Comments (91)

• Michael A. Clem

  The comparison between Friedman's "steady state" theory of money inflation and the ABCT makes a good contrast between Chicago and Austrian schools of economics.
  
  As far as the gold standard goes, am I correct in thinking that under such a system, inflation is still possible, because more gold could be produced, but the business cycle is not, because gold is real and valuable commodity, unlike fiat money or fractional reserve notes? Producers of gold would still be diverting resources to their preferred uses, but such diversion isn't unsustainable because money would be gold, and not fractional or fiat money?

  Published: November 12, 2008 9:08 AM

• John

  Michael,

  That sounds correct. I think of inflation as an increase in money supply, higher prices, and reduced purchasing power (the latter two are caused by the increase in money supply). As Shostak said in his article, when John the miner increases his production of gold, its value as a medium of exchange decreases because there is more of it in relation to other things (ceterus paribus), so that scenario would seem to meet the criteria of inflation.

  Perhaps the physical constraints of commodity money, the economic constraints of a free market, and the availability of other commodities to take gold's place (silver, others?) would relieve the effects of this inflation.

  Published: November 12, 2008 9:32 AM

• ktibuk

  There are a couple of errors in Shostaks critique.

  "The benefit that gold now supplies people is by providing the services of the medium of exchange. In this sense, it is a part of the pool of real wealth and promotes people's life and well-being. When John the miner exchanges gold for goods he is engaged in an exchange of something for something. He is exchanging wealth for wealth."

  This is completely wrong. Money is NOT wealth. Gold may be part wealth as a commodity and part money. But as long as it is money it is not wealth.

  And Shostak is wrong about the "fraud", a concept of ethics not a value free economics concept.

  Lets say one discovered a cheaper way of producing gold than mining. Lets say chemistry is so advanced that alchemy became real and some guy could flood the market with new gold at once.

  Is this fraud, or a crime?

  No.

  What is the difference between increasing money supply by mining and alchemy?

  Just the cost of producing gold.

  The fraud that happened in the history of money is not when money supply increased. Like the time new gold from Americas flooded Europe.

  If you look at the history, the moment Nixon closed the gold window, that was an act of fraud. Because a promise was broken. Actually the increase of the money supply happened right after 1945 but it took till 1971 until others found out about it.

  But since then the dollar is accepted knowing full well that there is nothing else to back it up. So after 1971 every monetary expansion can not be called as fraud.

  It is harmful to the economy, yes. It dilutes the purchasing power of other moneys held by others. True. But that is not a crime by itself.

  If that would be the case, mining gold, or effective and less costly mining in a gold money economy would be a crime too.
  

  Published: November 12, 2008 9:35 AM

• Michael A. Clem

  Money is NOT wealth. Gold may be part wealth as a commodity and part money. But as long as it is money it is not wealth.
  
  I'm just not sure that this is correct. "Wealth" is essentially goods and services, resources available to people to use. Money is the most commonly traded good, that is, the good used as a medium of exchange. Since money is a good, it IS wealth. However, since it is only one good among many, money is only a small fraction of the total wealth in existence. Thus, even though it is wealth, it still essentially just "represents" wealth when used as a medium of exchange.
  

  Published: November 12, 2008 10:03 AM

• William Rader

  Interestingly enough, I was just investigating the Wikipedia entry on Ben Bernanke. I just came across this bit of information.

  "Bernanke is particularly interested in the economic and political causes of the Great Depression, on which he has written extensively. On Milton Friedman's ninetieth birthday, November 8, 2002, he stated: 'Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve System. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.' "

  The following were the citations:
  FRB Speech, Bernanke - On Milton Friedman's ninetieth birthday - November 8, 2002
  To Fill His Shoes, Dr. Bernanke, Learn to Dance
  Inside The Federal Reserve

  Published: November 12, 2008 10:27 AM

• Matt H.

  Ktibuk, I think you make an excellent point about whether fiat currency inflation is really fraud. I think part of the reason why so many Austrians would continue to call it fraud, even in light of your comments, is because it serves as a reminder that the heritage of fiat inflation, and indeed of inflation itself, is a heritage of fraudulent activity that eventually becomes legalized and protected by a state. Indeed, the natural, reasonable, free-market response, say, a village would have, if they found out their gold smith was over-issuing deposit tickets, would be to tar and feather the gold smith. It is because of the state, which legitimizes this activity, that we no longer regard it as fraud. So, in short I think the word "fraud" is not used in a technical, legal sense by Austrians, but rather in a a moral sense, with a long view of history.

  Published: November 12, 2008 10:36 AM

• Willabus

  To Friedman's defense he admitted that his rule may not be the best rule and that he would fully accept changing it in the event a better rule emerged. His concern was more focused on the fact that if the US is going to use a central bank to issue money then it must follow some clearly understood rule.

  I also hope that William Rader is not trying to suggest that Milton Friedman would have endorsed the current actions of the Federal Reserve and the Treasury. The problem with Bernake, as Anna Schwartz recently pointed out, is that he is trying to use tools that Friedman suggested for the Great 'Contraction' to the current problem. Unfortunately the current problem is not the same as the problem found during the Great Depression and I highly doubt Friedman would be endorsing these actions, just as Anna Schwartz is not endorsing these actions.

  Published: November 12, 2008 10:44 AM

• ktibuk

  "I'm just not sure that this is correct. "Wealth" is essentially goods and services, resources available to people to use. Money is the most commonly traded good, that is, the good used as a medium of exchange."

  Wealth is the total amount of goods and services that is correct. The more you have them the better.

  But that is not the case with money. The amount of money is irrelevant unlike goods and services. You can increase wealth by increasing the production of goods and services, but you can not increase wealth by increasing the money supply.

  Money has to originate from a good, a commodity, but once it becomes money, being valued for its exchange value, it is no longer a good.

  It is true gold was demanded because it was money AND it was a good. That means gold had money properties and good properties at the same time but of course it is impossible to measure percentage wise. Just like a person can both be a capitalist and an entrepeneur. But that doesn't mean they are the same thing. They are different functions embodied in one man. Just like gold had two functions, money and good.

  Right now gold isn't money just a commodity. Mostly it is demanded as a commoidty to be used in jewelry and industry. But because of its history as money it is also demanded as an investment tool to keep purchasing power, only one function of money. But it is not a medium of exchange or a tool for accounting.

  Also today fiat money has two functions. For paper money one is money and the other is scrap paper which is a good.

  Or take pennies, they are both money and the metal (copper?) that makes the coin.

  Published: November 12, 2008 10:49 AM

• DD

  ktibuk,

  "But since then the dollar is accepted knowing full well that there is nothing else to back it up. So after 1971 every monetary expansion can not be called as fraud."

  The term "fraud" is used to describe the economic effect from a moral perspective and not a legal one. Obviously, Government holds a monopoly over legislation, so it can legalize anything. It does not change the fact that creating paper money out of thin air, debases the value of the currency and robs people of their savings. Economically speaking, this legalized process of creating money is no different then some mobsters counterfeiting in their basements. It has the exact same effect, only the banks have been given the legalized privilige and the mobsters haven't. Banks are litterly making a profit in the form of interest on lending out wealth that has been transferred to them by involuntary means from other people. That fits fraud under any objective standard that I can think of. Government can legislate laws, but they can't legislate away basic laws of morality, just as they can't create wealth, and have to resort to confiscating it.

  Published: November 12, 2008 10:51 AM

• Inquisitor

  Ktibuk, starting with a system of private property rights, asserting that multiple claims to the same good, which a bank agreed contractually to store, is pretty much fraud, in any sense you'd like to mention. Are economists prohibited from using the word when they are speaking of a society in which fraud is a crime? FRB is fine if it is made known to the bank's clients what it is doing, and done so explicitly.

  Matt, by fiat I think you mean FRB. Fiat money is a subspecies of FRB, and not a laissez-faire one.

  Published: November 12, 2008 10:53 AM

• Inquisitor

  Gah, that didn't come out right. Should be: "is pretty much fraud, is correct in any sense you'd like to mention." Basically, what DD said.

  Published: November 12, 2008 10:57 AM

• ktibuk

  DD and Inquisitor,

  Shostak is claiming increasing the money supply is fraud. He compare gold miner and dollar printer and claims gold miners increase of the money supply is good but the CBs increase of money supply is bad. That is not true.

  Claiming the paper notes are backed by gold and not delivering is fraud. Closing the gold window is fraud. Confiscating gold is theft.

  These are all true.

  But technically increasing money supply is not fraud. Yes it lowers the purchasing power of other money but it is not aggression against property.

  Published: November 12, 2008 11:04 AM

• joebhed

  central government planner here-

  Well, isn't this interesting?
  As I have posited here prior, Friedman's call for 100 percent reserves, coupled with his anti-inflationary, "money-creation" rule could do exactly what the author has questioned: to wit - stabilize the economy today.
  To be clear, that means stabilizing to some degree the ride down to sustainability in economics.
  For all the gold-standard gibberish out there, I see little that stands in the way of a positive answer to the matter of economic stability through the measures that Friedman advocated in THIS part of his economic philosophy.
  It would have prevented all those obviously unproductive financial market creations, both from the quantity side - outside the limitations of money growth -, as well as from the soundness side - who would allow the funding of SIVs with real money?
  To trot out the old gold miner cum barter ideal in light of where we are at today is folly.
  Let's get on with real monetary reform now.
  100 percent reserve banking.
  Money growth tied to productive economics.
  Government creation of debt-free money for all of that growth.
  Then, let the banks and the free markets have at it.

  Pillory away.

  Published: November 12, 2008 11:14 AM

• Mark Humphrey

  Frank Shostak's observations that gold-money is wealth, and that the issue of fiat money is fraud, are both correct.

  Gold-money, or any other commodity or good selected by the free market as the ultimate medium of exchange, is wealth. The market process gives rise to the widespread selection of some highly marketable commodity for use in subsequent exchange; eventually the use of this commodity as a store of value and exchange-commodity becomes universal. Gold, or other forms of free market money, is wealth because people use it to to secure their material well being.

  The issue of fiat money is fraud, as Shostak clearly explains, because the fiat money is originally issued as a receipt for a unit of commodity money that does not exist.

  The observation that fiat money is based on embezzlement is emphatically not value-neutral; nor should it be. Austrian economics employs methodology that ignores the content of values for the narrow purpose of tracing through cause and effect in complex relationships. But the purpose of good economics is to explain why economic freedom is necessary to individual prosperity and flourishing. In other words, the purpose of economics ought to be to elaborate the conditions necessary for man to achieve a crucial moral value necessary for human life: material well being.

  Frank Shostak's observation that fiat money embezzlement erodes the pool of real wealth is akin to observing that if everyone steals from everyone else, instead of working productively, everyone will become poorer. Is this simple observation invalid because it is value laden?

