Commodity Prices and Inflation: What's the Connection?
There is almost complete unanimity among economists and various commentators that inflation consists in general increases in the prices of goods and services. From this it is established that anything that contributes to price increases sets inflation in motion. Contrary to the popular definition, inflation is not about a general rise in prices but about increases in money supply. The general increase in prices as a rule develops because of the increase in money. The harm that most people attribute to increasing prices is in fact due to increases in money supply. Policies that are aimed at fighting inflation without identifying what it is all about only make things much worse. FULL ARTICLE
Comments (213)
Frank, you really are a refreshing voice of sanity amidst all the sagely prognosticating economic talking heads on Australian TV who tut-tut about CPI/credit crunch this and long-term/short-term that, dazzling the viewers with terminology without really saying anything substantial. They remind me of those cold-reading psychic charlatans like John Edward who attempt to remain as vague as possible to convince people that they can actually talk to people's dead relatives. I wish the ABC would interview you instead.
Published: July 1, 2008 9:03 AM
Good article separating "inflation" (general increase in prices) from inflation (increase in money supply). I especially appreciated the scenario of the increased production of goods, because that one had been bugging me. When there is increased productivity, what should happen is a general decrease in prices, not steady prices.
Published: July 1, 2008 11:16 AM
Great article Mr. Shostak. Thank you.
Hayesy's "refreshing" comment sums it up.
I add you to my list of favourite commentators like Mike Shedlock and Gary North. You've got gray hair, experience, practice Austrian Economics and are involved in the "real" world.
It's not just academic chatter.
Published: July 1, 2008 11:45 AM
What a great article. Isn't the money supply also affected by the deficit and the balance of payments deficit? It's amazing to me that
no one at the Fed ever talks about all of this.
Published: July 1, 2008 12:07 PM
It never ceases to amaze me how people just cannot or will not see the reality of inflation. I can talk until I am blue in the face, but most do not get it.
Here is one example of the problem:
In a recent conversation, the subject arose concerning the Austrian insight that value is relative. One participant went from this to the notion that a gold standard would be meaningless because “money is worth whatever people think its worth” – in a single statement dismissing inflation as even a passing concern.
Published: July 1, 2008 1:39 PM
Frank
You might want to comment on the Phillips Curve, another artifact of an incorrect definition of inflation.
"Low unemployment is inflationary since labor shortages leads to higher wages and higher prices!"
Published: July 1, 2008 1:59 PM
Over all this was a good piece, however, I believe your analysis is lacking in a particular area. This is in response to the following paragraph:
“So irrespective what people's expectations are, if the money supply hasn't increased, then people's monetary expenditure on goods cannot increase either. This means that no general strengthening in price increases can take place without an increase in the pace of monetary pumping.”
It is true that the overall money supply would be unchanged unless the “pace of monetary pumping” changed. However, you are assuming that 100% of money supply is in circulation. If for example, consumers who are expecting inflation have a reserve of money supply currently not in circulation, they could put it into circulation to purchase goods. Therefore Frank, the amount of money spent per unit of goods will CHANGE.
Then again I am 25 and do not know what I am talking about.
Published: July 1, 2008 2:29 PM
Excellent Article.
However it should be noted that The FED and Congress to a very large extent DO KNOW what Frank is talking about is true. Do they ever look in the mirror and see thievery being perpetrated and what this eventually leads to? The public education system has created economic morons for the most part, but the Federal Reserve Folks do know what they are propagating...in one word.. INJUSTICE.
Published: July 1, 2008 3:06 PM
I have a question for the Mises community. Mr. Shostak wrote:
"If the price of oil goes up, and if people continue to use the same amount of oil as before, people will be forced to allocate more money to oil. If people's money stock remains unchanged, less money is available for other goods and services, all other things being equal."
My question is that if oil is used in the production of other goods and the price of oil goes up, shouldn't this increase the prices of other goods dependent on oil as an input? Or does the decrease in demand due to less money being available equal or outweigh the rise in the cost of a factor of production? Or does something else happen?
Published: July 1, 2008 3:36 PM
I'm a little surprised to not find our friend Mike Sproul here peddling his real bills doctrine (RBD). While not as devoted as he is, I'll offer my own RBD-lite theory:
Writers here at mises.org tend to insist upon a relatively stable supply of money such as gold or silver (of course, even the supply of precious metals is not fixed -- but it's more predictable). They correctly point out that, for a fixed amount of goods, prices will be higher per unit of money if the supply of money increases. To them, increases to the money supply by any means other than the normal mining of gold or silver is to create money "out of thin air". While I am a strict advocate for the gold standard, I think that such language is inaccurate.
Without going into the painful details, I'll explain it simply this way: Money may be backed by anything that we choose to back it with. There may be strong reasons to advocate a strict gold standard, but I can find no compelling reason for an Austrian economist to reject the ability of a bank and an individual to voluntarily contract to create (illustrating) $200,000 in new money in exchange for your home as collateral. Figuring out the value of the collateral is the tricky part. Such an arrangement works best if there is both financial convertibility (the IOU on the home) and physical convertibility (a certain amount of silver, for instance). If $200,000 of the bank notes are exchangeable for a certain amount of silver and the home may be exchanged for at least that much silver, then there is no reason to find the bank insolvent as long as it makes provisions for liquidity (supposing there is a run on the bank, it would be wise to stipulate in its contracts the ability to delay payment so that it could sell the IOU). There is also no reason to say that the money is created "out of thin air". The home is the backing. You have effectively monetized the home.
Exercises could be followed to consider what would happen to the money in cases of default or in cases in which it is put to productive use. There is no question that in dollar terms, goods would cost more after the collateralization. But that simply reflects the increased demand of the home owner to obtain the goods. Under a strict gold standard, the new demand would have been seen not in price increases but in interest rate increases.
Without a doubt, the arrangements I described are more complicated than a 100% gold standard. Don't take this as an endorsement of such a system. I'll also offer a disclaimer that I am not convinced that our banking system is so sound. Even if it has full backing (both financial and physical as Mr. Sproul claims), I think that the value of the collateral is questionable at best.
What is egregious is that the majority of the assets held by the Federal Reserve are government bonds -- essentially promises to rob in the future. It is the taxation that ought to be condemned, not the absence of a gold standard. In like manner, the king who clipped the coins was guilty of fraud and violence (or at least its threat). Absent those elements, the mere act of clipping the coins was no crime. It could have been a voluntary exchange whereby the holders of the larger coins were paying for services rendered by the king.
In any case, it is always violence and fraud that should be opposed. Absent those crimes, we should not criticize.
Published: July 1, 2008 3:40 PM
C. Evans:
I was thinking about the same matter. Because oil is often a factor of production, its price and availability will certainly impact the quantity and price of other goods. To the extent that less oil becomes available, production may decrease. Inflation would then result not because the supply of money increased but because the same supply of money would be chasing a decreased amount of goods.
Published: July 1, 2008 3:47 PM
C. Evans: “My question is that if oil is used in the production of other goods and the price of oil goes up, shouldn't this increase the prices of other goods dependent on oil as an input? Or does the decrease in demand due to less money being available equal or outweigh the rise in the cost of a factor of production?”
I think you answered your question. Higher oil prices do affect transportation costs of all goods, but the effect is much smaller than most economists think. And as you pointed out, a fixed supply of money means that consumers must take money from other areas in order to pay for higher fuel prices and that lowers demand for other goods.
Published: July 1, 2008 4:19 PM
Joe: "increases to the money supply by any means other than the normal mining of gold or silver is to create money "out of thin air".
That's not quite accurate. Things besides gold and silver can be money. In the US, paper is money, but it's not the real problem. Checking account money is roughly 20 times the value of paper money in circulation. The checking account money that is in excess of the paper money is what was created out of thin air.
Joe: "To the extent that less oil becomes available, production may decrease. Inflation would then result not because the supply of money increased but because the same supply of money would be chasing a decreased amount of goods."
Good point. Price inflation will not result if the increase in the money supply matches the growth in production of goods. One way of describing the current increase in oil prices is to say that oil production slowed to a rate below the increase in the money supply.
Published: July 1, 2008 4:31 PM
My question is not identical, but is along the lines of C. Evans...
While I am persuaded that an increase in the supply of money (the true definition of inflation) can lead to a general increase in prices, I am wondering whether it is required.
Suppose there is a "shock" to the oil market and the supply curve shifts up/left. The new equilibrium price will be higher and the quantity purchased will be lower, all else equal.
Now, consider an individual consumer. His consumption of oil at the higher price will be lower. He will pay more for that unit of oil but it is possible that he will spend less of his income on oil overall (he'll get less bang for his buck so to speak, getting a smaller quantity at a higher price). Then, if he spends less on oil, and assuming he doesn't curtail his total consumption, he will have more money to spend on other goods and he will bid up the price of socks, movie tickets, etc. Thus, it seems that the supply shock in the oil market could lead to a higher price for oil AS WELL AS higher prices on other goods. Presumably, this could all happen without any increase in money.
Any thoughts?
Published: July 1, 2008 4:53 PM
C. Evans: “My question is that if oil is used in the production of other goods and the price of oil goes up, shouldn't this increase the prices of other goods dependent on oil as an input? Or does the decrease in demand due to less money being available equal or outweigh the rise in the cost of a factor of production?”
The lower demand for other goods, assuming more money is spent on oil, leads to lower prices for "All Other Goods". It is true that an increased price for oil will lead to some goods increasing in price, but "on average" the price of other goods must go down.
