Comments (42)

• Current

  As a Brit this reminds me MacAuley's...

  "You know how assiduously those enemies of all order and all property have laboured to deceive the working man into a belief that cheap bread would be a curse to him. Nor have they always laboured in vain. You remember that once, even in this great and enlightened city, a public meeting called to consider the corn laws was disturbed by a deluded populace. Now, for my own part, whenever I hear bigots who are opposed to all reform, and anarchists who are bent on universal destruction, join in the same cry, I feel certain that it is an absurd and mischievous cry; and surely never was there a cry so absurd and mischievous as this cry against cheap loaves"
  

  Published: December 19, 2008 9:07 AM

• N. Joseph Potts

  On December 22, 1947, Henry Hazlitt published the following remark in his column in Newsweek:

  The basic cause of inflation, always and everywhere, lies in the field of money and credit.

  But Friedman and Schwarz probably didn't read Newsweek.

  Published: December 19, 2008 9:56 AM

• Willabus

  N. Joseph Potts,

  How is what Hazlitt wrote different from what Friedman wrote?

  Published: December 19, 2008 10:07 AM

• Brian

  How do the massive amount of off balance sheet transactions and derivatives change the dynamics of money supply and credit? Some suggest that the large amount of these hidden transactions are the real "marginal" driving force for "money" supply. Could this help to explain the seemingly more volatile and shorter lived asset bubbles? Do the existence and heavy use of derivatives minimise the power of the Fed and Central Banks? Do they provide exponential money supply as compared to the past? Does anyone know where to find an analysis that shows off balance sheet transactions and derivatives included in a discussion created around an Austrian framework?

  Published: December 19, 2008 10:08 AM

• KK

  But doesn't socialistic policy and expansion of the monetary base purely affect inflation on a Dollar price basis. Isn't it fair to say, no matter how much Dollars the Central Bank supplies to expand money supply, any pick up in Dollar Prices would be offset by a decline in value of the currency (be it in other countries Currencies or vis-a-vis Gold), but net-net, shouldn't Central Bank actions result in a decrease in standard of living in a global economy

  Published: December 19, 2008 10:10 AM

• greg

  You must understand who sets the price for commodities. It isn't between the wheat farmer and the flour manufacturer, it is set by people trading in the commodity futures markets. To put it in simple terms, it is set by the supply and demand for commodity contracts.

  Look at the rapid increase of prices which cannot be explained by the money supply. It was driven by nothing more than pure speculation as more and more people started to invest in these markets rather than staying in low interest CD's.

  Rule number 1 in commodity investing is "what ever goes up fast, will fall faster". Rule number 2 is to follow rule number 1. The reason the commodity falls faster is simple. The people invested in the futures market deleverage causing the market to fall. Then the people that have the commodity to sell, sees their prices cut and need to sell more to meet their cash requirements which results in further declines. This is what your seeing in the oil market today as you can read about on the front page of the Wall Street Journal and the unrest in Russia.

  What truly makes matters worse is that this fall in oil prices is injecting $600 billion into the market and the government is ignoring it and pushing for further stimulus. Let the declining commodity prices ride and the economy will recover.

  Published: December 19, 2008 11:02 AM

• Henry Meers

  Mr. Bonn does a good job, although I would add money is a price, the intersection of supply and demand for dollars in this case. The concept was easy to see and correct through arbitrage under the classic gold standard, but Volcker totally missed it in the early 'eighties. He was watching the money supply, while those of us in the brokerage business were seeing huge inflows from abroad to take advantage of Reagan's tax cuts and the stronger economy those investors anticipated.

  "Tall Paul" saw the money supply rising as a result and tightened, when he should have"loosened" by monetizing the inflow (almost exactly what Benjamin Strong did to give us the Panic of 20 - 21). Both events were nasty, unnecessary deflations. This is not a trival concept, as Greenspan, the gold guy of 1968 in Fortune, showed by allowing the dollar to rise from $350 an ounce to $250 in 1999.

  The rest of the article explains the fascist tendencies of the New Deal. Nowdays, they call that sort of thing industrial policy, but it remains a way to allow private ownership (so you can pay taxes?) with the government playing favorites. That sort of reasoning prolonged the "Great Depression" and left controls on various parts of the economy until the 1970's. (Rent control lingers in Now York City to this day).

  Published: December 19, 2008 11:04 AM

• Brian

  Greg,

  I agree, especially when you look at the liquid exchange traded futures commodities. However, the run up in "biomass" crops as well as their land values can be attributed to federal energy policy and the climate change initiatives, or was it national security. I forget the exact political excuse.

  What is interesting is that the price rise was more pronounced on the short end of the curve and to a much lesser extent in the outlying expire dates and even less so for those commodities without deep futures markets. From an physical asset view (ag land) as opposed to a securities view (futures), interesting dynamics can be seen. Notably if you break apart the land and the crop for the physical asset view, the land appreciated much more than the crop value for those without biomass hysteria and deep futures markets associated. Why? Negative real rates? Government intervention is boundless in the ag space so it is hard to pinpoint the particulars.

