
Are you saying that the RBD works well on paper but not in real life, like socialism? Do you know of any instances when real humans tried to apply RBD and it actually worked? Besides, how do you know that Mugabe isn't trying to apply RBD? German central bankers were honestly trying to apply RBD before and during the hyperinflation of the 1920's and were sincerely confused about the result. They honestly believed speculators and foreigners ruined their currency, not them. The US Fed sincerely applied the RBD during the 1920's in the US and also blaimed speculators for the problems.
Published: July 17, 2007 6:42 AM
Sorry, can you rephrase? What do you mean by the deed?
I can't say I know any history on hyperinflation and price fixing, what has happened to other governments that have done a similar thing to Mugabe?
Published: July 17, 2007 7:29 AM
P.M.: "The only thing wrong with the Real Bills Doctrine is human nature;"
The main problem with socialism is hubris. As Hayek has pointed out, the socialist leadership can't possibly know all that it needs to know in order to plan the economy. Such knowledge is beyond human ability. Maybe the same thing could be said of the RBD. Extremely intelligent men have tried RBD and failed. Is it possible that, like socialism, the knowledge required of bankers to make RBD work is beyond human capabilities? God could make it work, but not mere humans?
Published: July 17, 2007 8:59 AM
Simon, the price fixing and rapid depletion of inventories engineered by Mugabe will immediately result in the complete absence of goods to replace the ones that were sold.
In effect, these goods were stolen, at the government's command. What merchant is going to stay in business under these conditions? Productivity and distribution will come to a sudden halt on all goods affected by these rules. Businesses will close. Economic activity in Zimbabwe will go from minimal to basically zero. The economy of that country is over.
Published: July 17, 2007 9:03 AM
Tom Rafael - Not "economic suicide", but basically deliberate theft, as P.M. Lawrence and George Gaskell have pointed out.
No doubt this is also combined with various aspects of self-justification, self-deception and lack of comprehension about how economies work, but at its core it has long been clear that Mugabe and his supporters have been systematically looting that country, on a more blatant scale that what we see with rent-seeking at home.
Published: July 17, 2007 9:43 AM
RogerM: I'm not sure that Germany in the 20s was an example of a central bank exploiting the RBD. To use the RBD, you'd have to print money *only for loans* that would have to be paid back. Weimar didn't do that -- it just printed the money to buy things. Now, I'm not trying to defend the RBD (I'm still up in the air about it) but it's unfair to claim that that was an instance of its failure.
As for the US Fed at the same time -- I thought they *contracted* the money supply in '29 and that Rothbardians *support* that move, saying that what set off the Great Depression was the federal governments policies that kept nominal prices from adjusting.
What am I missing?
Published: July 17, 2007 9:50 AM
Right, I think I now understand how they are literally looting the country. But, he can't suppress a country full of angry people forever can he? What is likely to happen next?
Published: July 17, 2007 9:54 AM
I'm confused... based on the the wikipedia page on RBD (http://en.wikipedia.org/wiki/Real_bills_doctrine), I can't see anything wrong with it.
Can someone clear this up for me?
Published: July 17, 2007 10:11 AM
What happens next?
What happened in Yugoslavia in the early 1990s?
What happened in China in the late 1940s?
What happened in Germany in the 1920s?
What happened to the French Legislative Assembly in 1793?
What happened to the Roman Empire in the 4th century?
Hyperinflation and a collapse of a money economy often leads to widespread economic ruin, followed by war and a collapse of governments.
Published: July 17, 2007 10:15 AM
George Gaskell is correct- the economy is done. Transactions will cease. The next step is revolution and bloody, bloody attempts at repression.
Published: July 17, 2007 10:18 AM
Person: "I'm not sure that Germany in the 20s was an example of a central bank exploiting the RBD."
Mises was convinced that they were following the RBD, which was called the "Banking School" in his day. The central bank extended short term credit to the government, which owned many industries, and to businesses to meet their needs, both of which were supposed to pay back the loans and for the most part did. But the businesses, private and state owned, used a lot of the money from those loans to pay wages. The increased wages from employees then caused price inflation because consumers had not restrained consumption and producers couldn't keep up with demand.
As for the US Fed, Rothbard shows in his history of the Great Depression that the Fed raised interest rates, but kept expanding the money supply in other areas, primarily by purchasing business business and government bonds. The contraction in the money supply actually happened because of bank failures and the refusal of the American people to hold paper dollars.
Jean Paul: "I can't see anything wrong with it."
Wikipedia: "In a RBD economy, banks would be allowed to issue notes, that is currency, based on real bills that they hold, in addition to specie."
The purpose of specie (gold) is to limit the volume of notes (paper money) in circulation. When the banks issue paper money based on other assets, such as land or goods produced, the money supply expands dramatically. More money chasing a fixed amount of goods leads to price inflation. When the US Fed and the German central bank applied the RBD, the money supply increases caused businessmen to make bad investment decisions and invest too much money in areas for which there was not enough demand. In Germany, this caused price inflation. In the US, prices didn't rise because productivity was increasing rapidly, but the bad investments still occurred. The stock market only crashed when people realized how many companies were in financial trouble.
Published: July 17, 2007 10:51 AM
As far as I can understand money does not create wealth. It just measure it.
And that the main problem for all attempts of makiing money out of.. "thin air". Or even "thick air" ))
Published: July 17, 2007 11:15 AM
Jean Paul: "I'm confused... based on the the wikipedia page on RBD (http://en.wikipedia.org/wiki/Real_bills_doctrine), I can't see anything wrong with it. . . . Can someone clear this up for me?"
As far as I can see, the main problem with RBD is that there is an unspoken assumption in the model that values of assets are static. The model breaks down if the values of the bank's assets can change with respect to the supposed redemption commodity, since the bank would then no longer be holding assets equivalent to the notes it issued. In practice, of course, values are subjective and in constant flux, and any decrease in the value of the bank's assets w.r.t. the redemption commodity would eliminate financial convertability and introduce inflation.
Would anyone with more experience care to elaborate?
Published: July 17, 2007 12:21 PM
RogerM: "More money chasing a fixed amount of goods leads to price inflation"
The system starts with zero money plus some non-zero quantity non-money goods. Different goods have exchange rates against each other. Regardless of the existence of money as a measurement of value, a common value scale DOES exist, otherwise you could have a rock-paper-scissors type scenario where A is valued more than B is valued more than C is valued more than A, and by trading in the right direction you could profit infinitely.
Actor 'Bank' takes some goods out of the market and replaces those goods with notes equivalent to a claim on the goods. The quantity of 'wealth' in the market does not change. Also, the exchange rate of goods versus each other should not change, since the money is equivalent to the goods removed.
So where does it break? The exchange rate of the money against the market goods is just the arbitrary rate that the bank chose for money versus collateral, times the rate of the collateral versus the other goods. Provided the bank's arbitrary rate is held constant across every issue of new notes (which of course would be the case since neither the issuer nor the issuee will be willing to take a loss), the exchange rates of goods versus goods should never change (since the qty of goods in existence does not change) the exchange rate of money versus goods should never change (since the currency is directly redeemable from the bank for the goods it represents)...
The reasoning seems sound to me.
Published: July 17, 2007 12:31 PM
So stated another way... It's not that you end up with more money chasing a fixed amount of goods... you actually just have a fixed amount of goods of each type chasing a fixed amount of goods of all other types, and whether anyone uses the goods themselves or a representative measure of the goods (money) for exchange shouldn't make any difference.
I can't see the flaw in the reasoning and it's quite troublesome.
Published: July 17, 2007 12:42 PM
Who is John Galt?
Published: July 17, 2007 12:47 PM
Jesse,
The alternatives to RBD I suppose would be what... no money at all? Money with a single homogeneous asset as backing? A one-time issue of money? None of these approaches seem in any way different from the scenario under RBD.
In any of these cases, the values of different goods versus each other are still in constant flux as you say, as attitudes change, and as wealth is created or destroyed or just redistributed... and so you have a situation of constant price inflation/deflation as measured in different 'goods' anyway.
Seems a currency, whether obeying RBD or otherwise, just averages those various inflations and deflations and presents them in the aggregate - which I suppose is a good thing. It doesn't seem to me that RBD, strictly obeyed, causes a net change in inflation / deflation versus the natural market rate under any other fully backed currency system.
Unbacked currency is clearly a problem... but as I understand it, that's not what the RBD is...
Published: July 17, 2007 1:15 PM
Jean Paul: "Actor 'Bank' takes some goods out of the market and replaces those goods with notes equivalent to a claim on the goods."
In the first place, this is what 100% reserve (honest) banking does, not RBD. In RBD, no goods are taken out of circulation and held as reserves against redemption of the paper money. In RBD, a businessman gives the bank an IOU in exchange for paper money.
If in RBD the commodities backing the paper were taken out of circulation and held in reserve, you would essentially have the same thing as 100% reserve banking or money backed by gold (if the commodity backing the paper is gold). That's the whole point of ABCT: in order for money to be available for loaning to businesses, consumers must save, which means that they must reduce their consumption. What consumers give up in consumption becomes available to loan to others. That's not how RBD works. In RBD, new money available for loans is fabricated out of nothing, although a businessman might exchange an IOU for it. In that case, the businessman has his cake and eats it, too, in that he has both his commodities that he pledged as security for the IOU (although sometimes there is no collateral) and the new money. No one gave up consumption in order to loan the businessman money in the case of RBD.