  Published: November 12, 2008 11:14 AM

• Patrick Barron

  I have enjoyed reading this discussion. I'll my my two cents' worth. Gold is part of the market economy and has been selected spontaneously by the market as a medium of exchange. If the alchemists found a way to produce gold in very large amounts, the market would adjust, again spontaneously, to this new reality and probably find something else to use as a medium of exchange. Remember that many, many commodities have been chosen as mediums of exchange over the years, from sea shells to cigarettes (watch the movie Stalag 17--very good example of using cigarettes as money, because they were the most readily available and most effective commodity at hand.) So, I am under the opinion that wealth cannot be "stored" in the sense that there is any guarantee that the vehicle chosen--whether gold, silver, or cigarettes--will continue to be demanded by the market as a medium of exchange. There are no guarantees in this world--we all have to produce wealth every day.

  Published: November 12, 2008 11:18 AM

• RichardJ

  So if the gold supply increases, will interest rates fall in the way that they do when the supply of fiat money increases? If so, how will this not lead to malinvestment? After all, the gold supply increase shouldn't change peoples' time preferences.

  Published: November 12, 2008 11:26 AM

• William Rader

  The problem with Bernake, as Anna Schwartz recently pointed out, is that he is trying to use tools that Friedman suggested for the Great 'Contraction' to the current problem. Unfortunately the current problem is not the same as the problem found during the Great Depression and I highly doubt Friedman would be endorsing these actions, just as Anna Schwartz is not endorsing these actions.

  Thank you, Willabus. No, I am, as you state, just pointing out Mr. Bernanke's appreciation for the work of the late Nobel Laureate and that Mr. Bernanke is attempting to apply a "Friedmanesque" solution to the current problem. As you state, the conditions we are facing at present are not, and could never be, identical to the conditions faced in the early part of the 1930s.

  Published: November 12, 2008 11:31 AM

• Tom

  I think we agree that the increase of the money supply (out of thin air), creates an asymmetry that encouages the use of that money. However, it would seem to me that productive as well as nonproductive goods and services would be increased. After all if asymmetical information is involved, the economy doesnt know to waste the money.

  Published: November 12, 2008 11:42 AM

• Howard Boggs

  This is an excellent primer for us lay people on why fiat money is no good and how the Fed harms the economy. And this, after all, is the chief reason our current economic woes are upon us. If more John Q. Publics understood this, they would think and vote more productively. Thanks for putting this out.

  Published: November 12, 2008 11:43 AM

• jp

  "Money has to originate from a good, a commodity, but once it becomes money, being valued for its exchange value, it is no longer a good."

  If a good is defined as anything for which someone holds positive subjective value, then your comment is contradictory. If money is valued, as you say it is, than it must be a good. If money is a good, it must be wealth.

  But we know that Rothbard differentiates between money and wealth. Either money is a different type of wealth, or it is a different type of good, or the process of valuation for money is a different one than for non-money.

  Published: November 12, 2008 11:44 AM

• Stanley Pinchak

  RichardJ,
  Hulsmann and others contend that it is not just a reduction in the interest rate that causes malinvestment, but intervention in the interest rate. The spontaneous reduction or increase in society's time preference can effect the interest rate and prove some entrepreneurs' investment strategies as wrong, but this is not the same cyclical problem that occurs with state intervention in the interest rates, or in the granting of fractional reserve privileges to the banks. See Toward a General Theory of Error Cycles.

  Published: November 12, 2008 11:59 AM

• Eric

  Interesting, if gold's value is partly from its use as a commodity, and partly from its use as a medium of exchange (MOE), what are the relative percentages?

  Paper fiat money, would seem to be 0 for commodity and 100% MOE. But what of Gold? Is it 1 and 99 or .01 and 99.99, 50 and 50 or just what? Can this even be determined?

  If gold's value comes mostly (say 99 to 1) from it being a MOE, then its preference as money over paper would seem to be in it's level of difficulty in increasing the total supply. But then in the fiat world, the actions of government would seem to provide the same service, albeit poorly. Governments do curtail the creation of counterfeit money by others, such as you and me. So, in this sense, they provide the same service as nature does when it makes it costly to mine gold. True, governments also create a lot of money, but I don't see why this is any different than if we were on a gold standard and governments did a lot of mining. Yes, people are weak and so gold does a better job limiting the increase in the money supply.

  But suppose that the central banks did subscribe to a percentage rule. Further, let's assume that the percentage chosen (and adhered to) was equivalent to the percentage increase in gold as seen in mining activities. Could fiat money with a central bank then work just like gold? I think Friedman believed this was the case.

  Let's also assume (ignoring the reality of this for a moment) that we have 100% reserves - since fractional reserves are possible with gold or fiat money and present problems all by themselves.

  Suppose then, that instead of nature, we have some alien (Michael Rennie for example) come to earth with a robot police force and convince the central banks to not inflate since they see it as a threat to the other planets. Would this then work as well as gold?

  On another issue, Frank says:

  "A fall in the money supply out of thin air undermines various nonproductive activities. Their ability to divert real funding from wealth generators is curtailed."

  I parse this sentence to mean that what falls is NOT the money supply, but rather I see this as meaning a fall in the rate of increase of the money supply, but perhaps my grammar is incorrect here. But assuming I'm right, then while gold is not normally used up (ignoring its use as a commodity) its supply is NOT reduced either. So, I don't follow how a reduction in gold mining wouldn't lead to a bust, just as ending a fiat money expansion does.

  And gold mining does set off booms, if my history of various gold rushes is accurate. And when the gold runs out, there are plenty of busts - called ghost towns.

  So, the bottom line is I'm not sure that fiat money is different than gold on a technical basis; rather, it would appear that humans cannot resist turning on the printing presses and it this which is gold's advantage. So, if Friedman's rule could actually be put in place (a huge assumption) it might not be as bad as what we have now and might even approach the result we would have with gold as money.

  Friedman was always looking for a way to get from where we are now to where we want to be. I recall reading that Friedman said we'd be better off without a FED, but given the inability of governments to police itself, he saw nothing short of a revolution which would dismantle the FED. Therefore, his conclusion was to bind it down with a rule. But that would probably be as effective as binding down the politicians with the chains of the constitution. So, while an interesting idea, I'm not sure it's practical, even if there were some way to enforce the rule.

  
  

  Published: November 12, 2008 12:05 PM

• haragan

  I thought that Friedman's rule of a stable growth in the money supply was consistent with trend growth of the economy to keep price stability, so in that sense it is not destabilizing as it does finance productive activities (rather it avoids disinflation).

  Also, I found the logic of why gold is good and paper money bad somewhat shaky. When the article describes how the production of gold does result in the exchange of something for nothing, I'm not sure why that is. Or it would seem they same is true for paper money. That gold is a commodity that can be used for other things should not matter (rather it would seem it interferes with its role as medium of exchange and what do I care about shiny things any more than pieces of paper). Increasing the supply of gold would be tantamount to increasing the money supply with all its negative effects (Colonial Spain?). Also, doesn't hoarding of gold and keeping it out of the market result in a fall in the money supply (it has value because it's somewhere but it is not freely available as a medium of exchange).

  Finally, it would seem that fluctuations in the money supply would still exist under a gold standard, although to a much lesser degree as it is dependent to the rate of mining extraction. It would seem, rather, that the case against paper money is that its production is monopolized by the government, and this interferes with the people's freedom to choose whatever they actually want as a medium of exchange and store of value (although, can't people do this already?)

  Sorry for the confusing post, but I guess that I didn't find the article all that clear and need further clarifications. Thanks.
  

  Published: November 12, 2008 12:21 PM

• fundamentalist

  RichardJ: “So if the gold supply increases, will interest rates fall in the way that they do when the supply of fiat money increases? If so, how will this not lead to malinvestment? After all, the gold supply increase shouldn't change peoples' time preferences.”

  This gets confusing because there are many components to the interest rate. Hayek points out in “Prices and Production” (I believe) that time preference determines how much people will save. Obviously, if people save more, then interest rates will fall. But on top of that, marginal productivity of capital goods must be figured in. Then there is risk and price inflation. Finally add in demand for loans due to technological innovations. All go together to make up interest rates.

  Business cycles and price inflation can happen under a pure gold standard if you have fractional banking that doesn’t consider deposits as money. This happened a lot in the late middle ages. Under a pure gold standard, you would eliminate fractional banking if deposits were considered money because the sum of currency and deposits couldn’t be larger than the amount of gold available.

  Malinvestment happens not necessarily because the money supply grows, as it would under a gold standard, but because of fractional banking. Under fractional banking, money is created out of thin air in the form of bank deposits. The supply of loanable funds increases without an increase in savings, so people continue consuming the same amount while at the same time some want to borrow and consume more and some want to expand businesses by hiring more workers and buying raw materials to produce more capital goods. As a result, the structure of production and consumption gets distorted. Too much money is chasing a fixed amount of consumer and producer goods. Someone has to loose. If the supply of loanable funds grows because people save more, then no malinvestment takes place because people are consuming less when they save.

  An increase in the supply of gold may or may not cause malinvestment. It depends on whether you count bank deposits as money or not. If not, you will have fractional banking and the ensuing malinvestment. If so, then you won’t have fractional banking or necessarily malinvestment. In the latter case, an increase in gold will have different effects depending on what the mine owners do. If they spend it all on consumption goods, it will benefit the gold miners and the first receivers of the new gold, such as the mine workers, at the expense of those who get the new gold last as price inflation works its way through the economy.

  Mark Thornton in “Cantillon on the Cause of the Business Cycle” wrote: “Cantillon showed that changes in the quantity of money could have several
  different types of real effects on production, investment, consumption,
  and trade depending on who first received the money; effects now labeled
  Cantillon effects, injection effects, or first-round effects. In his first example,
  he showed that increased money via domestic gold and silver mining would
  lead to increased consumption by people in the mining industry and that
  would drive the prices of the goods they purchased higher (e.g., meat and luxury
  goods). Entrepreneurs would adjust their production and farmers would
  plant their fields to meet this new pattern of demand so that the structure of
  production would be changed. People not associated with the mining industry
  would face higher prices and fewer goods to consume so there would also
  be a change in the distribution of income. As prices continued to rise, gold
  would be exported in exchange for imported goods and people from the nonmining population might even migrate to areas of higher real wages.”

  So the effects of an increase in the supply of gold under a pure gold standard with no fractional banking can still be negative. The advantage is that the increase of gold is limited by gold’s scarcity and the technology available. On the other hand, fiat money has no limits at all. The quantity of gold can increase by only about 3% per year, whereas fiat money can increase by hundreds of percent daily, and in the US on average around 10% annually. Gold as money isn’t perfect, it’s just the best of all possible worlds.