  Published: December 19, 2008 11:39 AM

• Texas Conservative

  Willabus:

  Both Hazlitt (and the Austrians) and Friedman (the monetarists) diagnosed the disease correctly. However, Friedman's prescribed solution was to continue inflating, in a "controlled and responsible" manner. Friedman's faulty assumption is that government is neither controlled nor responsible.

  Deflation gets a really bad rap, not only in the economic press but also in the MSM, universities, business schools, etc. It is portrayed as the cause of the economic bust, when in actuality the bust causes the deflation. Lowering prices is a rational economic response to overinvestment in inventories.

  Published: December 19, 2008 12:20 PM

• greg

  Brian,

  You have to consider that commodity prices reflect supply and demand on a commodity that can see changes in supply within a growing season. Where as land is not subject to supply changes.

  When investing in commodities, it is not so much about the commodity as it is about the people investing in them. A good example is gold, a favorite within the Austrian group. It really has a low industrial or commercial value. But it has a high speculative value to inflation fears. You basically play on the speculator value, not the real value. That is why I posted earlier that gold should be shorted in the $875 to $900 range, and bought in the $700 to $725 range. Basically, play against the trend.

  When the ethanol craze hit, it was more about the people's perception of value than what was real. The result was a run up in corn, increased corn production, fall in oil, fall in corn prices and a bunch of people left out in the cold. The rule of thumb, in futures there are 10% winners and 90% loosers. Again, that is why you don't follow the crowd.

  Published: December 19, 2008 1:03 PM

• Willabus

  Texas Conservative:

  I understand the main the difference between the Austrian and Friedman solutions but not the details. It was only in the last year that I began educating myself on economics and before I could study the detailed theories I knew I had to first grasp the philosophies. So far I have read Capitalism and Freedom, Free to Choose (and watched the entire video series), The Road to Serfdom, The Fatal Conceit, Economics in One Lesson, and I am just finishing up on The Constitution of Liberty. Next I would like to read some of the works of Rothbard and Mises to fully develop my understanding of the philosophy.

  Based on this it is difficult for me to understand the hostility of Austrians towards Friedman as he was in the same philosophical mold as Hayek. The only real difference appears to be in monetary policy. Based on what I know of Friedman I would be hesitant to even call him a monetarist. I believe the monetarists to be old Keynesians that needed something new to believe in and they took what Friedman proposed and turned it into something Friedman would not be for. Ironically this is the same thing that the Socialists did to Keynes! (Keynes himself supposedly admitted to Hayek that his biggest fear was that people would use his theory in a way that it was not meant to be)

  Friedman did not argue that the Depression was caused because the Fed did not inflate enough but that the contraction was caused by the Fed itself for not following the rules of the current gold standard.

  I admit I could be mistaken as I have only read the philosophical works and not the scholarly. I have, however, watched a brief powerpoint by Roger Garrison explaining the overall concepts of Keynesian vs Misean/Hayekian and it amazes me how anyone could still support government spending and inflation as a means to get out of a recession.

  For the first time I feel as if my eyes are truly beginning to open. The unfortunate part about that is I now see how close we are to the end of the road to serfdom.

  Published: December 19, 2008 1:20 PM

• J. Bonn

  I want to make a quick comment to all of you and thank you very much for the kind consideration of my article. I appreciate all the comments, I only wish I had the time to discuss them all.

  I did want to comment on one thing that I thought could bear repeating. Greg made mention that in futures trading there are 10% winners and 90% losers. This speaks to the pyramidal nature of so many "investments" available to people these days. As recent times have borne out, some investments are pure fraud.

  I suppose in the long run of time we can only hope that the public turns a more skeptical eye to both the assurances of the salesman and his government insurer.

  Thanks all, Jeff

  Published: December 19, 2008 4:16 PM

• N. Joseph Potts

  Willabus -

  You've correctly noted the great similarity between what Hazlitt said and what Friedman said. There are two differences between the two utterances:

  (1) Friedman is everywhere and always quoted as the originator of the insight; and

  (2) Hazlitt said it 16 years earlier than Friedman.

  Published: December 19, 2008 7:24 PM

• newson

  having worked as a commodity futures broker, i would put the losers/winners ratio as closer to 95%.
  not to say that most mug punters lose fortunes, just that all of their chips get scooped off the table by the properly capitalized (money management is the number one futures skill) and disciplined few.

  this has nothing to do with pyramiding or any of the other symptoms of our sick monetary regime, it's just that most people are not good at ruthlessly cutting losses and letting profits run. this runs counter to human nature, and explains why the winners are so few.