Published: July 17, 2007 1:27 PM
As asserted by the wikipedia article, it isn't supposed to matter what the good is - be it physical assets, certificates of ownership, finanial instuments, IOUs... doesn't matter, so long as the good is exchanged for its true market value in notes.
So: is the bank at fault for issuing notes against a special category of 'blacklisted' market goods (i.e. you imply IOUs are such a blacklisted good).
Or is the business at fault for issuing the IOU?
Or is the market at fault for mis-valuing the IOU?
If the IOU is a correctly valued market good exchanged for the bank notes, I once again fail to see the problem.
Published: July 17, 2007 1:41 PM
Jean Paul:
You see nothing wrong with the RBD because there IS nothing wrong with it. I've posted some material on the subject at
www.csun.edu/~hceco008/realbills.htm
You mentioned that unbacked money is clearly a problem. According to the RBD there is no such thing. Money without backing will have no value, just as corporate stock without backing will have no value.
Jesse:
It's not quite right to say that the RBD "breaks down" when the value of assets is not static. The correct view is that if the assets backing money lose value then the money loses value. This is exactly what the RBD implies.
PM Lawrence:
The RBD says that money will hold its value as long as money is only issued in exchange for assets of adequate value. When the RBD is correctly stated (and it isn't always) it becomes clear that it doesn't matter whether the assets backing the money are "real" or not. All that matters is that the assets have adequate value.
Published: July 17, 2007 2:13 PM
Jean Paul: "If the IOU is a correctly valued market good exchanged for the bank notes, I once again fail to see the problem."
You have to think of the bank note as a commodity, too. When gold was money, it was a commodity with a certain value against other commodities. Paper money was originally a convenience for people so that they wouldn't have to carry gold and silver around all of the time, so paper money represents the commodity gold, and acts like that commodity.
But let's say that the commodity in your example that backs the paper money is potatoes. You issue one note per potato. Potatoes have a fixed exchange rate with other commodities. Say for example you can trade 1 potato for a loaf of bread. In that case, you can trade one piece of paper money (let's call it a dirham) for a loaf of bread. Now imagine that for some reason the supply of potatoes doubles. Will the exchange rate between bread and potatoes stay the same? Not at all! If the supply of bread hasn't changed, it will probably sell for 2 potatoes, or 2 dirhams. Now, suppose that the supply of potatoes hasn't changed, but the bank decides to print twice as many dirhams as before and exchange them for IOU's. The effect will be the same as if the supply of potatoes has doubled because the dirhams represent potatoes.
The exact same thing happens with gold as money. If the supply of gold doubles in an economy, and all other goods remain fixed in their supply, the value of gold will fall to one half its previous value against all other goods.
Paper money works the same way. If you double the amount in circulation, it's value in exchange against goods and services will fall to one half its previous value. Paper money acts as a commodity. Its value changes with its supply relative to goods.
If a bank issues a fixed amount of dirhams, (backed by gold, potatoes, IOU's or nothing at all, it doesn't matter) the value of those dirhams will reach a certain level in exchange and maintain that level of value as long as the ratio of dirhams to goods doesn't change. But that value will change when the ratio changes. If the stock of dirhams remains constant and the supply of goods doubles, the value of the dirhams will double; if the supply of goods falls by half, the value of dirhams will fall by half.
The RBD fixates on the backing of the dirhams. But ABCT doesn't care what backs the dirhams; it cares about limiting the growth in the supply of dirhams so that they maintain their value. Gold was chosen by people in the marketplace over thousands of years as money, and then backing for money, because its supply is relatively limited. Gold isn't perfect money, nor is gold-backed paper money; it's just the best of many alternatives. If we chose to back dirhams with potatoes, everyone would grow their own potatoes and the increase in supply would overwhelm their value. People can't grow their own gold. Getting it out of the ground is expensive and time consuming.
You'll understand the problem if you quit worrying about what's backing the paper money and worry about what determines the volume of money in circulation. What backs the paper money doesn't matter at all; what matters is will the thing backing the paper money limit the growth of the supply of paper money to reasonable levels, say not more than 3% annually. If production increases 3% annually, then prices in general will not increase or decrease.
Published: July 17, 2007 2:13 PM
RogerM: "Now, suppose that the supply of potatoes hasn't changed, but the bank decides to print twice as many dirhams as before and exchange them for IOU's. The effect will be the same as if the supply of potatoes has doubled because the dirhams represent potatoes."
I feel like this ignores the effect of the IOUs. Following the new issue of dhirams, they no longer represent JUST potatoes. They represent 50% potatoes and 50% IOUs.
We could look at that and agree that to purchase one whole potato will take two dhirams, but with your two dhirams you will have inadvertenly also purchased one whole IOU, which is redeemable for one dhiram (that was the original rate of exchange offered and presumably still honored by the honest bank). Of course there is no need for this many transactions to play out - the end result is that one dhiram is worth EITHER one potato OR one IOU, etc.
I guess you look at it as "goods went into the bank and money came out; therefore the ratio of money to non-money goods in the market increased; therefore prices go up in terms of money."
I think this is wrong because, instead of paying the inflated prices you claim would show up on the market, I'd instead just go to the bank and redeem a smaller quantity of dhirams for the same goods, as would all other holders of dhirams.
Published: July 17, 2007 2:46 PM
Jean Paul,
If you "instead just go to the bank and redeem a smaller quantity of dhirams for the same goods" but the banks reserve of those goods is depleted you would either have to accept a bond from the bank or one of their IOUs that they received from, say, Kramerica Industries.
Unless Im mistaken, I see something wrong right away. You walk into the bank to demand your potatos, and they say: "Sorry we dont have them, but would you accept a bond or this IOU that we have from Kramerica Industries instead?"
The banks assets and liabilities are balanced. But it seems like a scheme to shift the reserve responsibility to the companies that they have IOUs from, i.e. Kramerica Industries, so that they can inflate, and still maintain that they are fully 'reserved.' But, I think, here is where the problem manifests itself. Kramerica Industries appears to be the bankers' bank. The bank has shifted their potato reserve responsibility onto them. Ultimately, the balanced assets and liabilities of the bank relies on its IOUs from Kramerica Industries.
But, Kramerica isnt a bank, and doesn't 'know' that it should act like one. There is, therefore, no impulse to keep a reserve of X amount of potatos just in case the bank needs it. They don't expect to need the potatos until the time that the IOU is due.
So, if I am understanding everything correctly, my question is: Given that the banks reserves are dependent on the IOUs to Kramerica Industries, what guarantees the fulfillment of the IOUs if Kramerica isn't expecting to have to pay it back right away?
Published: July 17, 2007 3:21 PM
Let me see if I can break this down step-by-step, since we're obviously not communicating clearly. Note that "inflation" and "deflation" in the following refer to currency inflation, not price inflation. As you pointed out, price inflation happens all the time and doesn't necessarily have anything to do with issue of currency.
First, we define one currency unit ("dollar" for simplicity) as one ounce of silver, like they did in the WP article. This amount is arbitrary, as is the commodity itself.
Initially there is no currency and the bank has no assets.
Someone deposits 100 oz. silver and receives 100 dollars in exchange. No inflation results, now or ever, since the bank always has 100 oz. of silver and the dollars are worth exactly 100 oz. of silver. There are now 100 dollars, and the bank's assets are exactly 100 oz. silver.
Someone else takes out a loan of 100 dollars backed by "100 dollar's worth" in non-silver assets. Obviously this assessment, while close, is inexact, and is made at the time of the loan. Now there are 200 dollars and the bank has 100 oz. silver and almost exactly 100 oz.'s worth of other assets. We'll be generous and say there's still no inflation.
Some months later the value of those "other assets" falls to 80 oz. silver (and thus 80 dollars). There are still 200 dollars in circulation, but now the bank has 100 oz. silver and other assets worth about 80 oz. silver. Inflation has occurred: one dollar is now only backed by about 90 cents (0.9 oz. silver or present-value equivalent) in assets. Obviously price inflation would occur as a consequence, with people now paying a full dollar (but still 0.9 oz. silver) for anything previously worth 90 cents.
Published: July 17, 2007 3:30 PM
A bank can issue 300 paper dollars in exchange for 100 ounces of silver and an IOU that is currently worth 200 ounces. Rational customers have no reason to object to the arrangement, since the IOU's earn interest, (some of which will be paid to the customers) and the IOU's are less likely than the silver to be stolen. Austrians would have no objection if the bank took 200 actual ounces of silver instead of the IOU. But let the actual silver be replaced by an IOU that is worth 200 ounces and they call it fraud--even if all parties have agreed to it. This is an indefensible position for Austrians to take. The RBD as a theory is much more consistent with libertarianism than is any other monetary theory. What a shame that Austrians fight against the very theory they should be promoting!
Published: July 17, 2007 3:38 PM
The WP article says the same thing if you look under the "Inflation" and "Bank Runs" sections. Under closer examination only the second option given under "Bank Runs" would actually work (devaluation, just like I said). The first option uses bad math: you now have 600 oz. silver but also a ton of new currency; the exchange rate is unchanged. The third (a bailout) just shifts the problem to someone else (presumably a central bank); even the pro-RBD article is wary of it.
