Chicagoites as confused as ever
Bloomberg runs a long and interesting report this morning on the disarray that Chicago school economists find themselves in as a result of the current financial crisis.
The article explains that "For half a century, Chicago's hands-off principles have permeated financial thinking and shaped global markets." But today, "once ascendant free-market acolytes are finding themselves in an unusual role: They're battling a wave of government intervention more sweeping than any since the Great Depression as the U.S. struggles with the worst recession in seven decades." So much so that many Chicagoites are now rediscovering the virtues of government regulation and bailouts and are parting with their "free-market" colleagues. Or is this really what's going on?
The piece begins with the story of economics professor John Cochrane, who was so infuriated by Henry Paulson's first $700-billion bailout proposal in September that he launched a petition attacking it that eventually collected the signatures of 230 economists from across the U.S.
Cochrane explains that "a rash of bailouts will expand government and kill entrepreneurship." True enough. But that's the "fiscal stimulus" aspect of all the government intervention that has been taking place for the past couple of months. What about the "monetary stimulus" side of it? That's where the free-market principles go out the window in typical Chicago fashion:
Cochrane says he was encouraged by the Fed's Dec. 16 rate cut and its plan to buy mortgage-backed securities, saying these moves will help unfreeze capital markets.
"This is exactly the right thing for a central bank to be doing in the midst of a credit crunch," he says.
So, from the perspective of what we could call the "right wing" of the Chicago school, it's bad economics when the executive and legislative branches of the governement throw money at failing sectors. But when it's bureaucrats from a governement monetary planning agency who do it with counterfeit money, no problem, that's the right free-market thing to do!
This stance is not very surprising of course, considering that Milton Friedman supported government control over money (albeit under the helm of the Treasury instead of the Fed, which he wanted abolished) and inflationary policies (he wanted a stable and modest increase of fiat money in normal times, and big increases during periods of crisis).
That's still too much free market for some Chicagoites who now find themselves on the "left wing" of the school. Robert Lucas, who
won a Nobel in 1995 for a theory that argued against governments trying to fine-tune consumer demand, says deregulation may have gone too far.
Depression-era laws that separated commercial and investment banks helped depositors decide if they wanted secure accounts or riskier investments. Today, without these distinctions, people can't be sure if their investments, or those of their customers, are safe.
"I'm changing my views on bank regulation every week," Lucas, 71, says. "It was an area I saw as under control. Now I don't believe that."
Let's ignore the fact that a 71-year-old economist who won the Nobel Prize can still change his views every week on bank regulation. One would think he would have found a stable theoretical framework to think this through by this time―monetarism has obviously not been very helpful. Note instead the interesting reason he gives for his new scepticism: when they put their money in a bank, depositors cannot know if their money is in a secure account or in a risky investment.
Isn't this one of the fundamental problems with the current banking system, that is, fractional reserves? You think your money is there and you can retrieve it at any time, but the bank only keeps a fraction of it in its vaults and has lent most of it to someone else. Austrians and others before them have been saying for centuries that this was a sort of fraud that led to unsustainable leveraging and to booms and busts. Mr. Lucas is right to see that there is something wrong here. He just hasn't found a good explanation of why and what should be done about it, and so he adopts the default position of confused free-marketeers, which is that more regulation must be the answer.
The article tells us about another left-wing Chicagoite, Douglas Diamond, who refused to sign the petition against Paulson's bailout because he believes governments have no choice but to provide safety nets for banks and tougher oversight. Again, the explanation given by the finance professor for parting with his colleagues is quite interesting:
Diamond began studying bank failures when he was a doctoral student at Yale in the 1970s. The 1963 book that Friedman wrote with Anna Schwartz, "A Monetary History of the United States, 1867- 1960," provided the foundation. A copy, held together by Scotch tape, sits on Diamond's desk, even though he concluded at Yale that a main premise was wrong.
Diamond rejects Friedman's view that banks failed in the 1930s because the U.S. money supply contracted as panicky Americans started hoarding cash and the Fed reacted too slowly. Diamond sees the money supply as less significant than Friedman did.
Banks failed, he says, because their assets weren't readily converted into the cash that depositors were demanding.
Is it just me or do I see a pattern here? There is no explicit mention of it, but just like Mr. Lucas, Mr. Diamond seems to have realized that the fractional reserve system (that's what the last sentence is referring to) is a crucial part of the problem. His solution however (if his views are correctly reported in the article) is to have governments impose even more regulation on the banking system and to intervene to save it when it is on the verge of collapse. When it's precisely because governments control the monetary system, condone banking fraud and constantly save banks from the consequences of their fraudulent practices that we have this problem.
Chicago school economics is in such a mess that it's hard to decide who we, as Austrians, should sympathize with: the inflationists who are still claiming to defend free-market principles, or those going over all the way to the interventionist side but who may be doing it on the basis of a legitimate preoccupation with the fractional reserve system.
One can't help but agree with arch-Keynesian James Galbraith, who is quoted in this article as saying that "The inability of Friedman's successors to say anything useful about what's happening in financial markets today means their influence is finished."
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Comments (122)
Comments (122)
Garetz
...interesting blog discussion, same subject:
http://www.ritholtz.com/blog/2008/12/chicago-repudiation/
"From the efficient-market theories, to the concept of man as rational profit maximizers, much of the edifice that is was the Chicago school of economics is based on a foundation that is false, disproven or otherwise questionable."
Published: December 23, 2008 5:49 PM
Jeff
I'm relatively new to Austrian economics, but please tell me what would replace fractional reserve banking. If savers want a return on their excess cash, they will have to place it with some type of financial intermediary. The intermediary puts the cash to work by lending it to businesses and others who are willing to pay a rate of interest to use that cash. The intermediary keeps only a fraction of the cash as a reserve for the liquidity demands of the original savers. If Austrians forbid banks from doing this, then some other kind of fractional reserve "non-bank" financial intermediary would spring up in its place. What alternative mechanism have Austrians proposed to meet the cash flow needs of businesses and consumers?
Published: December 23, 2008 7:57 PM
Phil
While still a novice at Austrian economics, I think the possible demise of the Chicago school can't really be a good thing for America. I understand their inherent mistakes in reasoning, but what will fill their void? More Keynesians?
Published: December 23, 2008 8:37 PM
Brent
Jeff,
If the bank is going to lend out customers' money to others, it should explicitly state that fact to consumers who are depositing their money with the bank.
Without fractional reserve banking, you'd see more money go into non-demand deposit accounts, such as savings accounts and certificates of deposit.
Short of abolishing fractional reserve banking in favor of 100% reserve banking, Austrians support getting rid of the central bank and allowing "free banking", which would reduce the ability for banks to create fiduciary media (inflate) because that the means to keep the cartel behavior going (i.e., the fed reserve) would be removed.
Published: December 23, 2008 8:37 PM
Bruce Koerber
Empiricism is always on the verge of becoming whatever the interpreter of the data wants to make it, which explains why the rhetoric of empiricists range from 'free market' to social planning to the nth degree.
In other words, whatever the empiricists claim (their perspective) is exactly what their data 'means.' Friedman was 'free market' because he interpreted his data from that perspective.
As perspectives change, most notably in search for money to sustain themselves as professional economists, so miraculously does the interpretation of the data change.
Empiricists seek data not truth. The laws of human action are not points of data which means that the empiricists cannot fathom a priori economic laws.
These laws do not change with the wind, or because of political correctness, or because of the financial control of the academia by the unConstitutional coup.
The 'free market' is not just the rhetoric of the likes of the Chicago School type empirical economists. In fact empirical economics is incompatible with free market economics since the market is only free when its subjectivism is wholly respected.
There is only one true free market philosophy and that is classical liberalism. All of the perversions of the free market that are being passed off as 'free market' are fraudulent.
We need to separate ourselves from the duplicitous empiricists and expose their methodology as erroneous. We need to counteract the propaganda of the unConstitutional coup.
Published: December 23, 2008 8:39 PM
Curtis Zwick
It is the difference between demand deposits and investment. There is nothing at all wrong will depositing with an institution that will invest your deposit and pay you interest for a given time frame. You would know your money is being used for investment and cannot be withdrawn at any time of your choosing, and you would be paid accordingly. Under fractional reserve banking supposedly your money is actually yours and can be withdrawn at any time. In reality they do not even have your money while pretending they do. It is the difference between fraud on the one hand, and a voluntary arrangement on the other.
A poor explanation but check out Rothbards "The Case Against The Fed" for a much better one. It is a short book and well worth the time.
Published: December 23, 2008 8:50 PM
Justin
I don't see why, from an Austrian point of view, fractional reserve should be banned. So long as the bank discloses the fraction held in reserve there is no fraud. 100 % reserves would have lower risk and lower returns. Those who lose their money in bank runs would be those who took the higher risk in hopes of a higher return.
Published: December 23, 2008 9:44 PM
Justin
I don't see why, from an Austrian point of view, fractional reserve should be banned. So long as the bank discloses the fraction held in reserve there is no fraud. 100 % reserves would have lower risk and lower returns. Those who lose their money in bank runs would be those who took the higher risk in hopes of a higher return.
Published: December 23, 2008 9:44 PM
Curtis Zwick
"Those who lose their money in bank runs would be those who took the higher risk in hopes of a higher return. "
I don't know about "Austrians" but I wouldn't argue that only holding a fraction of deposits as reserves is in itself fraudulent or should be banned. If, as you say, customers deposit with institutions that openly practice it in hopes of higher returns and accept the risk of losing those deposits. But this is not the case under the current system. As far as I am concerned it is the institutionalized, and yes, fraudulent, Federal Reserve backing that is the problem. It is backed by a promise that your money is there when it is not. When they need to fire up the printing presses, thereby devaluing all of our dollar denominated holdings, in order to keep that promise, which is indeed the case, then it is fraud. They have stolen my, and indeed everyones, purchasing power when I never agreed to assume any of that risk.
If you want to deposit your money with a bank that only holds a fraction of your deposit in exchange for higher returns, by all means do so, but keep me out of it.
Published: December 23, 2008 11:00 PM
Brent
"I don't see why, from an Austrian point of view, fractional reserve should be banned. So long as the bank discloses the fraction held in reserve there is no fraud. 100 % reserves would have lower risk and lower returns. Those who lose their money in bank runs would be those who took the higher risk in hopes of a higher return." -Justin
No one really disagrees with that, Justin. In today's mess, though, the banks don't disclose the risks they are taking by making loans to their demand deposit customers. Moreover, the central bank makes it possible (and necessary) for the banks to reduce their reserve ratio beyond what they could in a free market (without the central bank).
Austrians (at least quite a few of them) point out that the banks are currently promising every customer immediate withdrawal rights to every dollar in every checking account, as if checking accounts are risk-free. These contracts are, of course, impossible for the banks to honor if even a small minority of account holders exercise their rights within a short period of time.
Published: December 24, 2008 1:00 AM
J Cortez
Justin said: I don't see why, from an Austrian point of view, fractional reserve should be banned. So long as the bank discloses the fraction held in reserve there is no fraud. 100 % reserves would have lower risk and lower returns.
I think Rothbard spoke about this in regards to CDs and money market accounts. Since there is disclosure and these accounts aren't checking demand accounts, it was acceptable to him but I can't say that with much conviction as it's late and my brain is soft. (If I am incorrect, somebody please post something.)
Somebody correct me if I'm wrong, I thought there were a few free banking advocates that were Austrians?
Published: December 24, 2008 2:32 AM
Inquisitor
As long as there is full disclosure, FRB is fine. Commodity money is the most likely system to arise even then with near full backing. Loans can still be made out of time deposits or other bank funds. It's not as though these will cease to exist. And yes, credit cards or banknotes representing gold are perfectly possible.
Published: December 24, 2008 3:25 AM
David
I think it is quite interesting that until the early sixties term lending was hardly known in UK banking and mortgages were the province of the building societies.
The American banks entering London changed all this and then later, the derugulation of the building societies allowed banks to enter the mortgage market.
Most deposits until then were either on a short tenor or at sight and almost all lending was by overdraft repayable on demand.
It was not perfect, but it worked and so long as the relationship between lender and borrower remained good it left the banking system in a far sounder state.
Published: December 24, 2008 3:47 AM
Inquisitor
BTW I thought Lucas was one of the good guys! One must wonder if Galbraith is hoisted by his own petard, though.
(to minarchists: you look just as bad on defence as Chicagoans do on banking... :) )
Published: December 24, 2008 4:11 AM
ktibuk
FRB can not work in the free market because as soon as all the information is disclosed the checks (or money substitutes) of the FRB banks would be traded at a discount.
Imagine you have a checking account at a bank that fully discloses its FRB practice. This means if a bank run happens there is a risk that you can not get all you money from your checking account. You may be fine with this (maybe because you get some money out of it), but the people who would accept you checks would be also assume the same risk and most probably they would demand a discount on your check. Also the discount would be close to the fraction of the banks reserves. If the banks creates 10 times more money by 10% reserve ratio all the checks from that banks would be traded at a discount close to 90%.
I don't think this would happen in a free market. Not widespread anyways.
Published: December 24, 2008 4:33 AM
scineram
There was no such discount, because arbitrage opportunities would drive down the difference to zero.
Published: December 24, 2008 5:38 AM
DS
"...interesting blog discussion, same subject:
http://www.ritholtz.com/blog/2008/12/chicago-repudiation/ "
If you read the whole thing it is a sad, pathetic attempt to substitute Keynsian, big government, omnipotent regulationism for Chicago style Central bank manipulated capitalism. A distinction begging for a difference.
Just a side note, there is a lot of dicussion on that thread about the word "rational" and "irrational" - which I think is an unfortunate term that is used in economics. Most economists when they use the word "irrational" essentially mean any action that doesn't conform to their already formulated economic theories. It's a circular argument in a closed system. The fact that people sometimes act "irrationally" is used as the reason for goverment regulation - as if government, the politicians that pass the laws and the bureaucrats that run the system have some sort of super-human ability to be rational - and omnipotent.
What is supposed to happen in any intellectual pursuit when reality doesn't fit theory is to re-look at the theory and try to come up with a new theory that explains ALL of the real evidence. Instead, economists take anything that doesn't fit into their theories and throw it in a bucket and call it "irrational".
Published: December 24, 2008 7:34 AM
newson
jeff says:
"If Austrians forbid banks from doing this, then some other kind of fractional reserve "non-bank" financial intermediary would spring up in its place. What alternative mechanism have Austrians proposed to meet the cash flow needs of businesses and consumers?"
i think if your vehicle were correctly labeled as a hedge fund, or mutual fund, it would attract a different clientelle to the bank customer. in order that no deliberate misrepresentation occurs (this is the "fraud" that many austrians refer to), it's necessary that the word bank "deposit" or "current account" really reflect the economic reality, which is not the case under frb.
banks would not be precluded from the intermediation game, matching off term-investors with term-borrowers, but this has no effect on money supply, and also encourages matching of maturities, lessening the risk of catastrophic failure.
Published: December 24, 2008 8:06 AM
newson
inquisitor says:
"As long as there is full disclosure, FRB is fine"
first, if you defend this position, does this not mean you are comfortable with fraud in warehousing for commodities other than money?
second, what is "full disclosure"? reserves presumably would vary depending on each banks tolerance for risk, and may also change over time within the same institution (this would be consistent with market competition).
if you're going to police the disclosure aspect, or have legal avenues open to losing depositors, why not go the whole hog and proscribe frb?
i'm interested in why your thoughts on this point diverge from other anarchists like hoppe or rothbard.
Published: December 24, 2008 8:29 AM
Inquisitor
How on earth can there be fraud if the bank alerts its clients what it is doing with the money? Sorry, they have no reason to complain if they sign such a contract. This may be impracticable for various reasons (e.g. other banks redeeming claims) but it's not immoral from an a priori perspective.
Published: December 24, 2008 9:39 AM
fundamentalist
jeff : "If Austrians forbid banks from doing this, then some other kind of fractional reserve "non-bank" financial intermediary would spring up in its place. What alternative mechanism have Austrians proposed to meet the cash flow needs of businesses and consumers?"
Hayek had a different attitude toward fractional bankin in his “Monetary Theory and Trade Cycles.” That is one of the best short explanations of how banking works. His attitude is that fractional banking has been around for centuries and has the support of the majority of economists and business people because they don’t understand economics. So instead of tilting at windmills, we should spend our time explaining how it works so they can avoid the pitfalls.
And you're right that if fractional banking were outlawed other forms of fractional banking would pop up. De Soto gives the example of life insurance as a form of fractional banking. Like trafficking in drugs, there is too much money to be made in fractional banking to keep people from doing it. The only real option is free banking, but good luck on that. The majority of people worship the state and insist on it controlling everything. They'll never allow free banking because they trust their state far, far more than they trust bankers. That's why they're calling for greater regulation.
Poor Uncle Miltie. He had the zealousness for free markets without the necessary knowledge. His support appears to have been empirically based (they work) rather than theory based. As a result, the crisis caught his followers unaware as much as it did Keynesians. Neither have an explanation or a remedy. Unfortunately, the beating the monetarist and Keyensians are taking could consume Austrian reputations as well.
Published: December 24, 2008 10:03 AM
Andras
I think it is time to reconsider the Real Bill "doctrine". I know it is hard for Austrians but it is still not too late.