  Published: December 19, 2008 7:36 PM

• Bennet Cecil

  Fighting deflation is used as another excuse by politicians to spend more taxpayers' money. Politicians cheapen the savings of the successful, transferring some of their savings to others to buy votes. It is an indirect tax. Instead of directly raising tax rates they artificially inflate the price of assets and income.

  Americans want socialism and big government. Voters will continue to elect democrats and republicans who grow the power of the federal government until the system collapses. Savers can resist by emphasizing real assets now in their portfolios and minimizing their exposure to US currency forcing up rates. Purchasers of "safe" 30 year treasury bonds now yielding 2.55% will not feel so safe with their investment once inflation returns. Maybe in 2015 we will be able to purchase 30 year bonds yielding 14% like we could in 1982? Maybe stocks will be down another 40% next year or 2010?
  Investors may get the opportunity of a lifetime.

  Published: December 19, 2008 8:56 PM

• Rasoul Namazi

  Another question from a beginner: you made a reference to the famous dictum of Friedman: Inflation is always and everywhere a monetary phenomenon". I guess its the monetarists fondamental principle, and I know austrians aren't monetarist and they disagree with Friedman. But I dont understand exactly what is the difference between austrian position and monetarism. In other words, why austrians agree with Friedman on this point, and why they disagree with him in general. Any article or text on the subject is highly welcomed. Thanks.

  Published: December 19, 2008 8:58 PM

• P.M.Lawrence

  "...the mercantilist policies of colonial Britain, which forced the British populace to pay the higher prices of British producers, to the boon of the businesses and the pain of the populace".

  That's actually wrong. While Britain was still mercantilist, roughly speaking before the Repeal of the Corn Laws, it worked to the benefit of landlords from higher food prices they could tap through rents, but not to the benefit of food producers and certainly not to the benefit of businesses, who couldn't hire more workers at lower wages and/or still get a customer base with more disposable income while the cost of living remained correspondingly higher. The thing is, in that specialised situation there was a zero sum on food supplies - which meant that any gain to the landlords showed up as less for businesses and others. That's why business ended up in favour of repeal while the landed interests wanted the Corn Laws kept (the others didn't have much of a vote then, so they hardly counted). There were opposing interests.

  Published: December 20, 2008 12:33 AM

• Anon from Oz

  Rasoul Namazi,

  I recently downloaded the following mp3 which is a recording of a lecture delivered by Roger Garrison.

  Althought the topic is the "Great Depression" which is interesting in itself, he also examines differences between the Austrians and Monetarists in explaining the causes of recessions/depressions.

  http://mises.org/multimedia/mp3/MU2007/22-Garrison.mp3

  It was recorded on 1 August 2007, which was actually before the current mess blew up.

  It goes for just under 1 hour, but worthwhile if you are interested in this topic.

  There is also an audio recording of a speech by Murray Rothbard which is a much stronger critique of Milton Friedman and monetarism. This was recorded in 1970:

  http://mises.org/multimedia/mp3/Rothbard-04-21-1970.mp3
  (1:13min)

  Let me know what you think!

  Published: December 20, 2008 3:00 AM

• fundamentalist

  Rasoul Namazi: "...I dont understand exactly what is the difference between austrian position and monetarism."

  Friedman made valuable contributions to Keynesian economics, especially with his monetary theory. Austrians had tried for decades to get Keynesians to take money seriously. But Friedman didn't go far enough, so some of his ideas are actually dangerous. For example, he promoted the idea that the Fed allowed the Great Depression to happen by not pumping enough money into the economy. Austrian econ demonstrates that monetary pumping always damages the economy.

  And Friedman never saw the problems of the boom caused by the Fed's monetary pump. In fact, he claimed there were no booms, only dips from the normal trajectory of economic growth. He pictured economic growth as a straight string trending upwards with occasional dips as if someone pulled the string down in certain places. This is probably one of his most damaging ideas because he gave economists the idea that the Feds never do anything wrong except cause price increases, which are relatively harmless. If the Feds pump vast amounts of new money into the economy, prices rise and that's all. Without Fed created booms, then the economy just falls into a recession because of "shocks" which is another way of saying without explanation. It just happens. Like an old man who just stumbles and falls, the economy needs the Feds to pick it back up, dust it off and send it on its way with massive amounts of monetary pumping. Friedman arrived at his view of the economy by relying completely on Keynesian aggregates like GDP. Had he listened to his Austrian friends, he would have been more skeptical of such aggregates.

  Finally, Friedman never understood capital, so he didn't see the damage that the Fed's monetary pumping does to the capital structure which causes the business cycle.

  Friedman was an excellent friend of liberty most of the time, but his ideas on money only encouraged greater intervention in the marketplace by the Feds and he couldn’t see that contradiction in his own ideas.
  

  Published: December 20, 2008 8:41 AM

• Rasoul Namazi

  Anon from Oz,
  Thanks for links, I'm listening to them.

  fundamentalist,

  Thanks for your explanation. Good summary.