  In addition, with gold and without fractional banking the money supply won't collapse suddenly as it does under fractional banking with all of the problems that follow.

  Published: November 12, 2008 12:39 PM

• RichardJ

  Thanks for the responses. The reason I ask is because according to Mises & Rothbard, increases in the money supply artificially lower the interest rate leading to malinvestments etc. However, Rothbard claimed in AGD that an increase in the gold supply wouldn't have this affect in the way that an increase in fiat money would. The problem to be blunt is I don't quite "get" Rothbard's explanation. I believe it is covered in the article linked to by Stanley Pinchak where Hulsmann questions its viability.

  Rothbard's explanation is as follows:

  One crucial distinction between a credit expansion and entry of new gold onto the loan market is that bank credit expansion distorts the market’s reflection of the pattern of voluntary time preferences; the gold inflow embodies changes in the structure of voluntary time preferences. Setting aside any permanent shifts in income distribution
  caused by gold changes, time preferences may temporarily fall during the transition period before the effect of increased gold on the price system is completed. (On the other hand, time preferences
  may temporarily rise.) The fall will cause a temporary increase in saved funds, an increase that will disappear once the effects of the new money on prices are completed. This is the case
  noted by Mises. Here is an instance in which savings may be expected to increase first and then decline. There may certainly be other cases
  in which time preferences will change suddenly on the free market, first falling, then increasing. The latter change will undoubtedly cause a “crisis” and temporary readjustment to malinvestments, but these would be better termed irregular fluctuations than regular processes of the business cycle. Furthermore, entrepreneurs are trained to estimate changes and avoid error. They can handle
  irregular fluctuations, and certainly they should be able to cope with the results of an inflow of gold, results which are roughly predictable. They could not forecast the results of a credit expansion, because the credit expansion tampered with all their moorings, distorted interest rates and calculations of capital. No such tampering takes place when gold flows into the economy, and the normal
  forecasting ability of entrepreneurs is allowed full sway. We must, therefore, conclude that we cannot apply the “business cycle” label to any processes of the free market. Irregular fluctuations, in response to changing consumer tastes, resources, etc. will certainly occur, and sometimes there will be aggregate losses as a result. But the regular, systematic distortion that invariably ends in a cluster
  of business errors and depression—characteristic phenomena of the “business cycle”—can only flow from intervention of the banking system in the market."

  Can anybody make this clearer please?

  Published: November 12, 2008 1:26 PM

• Eric

  Fundamentalist writes,

  "On the other hand, fiat money has no limits at all...whereas fiat money can increase by hundreds of percent daily, and in the US on average around 10% annually. "

  That seems self contradictory. If it has no limits at all, then why hasn't it reached hyperinflation yet? Something must be a drag on the limitlessness creation of fiat money. I would think that fear of inflation is the limiting factor. After all, the FED does sometimes raise it rates - which it wouldn't do if there were no limits of any kind.

  I guess what was really meant was that in theory there are no limits. But in practice, fear of a currency collapse tends to be a brake on money creation. And we still aren't all running out to buy wheelbarrows - yet.

  Published: November 12, 2008 1:36 PM

• Mark Humphrey

  Fundamentalist, I don't think an increase in gold money would cause an artificial decrease in interest rates or precipiate the business cycle. For in the broadest sense, the business cycle is brought about by the diversion of real wealth from natural economic activities that are productive, to unnatural activites that consume wealth.

  The wealth consumption is caused as follows: those who receive the new fiat money realize gains when they exchange it for goods. For example, the buyer of a rental house will gain to the extent that the house rises in price in response to the new increase in fiat money. But this gain is not the result of productive activity that yields an increase in goods. Rather, it is the result of losses incurred elsewhere in the economic system--in this case losses incurred by the bank that loaned depreciating money to the buyer of the rental house. The house buyer's gain is some bankers loss; not the result of increased production.

  George Reisman, in his great economics text book "Capitalism", calls the above the "Withdrawal of Wealth Effect" (page 936) He explains that consumption results from this effect because it pays for consumption goods when spent by consumers; and it pays for malinvestments when spent by businesses. The idea of "forced saving" from fiat credit expansion fails, because most of the new money spent by consumers in response to unsustainable rises of their incomes; and of thenportion that is spent by businesses--usually engaged in malinvestment--much is spent on wages which are almost all consumed.

  But none of these destructive processes operate under a gold standard. First, an increase in gold is an increase in real wealth. So the exchange of newly mined gold for other goods creates mutual, rather than zero-sum, gains. Second, to the extent that gold mining increases in output, it is likely to occur in step with rising productivity in the other areas of economic endeavor. So gold supplies rise, but the quantity of other goods rise as well. Third, the interest rate is not depressed artificially under a gold standard, because tointerest rates will fall only to the extent that the new gold is saved. New gold that is spent on consumer goods, instead of capital goods, is congruent with heightened time preferences and rising interest rates.

  Published: November 12, 2008 1:48 PM

• William Rader

  In terms of gold mining, many of the large mining companies mine high-grade ore in their deposits when the demand for gold is high and low-grade ore when demand is low.

  Published: November 12, 2008 1:56 PM

• DD

  ktibuk ,

  Let's see if I can offer a solution to the problem:

  Gold is a very scarce commidity, and mining it and producing it into convinient and durable means of exchange requires yet more cost in terms of its means of production. That makes it a valuable commidity that has been historically chosen by the free market to serve as a medium of exchange. It is this fact of scarcity, that strickly limits its practical susceptiblity to inflation. But you see, the important thing to realize here is that Gold is now a real scarce commidity in the market, which even though is used mostly as a medium of exchange, has real value derived from it's unique properties that have made it the preferred medium of exchange.
  Now, paper money is theoretically also scarce, as any other commodity that has real physical properties. But compared to Gold, it is not scarce at all, in fact,it's resources are extremly abundant and its mass production costs are very cheap. It's value can now only take hold if we succeed in forcing it into a scarce commodity by limiting its production, assuming we can eliminate counterfeiters. Given a limited amount of this paper money, its value will be derived from how scarce these paper bills really are. In other words, the value is artificial,since the real production costs are negligent. Fiat money therefore is really kind of an abstract commodity used as a medium of exchange, whild Gold is a reall physical commodity chosen by the market to serve as that medium of exchange for exactly its qualities.
  Paper money can work as long as Government is successfull in limiting its production to a fixed amount and counterfeiters are contained. Since Government is the primary counterfeiter (not in a legal sense, but in an economic sense) and there is no theoretical limit on its production, as in the case of Gold, it becomes obvious that Gold and Fiat money differ not only in its production costs.
  To prove this point, assume the case of hyper-inflation. As the money supply is inflated with more and more paper bills, it's value will eventually be reduced to some critical value, where the value of the paper bill are equal to its production costs. At this point, all the Government has to do is to start to take out of circulation the lower value bills, say 1$ and print only $5 and up. Or it can issue a new currency. Say 1 "New Dollar" is equal to 1000 "old dollars". This way there is no theoretical limit on the inflation of the money supply when using paper.
  That can never happen with a true scarce commodity such as gold. Even if the mints become more efficient and inflate, at some point an equilibrium point will be reached where a mint cannot profit out more Gold coins due to their lower purchasing power. A miner cannot simply issue a new value for Gold, as it could if using paper. The value is real and it comes from its scarcity and cost of labor and tools to produce the coins.
  I hope this convinces you that there is a fundamental difference between inflation of Gold and inflation of paper money. One has a natural limit, the other is at the mercy of Government restraint. And by the way, if chemistry reaches a point that they can turn stone to Gold, then us advocates of free markets need not be concerned because the market would gradually shift to a different scarce commodity, say Titanium. And if Chemistry reaches a point where it can turn anything into anything at no cost, then our problem of scarcity is gone, and then who needs economics.

  Published: November 12, 2008 1:59 PM

• fundamentalist

  RichardJ, It seems that Rothbard is emphasizing time preferences (artificial changes) as a cause of business cycles and that an increase in the supply of gold will not change time preferences. I’ve been more influenced by Hayek, who emphasizes price changes due to an increase in money without an increase in savings. These price changes cause the Ricardo Effect to kick in, which causes a shift from investment in capital goods to investment in consumer goods. In that respect, an increase in gold would certainly have the same effect as an increase in fiat money. Hayek also limits the effect of time preference to the amount of savings which indirectly affects interest rates. The difference between an increase in gold and an increase in fiat money would be one of degrees rather than kind.

  Published: November 12, 2008 2:01 PM

• ktibuk

  "If a good is defined as anything for which someone holds positive subjective value, then your comment is contradictory. If money is valued, as you say it is, than it must be a good. If money is a good, it must be wealth."

  Money is unique. It is not valued for its own sake as other goods and services. It is valued because of its exchange value.

  If the number of the cars in a country increases, total wealth increases. Because of diminishing marginal utility every addition would be valued less. But overall the value increases. In no case an addition of a car to the total is neutral or have a negative effect to the overall wealth.

  That is not the case with money. Today total money supply may be 1,000. Tomorrow it may be 1,000,000. Overall people wouldn't be any wealthier.

  Money actually is neutral but only if the increases or decreases effect the existing money supply at the same time. Which almost never happens.

  The only time this neutral change of money supply is, when they throw out zeros from moneys. I Turkey we threw out 6 zeros recently. Money supply shrank in one night by 1 millionth. Nobody got any poorer, or lost any wealth. But if any other good shrank that much we would be much poorer.

  But increases in money supply always trickles down from the CB to the Banks to the first to loan, etc. That is why it is not neutral. The people who get the extra money first, transfer the purchasing power of the rest to themselves.

  Published: November 12, 2008 2:12 PM

• ktibuk

  DD I am not disputing anything you say. I am an advocate of the free market and gold money.

  The problem is here.

  You say, "And by the way, if chemistry reaches a point that they can turn stone to Gold, then us advocates of free markets need not be concerned because the market would gradually shift to a different scarce commodity, say Titanium."

  Yes the market would shift and abandon gold as money. But would you call the alchemist a criminal? Would you punish the person who discovered the method to produce gold at very low cost levels?

  That is my problem with "fraud".

  Published: November 12, 2008 2:20 PM

• ktibuk

  "RichardJ, It seems that Rothbard is emphasizing time preferences (artificial changes) as a cause of business cycles and that an increase in the supply of gold will not change time preferences. I’ve been more influenced by Hayek, who emphasizes price changes due to an increase in money without an increase in savings. These price changes cause the Ricardo Effect to kick in, which causes a shift from investment in capital goods to investment in consumer goods. In that respect, an increase in gold would certainly have the same effect as an increase in fiat money. Hayek also limits the effect of time preference to the amount of savings which indirectly affects interest rates. The difference between an increase in gold and an increase in fiat money would be one of degrees rather than kind."