Published: December 24, 2008 10:14 AM
fundamentalist
Andras, the Fed has always followed the RBD and still is.
If anyone wants a quick intro to banking economics, I highly recommend Hayek's "Monetary Theory and the Trade Cycle."
Published: December 24, 2008 10:28 AM
Brian Macker
"How on earth can there be fraud if the bank alerts its clients what it is doing with the money?"
Banknotes end up in general circulation and they can't properly notify the non-clients. In fact, historically they have improperly informed their own clients as to the full repercussions of their actions. Also the banknotes have misrepresentations on them that make it so they are able to circulate.
If a bank is only holding 4% reserves then the note should state not that it is a note for "One Ounce of Gold". What it should state is that it is a immediate claim against at most 1/25 tho of an ounce of gold with a payment possibility of up to twenty five times as much. It's a kind of lottery ticket that if enough people try to redeem at once will break the bank.
It's a sophisticated enough fraudulent scheme that most people, even when it's explained to them, don't get it.
There is no reason that we have to allow fraudulent schemes. The rules of Pyramid schemes is apparent when you join them. What is not apparent is why it's an invalid contract to begin with. Essentially the contract states: "I, Mr. B, will pay Mr. A and will receive nothing from him other than the the opportunity to cheat Mr. C, directly, or some sucker that Mr. C gets to join the scheme."
Many people are just not sophisticated enough to understand why pyramid schemes are fraudulent, and the associated contracts invalid, because the contract involves the assumption of the existence of third party chumps. In the case of the pyramid scheme and infinite supply of chumps. Because chumps are not in infinite supply it is impossible to deliver on the terms of the contract.
My understanding is that for a contract to be valid it must be possible for the parties involved to execute the terms of the contract. They must also actually deliver on those terms. Mr. A the inventor of the pyramid scheme contract cannot do so. This is true of all pyramid contracts, and therefore it is valid to outlaw them.
One can also claim that a contract is invalid if one of the parties is incompetent to sign it. If you think that a pyramid scheme is an investment then it is pretty clear that you are incompetent to sign it. If on the other hand you understand that the nature of the contract is really to find someone else to cheat then it is invalid on the grounds that it is founded on criminal behavior.
I think that it is the very nature of current fractional reserve banking that the very signing of the contract, or acceptance of the banknote as equivalent to the normally stated amount of money, does indeed show that the person signing or accepting truly does not understand the terms of the contract, or the nature of the banknote.
That doesn't mean an honest form of fractional reserve banking couldn't be created. It's just that such a system probably would NOT be very successful in the market.
Someone is far more likely to accept a bank note that has printed in large letters "One Dollar, This Note Immediately Entitles the Bearer to One Ounce of Silver" than one that has printed in bold letters "1/20 Dollar Fractional Reserve Note. This Note Immediately Entitles the Bearer to 1/20 of an Ounce of Silver with the additional potential for payment of 19/20ths of an Ounce of Silver Over the Next Fifteen Years if Our Investments Pan Out. We May, At Our Discretion, Pay a Full Ounce of Silver Immediately but Doing So Increases the Likelihood that We Will Go Bankrupt and You Will Get Only the Smaller Fraction or Potentially Nothing."
The latter wording makes it clear that the majority of the note is not really backed by any actual silver, and should not be accepted at par value with silver.
With honest fractional reserve contracts and notes the holding of 1/20th reserves would not tend to increase the money supply by 20 times. People would view the notes for what they are, lottery tickets, and therefore value them lower. Prices in the underlying Commodity Money would be much higher than prices in the fractional reserve notes.
Thus you wouldn't get the fractional reserve price inflation associated with the lowering of fractional reserve levels. As reserve levels dropped from 1/2 to 1/20th of deposit there would be inflation in the prices of the bank notes, not in terms of the commodity money.
The fraud would truly be out in the open and therefore no one would be tricked by it. Banks having reserves at 50% would have half ounce notes, and banks running with 4% reserves would have 1/25th ounce notes. Their face value would more closely represent the actual backing, and would do so in a mathematically rigorous way.
A note backed by 50% reserves and one backed by 4% reserves are truly not the same, and to print "One Dollar" or "One Ounce" on both is deceptive to say the least.
Published: December 24, 2008 11:07 AM
Inquisitor
Simple solution: don't accept notes issued by banks that do not back their reserves 100%. As long as it is made clear to 3rd parties that the bank engages in FRB, there is no problem. I agree this form of banking will likely fail, though.
Published: December 24, 2008 11:15 AM
Andras
Fundamentalist: "the Fed has always followed the RBD (Real Bill Doctrine) and still is."
How could you say that? When does the FED retired debt after 90 days? How does the FED comes into the RBD picture after all? Where are legal tender laws in RBD?
The comments went to discuss pure gold standard vs. FRB, the reason I dared to mention RBD.
Let's clarify: I am talking about Fekete's proposals.
I know he is (I am) a heretic. This might be not the right place to discuss this. But in a dark room, behind shades and alone you may still consider it.
Published: December 24, 2008 11:18 AM
Inquisitor
Reconcile RBD with the ABCT, and I'll consider it. That's the litmus test.
Published: December 24, 2008 11:39 AM
J Cortez
Brian Macker,
George Selgin, who wrote a book recently (called Good Money) on private coinage, has had a few things to say about fractional reserves and free banking.
Here's a interview with Russ Roberts:
http://www.econtalk.org/archives/2008/11/selgin_on_free.html
It's very interesting. I don't like the idea of fractional reserves but can see how the system he proposes could work. But I agree with him that the market would keep everything in check.
Selgin mentioned in a historical example of Scottish free banking, Scottish banks had to keep watch on what they did. Bank A loans out X amount of money and creates Y amount of notes. Banks B, C and D receive the notes after they've circulated through the system and come looking to redeem them for gold/silver/whatever.
If all of the banks in the system don't act intelligently, they will be at the mercy of their competitors, not to mention their depositors. Also, if the notes from a particular bank come into question, people can refuse them, like Inquisitor said in his post.
Whatever problems that might occur through this, it certainly is exponentially better than a central bank and the crisis it creates.
Published: December 24, 2008 11:50 AM
Brian Macker
"I think it is time to reconsider the Real Bill Doctrine".
The Real Bill Doctrine is the belief that one can replace the commodity money backing fractional reserve banknotes with collateral assets that the bank has loaned against.
This seems at first light to be reasonable. As the banker, I have just lent a thousand ounces of commodity money to purchase the house on the market, so the market is saying that it is worth that much. Plus I can always repossess the house to pay off the bank note. Thus the bank note is backed.
However this makes the mistake of not realizing that the very issuance of fractional reserve banknotes will in fact drive up the prices of the assets that are being lent against.
Remember that prices are ratios. The price of housing in terms of a commodity money would be expressed in terms of ounces/house. Without fractional reserve banking the market would come to a particular ratio. Lets pretend houses are uniform and that the market settles on 1000 ounces per house.
Now if fractional reserve banking is initiated and reserves are set at 50% and all money is deposited in the banks then the number of fractional reserve notes initially generated will be twice the amount of total ounces of the commodity money. Thus one would expect the prices of houses in terms of notes to be half as much.
Note that the commodity money is being used for exchange against all goods, food, clothing, transportation, education, etc. The areas that bank lends in is a small porportion. Thus the quantity of money entering this smaller sector of goods is actually much larger than double in our example. If the housing sector amounts to 1/4 of total goods then the power of the doubling of bank currency will have a direct effect, at first of almost a factor of eight.
Thus housing prices will be bid up in terms of banknotes.
In a certain sense the real bill doctrine is true. Fractional reserve banks truly are trying to back money with houses. The problem is that the price ratio is no longer determined by ounces of commodity money in the system. Instead in equilibrium it is something like this:
promised ounces from banknote/ounces of commodity money = 2/1
price of house = ounces + (houses owned * price of houses) / house
The price of houses are now set in terms of the price of houses. It's a run away process.
Using real bills the banks can loan out more an more money. They more money they lend the higher prices go. The more prices go up the higher the value of the assets backing their loans.
If in fact the banks didn't lend the money out and instead directly bought the houses themselves, thus allowing them to claim the full current market price as a backing asset instead of the loan this process could indeed go to ever higher prices.
This doesn't happen because the banks are only allowed to get the actual borrowed amount. Remember however that your payments at first are mainly interest. Often the very first payment consisting only of interest. Thus the bank in a sense is getting more money for the house than it lent in the first place.
So in our example, of 50% reserves, after things have settled down a bit, the prices of houses would be bid up from 1000 ounces/ house to somewhere north of 2000/house. But that's in banknotes. The real price in terms of commodity prices should still be 1000 ounces/house.
So what the bank is doing when lending for each new house at that point is paying out claims for 2000 ounces of gold, for houses worth only half that much. So the claim of "Real Bill Doctrine" is false. The bank really doesn't have assets backing it's notes of equivalent value.
One sees this once the scam is revealed as the housing boom goes bust. In fact, we are experiencing this right now.
However, it's far worst for the Real Bills Doctrine then I have outlined here. This is for many reasons. I will outline two.
The increase prices of the houses will cause market participants to over produce houses. Thus the ratio of ounces of commodity money should fall below 1000 ounces per house. There are more houses so it should drop.
Also, houses are NOT like money commodities. They are missing many of the qualities that make certain commodities useful for use as money. Houses are not uniform as in my example, transferring ownership of houses has high transaction costs, houses need repair and upkeep, houses are consumer goods that have value only in consumption, houses are long term consumer goods whose value is spread over time, houses can be easily increased in quantity, houses are not easily divisible, etc. Plus that assumes the bank note is directly backed by the house. It isn't. It's also tied to a contract and a contract with a specific buyer with additional qualities that need to be assessed.
Each one of those differences between houses and money makes for difficulties. Part of the problems faced in the current monetary crisis is the inability to assess the value of these mortgages on the banks books. Since the fraud of the price run up has been exposed banks are no longer just assuming rising prices and need to assess the backing assets before lending to other banks.
The Fed is trying to alleviate this problem in crazy ways to prop up prices, like swapping Treasuries for Mortgage Backed Securities at one for one par with current prices, but it just isn't going to work. It's impossible to correct the fraud. This will only lower the value of treasuries in the future as they try to unload them, either that or lower the value of the dollar.
Real Bills is NOT accepted by Austrians for a reason. It's based on bad economics, and it's based on fraud. The banknotes still claim to be able to deliver more commodity money that is possible. They are short term and the houses are long term. Attempting to redeem the notes via selling the houses only serves to expose the fraud as prices drop.
Published: December 24, 2008 11:58 AM
Brian Macker
J. Cortez,
I have a book on free market banking in Scotland that I have already read that argues in that direction. So I am informed in that regard.
I suggest that you read, "The Myth of Free Banking in Scotland" by Murray Rothbard to get a more complete picture. The picture was not so rosy as some depict.
Scottish banking escaped none of the problems that are inherent in trading fractional reserve bank notes on par with specie.
It's effect of the fraud are far from obvious but I did outline above why the scheme is not economically sound and will tend to fall apart. What in fact a fractional reserve system create is a monetary system with a "strange attractor".
The ratio of prices, money, and reserves held is NOT a system that tends towards a stable attractor. This is not like a cherry rolling to the bottom of a bowl. It's more like a cherry bouncing down a series of inverted bowls and funnels like some kind of pachinko machine.
A commodity money system is stable. It does tend to pull prices back in towards the attractor. Fractional reserve tends to repel from the attractor when prices are moving through and past the attractor. Prices rise merely because they are rising as the reserves are lowered below the supposed level of equilibrium.
Likewise when prices are falling from above there is a feedback between reserves, prices, and backing assets that drives the reserve levels way up beyond the supposed equilibrium point, causing a reinforcing price deflation, and lowering of the value of backing assets.
The Scottish history actually bears this out. As you can read in Rothbard's critique.
In fact the Scottish banks were not free as Rothbard points out:
The dynamics of this is that fractional reserve banking, even supposedly free banking, results in wild gyrations in prices. This leads to problems. Debtors are feel, rightfully, that they were somehow tricked by the system and now owe more than they can pay due to the downturn. Creditors feel cheated, More banks get in business during a boom and more banks go out of business during the bust. After all the credit cycle is still present. As shown by the actual evidence.
These wild gyrations then lead to political pressure. Debtors, Creditors, and bankers all insist that the government intervene. It does, But it does NOT get rid of the problem, the fractional reserve, instead it exacerbates the problem by propping up failed banks, allowing suspension of payment, and the like.
Which allows the banks to run with even lower reserves. Levels that are way beyond what the fraudulent system would normally run if we allowed the chumps and the fraudsters setting up the scams to run free.
It turns out that the lower the reserve levels the wilder are the gyrations, and thus even more government intervention is requested.
Free banking cannot work because it is based on an unstable fraudulent scheme.
Published: December 24, 2008 12:39 PM
Brian Macker
J. Cortez,
I have a book on free market banking in Scotland that I have already read that argues in that direction. So I am informed in that regard.
I suggest that you read, "The Myth of Free Banking in Scotland" by Murray Rothbard to get a more complete picture. The picture was not so rosy as some depict.
Scottish banking escaped none of the problems that are inherent in trading fractional reserve bank notes on par with specie.
It's effect of the fraud are far from obvious but I did outline above why the scheme is not economically sound and will tend to fall apart. What in fact a fractional reserve system create is a monetary system with a "strange attractor".
The ratio of prices, money, and reserves held is NOT a system that tends towards a stable attractor. This is not like a cherry rolling to the bottom of a bowl. It's more like a cherry bouncing down a series of inverted bowls and funnels like some kind of pachinko machine.
A commodity money system is stable. It does tend to pull prices back in towards the attractor. Fractional reserve tends to repel from the attractor when prices are moving through and past the attractor. Prices rise merely because they are rising as the reserves are lowered below the supposed level of equilibrium.
Likewise when prices are falling from above there is a feedback between reserves, prices, and backing assets that drives the reserve levels way up beyond the supposed equilibrium point, causing a reinforcing price deflation, and lowering of the value of backing assets.
The Scottish history actually bears this out. As you can read in Rothbard's critique.
In fact the Scottish banks were not free as Rothbard points out:
The dynamics of this is that fractional reserve banking, even supposedly free banking, results in wild gyrations in prices. This leads to problems. Debtors are feel, rightfully, that they were somehow tricked by the system and now owe more than they can pay due to the downturn. Creditors feel cheated, More banks get in business during a boom and more banks go out of business during the bust. After all the credit cycle is still present. As shown by the actual evidence.
These wild gyrations then lead to political pressure. Debtors, Creditors, and bankers all insist that the government intervene. It does, But it does NOT get rid of the problem, the fractional reserve, instead it exacerbates the problem by propping up failed banks, allowing suspension of payment, and the like.
Which allows the banks to run with even lower reserves. Levels that are way beyond what the fraudulent system would normally run if we allowed the chumps and the fraudsters setting up the scams to run free.
It turns out that the lower the reserve levels the wilder are the gyrations, and thus even more government intervention is requested.
Free banking cannot work because it is based on an unstable fraudulent scheme.
Published: December 24, 2008 12:40 PM
fundamentalist
Andras: "How could you say that? When does the FED retired debt after 90 days? How does the FED comes into the RBD picture after all? Where are legal tender laws in RBD?"
There are variations on the same theme within the RBD community, but the Fed has always followed the RBD in spirit, if not every letter of every version. The essence of the RBD is that money should expand to meet the demand from legitimate business interests and contract when businesses don't want it. And the Fed has always done that, from the beginning. Since WWII, the Fed has added Keynesian voodoo that says making more money avaible when business is slow will stimulate business borrowing, but that's a minor sin.
Published: December 24, 2008 12:48 PM
J Cortez
Keep in mind, I have no issue with 100% reserve or a commodity standard. I think it's the way to go.
But take away all banking laws, take away a central bank, and the issue, as I see it, is more of a ethical one regarding people engaged in free exchange. If Customer A contracts into a money market account with Bank B, as long as there is full disclosure of the fact the account is a fractional reserve with the warning the money in question could be lost, I reconcile it as ethical within the realm of private contract.
Also, as to whether other market participants have to deal with fractional practices of Bank B's notes, there is no legal tender and no central bank, so there is nothing to force people from accepting any note from Bank B.
If the the cycles in Scotland were due to ABCT, was it because Scottish banks were based on Bank of England credit, which according to the Rothbard you mentioned acted as a quasi-central bank for Scotland, or solely because of their practices in the context of their banking system?
The way I see it, which admittedly might be wrong, a central bank is on several hundred orders of magnitude much worse than say a thousand small free banks. The banks in the free system have to start with something and will always be constrained by whatever they want to pyramid on top of. They are much more less likely to be able to distort the market because of this and the fact that the power is decentralized. Central banks don't have those constraints since they can just create whatever money they need and can dictate to every bank in the system.
Please check out the interview if you can, if only to see his version of the argument. Having never studied much on free banking previously, I found it very informative. Of course, I now have to check out what Rothbard said on the same subject.
What was the name of the book on Scottish banking you mentioned?
Published: December 24, 2008 1:34 PM
Brian Macker
"... so there is nothing to force people from accepting any note from Bank B."