The article calls this scenario "inadequite backing" as if to dismisss it, but that is exactly the problem with the RBD and any other system that claims to maintain a constant exchange rate without being 100% backed by the redemption commodity. Anything other than the redemption commodity can become "inadequite backing" as a result of unpredictable future revaluations.
Published: July 17, 2007 4:12 PM
Dan: "The bank has shifted their potato reserve responsibility onto them. Ultimately, the balanced assets and liabilities of the bank relies on its IOUs from Kramerica Industries. But, Kramerica isnt a bank, and doesn't 'know' that it should act like one."
First note that the responsibility is not to maintain specifically a reserve of potatoes, but to maintain a reserve having ephemeral 'value' equal to the notes issued.
Meanwhile the bank is still a bank, and has in no way abdicated any responsibility, unless it is an irrationally self destructive bank. The bank knows that if it overvalues a backing asset when issuing notes (the IOU, or the collateral behind the IOU), then it will suffer the severe and negative consequences of price inflation as described (incidentally going bankrupt along the way). Therefore it is in the bank's interest to get the valuation right. The bank will use all of the enterpreneurial prowess at its disposal to make this determination, probably drawing heavily on what the market indicates the value of the asset is.
It's not Kramerica's job to ensure they can back the asset. The market will attempt to show the true value of the asset (the market is better able to do this than any alternative institution), and it remains the bank's job to decide whether to trust that valuation.
The potential disaster is not that Kramerica goes bad; it's that the market fails to anticipate this, and overvalues the IOU.
Jesse: I follow fully and see nothing wrong with the example you provided. I would note that with this example, you have demonstrated exactly the claim of RBD: that the price inflation is caused solely by the devaluation of the backing assets, and in no way caused by the increase in money supply.
I would say also that that the price inflation happens regardless of whether there was a bank involved at all. Absent the bank, the price of silver still inflates relative to the 'other assets', because that's the scenario you propose.
I'm quite convinced the RBD is NOT at fault.
Published: July 17, 2007 4:34 PM
Mike, I think we're in agreement on the RBD... the theory is sound, but of course subject to garbage-in-garbage-out. As goods naturally change in value relative to each other, price inflation/deflation will happen in the world without the RBD-abiding bank, and an identical relative inflation/deflation would happen in the world with the RBD-abiding bank.
A large bank having a large portfolio, and with interest earnings tuned case-by-case according to assessed risk, will see increases and decreases in the different assets in its portfolio balancing out, and thus its currency will be quite stable.
As far as I can tell, the RBD is really no different than 100% reserve banking, just with a more general (properly so) concept of what constitutes backing.
Published: July 17, 2007 4:51 PM
Jesse: "We'll be generous and say there's still no inflation."
But you can't say there's no inflation when the money supply has doubled. The foundation of ABCT is the quantity theory of money which says when the money supply increases, and the volume of goods doesn't, the value of money falls, or from the perspective of goods, prices increase. This is the core of Austrian economics and almost everything else is built on it. It doesn't matter that the value of the IOU's declined.
Jean Paul: "...instead of paying the inflated prices you claim would show up on the market, I'd instead just go to the bank and redeem a smaller quantity of dhirams for the same goods, as would all other holders of dhirams."
Exactly! Every consumer for the past thousand years has done the same thing. But in every single case without exception, the banks have not increased the money supply by twice, but usually by 15 or 20 times the value of their reserves. So even though a dirham might be "fixed" at one potato, in the market it might take 20 dirhams to buy a potato. Even Okie's aren't stupid enough to pay that when they can simply go to the bank and exchange their dirhams for potatoes at a 1:1 ratio. So everyone in the country goes to the bank and demands one potatoe for each dirham; that's called a run on the bank. But the bank only has enough potatoes for 5% of the population. All the other dirhams are backed by IOU's, but no one wants an IOU, they want potatoes. IOU's are promises to pay in the future; potatoes are cash. Now the people lose confidence in the dirhams and their value falls even more. Now you have hyperinflation.
Please quit thinking about the value of the asset that backs the paper money. IT DOESN'T MATTER AT ALL! The only thing that matters is limiting the supply of dirhams. If you limit the supply, then you don't need any backing for them, not gold or even IOU's. If you don't limit the supply, no backing will prevent hyperinflation, not even gold.
Published: July 17, 2007 5:13 PM
Jean Paul: "I would note that with this example, you have demonstrated exactly the claim of RBD: that the price inflation is caused solely by the devaluation of the backing assets, and in no way caused by the increase in money supply."
Oh, was that their claim? It looked to me that they were making the claim that they could maintain a constant exchange ratio (and thus no currency inflation/deflation) despite not having 100% backing in the redemption commodity. If they merely claimed that the issue of money does not cause inflation at the time of issue, then I have to agree -- but such a miniscule claim hardly makes the RBD noteworthy.
Anyway, I would argue that even that claim breaks down when you look at it closely. The inflation (devaluation of the currency vs. its stated exchange rate) resulted, ultimately, from the issue of new currency in exchange for something other than the redemption commodity. Just because it didn't happen right away doesn't mean the issue of currency wasn't at fault.
Jean Paul: "I would say also that that the price inflation happens regardless of whether there was a bank involved at all. Absent the bank, the price of silver still inflates relative to the 'other assets', because that's the scenario you propose."
Removing the bank would make the RBD's claims irrelevant, so let's not do that. True, the relative values of silver and "other assets" would still fluctuate, but the bank's claim (consistent with the RBD) was that it could maintain a fixed exchange rate: one dollar for one ounce of silver. After the revaluation the bank cannot meet this claim, and must devalue its currency to avoid a bank run, despite only issuing currency in exchange for (at the time) equal-valued goods. The fundamental claim of the RBD was stated in the article: "so long as a bank issues its notes only in the discount of good bills . . . it cannot go wrong in issuing as many as the public will receive from it". However, as my example shows a bank can indeed go wrong in following the RBD.
The alternative to the RBD that you asked for is this: one cannot guarantee the maintenance of a fixed exchange rate between any two distinct commodities. Either a currency is 100% backed by and thus equivalent to a particular commodity, or it is a separate good in its own right and its value will fluctuate in terms of all other commodities.
Published: July 17, 2007 5:19 PM
Mike: "But let the actual silver be replaced by an IOU that is worth 200 ounces and they call it fraud--even if all parties have agreed to it."
Silver must be considered money in order for it to be deposited in a bank and used to issue paper money. So if someone deposits silver for safe keeping for a fixed period of time, the owner of the silver has given up an amount of consumption equal to the value of the silver, in other words, he has actually saved some money and taken it out of the money supply. The money supply is smaller as a result of the deposit of silver. If the banker then loans out money based on the silver, the money supply returns to the previous level.
But when whose money does the banker loan to the businessman in exchange for his $200 IOU? No one's. The banker creates the money on the spot and hands it to the banker. As a result, the money supply increases by $200, whereas with the other transaction, the deposit of $200 worth of silver and then loan of money based on the silver deposit, the money supply did not increase at all.
Published: July 17, 2007 5:22 PM
Mike_Sproul: You'll notice I said what you normally would say, before you said it this time. So I think you can accept I'm trying to be even-handed about this.
RogerM et al. are correct that the IOU is not a perfect substitute for silver. When you claim something is consistent with libertarianism, it's not possible to evaluate that without knowing exactly what the bank is promising. If the bank promises to convert dollars to gold, it can only guarantee this if it keeps gold as its assets. Any substitution of an IOU introduces the possibility of default, which does not exist in the physically convertible case.
Not all Austrians would object if the understanding was that the bank would hold other assets and conversion was not guaranteed.
Published: July 17, 2007 5:35 PM
"As you pointed out, price inflation happens all the time and doesn't necessarily have anything to do with issue of currency."
What do you have in mind? If by inflation you mean the result of increasing scarcity of certain goods (e.g. oil), this doesn't count.
RogerM, surely you mean the ABCT is the basis of Austrian macroeconomics? It's hardly the basis of the entire science.
Published: July 17, 2007 6:10 PM
Anthony: "surely you mean the ABCT is the basis of Austrian macroeconomics?"
I think the ABCT is an application of Austrian economics in general. The heart of Austrian econ, it seems to me, is its theory of capital, but essential to that theory of capital is the quantity theory of money. The ABCT brings all of Austrian theory together to explain business cycles.
Published: July 17, 2007 6:40 PM
Person: "Any substitution of an IOU introduces the possibility of default, which does not exist in the physically convertible case."
Exactly! And another difference is that the supply of silver is limited, so silver-backed money automatically limits the supply of paper money. But the supply of IOU's is unlimited, so IOU-backed paper money has no limits. Followers of RBD don't understand that, which is why the German central bankers were so dumbfounded when price inflation exploded. RBD is supposed to prevent that from happening, so they blamed speculators and greedy capitalists. German central bankers followed RBD to the letter and understood it very well. Just read Mises's account of the hyperinflation.
Published: July 17, 2007 6:44 PM
From the WP page on inflation: "In mainstream economics, the word 'inflation' refers to a persistent rise in the general price level, as measured against a standard level of purchasing power." This is the sense in which I use the term "price inflation", and it includes all increases in the "general price level" (however you define that, within reason) regardless of the cause.