Published: July 1, 2008 5:56 PM
Eric Spiess,
You question assumes that the supply of oil decreases. This is entirely possible and at least some of your observations logically follow from such a scenario, but it is not consistent with what we typically observe. In fact, the supply of oil has actually increased. See:
http://mappingthefuture.csis.org/08oilconsumption.html
Published: July 1, 2008 6:03 PM
If an economy is going to grow but the money supply stay constant, will this not result in deflation as the same amount of money purchases a larger amount of goods? To have stable prices wouldn't the money supply, by mathematic proof, need to grow at the same rate as the production is growing?
Can we conclude that inflation to match economic growth is a good thing?
Thanks for the article, and I appreciate any enlightenment on the above.
Published: July 1, 2008 6:07 PM
Duncan: "If an economy is going to grow but the money supply stay constant, will this not result in deflation as the same amount of money purchases a larger amount of goods? To have stable prices wouldn't the money supply, by mathematic proof, need to grow at the same rate as the production is growing?
Can we conclude that inflation to match economic growth is a good thing?"
This is the simple version of Milton Friedman's argument.
The general response you'll find here is that price deflation is not a bad thing and, because of the manner in which the central bank inflates the money supply (the money goes to some people first, at the expense of everyone else), any such scheme is not economically efficient (for many of the same reasons that all wealth redistribution is inefficient).
Published: July 1, 2008 6:14 PM
Brent:"The lower demand for other goods, assuming more money is spent on oil, leads to lower prices for "All Other Goods". It is true that an increased price for oil will lead to some goods increasing in price, but "on average" the price of other goods must go down."
Thanks for your reply and to everyone else who helped guide my thinking on this question.
Published: July 1, 2008 6:16 PM
Duncan:
Why would falling prices be a bad thing? If capitalism is the great source of wealth creation that we all believe it to be, then it should work absent inflation. And it does. Prices should fall.
Another interesting aspect of inflation is the link to wealth inequality that modern liberals are so concerned about.
"Likewise, it is monetary inflation, and not increases in prices, that erodes the real incomes of pensioners and low-income earners. As a rule, they are the last receivers of money — often called the "fixed-income groups." "
The rich get richer because they are the first receivers of new money and as such are the beneficiaries of inflation. If that is true, raising taxes on the rich will not solve the problem. In fact, I suspect it will make inequality worse. The only way to solve the inequality problem (and so many of our other economic problems) is to define properly and stop inflation. Great job Mr. Shostak!
Published: July 1, 2008 6:40 PM
Thanks for the insightful article on the connection of Commodity Prices and the Inflation. I am a toddler when it comes to Austrian Economics, so seeing real world application of Austrian Theory is extremely helpful. The contrast with other economic schools of thought proved insightful:
"Please note we don't say, as monetarists do, that the increase in the money supply causes inflation. What we are saying is that inflation is the increase in the money supply."
I look forward to reading more of your articles.
Published: July 1, 2008 7:20 PM
Frank Shostak:
You present the quantity theory of money--the belief that more money causes higher prices--as if there were no other theory worth considering. You do not even mention the real bills doctrine, which states that the issue of new money is not inflationary, provided that the issuer acquires adequate additional backing for the money issued. The real bills doctrine has been logically and empirically supported, in preference to the quantity theory, by the research of Cunningham, Smith, Sargent, Calomiris, Bomberger, Makinen, and other reputable economists. This issue has been discussed on many Mises threads, and several readers, myself included, would like to see it addressed.
Published: July 1, 2008 8:12 PM
Hi Mr Sproul,
As far as I know the real bill doctrine was recently discussed by Austrian economists. If I am not mistaken by Robert Blumen and Sean Corrigan. If I will have the time I promise to provide my side of the story on this issue. With respect to your comment regarding my article all that I can suggest at this stage that in the present world of fiat standard printing money is always bad news.
All the best,
Frank Shostak
Published: July 1, 2008 8:30 PM
Frank Shostak:
"all that I can suggest at this stage that in the present world of fiat standard printing money is always bad news."
If you do get time, and I hope you do, one point that needs to be addressed is the real bills claim that there is no such thing as fiat money.
Published: July 1, 2008 9:43 PM
"Low unemployment is inflationary since labor shortages leads to higher wages and higher prices!"
Don't forget the politician's favourite canard, that tax cuts are "inflationary", and hence undesirable.
Published: July 1, 2008 10:34 PM
When it comes to RBD, I don't really see what the problem is with the creation of money backed by securities, per se.
The fact that our currency is backed by the "full faith and credit" in the Treasury's ability to tax people in the future (bonds) means that there need not be a physical asset. If we actually lived in a free market, people would be allowed to decide if that was sufficient credit with which to back a currency, and even if people believed in the Treasury's ability to raise enough money by later taxation, they still could reject the currency if they were uncomfortable with the moral implications.
From here, the problem seems to lie more in the fact that we live in a society of legal tender laws in which a particular "brand" of currency (Federal Reserve Notes in the US) is forced upon the populace. Since all sellers are forced to accept these notes, their supply can be expanded ad infinitum without the threat of rejection. The fact that there are no physical assets directly backing these notes means that the supply can be expanded as quickly as is desired, but this is possible only because their legal tender status is what makes them non-rejectable.
Again, I know little about RBD, and I'll be looking over Prof. Sproul's literature to expand on it. Given my current knowledge, however, I don't see what the problem is with RBD per se, since legal tender laws (the force that turns our FRB notes into "fiat money") are not necessarily implied by the doctrine.
Published: July 2, 2008 2:47 AM
Expectations matter in the extent they affect credit expansion.
In the example Frank uses, there is no expansion of credit but take a contemporary example, expectations of house price increases. If people expect house price gains to outpace the cost of servicing the related debt, the consequence of these expectations will lead to house purchases, creating credit.. hey presto, no?
Published: July 2, 2008 3:10 AM
Some additional info:
http://research.stlouisfed.org/fred2/fredgraph?chart_type=line&width=1000&height=600&preserve_ratio=true&s[1][id]=BORROW
Published: July 2, 2008 3:34 AM
BTW I think the mainstream attaches a different meaning to the word inflation, than Austrians. The mainstream thinks inflation is the increase of the price of the "consumer basket" so if there would be a fixed money supply and bread and fuel and trousers are more expensive but loans and excavators cheaper, the mainstream would see it as inflation while Austrians would see as simply different preferences. Thus there is an implicit value judgement in the mainstream view: inflation is whatever hurts the "little guy".
Published: July 2, 2008 3:40 AM
Miklos,
"bread and fuel and trousers are more expensive but loans and excavators cheaper"
Totally agree. When did you hear anyone complain about "house price inflation" or "stock price inflation"?
Published: July 2, 2008 4:33 AM
Miklos,
"bread and fuel and trousers are more expensive but loans and excavators cheaper"
Totally agree. When did you hear anyone complain about "house price inflation" or "stock price inflation"?
Published: July 2, 2008 4:35 AM
"Isn't the money supply also affected by the deficit and the balance of payments deficit? It's amazing to me that
no one at the Fed ever talks about all of this."
In my mind these are minor pieces of the puzzle - effects as opposed to causes. While the budget deficit is the method the Fed uses to get more debt with which to inflate the currency, there is so much government debt already in circulation that a budget deficit is not required to create more money and credit.
The "trade deficit" is a symptom, not a cause of excess money creation and inflation.
My real problem with putting these issues front and ceter is that they divert attention from the real issues. For instance you could reduce the trade deficit by limiting trade and the budget deficit by raising taxes - both of which will actually make the situation worse, not better.
I prefer to focus on the fundamental issue: fiat currency and it's devasting long term effects on the global economy.
"If an economy is going to grow but the money supply stay constant, will this not result in deflation as the same amount of money purchases a larger amount of goods? To have stable prices wouldn't the money supply, by mathematic proof, need to grow at the same rate as the production is growing?
Can we conclude that inflation to match economic growth is a good thing?"
An economy that is experiencing REAL growth - increased productivity - SHOULD have price deflation and that is a good thing. In such an environment goods become more affordable to consumers and businesses make higher profits because input costs are also declining. The constant lowering of prices motivates businesses to continue to innovate to increase productivity, because failure to do so would result in decreasing profits. When the mirage of increasing profits through inflation is removed - if prices and costs go up by the same percentage nominal (though not real) profits go up - there is no real incentive for producers to increase productivity.
Monetary inflation creates malinvestments, distortions and inequalities (for those Jacobites concerned with those things) in any economic environment. Forcing an increase in prices on an economy where the productive forces of capitalism are trying to lower prices through productivity is as disasterous as increasing the money supply into an environment where price inflation is 10% or 50% - the effects are just less obvious in the short run.
Supposedly the 1920's and 1990's were times of productivity growth that SHOULD have lead to mild price deflation - a boon to mankind. Instead, the Fed in both cases looked at mild deflation as a curse to be avoided at all costs and inflated the money supply to keep consumer price inflation in the low single digits. The results are now plain to see, but few mainstream economists, especially one Ben Bernanke, are completely oblivious to this idea.
Of course the Fed doesn;t actually exist for the purpose of keeping price inflation contained, stimulating economic growth, or providing a stable dollar. The Fed exits to maintain the profits of the banking cartel - the rest is jsut what they tell the politicians so that they won't take away their unique privilige.
Published: July 2, 2008 6:40 AM
fundamentalist:
Things besides gold and silver can be money. In the US, paper is money, but it's not the real problem. Checking account money is roughly 20 times the value of paper money in circulation. The checking account money that is in excess of the paper money is what was created out of thin air.
The point that I have conceded to Mike Sproul is that both the paper money and the checking account money may have backing. Typically, checking account money comes into existence via loans. When you build a new home and fund it by a loan of newly issued checking account dollars, I am saying that it is inaccurate to claim that those dollars were created "out of thin air". They are backed by the home. Similarly, if I understand correctly, the dollars at the Fed are also backed primarily by real assets represented by the wealth that may be acquired through taxation. The backing is real. The problem is that it is stolen.