  Yes you are right. The problem is any increase in the money supply mimics a change in time preference when there is none. Whether through mining gold or printing fiat money. The only difference is mining gold is limited by nature, while printing fiat money is not so much.

  Published: November 12, 2008 2:28 PM

• fundamentalist

  Dave: “…how did these 18th century British merchants acquire the gold/silver?”

  There were some mines in Europe and they got some gold from exports.

  Dave: “What is the legacy of such a monetary system in which those who enslave/kill in the name of acquiring silver and gold become our trusted bankers?”

  The blood-stained gold from the Americas cause mild (by today’s standards) price inflation throughout Europe for a century. But the Spanish, who did the enslavement and murder, didn’t become bankers. They spent the money on wars and luxurious living, most of it ending up in the Dutch Republic. The Spanish grew continually poorer in spite of their gold while the Dutch grew richer. That paradox was a major instigator of economic theorizing and led to modern economic thought.

  Dave: “Mostly, I want to understand why we need gold/silver to back up money.”

  We wouldn’t need gold or silver if central bankers understood economics and had a tiny bit of self-control. The value in gold as money comes from its limited supply and scarcity. It’s more difficult for the state to manipulate. But you have to get rid of fractional banking, too, or else it undermines the scarcity of gold.
  

  Published: November 12, 2008 2:29 PM

• Stanley Pinchak

  DD,
  although I appreciate much of your comment, I disagree in that even in the world of alchemy, there will still be scarcity, if only time and standing room (from a technical standpoint, we will still run into the laws of thermodynamics, and will subsequently still have to deal rationally with entropy). As such economics and ethics will still be of value to to humans.

  Published: November 12, 2008 2:42 PM

• ktibuk

  There are two problems with monetarist theory.

  One is you can not calculate the money supply, and if you can not calculate the money supply you can not increase it by some percentage. Why do you think these M numbers have been floating around for ages? M1, M2, M3, MZM, TMS, etc etc.

  Money is the most liquid asset and liquidity partly depends on perception of individuals. Demand for money comes from the demand to hold money. And this is because there is uncertainty. Any asset that is perceived to be liquid is money. Cash, demand deposits, time deposits, stocks, bonds, jewelry etc.

  The other one is even the central banks can not control the money supply in a fractional reserve system. Today the FED is trying like crazy to inflate but it can not do so. That doesn't mean they will give up but at this point they can not.

  Also in fractional reserve system banks, even individuals can create money by writing checks. So steadily increasing money supply is a naive dream.

  Published: November 12, 2008 2:49 PM

• DD

  ktibuk,

  Here is why a Gold mint industry in a free market doensn't amount to fraud, as oppose to counterfeiting fiat money.

  The production level of Gold coins will be maintained in a free market equilibrium just as any other commodity in the market. Unlike the arbitrary laws of an inflationary policy, the laws of supply and demand will determine its value. This means that the mints will be providing a real service that will be desirable by the market. The mint is not counterfeiting, it is producing a useful commodity in demand, and just like any other business, it has costs of material (scarce Gold from mining), costs of machinery and cost of labor. It makes a profit just like nay other business and it will be subject to competion just like any other business. Since there is real cost involved in minting Gold coins, it's productions will be limited so that its value in the market can enable the mint to still make a profit. The mint can never just inflate at no cost and start to benefit from the "counterfeiter effect".
  Perhaps you may still claim that producing Gold coins beyond a certain amount, would be non productive. But what is considered productive? Is Gold jewelry productive? you can't eat it or drink it. Would you not regard Gold Jewelry as wealth simply because one can do with out it. You can say that about any commodity that is not for pure survival. It is the market that decides what is desirable good or service. Consider the fact that mints for Gold coins in a free market, would be desirable if just to replace lost coins, or compensate for unwanted (psychological reasons) lowering of prices or wages (not real wages) due to a fixed supply in a growing economy.

  Published: November 12, 2008 3:24 PM

• Campbell

  I have a question about the gold standard: I know that gold is chosen as the standard of currency somewhat arbitrarily, ie currency can be almost anything if it's practical (ie divisible, preservable, portable etc.) We could just as easily set a platinum standard. But making a transition to a fixed value currency is fraught with danger - you have to set the initial value basically at random, and the correction of that value would be messy.

  So why increase the monetary supply at all? Why not set the printing rate as the replacement rate for money? ie for every dollar that physically wears out, we print a new one. The total number of physical dollars in the system stays constant, and the only expansion/contraction of the money supply occurs in a decentralized manner by individual banks in lending decisions. As an added bonus, you don't have to worry about arbitrarily changing the value of the currency; you can leave it where it is and let the market determine the value of the exchange tool.

  Alternately, why not just remove the restrictions on what you can use as currency? The market would gravitate towards the most stable option, and in the case of large fluctuations people could switch to another store of value.

  What's wrong with these ideas? Thanks in advance for the clarification.

  Published: November 12, 2008 3:30 PM

• ktibukk

  "So why increase the monetary supply at all? Why not set the printing rate as the replacement rate for money? "

  In theory you could. But it is like the ring in the lord of the rings. CB has too much power and it is tempting. Especially for governments who love to spend. If you give them the tools to replace they will increase the supply.

  So the best known alternative is use something that its supply can not be manipulated like gold.

  Published: November 12, 2008 3:48 PM

• ktibuk

  DD

  All you are saying is increasing the money supply by the way of mining gold is legitimate because there are costs associated.

  This implies that any reduction in costs of mining, aka increasing efficiency, is a path to illegitimacy.

  I am saying take it further. Say mining is so efficient that it is almost costless to mine gold (as costless as printing paper money) and increase the money supply.

  Is this a crime or not?
  

  Published: November 12, 2008 3:53 PM

• Oil Shock

  I am a little confused. I am wondering if someone can rephrase it for me. Why is it that the increase in supply of fiat money causes malinvestment, where as the increase in supply of gold does not?

  Another problem I had was, even under a system with 100% reserves, there could potentially be more paper circulating than the gold available. Wouldn't that cause a credit bust?
  Imagine if I took out a loan for buying a factory. If the current owner of the factory deposits the proceeds from the sale into his time deposit account, wouldn' t the bank then be able to create more loans from that same gold? Can't this pyramid build up over time?

  Published: November 12, 2008 4:12 PM

• DD

  Ktibuk,

  You are neglecting a very important factor and that is that in a free market, any commodity can serve as a medium of exchange, therefore your miner would always face competition. If your miner has discovered a way to produce Gold in amounts and costs comparable to paper money, then he would be driven out of the market by the free market. His gold would be worthless, and in reallity, the market would have moved to some other scarce commodity long before he reaches this fantastic capability. You see, the self regulatory market would drive him out just as in free banking, banks that expand beyond their reserves would eventually go bankrupt.
  If however, your miner lobbies government to make his Gold standard the only legal standard and his wishes are granted. Then yes, now that he had removed competition with Government help, he holds a monopoly over the medium of exchange and he will be commiting fraud with his fantastic capability of producing gold coins at such low costs. The laws of price and demand will no longer apply to him and he will be free to inflate to his advantage at the cost of others. But we are now back to where we started -fiat money! instead of printing on paper we print on cheap metal (like our copper coins). But you see, we had to get back to a coercive monopoly and a non free market to turn the miner into a thief.
  

  Published: November 12, 2008 4:34 PM

• RichardJ

  "RichardJ, It seems that Rothbard is emphasizing time preferences (artificial changes) as a cause of business cycles and that an increase in the supply of gold will not change time preferences."

  I was under the impression that under Mises-Rothbard theory, the point was that time preferences didn't alter, which is why the investments made due to the money supply increase are malinvestments.

  "I am a little confused. I am wondering if someone can rephrase it for me. Why is it that the increase in supply of fiat money causes malinvestment, where as the increase in supply of gold does not?"

  Ditto. Any takers?

  Published: November 12, 2008 5:14 PM

• andy

  Even Rothbard called the gold miners counterfeiters. I liked the article, but I disagree that the gold miners do not commit a fraud. They are not getting something for nothing, but they are adding to the total amount of gold in supply. It has to affect inflation at some level.

  Published: November 12, 2008 5:19 PM

• Mark Humphrey

  Kitbuk thinks that in a free market an increase in the supply of (say, gold-) money has identical effects to an increase in fiat money unbacked by the production of valued goods. He is mistaken, I think.

  As I explained in my previous post, an increase of gold is an increase in real wealth, because gold is a real good. In contrast, an increase in the quantity of fiat money does not increase real wealth; it merely dilutes it per unit of fiat money.

  Fundamentalist thinks that an increase in the supply of gold somehow alters the structure of production leading to the cycle of boom and bust. But this would seem to be mistaken, because an increase in gold-money does not artifically depress interest rates below the natural rate established by time preference. If time preferences remain unchanged following the increase in gold supplies, the new gold-money will be spent and saved in proportions identical to that prevailing before the gold increase. As such, the demand for and pricing of consumer goods relative to capital goods will--other factors remaining unchanged--be the same as it was prior to the increase in the supply of gold money. But if relative prices are unchanged, the originary rate of interest is unchanged, and production goes on just as it had before the increase in gold money.

  In summary, the interest rate is not depressed by an increase in gold-money, because gold that is not saved cannot be funneled into the loan market, in contrast to fractional reserve fiat money.

  The only change effected by the increase in gold money is on aggregate spending. If the increase in gold were greater than the general rise in the production of other goods and services, then prices would eventually rise. As people spent the additional gold money, again in the same proportions on consumer goods and capital goods as prevailed earlier, then the nominal rate of profit would temporarily increase for the first recipients. But this temporary effect would soon be dissipated throughout the economy, as costs rose to return profit margins to previous levels.

  At least, this is my perhaps imperfect understanding.

  Published: November 12, 2008 5:31 PM

• greg

  Friedman was a realist! We will never see the gold standard again and he was working with the system at hand and laid the basics for a balanced monitary policy.

  Published: November 12, 2008 5:55 PM

• RichardJ

  "In summary, the interest rate is not depressed by an increase in gold-money, because gold that is not saved cannot be funneled into the loan market, in contrast to fractional reserve fiat money."

  Thanks for the explanation. Question is, if the government introduced 100% fiat reserves then increased the money supply by 2% a year by giving cash to every citizen i.e. not the loan market, would this mean there would be no boom-bust cycle? I know this scenario is unlikely but am trying to establish if it is the increase in fiat money that causes the boom-bust cycle or the fact that the extra money ends up in the loan market.

  Published: November 12, 2008 5:56 PM

• greg

  MF Global? Are you net long on your gold positions? Gold standard would help a lot!