By "currency inflation", on the other hand, I mean devaluation of the currency w.r.t. its stated value, e.g. the shift from a dollar being equal to one ounce of silver to it equaling 0.9 ounces. In other words, a change in the relationship between the value of a quantity of currency and the value of that currency's backing, both with respect to any one commodity over time.
Published: July 17, 2007 7:08 PM
Everyone agrees that if a bank backs $100 with 100 oz. of silver, then each dollar is worth an ounce. Same if it backs $300 with 300 oz. But let that bank sell 200 oz. of its silver for an equal value of gold, copper, land, IOU's, or anything else, and many (not all) Austrians call it fraudulent and inflationary--even if the bank's customers agreed to it!
If such a trade did reduce the value of the dollar--say to 1/3 oz. of silver, then I'd eagerly buy up all $300 for 100 oz of silver, then I'd head to the bank to claim 100 oz of silver PLUS the gold, copper, etc. that is worth 200 oz. of silver. A nice free lunch.
The RBD says that no such free lunch will occur. When the bank sells its 200oz. for something of equal value, the total amount of backing for the $300 is unaffected, and so the value of the dollar is unaffected, and so there is no free lunch.
Like I said, it's a shame that Austrians attack the RBD when they should be promoting it.
Published: July 17, 2007 7:26 PM
a common value scale DOES exist, otherwise you could have a rock-paper-scissors type scenario where A is valued more than B is valued more than C is valued more than A, and by trading in the right direction you could profit infinitely.
What makes you think that doesn't happen? Of course you can't profit infinitely, because your trading action will increase the price of A in terms of B and B in terms of C, and decrease the price of C in terms of A until there's no more gain to be made. It's called arbitrage.
Published: July 17, 2007 7:26 PM
Someone deposits 100 oz. silver and receives 100 dollars in exchange. No inflation results, now or ever, since the bank always has 100 oz. of silver and the dollars are worth exactly 100 oz. of silver. There are now 100 dollars, and the bank's assets are exactly 100 oz. silver.
That's a wrong approach, right from the start. The bank has no assets - the customer's assets are 100oz of silver. The paper "dollars" are merely receipts for the silver, not a separate entity (otherwise it would be inflationary: the bank now has 100oz Ag in assets it didn't have before, and the customer also has 100oz worth of assets in "dollars"). The term "dollar" needs to be recognized as applying to the silver, not the paper he carries in its place.
Published: July 17, 2007 7:40 PM
Jean Paul:
"First note that the responsibility is not to maintain specifically a reserve of potatoes, but to maintain a reserve having ephemeral 'value' equal to the notes issued."
So during a period of falling demand for money, you wouldn't care if you walked into a bank asking for your silver or potatoes and they told you "we don't have any, but if you wait a couple days and come back, we are going to sell off some assets and try to redeem some IOUs and we will have your money then."?
Banks have a responsibility to maintain a 100 percent reserve of the monetary commodity because only in that case can the bank survive a situation where everybody with demand deposits want all of their money back right now (it is their stuff by the way, not the bank's). They don't want bonds, or to shop assets around, or wait while the bank sells off the assets for them. Imagine a situation in which everyone wanted their own stuff back right now.
It is at this point that you and Mike must acknowledge that fraud has occurred. The bank has printed up too many promises for silver or potatoes, etc. They can't possibly give everyone their stuff back right now this very minute. It doesn't matter how many back up plans you come up with, if, at any given time whatsoever, there are more promises-for-silver than there is silver, its fraud.
Published: July 17, 2007 7:50 PM
Peter: "That's a wrong approach, right from the start. The bank has no assets - the customer's assets are 100oz of silver. The paper "dollars" are merely receipts for the silver, not a separate entity . . ."
We're talking about banknotes, not warehouse receipts. The banknote is a payable-on-demand IOU received in voluntary exchange for the deposited money, which becomes the bank's property. Provided depositors are made aware of the possibility of default on the part of the bank such notes are no more fraudulent than any other loan. (I agree that depositors are often not given sufficient warning of this fact, but that doesn't make the whole system fraudulent.)
Peter: ". . . otherwise it would be inflationary: the bank now has 100oz Ag in assets it didn't have before, and the customer also has 100oz worth of assets in 'dollars'"
You left out the 100 oz. Ag in liabilities the bank now has, which balances out its new assets precisely. As I said, it's no different than any other loan: both the good loaned and the IOU have value. If the bank depletes its reserves and cannot redeem its notes it's the same as defaulting on a loan, and the notes are no longer worth 100 oz. Ag.
The value of the notes to the bearer is complementary to the non-reserve value of the assets to the bank. Between the bearer and the bank the value of silver offered in exchange has not increased.
Published: July 17, 2007 8:36 PM
'From the WP page on inflation: "In mainstream economics, the word 'inflation' refers to a persistent rise in the general price level, as measured against a standard level of purchasing power." '
It must be alluding to the Keynesian fallacy of cost-push inflation then. As I mentioned though, increasing scarcity (i.e. falling supply) is what accounts for this.
Published: July 17, 2007 8:51 PM
Mike: "When the bank sells its 200oz. for something of equal value, the total amount of backing for the $300 is unaffected, and so the value of the dollar is unaffected."
That's simply not true. Again, what backs the paper money has nothing to do with the value of the paper money. Nothing at all. The only reason Austrians want gold or silver to back paper money is because they automatically limit the volume of paper money in circulation. IOU's and land are virtually unlimited and therefore cannot limit the supply of paper money. The only thing that determines the value of paper money is the ratio of money to commodities.
Published: July 17, 2007 9:08 PM
Why does the money have to be redeemable for any particular thing? Why can't it just represent a share in some portfolio of assets, managed by the bank so as to maintain the exchange rate of the dollar with the held assets, as determined by a free market?
In this situation, by definition the reserve is 100% of the currency issued.
In this situation, the claim of the RBD is that the amount of money in circulation will not affect the exchange rate of the dollar with the commodities (if that's called inflation by some definition, use that definition of inflation - that's the kind of inflation that doesn't happen under RBD).
The appropriate thing to measure this total lack of effect against would be the situation absent the bank, and the exchange rates of commodities therein. It should be clear that so long as the bank makes good trades (as required by the RBD), the rates with or without the bank will be the same. Those rates will shuffle naturally, but that shuffling is unaffected bu the presence or absence of an RBD-style bank.
...IF THE TRADES ARE GOOD, which is a requirement of the theory.
Published: July 17, 2007 9:18 PM
Jean Paul,
So what you are talking about is basically using fund shares as money? Is this really what the RBD is about? If so, I can't find anything philosophically objectionable about it but it sure sounds inconvenient.
Published: July 17, 2007 10:06 PM
RogerM, I am not saying that the Real Bills Doctrine is a good idea, I am pointing out how it fails. In that sense your parallel with socialism is valid. If you look at Zimbabwe today, it is irrelevant whether or not Mugabe had in mind Real Bills; wht counts is that, right now, the bills aren't real. So, the failure is not of Real Bills Theory but of Real Bills Doctrine. Of course the failure is hubris; only, not from lack of knowledge, but from a Sahakespearean tragedy in which everybody always goes too far and everybody else can always see it coming, if they only look. But there's the rub.
That's basically the answer to Jean Paul, too. There is a hybrid in which a bullion base is set up with built in depreciation, so that the money issuers can issue money but only up until a certain point; they can still get a permanent benefit if they apply the seignorage to acquisitions of a revenue yielding asset base, a "domain", typically of land. (There is historical precedent.)
Simon, you state "...he can't suppress a country full of angry people forever can he?", (a) he doesn't have to, only long enough to remake things his way; (b) he could if he had to, bearing in mind that physically and morally he can resort to massacre and exile; and (c) the whole point is, it's not the whole country - and, the angry ones didn't like him to begin with, so he has nothing to lose anyway.
As to what is likely to happen next, based on precedent elsewhere, it's a rebasing of the currency on the back of a punitive tax regime/land reorganisation, with a functional economic core held by his supporters and non-functional periphery for the rest. Control of restricted imports will provide patronage. Part of the precedent is having hut and/or poll taxes that can be paid off in kind at fixed prices, or in the new currency, with a road building programme or similar to accept payment in labour.
Jesse, the problem with RBD isn't that "there is an unspoken assumption in the model that values of assets are static". The assumption is that all bills that are "out there" will automatically - since they were chosen that way - be retired in the short term, and that any discrepancies can then be adjusted on the back of the gains realised by the economic activity they generated. In other words, the financial risk is covered by the bankers, on the back of the bankers' seignorage. The catch is that the bankers keep letting that time horizon stretch further and further out, and accept book values that are riskier and riskier, always tending to the limit of simply printing money. Ultimately - in fact quite early on - it all inhibits economic growth and there are no gains anyway.
So, Mike Sproul, you'll see we're actually in agreement, but I wasn't clear enough in stating that I was trying to show how it was that people followed the slippery slope. A partial counterexample is something that happened in Jersey at the end of the Napoleonic Wars, though I can't find the references off hand (can someone help?). There, peace and responsible control came back, the former permitting central authorities to impose the latter on the Jersey bankers who were quite put out since they hadn't actually hit any problems by then.
Published: July 17, 2007 10:06 PM
Jean Paul: "Why does the money have to be redeemable for any particular thing?"