Again, I'll stress that I am not endorsing our banking system. Even ignoring the theft, I think that it is very challenging to keep track of the value of the collateral especially given the lack of physical convertibility. Mike downplays this, but I think that the link to a stable commodity would be key to giving objective value to the currency.
Published: July 2, 2008 8:10 AM
All in all, what bothers me the most about RBD is its lack of explanatory power. Austrian economics provides logical and reasonable explanations of money, inflation, the business cycle, interest, business productivity, and more. RBD doesn't seem to explain much of anything.
Money may be backed by anything that we choose to back it with.
I'll go you one step further, Joe. Money doesn't have to be backed by anything. The only thing that truly matters is that people accept money because other people accept money. The value of money is subjective, like any other commodity. Asset backing's main purpose is to control the amount of money issued by banks. As such, our current system of backing based on debt provides little or no controls.
I agree that commodity backing is most likely the best form of backing, and in a true free market, would probably be the most likely choice of banks and consumers for currency stability. But I don't see that it's a necessary and essential requirement for the existence and workings of money. Gold and silver have simply been the customary historical standards for money.
Last, but not least, I don't see how the backing of money really affects the value of money. It may provide a psychological comfort to consumers to "know" that the pieces of paper or credits in their account are "worth" so much in gold or other assets (assuming that it's true), but again, the real value of money comes not from its backing, but from the fact that other people are willing to accept them in exchange for goods and services. If Americans lose trust in the "full faith and credit" of the U.S. government, our Federal Reserve Notes will become as valueless as a piece of paper with Robert Mugabe's picture on it.
Published: July 2, 2008 9:12 AM
"I don't see how the backing of money really affects the value of money. It may provide a psychological comfort to consumers to "know" that the pieces of paper or credits in their account are "worth" so much in gold or other assets (assuming that it's true), but again, the real value of money comes not from its backing, but from the fact that other people are willing to accept them in exchange for goods and services."
It's not psychological - gold (or some other valuable commodity) backing is not a psychological effect. When the dollar was backed by gold anybody could demand exchange of paper dollars for gold at any time - the issuer was contractually required to exchange a dollar for a fixed amount of gold - it was illegal for him not to (although the government has on numerous occaisions let issuers violate their contractual agreements when they get themselves into a bind). That meant that no matter how many paper dollars were printed and how much value they lost as a result you could still trade them in for a fixed amount of gold. This was not just a tremendous restraint on currency issue by banks it was an insurance policy that the currency you accepted from your employer or from other citizens in payment would hold its value regardless of the actions of banks (including the Fed) that you could not control.
In contrast, today if the currency you hold depreciates due to over-issue you have no recourse. The only backing of the dollar is other depreciated dollars or treasury notes denomenated in the same depreciated dollars. Even if you choose to buy gold with your depreciated dollars the value is already lost - the gold just insures against further loss in the future.
The result is that TODAY in a pure fiat currency world with no backing (or precisely the backing of the "full faith and credit" of the United States government) the value of a currency IS based on faith and nothing else - the faith that the government can take equally depreciated dollars from other citizens and give them to the holder on demand.
That is not the case with REAL physical backing by a scarce commodity.
Published: July 2, 2008 9:47 AM
Joe: "The point that I have conceded to Mike Sproul is that both the paper money and the checking account money may have backing."
I think some confusion is caused by the way the term "backing" is used. When RBD says money is backed by something, it means the loan has collateral. But when quantity theoryg (QT) talks about backing, they mean that paper money, or checking account money, has a one-to-one correspondence with something tangible. "Backing" as used by the QT limits the amount of money that can exist by what "backs" it. But "backing" as used by the RBD places no limit on the amount of money issued.
Also, I think a distinction should be made between backing for money and for the loan. In fractional banking, FRB, and RBD, the backing is for the loan, not the money, technically. With 100% reserve banking, money issued from loans must come from reserves, which are the savings of depositors. So no money gets created; it's just exchanged. The RBD is just a justification for FRB, and in FRB, the bank is not limited to loaning out the savings of other people; it can create new money that never existed before and doesn't represent savings. That's why people call it created out of thin air. It's not derived from something else as were gold/silver certificates. Then that newly created money is exchanged for something of value, an IOU with the backing of collateral such as land.
Published: July 2, 2008 11:32 AM
For an educational comparison of Mr. Shostak's excellent article with the nonsense of mainstream econ, check out Jeffry Sach's article "Saving Resources to Save Growth" at project-syndicate.org/commentary/sachs142. He calls for state intervention in the marketplace world wide because of the following:
"First, history has already shown how resource constraints can hinder global economic growth. After the upward jump in energy prices in 1973, annual global growth fell from roughly 5% between 1960 and 1973 to around 3% between 1973 and 1989.
"Second, the world economy is vastly larger than in the past, so that demand for key commodities and energy inputs is also vastly larger.
"Third, we have already used up many of the low-cost options that were once available. Low-cost oil is rapidly being depleted. The same is true for ground water. Land is also increasingly scarce.
"Finally, our past technological triumphs did not actually conserve natural resources, but instead enabled humanity to mine and use these resources at a lower overall cost, thereby hastening their depletion. "
Published: July 2, 2008 11:41 AM
Michael Clem:
All in all, what bothers me the most about RBD is its lack of explanatory power. Austrian economics provides logical and reasonable explanations of money, inflation, the business cycle, interest, business productivity, and more. RBD doesn't seem to explain much of anything.
I haven't spent much time considering RBD to be frank. While the subject deserves more than what I could reasonably ask you to read in a blog comment, I'll give a shot at some of my initial thoughts.
Money: I'm not sure exactly what you mean by wanting an explanation for money. I don't think that RBD and Austrian economics necessarily explain money differently. It's just that someone following Austrian thinking is likely to call for commodity backing while an RBD advocate is more likely to accept financial backing.
Inflation: In my opinion, Mike Sproul has done himself no favor by adamantly denying that financial backing causes inflation. Relative to 100% commodity backing, prices in currency backed by an expanding base of financial assets will have higher prices per unit of currency. This follows from simple algebra - no economic theory is needed. The way I understand it, RBD claims though that as long as backing is adequate (very important later), the supply of money will match the level of production. So overall, on an absolute basis, there need not necessarily be inflation even though there is inflation relative to 100% commodity money.
The business cycle: This is the interesting one. According to Austrian theory, the business cycle is caused by an increase of money that goes into projects that are not backed by actual capital. The boom spawned by the new projects is followed by a bust when the it is discovered that the projects are unrealizable for lack of capital.
I think that RBD would claim that the business cycle is caused by inadequate backing. In theory, there would be no cycles as long as the backing was adequate. When you stop to think of it, even under a gold standard, a bank could print more dollars than it had gold to back it. A boom/bust cycle would ensue. The problem with financial backing, my opinion, is the greater difficulty to judge backing adequacy. I suspect also that there are strong psychological factors artificially inflating the value of collateral. For instance, a great deal of bank collateral is wrapped up in real estate. How dollars may be exchanged for property is entirely subjective. And in our mortgaged society, everyone has incentive to avoid admitting that the values we're assigning to our homes are out of line with other values. But until the bust, those values may be monetized and are to a great extent.
I remain a gold standard advocate from a pragmatic standpoint.
Interest: This one is also interesting though I haven't thought it out entirely. It's clear to me that in a 100% commodity currency, greater demand for loans will result in higher interest rates. When the currency is backed by financial assets, the demand for loans will result not in higher interest rates but in higher prices of the goods purchased with the new money. I believe that there is an inflation/interest rate trade-off here depending upon how you back the currency.
Business productivity: I'm not sure that I understand what you mean by this. A few comments about the results of production levels are in order. Under a 100% commodity currency, increased productivity should result in lower prices generally. With financial backing, we may assume that many projects will be financed using prior production as collateral. If the projects are productive, price levels will tend to be stable. If they fail to produce, I think that the question of what happens is less clear. It seems that the currency base might just contract. Otherwise, inflation would certainly result.
Conclusion: I'm sure that my analysis has not been completely thorough in every way. As I've said, I'm still thinking about this. I still do remain convinced that a 100% gold standard would be the best practice. However, I oppose first and foremost the practices of taxation and legal tender laws. Absent those crimes, monetary systems return to matters of preference.
Published: July 2, 2008 11:50 AM
Joe: "The way I understand it, RBD claims though that as long as backing is adequate (very important later), the supply of money will match the level of production. So overall, on an absolute basis, there need not necessarily be inflation even though there is inflation relative to 100% commodity money."
Based on Mike's previous posts, I think he would say that the supply of money relative to the level of production is a concern for the QT, not the RBD. In the RBD, inflation results purely from banks making loans on poor collateral. The collateral for the loan (which is the backing for the money exchanged for the loan) loses value which caused the money loaned to lose value.
Joe: "I think that RBD would claim that the business cycle is caused by inadequate backing. In theory, there would be no cycles as long as the backing was adequate."
Based on previous posts from Mike, the RBD doesn't have an opinion on business cycles because they're not related to money. In this regard RBD is very similar to mainstream econ in that business cycles result from mysterious shocks that come from nowhere. RBD is concerned with providing adequate flows of money when businesses need it, such as during a boom or the Christmas rush, and reducing the money supply when business doesn't need it, such as during a bust. So the RBD would be procyclical and make the highs and lows of a business cycle higher and lower than they would be under a fixed money supply. But RBD isn't concerned with business cycles because it sees money as having no effect on inflation or the business cycle.