  Published: November 12, 2008 6:02 PM

• Mark Humphrey

  Reading Shostak's article raised a business analysis question in my mind. If the M1 money supply increases as the Fed lifts the monetary base, capital will be malinvested and wasted, leading to subsequent loan losses among banks. Dr. Shostak states that these loan losses will depress subsequent bank lending, dampening further increases in the m1 money supply that would ordinarily multiply from the monetary base increase. In other words, banks will maintain higher levels of excess reserves.

  I think this is true. The authorities can't force banks to make good loans, anymore than they can force a speculator to make profits, or a portrait painter to create great paintings. Banks will try to pull in their horns by waiting for appealing lending profit opportunities to appear and stockpiling cash. It is true that banks must pay interest on deposits, but the market rate for such deposits will fall in line with profitable lending opportunities.

  Banks can tide themselves over, temporarily, by lending to government instead of riskier business. But as all banks seek this haven, short term rates on government securities fall to returns that are submarginally profitable. Banks can buy longer term government securities to earn a higher rate, but on a risk-adjusted basis, the returns are still submarginal. If long term interest rates rise due to increased government borrowing and/or inflation, then banks will suffer additional capital losses on their government bond investments.

  So banks are likely to wait for more attractive lending opportunities among business applicants, rather than risk capital losses merely for the sake of lending their reserves. As they wait, interest rates on CDs evaporate; this enables banks to bleed more slowly.

  When the economy climbs out of the recession, better lending opportunities appear and banks resume lending.

  But what if the real pool of savings--to borrow Shostak's phrase--continues to contract in the wake of ill-conceived and worsened government policies? If real savings spiral downward, then the bulk of the economy--business-to-business sales (capital goods production)--suffers falling revenues and profits. In this case, bank lending does not resume in a big way, because profitable lending opportunities remain scarce.

  Meanwhile, of course, the Fed is busy ramping up the monetary base, flooding the banks with new reserves. This act, of course, hastens the decline in real savings and accelerates the consumption of capital. For savers now forgo any return on savings, which before served as a major well spring of subsequent saving. This worsens the plight of businesses and of banks that would prefer to lend to them.

  As the Fed pumps up the base, reserves go way up. So banks--lacking a better alternative on a significant scale--reluctantly buy government bonds. This lifts the supply of money, although at a heightened reserve ratio, so that each dollar increase in base money produces less checking account money than before. Now the dollar begins to fall, because reduced production and rising money reduces its purchasing power relative to other currencies. Moreover, bargain basement interest rates inspire foreign investors to repatriate their capital.

  Now banks get loan applications from foreign firms, eager to take advantage of our low interest rates and falling currency. As they borrow dollars, they sell those dollars to acquire other currencies in which they conduct their business. This further reduces the value of the dollar.

  My question. If this scenario played out, would not the crumbling of American business due to the downward spiral in real savings render the banking system more fragile and vulnerable to crises? Or to put this slightly differnetly, if our business sector goes into long-term recession, in which wages and incomes decline for years on end, the result ought to be rising prices and ruined banks.

  But also, if banks are ruined, is not the risk of a financial panic much greater during the frequent downturns among the anemic recoveries? Could not a financial panic lead to sky rocketing demand for money and a rogue monetary deflation?

  Sorry for the length. I'm just thinking out loud. Perhaps someone might want to comment.

  Published: November 12, 2008 6:22 PM

• stuart R

  Gold is money. IOU's are money. What we have today is a vigorous contraction in the IOU component of the money aggregate. A bubble is bursting. Governments can crank up the printing presses but only God knows when to stop to prevent inflationary overshoots. Give Mr Market a shot at economic stimulus in a recession, depression, or that old fashioned word panic.. Distribute certificates whose dollar value declines at say 10% year. Misers won't hang on to them. One would spend them immediately. If the grocer wont accept one since he couldn't pay the farmer with one he could pay his taxes with it. T'was known as the velocity dollar. As the IOU money aggregate resurges one just stops making velocity dollars.

  Published: November 12, 2008 8:45 PM

• fundamentalist

  Mark Humphrey: “Fundamentalist thinks that an increase in the supply of gold somehow alters the structure of production leading to the cycle of boom and bust. But this would seem to be mistaken, because an increase in gold-money does not artifically depress interest rates below the natural rate established by time preference.”

  Keep in mind that time preference is just one of the factors that makes up interest rates. Hayek says it determines how much people will save, but only indirectly determines interest rates.

  Mark: “If time preferences remain unchanged following the increase in gold supplies, the new gold-money will be spent and saved in proportions identical to that prevailing before the gold increase.”

  That can’t be the case because the money won’t be evenly spread over the entire economy. It enters at a certain point. For gold it would be through the miners and their employees. Even if that is the case, you still have more money chasing a limited amount of goods in the short run. It will drive up prices and profits in consumer goods and set in motion the ABCT.

  If all of the gold is spent on consumption, the prices of consumer goods will rise, as Cantillon wrote, unless there has been a depression and idle resources are lying around. If all the gold is saved, it will depress interest rates. Most of the money invested will go to pay salaries which will increase demand for consumer goods, too. I don’t see how you can get away from an increase in gold causing consumer prices to rise relative to producer goods, and that kicks in the business cycle. Of course, the cycle will be shorter and milder than any caused by fiat money.

  RichardJ: “Question is, if the government introduced 100% fiat reserves then increased the money supply by 2% a year by giving cash to every citizen i.e. not the loan market, would this mean there would be no boom-bust cycle?”

  It’s hard to say. Money manipulation is the most frequent cause of boom-bust cycles and it causes them to be deeper. But drought, crop failure, and natural disasters can cause busts while war can cause a boom then a bust.
  

  Published: November 12, 2008 8:55 PM

• coquillion

  Assuming we abandon fiat money for gold (or other tangible store of value) and eliminate fractional reserve banking, doesn't that imply an ongoing deflationary trend? Assuming that the money supply expands through mining, won't the use of gold as a medium of exchange create a distortion in the importance of mining gold, relative to other capital intensive activities? While people have historically accepted gold as a store of value and something to be desired, it doesn't seem that gold has that much practical utility (besides its industrial uses.) Wouldn't it be better to use energy as money (not necessarily directly) instead?

  Published: November 12, 2008 10:25 PM

• Mark Humphrey

  Richard asks: “Question is, if the government introduced 100% fiat reserves then increased the money supply by 2% a year by giving cash to every citizen i.e. not the loan market, would this mean there would be no boom-bust cycle?”

  We assume the Federal Reserve prints currency equal to 2%, and mails it to citizens. Every citizen now has an extra $100 to save or spend.

  Let's first assume that, in accordance with time preferences, 100% of the new money is spent at the mall. The profit margins of retailers expand unsustainably, and they consume all the additional 2% in revenues that flows into added profits. The firms they patronize do the same, until retail prices rise 2%. No expansion of retail production occurs in this instance, because all the new money went into consumption. Because no additional output of consumer goods occurs, the winners in the zero-sum redistribution of wealth are the consumers who get to the mall the soonest.

  However, consumers are fooled by the new money into believing that they are $100 richer than before. So instead of continuing to set aside funds, as in the past, to cover depreciation and amortization of various capital assets, for the purpose of just maintaining those assets, as contrasted with saving and accumulating additional capital, consumers spend 2% more of their incomes on consumption than they would otherwise. This 2% increase in consumption is necessarily extracted from the capital base. This reduction in capital erodes real incomes and wage rates, and profits among capital goods producers--a condition identical to the recession brought on by artifically depressing the rate of interest through fractional reserve inflating. So in this example, the boom and bust cycle rides again.

  Next, let's assume that the recipients of the new money spend one half and save one half, again in accordance with their time preferences. The new money that is spent at the mall produces the effect described in the paragraph above. The money that is saved is deposited, and then loaned by banks to consumers and business. To the extent that consumers borrow the new loan money, consumer prices rise further, thereby reinforcing the process by which people are fooled into eating their seed corn. To the extent that producers borrow the new money, producer profit margins expand unsustainably, prices rise, and capital gets eroded.
  Again the erosion of capital depresses business spending, profits, wage rates, and incomes. Again, the effect is similar to a recession resulting from fractional reserve inflating.

  In summary, the boom and bust feature is unavoidable, because printing new money is necessarily promotive of consumption beyond the level that is consistent with prevailing time preferences. When people reassert their old time preferences, a temporary slump occurs.

  That's my best imperfect understanding of this, for tonight, at least.

  Fundamentalist, we agree that an increase in gold production that is substantially greater than the increase in the production of other goods will lead to rising prices. But we disagree beyond that point.

  If mines double their gold output in a single year due to some technological breakthrough, then particular firms and individuals will be the earliest recipients of the big supply of new gold-money. Some firms will save more than the aggregate time preference that influenced spending before; some individuals will consume more than aggregate time preferences influenced aggregate spending before.

  But very rapdily, the new money is exchanged for various goods and services. As it comes into new hands, they spend the money in accordance with old, presumeably unchanged time preferences. Nobody got tricked into assuming they were wealthier than they actually are, as in the case of fiat money expansion. Why? Because, in fact, they really are wealthier than before the increase in gold production. Gold is a real good that comprises real wealth. As we both know, fiat money is not a good; it is a means of embezzlement.

  Finally, the business cycle that results from fractional reserve inflating is characterized, not by an initial rise in consumer goods prices, but instead by an initial rise in demand for capital goods, followed quickly by a rise in capital goods prices. This rise in capital goods demand and pricing starts the boom. When the new money finally percolates down to consumer prices, the reality of scarcity forces people to adjust back and the recession begins.

  Published: November 12, 2008 10:27 PM

• newson

  ktibuk says:
  "I am saying take it further. Say mining is so efficient that it is almost costless to mine gold (as costless as printing paper money) and increase the money supply.
  Is this a crime or not?"

  there's no crime. a service is rendered to society by the alchemist. instead of gold having mainly (but not entirely) monetary value, the plumbing industry now has the perfect anti-bacterial pipe, ointments can now use nanoparticles of gold as antifungal agents, and lenin's urinals can now sensibly be gold-plated.

  the metallurgists who perfected aluminium smelting killed it as a monetary metal, but gave us coca-cola in cans.

  there would naturally be cantillon effects as the devaluation of gold worked its way through the world.

  the fraud is that the paper money is masquerading as some real, tangible good. when the notes are only worth their paper value, the game is over!
  

  Published: November 13, 2008 12:12 AM

• Chuck

  All this talk of gold vs paper is missing the point. Government should not control the money supply. Few would say government needs to control the supply of socks to prevent sock shortages/surpluses. Why is money any different?