It's not a matter of force. It's a matter of fraud. The note lies on it's face. Were the note to contain the full verbiage explaining the scam then I might think there was no explicit fraud involved. However the fraud could then be implicit.
Furthermore, there are problems with the way the banknotes are traded. Usually they are just handed over without signing a formal contract. There is no way to know that the person who accepted the terms of the banknote was actually aware of those terms, or consented to them in full.
The transaction costs involved have been socialized by convention but not correctly so.
When you are handed a bank note that says that it is a claim for so many ounces of specie, then presumably the specie is there, otherwise it is a fraud. If things are otherwise, and complex in nature this needs to be communicated. Either by a contract that is signed on the banknote itself, or by means of an ancillary contract between the purchaser and the seller.
Otherwise the courts become clogged with claims that it cannot be expected to resolve. If A hands B a banknote for ten ounces of gold, but bank C doesn't have it then who's to blame? Certainly B should get his X ounces of gold that A promised him. If C could not execute on this claim but A has signed a contract with C where he knows it likely that C can't deliver then it is A who is defrauding B. If the contract between A and C is not clear then C is defrauding A, not B. Therefore B still needs to go after A, then A after B. Mr. A cannot discharge his responsibilities to B on the bank C in this manner.
I can't borrow money from you, lend it to Charlie and when you come after me say, "Go see Charlie".
Banknotes should not have the same status as direct trades, because the are not the equivalent to direct trades. Banknotes aren't goods, they are agreements, contracts. Contracts cannot be traded in this way without additional contracts.
We have set up a system of legal conventions that pushes the transaction costs involved in fractional reserve banking onto others via the tax system. This would not likely happen with a common law court system. In fact, the switch from treating banks as depositories, and bank notes as warehouse claims, to treating them as direct money was done via state run courts.
Without this transfer of costs the people using banknotes in their transactions would need to pay higher legal fees and insurance costs, than those transacting with specie.
Published: December 24, 2008 1:58 PM
Brian Macker
I've also read the claims that banks couldn't operate without fractional reserve, that banknotes competed openly in the market and one, etc.
I reject these claims because they miss important aspects of what actually occurred.
Just like I reject claims currently made that commodity based currency doesn't work. The observations these people make are tainted with there own theories.
Gold and Silver doesn't work as money today precisely because it has been demonetized by de Jure. Legal Tender laws, taxation laws, laws on treating specie transactions, all hinder the ability to use precious metals as currency. It's not that fiats currency won in the market. It's that specie currency was banned by law.
Likewise with banknotes vs. specie. Laws were passed that removed the advantages of specie over banknotes. Laws passed at the behest of the banks.
Published: December 24, 2008 2:07 PM
J Cortez
It's not a matter of force. It's a matter of fraud. The note lies on it's face. Were the note to contain the full verbiage explaining the scam then I might think there was no explicit fraud involved. However the fraud could then be implicit.
Furthermore, there are problems with the way the banknotes are traded. Usually they are just handed over without signing a formal contract. There is no way to know that the person who accepted the terms of the banknote was actually aware of those terms, or consented to them in full.
I think it is a matter of force. Like stated previously, in a free system, people can accept or not accept the notes. If Business A wants payment from from Customer B, Business A can ask for whatever payment it wants, it is up to Customer B to supply it, whether it be gold, silver, or notes from either Bank X, Bank Y or Bank Z.
The notes would be subject to the market's demand. If Stupid Bank D engages in a over-extended pyramid fractional scheme, it will be found out and attacked by not only its depositors but other banks in the form of bank runs. There would be many different types of banks with different practices. In free banking, I think there would also be banks that would completely forgo fractional reserves and be 100%.
In regards to A and B and Bank C in your example. I would say it depends on the contracts involved. However, the courts issue is another matter, I think. (I believe there should be private courts.)
Banknotes should not have the same status as direct trades, because the are not the equivalent to direct trades. Banknotes aren't goods, they are agreements, contracts. Contracts cannot be traded in this way without additional contracts.
Banknotes would not have the same status as direct trades, because as you said, they are contracts. In a free banking system, I don't think notes would be treated as direct trades.
Again, I think 100% commodity standard is correct. I agree that the act of depositing money should be seen as warehousing. But under free exchange, market participants would be able to engage in fractional reserves provided there were disclosure contracts. That is the only way I know to reconcile it with a free society.
Published: December 24, 2008 2:35 PM
Andras
fundamentalist,
There are two parallel discussions here:
First, we started on the viability of 100% gold reserves and then the FED and its legal tender laws came into the picture. As Brian Macker showed, under the second even the first would not be able to work. So leave the crooks out and try to discuss the world after them. I am sure they will still want to be part of the system and we will be easy prey if we ourselves can not agree on the way forward. Actually, I agree with J Cortez: The market will sort it out if it is left alone. We do not want to be the next social planners, do we?
Published: December 24, 2008 4:15 PM
Brian Macker
J Cortez,
Well this is the point where I'm going to have to say that I don't know what would happen, and bow out for the evening.
I'm not against fractional reserve just so long as full disclosure to all parties is made and transactional costs aren't shifted to third parties via force.
So I don't think we are so far apart.
Published: December 24, 2008 5:40 PM
fundmentalist
Andras: "The market will sort it out if it is left alone. We do not want to be the next social planners, do we?"
I agree. But we had periods of free banking in the US before and after the Civil War and they didn't turn out so well. Free bankers want free banking on principle. I'm more interested in practical results. Like Hayek, I don't think central banking is ever going away. Neither are we going to follow a gold standard. The best we can hope for even in the distant future is a central bank that understands economics and tries to maintain a steady money supply. Greenspan did that in his first term by targeting the price of gold. It would be a very simple plan to implement again. Practically speaking the results would be as good as free banking.
Published: December 24, 2008 6:32 PM
George Selgin
It's time people stopped quoting Rothbard on the Scottish system. His criticisms have been answered more than once, in various articles by White, which articles are themselves now more than a dozen years old; the later edition of White's book refers to the literature in question. It's annoying to have defunct arguments dragged up again and again after they've been answered. (The same goes, by the way, for most arguments against fractional reserve banking.)
Published: December 24, 2008 7:19 PM
newson
to inquisitor:
why be evasive? i've asked you why should the law for warehousing of money deposits be any different from warehousing of any other homogeneous good like grain or oil? you've just given me the standard free banking answer: read the fine print.
but as brian macker points out, and huerta de soto discusses at length, the depository function under frb is a non-sense. any contract, aside from an aleatory one, is null and void right from the word go. much as if you and i signed a contract that i was to deliver you eternal life when you handed over the million. i cannot deliver, and no court could respect a contract that it unable to be honoured from the outset, regardless of mutual consent.
words convey understanding, and "deposit" should honour it's meaning. instead the banks, and a few generations of compliant or ignorant judges, have allowed deposits to be conveniently treated as "loans", at least in economic terms.
twisting the lexicon to mask what's really going on in economic terms shows what a rort frb is. free banking (ie frb without state involvement) is a chimera. sounds great as an abstraction, but in practice always leads to where we are today. at least the 100% reserve argument has internal coherency, even if it's chances of implementation are miniscule.
Published: December 24, 2008 8:55 PM
newson
to george selgin:
could you cite some of these rebuttals of white? i'm still trying to find convincing arguments for frb (i've read "in defense of fiduciary media...", amongst others). so far the only one that sticks is that there is so much money to be made by bankers, that frb is always going to prevail, regardless. this is the sort of "just get over it" argument that fundamentalist raises.
Published: December 24, 2008 9:12 PM
David Hillary
George,
Quite frustrating isn't it?
I think most people posting here disagree with fractional reserve banking because they hold onto the quantity theory of money. They are more concerned about maintaining stability in the stock of money than they are about liberty, and so liberty gives way to bad economics.
Sound economics and proper legal analysis of bank notes and bank demand deposits would dispossess people of both their hostility towards fractional reserve banking and enable a proper appreciation of the merits of liberty concerning money and banking.
Published: December 24, 2008 9:26 PM
newson
has anyone seen zeitgeist? a film on the federal reserve and fiat money that's available on youtube?
is it worth eyeballing, and how come i didn't hear of it via the mises grapevine?
Published: December 24, 2008 9:27 PM
newson
to david hillary:
why is it that money should be exempt from the law of supply and demand? particularly if you follow the misesian regression theorem that money must ultimately be derived from some commodity (and presumably that original commodity was subject to the law of supply and demand).
Published: December 24, 2008 9:42 PM
newson
er....zeitgeist gets hammered in the mises forum.
Published: December 24, 2008 9:56 PM
David Hillary
Newson,
The law of supply and demand relates to FLOWS not stocks, generally. The so called 'money supply' is a stock, not a flow, i.e. it should be called the 'money stock' not the 'money supply'.
Metallic money has flows of production-supply and consumption-demand for the underlying monetary metal, the intersection of which provides a sort of anchor for the purchasing power of both metallic money, and debts denominated in metallic money payable on demand (as well as those not payable on demand). As White points out, if the stock of monetary metal reached zero, the non-monetary supply and demand functions would provide an anchor for the value of bank-issued money denominated in the metal. Although there is a good reason for the stock of metallic money not to reach zero (it has a yield of saved transaction costs, making it viable to hold in some quantity), this case provides an insight into the ability of metallic money to have a value anchor in terms of other goods and services, irrespective of its stock or use as money.
I hope this provides an insight for you into where the quantity or stock of money is NOT relevant to supply and demand flows that 'the law of supply and demand' recalls.
Published: December 24, 2008 10:01 PM
Inquisitor
"why be evasive? i've asked you why should the law for warehousing of money deposits be any different from warehousing of any other homogeneous good like grain or oil? you've just given me the standard free banking answer: read the fine print."
How is that evasive? It is a contract between two parties. It is not a slavery contract and thus valid. So why not read the fine print? If the bank fails to deliver, these contracts will simply die out. Why not just let the market decide?
Andras, can you reconcile RBD with the ABCT? If you want people to buy into it, you better show how the two are compatible.
Published: December 25, 2008 12:43 AM
newson
to inquisitor:
even an anarchic regime, contract law cannot be enforced where the contract is unexecutable, as is the case with frb "deposits". like my promise to give you eternal life, would be a null contract.
are you implying that all but slavery may be subject to contract law? as for the success or otherwise of frb in the market, that's a separate issue, depending on the politics of the day.
but the historical record shows that invariably when the frb fails the market test (bank run), the state does intervene and suspends convertibility or bails out the delinquent bank.
Published: December 25, 2008 1:15 AM
newson
i'll read some more of your past posts to get a better feel for your position, but correct me if i'm wrong...
you're not a believer in the austrian view of interest rates reflecting a society's aggregate time preference (hulsmann i believe makes a good case that it's the link between means and ends)?
if that's your contention, what does determine interest rates in a purely barter economy?
as regards the stocks vs. flows argument, i cannot see the relevance, the most recently printed dollar is valued at the margin in the same way as the most recently mined gold oz. the stability of gold is a reflection of its low flow/stock ratio. the dollar has a much higher flow/stock ratio.
Published: December 25, 2008 1:37 AM
P.M.Lawrence
Brian Macker, what you say about bills backed by assets like houses is accurate, but it isn't a criticism of authentic Real Bills Theory. That deliberately confined backing to assets that would self liquidate in the short term without those issues coming up; the only thing wrong with it was what happened when it got put into practice, since human nature led practitioners to over-estimate things like risk and soundness etc.
No, yours is a valid criticism of people around today who claim to be advocating Real Bills Theory but have actually thrown out the very thing that went into the definition of "real". At least earlier practitioners thought they were trying to keep it, even though they were wrong about being able to pick the winners that that needed.
Published: December 25, 2008 1:43 AM
P.M.Lawrence
Newson, where the question of stocks versus flows really matters is in the stabilising effect of things like Pigou's Real Balance Effect. Although it can be small, that actually stops instability, and because it is cumulative it always eventually builds up corrections of the right size. Provided other distortions like state intervention don't drown it out, that is...
Published: December 25, 2008 1:54 AM
newson
thanks pm lawrence. merry christmas to you, and to all the other irrepressible frequenters of mises.org!
i understand the significance of flows/stocks insofar as price stability goes, i just cannot see why paper dollars should be subject to any different economic laws.
david hillary seems to be talking a different tongue.
Published: December 25, 2008 3:45 AM
David Hillary
Newson,
under barter, interest rates are theoretical constructs, perhaps representing real rates of return or real opportunities or opportunity costs for investment or deferred consumption. It is only in a monetary economy that interest rates are actual market prices, i.e. nominal interest rates on loans of money. Real interest rates can be derived from nominal ones by adjusting for some definition or measure of the rate inflation, but these are not market prices, they are inferences based on theoretical constructs concerning prices.
The term 'time preference' is a misnomer, as time cannot be bought or sold. What is bought and sold are loans of money. My theory of the interest rate is that it is the market price of loans of money, and that this rate is determined in the 'money market' by investors optimising their portfolios between non-interest earning metallic reserves and interest bearing securities (loans). At the margin these two asset classes must have the same risk adjusted rate of return (otherwise agents' portfolios would not be optimised), and since in the short run the stock of metallic reserves is fixed, the market interest rate is determined on the demand side: the demand to hold metallic reserves rather than interest bearing securities. Should people want more specie, they cannot have anymore than there is just now, so the price mechanism, the interest rate, allocates it to those willing to forego the highest interest rate to hold it. In the same way, should people want more interest bearing securities and less specie, they cannot have any less, the specie must be willingly held in some agent's portfolio, and so the price mechanism, the interest rate, allocates it to those at however low a interest rate is necessary to make the existing stock of specie willingly held by someone. Based on this market structure, I conclude that there must be a negative relationship between the stock of specie and the interest rate (assuming that, other things equal, the stock of specie is subject to diminishing marginal returns). The rate of return on other assets such as buildings need not be the same as the rate of return on holding metallic reserves. I would define the rate of return on metallic reserves as the interest rate, and the rate of return on buildings etc. as 'building rent'. and consider the allocation between the two forms of capital on the market.
I think you've failed to understand the way units of money are valued under a gold standard with free banking. I encourage you to think very carefully and to try to identify all your assumptions and test them to see if they stand up.
Published: December 25, 2008 3:52 AM
newson
to david hillary:
i think actually you'll have to firm up your theory about the trade-off between consumption and investment in a barter economy before you'll convince me to follow you up the abstraction ladder into the money economy.
you've described how hoarding is moderated by the opportunity cost of forgone interest without explaining the phenomenon of interest in the first place.
by the way, i'm reading:
ECONOMIC PRINCIPLES AND
MONETARY INSTITUTIONS
Review Essay on THE THEORY
OF MONETARY INSTITUTIONS
Lawrence H. White
By Jörg Guido Hülsmann
just to figure out where you're coming from...
Published: December 25, 2008 5:18 AM
newson
this is a section of the hulsmann paper that i think nails it:
"To capture the true impact of fractional-reserve banking on the demand for
money let us recall that, in distinct contrast to all other goods, the demand for
money is not independent of the supply of money since the supply determines the
purchasing power of money. From this it follows that the titles issued by
fractional-reserve banks never just offset a previous increase of the demand for
money. Rather, they are themselves the cause of an increase of the demand for
money. (More precisely, they cause further increases, thus adding to preceding
increases of the demand for money.) The fundamental fact is that every new
issue of an uncovered money title dilutes the purchasing power of money. The
money prices on the market are necessarily higher than they would have been
without the issue of the additional title. And since the market participants desire to
own certain quantities of purchasing power, rather than nominal quantities of
money, the demand for money increases. Thus we see again the perverted
operation of Say's Law: The new uncovered title increases money prices and this
further stimulates the demand for money (or money titles).
In conclusion, White's error springs from his view that the demand for money
can be defined independently of the supply of money itself. Since this is not the
case, however, fractional-reserve issues do not "respond" to previous shifts in
money demand but rather create their own demand."
Published: December 25, 2008 6:22 AM
fundamentalist
Merry Christmas everyone!
David Hillary:"My theory of the interest rate is that it is the market price of loans of money, and that this rate is determined in the 'money market' by investors optimising their portfolios between non-interest earning metallic reserves and interest bearing securities (loans)."
For the most part, what you right is correct. I think you may be confusing demand for loans with demand for money. The demand for loans contributes to the determination of the interest rate, while the demand for money responds to the interest rate.
What the Austrian theory of money attempts to do is explain the causes of the changes in the value of money, such as 'why do people hold money at all?' and 'why does the amount of money people want to hold change?', or as newson pointed out 'how does the supply of money affect the demand to hold money?', 'what changes the supply of money?'.
David: "The term 'time preference' is a misnomer, as time cannot be bought or sold. "
No one has ever claimed to be selling time. Time preference is just a convenient name for the idea that people plan for the future. Some plan more than others, some less. Many economists use the phrases 'desire for present goods versus future good' but it means the same thing.
Hayek has pointed out that time preference determines the level of savings available to loan out, but demand for loans, risk, and profit all go into determining the market loan rate.
But the market loan rate is a completely different subject from the value of money, although they cross paths occasionaly. The value of money is determined by the ratio of the stock of money to the stock of goods and services. An increase in the supply of money relative to goods will reduce the value of money, but what we see is an increase in prices. When prices go up, people need to hold more cash to meet expenses so they demand more money. But if the value of money falls too low, that is, prices rise rapidly, people will demand less money because it loses too much value while they're holding it. Graphically, the value of money in terms of the prices of goods and services is a quadratic, or U-shaped function. As prices rise, people demand more cash until prices reach a tipping point beyond which they demand less money.