  You guys are great, everytime I have a question, I come here and I find great people and good advices. Thank you again.
  
  

  Published: December 20, 2008 9:56 AM

• Brian

  You all made good points about commodities. My point is that a good portion of the universe of agricultural investments has nothing to do with the publicly traded futures which are absolutely succeptable to the greater fool theory. It seems as though that the more "liquid" the market, the more irrational the pricing and volatility becomes. Even though the same government policies affected both the land and non traded ag's (which are much more difficult to in invest in), the effects were much less volatile and more muted. This leads to the illusion of many investors to believe that the non publicly traded are "non-correlated" which is obviously not true. The pricing non traded ags and land were more a direct function of cheap debt at the project level and the belief that ag provided a better relative yield than real estate and "like kind exchange" federal tax policy. The excess liquidity flows to the highest net yield without much regard for the underlying asset and without regard to any measure of risk. Publicly traded futures were moved by a different, set of criteria. This is similar to the difference between REITs and project level real estate until very recently. I think this says something about time preferences but I am not smart enough to close the loop. Seemingly very similar drivers (ag generally) but very different perceived return drivers.

  Published: December 20, 2008 10:54 AM

• greg

  Brian,

  I am going to close the loop for you. A public traded commodity is very liquid and you can chose an entry and exit point within seconds when the market is open. The non traded commodities, not so much.

  Let me use housing, which is easy for me since I have been a builder. My decision to build a spec home is not based on the current interest rate. My decision is based on my estimated cost and what the market will pay 7 months from the day I start.

  The key here is you are making decisions based on a product selling months in the future. Same with non public traded ag products. The farmer makes his decision to plant a particular crop a good 6 months out.

  The reason interest does not play a part in my decision is simple, all my competition pays the same thing. I spend more time being more efficent than my competitors and selecting the best lots.

  So why the run up in real estate. The answer is simple, it indirectly became a public traded commodity. It was the buying of packaged mortgages that pushed the market forward. Investment firms over leveraged these assets and when they started to collaspe, mass liquidation and here we are today.

  Published: December 20, 2008 6:50 PM

• Brian

  Greg

  Thanks for closing the loop for me. A few points, permanent crops are 25+ year capital investments and are not replanted every 6 months. The on-going decision is whether the land has higher better use and encourages you to tear out the crops and develop or mitigate. Second point is buying debt collateralized by assets (mortgages for real estate) is not (should not be) the same as owning the underlying asset (real estate). However the cost of debt should be a major factor in what someone will pay for an asset 7 months from now (say a spec home). If it is not, then debt is too cheap and the difference between debt and equity or the residual claim disappears. Result is a nominal asset valuation increase that is unsustainable. Additionally when the cost of debt becomes a relevant factor, the buyers for the said assets (spec homes) disappear. This is nothing new.

  The crucial question(s) at the end of the day becomes; are we headed for significant price increases or sustained asset price depression? Additionally, does the federal reserve still impact the direction significantly or does the massive hidden money supply (derivatives and off BS transactions) really determine the ultimate answer. If fractional reserve banking is bad, then derivatives must make the problem much worse and the recovery much farther away???

  Published: December 20, 2008 11:21 PM

• Brian Macker

  Greg,

  The decision to pay a higher price for a house is determined by interest rates. Thus if you are using prices then you are dependent on interest rates.

  Published: December 21, 2008 12:51 AM

• DS

  The key lesson of the Austrian Business Cycle Theory sometimes gets obscured in these discussions of inflation and deflation. And in discussions with most non-Austrians there is a confusion of what the terms inflation and deflation mean.

  The key lesson is not that inflation of the money supply causes prices to rise, it is the fact that monetary inflation causes MAL-INVESTMENTS.

  If the simplistic idea of inflation that most economists assume were true - that inflation is a rise in consumer prices where all prices rise by the same amount over the same period of time - then it would truly be benign as many of them claim. But this is not what happens. Prices rise unevenly and their effects are experienced differently by everyone in the economy.

  For instance, monetary inflation resulted in a huge bubble in commodities, which caused the price of food and gasoline to rise at significant rates. On the flip side, a lot of prices - like those for flatscreen TV's and other imported consumer electronics actually have fallen in price. The price of cars has not even kept up with the CPI over the last 2 decades. It is easy to see that the greeter at Wal-mart would experience a much greater decrease in his standard of living than an IT professional at a Fortune 500 company. Yet the standard, simplistic assumption is that on average these 2 people experience the same consumer inflation rate. Of course that is nonsense. You can follow the same line of reasoning by expanding your definition of inflation to include housing prices and the price of financial assets (like dotcom stocks). Those bubbles were experienced by different groups very differently as well.