  Published: November 13, 2008 1:25 AM

• newson

  inquisitor says:
  "...starting with a system of private property rights, asserting that multiple claims to the same good, which a bank agreed contractually to store, is pretty much fraud, in any sense you'd like to mention."
  "FRB is fine if it is made known to the bank's clients what it is doing, and done so explicitly."

  if you concede that frb is a fraud, then how can disclosure absolve this? surely you're not suggesting that fractional reserve banks actually include the "f" word in their disclaimer?
  besides, who is going to enforce the obligation to disclose? the government?
  written disclaimers are often set aside by courts, so i don't find this argument persuasive, either on a moral plane or on a practical one.

  if i buy shares in a brickworks, i expect the inventory has been checked out by both internal and external auditors. whilst the government doesn't run the company, i can still sue the directors or auditors should it turn out that the bricks on the balance sheet don't exist, and they knew or should have known. why shouldn't that be the case with depository banks? what on earth makes banks unique in both company law and corporate accounting from any other corporation?

  Published: November 13, 2008 1:50 AM

• Paul

  Another educational article by my favorite contributor Frank Shostak, for sophomore students of the Austrian School such as myself.

  Published: November 13, 2008 2:34 AM

• ktibuk

  Mark Humphrey, "As I explained in my previous post, an increase of gold is an increase in real wealth, because gold is a real good. In contrast, an increase in the quantity of fiat money does not increase real wealth; it merely dilutes it per unit of fiat money"

  This is the part where you are mistaken just like Shostak. Gold money is not only a good. It is part money, part good. Those are two different functions.

  Increase in gold in a "gold money economy", increases both "gold as a good" and "gold as money". The increase of "gold as a good" increases wealth. But increase of "gold as money" dilutes the purchasing power of money. It has no positive effect. Neutral at best, but since the new money enters the economy unevenly through miners it dilutes the purchasing power of the previous money and has the same effects of fiat money increase. And since this effect also depresses interest rates, the increase of wealth through the increase of "gold as a good" can not compensate the negative effects. But we have witnessed through history that this negative effect is negligable.

  It is the same thing with paper fiat money, but weight of "money" and "good" functions are a little different.

  That 10 dollar bill you have in your pocket, has both money and good functions. But compared to "gold money", good function of paper money is tiny. It is scarp paper. As a good more of the scrap paper, better it is. For other uses of course. It increases wealth. But as money the amount is irrelevant. And if the amount increases unevenly then there is a wealth transfer because it dilutes purchasing power, plus it mimics a change in time preference because it depresses the interest rate when there is no change hence causing the boom in the cycle.

  Money is not a good and it is not wealth. It is a function. And many different things can have this function to a degree. That is why it is impossible to calculate and control the money supply. That is where monetarism is wrong.

  There is also no inherent difference between money and money substitutes as money functions. That is the reason why money substitute can function as money. The only difference is in commodity money increase of the supply is dispursed among different miners and increase happens relatively slowly because of natural reasons. But in a fiat money economy there is one that produces money and production is fast so money supply increases relatively more quickly.

  Published: November 13, 2008 4:08 AM

• ktibuk

  Newson, "the fraud is that the paper money is masquerading as some real, tangible good."

  Yes I agree. This happened in history but as of now when the FED floods the economy with dollars they are not doing this. Today nobody thinks the dollars they hold represent some other real, tangible good.

  It is like there is one miner, one very efficient miner and he is pumping gold into the economy. And since no one thinks that gold is backed by something else there is no fraud.

  This may seem a minor point but I think it is important to understand what money is.

  Published: November 13, 2008 4:21 AM

• Ireland

  ktibuk: Today nobody thinks the dollars they hold represent some other real, tangible good.

  Control question: Why on earth would then anyone accept USD as salary, for settling trade, savings etc?

  The statement in italics is fully true for continentals and other already failed fiat money. While current USD is accelerating the same way, we're not there yet.
  

  Published: November 13, 2008 7:26 AM

• Campbell

  ktibuk - Thanks for your reply. The thing is, the central bank/government has the power to devalue currency whether it's made of paper or paper-representing-a-commodity. For a case study, see US monetary policy 1913-1971.

  The only way out I can see is to use the commodity itself, directly, as currency. Legislate against government interference with money in any way. I suppose gold or platinum coins would work well with vending machines, but I'd seriously have to re-tool my wallet.

  Capitalism is a fantastic engine for improving the lot of society. The big problem is, it has no steering wheel.

  Published: November 13, 2008 7:35 AM

• joebhed

  Thanks to greg for making very simple and rational observations.
  As to mark h's proof offering using the 2 percent increase in money BY THE GOVERNMENT, it falls apart based on Friedman's plan.
  The only reason for the 2 percent increase in fiat money is because there is a 2 percent increase in economic production
  Were there a 0 percent increase in production, it would call for a 0 percent increase in the money supply.
  Ladies and gentlemen.
  It is time to forget about the gold standard as the solution.
  It is time to forget about the government getting out of its constitutional power to control the money system of the country.
  THAT will never happen.
  What we want is an honest and fair money system and we can get most of that from Friedman's platform of eradicating the fractional reserve system, and a productivity-based (however YOU want to define that) increase in the money supply on an ongoing, sustainable basis.
  By the government(Treasury) and not the bankers.
  Pillory away.
  

  Published: November 13, 2008 7:59 AM

• newson

  to ktibuk:
  the alchemist has rendered a precious metal so common that a myriad industrial uses now are possible for the devalued gold. if its monetary utility is diminished as a result of its abundance, it means that people now value its industrial utility more.

  the fed ruins good paper by dyeing it. blank paper at least has commodity value.

  as regards the fraud of paper masquerading as a good, i had frb in mind, not irredeemable dollars.

  Published: November 13, 2008 8:04 AM

• newson

  to ktibuk:
  let me twist your analogy a little. if i somehow figure out a way to increase wheat yields ten thousand fold, i may well bankrupt many corn, rice, sorghum producers, as well as my conventional wheat-farming competitors. but i produce a gain to all the actual and potentially-new wheat consumers, so i'm not sucking the lymph of society at large.

  counterfeiting produces no net gain to society, merely redistribution.

  Published: November 13, 2008 8:16 AM

• Michael A. Clem

  It enters at a certain point. For gold it would be through the miners and their employees. Even if that is the case, you still have more money chasing a limited amount of goods in the short run. It will drive up prices and profits in consumer goods and set in motion the ABCT.
  
  Fundamentalist, I would agree that an increase in gold is inflationary and would drive up prices, but I don't think that it starts ABCT, because, yes, the new gold will divert the allocation of resources, but since new wealth in the form of gold has entered the system, it is not unsustainable. Unlike the fiat system, they are not getting something for nothing.
  

  Published: November 13, 2008 8:32 AM

• fundamentalist

  Mark Humphrey: “Finally, the business cycle that results from fractional reserve inflating is characterized, not by an initial rise in consumer goods prices, but instead by an initial rise in demand for capital goods, followed quickly by a rise in capital goods prices. This rise in capital goods demand and pricing starts the boom.”

  I think if you look again at Hayek’s “Prices and Production” you’ll find that consumer prices always rise faster than capital goods prices. Hayek takes a lot of space to make that clear in several of his works. Yes, the boom starts when businesses borrow to invest and purchase capital goods. But those capital goods won’t produce any new consumer goods for a long time. Meanwhile, the new workers in the capital goods industries are spending their wages on consumer goods, demanding more.

  If consumer goods prices didn’t rise faster than capital goods prices, then profits in consumer goods industries wouldn’t be higher and there would be no shift in investment from capital to consumer goods production. Also, the Ricardo Effect, which Hayek places a great deal of emphasis on, requires that wages in the consumer goods industries fall relative to the price of output. That happens when consumer prices rise relative to wages. The relatively lower wages cause businesses to use more labor and less capital, which is one of the things that brings about the bust in the capital goods industries.

  The prices of capital goods do rise, but only after consumer prices rise. The order of the rise in prices is very important to Hayek’s understanding of the business cycle. Yes, consumers do reassert their time preferences, but only after the new workers are hired in the capital goods industries and start spending.

  These effect happen because the new money injected into the economy did not come from savings. Had they come from savings, then consumers would reduce their consumption so that more consumer goods would be available to new hires in the capital goods industries. An injection of gold money into the economy will have the same effect as an injection of fiat money. However, the benefit of gold is that fluctuations in the gold supply are much smaller.

  Ktibuk: “Increase in gold in a "gold money economy", increases both "gold as a good" and "gold as money". The increase of "gold as a good" increases wealth. But increase of "gold as money" dilutes the purchasing power of money.”

  This is a very good point! Bastiat makes the same point in many of his writings. He writes that money is not wealth at a time (1800’s) when gold was the only money:

  “I cry out against money, just because everybody confounds it, as you did just now, with
  riches, and that this confusion is the cause of errors and calamities without number. I cry out against it because its function in society is not understood, and very difficult to explain.” (Bastiat “What is Money?”)

  Cantillon pointed out the harmful effects of a sudden increase in the supply of gold in a country with gold mines:

  “In his first example, he showed that increased money via domestic gold and silver mining would lead to increased consumption by people in the mining industry and that
  would drive the prices of the goods they purchased higher (e.g., meat and luxury goods). Entrepreneurs would adjust their production and farmers would plant their fields to meet this new pattern of demand so that the structure of production would be changed. People not associated with the mining industry would face higher prices and fewer goods to consume so there would also be a change in the distribution of income. As prices continued to rise, gold would be exported in exchange for imported goods and people from the nonmining population might even migrate to areas of higher real wages. Cantillon demonstrated here that the Mercantilists were wrong; more money could hurt
  the economy and cause distortions in the pattern of production and wages, as in the cases of Spain and Portugal.” (CANTILLON ON THE CAUSE OF THE BUSINESS CYCLE by
  MARK THORNTON)
  

  Published: November 13, 2008 8:38 AM

• Campbell

  joebhed - I agree with you that the government is not going to give up its power over the monetary system. But by the same token, neither is it going to stop exercising that power when it believes it appropriate.

  For example, given our Friedman critique, any nominal growth rate is basically arbitrary, and differences between the market reality and this arbitrary number will build up over time, eventually precipitating a crash. So let's take your scenario of a 2% currency growth rate, and a "hands off" policy by the Fed chairman. Can you imagine a major market crash, where government had the legislative power to currency-manipulate and they refused to do it? They would have to resist tremendous pressure from every lobby, and from their voters... it would not happen.

  Where and how do you draw the line between what you're willing to try and make the government do, and what you give up on them doing? If we're going to be able to get our government "of the people" to make a major shift in monetary policy of any kind, I say go for the gusto. We may as well try and make them change the whole thing to a real free system if we think we can make them change at all.

  Published: November 13, 2008 8:57 AM

• Mark Humphrey

  Fundamentalist, thanks for your interesting reply to my critcism of the idea that an increase in gold money causes the business cycle.