Published: December 25, 2008 9:49 AM
Inquisitor
No, my point is that even if the contract is unenforceable (and I am not yet convinced it is), that that does not merit outlawing such exchanges. At best a court will refuse to enforce the contract I guess.
Published: December 25, 2008 10:12 AM
Brian Macker
"That deliberately confined backing to assets that would self liquidate in the short term without those issues coming up; the only thing wrong with it was what happened when it got put into practice, since human nature led practitioners to over-estimate things like risk and soundness etc."
It doesn't matter. The same principle will operate for any other good used to substitute for money. Even if short term. I did not point this out but besides the effect on houses in my example the general increase in the supply of money drives down interest rates and causes other long term goods to look more profitable.
So even if you only allow short term goods to act as "reserves" that would cause an increase in the money supply, lowering of interest rates, price increases, asset inflation (especially for goods further from consumption), the business cycle, and a whole host of other problems. Since houses are far from consumption they would go up in price also. Loans would still be "backed" by these overvalued houses, and similar problems would still exist.
It's better for Real Bills not to allow using houses as backing assets but only because that acts as a restriction on Real Bills backing. If you do less of a bad thing, that's better. But the bad thing is still bad.
The entire motivation behind Real Bills is misguided. It's motivated by the economic fallacy that more money means prosperity.
Published: December 25, 2008 10:16 AM
David Hillary
Newson,
Your quote shows how much you're begging the question, the conclusion is introduced as a premise:
'the demand for money is not independent of the supply of money [conclusion] since the supply determines the purchasing power of money [premise].'
Basically the premise and conclusion are the same: A only if A. However A is the issue under controversy!
Under free banking, the stock of bank issued money could be elastic and have no impact on either the interest rate or the purchasing power of money. For example, under a specie standard, and free banking, suppose that agents typically wanted to hold a substantial proportion of their portfolios in the form of demand deposits with banks. Perhaps the banking system might issue 100 million units of demand deposits, and invest the proceeds in a combination of liquid and illiquid assets and metallic reserves. Now suppose the government introduces a tax on bank deposits. What happens? Suppose that investors had access to unit trusts that were able to be redeemed by drawing cheques or negotiable orders of withdrawal on them, or otherwise were redeemable on demand at or close to par that were not subject to the tax: investors would draw cheques on their bank accounts and transfer their funds to the unit trusts, and the banks would sell their assets to the unit trusts to pay the cheques, the assets transfer, and the form of the liabilities changes from bank demand deposits to units in the unit trusts, the same 100 million units as before, the economy carries on unchanged using the alternative financial instruments. This example is far from academic: in many countries the regulation of banking has had basically this result: the substitution of bank deposits for money market 'mutual funds' or unit trusts and other similar forms of financial instruments that have similar functions as bank deposits.
I don't think I have a lot to add about the nature and origin of interest considered as a rate of return on capital generally. I feel that the Solow growth model actually has a lot of merit and that the marginal rate of return on capital is a decreasing function of the stock of capital, other things being equal -- I understand many Austrians are hostile to this view? Another way of coming at the issue is based on preferences or demand: that desire for immediate consumption is preferred over otherwise similar future consumption, i.e. something similar to the 'time preference' theory, although I'd avoid that term. The demand side theory has this limitation: it is not sufficient to determine the rate of interest, since the price requires both a supply and demand function. Also, I consider that the actual stock of capital may be higher or lower than equilibrium, so that the market interest rate may not be at equilibrium, even under barter. E.g. suppose that part of the stock of capital was destroyed: wouldn't this increase the market interest rate without changing social preferences, simply through scarcity of capital?
Published: December 25, 2008 12:42 PM
Jason White
The greatest advantage to 100% reserve banking as I see it is the intertemporal coordination of production. Money held for immediate needs (demand deposits) is only available for immediate needs, not to fund longer term projects. Money held as savings (CDs, bonds issued by banks etc) is available to fund longer term projects in accordance with the time preferences of savers. So that as time preferences change, for example from changes in demographics, funding is available over the time periods necessary to supply production for future consumption.
Published: December 25, 2008 4:45 PM
David Hillary
Jason White,
Money held for immediate needs does not need to be held in the form of metal, it can also be invested.
There are two investment options that can meet these needs:
1. Marketable securities (e.g. commercial paper). These are securities that do not mature until a future date (e.g. 90 days), but are very easy and cheap to buy and sell, so that you can get your money back by selling the investment to someone else, or invest by buying from someone else. Typically also issued by low risk issuers, so that the costs of credit risk management are reduced to low levels.
2. Invest in redeemable securities. These are securities that can be redeemed on demand or within a short period of notice, so that you can get your money back by asking for it. The issuer can get the money by either selling its own assets or by finding other investors or financiers to take your place. The most common examples of redeemable securities are bank notes and demand deposits with banks, other examples include redeemable preference shares of companies, building society shares, credit union shares and unit trust units.
Why should short-term, redeemable or marketable investments or securities not finance long term borrowing needs? This is one aspect of financial intermediation that financial intermediaries such as banks do. Any other aspects of financial intermediation you wish to attack?
Published: December 25, 2008 7:36 PM
newson
to david hillary:
it seems to me that you're pretty much following the adam smith real bills doctrine, or am i mistaken? white seems to be similar.
Published: December 25, 2008 8:21 PM
newson
to inquisitor:
if you've not already read it, the first three chapters of huerta de soto's "money, bank credit and economic cycles" deal with the legal murkiness of frb.
where ambiguity of title exists, free markets cannot function properly. the only contract that could define frb and remain faithful to economic reality is that of a lottery.
Published: December 25, 2008 8:53 PM
David Hillary
Newson,
Smith's analysis of banking is fairly good but it might be helpful to consider his doctrine that banks should only invest in 'real bills' as management advice rather than economic theory. Today's bankers and their advisers obviously do not take his advice: they primarily invest in long term loans secured over land and buildings, and hold reserves of marketable securities and cash for liquidity. Bank today also substantially finance their assets by term deposits and non-demand debt, reducing their exposure to runs (I'm not sure if banks in Smith's day used term borrowings substantially).
Smith's advice to bank was flawed because:
1) banks can fail for reasons other than illiquidity, typically because of exhaustion of capital through bad loans. Even if banks invest in bills that are reasonably marketable and mature fairly soon, if too many of the bills go bad, the bank will still fail.
2) banks can rely on their ability to re-borrow or re-finance their liabilities as their primary means of meeting debts that could be due at any time. To do this they must have a high and reliable credit standing, and good access to funding markets, e.g. commercial paper, term deposits, listed bonds etc. They can also use illiquid assets as security to borrow funds to repay demand depositors, leaving term depositors as unsecured creditors in a distress situation while demand deposits run off. This is also why modern banking regulation has a focus on capital adequacy rather than liquidity ratios.
Published: December 25, 2008 9:35 PM
David Hillary
Newson writes that frb is like a lottery.
I wonder what he would make of an industrial company with an overdraft facility and no cash reserves at all. The company's land, buildings, equipment, stock and accounts receivable provide security for the overdraft. The overdraft is repayable on demand. Is such an overdraft also like a lottery ticket?
Published: December 25, 2008 10:03 PM
fundamentalist
David: "I feel that the Solow growth model actually has a lot of merit and that the marginal rate of return on capital is a decreasing function of the stock of capital, other things being equal -- I understand many Austrians are hostile to this view?"
Yes, Austrians are hostile to it. It reflects mainstream econ's habit of viewing capital as homogenous. Diminishing returns on capital applies only to investments in capital of the same kind. Some of that kind of investing happens, but the really important investment goes into capital of different kinds, what Austrians call more roundabout or more capitalistic. It involves the greater use of machines and less of direct labor in production. That kind of investment does not suffer from diminishing returns.
Published: December 25, 2008 10:28 PM
David Hillary
Fundamentalist:
The distinction between kinds of capital and capital in aggregate is important, and this is I guess the insight I have into the coin stock as a kind of capital subject to diminishing marginal returns.
I can't really get the point of not accepting diminishing marginal returns on the capital stock in aggregate, its a rather academic point anyway. I guess it becomes important in the case of a small open economy: unless the small open economy is subject to diminishing marginal returns on capital, how can capital be allocated efficiently between the different small open economies that make up the world economy? I guess you could answer this by saying a 'kind' is also a place or geographic region.
Published: December 26, 2008 1:08 AM
Inquisitor
Newson, I plan to, I guess that might give me the missing link in the arguments against FRB.
Published: December 26, 2008 2:38 AM
newson
to david hillary:
bank depositors can present with demands for immediate withdrawal at any time, and in any number, in ways that defy statistical modeling. the bank is faced with closure once the limited cash reserves are exhausted.
an overdraft or line of credit is usually arranged upfront with some sort of covenant. unless there occurs a breach of this compact by the borrower, the facility remains until expiry.
in your (extreme) situation, where the loan can be called in unilaterally and immediately, the company would in fact be risking a liquidity crisis and perhaps even face a wind-up action.
the company's future would hang on a complete uncertainty, and the directors would in effect be gambling. unlike the bankers, they may end up being pursued in the courts over this dereliction of duty. they probably won't be on the receiving end of a government rescue package, either.
Published: December 26, 2008 5:54 AM
fundamentalist
David: "unless the small open economy is subject to diminishing marginal returns on capital, how can capital be allocated efficiently between the different small open economies that make up the world economy?"
I'm not sure what you're asking. Are you saying that as capital gets invested in a country and the capital intensity increases, the marginal return falls and eventually capital will go to countries with higher marginal returns? If so, I don't have a problem with it as far as it goes. The Austrian difference would be that capital intensity isn't the only factor to consider. You'll find two countries with the same capital intensity and very different marginal returns on capital because they have invested in different kinds of capital. For example, if a farmer increases the labor input to his farm, the marginal returns will quickly diminish. But if he invests in a mule, the marginal returns will increase. If he invests in more mules, the marginal returns will decrease, but if he invests in tractors it will increase.
I may not understand you monetary theory, either. Are you saying that people allocate monetary capital by the marginal returns on it and holding cash is just part of the equation? The Austrian view is that real cash does not pay any return. If something pays a return, then it's an investment. Of course, today the dividing line is pretty blurry. Still, things that are considered cash-like, such as money market mutual funds, pay such a low return that you have to ask why would anyone put their money in them? The marginal return on any other investment is much higher.
The reason people hold cash is that they have current expenses to pay; they have some doubt about expenses in the immediate future; and they have recently divested of an asset and are searching for another asset to invest in. They keep as little wealth in cash as possible in order to earn the highest marginal return. That's why if the Feds increase the supply of money beyond that which people want to hold they will get rid of it by purchasing things or buying more investments such as stocks and bonds.
But the odd thing about money is that it's an asset and a commodity, but it has unique qualities. As the stock of money increases, its marginal return doesn't diminish in the same way that increasing the stock of the same kind of capital does. What happens is that the prices of everything else goes up to adjust to the new stock level and the marginal return stays the same, which generally is zero.
Published: December 26, 2008 9:16 AM
jp
Inquisitor: "I guess that might give me the missing link in the arguments against FRB."
Your initial suspicions of the anti-FRB arguments are well-placed. The first three chapters of De Soto's book are interesting but they by no means hammer the nail shut on FRB.
De Soto points out that FRB rose by mimicking warehouse accounts. That may be, but he assumes that all bank accounts MUST be 100% backed warehouse deposits and CANNOT be loan accounts. In other words, he cannot imagine a world in which people freely lend to banks, these funds being invested by the bank with a fraction of the money kept in reserve to allow for a limited number of redemptions.
In a free world, if a bank properly indicates the differences between the various types of accounts it offers - a fractional reserve lending product, a 100% reserve deposit product, a savings account product, etc. - than you can get around his critiques. After all, people are free to choose to warehouse with or loan to any bank they choose.
This reduces De Soto's arguments to this: it would be illegal for the bank to secretly put a client's money in an FRB account if a 100% deposit account was desired by the client. But this is pretty obvious, in the same way that if we ask our broker to invest in gold stocks it would be illegal for him to actually put our money in tech stocks.
David Hillary has a good critique of the warehousing/lending distinction here:
http://davidhillary.blogspot.com/2008/12/property-rights-analysis-of-banking.html
Published: December 26, 2008 11:04 AM
David Hillary
JP,
Thanks, readers should also be referred to my post on the legal nature of bank notes and customer deposits, showing that they are not bailments (warehoused chattels) but loans: http://davidhillary.blogspot.com/2008/11/banking-defined-and-defended-part-1.html
Published: December 26, 2008 12:08 PM
David Hillary
Fundamentalist:
If cash has no return, why would any agent hold it in his portfolio, when investments that do have returns are available? The optimal cash balances would always be zero unless cash has some return.
Your attempt to answer this question makes you basically imply that that the optimal cash holding is as close to zero as possible, and that financial markets and financial instruments can and should develop to enable productive investments rather than unproductive cash holdings to fill agents' portfolios, and perhaps to intermediate trade in lieu of cash as well.
It seems you are assuming what you are trying to prove in respect of money's unique properties. If you don't start with the assumption that the marginal return on cash holdings is and stays at zero regardless of the quantity of capital allocated to cash, then I don't think you'll reach that as a conclusion either. It's funny you believe other categories of capital are subject to diminishing marginal returns but make an exception for cash. Your position ends up inconsistent and arbitrary.
Published: December 26, 2008 12:32 PM
Brian Macker
David Hillary,
"Why should short-term, redeemable or marketable investments or securities not finance long term borrowing needs? "
How can you ask this question?
You wrote, "Quite frustrating isn't it? in response to George Selgin, and his comments which included the sentence, "It's annoying to have defunct arguments dragged up again and again after they've been answered."
I sit here amazed that you are ignorant of the answer to this question when you applaud others for failing to support their positions, while making comments like that.
Would you like it if I responded to you that way. Because I could at this point. I could just respond:
Then I'd be arguing the way you two are, without supporting my position. I'll take the implicit insult from both of you but just be aware that you live in a glass house.
At this point from reading both of your comments it is clear to me that neither of you understand the economic issues involved. You have a tendency to confuse yourselves with complications.
I also find your speculation in that post that, "They are more concerned about maintaining stability in the stock of money than they are about liberty, and so liberty gives way to bad economics."
In fact, it's your economics that is unsound. The choice is not between liberty and maintaining stability in the stock of money. That was never an issue. If you understood.
Maintaining stability in the stock of money is NOT my goal. If it were then my position would include a ban on the exploration, and mining of specie. It doesn't. It would require that a mandatory commodity money be settled on and enforced by law.
I'm all for people deciding what they want to use for money, and am not against any naturally occurring mechanism, that do exist, by which the stock of money would change.
I am also fully aware, that such natural changes cause disruptions. Disruptions that are pretty much indistinguishable from ones that could be created artificially with a fiat currency.
Food prices are driven up by a crop failure. There is however a big difference between a crop failure causing a disruption, and one caused by the government forcing farmers to take debased coinage in payment for their goods.
Likewise there is a difference between changes in the quantity of commodity money caused by honest exploration and mining, than the false signal delivered by fractional reserve banking.
In fact, the exploration and mining can be viewed as a good thing.
No I have NOT answered the question, "Why should short-term, redeemable or marketable investments or securities not finance long term borrowing needs? " yet again. I'll do that in a second comment.
The purpose of this comment is to give you notice that I am no longer going to give either of you the benefit of the doubt much longer. I will be treating you the way you feel that you can treat me.
If you continue, my comments will be much more disdainful because it is clear that you are having trouble understanding, and interpreting your failure to comprehend as stupidity on the part of your opponents.
The comment made about time preference was incredibly ignorant of the economic issues involved and you speak of your opponents "bad economics."
Published: December 26, 2008 3:34 PM
Brian Macker
"Why should short-term, redeemable or marketable investments or securities not finance long term borrowing needs? "
This sentence has needless complications that only serve to confuse.
So here is the reformulation so as not to distract. You first have to answer this question.
"Why should short-term not finance long term borrowing needs? "
The short answer is that because then they would NOT be short-term investments.
They would in fact be long term investments, even if the investor didn't recognize the fact. In fact, if the investor is sold a long term investment as a short term one then he is being defrauded. If this scheme is explained to him and he still thinks it is a short term investment then he has in fact shown his incompetence in understanding the investment.
Nor is a long term investment that is easily marketable a short term investment. It's a long term investment that can be traded. It is NOT a cash account and it is not a short term investment.
Marrying long term investment to some reserve cash doesn't transform it magically to a short term either.
You are making the same exact mistake the rating agencies did for the mortgage backed securities. In their case the question was, "Why can't garbage loans back AAA grade securities?"
I was actually at a party and several years ago and was discussing the looming crash, well looming to me, not the general public. By chance I was talking with a guy who was actually employed at a rating agency to do these MBS ratings.
He got concerned about what I was saying about housing being in a bubble. He explained the methods he was using to rate the risks on the mortgage securities. Bundling, tranches, etc. When he got done, both myself and my accountant brother chucked afterward. We then explained his error.