  The second part of this - MAL-INVESTMENT - is a more difficult concept, but they are interconnected. The monetary inflation that caused the price of housing to increase at rapid and unsustainable rates caused people to think they had to buy a new bigger house now because the price would continue to go up. Their choice was to buy a new, bigger house now or not be able to afford that new, bigger house later. The monetary expansion allowed lenders to lower their lending standards which allowed more people to rush in and participate - driving house prices even higher. Note - at the same time many consumer prices like computers, cars and flat-screen TV's were declining in price or at least not rising at a rate lower than the CPI (this would cause some liek Alan Greenspan for instance to argue that on average there was no inflation, and act accordingly). This process sent economic signals to home builders that demand for housing was increasing and thus they should accelerate their efforts to build more houses. And since monetary inflation was providing low cost financing to the home builders as well they were able to accelerate the number of houses built.

  But in the end the monetary inflation simply transmitted false signals about the number of houses needed and the price at which would clear the market. When the cheap money stopped and the number of houses exceeded the actual need for them the whole thing crashed. There were way more houses built than needed and the prices crashed, as they continue to do.

  Those houses that were built that are not needed are MAL-INVESTMENT. Until the price of houses decline enough to make those houses affordable all house prices will continue to decline. This is the liquidation phase of the cycle - the one politicians and Fed officials loath and try to do everything they can to prevent.

  Note - the MAL-INVESTMENT process is not uniform either, geographically or by it's effect on different people at different levels of income.

  What this shows clearly is that the government and the central bank cannot "control" the economy using aggregates as their measurements and trying to manipulate large scale changes in the money supply. These things cause incredible MAL-INVESTMENTS which are much worse than the supposed economic outcomes they are trying to defeat. The big falacy is trying to treat the economy as one big deterministic equation where x amount of monetary inflation equals y amount of price inflation and z amount of GDP and employment growth. But it doesn't work that way. The excess money created goes to the path of least resistance, not to the path where the government wants it to go. The government usually wants it to go to the path of most resistance - like pumping money into dead banks on the hope that they will lend it to insolvent people, when too much lending to insolvent people is what got them into trouble in the first place. Instead they have created a treasury bond bubble and driven up the price of gold. Not at all what they wanted - more MAL-INVESTMENT.

  Understanding MAL-INVESTMENT is the key to understanding the ABCT, and understanding what is going on now. Once you understand this concept you will feel like the kid in the movie "The Sixth Sense" - you will see MAL-INVESTMENT everywhere, all of the time.

  Published: December 21, 2008 9:38 AM

• Brian

  Thanks DS, that was very helpful. Do you believe that off balance sheet transactions and certain derivatives create more mal-investment by hiding the true amount of exposure to a particular asset class and therefore sending the wrong supply and demand signals to entrepreneurs?

  Published: December 21, 2008 12:26 PM

• John Hasse

  I have read recently that 7.2 Trillion dollars have disappeared between decreased value of homes, and stocks, and commodities. This seems to be deflationary. To be sure, the fed is cranking up the presses, and soon we WILL have inflation. However, it seems that so far 'money' has been destroyed faster than it has been created. With the continuing malaise, (unemployment, real estate forclosures, etc) it seems quite possible that we could have another serious leg of deflation before the inflation kicks in.

  Published: December 21, 2008 2:07 PM

• Ron Muzzy

  Some years back, in an article in The Walll Street Journal, Milton Friedman called John Maynard Keynes a "great economist."
  Friedman also said that "nobody reads Keynes."
  
  I wonder if anyone reads Ludwig Von Mises' HUMAN ACTION, particularly Chapter XX, Interest, Credit Expansion, and the Trade Cycle.
  
  On Page 554 in HUMAN ACTION, Mises states:

  "A general rise in prices can only occur if there is either a drop in the supply of ALL commodities or an increase in the supply of money."

  (ALL in HUMAN ACTION is italicized.)

  Thus, Friedman's statement that "inflation is always and everywhere a monetary phenomenon," is wrong as stated, although one can agree Friedman's statement is usually the case, a shortage of ALL commodities probably happening only after a war has ravaged a country's industry and food industries.

  On Page 555 of HUMAN ACTION, Mises states the basis of monetary theory:

  The essence of monetary theory is the cognition that cash-induced changes in the money relation affect the various prices, wage rates, and interest rates neither at the same time nor to the same extent.

  READ MISES' HUMAN ACTION, CHAPTER XX, AND UNDERSTAND WHAT IS REALLY HAPPENING IN THE MONEY/ECONOMIC AREA.

  JOHN MAYNARD KEYNES WAS WRONG ON ECONOMIC CAUSE AND EFFECT, AND FRIEDMAN IS CONFUSED ABOUT WHAT IS AND IS NOT MONEY, AND THAT STABLE PRICES SHOULD BE A GOAL OF GOVERNMENT POLICY.

  Published: December 21, 2008 4:42 PM

• DS

  "Thanks DS, that was very helpful. Do you believe that off balance sheet transactions and certain derivatives create more mal-investment by hiding the true amount of exposure to a particular asset class and therefore sending the wrong supply and demand signals to entrepreneurs?"