Who said it can't? Banknotes can be redeemable for anything. I'm a free-banker myself, so I don't have any objection to someone attempting to run a bank under RBD principles. However, the RBD is a system of currency management which purports to allow a bank issue redeemable notes without a 100% in-kind reserve without risking bank runs or devaluation. It simply can't do that in practice, because the condition (always make good trades ex post) is impossible to achieve. If that is a precondition of RBD then RBD is irrelevant; if it is not then RBD is wrong.
Consider, too, that in a bank run the first thing to change would be an increase in the value of the redemption commodity, and a corresponding relative decrease in the bank's assets. The very situation where the bank's "good trades" are put to the test could easily render them poor trades in retrospect.
Jean Paul: "Why can't it just represent a share in some portfolio of assets, managed by the bank so as to maintain the exchange rate of the dollar with the held assets, as determined by a free market?"
In that case the banknote is redeemable for one share, which is still a specific commodity. Also, you've just reinvented the mutual fund.
Jean Paul: "In this situation, the claim of the RBD is that the amount of money in circulation will not affect the exchange rate of the dollar with the commodities. . . ."
Which is false, since a revaluation of any one backing commodity will affect the exchange rates between dollars and all the other backing commodities. (Well, provided the composition of the backing varies with issue of new currency -- but if it didn't this wouldn't be RBD.)
Jean Paul: "It should be clear that so long as the bank makes good trades (as required by the RBD) . . ."
The bank can't know whether it made good trades until after the fact. It does indeed all fit together if you make that assumption, but that qualification also renders the RBD useless as a guide. In the present, all you can say is that the issue of bills will either inflate or not, depending on whether the bank's trades turn out to have been good ones from some future point of view, with a bias toward "not" in the event of a bank run. Granted, the fact that it's not guaranteed to cause inflation is a step above some other systems where inflation is systemic, but it's still not much of a claim.
Published: July 17, 2007 10:44 PM
"The only thing wrong with the Real Bills Doctrine is human nature". Since the real bills are being issued by human beings, each of whom must have a human nature to comply with the definition, doesn't this damn it before it starts?
This reminds me of Basil Fawlty- he felt he could run a really good hotel if he could just get rid of the one annoying impediment to his plans- the hotel's guests! I believe they made a documentary series about his hotel. you might have seen it.
There's always more than one way to look at events. When Germany was going through its' meltdown, eighty years ago, whilst the locals suffered, foreigners (and their good currencies) had a bargain of the whole country!
Published: July 18, 2007 1:15 AM
'"The only thing wrong with the Real Bills Doctrine is human nature". Since the real bills are being issued by human beings, each of whom must have a human nature to comply with the definition, doesn't this damn it before it starts?'
nick gray, that's what I've been bloody saying. Why on earth do readers immediately suppose that I'm too thick to realise that this is a real difficulty? I'm against, because I know what the problem is. It's just that - as Jean Paul has spotted - the problem does not come from any inconsistency or like flaw in the theory.
Published: July 18, 2007 1:32 AM
licing in Cape Town, I have watched the crisis unfold over the last 7 years or so. Heres a comment I made in another forum yesterday, in the thought that readers here may be interested.
the seeds of the ( Zimbabwe) problem were sown a long time ago - in the grand tradition of European Monarchs of generations past, the Mugabe regime at some point stopped bothering to even notionally limit its civil service spending to the amounts collected by 'orthodox' taxes ( Lets not go into the broader tax question here....), and instead debased the currency by simple expedience. In this case, they simply printed 'money' to pay cabinet ministers, soldiers, policemenn, and bureaucrats. Directly, in wads of freshly inked paper. And they still do. Theres not even the usual pretence of fiscal repsonsibility that marks other countries' central banking.
This massive influx of unbacked, unearned currency had a completely predictable effect: more money+ same supplies of goods = price increases across the board, just as sure as day follows night. Of course, the new money has to be injected into the economy first before the prices respond to the increase in demand, so the first holders of any newly-injected money still get to pay the old pre-injection prices, and the rest of the population have to face the resulting round of price increases. thus it is that (assuming a monthly payday) the favoured few (viz. everyone on the government's payroll) are always one month ahead of the price-inflation cycle, and score big-time.
In oither words, by resorting to the printing press, the regime has been able to tax the whole population at an effectrively asymptotic rate, and hand the proceeds to its employees, without even needing a databse of taxpayers or collections infrastructure! . In effect, they have, quite criminally, stolen the the whole country's accumulated life ( cash) savings, and appropriated the proceeds in the form of actual goods and property.
Then, in an attempt to displace the responsibility for the resulting economic disruption and ill-feeling, they demonise the merchant classes. (This is also in the grand tradition of the old despotic European monarchs, who spent centuries blaming Jews for all economic woes, howsoever arising). And so they enforce all sorts of price freezes and cuts by decree, neutralising any rationale for any producer or seller to remain in business, and bringing produictive activity to a halt. This price-setting policy as a cure for inflation is exactly analogous to the Health department fighting TB by forbidding the patient to breathe.
The thing that I find sad is the naieve readiness of evereyone, in Zim and elsewhere, to lay the whole thing before Mugabe himself - there is a blind faith that 'when he goes, everytrhing will be OK again'. Not so. While he clearly has a hand in it and has been a central catalyst, and is something of a figurehead, we neglect to recognise that there is a big segment of Zimbabwean society, largely Shona, that comprises the political elite , and hunjndreds of thousands of second- and third-teir civil servants who owe their livelihoods to the continued entrenchment of Zanu PF, and the only way to keep that going is to assure a continuation of the wholesale inflationary theft from everyone else, such wealth appropriation magnified by an open and tacitly-approved arbitrage between the black and official exchange markets - you see, if you are 'A list', you can do it with impuinity, (as long as you don't make enemies of anyone more powerful than you). And if you are not, you get beaten up and jailed, or worse.
Remove Mugabe, and you still have a well-entrenched, well-armed, and very wealthy constituency which is used to weilding power and behaving with impunity. They will fight tooth and nail to retain their economic dominance and power so continued access to their feeding grounds can be assured. And, a few sincere idealogues aside, theres another seething constituency that is seeking to attain that same position of power and influence, merely by switching the boot to the other foot and getting their own back. And, frankly, who can blame them?. That underlying problem isn't going to be solved by the death or departure of one belligerent old man.
Zimbabwe is widely viewed as an aberration. I dont think so. I think it is an instructive case study of the natural tendencies of all governments everywhere - this is merely an extreme example of what happens when the institutional and constitutional constraints on the behaviour of the governing classes are removed or weakened.
the first signs of such (con/in)stitutional weakening are, always and everywhere, normally found in three key areas: loss of or compromise in judicial independence, increased control on the press and what it can and can't say, and interference in free markets. (All 3 of which symptoms, incidentally, have slowly, incrementally, given grave cause for concern in that other land of the free, the yewessovay, these last 7 years).
Which is why I fear, above all else, any hint of government censorship of whatever nature, and any political meddling in the courts, and any form of market interventionism, however well-intentioned the rationale appears to be. For these are the only things standing between us citizens and despotic oppression - quite irrespective of what continent we happen to be on, or who is president, and how nice a guy he might be.
Published: July 18, 2007 3:47 AM
Why does the money have to be redeemable for any particular thing? Why can't it just represent a share in some portfolio of assets, managed by the bank so as to maintain the exchange rate of the dollar with the held assets, as determined by a free market?
Because that's not what money is. Read a bit of Mises on how money arises out of barter.
Published: July 18, 2007 7:22 AM
Jesse: "The condition (always make good trades ex post) is impossible to achieve."
Likewise, it is impossible to choose a commodity (such as gold, silver, potatoes, etc.), which will be guaranteed to hold its value relative to the rest of the market.
So why is this considered a flaw of the RBD, but not alternative approaches?
Published: July 18, 2007 10:24 AM
Jean Paul: "Likewise, it is impossible to choose a commodity (such as gold, silver, potatoes, etc.), which will be guaranteed to hold its value relative to the rest of the market. . . . So why is this considered a flaw of the RBD, but not alternative approaches?"
I'll start off by stating that, given the precondition that the trades the RBD refers to must be good ex post, I concede that the theory is correct (though irrelevant).
The problem with the RBD is that its only conceivable use is as a guide to running a bank which supposedly won't suffer bank runs or devaluation despite not having 100% in-kind reserves for its bills. However, it only works so long as the bank always makes good trades. A bank could choose not to follow the RBD and still have no worries about bank runs or devaluation; all that matters is that the bank has sufficient assets to buy up enough of the redemption commodity to cover its liabilities. How the bills are issued, or what they are issued in exchange for, is irrelevant to the end result. RBD doesn't do anything to reduce the risk of bad trades.
For that matter, the only case where you would end up with inflation in the underlying commodities is if you have legal tender laws; otherwise any notes not backed 100% by something will just trade at a discount relative to those commodities, with values approaching the amount of banking per note.
In sum, the RBD isn't saying anything we don't already know, and places unnecessary restrictions on the bank's operation -- but I agree that it's not actually wrong within its very narrow scope.
Published: July 18, 2007 12:13 PM
That should be "the amount of backing per note", of course, at the end of the next-to-last paragraph.