He walked away disturbed but I don't think he really got it. He couldn't see that the very fact that their investment "innovation" was in fact disrupting the very price and default signals that it was depending on to assess risk.
You are having the same exact problem. Backing long term investments with short term ones destroys the market price signals that people can used to coordinate their actions in a free market.
FRB is fraudulent precisely because the people who are signing these contracts are incompetent to understand that long term loans can't back short term ones.
If they understood and were really wanting to invest long term then they would just buy long term notes directly, with or without investment advice, and gain a higher interest. They would an emergency cash reserve themselves.
People who invest "short term" in FR Banks are falling for the same type of thinking that gets people involved in pyramid schemes. Adding potential suckers to a scheme does not make the math work out.
In their case the potential suckers are the ones they assume are going to relieve you of the long term debt they hold when they decide they need cash for their short term needs.
What if, the other players in the market already hold their long term debt, long term. What if, they are not the only sucker around and there happens to be large percentage of other suckers who are in on the scheme? They would all be expecting to unload short term and therefore would not be able to find enough buyers. What if some short term problem, like a hurricane, or whatever triggers a large enough percentage of them to try and redeem all at once?
Worse yet, suppose that because the scheme is prevalent enough it has the effect of making people think that they could hold smaller cash balances because of a booming market, has the effect of inflating the asset prices backing the long term investments, sends false signals via lowered default rates, etc. Suppose this leads to the business cycle, as it does.
What happens then is that they find their "marketable" long term debt becomes true long term debt. Suckers.
Part of your misunderstanding is revealed by this question: "If cash has no return, why would any agent hold it in his portfolio, when investments that do have returns are available? The optimal cash balances would always be zero unless cash has some return."
If you don't understand why people hold cash then you've got real problems understanding economics.
Do you think they are going to use long term debt to pay for their groceries? Is that what you think?
They hold cash because they need to buy things short term. They hold cash for unexpected expenses, emergencies. They hold cash to save enough to purchase short term items. There are many other reasons to hold cash.
Converting that short term cash into long term loans makes it impossible for the bank deposit serve that purpose, even if a reserve is kept.
Pooling emergency cash reserves with other people does not magically increase the size of your reserve. In fact, what it does is make it possible for someone else to draw on your reserve without you knowing, and without your explicit permission. If enough people do it then you get a bank run.
I'm not sure it's even possible to put together a contract that is clear on this subject. You don't understand what's going on. How's the average Joe suppose to understand.
A account with a FRB is NOT a short term instrument. It's a long term instrument wedded to a gambling scheme for the remaining reserves. Worse than a gambling scheme since at least with gambling there is a clear means for deciding who gets the winnings. With FRB, it's more like musical chairs.
BTW, I read your comments on White's understanding of economics and yours. You both don't seem to understand money, where it's value comes from, etc.
The value of commodity money is not anchored in the base production and consumption cycle for other uses besides as money.
You were also totally off base in understanding what time preference means.
Published: December 26, 2008 5:52 PM
David Hillary
Brian Macker,
I sure feel frustrated reading all the comments on banking etc. and I suspect George Selgin felt the same. Perhaps you feel the same reading my comments, anyway there is nothing wrong with such feelings or expressing them on occasion.
I think you need to have thick skin to debate these issues, so insults should not be implied, and if insults are made, I suggest you overlook them as I do and get back to the point. Also disagreement does not imply ignorance: perhaps others are aware of the points or facts or principles but interpert or apply them differently.
I interpert and apply the principle of liberty and freedom of contract to not restricting or prohibiting fractional reserve banking, and therefore view any restriction or prohibition as amounting to interventionist and against liberty. Given the principal argument for this restriction or prohibition is concerns about the consequences of changes in the stock of money rather than moral or legal reasoning, I think it is fair to characterise those advocating restrictions in this way (at least for those who principally employ this argument). If that is not your position or reason for arguing that way, e.g. the inconsistent or incompatible property rights argument, then I invite you to reply to my work addressing that argument.
I'm happy but not terribly surprised you support liberty in mining and minting coins, and scrapping them too.
I think the burden of proof against financing long term assets with short term or demand obligations rests on those opposing it. I've probably seen a few arguments but I don't recall any that I find plausible, even moderately. To me it just seems to be the ordinary business of financial intermediation to turn risky specific illiquid long life non-financial capital assets into, to at least some extent, non-specific, low risk, liquid, marketable or redeemable securities, and some residual risky and or specific and/or illiquid assets or securities or equity interests.
Published: December 26, 2008 6:14 PM
David Hillary
Brian Macker,
May I compliment you on your writing: it is well written and well argued.
Long term assets that are marketable can be held as a short term investment through purchase or sales of securities in the secondary market. The success or failure of this style of investment is a matter for individuals to decide for themselves, who are we to restrict them? If this is what you are proposing, and I suspect you're not, then I can't see why this cannot be objected to as contrary to liberty.
The success of this business model or investment strategy depends primarily on the degree to which availability of funds to invest and need for funds from sales of the investment coincide.
Redeemable securities operate in a different way, i.e. primary market issues and redemptions, but have the same effect and require the same conincidence between incoming and outgoing funds to be successful.
The demand for holding cash you describe is accurate but not really framed in economic (cost-benefit) terms. The ability to execute transactions gives rise to a benefit. E.g. to buy something cheaper or in a more timely manner to use it has a value, and holdings of cash are the means of providing this benefit. These benefits should be construed in terms of marginal utility or marginal revenue. I conclude from this line of reasoning that metallic money is a form of productive capital, albeit subject to diminishing marginal returns.
Although long term debt cannot be used to pay for the groceries, debts are routinely exchanged for goods from merchants: merchants accept bank cheques, money orders, travellers' cheques, customer's cheques, and many also sell goods on credit sending an invoice for payment later. So why not bank notes or EFTPOS?
Published: December 26, 2008 8:03 PM
P.M.Lawrence
Brian Macker quotes me on Real Bills Theory, "That deliberately confined backing to assets that would self liquidate in the short term without those issues coming up; the only thing wrong with it was what happened when it got put into practice, since human nature led practitioners to over-estimate things like risk and soundness etc.", then writes "It doesn't matter. The same principle will operate for any other good used to substitute for money. Even if short term. I did not point this out but besides the effect on houses in my example the general increase in the supply of money drives down interest rates and causes other long term goods to look more profitable."
That's missing some of the implications of Real Bills Theory.
First off, I'd like to remind readers that I don't agree with that theory, because in general the conditions aren't met. In what follows I'm pointing out the theory's implications, which apply when the conditions do happen to apply by coincidence.
The Real Bills Theory not only supposes that the bills are matched to real goods and services in such a way that they self liquidate when those reach the market. It also supposes that issuing those bills caused them to be produced in the first place, by providing working capital for them. So, when the conditions are met, issuing the money doesn't bid up the price because it calls a matching amount of goods and services into existence (not just the end ones, also the intermediate work-in-progress ones). It's an attempt to monetise the original core business of banks, which was to finance trade credit and working capital.
As for 'So even if you only allow short term goods to act as "reserves" that would cause an increase in the money supply, lowering of interest rates, price increases, asset inflation (especially for goods further from consumption), the business cycle, and a whole host of other problems. Since houses are far from consumption they would go up in price also. Loans would still be "backed" by these overvalued houses, and similar problems would still exist.' - that's absolutely correct when the conditions don't apply, but as I pointed out, that's not a problem with the theoretical structure, it's the problem that means the theory isn't a real world theory after all. If it were, that new money wouldn't flow through to bidding up the prices of the other assets, it would be drawn back to the new ones generated by the money by a sort of suction, a process that would effectively sterilise the new issues.
"The entire motivation behind Real Bills is misguided. It's motivated by the economic fallacy that more money means prosperity."
Yes to the first sentence, no to the second. It's actually motivated by the subtler economic fallacy that you can pick winners. Issuing money in such a way that it all went to new production really would work out. The fallacy is thinking that you can pull off that trick. In fact, trying it would work for a proportion of the new backing, so it wouldn't be as bad as simply issuing new money for other purposes, but there would be a continual and cumulative leak from the proportion that didn't work out as backing. Since Real Bills advocates want to keep rolling things over rather than allowing the self liquidating to happen, and the time scale is quite short, you rapidly get something that's pretty much the same as plain ordinary printing money in its effects.
Published: December 26, 2008 8:48 PM
newson
david hillary says:
"I interpert (sic) and apply the principle of liberty and freedom of contract..."
here's where we diverge. the frb "deposit" could not be structured under any valid contract short of a lottery. the title to the deposit is unclear from the outset. other commercial contracts have an "out" by way of force majeure. but there is no act of god that can be invoked to defend non-performance of an f.r. bank, faced with a depositor unable to access his supposedly ready cash.
if the word "deposit" and "depositor" were not used, but the instead "loan" and "lender" substituted, it would accurately reflect the economic reality of the transaction, and may give people pause to wonder.
Published: December 26, 2008 8:52 PM
newson
jp says:
De Soto points out that FRB rose by mimicking warehouse accounts. That may be, but he assumes that all bank accounts MUST be 100% backed warehouse deposits and CANNOT be loan accounts.
just to be more precise about this, de soto only insists that deposit accounts truly reflect their common english meaning. he's not against customers loaning out their money to their bank, only that the two functions not be deliberately intermingled.
this wikipedia excerpt on "deposit" shows the sleight of hand:
"The banking terms "deposit" and "withdrawal" tend to obscure the economic substance and legal essence of transactions in a deposit account. From a legal and financial accounting standpoint, the term deposit is used by the banking industry in financial statements to describe the liability owed by the bank to its depositor, and not the funds (whether cash or checks) themselves, which are shown an asset of the bank. For example, a depositor opening a checking account at a bank in the United States with $100 in currency surrenders legal title to the $100 in cash, which becomes an asset of the bank. On the bank's books, the bank debits its "currency and coin on hand" account for the $100 in cash, and credits a liability account (called a "demand deposit" account, "checking" account, etc.) for an equal amount. (See Double-entry bookkeeping system.) In the audited financial statements of the bank, on the balance sheet, the $100 in currency would be shown as an asset of the bank on the left side of the balance sheet, and the deposit account would be shown as a liability owed by the bank to its customer, on the right side of the balance sheet. The bank's financial statement reflects the economic substance of the transaction -- which is the bank has actually borrowed $100 from its depositor and has contractually obliged itself to repay the customer according to the terms of the demand deposit account agreement. To offset this deposit liability, the bank now owns the actual, physical funds deposited, and shows those funds as an asset of the bank."
Published: December 26, 2008 9:06 PM
fundamentalist
David: "If cash has no return, why would any agent hold it in his portfolio, when investments that do have returns are available?"
The Austrian position on cash is that the return is purely psychological. There is no monetary reward to holding cash. See Mises chapters on money in "Human Action". Again, people hold cash because they have to, not because they want to optimize a portfolio. Cash is primarily for meeting current needs and unexpected expenses in the short run. If people could see the future perfectly, there would be no need for cash.
David: "It's funny you believe other categories of capital are subject to diminishing marginal returns but make an exception for cash. Your position ends up inconsistent and arbitrary."
Well then Mises was inconsistent and arbitray, too, because I learned what I know from him and Hayek. Belief has nothing to do with it. It's a well-known fact that increasing amounts of the same time of capital results in decreasing marginal returns. It's simple math. Austrians usually don't include money in a definition of capital, either. It has some characteristics of capital, but not all of them since money doesn't produce anything else whereas capital, in the Austrian tradition, are means of producing something else.
Published: December 26, 2008 10:20 PM
Brian Macker
P. M. Lawrence,
How are these two sentences different in your mind?
You:"It also supposes that issuing those bills caused them to be produced in the first place, by providing working capital for them."
Me:"It's motivated by the economic fallacy that more money means prosperity."
I think they make the fallacy of thinking that money actually provides the capital. Whereas it doesn't because it isn't backed by real savings. There is no true backing capital.
Published: December 26, 2008 10:41 PM
fundamentalist
PM Lawrence: "So, when the conditions are met, issuing the money doesn't bid up the price because it calls a matching amount of goods and services into existence (not just the end ones, also the intermediate work-in-progress ones)."
Thanks for the clarification of the RBD. However, the doctrine does cause consumer price inflation because there is a lag between investing the money from the loan and the arrival of new consumer goods. Hayek deals with the problem in "Profits, Interest and Investment."
Now the RBD may not cause inflation in the sectors closest to retail, those that assemble finished products because the lag time between investment and final product is so short. But any money invested in sectors more remote from retail, such as the steel industry, will cause consumer price inflation because most of the investment will go to paying wages and those new workers will spend most of their new income on consumer goods. Since the steel they produced has a ways to go before it comes out as a consumer product, no new consumer goods appear, yet, so prices start to rise in wholesale and retail.
Published: December 26, 2008 10:52 PM
newson
to brian macker:
am i right in saying you had a damascene conversion over frb? and if, so, what was the trigger?
Published: December 27, 2008 5:19 AM
Brian Macker
Newson,
No, what made you think that? In which direction do you think I converted? I'm very close to the positions that people are taking on both sides. I share all the concerns that you have expressed.
David Hillary quite reasonably stated: "If that is not your position or reason for arguing that way, e.g. the inconsistent or incompatible property rights argument, then I invite you to reply to my work addressing that argument."
He's right, I haven't expressed my understanding of liberty.
I will now express part of my understanding of natural rights, negative rights, and positive rights. I do NOT believe that the set of natural rights is equivalent to the set of negative rights. I believe that human nature forces certain positive rights matching certain limiting criteria into the category of natural rights.
This happens via knowing that humans are forced to behave certain ways given certain circumstances, and recognizing the right not to be unreasonably endangered by others.
As an example. In the movie "Bend of the River" the character played by James Stewart , Glyn McLyntock, gets the notion he is going to trek up to the gold fields just as winter is about to hit, for whatever reason.
The local law was preventing him from leaving for the area until he stocked up with enough provisions to allow him to survive the winter. The reasoning being that there was no stores or restaurants up there for him to buy goods with, and that money (gold) is pretty much not going to buy you much up in a gold field even if you thought you had enough money to buy food.
The further reasoning being that if he did get up there and did run out of food he'd be left with two options, begging and stealing. If the begging failed (and it probably would because others were only packing in enough for themselves and there were already low on food in the only gold town near the fields) then he'd be forced to steal.
This is in recognition of the fact that when a man is starving the rule of reciprocity break down, and likewise his power to behave in a civilized manner.
Reciprocity can only hold where a person is likely to receive the benefits that it brings, dead men don't receive benefits, therefore starving men are not likely to obey rules that turn them into dead men.
It is well known that despite peoples best intentions to respect others rights that when they face death their own survival instincts often kick in. Thus a starving man is not going to respect another's property rights. We've seen this over and over. Hell, some people resort to cannibalism in these situations, and it is not always clear that the person died naturally.
So I think that natural rights has to recognize certain facts about humans like these. Thus the standard libertarian formula of, "Do not initiate force or fraud" is insufficient. It has to be extended to include not endangering others. Other people have the right not to be endangered by your actions.
The risk of endangerment can be predicted beforehand. You cannot store dynamite next to your neighbors house even if you own the property and the dynamite. This does not mean you cannot store dynamite but that we have to look to the past to decide what is reasonable. Often this requires expertise the average person does not have. Thus the requirement for laws that take such expertise into account.
It was clear and predictable that McLyntock was setting off on a course of action that would likely harm someone else, even if not with certainty. This was endangering of others and did need to be outlawed.
The problem for such laws is that they need to be established based on what we know and not what we imagine. We need very good grounds for such law.
Gambling, and drug use can be restricted on these grounds once we know what happens. In the case of gambling we know it is harmless in moderation, yet results in a desperate individual when it gets out of hand. Thus it is reasonable to produce laws that prevent individuals from "losing it all" to gambling.
I think gambling should be legal but that it should be treated as if the parties are bound by certain rules. Such as the rule to make sure the other party is not gambling to the point of destitution.
With regard to FRB it is clear that the current rules are fraudulent. As you say calling a loan a deposit is fraud. Plus the banknotes themselves lie on their face. Thus according to the less expansive libertarian rules there is grounds for banning FRB.
However I think the libertarian rules need to be expanded. To distinguish myself from liberarians and to not get them upset, I do not call myself a libertarian, but instead a Responsibilian. The expanded set of rules being responsibilian ones.
I also believe that these rules are compatible with liberty, as correctly understood, whereas, the original libertarian rules are not. The libertarian rules not taking fully into account peoples right not to be endangered by others.
Responsibilian rules would also include the rule "do not freeload off the compassion of others". That however is a longer story, and I will not get into it unless you want to hear it.
Because of what I believe I think that FRB can be further banned on the grounds that it endangers others. It predictably puts other people in a position of destitution that results in them harming others. Not only via stealing but by pushing for laws infringing the rights of others through the political process.
That is the current rules for FRB. Well what if the rules are amended. Suppose the do everything that you and I suggested. They identify them as loans, refer to the banknotes as lottery tickets, and print only reserve quantities as the face value of the notes?
Well then I don't see a conflict between libertarian rules and amended FRB anymore. There is no longer any fraud.