  All of those things are funded by debt that results from monetary inflation, but derivatives and off-balance sheet transactions are not good or bad in and of themselves. These are symptoms, not causes. They ARE mal-investments.

  Most derivatives are funded by some sort of debt transaction. But the key thing that enabled the hundreds of trillions of dollars of derivatives that are now hanging over everybody's head was the moral hazard created by the governments of the world through their alphabet soup of regulatory agencies, their central banks and their endless ability to tax their citizens. This lead to a false sense of security where everybody believed they'd be bailed out if they got into too much trouble. Absent the moral hazard, nobody in their right mind would ever give their money to somebody operating at 10, 20 or 50 to 1 leverage ratios. But that is what happened with derivatives - otherwise sane people believed that if the thing blew up they would be bailed out - or they just thought they were smarter than everybody else. Or they just assumed that the omnipotent government regulators would never allow such thing to be sold if it wasn't "safe" - so they suspended caveat emptor and their natural disbelief, and instead believed in "something for nothing".

  As for "off balance sheet" transactions - the same moral hazard exists. The regulatory apparatus has set up a system where anybody operating is deemed to have had their balance sheet fully policed, at all times, by the alphabet soup agencies. Of course this is an impossibility.

  The real answer is to get back to the pre-depression way of doing business: a healthy company pays back it's shareholders with a generous and growing dividend as proof of it's economic health, not fickle stock price appreciation. A company can't fake a dividend, at least not for very long, no matter what it's balance sheet looks like. Forcing companies to submit quarterly accounting reports to the public is another form of moral hazard - you can learn 10 times as much about a company by the dividend it pays out to it's shareholders than by how it slices and dices it's accounting numbers. There are literarlly hundreds of different ways to take the same revenues, costs, assets and liabilities and produce a profit number, and none of them are "wrong".

  Again, that whole situation causes enormous mal-investments because people base their investment decisions on these accounting numbers. But trying to blame that on the companies producing the accounting reports is missing the larger issue.

  Published: December 21, 2008 5:26 PM

• newson

  to ron muzzy:
  this is from gary north's "mises on money"

  The latest and by far the simplest statement by Mises regarding his definition of inflation was made at a seminar sponsored by the University of Chicago Law School in 1951.
  "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.)

  Published: December 21, 2008 6:28 PM

• Mikebrah

  DS,

  Thanks for the comments. Very informative.

  A question to you (and everyone):

  The flipside to mal-investment is under-investment, right? Won't the artificial stimulation which lead to mal-investment in one sector (housing) lead to under-investments in areas that need it (commodities/metals exploration and production)?

  The same confusion that caused people to over-extend on the upside is now causing everyone to retreat from all asset classes into cash and treasuries (as you mentioned) irrespective of the merit of the asset itself. This explains why all hard assets are dropping but Treasuries, and even the $US are rising.

  At some point this will lead to a violent whipsaw. The dramatic increase in money supply, combined with the recent halt of capital expenditures (especially for oil, metals, etc.) will lead to an inflection point at some unknown date with drastically higher prices.

  Does this logic make sense or am I being too simple?

  Thanks to all.

  Published: December 22, 2008 3:17 PM

• gene

  I think you are probably right. In a sense the hoarding or overly cautious investing becomes pent up demand. When it turns to splurging or as you say mal-investing, inflation could go atmospheric. Is it possibly a sort of equation, deduct paper losses and add fed injections? when the injections are substantially over the losses and the velocity begins to increase the monetary values will again shoot up. The money is so detached from actual value it is hard to come up with anything concrete. By the way, great article. Deflation is actually the great equity builder of the masses of working people!

  Published: December 22, 2008 4:10 PM

• DS

  Mikebra,

  "over" investment and "under" investment are BOTH mal-investments - the term refers to both cases generically because they are both damaging to the long run health of the economy. In a sense, for every over investment there is a corresponding under investment (it's not quite that simple, though).

  Using this logic you can easily work through a thought experiment where monetary expansion lead to over-investment in the dotcom bubble and, at least partially, caused of the textlie industry to suffer from under-investment and eventually moved off-shore (there are lots of reasons but mal-investment was certainly a contributing factor). Or select any other economic distortion and think it through.

  Published: December 23, 2008 1:56 PM

• gene

  But doesn't the problem originate not from these mal-investments you speak of but the lack of a governor or system of checks and balances. If interest can determine its own level rather than be determined by policy, investments are brought into line by reward and punishment, right? of course, its not entirely that simple, but the ability of the marketplace to determine interest will guide investors to the best place for capital. i am not only referring to the fed setting of interest rates but the injection of currency usually directly to those beside the fed, who have influence over the rates. The dilution that occurs from this policy would certainly seem to cause mal-investment, since profits can occur that don't necessarily have much to do with productivity. in a sense it is earning interest on money simply for its own sake rather than interest because the money represents capital. a ponzi scheme based on the money itself. is this logic out of line with what has been happening?