Published: July 2, 2008 12:33 PM
fundamentalist:
I think some confusion is caused by the way the term "backing" is used. When RBD says money is backed by something, it means the loan has collateral. But when quantity theoryg (QT) talks about backing, they mean that paper money, or checking account money, has a one-to-one correspondence with something tangible. "Backing" as used by the QT limits the amount of money that can exist by what "backs" it. But "backing" as used by the RBD places no limit on the amount of money issued.
I agree with everything you wrote. Financial backing places no practical limits on the amount of money that may be issued. In the absence of physical convertibility, a currency is furthermore dominated by the subjective valuations of the value of the collateral. That those valuations are made in terms of the currency being expanded leaves me wondering how we could ever truly keep track of the backing.
I do disagree with one statement in your second paragraph:
The RBD is just a justification for FRB, and in FRB, the bank is not limited to loaning out the savings of other people; it can create new money that never existed before and doesn't represent savings.
First, allow me to offer a disclaimer. I have never been convinced that our banking system can even in principle claim to be fully backed. I am arguing for an abstraction (as are all of us - few people here, if any, will argue for the reality of current day banking).
I don't think that you can categorically say that money backed by financial assets does not represent savings. If money is created through issuance of a mortage on your home, that money didn't come out of thin air. It was created through the monetization of a real asset that required actual savings and real capital to produce.
The problem, of course, is in the subjective valuation of your home. You'll get no resistance from me that currency backed by a 100% commodity standard will be more objective and stable than one backed by financial assets. I am encouraging you to back off statements such as "out of thin air". I don't believe that they are accurate. Furthermore, they distract from the real sources of wealth transfers -- taxation and legal tender laws. I think that we would all be united in opposing those crimes. Once abolished, what sort of backing we allow for our money may be matters of preference. At that point, I'll certainly recommend that financial backing is much more prone to fraud. However, it is benign in itself.
Published: July 2, 2008 12:56 PM
I'm sure that Mike and I don't agree on alot. That's why I initially called my ideas "RBD-lite". Since then, I've usually tried to make distinctions between physical and financial convertibility rather than appealing to RBD as any appeal to dogma.
Mike has gotten me thinking simply that money backed by financial assets may be legitimate (meaning the result of voluntary exchanges). Whether it is wise is another question.
fundamentalist: Based on previous posts from Mike, the RBD doesn't have an opinion on business cycles because they're not related to money.
If so, I disagree with RBD. In this, I probably remain more Austrian. But RBD has prompted me to change my stance somewhat. Previously in my mind, business cycles were caused by any changes to the money supply. What was needed to avert them was stable money. Now, I am claiming that they are caused by unbacked money. I've already proposed that money may be unbacked in a gold standard by banks fraudulently printing more money than what may be backed by their gold. I also concede that a system of full financial convertibility will be hard pressed to objectively keep track of the value of its collateral. I could approve of a system of mixed convertibility in which (for example) your home, a certain number of dollars and a certain amount of gold are all interchangeable. In such a system, I do not have a fundamental problem if new dollars are printed with your home as backing.
Published: July 2, 2008 1:22 PM
I'm sure that Mike and I don't agree on alot. That's why I initially called my ideas "RBD-lite". Since then, I've usually tried to make distinctions between physical and financial convertibility rather than appealing to RBD as any appeal to dogma.
Mike has gotten me thinking simply that money backed by financial assets may be legitimate (meaning the result of voluntary exchanges). Whether it is wise is another question.
fundamentalist: Based on previous posts from Mike, the RBD doesn't have an opinion on business cycles because they're not related to money.
If so, I disagree with RBD. In this, I probably remain more Austrian. But RBD has prompted me to change my stance somewhat. Previously in my mind, business cycles were caused by any changes to the money supply. What was needed to avert them was stable money. Now, I am claiming that they are caused by unbacked money. I've already proposed that money may be unbacked in a gold standard by banks fraudulently printing more money than what may be backed by their gold. I also concede that a system of full financial convertibility will be hard pressed to objectively keep track of the value of its collateral. I could approve of a system of mixed convertibility in which (for example) your home, a certain number of dollars and a certain amount of gold are all interchangeable. In such a system, I do not have a fundamental problem if new dollars are printed with your home as backing.
Published: July 2, 2008 1:26 PM
Sorry about the double post - not sure how that happened...
Published: July 2, 2008 1:29 PM
Here's a fundamental question: Austrians generally agree that most any amount of currency will work (within reasonable divisibility limits), and the problems are related to the changes in currency, usually inflation (increases in the money supply). RBD seems to say that changing the money supply has no effect on pricing, as long as the backing or collateral stays in lock-step with those changes.
Obviously, if you have a certain ratio of money to commodities, and they change to the same degree, the ratio hasn't changed, and prices are stable. But as has been noted, Austrian inflation has still occurred (or deflation, in cases of reducing the money supply), because normally, increased productivity should be a boon to consumers that results in lower prices. RBD thus seems to be aimed towards stable prices, and not towards "accurate" prices.
RBD cannot deny that absolute changes to the money supply have occurred, no matter how solid the backing asset is. So the question is which is more important: absolute changes to the money supply, or the ratio of money to commodities?
Published: July 2, 2008 2:01 PM
Michael: "RBD thus seems to be aimed towards stable prices, and not towards "accurate" prices."
I don't want to pretend to be an expert on RBD. All I know is what I've read from Mike's posts. Based on that, I think it's not quite accurate to say that RBD aims at stable prices because RBD sees almost no connection between money and prices, except in the rare occasion when the value of the asset "backing" money falls. RBD sees many other things as being more important in determining prices with money having the least, almost insignificant, role. The goal of RBD appears to be nothing more than to guarantee the supply of loanable funds when businessmen request them. Of course, the businesses should be sound and they should provide sound collateral. In that way, interest rates would never rise to choke off a boom. In addition, when the inevitable bust happens, then the money supply automatically contracts. If anything, I would say the RBD aims for steady, low interest rates.
Michael: "So the question is which is more important: absolute changes to the money supply, or the ratio of money to commodities?"
According to Austrian theory, the absolute changes are the most important because they cause the business cycle, in which there is a great amount of wasted wealth, and absolute changes increase inequality by transferring wealth from late to early receivers of the new money.
Published: July 2, 2008 2:36 PM
I challenge the idea that wealth transfers occur simply because the money supply increases. Allow me to illustrate by the following scenarios. In each, suppose that you wish to acquire $50,000 and own a home worth at least $200,000.
1) You request a loan and receive gold (or claims to gold) worth $50,000. Whether or not you post your home as security on repaying the loan is immaterial to the outcomes though it will certainly impact the interest rate you pay.
2) You request a loan and receive $50,000 of newly created money. You place a lien upon your home to back it.
3) You request a loan and receive $50,000 of new money. The only security on that loan is an IOU on your future income based upon your fine credit.
4) You steal $50,000 worth of assets.
5) You request and receive a $50,000 grant from the government.
I began to provide my own outcomes but would not be able to finish until tomorrow. Rather than leaving this half finished, I think that I'll allow any interested readers to comment on which cases involve wealth transfers. We can use 1) as the base case in which we all will certainly agree that no wealth transfer has occured. In order to prove a wealth transfer, you must demonstrate how you would be better off than pursuing 1).
Published: July 2, 2008 4:01 PM
Joe said:
"I don't think that you can categorically say that money backed by financial assets does not represent savings. If money is created through issuance of a mortage on your home, that money didn't come out of thin air. It was created through the monetization of a real asset that required actual savings and real capital to produce."
I agree with that. Same with a new chequing account created with IBM shares as collateral. Those IBM shares had to come from savings at some point. And if the shares are already standing as collateral for another loan, no bank would accept them for a new loan. So even with FRB the amount of chequing account dollars is limited by the pool of prior savings, whatever collateralizable form these savings may take.
Poor standards for collateralization cause booms and bust. Government monopolies ie. central banks are protected from competition, allowing standards to deteriorate. Banking guarantees such as FDIC help relax standards even more by engendering moral hazard. As long as their is no banking monopoly and banks try to maximize profits, collateralization standards should stay strong.
It seems to me that the whole "money out of thin air" meme is a useful expository tool used by Austrians to convert those new to economics to the Austrian fold. After all, when you first hear about a group that can create money from nothing you can't help but be a bit angry, given the fact that everyone else has to work for their cash. But once you spend some time reading Mike and looking underneath the hood of banking it's hard to continue supporting the "out of thin air" critique. I'd encourage people to back off it too.
Published: July 2, 2008 4:03 PM
Mike’s use of the term “backing” has got some of you confused about money creation. So let’s look at the real economy without money. Suppose a construction company needed potatoes to feed its crew until they finished a building and got paid. The company owner can put up his equipment as collateral for the loan. There are no banks because there is no money, but what would be equivalent to a bank? A food storage company. Potato farmers who grew more potatoes than they consumed put their excess potatoes (their savings) in the storage facility for sale later. The construction company owner might be able to go to the storage facility and borrow potatoes to feed his crew in exchange for returning an equivalent amount of potatoes later plus extra potatoes as interest.
This scenario is roughly equivalent to 100% reserve banking. But suppose that the storage facility held just 100 lbs of potatoes when the contractor needs 200 lbs.? In the real world, the contractor is out of luck. He will have to settle for 100 lbs of potatoes. In the case of 100% reserve banking, borrowers are limited to the actual savings out of production of other people. This is the part of Austrian monetary theory that RBD objects to. It says that loans should not be limited to savings.
Now in the FRB/RBD world, the storage facility isn’t limited to loaning out the 100 lbs of potatoes that it keeps in reserve. It has a machine that can create food like those replicators on Star Trek. So the storage guys replicate 100 lbs of potatoes to add to the 100 lbs. in storage and make the loan to the contractor.