Likewise it will not be clear, as of yet, whether the amended rules are a violation of Responsibilian principles. We have no history of using such a system, and would therefore not know if it would tend to cause destitution and the endangerment of others.
That is why I said before: "Well this is the point where I'm going to have to say that I don't know what would happen, and bow out for the evening." in response to J. Cortez.
I also think of new questions all the time. Like yesterday I was thinking about the face value of these bank notes and the reserves. I was assuming that if we printed the reserve amount on the banknote that would be sufficient. But now that I think about it further, it is impossible for the Bank to even guarantee that reserves won't fall below this amount. That's because depositors and bank notes are drawing from the same pool of specie.
The only possible solution I can see is to require 100% backing of the bank notes with specie. That is, the bank would have to keep a separate pool for banknotes, and stop depositors from withdrawing when their separate pool went below some specified amount. Also bank note holders would get first dibs on any specie holdings and if that falls short any other assets.
So I don't think I have had any major shift in my position.
I also happen to believe that Good Samaritan law can be written in a way that is compatible with liberty, and that in fact it is criminal (with or without the law) to take certain actions. Like if you spot a baby drowning in a bucket and do not lift a finger to help, or call for help, then I feel you are freeloading off the nature of others. After all they would help you in such circumstances, and in fact, most could not help themselves due to their nature. Thus you are in essence freeloading of an insurance plan you can't help but be enrolled in.
To claim that you wouldn't accept such help in dire circumstances is to be ignorant of your own nature.
Now certainly the person rendering help need not do so if they are substantially endangering themselves, but what danger is there to calling for help if a person is drowning?
I also feel that it is neccesary for the victim to repay the Good Samaritan for his efforts, or for property destroyed in the process.
This is my solution to the "Starving Hiker Finds a Cabin in the Woods" delimma. The answer is that the hiker can break in so long as he makes and effort to identify himself, and repay the damages.
Even if the owner is there he cannot refuse to help unless a reasonable person would believe that the person in need would not be able to repay the cabin owner in the future. Certainly if the help rendered the Cabin owner without food himself, and endangered him of starvation, there would be no means to repay. In such circumstances he could refuse to help.
If the cabin owner refused to help, yet had sufficient supplies, then the hiker has a right to use force to get those supplies. If the cabin owner kills the hiker over this then he is guilty of murder, because the hiker was within his rights.
Likewise, if the cabin owner was truly in danger of dying, or does indeed die of starvation, then the hiker was not within his rights and can be held criminally responsible.
In any case the hiker must repay the cabin owner for damages, supplies, cost of transporting the supplies, etc.
There are other criteria that I use for restricting the scope of these positive rights. There must be an emergency, there must be proximity, knowledge, like circumstances, etc. For instance, it is not likely that a starving person in Africa is going to be helping you by pulling your baby out of a bucket, so there is no need for you to travel the world looking for such instances, and failing to act in such cases is not criminal, nor even immoral.
I actually classify the right to be free from imposition of endangering risks as a subcategory of the right to be free from trespass. So I think you can believe in that and still call yourself libertarian.
My beliefs about freeloading on the charity of others puts me outside traditional libertarian turf.
Published: December 27, 2008 10:04 AM
David Hillary
Fundamentalist,
So, what you're saying is that 'productive' and 'capital' refer only to the means of producing goods and not to the means of producing psychological benefits?
Does this mean consumer durables such as household refrigerators are not capital either? How about inventories of finished goods?
I'd include inventories, including metallic reserves, within the definition of capital, as well as consumer durables.
Published: December 27, 2008 2:20 PM
fundamentalist
David: "So, what you're saying is that 'productive' and 'capital' refer only to the means of producing goods and not to the means of producing psychological benefits?"
That's correct. That's the Austrian definition of capital in brief. Refrigerators are not capital, nor are inventories of finished consumer goods. Inventories of capital goods, which will be used to produce other goods, are capital goods.
David: "I'd include inventories, including metallic reserves, within the definition of capital, as well as consumer durables."
One reason economics can be so confusing is that different schools have their own definitions of terms and confusing terms like "human capital". Austrians use the term to refer to anything used to produce other goods. The emphasis is on usage. For example, a pickup truck used by a consumer for towing his boat is not capital. It's a consumer good. But a pickup truck used by a rancher to haul hay for his cattle is capital.
Money is not capital. It's a measure of the value of capital at a particular point in time. Accountants will include the cash of a company as capital, but for Austrian economists, it's not capital.
Published: December 27, 2008 5:24 PM
newson
to brian macker:
sorry for the misunderstanding, i thought i'd read you defending frb some time past.
i too, would be happy for frb to be permitted, provided the lottery aspect were made clear. as you say, a "lender" (not "depositor") can recover anywhere between 100% and zero of their money in the bank-run scenario (which itself is completely unpredictable).
i don't agree with your stance on protecting people against themselves, which seems paternalistic (some people will always self-destruct, notwithstanding laws, family concern etc). black-letter law is totally ineffective in promoting moral redemption, which must come (or not come at all) from within.
in your "Starving Hiker Finds a Cabin in the Woods" scenario, i disagree. the fact is the hiker does seize the woodsman's property against his will. extenuating circumstances would be highlighted in the sentencing. most legal codes allow legitimate defense, subject to proportionality of response to threat. but murder? i think not.
Published: December 27, 2008 5:26 PM
David Hillary
So inventories of copper are capital because they are half way to making electrical wire etc. but inventories of gold coin are not? Perhaps gold would be coined normally after being mined, and then would be used as a material for making jewelery? So does not that make inventories of the monetary metal (I can't see coining it or melting it into bullion makes much difference) capital after all?
Published: December 27, 2008 6:18 PM
newson
to david hillary:
your point is an interesting one. i've always imagined that in a gold money system, money supply would only include gold that is universally marketable without assaying. that is, ingots and coins from reputable refiners and mints.
jewelry and non-assayed gold would not qualify as money.
non-monetary gold would either be a consumer item or a capital good, depending on it's owner's use.
Published: December 27, 2008 7:54 PM
David Hillary
Newson,
Legally, under a gold standard, gold coin is the standard of value, and so gold bullion is just a commodity, it has a price in terms of money, i.e. in terms of gold coin. This will be at a discount, due to the costs of coining bullion into metallic money -- the great this discount, the greater the gross margin for coining, and so the more viable will it be to coin bullion. However, this discount does little to impact on the viability of either mining gold or consuming gold by using it as an input to make other things, chiefly jewelery, which of course is not legally money.
The legal standard of value is just that, a standard, against which other forms of consideration or tender are measured. For example payment by cheque gives a conditional satisfaction of debt if accepted: 'the condition to which payment is conditional is a condition subsequent, namely that the cheque will be met upon proper presentation for payment.' (Tyree's Banking Law in New Zealand, Second Edition, 6.10.2). Another example is the use of bank cheques to settle contracts for the sale of land: 'In contracts for the sale of land there is an implied term that tender of a bank cheque in settlement shall be a good tender of the amount expressed thereon. To cover the remotest contingency we would add the proviso that it may be refused only if the recipient has reasonable grounds for believing that because of insolvency the bank may not honour it.' (NZ Court of Appeal, Williams v Gibbons [1994] 1 NZLR 273) and noting that bank cheques are akin to bank notes as they are promissory notes, not cheques (Since they are not 'addressed by one person to another' but are addressed by the bank to the bank, effectively a unilateral promise to pay).
The use of agents such as banks to pay and receive money on behalf of their customers also creates ways of discharging debts of money without the use of coin each time: Suppose A acts as payment and receipt agent for both B and C, and A owes $100 to B and $500 to C. C owes B $100 so C writes an order to A to pay $100 to B, and B presents it to A, who credits the account of B $100 and debits the same amount from C's account. Although A has paid the money from himself as agent of C to himself as agent for B, C's debt to B is discharged by this order and book entry process. The discharge is good even if A fails to pay B, since payment to an agent is good discharge of a debt to the principal even if the agent fails in his obligations to his principal. (A similar example could be constructed for inter-bank settlement, however it would be slightly more complex.)
A company that deals in manufacturing equipment such as presses or injection moulders etc. would classify such equipment as current assets on its books, although a manufacturing company that purchases the same equipment to produce its own goods would classify them as fixed assets on its books. In other aspects of accounting sometimes the intention or business of the reporting entity changes the same kind of asset or liability (or income or expense). For example trading securities vs. investment securities on a bank's books are reported separately, and sometimes valued differently. Often economists would not use the same categories or accept such distinctions as noting significant differences. However, when it comes to capital assets, it seems to me these kinds of distinctions are being made.
Published: December 27, 2008 11:27 PM
P.M.Lawrence
Brian Macker asks 'How are these two sentences different in your mind? You:"It also supposes that issuing those bills caused them to be produced in the first place, by providing working capital for them." Me:"It's motivated by the economic fallacy that more money means prosperity."'
My mind has nothing to do with it. The difference is right there, "by providing working capital for them". The two sentences would be equivalent if that were dropped.
"I think they make the fallacy of thinking that money actually provides the capital. Whereas it doesn't because it isn't backed by real savings. There is no true backing capital."
No, they think the converse: that the working capital (right there, in the businesses) is providing the money. They issue the money to bring in the working capital, in the full knowledge that they aren't creating the capital but only mobilising it. At no stage does the money lack backing - providing their assumptions continue to hold, which as I pointed out is their mistake.
Fundamentalist writes of my "So, when the conditions are met, issuing the money doesn't bid up the price because it calls a matching amount of goods and services into existence (not just the end ones, also the intermediate work-in-progress ones)", 'Thanks for the clarification of the RBD. However, the doctrine does cause consumer price inflation because there is a lag between investing the money from the loan and the arrival of new consumer goods. Hayek deals with the problem in "Profits, Interest and Investment."'
Ah... take another look at what I wrote. To the Real Bills advocates, that's a non-issue because the holder of the cash is connected to the time scale of the work in progress assets and doesn't go out and spend the cash he holds any faster than the work gets finished (his need to hold cash makes him hang onto it for a while or up to a certain level of holding). That comes out of choosing only to issue money backed by short time scale stuff.
So that effect is very real, and one of the things that does go wrong, but again it goes wrong from the assumptions being wrong and not from a failure of the reasoning in the theory. You can see just how difficult it would be for this particular stopped clock ever to have real world facts line up just right so that it would work properly (although as I also pointed out, it's often close enough that there is only a slow leak which its advocates are able to ignore, at least for a while, and then maybe blame on something else).
I'm trying to show that these people are wrong in ways that aren't what most people think, in their assumptions and not in their reasoning. Without that insight it would be hard to recognise other problems of a similar sort, and also it would be hard to counter these people because they would recognise the flaws in the objections and come away reinforced in their error.
It's as though Sir Isaac Newton (who dabbled in alchemy) had written "if I can find the Philosopher's Stone I will be able to turn lead into gold", and a modern scientist who knows it can't be done commented "even if Newton could find the Philosopher's Stone he still couldn't turn lead into gold". Of those two sentences, the former has good logic and the latter is logical rubbish. The truth of the matter is that because you can't turn lead into gold there can't be any Philosopher's Stone for anybody to find. However, by definition, the Philosopher's Stone is a tool for the job, so the first sentence is a tautology and the second is a contradiction in terms. The scientist is so sure that you can't turn lead into gold that he didn't bother to say that properly and came out with a nonsense. If Newton could somehow have been told that, he would have dismissed it as nonsense without being confused by the actual impossibility of the end result since he didn't know about it.
Published: December 28, 2008 12:23 AM
Brian Macker
"No, they think the converse: that the working capital (right there, in the businesses) is providing the money.
I don't care what they think they are doing. There is no backing capital because it is double counting. No new savings was done to accumulate the capital ahead of time. Banknotes are not capital, they are only markers against capital.
If you issue new notes based on future revenue then you are double counting. Money was already spent in accumulating that capital into a business. If you issue new money you are double counting.
They are printing up new money to mimic what happens with savings, without actually doing any savings ahead of time. Time matters when it comes to saving, and they are ignoring that. The savings has to happen before, not after investment.
"They issue the money to bring in the working capital, in the full knowledge that they aren't creating the capital but only mobilising it."
"Mobilising it" being short for "stealing it" via notes unbacked by specie which will cause inflation. They are in essence counterfeiting and using the newly printed cash to buy goods at old prices before the inflation kicks in.
"At no stage does the money lack backing - providing their assumptions continue to hold, which as I pointed out is their mistake."
Their assumptions are wrong from the start. They don't become wrong. Even if they were omniscient in their actions there would still be problems.
If there were no FRB then the quantity of specie at current prices would already reflect the generic savings available for investment (as opposed to savings done by stockpiling specific goods). Issuing new notes dilutes the value of the existing money the minute it is done. The real bills doctrine claims that it is not inflationary. However it is from the start.
That initial inflation in the money supply works against the old prices set during the period with no monetary inflation. It makes the revenue streams look more promising than they are because they are buying at the lower prices set with less money.
The real bills doctrine is lending based on these inflated revenue streams. The very ones it caused. Thus it will over-issue notes above the equilibrium for the new system.
In addition it will funnel investment in the wrong areas. It's not that they fail because they aren't perfect in their choices for investment. They'll fail because their system explicitly will make the choose the wrong choices.
Although inflationary in the short run, it is NOT inflationary in the long run because the business cycle kicks in and the expanded money supply collapses on the back of the failed investments.
So in a way they are correct. It is not inflationary in the run-away sense. But the same can be said for plain old FRB without the real bills doctrine.
Meanwhile, as the boom tops out and then collapses the prices will end up falling below the starting point. People will cling to their money fearing to invest lest it be lost, and things will be worse than before their scheme was put in play.
There will actually be more actual savings occurring than money representing it on the downswing. Which is the exact reverse of what happened going up.
Eventually the depression will pass, things will pick up again and the cycle will repeat.
Their fundamental mistake is thinking that printing up the new money is going to give them capital NOW. It won't. Their second mistake is in thinking that this magically created capital is going to increase production the way real savings does, which they think will then allow them to print yet more money to match the increased goods. Thus in their minds they think they are keeping prices stable while continuing to expand the money supply.
They were never claiming it would not result in monetary inflation. They were claiming it would not result in price inflation. They think backing their notes with something other than specie is non-inflationary from a price viewpoint, since they believe at any point they can sell backing assets, get specie, and repay.
They falsely believe that bank maintaining 100% backing of notes with specie for demand accounts is somehow tying up capital. It isn't. All capital that people are willing to lend is already being lent out via loans. People need their cash accounts to maintain their cash flow.
The cash accounts (and personally held cash) as specie serves as a medium of exchange. Trying to force that cash into service as a capital good leads to problems. If it is lent out as if it is backed by capital good then less is available for it's actual purpose. The accounting fraud inherent in this takes time to play out but as the boom turns to bust people are essentially put in the position of a more barter economy. Not having enough cash to properly trade at the inflated prices.
The difference between a barter economy and a money economy is more than having commodity that can serve as a medium of exchange. There needs to be a price structure, and that price structure must value the commodity money at a high enough level so that it can serve as a medium of exchange.
If the commodity money is merely valued at it's non-monetary use value then it will only be used for those purposes. The ratio of goods to the commodity money in trade would be too low. That is why I said that such a price level does not set an "anchor" for that commodity money. It doesn't truly serve the purpose of money in the system at those prices.
The addition use of the commodity as a medium of exchange is what raises it's value in terms of other goods, above that supposed anchor. But it's not the anchor price that determines, in any way whatsoever, the value of that commodity as a medium of exchange, or a store of value in a money system.
Money cannot serve it's purpose in the system if banks are allowed to print up fraudulent notes that claim to pay specie that don't actually have specie backing. Back them with something else and they distort the system. So if you have a banknote that says one ounce of gold that is backed by much less you will get problems.
I do not know what would happen if you put the actual value on the banknote as "Lottery ticket: Only backed by 1/20th of an ounce of gold, maybe less, and you may get a full ounce if you get to the bank before the next guy". People might trade in these things, or maybe not.
I think though the fact that there are 20 times as may of these things as specie and they are marked at 1/20th at least makes the math balance out with the amount of backing specie.
I don't see why people couldn't trade in notes backed by loans either. Problem is that then people would question exactly who was loaned to, what the risks were, etc. Such notes would be harder to move and would trade a discount to specie.
Otherwise the price structure is distorted by these false notes flowing through the system. Everyone is defrauded by this process, even those who are not directly participating.
If party A offers one ounce of specie for a good sold by C and party B offers a banknote backed by only a 1/20 this then party A is being underbid with a false bid. Which really isn't fair to A. It is a fraudulent intereference in his freedom of association with C, by a falsehood being promoted by B.
This is the same issue as if C was trying to attend a concert being provided by A, and B screamed fire if there wasn't a fire. It would be B's falsehood believed by C, which would interfere with A interacting freely with B. A cannot freely associate with B under these circumstances of C lying. Especially where it is hard to catch the lie, as happens with this sophisticated monetary scheme.
Likewise the use of fraudulent banknotes to trick other parties harms more than just the parties that consent party C and party D (the bank). It harms those people who are fooled by the banknotes, and it also harms those who are not fooled in their relationships with those who are fooled.
I do NOT believe that a system that is fraudulent should be allowed to continue even if the suckers haven't gotten wise to it. Since the scam is effecting me I have the right to interfere. The only problem is I don't have to power to right things, as is often the case.