  I'm still not convinced that this is true, but I know less about this than I thought I did. I don't have more time to spend. But you've convinced me that I ought to read my Hayek.

  Published: November 13, 2008 9:28 AM

• fundamentalist

  Mark, It's hard to find, but I thought Hayek's "Profits, Interest and Investment" to be the more presentation of his cycle theory. I had to get a copy through interlibrary loan. "Monetary theory and the trade Cycle" is good, too. "Prices and Production" is the most detailed and most difficult to follow.

  Published: November 13, 2008 9:39 AM

• Deefburger

  "A major problem with the Friedman rule is that we are still going to have an expansion in the money supply out of thin air. (Remember, Friedman advocates the expansion of money at a constant percentage.) This in turn means that various nonproductive activities will be generated."

  
  I saw an example of non-productive activity with the mortgage. Every month a new bank would send a letter stating that they were the new holder of the loan. Every time it changed hands, a percentage of the equity was drained off and into the coffers of non-productive banks. As a consumer, I had no need for the switch, or any say on who owned my mortgage.

  I realized that if this continued for months, and not just for me, then there was billions of dollars in equity being siphoned off the capital during the inflation period of the real estate market. Had the loans remained with the original bank, there would have been breathing room when the down-turn came.

  Instead, there was no room at all. The banks had been playing "hot potato" with ALL the loans! So the big banks that bought large lots of these second, third, fourth, umpteenth hand loans bought them knowing that they would have to keep them moving in an inflationary market or they would own duck spit when the market turned. Then the market turned, and there they were, stuck with duck spit.

  "Lets call it a calamity! Help! It's not our fault the market turned!" Stupidity & Greed Laurel and Hardy in disguise.

  Published: November 13, 2008 9:54 AM

• joebhed

  campbell-

  In responding to why not go for free banking when we might have the fractional reserve system over a barrel, perhaps my answer is incrementalism.
  There is an opportunity arising for a monetary revolution, in case you haven't noticed it.
  Most people perceptibly charge the free-marketeers on bank street with the run-up to the conflagration that is about to happen.
  I am both among those, and among those who do not believe that free banking is the answer.
  There is no way to free banking and unregulated money power from where we are.
  People are demanding government solutions - as dreadful as they are.
  I like to believe that most of the Mises posters actually do believe that 100 percent reserve bank lending and a resort to more rational money supply growth are measures that can begin to move us in the direction that monetary policy ought to take.
  Thus, a revolutionary change from the present and an incremental change to where the Mises people think we need to go.
  As to where to draw the line between the possible and the need for revolution, well I say you get waht you can, and then you move the line forward.
  I know that as the central government planner among the posters I am in the minority in believing that by GETTING control of the money system, we the people can define where that control will take us.
  But, that is what I believe.
  The money power is in control of the government, and not the other way around.
  When I visited Frank Shostak's website, his firm is in the business of marketing the insane, non-productive financial market gimme's that are driving the debt and money creation engine that is driving this inflationary game that we all claim to abhor.
  I'll take the government's hand on the tiller any day rather than the fat cats of finance who have driven us to the present approach of the abyss in front of us today.

  Published: November 13, 2008 10:08 AM

• James

  Fiat money ( water marked paper) and money represented by electronic digits are essentially only a convenient medium of exchange. Unlike Gold, or any other productive wealth, they have no intrinsic value in and of themselves. They have efficacy only in so far as they are backed up bysomething of intrinsic value; the real productive wealth of a nation.
  Financial bailouts compromise the integity of a nation's money supply and undermine the soverignty of that nation. It encourages excess printing of currency that is, in effect, worthless paper. This paper not being backed up by intrinsic value increases the money supply to where it does not accuratly represent the real wealth and productivity of a nation.
  Because the law of supply and demand cannot be conned, inflation is the result. If one wishes to make more lemonade, one should increase the water content only in proportion to the extent that one increases the other ingredients, otherwise, increasing the water content alone waters it down, it loses its efficacy and people shun it because it becomes tasteless,
  The U.S. Federal reserve is printing counterfit money.It is avoiding skylla only to be gobbled up by caribdis.Classical inflation is the result( too many dollars chasing too few goods). Productivity is the measure of real wealth in a nation. In America's case real dollars are backed up by productivity but the productivity is in China and other countries.they are afraid if America defaults they will lose their best customer.
  A solution would be to restructure the Breton Woods Agreement into a truly international aggreement. Since world trade is conducted in the exchange of goods and services, those nations who do not reciprocate enjoy trade surpluses that increase holdings in their foreign reserves. As I said, the law of supply and demand cannot be conned for in doing so they increase their holdings in inflated dollars and both sides become losers. The world Bank should have the authority to write of Balance of payments deficits by recalling surplus balance of trade U. S. dollars out of world circulation, strenthening the integrity of the money supply and restoring eqilibrium in the balance of payments.
  
  James
  

  Published: November 13, 2008 11:56 AM

• Michael A. Clem

  I'll take the government's hand on the tiller any day rather than the fat cats of finance who have driven us to the present approach of the abyss in front of us today.
  
  Which misses the point: the "fat cats of finance" couldn't have gotten fat without the hand of the government. Incrementalism may be the practical way of making change, but it only happens because we agitate for more radical change.

  Published: November 13, 2008 2:37 PM

• james

  Government has given too much control to the Financial system. Government should not have to borrow from the very people to whom they give a license to print money in the first place.
  An investment in infrastructure and green renewablle energy would stimulate real wealth creation as result of the multiplier effect. This is what is needed in the nidst of a liquidity trap like the present.
  The government should not have to borrow this money, it should be able to print the money it needs. It would not be inflationary because the money would be backed up by
  something of intrinsic value, the capital stock of the nation.
  When the nation borrows this money it not only increases debt because of interest charges that compound after several years, the borrower becomes servant to the lender. It makes one wonder, who really runs the country? obviously it is the banks. This needs to change.
  James MacInnis

  Published: November 13, 2008 3:32 PM

• joebhed

  michael
  ""the "fat cats of finance" couldn't have gotten fat without the hand of the government.""
  Again, this is where we totally agree.
  I do fault the government.
  Thus, we demand that the government regain for the people the right of money-creation.
  The FRS, with its ability to enslave the masses through fractional-reserve debt-money creation, was created by a pen, and can destroyed by a pen.
  Let's do THAT!
  Let's build the green infrastructure for tomorrrow's progress and pay for it only once, and not thrice.

  "Incrementalism may be the practical way of making change, but it only happens because we agitate for more radical change."

  Please understand that we disagree on the nature of the more radical change that is coming.
  But, we need to be at a place where we can argue point for point each of the remaining changes that we all think are necessary or possible.
  IN THE MEANTIME, if we can get to the bridge of 100 percent reserve banking and price-stable money growth, we will be in a better position to determine the "next best thing" to pursue.
  Respectfully.

  Published: November 13, 2008 3:55 PM

• newson

  to fundamentalist:
  "Cantillon demonstrated here that the Mercantilists were wrong; more money could hurt
  the economy and cause distortions in the pattern of production and wages, as in the cases of Spain and Portugal."

  i think thornton is right about "distortions", wrong about "hurt". i don't see anything particularly unnatural about changes in consumption behaviour. although there is inflation, without frb, there is no business cycle, and these businessmen will service a need until the gold flow stops, when they will have to change business model.

  Published: November 13, 2008 5:08 PM

• Ireland

  Well, I don't know. It's different when things change from one state to another, and stay there - a change for better via innovation, or for worse due to natural disaster - people adjust all right.

  But if there's change in gold supply, and the fact that the increase is only temporary is obfuscated, or people simply believe hard that it's the "new prosperity, which will last forever", then once things go back and reality kicks in - Well I'd bet that forced change of business model will be called a bust and business cycle.

  Control question: was Tulip mania a business cycle? What was used for money?
  

  Published: November 13, 2008 5:27 PM

• gene berman

  William Rader:

  You've got it exactly backwards. As the market price of gold rises, so does the total value of all the gold in the "reserves" of differing concentrations. But the actual concentration of those reserves, as it affects the mining and milling processes, decrees that some
  ores are more expensive to mine, i.e., they cannot be exploited profitably until the price of gold on the market has increased sufficiently to justify such extraction.

  In practice, things are rarely quite so simple, so, for most mines, it would still be a matter of extracting ores of differing grades, with the range of ore values shifting downward with price increases and upward with declines.

  My guess is that you probably knew that and just wrote it backwards.

  Published: November 14, 2008 8:19 AM

• gene berman

  William Rader:

  In practice, a mine with ores of substantially differing concentrations (or a mining company with properties exhibiting similar variations) is guided by futures markets for the out-turn; they can plan just which ores they will work on and when in order to make more secure a certain margin of profit; they also can (and many do) sell a certain amount of their production forward to achieve the same effect.

  A 'wild card" for which they have less information and control is the prospect for changes in costs of production: labor, energy and fuel, water, etc. Big enough changes in one or more of these can play havoc with profitability projections based just on market prices and ore values. Another is the risk of loss due to unanticipated production failure, whether due to a "wildcat" strike, to equipment failure, flood, or fire. The actual damage may be compensated by insurance that will restore a mine's equipment, etc. but the time required may play havoc with prior planning. You can satisfy your futures contracts by delivering the gold you've mined to assure your profit but, if you haven't mined the gold, the "nut" has got to come out of your pocket.

  Published: November 14, 2008 8:45 AM

• newson

  to ireland:
  have a read of the blog comments that follow doug french's article on tulipmania
  http://blog.mises.org/archives/006683.asp
  i am not totally convinced by french's arguments, and nor are many of the bloggers, one of whom points out that the bank of amsterdam really breached its charter and became a fractional reserve bank not long after its creation.

  constantly changing business models is part of progress, and doesn't imply a business cycle. horse and cart turned into lorry and car without provoking boom or bust.

  
  the abct swings on the presumption that the "natural" rate of interest is not allowed to prevail by dint of interference by government or bankers, ie fiat money or frb. in a free market of specie money, the natural rate is determined by people's time preferences.

  rothbard and mises, from memory, define inflation as growth in money supply over and above the growth of specie. this strikes me as problematic, given that there have been historical periods where specie supply has experienced dramatic increases.
  

  Published: November 14, 2008 9:27 PM

• newson

  besides, in a totally specie-money economy (no fiat, no frb), the only way for deflation to occur is for the industrial use of specie to consume more than the current mine production. with a specie money only, it's hard to imagine anything but disinflation occurring, when the mining flows fall off.

  Published: November 14, 2008 9:45 PM

• gene berman

  Newson:

  "rothbard and mises, from memory" etc.

  Dunno about Rothbard but, insofar as von Mises is concerned, your memory ain't much good. As a matter of fact, my memory is that Mises insists that "inflation" is a term without economic definition or even use; it's a common-language designator of the public experience of a rising price level and especially favored by those with political axes to grind.