As you can see, both scenarios have the loans backed by the collateral of the construction equipment. But in the FRB/RBD world, potatoes are loaned that didn’t come from savings. They were created out of thin air. The case is the same if you add money to the scenario. The money is created out of thin air because it didn’t exist in the bank’s vault before the loan was made. The new money is created at the conclusion of the loan; it did not exist before the loan transaction was completed.
Published: July 2, 2008 4:30 PM
Okay, I agree that #1 is not a wealth transfer, assuming that the $50,000 (or gold) was from the bank's deposits. I think we can also safely assume that #4 and #5 are wealth transfers. Theft involves taking something from someone against their will and providing nothing in exchange. Likewise, for #5, the government takes money in the form of taxes and then redistributed it in the $50,000 grant. The grantee may pay taxes, but his share of the $50,000 that he paid in is going to be so small as to be insignificant.
But as for #2 and #3, in both cases, new money has been created, increasing the money supply. The receiver of the loan has money that didn't exist before to bid up prices in whatever industries he spends the money on. In #5, wealth was transferred from taxpayers to the receiver. In 2 and 3, wealth was transferred from everyone who uses the currency to those who receive the new currency, until the prices are readjusted to account for the new currency.
True, $50,000 is pretty small when compared to the trillions of dollars already in circulation, but that just means the wealth transfer was proportionally smaller, than, say, #4, where the victim of the thief bears the entire loss of $50,000, or even #5, where, while there are many taxpayers, they are still fewer than the total number of people using the currency.
Whether or not some collateral was put up is irrelevant to the fact that new money was created, although if the receiver is unable to pay back the loan, the bank may end up the big winner instead of the receiver--the bank may get a home for the cost of printing the currency, instead of just receiving the interest on the loan.
You may want to say that the receiver is no better off than he would be in #1, since he received the same amount of money, but this ignores a simple fact: if the bank had to loan him the money from deposits instead of creating new money, would they have been able to? Receiving the loan from newly created money makes him better off than not receiving the loan because the bank can't cover it. And the bank is certainly better off, even if he doesn't default on the loan.
Published: July 2, 2008 4:58 PM
"Same with a new chequing account created with IBM shares as collateral. Those IBM shares had to come from savings at some point. "
Really? Do 100% of the value of those shares represent real savings or only some fraction?
That's the problem with fractional reserve banking - even if it's based on gold only a portion of it represents real wealth, the rest of it is out of thin air. The fact that the "real" portion once came from savings doesn't stop the whole amount from being used as collateral to pyramid even more money creation on top.
Is it really fundametally different to say that money is created "mostly" out of thin air versus "entirely" out of thin air?
"So even with FRB the amount of chequing account dollars is limited by the pool of prior savings, whatever collateralizable form these savings may take. "
The fact that some portion of the value at the bottom of the pyramid represents real savings doesn't really make much difference - it's like being somewhat pregnant.
Monetizing assets that were not previously monetized is creating money by it's very definition, and it IS inflationary. So is digging gold out of the ground. The difference is that there is a finite rate at which new gold can be found. There is very little limit to the amount of assets that can be collateralized - government bonds can be created at extremely high rates, though not infinite. The limit is the point where creation of government debt as collateral and the money it spawns causes the system to collapse. This is a minor distinction and the technicality that I believe RBD uses to claim that there is no such thing as fiat currency. Austrian Business Cycle theory explains this point succinctly.
Published: July 2, 2008 5:28 PM
Fundamentalist: In your potato storage and potato lending example, farmers X, Y and Z deposit their 100 potatoes with the storage facility. At that point, the storage facility is operating on a 100% reserve system. However, when the storage operator lends the 100 potatoes to the contractor for his I.O.U., the storage facility has zero potatoes left in reserve for X, Y and Z, who may now want their potatoes back. In what sense then do you regard this as a 100% reserve system.
Published: July 2, 2008 5:42 PM
Alex: "In what sense then do you regard this as a 100% reserve system."
That's a good point. For the system to involve 100% reserves, the farmers who stored their potatoes would have to agree to give up use of the potatoes for a certain period of time. Fractional potatoe storage would result if the farmers withdrew potatoes as they needed them while the storage facility was lending most of them out at interest. In that case, both the farmers and the borrowers would have claim to the same potatoes.
Published: July 2, 2008 8:06 PM
Joe's five cases above illustrate how RBD (and FRB for that matter) hinges on semantic confusion between real money (a commodity generally accepted as a medium of exchange), money substitutes (accounting claims on a physically specified quantity of real money), and shares of ownership in some other real good. Cases 2 and 3 are wealth tranfers (and inflationary) because (fraudulent) claims to real money, which are actually claims to something else, are created without a corresponding increase in the stock of the actual commodity money.
While savings can take many physical forms, only that form which constitutes the actual physical commodity that is generally accepted in exchange transaction is in fact money. Calling a house "money" does not make it money, any more than calling a calling a cat a "dog" makes it a dog. A claim to a share of ownership in a house (or the future income of the borrower) is not the same as a claim to a specified quantity of real money. Anyone ever tried buying groceries by offering the clerk shares to your house? Of course not, but the clerk will accept a note that is indistinguishable from a claim to real money (despite the fact that it is actully a claim on some other good). Sellers who accept the new (fraudulent) notes from the borrower in exchange for real goods are decieved by the borrower and the lender into believing that they represent claims to real money as opposed to claims to a share of the house.
In both cases 2 and 3, the supply of circulating claims to money is increased without a corresponding increase in the supply of real commodity money (inflation) and wealth is redistributed toward the point of origin of the new, fraudulent notes. All of this is made possible by confusion on the part of market participants between money, money substitutes, and the fake notes which the issuers claim to be something they are not.
If the new notes were printed and issued in good faith (cleary stating that they not claims to money but to some other good) market participants would shun them in favor of claims to real money for the reasons Mises describes in his theory of the origin of money. In the case where the issuance and acceptance of notes that are claims to goods other than money as if they were money is condoned and enforced by government we see that what we essentially have is a return to barter, and it becomes clear that RBD/FRB is really an attack on one of the key foundations of the market society.
Published: July 3, 2008 8:50 AM
fundamentalist:
Here's a counter example. Let's suppose that the construction company needs 100 lbs of potatoes to feed its workers. Assume further that this is an economy in which gold is used as money. The construction company currently lacks enough money to pay for the potatoes. However, the owner is able to convince the potato farmer to accept in exchange the promise to do some minor construction work on the farmer's property in exchange for the potatoes.
Is there anything objectionable in this arrangement?
Now, suppose that we introduce a banking intermediary. Instead of transacting by barter, the construction company goes to a bank. While it is short on cash, it is able to convince the bank that its future prospects are good. The bank issues new money in exchange for an IOU to repay the loan plus interest. The construction company uses this new money to purchase the potatoes. The farmer then pays the money to the construction company in exchange for the work he wanted done on his farm. The construction company pays the loan back. Along with the principal, it must produce enough additional money (gold or an equivalent) to pay the interest. Having repaid the loan, the IOU is gone. In order to remain solvent, the bank must take the now unbacked money out of circulation. It keeps the interest as its compensation for doing business.
Replace the new money with an actual gold reserve, and the exchanges are the same. The amount of money the bank has earned is also the same.
You might now wonder what will happen if the construction company defaults on its loan. Its IOU will have been found to be worthless. However, no money was returned to the bank for it to destroy. In order to remain solvent, it must take gold out of its own earnings to back the money that it put into circulation. If you follow through the chain of events under a 100% gold standard, you'll find that every immediate participant is in the same position. No wealth transfer has been made at least for those immediately involved.
Being the good economists that we are, we should now turn our attention to the broader picture. I don't have the time to continue my thought experiment at the moment. But the question that I leave for all of you to ponder is what happens in each case to the broader economy. My hypothesis is that there is a trade-off between inflation and interest rates. When new money is created, prices will rise upon default. That is generally okay because there is more money in circulation now to follow the higher prices. The people hurt are the ones holding the empty bag after default. When existing money is loaned, prices won't rise upon default. But I think that banks may tend to raise their rates to compensate for their losses. Again, this isn't well thought-out, and I welcome commentary.
Published: July 3, 2008 9:01 AM
Joe: “Replace the new money with an actual gold reserve, and the exchanges are the same.”
Adding money to the scenario doesn’t change the situation; it just makes it more complex. In my scenario I kept money out in order to show that the storage company would have to “replicate” potatoes in order to make the loan to the contractor. When you add money, whether gold or paper, the bank still must “replicate” it in order to make the loan to the contractor.
Actually, the exchanges can’t be the same. You wrote that “The bank issues new money in exchange for an IOU…” This is an example of “replication” of potatoes. Money that did not exist before the transaction exists after it. So the money supply increases and sets in motion the business cycle boom and bust.
Joe: “However, no money was returned to the bank for it to destroy….No wealth transfer has been made at least for those immediately involved.”
However, if the contractor defaults on his IOU, the bank then gets his collateral, so the bank is better off; it exchanged money that it created from nothing for real property. But that’s not where Austrian econ places the transfer of wealth. It happens when the monetary inflation causes price inflation. The rise in wealth of the financial sector of the past decade is a good example. When the Feds lower interest rates, hedge funds and investment banks are among the first to borrow. They invest in assets, such as housing, before prices rise. It takes 12-18 months for new money to affect prices. After prices have risen, they sell those assets for a considerble profit. Wage earners, particularly in retail, receive the new money last, after prices have risen. They purchase assets (such as houses) from those who received the new money first. So the transfer of wealth takes place after prices have risen and goes from the late receivers of money to the early receivers.