Published: July 18, 2007 12:16 PM
Where I have always thought that RBD, as practiced, goes wrong is that it extends the definition of what is money to every possible traded good, over and above what humanity ultimately, through trial and error, settled on- a stable, commodity money like gold and silver. Take some of the examples described in this thread and others- potatoes, IOUs, farmland, my own example-a barn, or in Jean Paul’s treatment- a basket of assets. A bank that issues dollars for any asset, and considers this as backing, is creating inflation if the population believes that the paper dollars themselves are exchangeable for the true commodity monies of gold or silver. Is it ever the case that this is not the expectation? Consider opening a bank that issues banknotes as currency using physical assets as backing. How do you determine how many banknotes to issue for my barn? Of course, you judge my barn’s value based on the commodity that presently serves as money for the economic system. Now who would take these banknotes in exchange for goods and services? Well, if the notes claimed to be exchangeable for a barn, then the takers for my notes will consist of two groups- those that want my barn, and those who don’t want my barn but are willing to take my notes if I give them a discount on their face value. In the second case I have little incentive to make the initial transaction with the new bank in the first place. If the banknotes claim to be exchangeable for true commodity monies, then the bank has to sell my barn for gold and/or silver. If it doesn’t do this, but claims that its notes are exchangeable for commodity money, then inflation occurs for the term between the issuance and the redemption of the notes for gold or silver. We can extend this process to the point of absurdity. Banks open that take as backing any asset one wishes to bring, all in return for banknotes that have denominational value equal to the assigned market value of the asset in terms of the original commodity money, and at each incremental step, that assigned, nominal value goes up because of all the new money that is now circulating.
Let us construct a hypothetical scenario. We have YanceyLand where there are 1000 ounces of gold serving as commodity money and total land that has a total market value of 10000 ounces of gold at time t(zero). Bank A opens and issues 1000 ounce notes, and takes as backing 10% of the total land available in YanceyLand. To the population of YanceyLand, the notes have denominational value of 1000 ounces of gold. Both the notes and the gold itself now serve as money. The money supply has doubled and, eventually, the price level doubles. The total land is now worth 20000 ounce notes/gold. Bank B comes along and decides it will do the same- it issues 1000 ounce-notes using land as backing, but because of the changed price level, its backing is only 5% of the total available land in YanceyLand. Eventually the price level adjusts to all the notes and gold that are circulating and the total land of YanceyLand is now 30000 ounce notes/gold. We can carry this on for quite a while, but each equal incremental addition of new bank notes has less land as backing. Indeed, since the land is all the same, Bank A’s notes are worth more than Bank B’s notes only if the notes themselves are explicitly exchangeable for the same proportion of land taken as backing in the first place. However, if that had been the promise in the very beginning when Bank A issued its notes, we would have the same problem of finding people with which to trade that I described in my first paragraph.
Published: July 18, 2007 12:17 PM
Yancey,
In addition to your contention that the problem with RBD is when asset or bill backed money is believed to be redeemable in the monetary commodity, isn't the time aspect of the asset itself part of the problem?
From what I've gathered, when a bank would print money for a bill supposedly the money is 100% backed by the bill. But isn't the bill strictly a future good, and the cash money is expected to be instantly redeemable for goods. When considering the banks balance sheet in light of the time aspect of the bill, the assets and liabilities cannot be objectively balanced until the maturation of the bill.
In this way I disagree with Jesse. Even if you concede 'good ex-post trades' the problem with RBD is that future goods cannot objectively balance with present goods on a balance sheet.
Published: July 18, 2007 1:52 PM
To be more precise, I should have called the printed money 'present liabilities' rather than 'present goods', and the bill a 'future asset' rather than a 'future good.'
Published: July 18, 2007 1:55 PM
Dan,
In the form of RBD advocated by Antal Fekete, he seems only to advocate the issuance of bank dollars for soon-to-the-market goods and services, with the bank dollars extinguished by the gold and silver that is ultimately exchanged on the sale of these goods and services. He has claimed that such real bills are needed because gold and silver cannot fulfill the function of "circulating capital". His desription has always seemed to me to be very short period of inflation followed by deflation (90 days or less in his treatment). I have never really understood why gold or silver couldn't easily serve as the medium of direct exchange in his system. His RBD seems unnecessary to me. Robert Blumen, I think it is, has dealt with this topic on this site in the past. I am still open to the possibility that Fekete is correct, but he still hasn't convinced me.
Now, if the trades are always net good, then the bills are extinguished completely within 90 days with the bank making a small net profit for the financing. At least, this is my understanding of the system. Again, I see inflation followed by deflation as long as the bills are extinguished at some point in the future. One thing that I am having a hard time thinking through clearly is whether or not this inflation/deflation cycle is symmetrical- in other words, do they net out evenly for everyone. I have the feeling that they don't and that this, itself, is the source of the bank's profit.
Published: July 18, 2007 2:56 PM
Dan: "When considering the banks balance sheet in light of the time aspect of the bill, the assets and liabilities cannot be objectively balanced until the maturation of the bill. . . . Even if you concede 'good ex-post trades' the problem with RBD is that future goods cannot objectively balance with present goods on a balance sheet."
Why not? Future goods have a present market value; that's what's being compared. I see no problem with directly comparing the discounted present value of a future asset against the discounted present value of a future liability. People -- not just banks -- do that all the time. Anyone dealing in bonds will make such comparisons, for example.
Yancey Ward: "One thing that I am having a hard time thinking through clearly is whether or not this inflation/deflation cycle is symmetrical- in other words, do they net out evenly for everyone."
There's a simple answer for that: inflation and deflation never balance each other out from an individual point of view, because there are nonlinear changes involved. Basically, one group benefits from inflation and a different group benefits from deflation (both at the expense of everyone else). The total amount of currency doesn't change, but it's not returned to its original allocation.
Published: July 18, 2007 3:19 PM
Jesse,
Yes, I think you have it right. I am making it more complicated than it had to be.
Published: July 18, 2007 3:29 PM
This has been an enlightening and invigorating discussion... I have to say I've come down solidly on the side of the RBD - in its modernized/generalized form as presented here:
http://www.csun.edu/~hceco008/rbd2000.doc
(Thanks Mike for this!)
The key point that I get out of all this is that the value of money equals the value of its backing - and is not at all dependent on any other factor, including quantity, etc.
Of course the BACKING is ultimately subject to supply and demand, thus the quantities of the commodities underlying the backing assets determine their relative values, but the currency itself MUST equal its backing...
Published: July 18, 2007 4:04 PM
Jesse,
"Why not? Future goods have a present market value; that's what's being compared. I see no problem with directly comparing the discounted present value of a future asset against the discounted present value of a future liability."
The answer is that time preference is subjective. The RBDers want to say that the system is a 100% reserve system, which would mean that each note is redeemable. Redeemable for what? As Yancey went into detail to explain, the notes are EXPECTED to be redeemed on a 1:1 basis with a certain amount of weight in the money commodity.
Not all customers who hold bank notes will accept the bill instead of money, especially the guy -as I've said time and again here without a worthwhile response from the RBDers- who wants his money right now this minute, i.e. the guy with a very high current time preference.
If a bank isn't 100% sure of the redeemability of their bank notes to anyone that holds one or could possibly hold one (and I don't see how they could be sure given the subjectivity of time preference), then they can't be 100% sure of the objectivity regarding that bill as a present asset. The only thing that the bank can be 100% sure of is the liabilities that they have NOW, and, pertaining to the bill, the value in money that it will bring upon maturation, as that is written into the bill in the first place.
Only at that time, can the bill's value be properly placed as an asset on the balance sheet. But what is put on the balance sheet at that time IS money, since the bill has matured and has been cashed in.
Published: July 18, 2007 4:10 PM
Dan, that's exactly what the "good trades" assumption is: the theory assumes that the bank's bills can be traded at any time on the market for the amount of money commodity they are supposely equivalent to (the amount issued in notes). If that is not the case they were not good trades.
As I pointed out, however, that assumption makes the theory worthless as a guide. It's basically just saying the bank will never default on its notes so long as its assets (including bills) are greater than its liabilities (in terms of the money commodity) -- which is obvious from the start.
Also, you can put an IOU on a balance sheet just as easily as any other non-money asset, by estimating its current market price. It's only an estimate, but it is based on objective market data (prices of similar items in past exchanges). Value, including time preference, is subjective, but prices aren't.
Published: July 18, 2007 4:55 PM
Dan: "Not all customers who hold bank notes will accept the bill instead of money, especially the guy ... who wants his money right now this minute, i.e. the guy with a very high current time preference."
This assumes the note is convertible to an X. Convertibility isn't a requirement in general.
Anyway, why does he want his X so badly instead of his bank note representing the equivalent market value of X?
To cook a soup? (X = potato)
To fill his car? (X = gasoline)
To make a pair of earrings? (X = gold)
To cast his vote at the shareholders' meeting (X = stock certificate)
Maybe just for the hell of it?
The only reason for going to the bank to claim your X is if you want to use the X as something other than money. If you intend to use the X as money, then you may as well just use the note.
If you REALLY want the X instead of the note, why not just go to market and get your X from there?
Anyway, the responsible, RBD-adhering bank isn't just hoping the IOU will pay off. If the IOU doesn't, then they take the farm or the boat or the fleet of dumptrucks or whatever the collateral was (the RBD-adhering bank does require sufficiently risk-free collateral), and they auction it off, and then they give you your X...