Published: December 28, 2008 10:05 AM
Brian Macker
"I don't agree with your stance on protecting people against themselves, which seems paternalistic ..."
It's not paternalistic, and is not protecting them against themselves. It's entirely based on protecting myself against there quite predictable actions. It is not, in fact grounded in desiring that their lives be better. That is merely a side effect.
in your "Starving Hiker Finds a Cabin in the Woods" scenario, i disagree. the fact is the hiker does seize the woodsman's property against his will.
To which I say, "So what". Property rights are not absolute. The reason we allow people to wall off sections of land is so that we can do the same, and that both of us can gain the benefits. There is no future benefit for the hiker in respecting the cabin owners "property rights" at this point, so that relationship evaporates under this circumstance.
The only way that relationship can be maintained is for the hiker to compensate the owner in the future, and for the owner to provide the goods now.
"... extenuating circumstances would be highlighted in the sentencing. most legal codes allow legitimate defense, subject to proportionality of response to threat."
What extenuating circumstances? The owner has no extenuating circumstances.
"... but murder? i think not."
Manslaughter, what ever you like. The guy is placing himself forcefully between a starving person and food.
It's the same as if you are standing on your dock and a guy falls out of his boat. He grabs for the dock in order to save himself. You decide it's your property and you don't want him using it. Especially since you charge people twenty five cents apiece to walk on your scenic dock, and the guy doesn't have a quarter at the moment. You keep stepping on his fingers every time he reaches up to grab the dock, and he eventually drowns.
You realize this is exactly why some people HATE libertarians, right?
What extenuating circumstances do you as the dock owner have to fall back on here? NONE. That you thought the guy wasn't good for the twenty five cents? You don't have extenuating circumstances however the guy drowning does.
Likewise the hiker. He's starving, and you have a cabin full of food, warmth, etc. What extenuating circumstances are you going to fall back on? That you didn't think the guy was good for the cost of a ham sandwich, a coke, and the cost of a phone call?
Don't argue at this point that everyone would just allow the guy to climb on the dock. You are claiming it isn't a crime, so under your system there really is no problem stepping on the fingers, other than other people thinking bad of you. Well some people can live with that, especially if they've inherited a lot of money, and have lived with silver spoon in their mouths all their lives.
The problem, even for the rich curmudgeon, is that were the table turned, then he would also reach for the dock that wasn't his, and if the normal humane person offered help then he would accept it. Even if he thought he wouldn't. I've been in a drowning situation and when you're drowning you grab.
What you are proposing here as the rules any normal person would find repulsive.
My rules are consistent with property rights and are based on how the rights arise, reciprocity. Your rules are just downright mean.
Not all libertarians believe that the owner can refuse the starving person, I might add. Although they have trouble justifying this given their beliefs. I have no such problems. Thus those libertarians have a flaw in their reasoning, as apparently do you.
So do you believe that if you were drowning that a dock owner could step on your fingers? If not, then why not. Heck, I betcha under your beliefs the owner has a right to retract his permission for you to be on his property at any time. Why not after you've been swimming off his dock with his permission, when you find yourself tiring and reaching for the dock.
Published: December 28, 2008 10:51 AM
Brian Macker
Newson,
"your point is an interesting one. i've always imagined that in a gold money system, money supply would only include gold that is universally marketable without assaying. that is, ingots and coins from reputable refiners and mints.
jewelry and non-assayed gold would not qualify as money."
See Human Action on this topic in the section titled "Secondary Media of Exchange".
That section also answers P.M.Lawrence's questions.
The answer is that money as a medium of exchange is not "capital" in the sense of holding value for being a capital good, one used in production. You can certainly use it as one. You can drill a hole in the middle of a gold coin and use it as a washer on your machine, and there might be circumstances where this is the most valuable use of the coin, at the moment.
That doesn't mean that gold, as money, is serving as as a capital good as defined in the theory, when it is being used as a medium of exchange.
The additional value of the money as a medium of exchange goes beyond it's value as a capital good, as a washer, as gold plating on a electrical contact, whatever.
And I'm talking about that particular gold coin. If it were more valuable as a capital good, at the margin, it would be converted to a capital good. It isn't. There is already enough gold being used to coat electrical contacts, at the greater value use, if it is of greater value. The additional gold would be of lesser value on the margin for other uses besides as a medium of exchange (and store of value).
Don't make the mistake of thinking the gold coins stored in banks is "capital". If all the true capital were destroyed, the machines, the tools, the buildings, etc. then those gold coins being used as a medium of exchange could not serve as capital, because they aren't.
The gold would lose much of it's value as a medium of exchange because the reduced production would mean less things to exchange. Less goods implies less exchanges, and less need for the medium of exchange, money.
Money becomes more valuable with more goods not because of any direct ratio between the quantity of goods and the quantity of money. The direct link is really to the quantity of goods exchanged and the quantity of money. The hidden assumption is that the quantity of goods exchanged will retain the same proportion with the quantity of goods as the amount of goods goes up.
It turns out that this is a good assumption in an economy based on a division of labor and specialization. Most goods are produced for exchange in the first place. Thus the rule of increased money without increased production causing increased prices holds. While increased production without increased money results in price deflation.
Don't get too tied up in all these definitions. It turns out that lemonade can be a capital good if employed in business to feed the workers. As long as consumption goods that were saved up are used to allow more production they are a capital good.
Thus the example of the fisherman saving up enough dried fish so that he can have the time to manufacture a net. The dried fish are being used as capital goods in this example. If he saved the fish up so he could take a long vacation then they are consumptive goods.
Published: December 28, 2008 11:19 AM
Brian Macker
Newson,
Forgot to add the link:
See Human Action on this topic in the section titled "Secondary Media of Exchange".
Published: December 28, 2008 11:22 AM
jp
Question for anyone. Is it fair to say that the Austrian categorization of future vs present goods directly corresponds to capital vs consumption goods?
Also, are financial assets like stocks considered capital goods? I'm curious about this from the point of view of someone who makes a living as a speculator, say a day trader who buys and holds a stock for a few minutes and makes a return on it. Capital good or not?
Also, are a firm's unfinished products considered capital? What about finished inventories of goods yet to be sold?
Published: December 28, 2008 1:27 PM
jp
P.M. Lawrence: "...So that effect is very real, and one of the things that does go wrong, but again it goes wrong from the assumptions being wrong and not from a failure of the reasoning in the theory. You can see just how difficult it would be for this particular stopped clock ever to have real world facts line up just right so that it would work properly."
Well, bankers can introduce methods like down payment requirements and low loan to value ratios to reduce their risk.
But isn't your critique of RBD something you can say of any business? In theory any business can work out, but in practice they don't. Those who run a bank well, like those who run a restaurant or a grocery store well, will survive. Those who don't fail.
RBD is just good business advice for a bank, just like "serve good food with good service" is good advice for a restaurant.
Published: December 28, 2008 2:45 PM
P.M.Lawrence
Brian Macker writes of my "No, they think the converse: that the working capital (right there, in the businesses) is providing the money", "I don't care what they think they are doing. There is no backing capital because it is double counting. No new savings was done to accumulate the capital ahead of time. Banknotes are not capital, they are only markers against capital."
No, there is no double counting, because they are not counting the original holding of the mobilised assets. That is also an error, but it is not that error (see below).
"If you issue new notes based on future revenue then you are double counting. Money was already spent in accumulating that capital into a business. If you issue new money you are double counting." - but it is not based on future revenue. The future revenue is what closes the loop and retires the issue of money (unless, as they do, they roll it over). The backing is the pool of work in progress assets.
"They are printing up new money to mimic what happens with savings, without actually doing any savings ahead of time. Time matters when it comes to saving, and they are ignoring that. The savings has [sic - 'savings' is plural] to happen before, not after investment."
The point they have in mind is that all those things are just sitting around anyway, not doing anything. Therefore they have no value until they are mobilised - which the advocates aim to do by buying them with newly issued money. The advocates are wrong; those assets do have a use and a value, because there is already a cash economy ticking over. That is how the advocates reach the position of not counting them in the first place (see above).
Brian Macker then writes of my "They issue the money to bring in the working capital, in the full knowledge that they aren't creating the capital but only mobilising it", '"Mobilising it" being short for "stealing it" via notes unbacked by specie which will cause inflation. They are in essence counterfeiting and using the newly printed cash to buy goods at old prices before the inflation kicks in.'
No, they sincerely believe that they are mobilising assets that are currently not in use by anybody, and that that mops up price inflation. So, they are not "in essence counterfeiting and using the newly printed cash to buy goods at old prices before the inflation kicks in", they are doing that in practice.
"At no stage does the money lack backing - providing their assumptions continue to hold, which as I pointed out is their mistake."
"Their assumptions are wrong from the start. They don't become wrong. Even if they were omniscient in their actions there would still be problems."
Actually, no. But they would end up mimicking a bullion standard or something of that sort.
"If there were no FRB then the quantity of specie at current prices would already reflect the generic savings available for investment (as opposed to savings done by stockpiling specific goods). Issuing new notes dilutes the value of the existing money the minute it is done."
In the real world, yes - but their faulty theory supposes that the buying power stays up because the increase of real goods and services reach the market as fast as the new money does.
"The real bills doctrine claims that it is not inflationary. However it is from the start."
Now, who is denying that? I'm only pointing out that the failure is in the assumptions, not in the reasoning.
"That initial inflation in the money supply works against the old prices set during the period with no monetary inflation. It makes the revenue streams look more promising than they are because they are buying at the lower prices set with less money. The real bills doctrine is lending based on these inflated revenue streams. The very ones it caused. Thus it will over-issue notes above the equilibrium for the new system."
Again, that is describing how reality breaks in, not the internals of the theory. To make that into a proper critique, aim it at the assumptions.
"In addition it will funnel investment in the wrong areas. It's not that they fail because they aren't perfect in their choices for investment. They'll fail because their system explicitly will make the choose the wrong choices."
That is wrong. If they could only find the right opportunities (which they can't) it really would all work out the way they think.
"Their fundamental mistake is thinking that printing up the new money is going to give them capital NOW. It won't."
Actually, it does - even when they don't get it right. It even does it for people who only want to print money. It's just that (as was pointed out) it's not giving a use to previously useless resources, it's taking them away from someone who had them before. Change "give" to "create", and that would be accurate.
"Their second mistake is in thinking that this magically created capital is going to increase production the way real savings does, which they think will then allow them to print yet more money to match the increased goods. Thus in their minds they think they are keeping prices stable while continuing to expand the money supply."
No, that is actually 100% accurate reasoning. The mistake is thinking that they do create capital (in the sense of finding a use for unused resources), not in misunderstanding what newly created capital would do (if they had it). That critique is faulty in pretty much the same way as the critique of the Philosopher's Stone that I described earlier.
"They falsely believe that bank maintaining 100% backing of notes with specie for demand accounts is somehow tying up capital. It isn't. All capital that people are willing to lend is already being lent out via loans. People need their cash accounts to maintain their cash flow."
Actually, that is wrong. More precisely, it's what happens in a healthy free market, but it's not what happens when some outside intervention has locked things up solid. Unsurprisingly, situations that are near to that have often led to Real Bills Theory becoming more popular (and even, on occasion, more practical than the lock down; Jersey indulged in it during the Napoleonic Wars, with some success, but fortunately the advocates were stopped before they went so far that they built up unmanageable dislocations of their own instead of the old ones).
Brian Macker also supposes that 'Human Action... in the section titled "Secondary Media of Exchange"... also answers P.M.Lawrence's questions'.
First off, I do not have questions, I am trying to keep critiques properly focussed. Second, it intrinsically cannot address the issue, because it is not a primary source. The only way to address Real Bills Theory is to go to what its advocates are touting, see it for what it is and criticise that (you will soon find out that one of the prominent advocates around here is actually a fake - he calls all sorts of things Real Bills that actually aren't, like government bonds and tax "debts"). As I have pointed out, there are no errors of reasoning within it - it is internally self-consistent - but the problems lie in the assumptions.
JP asks 'But isn't your critique of RBD something you can say of any business? In theory any business can work out, but in practice they don't. Those who run a bank well, like those who run a restaurant or a grocery store well, will survive. Those who don't fail. RBD is just good business advice for a bank, just like "serve good food with good service" is good advice for a restaurant.'
That's what would happen, if only the advocates kept it at that level. But they suppose that they can carry a money issuing structure on the back of that, in a material and enduring way.
Published: December 28, 2008 6:52 PM
gene berman
fundamentalist:
In your response to David (above) you err somewhat in your defintion (presented as the "Austrian" view or definition of "capital."
You state that inventories of produced goods are not capital. And, further, you state (separately) that money is not capital.
Neither is a true statement of the Austrian view (as expounded by Mises). At best, both are partially-true statements requiring further elaboration for understanding. I present the correct view following for however it may clarify your thinking or use in discussion.
The term "capital" denotes that which is intended for use in a process resulting in the production of a good (or service). Inventories of finished goods are, in this sense, not capital, as you have noted. But the same stocks of finished goods earmarked for consumption through some period during which their consumption aids a productive process--is capital. Money in one's pocket or even in one's personal bank account is not capital. But the same amount of money in the account of a firm engaged in production (whether of goods or services) is, indeed capital; and that money is capital whether it is owned outright by its possessor or is, in fact, wholly borrowed (and, following such intended use, both borrower and lender are "capitalists," as it is the clear intention of each that the sum in question be used in a specific productive process. Thus, also, a printing press at its manufacturer's plant is not capital to that firm but will be to the publishing house to whom it is delivered.
The function of capital is to enhance production, either by producing more or better goods in the same span of time, or the same amount of at least the same quality of goods in a shorter period. They (capital goods, including money intended for such use0 are always means intended to increase the productivity of labor. Whatever may be the productive goal, it becomes nearer through the employment of capital (though, whether investment will "pay" or not must be determined by entrepreneurial analysis of the individual case).
Published: December 28, 2008 9:13 PM
gene berman
This discussion thread has wandered substantially from its original focus on the "Chicago School" and in what consists the principal difference between that school and our own, the Austrian, which developed in almost straight-line fashion from Menger, through Bohm-Bawerk, to Mises.
In my own view, the essential difference between the two lies not so much in differences in their respective economic theories but, rather, in their fundamentally divergent views on the subject of human liberty (and the theoretical differences are ultimately traceable to this divergence).
Both men promoted the ideal of free markets and that authoritarian interference in market freedom was economically unsound and ultimately destructive, not only of prosperity but of freedom itself. The "schools" of each attracted adherents interested as much in the ideas of greater freedom as in anything specifically related to economic
science..
I read Mises' HUMAN ACTION first--in 1972; it was my introduction to economics of any kind. Because it took years (and many re-readings) to internalize, I read little else. This is by way of explaining that I've never read anything by Friedman and so cannot critique any of whatever may have been his arguments on various economic subtopics. Regardless, I feel fully qualified to reject a main thrust of Friedman and the Chicago School: their claim to champion freedom.
At its core, the difference is that Mises (and those of the Austrian School) go "all the way" in extending economic liberty to everyone; we wish there to be no "control" of economic affairs by coercive authority and insist, on the basis of theoretical understanding, that nearly all such instances lead inexorably to failure of the control;;;and worse.
I characterize the Chicago School as subscribing to a view in which is promoted a widespread relinquishment of most of all the more obvious forms of coercive control as long as ONE "master control" is maintained--the quantity of money---and that such control be in the hands of either Friedman or one of his Chicago School acolytes. I'd call it "an iron grip in a velvet glove." Like other methods in the toolkits of social engineers and regardless of whether it's effective for some particular period, it's still a step (and a major one) along the "road to serfdom." And I simply cannot buy that a smart guy like Friedman didn't understand that all just every bit as well as you and I.
Published: December 28, 2008 10:33 PM
newson
to brian macker:
thanks for the comments on capital.
as for your other comments: first, i don't purport to stand for anyone's views but my own, so i'm not going to be drawn into why some people may hate libertarian ideas. second: "responsibilitarianism" requires that "we" define rules that separate moderate (harmless) from immoderate (socially destructive) indulgence in vices like gambling and drugs. but how do "we" establish these limits? a non-drinker can become obnoxious after one beer, an alcoholic may be perfectly harmless (in a social sense) after a dozen beers. arbitrary limits don't work, and are going to push some into the black markets that "our" rules would create.
third, your credo seems to imply that not performing acts of human kindness should be criminalized. so the good samaritan wouldn't really be good, he'd be fearful of sanction. i really don't think there needs to be law protecting babies drowning in buckets (the rescue would be costless, anyway. where are the parents?). if i follow your line of thinking, what about prosecuting me if a don't jump in the surf (putting myself at risk) to rescue a perfect stranger? should i be forced to house the homeless?
if property rights are not black and white, everything collapses back into a game of proving who's in greater need. it's a slippery slope.
finally, your mean-bugger with the private wharf would be probably guilty of breach of contract (implicit in the invitation to swim off the wharf is the expectation that a safe exit will be provided, otherwise it's wilful entrapment).
apologies to gene berman for the tangent.
Published: December 28, 2008 11:35 PM
Brian Macker
"third, your credo seems to imply that not performing acts of human kindness should be criminalized."
Nonsense.
"the rescue would be costless, anyway. where are the parents?"