Published: July 3, 2008 9:36 AM
jp says:
"Poor standards for collateralization cause booms and bust."
that glosses over the most important weakness with rbd - that the very collateralization of a particular asset causes a price bubble in that very same asset.
the ascent of prices sucks in more and more punters, until the market is saturated, and then the bankruptcy of the marginal players drags down even the more conservative players. many deals that appeared relatively sane in the nasdaq mania turned out to be duds when the bubble popped.
besides, mike has been unable to explain the existence of legal tender laws in all countries. indeed these would be superfluous if fiat money did not exist, as he posits.
Published: July 3, 2008 9:50 AM
The bank issues new money in exchange for an IOU to repay the loan plus interest.
Once again, it doesn't matter what the collateral is, the simple fact is that new money has been issued. This is inflationary, per Austrian econ. Now, here's the fun part. If we replace the IOU with gold, that is, the bank is creating new money to buy gold, we STILL have new money, and thus, Austrian inflation. The only real difference is that the gold can't be created on demand ("with the stroke of a pen" or a computer entry) whenever the bank wants to create new money--it has to be mined and available. Thus, commodity banking (with 100% reserves) provides strong limits on inflation and the creation of new money in a way that debt-backed money cannot.
No wealth transfer has been made at least for those immediately involved.
But a wealth transfer did occur. The bank is earning interest on money that didn't exist before, as well as the fact that the people getting the new money can now use it to bid up prices, something that couldn't be done without the newly created money. The proof is in the fact that if the borrower defaults the bank has to scramble to cover the losses--it's a shell game. The bank is "floating" the new money, just like a person writing a hot check hopes to cover it with his next paycheck before it hits the bank. Everything seems fine as long as nothing goes wrong, but purchases have still been made with money that didn't really exist, purchases that couldn't have been made otherwise.
Published: July 3, 2008 10:09 AM
fundamentalist:
Actually, the exchanges can’t be the same.
Go back and read my narrative carefully. When all obligations are honored, the following exchanges are made:
1) The construction company receives the potatoes.
2) The farmer gets the construction work done.
3) Except in the case of straight barter, the bank earns interest.
Whether existing gold reserves are used or new money is issued, after all transactions are completed (including repayment of the loan and cancelling of the IOU), the money supply is the same as it was originally. The money supply may only increase without bound if the new production (for instance, the improvements on the farmers property) are then mortgaged for new money. I stress that this is true only when all obligations are honored and no fraud is committed by either the bank or by borrowers.
I arrive at these conclusions by simple applications of logic. We really can't proceed until we reach agreement on this.
Obviously, matters are complicated when one or more of the following occurs:
1) Default
2) Intentional fraud by the bank
3) Introduction of legal tender laws
4) Violence or coercion forcing collateral to be posted
We can proceed on these points after we get agreement on the base case.
Published: July 3, 2008 11:40 AM
Newson:
"the most important weakness with rbd - that the very collateralization of a particular asset causes a price bubble in that very same asset."
I don't think you'd make that claim if all paper dollars were physically convertible into 1 oz. of silver, and backed by assets worth at least 1 oz. of silver. If the issue of new dollars did cause the market value of the dollar to fall to .99 oz., then the superfluous dollars would simply reflux to the bank to be exchanged for 1 oz., so the value of the dollar never could fall below 1 oz. I wonder if you'd admit to the validity of the RBD in this simple case, because it's a short step to admitting its validity for our so-called 'fiat' system.
"esides, mike has been unable to explain the existence of legal tender laws in all countries. indeed these would be superfluous if fiat money did not exist, as he posits."
What's to explain? If 'legal tender' means that the government is obligated to accept paper dollars for taxes, then the government is using taxes to back dollars. If it means that private traders are obligated to accept dollars, then the government is using traders' weath to back dollars (a form of robbery). But in most cases, legal tender laws are meaningless. People in Mexico, for example, can insist on being paid in dollars, regardless of any legal tender inscriptions that might be printed on the paper peso.
Published: July 3, 2008 11:47 AM
Joe: "We can proceed on these points after we get agreement on the base case."
I'll agree that the money supply ends up the same after the loans have been paid in each scenario. But the devil is in what happens in between taking out the loan and paying it back. The money supply increases when the bank creates new money, but not when reserves are used to supply the contractor with money. Then when the contractor pays back the loan, the money supply contracts back to the original level (ignoring interest) with the new money scenario. But the money supply is not affected when gold/reserves are repaid; they just return to the bank.
Now if you apply the new money creation scenario to the whole economy, you have the business cycle. It's true that the money supply returns to a level close to what is was before the money creation, but a lot of time has passed during which the business cycle took place.
It's true that a version of the RBD insists on making short term loans so that the period of money creation doesn't have time to initiate the business cycle. But that ignores the fungible nature of money. Short term loans may do nothing but free up internal funds of companies for them to use in long term projects. In that way, even short-term money creation/destruction via the RBD can cause the business cycle.
Published: July 3, 2008 12:24 PM
"If we replace the IOU with gold, that is, the bank is creating new money to buy gold, we STILL have new money, and thus, Austrian inflation. The only real difference is that the gold can't be created on demand ("with the stroke of a pen" or a computer entry) whenever the bank wants to create new money--it has to be mined and available."
Wait a moment. If gold is the only money in circulation, and then banks start to issue 1 oz reedemable money certificates (IOUs) for 1 oz gold, eventually replacing all the gold in circulation with money certificates, than no Austrian inflation is occurring. Its a 1 for 1 trade.
Money depreciation only occurs when more gold is mined, this increased supply pushing down the value of gold and therefore the value of the certificates. But the actual creation of certificates, as long as it is done on a one to one basis and reedemable, doesn't cause any problems.
"that glosses over the most important weakness with rbd - that the very collateralization of a particular asset causes a price bubble in that very same asset."
Not if it is done at market prices and interest rates. If a bank provides financing to a home owner based on the same price that the owner could sell it on the open market, then there will be no mass movement to collateralize houses.
Only when government institutions like the Fed, Fannie Mae and Freddie Mac get involved do interest rates get out of whack and collateralization standards deteriorate. People who normally wouldn't be able buy a house suddenly find themselves capable of getting a mortgage. Enough of them and house prices will start to rise. This is a clearly a case of the very collateralization of an asset causing a bubble in the same asset.
To further show why collateralization of a particular asset needn't cause a price bubble, take a bank that starts to collateralize assets but does so too stringently. Say it provides loans on bicyles as security at 25% of their value, charging 100% interest per annum. That doesn't mean a bubble is going to start in the collateralizable asset; bicycles. Who would take a loan on such poor terms? The point of this extreme example is that the introduction of collateralization does not necessarily cause asset bubbles. Only bad collateralization does.
"Monetizing assets that were not previously monetized is creating money by it's very definition, and it IS inflationary. So is digging gold out of the ground. The difference is that there is a finite rate at which new gold can be found."
There is also a finite rate at which land can be pledged as collateral for loans. An untouched piece of land homesteaded by a new owner is worth little and can only stand as collateral for a small loan, if at all.
As the owner invests in their property by foregoing consumption and thereby saving, the land is improved. Buildings are added, a few fields, maybe a road. All through the owner's sweat and blood. The property can now stand as collateral for a larger loan since it is more valuable. But this only comes about through the owner's foregoing of consumption. This is done at a finite rate, much like gold mining.
Stocks and bonds are the same. The owner of those securities had to forego consumption to buy them.
Published: July 3, 2008 2:27 PM
"But the devil is in what happens in between taking out the loan and paying it back."
Exactly - just because a loan will be paid back in the future doesn't mean that there is no net money created (inflation), just the chance that it may be contracted at some later date. But that's a very simplistic view anyway because:
"Then when the contractor pays back the loan, the money supply contracts back to the original level (ignoring interest) with the new money scenario."
That's true for an individual loan, but as soon as the bank lends those re-paid funds back out the money suppply increases again. The bank's portfolio of loans will be large enough that the effect will be negligible. The overall money supply will increase by the amount of net loans outstanding.
Banks make money by collecting interest on loaned funds. Their revenue would disappear if each principal repayment on their outstanding loans were put in the vault (or more precisely disappear into thin air, because that was how it was created in the first place). Being re-paid is the worst thing that could happen to a bank because 1) their interest revenue is gone and 2) they have to spend effort (money) trying to find somebody else to loan those funds to in order to start up the revenue stream. The best thing that could happen to a bank is a client who is perpetually in debt but is solvent enough to make interest payments, but not pay any principal. If that sounds like credit cards, interest only mortgages and perpetual government debt (last paid off in 1836) then you're starting to understand how the game works.
The moral of the story is that no bank would ever voluntarily behave in a way that would shrink the money supply in the manner that the RBD theorizes - although sometimes they have that situation forced upon them. The RBD explanation falls apart in light of how banks actually work.
But we've had these discussions before on this site, over and over......
Published: July 3, 2008 2:59 PM
It's clear that making a loan creates money, and paying back the loan retires money. What matters is that the assets of the lender move in step with the amount of money created. More money, more assets. Less money, less assets. The amount of assets per unit of money is the same throughout, so the value of money is unaffected.
There is also the matter of the Law of the Reflux: If some bank creates 50 new dollars, and as a result, 50 existing dollars reflux to their issuer, there is no increase in the money supply.
Published: July 3, 2008 3:10 PM
If gold is the only money in circulation, and then banks start to issue 1 oz reedemable money certificates (IOUs) for 1 oz gold, eventually replacing all the gold in circulation with money certificates, than no Austrian inflation is occurring. Its a 1 for 1 trade.
True, IF gold is the money in circulation. I didn't see that the scenario was supposed to be that limiting. If gold is simply the backing asset, though, and the certificate itself is the money, then creating new money to buy gold causes inflation.