  Nor, of course, were either (M or R) unfamiliar with the economic effects (particularly on Europe) that came about as the result of great new gold discoveries, first of the New World and, later, in the American West.

  The main thing to bear in mind is that there are no constant relationships, including that of the annual addition to the above-ground amount of gold as the result of mining OR in the relationship of the money-function to the industrial usages of gold. Not onlt are these thing undergoing perpetual change but so are both the population and the uses to which money may be put, the latter subsuming not only productivity changes (especially due to the advance of technologic methods and their spread) but also the emergence of entirely new consumer desires.

  What I believe Mises would have us appreciate is that the structure of prices on "the market" at every moment (and continuously) conveys to every last participant the best, most accurate information available with which to plan his own economic actions, whether aimed at the satisfaction of the immediate moment or the more remote future. Though not "perfect" in any absolute sense, the market signals are the "best possible" and, furthermore, every attempt to interfere with either the mechanism or the various signals of the market, most especially by authoritarian interference, will, through causal relationships, produce "not much" of whatever was intended by such interference and much more of unwanted and unwelcome unintended consequences.

  If you don't screw with it, things may not make everyone ecstatically happy but most will be as happy as possible. If you do screw with it, you can, at the most, make a portion happier than they would have been, albeit temporarily, and most, if not all, will, before very long, be both poorer and unhappier than if you hadn't screwed with it in the first place.

  Published: November 15, 2008 9:16 AM

• newson

  to gene berman:
  "Inflation, as the term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check."(Economic Freedom and Intervention: An Anthology of Articles and Essays by Ludwig von Mises, 1990, p 99.)

  i read this to mean that mises does concur with rothbard that inflation is money supply growth over and above growth in specie money. i know mises was hesitant to define inflation in earlier works, feeling the meaning had been corrupted.

  Published: November 15, 2008 11:24 PM

• newson

  "Gold Changes and the Cycle
  On one important point of business cycle theory this writer is reluctantly forced to part company with Mises. In his Human Action, Mises first investigated the laws of a free-market economy and then analyzed various forms of coercive intervention in the free market. He admits that he had considered relegating trade-cycle theory to the section on intervention, but then retained the discussion in the free market part of the volume. He did so because he believed that a boom–bust cycle could also be generated by an increase in gold money, provided that the gold entered the loan market before all its price-raising effects had been completed. The potential range of such cyclical effects in practice, of course, is severely limited: the gold supply is limited by the fortunes of gold mining, and only a fraction of new gold enters the loan market before influencing prices and wage rates. Still, an important theoretical problem remains: can a boom–depression cycle of any degree be generated in a 100 percent gold economy? Can a purely free market suffer from business cycles, however limited in extent? One crucial distinction between a credit expansion and entry of new gold onto the loan market is that bank credit expansion distorts the market's reflection of the pattern of voluntary time preferences; the gold inflow embodies changes in the structure of voluntary time preferences. Setting aside any permanent shifts in income distribution caused by gold changes, time preferences may temporarily fall during the transition period before the effect of increased gold on the price system is completed. (On the other hand, time preferences may temporarily rise.) The fall will cause a temporary increase in saved funds, an increase that will disappear once the effects of the new money on prices are completed. This is the case noted by Mises.

  Here is an instance in which savings may be expected to increase first and then decline. There may certainly be other cases in which time preferences will change suddenly on the free market, first falling, then increasing. The latter change will undoubtedly cause a "crisis" and temporary readjustment to malinvestments, but these would be better termed irregular fluctuations than regular processes of the business cycle. Furthermore, entrepreneurs are trained to estimate changes and avoid error. They can handle irregular fluctuations, and certainly they should be able to cope with the results of an inflow of gold, results which are roughly predictable. They could not forecast the results of a credit expansion, because the credit expansion tampered with all their moorings, distorted interest rates and calculations of capital. No such tampering takes place when gold flows into the economy, and the normal forecasting ability of entrepreneurs is allowed full sway. We must, therefore, conclude that we cannot apply the "business cycle" label to any processes of the free market. Irregular fluctuations, in response to changing consumer tastes, resources, etc. will certainly occur, and sometimes there will be aggregate losses as a result. But the regular, systematic distortion that invariably ends in a cluster of business errors and depression—characteristic phenomena of the "business cycle"—can only flow from intervention of the banking system in the market. "

  rothbard takes a different view to mises as to whether increasing specie money precipitates the business cycle. "america's great depression", p 34.

  Published: November 16, 2008 12:11 AM

• Paul Marks

  If people found an easy and inexpensive way of flooding the market with gold then people would tend to use other things (such as silver - or something else) as money, they would make future contracts in some other material.

  What matters about gold-as-money is not that gold is a nice yellow metal (although that is not a problem) - it is that it takes power away from the government and the credit bubble fractional reserve banks that the government supports (by the way such banks are "frauds" because they lend out more money than there is real savings - and for borrowing to be greater than real savings fraud must be involved, no matter how "legal" the government and its courts say the whole scam is).

  This is the problem with the word "standard" in the term "gold standard" - the word "standard" implies that the gold is NOT the money, that gold simply "backs" the money.

  This lays people open to such massive frauds as the late 1920's when under the "gold STANDARD" credit money increased vastly.

  Either gold is the money or it is not - and if the gold is the money there is no need for the word "standard".

  Ditto with silver or any other material people choose to use as money.

  Published: November 16, 2008 12:32 PM

• James

  There are two types of inflation! Cost push inflation, caused by increases in prices or wages as a result of monopoly by Trade unions or oligopolies.
  If productivity increases at an annual rate of 2% and I recieve a raise in wages of 8%, that increase has to come from someone elses disposable income. If companys raise their prices for no reason other then the fact they have the privilage of doing so, this impacts on disposable income as well causing a demand for higer wages and the wage price spiral begins.

  There is also classical inflation,a result of increase in the money supply, too much paper chasing too few goods. Classical inflation can be controlled by guaranteeing that bank loans are backed up by something of intrinsic value, things such as a house or car or capital stock. Bank loans to individuals to fund margin calls, loans that have no wealth backing them up as well as Bank bailouts inflat the money supply, creating counterfit money. Since Fiat money is chiefly a medium of exchange, The counterfit money compromises the integrity of the money supply. As a result, inflation in the money supply in relation to the real tangible wealth in a nation impacts wages and prices also.
  
  .

  The laws of economics are immutable and fixed. They cannot be tampered with without producing negative effects. In particular, the law of supply and demand cannot be conned. The public catches on when there are too many dollars chasing too few goods. I believe it was Keynes who said [ the surest way to destroy a civilization is to destroy its money supply].

  James
  

  Published: November 18, 2008 12:24 PM

• newson

  james:
  "cost-push inflation" doesn't exist. friedman was right: inflation is always a monetary phenomenon. unfortunately the word has come to mean a whole range of the manifestations of the phenomenon. see this, and numerous other refutations on this site:
  http://blog.mises.org/archives/005135.asp

  keynes, supposedly quoting lenin ("the economic consequences of the peace"):

  "Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.
  Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.
  Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

  Published: November 18, 2008 4:22 PM

• peter helbich

  this is vienna austria where it all bagan.
  mozart,menger,mises,hayek etc.

  send this theorem to all your friends and spread it in th internet

  it proofs mathematically that the austria school of econimc is right

  regards peter helbich

  Published: November 18, 2008 6:25 PM

• James

  Newson

  If, the rate of productivity increases 4% and one area of a unionized labor force asks for and recieves a wage increase of 8 % the 4% above the productivity rate has to come from somewhere for it is not backed up by productivity.
  This begins the wage price spirel because Increased prices will reflect this increase and reduce the disposable income of those who consume these products or services. Therefore, those consumers are justified in demanding a similar increase in wages. This is cost push inflation.
  During the nineties the teachers union in Ontario,Canada asked for and recieved an 8% wage increase, an amount not heard of in previous negotiations. The office workers and the janitors soon followed suit. These increases were not caused by the money supply, it was greed.
  In addition, the high increase in oil prices due to the oil embargo by Opec nations during the seventies was not caused by the money supply. It was caused by the oil producing nations who used Western dependancy on oil to not only punish the west for its pro Israel policies but to increase profits as well.
  If these policys were not inflationary what would you call them? Gas prices evidently accelerated, increasing costs to industry and consumers. Other energy sectors soon followed suit as Hydro and natural gas prices increased.
  Monetarism, restricting the money supply forced the west into a long deep recession and

  businesses who wished to expand and create wealth could only do so by borrowing at high interest rates. Monetarism forced the genie of inflation back into the bottle but it came at the cost of a long deep recession in which businesses closed their doors and people were thrown out of work, losing their homes and savings.
  Most of the debt accumulated due to high interest rates that when compounded over several years foisted an onerous debt on the people.An incomes policy restricting wage increases to the rate of productivity and restraint on prices would have served more effeciently.

  Published: November 21, 2008 4:07 PM

• newson

  to james:
  cost-push inflation is a chimera. you're confusing the symptoms of money supply growth with the cause.
  maybe you want to read hazlitt's "what you need to know about inflation" (pdf) available in the literature section.

  "The 1973 OPEC oil hike is often cited as a graphic example of cost-push inflation and the cause of the Western world’s inflationary woes of the 1970s. If this explanation was correct, then the biggest oil importers would have the highest inflation rates. They did not. Germany is wholly dependent on imported oil, as is Japan, yet after the oil hike its inflation rate was 7 per cent while the Japanese rate was 25 per cent; Australia’s inflation rate was 17 per cent, even though it was 75 per cent self-sufficient in oil; America, which imported about 50 per cent of its oil, had a 12 per cent inflation rate; Britain, which had become an oil exporter, laboured under an inflation rate of 25 per cent; Saudi Arabia, the world’s largest oil exporter, had a 35 per cent inflation rate."

  http://www.brookesnews.com/060210inflation.html

  Published: November 21, 2008 5:14 PM

• scott

  As someone above pointed out, I do not think Milton Friedman thought his rule was the end-all. It was simply the best he could come up with in the Federal Reserve system. The main issues with the reserve system is that in the end, it is people who are choosing how much money to print, and therefore, they may print an amount unequal to the actual wealth being produced.

  However, the Gold Standard certainly has its limitations as well, for example, since the gold standard is based on a specific natural resource, there is an upper limit to the total amount which can be produced.

  However, more importantly, I do not think it really addresses the issue of a "bubble" in the economy. Bubbles are created because people incorrectly value commodities OTHER than the currency - such as Credit Default Swaps or Mortgage Backed Securities. Switching to a gold standard does not mean that some people will not be duped into paying too much gold for an over-valued asset.

  Published: December 23, 2008 8:56 AM