Yes, the rescue would be costless. What's your point? Perhaps the parents just died in a car accident, what's that matter?
"if i follow your line of thinking, what about prosecuting me if a don't jump in the surf (putting myself at risk) to rescue a perfect stranger?"
I already indicated that one criteria is that the act not endanger the rescuer. It's one thing not to jump in the surf and quite another think to walk away without summoning help.
"should i be forced to house the homeless?"
Of course not. It doesn't meet the criteria. There is no immanent danger, it is clear that that the homeless have no intention of repaying anyone. Remember there is a requirement for repayment. They would soon be in jail for not repaying the last guy who had to take them in on a freezing night.
"if property rights are not black and white, everything collapses back into a game of proving who's in greater need. it's a slippery slope."
Slippery slope is a fallacious way to argue. You think people are going to start getting themselves lost in order to starve just so they can break into your cabin, and then be forced to repay you? Are you aware that mountain climbers already are forced to pay for helicopter rescues that are provided for them. I don't see them purposely putting themselves into emergency situations just to get free helicopter rides.
"implicit in the invitation to swim off the wharf is the expectation that a safe exit will be provided, otherwise it's wilful entrapment"
Well the same argument could be used against absolute property rights, using the slippery slope principle. Wouldn't it also be willful entrapment to start selling water to someone and then cut it off when they are in most need of it.
The first example of the nasty wharf owner was not a matter of entrapment. He was just mean.
Besides much of this was already settled in common law and there was an established right to break into a cabin to save ones life. So property rights aren't absolute to begin with by the cherish libertarian common law.
Published: December 29, 2008 3:57 AM
Brian Macker
I stand by my understanding of real bills doctrine. It's about printing up fresh cash to divert capital from the true owners into their own schemes. It imagines that this printing of new money will somehow lead to prosperity, which is wrong. It will lead to the business cycle.
I don't see why having bad assumptions saves them from my accusation. If you are stupid enough to assume from the start that printing new money will lead to prosperity then it doesn't matter how self consistent the rest of your theory is. Your theory is still based on the idea that printing new money makes people richer.
Published: December 29, 2008 4:13 AM
Brian Macker
Gene,
You state that:
I think this is mostly correct but is too restrictive.
In my example of the fisherman saving up fish. Well he could have used the saved fish to feed himself while producing some other goods which in no way were intended to increase productivity.
For example, he may have used the fish to feed himself while collecting materials and building a beautiful present for his wife. The fish is still a capital good in this case. While the present would be a consumptive good. There is nothing that increases productivity in this case, unlike my example of building a net.
He's converted his capital, the fish, into a consumptive good, the present. Without the saving of the fish he could not have produced the present. Just like he could not have produced the net without the savings.
Published: December 29, 2008 4:28 AM
Brian Macker
Newson,
... and remember that if welfare recipients were required to repay they would soon be kicked off the dole when it became clear they couldn't. They would then have to rely on charity. Which is NOT covered by the criteria I had in mind.
You seem to be ignoring the very clear criteria that I had expressed. There are further criteria I hadn't but they are not needed to dispose of your objections.
Published: December 29, 2008 4:35 AM
Gil
Macker - if I get the gist of what poor ol' Mike Sproul has been talking about the RBD (and probably don't) - but I believe he was trying to assert that the RBD tries to go towards making 'true' money. 'True' money is what I would define as where money is merely a measure/store of values allowing people to be able to create, rate and trade good & services over time. But you & friends would point out that a hollow credit system can't last because there those who instead would deliberately create more money without any correlation to the good & services causing them to get immediate purchasing power and others pick up the cost and generally destroy the ability to rate the value of goods & services to each other.
The inevitable answer has been gold weights. Since you can't trust people who will inflate their way to unearned you pick a substance which happens to roughly match the quantity of the good & services yet cannot be created out of thin air. Alchemists represent the desire to (hyper)inflate and seize wealth without earning however we can gloat that no one can magically mine enough gold to serious inflate the exist gold stock. Simple, no?
Published: December 29, 2008 4:58 AM
newson
to brian macker:
the slippery slope in "responibilitarianism" is the necessity for the state to lay down and enforce these measures (be it gambling, drugs, turning one's back on preventable emergencies where there exists no nexus between the parties).
i don't think starving-hiker is within his rights to break into an occupied hut, though it's perfectly understandable he may do so. he would make the decision that a charge of trespass and theft under threat of violence was a lesser of two evils to starvation. but the cabin owner may not be wrong in shooting to repel the invasion, these details would weigh in the sentencing part of the trial. maybe the hut-owner was a frail, scared type who'd been assaulted before and the hiker a robust sort. who knows?
sorry, i read the wharf/drowning guy example wrong, and there's no entrapment. the drowning guy would be guilty of trespass, but that doesn't justify curmudgeon having him drown (i mentioned that there exists in most legal codes the requirement that reaction not be disproportionate to the offense.) wharf owner probably would go down on a manslaughter charge.
Published: December 29, 2008 9:28 AM
gene berman
Brian Macker:
A bit bleary-eyed, eh? You're just not recognizing what you've described as an instance of what we're talking about.
In putting aside the fish to underpin his need during the production period of the ol' gal's present, he's creating a "capital account." Without the fish, he can't produce the present at all or can only produce an alternative or inferior version: the "capital" brings the goal nearer: into the time-span of his ability to survive. Even the profit can be well approximated: it's the difference in value between the present and whatever would have been the substitute reduced by the difference in price between that of the fish minus that of whatever it were he would have eaten in the interim (or their sum if the fish was in addition to rather than substituted for original diet).. Actually, your example, though not of a "business," and certainly of a primitive level, contains all the major features of a capitalist venture, including the feature of "risk" (that he might not "get any" anyway).
I think the only reason you didn't see that staring you in the face is the feature that he was doing it for his own account rather than selling or trading it away. The same sort of capital-aware thinking can be seen, even though on the same primitive level, when one hires someone to mow his lawn so he can do something more valuable (to himself or others) or buys a better lawnmower so that either he or an otherwise unspecialized laborer can do his lawn more efficiently (reduced time-cost) while he goes fishing (for more capital, of course, he tells his wife), so he's happy and the gardener finishes the lawn even faster than expected (which, curiously enough, makes the gardener and the gal happier than the economically unlearned might otherwise even suspect).
Now, if he'd just had a little lower "time preference," he could have insured against the perceived risk by taking his wife along fishing. I know that's a tough row to hoe but he could have offset such disutility by getting the ho to row, catching mo' to pay for the next mow, and waiting till later to plow the furrow.
And, if you disapprove of all the gardening/farming metaphors, well, what else is a meadowfor?
Published: December 29, 2008 11:44 AM
jp
Gene: "Money in one's pocket or even in one's personal bank account is not capital. But the same amount of money in the account of a firm engaged in production (whether of goods or services) is, indeed capital"
It seems to me that your point contradicts what Mises said. Quoted in a Gary North article...
http://www.lewrockwell.com/north/north84.html
...and directly from Part 1, Chapter 5 of Theory of Money and Credit...
http://www.econlib.org/library/Mises/msT2.html#Part I,Ch.5
...Mises says that:
"What prevents us nevertheless from reckoning money among these "distribution goods" and so among production goods (and incidentally the same objection applies to its inclusion among consumption goods) is the following consideration. The loss of a consumption good or production good results in a loss of human satisfaction; it makes mankind poorer. The gain of such a good results in an improvement of the human economic position; it makes mankind richer. The same cannot be said of the loss or gain of money. Both changes in the available quantity of production goods or consumption goods and changes in the available quantity of money involve changes in values; but whereas the changes in the value of the production goods and consumption goods do not mitigate the loss or reduce the gain of satisfaction resulting from the changes in their quantity, the changes in the value of money are accommodated in such a way to the demand for it that, despite increases or decreases in its quantity, the economic position of mankind remains the same. An increase in the quantity of money can no more increase the welfare of the members of a community, than a diminution of it can decrease their welfare. Regarded from this point of view, those goods that are employed as money are indeed what Adam Smith called them, "dead stock, which . . . produces nothing"
So according to Mises, money is not capital, even if it is held by businesses. He created three separate categories for things: consumer goods, capital goods, and money. I'm not sure what the other Austrians had to say on this point though, or indeed what Mises thought in later life.
Published: December 29, 2008 2:02 PM
fundamentalist
jp, thanks for the Mises quote. I have bee reading Hayek mostly lately and he makes the same distinction. Money can't produce any other good, so it's not capital. But cash can be quickly converted to capital. This is another area in which accounting terminology thwarts efforts at understanding economics.
Published: December 29, 2008 3:54 PM
gene berman
jp (and fundamentalist):
I'm convinced that Mises is correct in all such matters and, further, that were my own view found to diverge from that taught by Mises, I'd consider myself in error and try to determine the source of that error in order to return to the correct view.
In writing the comment preceding, I attempted to synopsize Mises' explanatory passages (and to inject a bit of entertainment).
In reconsideration, however, I simply read the chapter (above-cited, from THEORY OF MONEY AND CREDIT); when finished the dozen pages or less and yet still confident that I had "relayed" Mises
thought faithfully and accurately, I could come to only one, inescapable opinion: that jp had not read the chapter. And that is because Mises explains the matter in almost precisely the same way as had I, though starting from a different angle.
Try it. Reading the whole thing, that is.
Published: December 29, 2008 6:18 PM
jp
Well, opinions will always differ.
Walter Bock thinks money is a capital good. See this pdf:
http://mises.org/pdf/asc/2003/asc9barnett.pdf
Money: Capital Good, Consumers’ Good, or (Media of) Exchange Good?
Published: December 30, 2008 4:44 PM
P.M.Lawrence
Brian Macker wrote "I stand by my understanding of real bills doctrine. It's about printing up fresh cash to divert capital from the true owners into their own schemes. It imagines that this printing of new money will somehow lead to prosperity, which is wrong. It will lead to the business cycle."
That understanding is wrong. It's not about "printing up fresh cash to divert capital from the true owners into their own schemes", that's just how it works out. What it's about, which is not what happens, is printing up fresh cash to divert otherwise unused resources into productive activity. It wrongly assumes that the resources aren't otherwise employed.
"I don't see why having bad assumptions saves them from my accusation. If you are stupid enough to assume from the start that printing new money will lead to prosperity then it doesn't matter how self consistent the rest of your theory is. Your theory is still based on the idea that printing new money makes people richer."
That is a 100% correct criticism of many politicians - but an utterly incorrect characterisation of Real Bills Doctrine. Never, not once, do its genuine advocates assume "that printing new money will lead to prosperity". What they assume, wrongly, is that there are unused resources around and that they can identify productive uses for those. They reason, correctly, that printing new money and using it only on those productive areas on the right time scale would work out. But they are never so idiotic as to think that it's just the printing new money; they are well aware that just doing that gets you nowhere constructive, they intend to catch what they throw up in the air with those new productive uses. Of course, as soon as it seems to be working, people who don't understand what they are aiming at come along and just print money for whatever they think is worthy, which confuses observers into thinking that those people are talking Real Bills Doctrine - and it all goes wrong even quicker than the authentic sort.
Published: December 30, 2008 6:30 PM
gene berman
P. M. Lawrence:
Yes--I think your explanation is as good as I've seen and about as concise as possible.
What I'd thought before (the explanations for which are far more involved but come down to nothing more than you've said) is that the general credit market as now extant is just the natural development of the desire to reduce the obstacle presented by the interest rate for projects---whether new or merely extensions of existing---whose prospects seem marginal at the prevailing rate. In the examples used by Dr. Fekete, they're businesses where the product goes through some origin-to-consumer cycle in three months' time. But, in practice, all the production in the world could get pressed into 3-month categories of origin-to-consumer segments if that was what was necessary to qualify for the funds. That even sounds like what for years was called the "money market" in which somewhat higher rates were paid for funds not specifically collateralized--by firms of all sizes up to the largest. It was a simple fact that such loans were routinely "rolled over" when desired unless some untoward event affected the firms creditworthiness.
And that, it seemed to me, was merely the working out in practice of the RBD.
The RBD folks also make assumptions about the time-tested reliability of such things as the producing firm, the client firm or customers, the constancy of demand for precisely what's being produced and the prices for which it certainly can all be sold, the continuance of the same competitive arena, etc. which are all at least problematic.
I don't know whehter I was making valid similes or not--but that's what went through my mind when I considered the matter.
Published: December 31, 2008 10:17 AM
gene berman
jp:
Your reply is a cop-out. The question is: just WHOSE opinions differed. Originally, you maintained that mine differed from that of Mises. So, expecting that the reference you cited might, somehow, support your contention (that my understanding of the proper categorization of money differed from that of Mises), I read the very chapter you cited, from which it was apparent that my own interpretation is exactly that of Mises (and further, that any otherwise-understanding had to have been based on reading some short fragment of the cited piece) and so pointed that out to you as an aid to the reformulation of your own thinking.
And now--opinions differ? Whose? Mine and Mises?
Or yours and Mises? You haven't explained that, either briefly or in detail.
Published: January 1, 2009 11:30 AM
Brian Macker
Gil,
"But you & friends would point out that a hollow credit system can't last because there those who instead would deliberately create more money without any correlation to the good & services causing them to get immediate purchasing power and others pick up the cost and generally destroy the ability to rate the value of goods & services to each other."
You're still not getting the point. There can be no correlation to goods and services to money once you start counting goods and services as money. It's a runaway process, not because we cannot control our greed. It's runaway because the commodity money to goods ratio, prices, are disturbed by the printing of the banknotes. The process raises the very prices that are suppose to be used to measure when to back off the monetary expansion.
You have to understand that goods don't have intrinsic prices. Prices are determined by the amount of money in circulation. As you up the amount in circulation the prices increase on the margin, which makes your entire portfolio of backing assets look more valuable, so you print more money.
The overproduction of banknotes isn't due to "those who instead would deliberately create more money without any correlation to the good & services". It's due to the use of prices as the mechanism for determining that correlation. You can't do that.
The very production of the extra banknotes gives you an additional positive price feedback that, using the rules, allows even more banknotes to be produced.
The RBD doesn't work regardless of human greed.
Published: January 1, 2009 7:15 PM
Brian Macker
Gene,
You are assuming that the present cannot be produced with equal quality and with equal time in a piecemeal fashion. Which isn't necessarily true.
The total time the present takes to make may be a week. It might be that saving up one days worth of fish on seven separate occasions to work on the present is just as efficient as saving up a weeks worth of fish and working on it all at once.
Doing it either way is no shorter than the other. If it takes four days to save up a days worth of fish then both methods take 7 weeks before the present is delivered.
In both cases the saved fish is capital. I might decide on the second method because I know my wife is going to be visiting her mother that week. My decision may not be based on increased efficiency of production, or shortening of time, but on some other factor.
The fish still counts as capital, even if it doesn't increase my production or shorten the time before I get the good.
Of course, if someone gives me the weeks worth of fish that will shorten my production time, since I will not have to save, but the same could be said if they gave me the present directly. It doesn't really shorten production time.
Of course, no one saves up to produce something in a way that takes longer. I was just pointing out that the equation isn't strictly (x
Published: January 1, 2009 8:15 PM
Brian Macker
So they are not trying to prosper by "divert[ing] otherwise unused resources into productive activity?" What are they trying to do? Make things worse?
Published: January 1, 2009 8:22 PM
P.M.Lawrence
Brian Macker again quotes me 'Never, not once, do its genuine advocates assume "that printing new money will lead to prosperity" and misses the point, 'So they are not trying to prosper by "divert[ing] otherwise unused resources into productive activity?" What are they trying to do? Make things worse?'
Watch closely. If someone takes a gold coin and goes out and buys a pig in a poke, he might - just might - get a pig. He is more likely to get dudded. But if he takes a gold coin and goes out and buys a coat with it, he ends up with something for it.
In the same way, the Real Bills advocates do not think that those two activities I described are the same thing. Both involve printing money, yes, just as both the gold coin purchases involved parting with a gold coin. But in each pair of examples, the former activity doesn't give the buyer anything but the latter does. It's not just where the money comes from that's significant, it's also what's done with it. The advocates' error is in thinking that they can actually hit what they are aiming at, Brian Macker's error is in thinking that because they can't, they aren't aiming - that all printing money is the same in principle, because it practically always leads to similar poor outcomes. So he is throwing away his chance to know the enemy, which means that if it ever comes along in a new form he might not recognise it until too late.
Published: January 1, 2009 11:14 PM
Gil
I think PML and I are on the same page Macker. By your line of thinking if gold coins were the money in a idyllic village then gold mining and outsiders bringing in gold would both be forbidden because they're essentially inflating the money supply. Theoretically, the gold miner is inflating since he would only mine gold if he ended up with more purchasing power than what he expended to mine it which ultimately is his profit. However if outsiders bring goods & services equal to the gold coins they bring with them then prices should stay the same as the ratio of 'gold chasing goods & services' would be roughly the same.
However, the alchemists who sought to turn worthless materials into gold were chasing the allure of DIY buying power with no goods or services to back it up thereby setting the stage for hyperinflation. The fact gold atoms can't be profitably tranmuted show that a gold weights economy could not suffer from hyperinflation (except through blatant theft or cheap space mining).
Published: January 2, 2009 4:50 AM