Latly: I don't see why instant gratification of convertibility needs to be part of it. The RBD-adhering bank, knowing it can't guarantee on-demand convertibility, just doesn't offer that as part of the agreement. The non-cnvertible currency is still absolutely useful in its role as money.
Published: July 18, 2007 4:56 PM
I don't think a lot of the posts above really understand the Austrian explanation of inflation and the real danger of the RBD. Austrian monetary theory is based on the quanity theory of money, which says MV=PQ, where M is money supply, V is velocity, P is price and Q is quantity of production. V is irrelevant to this discussion (and usually a constant), so let's change the equation to simple M=PQ. If the money supply increases, either P, Q or both must increase. Since Q is generally fixed in the short run, P rises.
Notice that nothing in the quantity theory says anything about what backs M, because it doesn't matter what backs it. The current monetary regime in the US proves it: nothing at all, not even hot air, backs the US dollar. Do we have inflation, price and monetary? Of course! Do we have hyperinflation? Not even close! The reason is that in the early 1980's the Fed got smart and decided to keep an eye on price inflation and attempt to squash it with interest rate increases. Those interest rate increases reduce the increase in the money supply by reducing borrowing.
No one accepts the RBD definition of inflation in which the value of the asset backing the paper money falls. No one! For Austrians, inflation is the rise in the supply of money. For everyone else, inflation is the rise in prices. For Austrians and Monetarists, the only possible cause of an across the board rise in prices, such as is measured by the CPI, is an increase in the money supply via credit expansion or simply printing paper dollars. Notice that neither school says anything at all about something backing the paper money, because it doesn't matter.
RBD claims that by making short term loans to good businesses for the immediate production of goods, the money supply won't increase because those bills will be taken out of circulation when the businessmen pay back the loans. Then why has the RBD caused such horrendous inflation? Some argue that bankers lack self control and make longer term loans, or bad loans. That may be true. But the other side of it is that when businessmen take out a loan to increase production, they spend a lot of it on wages. And if they use the funds to purchase materials, the vendors of those materials use their revenues to pay wages. Eventually, all of the money loaned on the IOU goes to wages. The employees spend 90% of their increase in wages on consumer goods. By the time businesses pay back their loans and extinguish their IOU's, the employees have spent their incrase in wages on consumper products and driven up their prices. That's how RBD creates monetary inflation and therefore price inflation. This is very basic Austrian econ.
Published: July 18, 2007 9:11 PM
Great, so now we have two RBD kooks?!?
Published: July 18, 2007 9:27 PM
RogerM,
I take it from your comment that you don't believe the deflation that occurs on extinguishment of the bills ever cancels out the inflation from the initial issuing of notes- that the inflation just keeps ratcheting upwards with each cycle.
Published: July 18, 2007 10:41 PM
Peter: Which two? I only counted one, Jean Paul. Sure, I conceded that RBD is correct given its definitions and precondition, but only because it then says nothing at all. A theory which claims nothing is technically correct.
RogerM: The correctness of the theory must be judges by its definitions, not yours. Different definitions can make the theory irrelevant, but not incorrect.
Published: July 19, 2007 11:36 AM
Yancey: "...you don't believe the deflation that occurs on extinguishment of the bills ever cancels out the inflation from the initial issuing of notes- that the inflation just keeps ratcheting upwards with each cycle."
That's a very good point. Technically, I guess you could say that some dollars are removed from circulation when the borrower pays back the loan, especially if the paper money isn't used as reserves. If only one borrower existed, then the money supply would jump when he spent his borrowed money, then fall back to the previous level when he paid it back. As a result, inflation would also jump as a result of the increased money supply, then deflation would set in when the money supply shrank. Does that sound familiar? Wouldn't that be the Austrian business cycle?
In reality, there is an unlimited demand for borrowing money. So for every borrower paying back his loans, two or more are taking out new loans. Also, individual borrowers repeatedly take out the short term loans, possibly several times a year. As a result, the supply of IOU's grows faster than the pay back of the loans. Interest rates fall, spurring further borrowing. So the money supply continues to grow for years and price inflation increases as a result. However, at some point malinvestment shows up and some borrowers can't pay back loans. Bankers tighten credit, issue fewer loans and call in some. The growth in the money supply lessens, causing prices to fall. Then the recession hits. This should sound very familiar to Austrians: it's the ABCT. And it's caused by RBD, which is just a type of fractional reserve banking. Yes, RBD tries to place restrictions on loans, but as Germany and the US in the 1920's learned, those restrictions are insufficient to stave off disaster.
Another good example were the bills of exchange used in the late middle ages. Bills of exchange were nothing but short term IOU's based on production. They were traded just like paper money. Gold and silver were the only money. But the total amount of bills of exchange often came to 20 times the total amount of gold and silver in circulation. These bills of exchange would cause business cycles just like paper money or fractional reserve banking does. In fact, they worked exactly as proponents of RBD say their theory should work.
Published: July 19, 2007 6:39 PM
RogerM,
Yes, that all sounds right. Thank you, your description really helps clarify my view of things.
Published: July 19, 2007 9:16 PM
Jesse:
"I conceded that RBD is correct given its definitions and precondition, but only because it then says nothing at all. A theory which claims nothing is technically correct."
The RBD says, for example, that if a bank issues $100 in exchange for 100 oz. of silver, and then issues another $200 in exchange for IOU's with a current market value equal to 200 oz. of silver, then the dollars will remain equal in value to one oz. If the IOU's rise in value the dollars rise too (to an upper limit of 1 oz, depending on the deals made by the banker), and if they fall in value the dollars fall too. This is not a theory that claims nothing. It is a theory that claims that the value of money is determined by its backing. Any stock market analyst will say that the same thing is true of corporate stock. Would you say that they "claim nothing" too?
MV=PQ. Money spent=money received. Now there's an empty theory!
Published: July 19, 2007 9:18 PM
Peter: Which two? I only counted one, Jean Paul.
Mike Sproul (who always pops up in these threads to support RBD and beg people to read his about how fiat money doesn't exist...at least his RBD stuff is in a useful format, unlike the no-such-thing-as-fiat thing)
Published: July 19, 2007 9:47 PM
RogerM: "V is irrelevant to this discussion (and usually a constant), so let's change the equation to simple M=PQ. If the money supply increases, either P, Q or both must increase. Since Q is generally fixed in the short run, P rises."
!
P = M V / Q
The most important thing you need to defend here is why V and Q are unchanged before and after the issue of money.
Since the RBD is correct (as conceded by some here), the conclusion is that V and Q move as needed to maintain P constant before and after issuing money IN EXCHANGE FOR SUFFICIENT SECURITY. There's no conflict here, except maybe over the definition of the word inflation, but who cares about that. What's important is the value of P denominated in bank notes, before and after the money is issued, and the fact that it doesn't change if you obey the RBD.
I'm sure someone can speculate why V might drop or why Q might rise or why both might do such things. It probably has to do with the diappearance of the big pile of backing assets from the market, which can no longer be traded for until sufficient money is returned to the bank to release those assets.
The assumption of static V and Q is plainly the problem here.
Published: July 20, 2007 4:23 AM
RogerM,
No good Austrian believes in the quantity theory of money. Our monetary theory is based on writings of Mises and Wicksell.
MV=PQ is professor Fisher's theory (and accounting identity as Mike stated).
Trygve Haavelmo has actually very nice presentation of Wicksells theory in mathematical form in his Probability Approach in Econometrics (Econometrica, 1944 supplement). That could be usefull.
Published: July 20, 2007 5:41 AM
In a free society, it is possible that privately run RBD banks would compete with private fractional reserve banks and private full reserve banks, all issuing their own currencies running the gamut from paper to commodity backed.
Customers would have to inform themselves on the relative merits of each one. Banks would need to explain their methods. Third parties would add criticism and advice. Competition would weed out the weak and determine which banks and monies survived. It is interesting to speculate who would win out, but in the end it is the market place that would decide, no?
Published: July 20, 2007 8:49 AM
adi,
I was under the impression that RogerM was addressing the alterations in the exchange ratios between money and commodities caused by changes in the monetary base. I didn't think Austrians had objections to this part of the quantity theory of money, but rather to that theory's inability to explain how the exchange ratios arose in the first place.
Published: July 20, 2007 10:29 AM
JP: I fully agree with your position, in support of free banking in general.
I do think the quantity theory of money is much less informative than the backing theory, because no one seems to be able to describe how Q and V actually behave (I've been searching - I can't find any literature on it, other than allusions that their behaviour is clouded in controversy).
Quantity theory, while based on the obviously true exchange equation, seems a poor theory versus the backing theory (which actually does have some predictive merit). I do disagree with the suggestion the RBD is irrelevant.
Wow, this is a long-running thread... and it barely even references Zimbabwe...
Published: July 20, 2007 10:44 AM
Jean Paul,
When monetary metals actually served as money, what was their backing?
Published: July 20, 2007 12:04 PM
adi:"No good Austrian believes in the quantity theory of money. Our monetary theory is based on writings of Mises and Wicksell."
I realize that Austrians don't believe that the quantity theory can solved as an equation because Q can't be quantified, since you can't add differing products such as apples and steel. But in concept, I can't see any difference between it and Mises/Wicksell. Please enlighten me.