Published: July 3, 2008 3:14 PM
Kevin T:
You've asked a perfectly straightforward question; I'm very surprised that not a single one of the knowledgeable Misesians has jumped forward to explain what seems to you a discrepancy.
Though it is true that the entry of previously-saved money into the general pool of money utilized for the purchase of goods has the effect of damping or retarding the rise in the prices of goods and services, this is not a process that in any way changes the picture (already painted).
The price structure (or what might be called "the data of the market") at any given time determines precisely how people will use whatever money they possess, including how much they will save and in what form. (The word "save" is commonly used to cover a multiplicity, including investments in securities, time deposits (CDs), savings accounts, and even cash under the mattress.). You could, if you wished, even view any of these forms of saving as "spending" of a special type--just a different method of achieving what one wants with what one's got.
In other words, in the absence of monetary inflation, the decision (by some or all) to spend part (or all) of what they've saved will affect the prices of virtually everything else in the market; on that, you've seen correctly. But, if you include "savings" in the general price level (as should be done), no increase in the general price level will have taken place. Folks will merely have rearranged how they've chosen to use whatever they've got.
It should also be borne in mind that, in the first place, the "lowness" of the general level of consumer prices is, in part, directly due to the fact that some have chosen to save rather than to buy something else. Further, this description is somewhat simplified: those who had formerly had money saved in bank accounts and CDs will have already enabled (through the magic of the fractional reserve system) other to borrow some multiple of that amount, which will be spent on many things tending to raise the level of other prices; conversely, when they withdraw and spend those funds, they will have reduced the "reserve" necessary to support that former spending level. But even if everyone kept their savings under the mattress (referred to as "hoarding") and then spent it into the economy, no "inflation" would have taken place--the rise in the level of prices in general is directly offset by the reduction which has taken place in the amount spent on "saving." This is one of the chiefest of the evils of the system of never-ending inflation: it makes saving far less attractive because it virtually assure the saver that, in terms of goods and services, his money will NEVER be as well-spent as RIGHT NOW. Whatever the normal propensity to save, doing so will make progressively less sense as inflation proceeds.
Under conditions such that there is no increase in the quantity of money (or even only a very slight change in either direction), the prevailing tendency is for the prices of goods and services to decrease, due to two factors. One is that, whatever the savings rate, a certain amount of those savings will be lent (or invested) in industries intent on increasing the "roundaboutness" of their productive processes--lengthening the period necessary for realizing the end-product, whose aim is the reduction of cost per unit, which in most cases is translated into a similar reduction in price (the intention being to achieve competitive edge by such efficiency and reap a larger unit profit at the same price to the same-sized market or to enlarge the market or the market share at some lower price and, in so doing, to enlarge net profits to the degree that the increase in net represents satisfactory return on investment for whatever's been sunk on the cost of the newer equipment or processes.
The problem with inflation is that it's never a single or occasional iteration, as would be the case with an instance of counterfeiting. The inflation always has a goal--the achievment of a "good" level of general business activity, production, employment, and savings. This can be achieved but the rise in the fortunes of some will be directly offset by the misfortune of those further from the source at which the money is introduced: as a very general matter, all those on fixed incomes whose purchasing power is reduced; technically this will include even employees of the government--their automatic raises (other than cost-of living adjustments) will be nullified. Only continued introduction of new money will even suffice to keep the former beneficiaries at their previous level (of purchasing power) and the rate of the introduction will have to be at some multiple of the old rate to have even the effect of "maintenance." In other words, if the rate of inflation has been at 2% for a year, the rate in the second year will need to be 2% higher than 2% and so on--each succeeding year. The advantage that accrues to those first to receive is that they're spending into a price structure not yet adjusted and, therefore, tricking those further from the source. But these aren't fooled for long and soon demand adjustments (COLA), which means that those without the COLAs are cheated even worse and, since there are now fewer people being deprived to the advantage of others, the pressure to increase the rate of money-creation is yet increased even more than the simplistic arithmetic I suggested immediately previous. At some point, the only alternative to hyperinflation (runaway inflation) is to surrender to recession.
The US (and the entire world) has been very fortunate over the last 40 years or so. The most amazing development, a before-unheard-of increase in human productivity due to the fortuitous, combined advent of computers, component miniaturization, and communications (internet, telephony, D-photo) has allowed us to keep ahead of the reckoning and even become somewhat better off. No lesson has been learned. There's an old saying about it being impossible to design something that a fool cannot screw up. I'm afraid we're going to learn that "the hard way" but the survivors won't be any smarter because they won't understand what made them fools in the first place.
I hope that gives you a clearer insight, Kevin. But reading Mises is much better; you won't even be able to think of a question of a question that's not answered fully--and then some. You owe it to yourself.
Published: July 3, 2008 3:16 PM
jp says:
"Only when government institutions like the Fed, Fannie Mae and Freddie Mac get involved do interest rates get out of whack and collateralization standards deteriorate."
central banks only convert isolated bank runs into systemic crises. the boom bust cycle did not start with central banks. the latter have changed the cycle by making it less frequent, but of greater amplitude. the dynamics remain the same. central banks only came into being on the back of public distaste for bank collapses.
whilst there is a finite amount of land available in the us for collateralization, this is an irrelevant argument. much of the land is unencumbered, and so is readily available for mortgaging. the rate of growth in real estate lending in the last decade attests to this.
the absence of the fed/freddie/fannie only means that the boom/busts would have been more localized, with the damage confined to the interested bank(s). the bank(s) shareholders and creditors would have borne the damage. with the government agencies in the picture, the damage has been borne by the dollar. everybody pays through eroding purchasing power of the currency.
Published: July 3, 2008 8:44 PM
to mike sproul:
yet where we part company is not on the backing of the currency (in your silver example), but on the convertibility aspect. for me it's necessary, you're not stuck on it.
mexico: sure, dollars are freely transacted, but you cannot oblige someone to accept them as satisfaction for a debt, and as you say, the government insists that imposts be paid in pesos. this is an order, or a fiat. even if the currency were 100% backed in gold but inconvertible, it would still be fiat currency. it's not the backing that counts, but rather the presence of regulations or fiats.
Published: July 3, 2008 9:10 PM
fiat: from the latin "let it be done".
Published: July 3, 2008 9:22 PM
"central banks only came into being on the back of public distaste for bank collapses. "
The history of central banking shows very few of them coming into existence to meet some overwhelming need of the public. Most have been created rather stealthily (if that's a word) and not one citizen in a thousand understand what they do, how they do it or what purpose they really serve.
I think the reality of the situation is almost precisely the opposite.
Published: July 4, 2008 6:50 AM
Newson said:
central banks only convert isolated bank runs into systemic crises. the boom bust cycle did not start with central banks. the latter have changed the cycle by making it less frequent, but of greater amplitude. the dynamics remain the same. central banks only came into being on the back of public distaste for bank collapses.
Albeit on the right track, this statement misrepresents the story a bit: Its not only about BANKS - its about the entire business sector.
Absent a cental bank and with a properly free market interest rate ( established by borrowing and lending activities in turn driven by activities in the real sector), businesses, (including banks), do their respective things. Some will make mistakes that cause them to be overshoot their expectations and perform surprisingly well, some will 'get it right' as it were, and some will make mistakes and incur unexpected losses, and some of those will fail altogether. There is no cycle as such - you merely have business at large continuing, with some inevitable failures occurring from time to time, and some astonishing successes also occurring from time to time.
INtroduce a central bank with the power to set artificially-low market rates. Now ALL market participants are responding to an incorrect pricing signal that has no causal influence from real-sector activity. The effect of this incorrect pricing signal is to firstly increase the likelihood of businesses making mistakes in planning investment and production, and secondly it will SYNCHRONISE most of the mistakes made in one particular direction. Ergo, when rates are set low, we get mini-boom of investment activity against a false expectation of successful deployment of that investnemt, which evaporates when the expectation is shown to have been false (viz. the investments' output fails to realise the expected returns envisaged at the outset). Around about this point, the central bank starts to fret about the economy 'overheating' ( 'we're here to control inflation, remember?), and beefs up interest rates, and new investment slows down in response and fresh borrowing eases. Meanwhile, the marginal (worst-performing/most vulnerable) of the mistake-makers who (Mises's word) 'mal-invested' during the cheap money stage, now fail in the high-cost debt environment. Thus do central bank activities both exacerbate the 'natural' rate of mistake making, and synchronise it - voila, a high-amplitude cycle is born.
Thus the Orwellian nature of the main Central Bank mandate: An agency whose mission is said to be aimed at providing 'stability', is in practice a profoundly destabilising influence. This is not the only instance of the Orwellian lexicon being applicable to government - other examples are legion and whole books could be written about them.
Published: July 4, 2008 9:44 AM
ds says:
"There is no cycle as such - you merely have business at large continuing, with some inevitable failures occurring from time to time, and some astonishing successes also occurring from time to time."
that's not at all the case. the business cycle was in existence long before the central bank was instituted, not courtesy of business, but rather of fractional reserve banking.
and yes, public disaffection following periodic bank collapses and recession wasn't the real motivation for setting up a central bank, but this was how it was propagandized.
Published: July 4, 2008 10:39 AM
sorry for the quote that belongs to david c, and not to ds.
to ds, the second part of my comment.
Published: July 4, 2008 10:43 AM
Fundamentalist or anyone else: Darn, after my post of 2 days ago I haven't been able to return to the discussion till now. Happy July 4 everyone!
With 100% reserve banking, why would banks exist at all? Whether fiat money exists, or instead money is 100% gold backed, $100 of deposits would have to be matched by $100 of "non-revenue earning" gold or fiat currency assets. How would the banks earn any revenue to pay the tellers and the all the costs associated with accepting deposits in the first place, and so why would they be willing to accept deposits? Lendable funds could still be raised by issuing bonds or equity, but you don't have to be a bank to do that.