  Published: December 23, 2008 2:26 PM

• Gerry Flaychy

  It appears to me that behind the words mal-investment and inflation, are hidden the words mal-distribution of the money: relatively too much money in the banking and financial system, and not enough money in the salaries of the working class, i.e. for a same amount of money supply, whatever this amount.

  Thus, more we increase the money supply, more we increase the discrepancy, and more we approach the breaking point.

  Published: December 24, 2008 10:17 PM

• Gerry Flaychy

  It appears to me that behind the words mal-investment and inflation, are hidden the words mal-distribution of the money: relatively too much money in the banking and financial system, and not enough money in the salaries of the working class, i.e. for a same amount of money supply, whatever this amount.

  Thus, more we increase the money supply, more we increase the discrepancy, and more we approach the breaking point.

  Published: December 24, 2008 10:19 PM

• Stephen Grossman

  Richard Salsman's 1996 "Philosophical State of Economics" (Ayn Rand Books) is an excellent discussion of the basics of the main academic schools of economics. He condemns Friedman as a skeptic, consumptionist, and advocate of socialist/inflationist banking.

  Published: December 25, 2008 2:28 PM

• Stephen Grossman

  Science is the observation-based, inductive, rationally systematic study of reality. It is not arbitrary hypotheses, definitions, measurements, experiments, descriptions, interpretations and policy recommendations for the next few moments. By this standard, mainstream economists are mere technicians, not scientists. The purpose of their techniques (they are not really theories, ie, systematic explanations) is consumption, equality and state control of the individual. In this context and no other, they are competent. Please do not consider such creatures as Bernanke and Krugman as scientists.

  Published: December 25, 2008 2:50 PM

• A. Viirlaid

  I have not read his original article -- but Mr. Cooper must be joking.

  Jeff Bonn writes "Mr. Cooper likens deflation to an economic ill of the most terminal variety."

  Jeff says "He [Mr. Cooper] goes on to blame this contagion for a real increase in the cost of credit."

  Mr Cooper: "Deflation is an economic disease caused by a sustained drop in overall demand and falling prices that forces business to cut prices ever deeper."

  Mr. Cooper: this is "the opposite of what monetary policy needs to do to combat falling demand."

  Right, I get it.

  We should get the FED to inject more liquidity into the system (monetary inflation).
  Then we get the FED to lower short-term interest rates to the bare minimum.
  Then we get the FED to buy up all long-term Treasury Bonds that are being offered in the marketplace to keep the imputed yield/rate (in that term-class bond price) to be no higher than say, 2.5%. Sure, this might take 100-s of billions, even a trillion of newly-printed "cash" but, hey we gotta keep things "liquid".

  Now, that should support consumer prices at a "higher" level --- what that might be, who knows, But Mr. Cooper knows. Just like the Climate guys who know what the optimum 'average' global temperature should be.

  So much Social Engineering to be done --- so little time.

  After all that, I turn back to studying my Economics 101 notes on Demand-Supply curves showing how pricing behaves against demand.

  Wait a minute!?

  My notes say that if I lower prices, consumer demand goes UP.

  What gives here, Mr. Cooper?

  I guess you want us to keep prices higher to reduce consumer demand?

  Do I have that right?

  Published: December 26, 2008 1:07 AM

• Gerry Flaychy

  "My notes say that if I lower prices, consumer demand goes UP." A. Viirlaid

  Don't your notes say too "...if nothing else is changed" ? Does your notes say that it is only for a certain good in particular, or for all the goods and services in the same time ?

  What does your notes say for the case that you are lowering all the prices, at the same time that the money supply is lowered, say 10% each: what happens then to the consumer demand ? Does it still goes up ?

  Published: December 26, 2008 9:35 AM

• A. Viirlaid

  Hi Gerry Flaychy, and thank you for your questions.

  1) "...if nothing else is changed"

  At the moment you shift the curve(s), nothing else has changed. So if I drop one price or all prices, demand will go up. Of course this is pedagogical technique --- I understand that.

  In the real world things happen in very small increments. They happen in a continuum. The natural world is continuous, analogue, not digital, except in our descriptions and futile attempts at modelling the natural world on digital computers, where we naturally have to use numbers to describe the natural world.

  2) "at the same time that the money supply is lowered, say 10% each: what happens then to the consumer demand ?"

  Do you mean the overall money supply? The money supply in the hands of consumers? The money supply at the non-lending retail banks? You have to describe the mechanism by which the money supply "drops".

  Do 10,000 retail banks fail tomorrow, for example, à la the 1930-s? Is there no FDIC to reimburse the losses of the depositors? Over what period of time? Somehow, "auto-magically"? Just "pedagogically"?