Jean Paul:"The most important thing you need to defend here is why V and Q are unchanged before and after the issue of money."
V, velocity, is historically doesn't change much, excpet in periods of high inflation when people don't want to hang on to paper money because it is deprreciating so rapidly. The V accelerates and acts as an increase in M. Q is fixed only in the short run. As the money supply increases and P increases as a result, Q will tend to rise. But the competition for resources and malinvestments will cause firms to go bankrupt.
Published: July 20, 2007 12:28 PM
In a free society, it is possible that privately run RBD banks would compete with private fractional reserve banks and private full reserve banks, all issuing their own currencies running the gamut from paper to commodity backed. ... Competition would weed out the weak and determine which banks and monies survived. It is interesting to speculate who would win out, but in the end it is the market place that would decide, no?
It depends. In your hypothetical scenario, what currency does the government accept in payment of taxes and such? What does it decree to be legal tender for all debts public and private?
Or does the proviso that this is a "free society" preclude the existence of such things?
Published: July 20, 2007 12:43 PM
Jean Paul: What predictive merit does RBD have, exactly? The inputs to the theory (whether or not the trades were good) are unknown until after the outcome has been observed (i.e. the notes have been redeemed). By the time you can actually make predictions, those predictions are no longer needed.
George Gaskell: Yes, "free society" means no taxes and no legal tender laws, among other things. What else could it mean?
Published: July 20, 2007 2:14 PM
Yes, "free society" means no taxes and no legal tender laws, among other things. What else could it mean?
It could also mean "no fractional reserve banks," but he included them in his question, so I wanted to clarify.
Published: July 20, 2007 3:47 PM
Jesse: "The inputs to the theory (whether or not the trades were good) are unknown until after the outcome has been observed."
I don't know what my dice will show until after they have stopped rolling. But I do know that in the long run I will hit snake-eyes about once in every thirty six rolls.
Probability theory, as well as an understanding of the possible things dice might do, and the likelihood of those things happening, gives me a great deal of predictive power.
Likewise - the RBD lets me translate predictions about the performance of a backing asset directly into predictions about inflation.
Specifically it tells me that to run a successful bank with stable or appreciating money relative to the market, I need to issue money for assets with an average rate of devaluation less than the average interest rate charged.
How is this not a valuable insight?
Published: July 20, 2007 3:54 PM
... it also tells me that the quantity of money in circulation is a red herring with respect to the purchasing power of the money, and illustrates the microeconomic mechanics of why.
Contrast with the strictly empirical claims about what V and Q tend to do over time on a macro scale.
I don't know about you but I will take a micro versus a macro explanation every time.
Published: July 20, 2007 3:59 PM
Yancey Ward: "When monetary metals actually served as money, what was their backing?"
All exchange, without exception, is at the most fundamental level a barter in means to satisfy wants.
The 'backing' of any asset is simply a function that regresses through the most efficient known chain of asset exchanges, subtracting the subjectively valued transaction and asset holding costs from the subjective value of the most desired want which can be satisfied.
The backing of every asset is ultimately measured in 'subjective value of wants satisfiable'.
That's true for gold, potatoes, oil, notes, etc.
Monetary metals arose as money, not valueless out of the blue, but because they were already assets with value attached to them due to their ability in exchange to satisfy wants. The market observed the relative stability of the value of the asset relative to the market (i.e. the stability of the 'backing' of the asset), and tended to the most cost minimizing technology available, which was precious metal coinage, or wheat, or receipts, or whatever.
(This is Mises' explanation of the origin of money, and I find it to be sound. Do we disagree?)
The point is, money isn't anything special. It's just another asset. It can be any asset. It's value is due to its ability to secure means to satisfy wants, which is the only definition of 'backing' that makes any general sense.
Published: July 20, 2007 4:14 PM
I have a question for the RBD proponents: is there an issue in the RBD debate about whether the non-metal notes should be designated as such? In other words, what would be the significance of designating these paper currencies on their face as "potato notes," "oil notes," etc.? Corporate stock certificates are certainly specific as to their "backing," and corporate shares are generally traded in some circles as though they were a kind of money.
I could see where post-issue changes in the exchange ratios of the commodities behind the non-metal notes might affect the notes' market value.
I ask because I am reminded of the gold notes and silver certificates of yore, where the bills themselves were noted as redeemable only in specific monies.
Published: July 20, 2007 4:38 PM
Jean Paul: "... it also tells me that the quantity of money in circulation is a red herring with respect to the purchasing power of the money, and illustrates the microeconomic mechanics of why."
The quantity theory of money has proven itself even in barter. If in barter a standard rate of exchange exists between bread and apples, and the supply of one increases relative to the other, one will become cheaper in relation to the other. So if the supply of apples doubles, the exchange rate of apples for bread will fall to one half its original rate.
And the quantity theory has proven itself with gold and silver. In fact, the Scholastics who discovered the quantity theory did so by observing steady price increases in Spain in the 16th century as Spain shipped boat loads of gold and silver from the Americas.
The quantity theory of money is the most well-established theories of economics, in a priori terms and empirically. Why would it seem so strange that it works with paper money as it does with barter and gold?
Published: July 20, 2007 7:30 PM
George,
You have identified the key issue- disclosure.
If you have followed many of these debates, you will notice one consistent theme whenever RBD proponents talk about backing- they start off with the claim that the bank issued notes are backed with monetary metals, but whenever pressed as to what happens when the reserves are not there, then say that they will exchange their notes for whatever assets are at hand- IOUs, deeds to land, potatoes. Of course, in the past, people used gold and silver as money, and certificates that represented these metals. Given a choice between accepting a certificate in payment for my bread, I will prefer one that is 100% exchangeable for gold to one that may or may not be depending on the banks balance sheet. To get me to take the other certificate, you will have to give me a discount on its face value. And on my next transaction, I will have to give my trading partner a discount, and on and on. Given freedom, people will choose to trade in the most money like commodity. Only fraud and government coercion can prevent the market from reaching this state.
Note Jean Paul's answer to my earlier rhetorical question about what was gold's backing. RBD proponents are clueless what this means in regards to RBD in a completely free market for money, absence coercion, and with full disclosure of the backing a bank note actually has.
Published: July 20, 2007 7:43 PM
"The quantity theory of money is the most well-established theories of economics, in a priori terms and empirically. Why would it seem so strange that it works with paper money as it does with barter and gold?"
You are confusing the law of demand with the quantity theory. The law of demand says that when the quantity of an actual consumable good rises, its price will fall. It's true for apples and for gold and silver.
Paper and credit money are not consumable goods. There is no production function by which labor and capital are transformed into checking account dollars. They are financial securities that can be created and destroyed at the stroke of a pen. The law of demand is not a meaningful model in this case, and it is a mistake to say that the law that applies to apples and oranges can be extended to apply to bookkeeping entries.
I also note that in the equation MV=PQ, the Q term does not refer to the economy's aggregate output of goods. It refers only to the quantity of goods bought with the particular kind of money designated by M. For example, if M is the quantity of green paper dollars, then Q is the quantity of goods bought with green paper dollars. It might happen that on one day, 10% of the economy's goods are bought with green dollars. On the next, the quantity of green dollars might double, and 20% of the economy's goods might be bought with green dollars. The aggregate output of goods need not have changed at all, but Q would have doubled as M doubled, and there will be no change in V or P.
Published: July 21, 2007 10:51 AM
Mike: "You are confusing the law of demand with the quantity theory. The law of demand says that when the quantity of an actual consumable good rises, its price will fall. It's true for apples and for gold and silver. Paper and credit money are not consumable goods."
The quantity theory of money is nothing but the general theory of value applied to money. In barter, if an good, not just consumable goods, becomes more abundant relative to other goods, it's value relative to other goods will fall. If a good becomes more scarce, it's value will rise. This applies to land, gold, human beings, bread, anything. Gold is not a consummable good and the law of value applies to it. Human beings are not consumable goods, but the value of their labor varies with scarcity and abundance relative to other goods. Services dominate our economy and the more abundant a service, the lower its price relative to other services and goods. Why would paper money be exempt from this universal principle? The only difference with paper money is that it can be easily created and destroyed, which means that its value is much more volatile relative to other goods and services than any other form of money.
Mike:"I also note that in the equation MV=PQ, the Q term does not refer to the economy's aggregate output of goods. It refers only to the quantity of goods bought with the particular kind of money designated by M."
That's simply inaccurate. Q not only refers to goods, but to services as well. M refers to all money, whether in the form of green paper bills or just accounting entries.
Published: July 21, 2007 1:13 PM
Hello,
It is my pleasure to write you in respect of my agency.
We are a private loan agency located in London, United Kingdom; we are searching for reliable persons who are genuinely in need of loans. Please if interested in transacting business with us you can contact us for more information, if this proposal is acceptable to you. Please get back to us, so that remuneration can be worked out for your services as our business partner as your location shall determine.
We offer the following kinds of loans:
* Personal Loans (Secure and Unsecured)
* Business Loans (Secure and Unsecured)
* Consolidation Loan
Combination Loan and many more.
Email us for more information about our loans.
Mr. Andy Johnson
Eardley Financial Agency
United Kingdom.
Email:msnandyjohnson2@live.com
Published: July 16, 2008 7:25 AM