Published: July 4, 2008 10:52 AM
"whilst there is a finite amount of land available in the us for collateralization, this is an irrelevant argument. much of the land is unencumbered, and so is readily available for mortgaging. the rate of growth in real estate lending in the last decade attests to this."
Not irrelevant, since the point has been made several times in previous comments that gold is finite and takes effort to mine, therefore it alone should back money. I was pointing out that the same applies to land.
Even if most of the land in the US is unencumbered, it doesn't proceed that a land boom will occur. Only if banks lend with land as security at below market prices and rates will a land boom occur. If lending practices are stringent it doesn't matter how much collateralizable land is available since no one will seek such loans.
Published: July 4, 2008 12:09 PM
JP: "Even if most of the land in the US is unencumbered, it doesn't proceed that a land boom will occur. Only if banks lend with land as security at below market prices and rates will a land boom occur. If lending practices are stringent it doesn't matter how much collateralizable land is available since no one will seek such loans."
Exactly right, and well put.
Newson: The mainstream definition of fiat money, and the definition I use, is that it is UNBACKED. Textbooks start their discussion of paper money by saying "The Fed won't give you gold for your dollar, so it is unbacked. The fact that dollars have value even without backing results from the fact that the government limits their supply, and people demand them for liquidity." The real bills response is that the dollar is not unbacked, it is merely physically inconvertible, while still financially convertible. The mainstream view that the dollar is unbacked would leave one wondering why central banks bother to hold any assets at all, if the only thing determining the value of the dollar is supply and demand. The mainstream view also leaves one wondering how currencies like the peso manage to have any value at all in the face of competition from the dollar. The real bills view does not have these defects. It says that the reason central banks hold assets is that backing matters, and the reason the peso has any value at all is that the mexican central bank holds assets to back the peso.
Published: July 4, 2008 2:12 PM
Mike Sproul said "The mainstream view that the dollar is unbacked would leave one wondering why central banks bother to hold any assets at all..."
Mike, as I have explained before (in the blog with regards to another daily article), the entire significance of a central bank recording the vast majority of the government bonds it holds as "assets" is simply to make its balance sheet balance, nothing more. Apart from a small amount that it may need for open market sales from time to time, central banks could simply burn their government bonds and nothing of economic significance would happen -absolutely nothing. While government bonds are on the balance sheets of central banks they represent government I.O.U.s to the government itself. The government pays interest semiannually to the central bank and the central bank remits it (usually after deducting the cost of operating the central bank, a minor amount, which amount represents taxes paid each year to operate the central bank). Also, as long as the central bank's portfolio of government bonds continues to expand, year in and year out, no government bonds are redeemed on net, and therefore to say that these government bonds are somehow "backed" by the ability of the government pay off via taxation is a fiction.
By the way, I'm still waiting for anyone who believes in 100% reserve banking to explain how banking would be profitable under such a scheme. There must be an explanaton, because I see people at this site continually advocating such a proposal.
Published: July 4, 2008 5:04 PM
"The government pays interest semiannually to the central bank and the central bank remits it (usually after deducting the cost of operating the central bank, a minor amount, which amount represents taxes paid each year to operate the central bank)." Sorry, the words "to the government" should be inserted after the words "remits it" in the above sentence.
Published: July 4, 2008 5:09 PM
jp says:
"If lending practices are stringent it doesn't matter how much collateralizable land is available since no one will seek such loans."
well, i'm assuming that we're talking about a real world situation, where competitive forces will mean that customers are attracted to seek loans. what sort of bank would offer a product priced out of the market? there will always be marginal loans.
the amount of land available for collateralization is vastly more than the amount of unencumbered gold, for that reason (amongst others) it is a preferable backing.
Published: July 4, 2008 8:58 PM
to mike sproul:
i don't know how economics textbooks define fiat money, and if what you say is correct then my beef is with them, too.
my point is purely etymological - the "fiat" or order really doesn't touch on the backing of the currency, but the legal tender aspect.
of course, one naturally concentrates on the backing issue, because otherwise why would governments have very precise money prescriptions?
i know your counterargument - why not do away with all pretense of backing, if it's a sham? i think the answer is that what central banks do is not to manage inflation, but to manage inflation expectations.
and this confidence game can go on for a very long time. ultimately the public calls the reserve bank's bluff, and then it's monetary collapse. i imagine that scenario is still years away.
Published: July 4, 2008 9:13 PM
alex says:
"By the way, I'm still waiting for anyone who believes in 100% reserve banking to explain how banking would be profitable under such a scheme."
it would be a reversion to the moneylender of yore. depositors would be charged for the convenience and security of using electronic or paper. banks would make money only on intermediation.
even if 100% reserve banking were made a legal stipulation, it's a given that the temptation to under-reserve will still tempt many. there is no possible remedy for this, legislation cannot prevent fraud, but it can convict transgressors after the fact.
Published: July 4, 2008 9:31 PM
"central banks could simply burn their government bonds and nothing of economic significance would happen -absolutely nothing."
You are right that if bonds were to be destroyed this wouldn't affect the interest income component of the Fed's income statement as it remits this all back to the treasury anyway. But the destruction of the bond also removes the Fed's ability to get its original principle back, or roll it over. Furthermore, the Fed is audited by KPMG in addition to several gov't watchdogs. I'm sure a burning of the bonds would be caught. This information would be made public and the Fed would lose credibility, the effect on the dollar being pretty significant.
Published: July 4, 2008 9:33 PM
Newson: Eg. Assets=$100 (gold or fiat currency); Liabils=$100 deposits. Where's the financial intermediation in this? It is a pure storage function. In this case depositors would have to pay interest (or storage costs), rather than receive it, to pay for the costs of the storage operation. If banks do lend out deposits, then there would, of course, be an intermediary function carried out, but this would mean fractional reserve banking.
So, am I to understand that those who wish 100% reserve banking really do not want banks to be involved in lending at all, that is, they want them purely to be storage facilities for gold or currency?
Published: July 5, 2008 3:25 PM
Jp: Yes, I know the pretense that the gov bonds on the central bank's balance sheet really are some kind of backing for the monetary base is useful for accountants (as I said earlier, it keeps the balance sheet balanced). But that's all it's useful for. If there is any financial market "credibility" in a central bank having its own federal government's bonds on its balance sheet, that credibility is grossly missplaced.
A simple thought experiment shows the above. Suppose the U.S. Treasury printed up a $10 trillion U.S. bond and "sold" it to the Fed for $10 trillion. Or, to be more realistic, suppose the government of Zimbabwe did it (since this is exactly the stuff Mugabe does to finance his regime's spending). Does anyone feel any better knowing that Zimbawe's central bank has enough Zimbabwe government bonds on its balance sheet to match its liabilities? There is absolutely no economic meaning in such a fiction.
Published: July 5, 2008 5:48 PM
Newson:
"this confidence game can go on for a very long time. ultimately the public calls the reserve bank's bluff, and then it's monetary collapse. i imagine that scenario is still years away."
Alex:
""central banks could simply burn their government bonds and nothing of economic significance would happen -absolutely nothing."
I don't suppose either of you would claim that a private bank could get away for long with issuing unbacked money. As soon as people find out, the bank would collapse.
Suppose some great new kind of money were introduced, and nobody wanted federal reserve notes (frn's) anymore. The Fed, if it does its duty, would use its bonds to buy back the unwanted dollars. Once the bonds were gone, the only way the fed could buy back the remaining frn's would be to sell its gold for the remaining dollars. (i.e., to finally restore physical convertibility) Naturally, if the fed had no bonds, and no gold, it could not buy back the unwanted frn's. I conclude that the bonds and the gold matter for the fed, just as they matter for private banks.
Published: July 5, 2008 8:07 PM
alex says:
"If banks do lend out deposits, then there would, of course, be an intermediary function carried out, but this would mean fractional reserve banking."
no it wouldn't. if i, 100% reserved bank, match up term deposits with loans of the same duration and size, i'm not exposed to any run. my only risk is that individual loans are not honored when falling due, and in that case my shareholders take a hit. presumably if my owners' equity is too slim, and my lending standards lax, then i will go out of business. i don't contribute to the business cycle.
current accounts are charged fees, as you acknowledge, and there is no chance of a devastating run, simply because cheque account monies aren't loaned out, and so are effortlessly redeemed on demand.
Published: July 5, 2008 9:49 PM
mike sproul says:
"Suppose some great new kind of money were introduced, and nobody wanted federal reserve notes (frn's) anymore."
this scenario flies in the face of mises regression theory, ie that money ultimately must derive it's value from a real commodity, and cannot merely be willed into existence.
Published: July 5, 2008 9:54 PM
Newson:
By "some great new kind of money", I had in mind, for example, cash cards issued by banks, better credit cards, or foreign currency that is superior to the domestic currency--sort of like the dollar invading mexico and displacing pesos. That doesn't fly in the face of any sensible theory.
Published: July 5, 2008 10:24 PM
mike sproul says:
"cash cards issued by banks, better credit cards, or foreign currency that is superior to the domestic currency--sort of like the dollar invading mexico and displacing pesos."
all the above are derived currencies, linked back to the usd, which in turn had been linked backed to gold. so the above don't qualify as "new", and therefore satisfy mises' money regression theorem.
Published: July 5, 2008 10:37 PM
It is a fallacy that prices are sticky downwards (especially a prominent element in Keynesianism).
If some institutional rigidity exists that causes prices to be sticky downward that enterprise is subject to being driven out of business in a free market economy.
All stickiness resulti