  For a moment, let’s look at the opposite example.

  If the FED creates or threatens to create sufficient pain, à la Zimbabwean hyper-inflation, by increasing money supply, which in effect is a tax on the consumers' money supply, the consumer class will dump their soon-to-be-worthless paper money. So demand will go to the moon. Of course the FED is not that stupid --- but you can read more from Ben Bernanke on “Deflation: Making Sure "It" Doesn't Happen Here” at http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021121/default.htm

  Of course, theoretically, the FED could make goods disappear from the shelves also à la Zimbabwe. Also no goods will replace those on the shelves because we will have no one who can make a proper return via that exchange medium. Intermediation will be provided underground or by barter. Pay for your coffee as you order because the price will double by the time you get up to leave the café.

  If the opposite happens, over some time, that you have not specified, then presumably (the consensus-thinking goes) the opposite would happen. But this deflation needs time to set in. Presumably some items fall in price first. Presumably they don’t fall too much.

  So sure, there will be always be those consumers that wait for the Thanksgiving Black Friday sales before they buy. Or post-Christmas January half-price sales.

  But my scenario for deflation is not the 1930-s kind. Not of the same degree (unless you can provide me with a plausible scenario).

  Dr. Ben Bernanke at the FED seems to be pre-emptively fighting a war against (price) Deflation as though this was 1929 or 1930. To do so without any evidence is foolhardy and terribly wasteful. IMO. And this is what I think you are alluding to.

  That’s what Greenspan was fighting in 2002 “in his mind”.

  Look at what it brought us to.

  My take on this is more benign. I also don’t happen to buy into the consensus-group-think that says (price) Deflation is the mirror-opposite of (price) Inflation. If it were, then of course ALL the mechanisms to AVOID (the so-called terrible disease of price) Deflation by creating price Inflation would apply.

  That is, if you could “cure” Deflation with Inflation, then by all means use all the tools you have to create Inflation.
  But this is a horrible mistake IMO that we have made since the ‘lessons’ of the Great Depression were supposedly learned. Because Deflation while appearing to be the opposite to Inflation, is not subject to being ‘cured’ by artificially creating Inflation.

  Jeff Bonn says that the chances of price deflation are remote: “It is nearly impossible for a broad sustained drop in prices to occur while the federal government is bringing about one socialist policy after another, spending on the public's credit to no good end and wildly expanding the money supply”

  One thing my notes do say is this. If you inflate the money supply, you will get price inflation, sometime, somewhere. So the correct answer is, yes if you REALLY auto-magically, by tomorrow, make everyone’s cash in hand (including amounts in the bank, so as to qualify as your ‘money supply’) reduce by a factor of 2, something will happen to prices.

  So if everyone had $100 today when they went to sleep, and tomorrow had only $50, then all prices should also, by sometime tomorrow, assuming our academic example, in the narrow pedagogical sense, given truly efficient markets, perfect information, and light-speed delivery of that information to all corners of the state ---- yes, all prices would now be one-half of what they were yesterday when we all went to sleep.

  But how would demand be affected? Shouldn’t be, should it? “All other things being the same” of course.

  Presumably none of our basic needs have changed. Nor our wants and desires.

  Presumably I am going to be as hungry as I would have been if nothing had changed. My desire or need for a car is the same. For gasoline, for clothing, for shelter.

  What, in our example, has changed? So you ask with your more benign example of 10%.

  My answer is the same. Since not all the academic conditions exist in the real world, of course it will take time for the price levels to adjust. But adjust they will. Unless these pending adjustments are short-circuited by a overly-eager, overly-concerned, overly-confident (in its own knowledge and lack of fear of using ‘easy money’ from its wonderful modern invention the MPP = Money Printing Press) Federal Reserve Board.

  IMO the logical fallacy that Bernanke’s essay also makes about what he refers to as Deflation is that we have a “cure” and that we need a “cure”.

  The cure may be needed but it is not Deflation we are fighting. Deflation is a symptom, a manifestation, of falling Aggregate Demand. That is a whole other ball of wax.

  What in a very short-handed way I was trying to say yesterday, was that the solution for our dear Doctor Ben is not to be found by rigging the price levels across the economy.

  And, yes, if you increase prices, moderately, which is the only thing that a prudent FED would do, you do run the real risk of REDUCING OVERALL DEMAND, which of course Bernanke does not want to do.

  We fortunately don’t have a Dr. Robert Mugabe = "ZIMBABWE is MINE!!!" running our Federal Reserve or our other Central Banks here in the WEST --- he is too busy running his own country into the ground.

  Please see http://www.theage.com.au/world/zimbabwe-is-mine-says-mugabe-20081220-72nx.html
  

  Published: December 26, 2008 2:12 PM

• Ama Abban

  i want an insight on cost and revenue curves in economics

  Published: November 11, 2009 4:31 AM