"The Yield from Money Held" Reconsidered
Like Hutt, I want to attack the following notion: that money held in cash balances and deposit accounts is somehow "unproductive," "barren," or "sterile," offering a "yield of nil;" that only consumer goods and producer (investment) goods are productive of human welfare; that the only productive use of money lies in its "circulation," i.e., in its spending on consumer or producer goods; and that the holding, i.e., the not spending, of money diminishes future consumption and production. FULL ARTICLE
Comments (60)
Conza88
Professor Hoppe, how is the book you are working on, coming along?
=D
Published: May 14, 2009 8:21 AM
fundamentalist
Very nice! Thanks!
It amazes me that the cult of state intervention can't see that depressions go deeper and last longer with intervention than without. They seem to think that without intervention, the prices of everything will fall to $0 and unemployment will reach 100%.
Published: May 14, 2009 9:34 AM
fundamentalist
PS, the uncertainty that causes people to hold more cash is uncertainty about future income. People want to be able to pay their bills even if they lose their jobs or customers can't pay on receivables. The only way to reduce that uncertainty is to hold cash, as Hoppe points out. The state wants them to borrow money instead of holding cash. But why would people take on more debt when they are uncertain about their ability to pay existing debt? That's irrational, but it's coming from PhD's in economics.
Published: May 14, 2009 9:38 AM
Kilmore
There is another reason why cash holding are not unproductive. First some goods or services must be sold to obtain certain amount of money, then (after some time) other goods or services are bought. Thus money holdings represent both saving and investment, in other words loan. If some people were eager to get more money they would have to offer more goods or services (lenders), vice versa if another people were willing to part with their cash holdings they would have to buy more goods and services (borrowers).
This supplements Hoppe's reasoning. In crisis people are willing to save through their eagerness to hold cash. This is great because more saving means faster reconstruction of capital structure. Money printing is mere distortion. It is not backed by any good or service, it consitutes spending.
Published: May 14, 2009 10:01 AM
C
Brilliant, once again, Professor Hoppe.
To extend Fundamentalist's argument, the investor who cashes out of stocks and other investments in uncertain times is concerned not only about his own potential unemployment, but about the uncertainty of the "employment" of his invested wealth. If one is frightened that the current use, or employment, of one's wealth in the investment markets is about to become a misuse, or misemployment, and may result in lost wealth, then one changes the employment of that wealth to hedge against this uncertainty.
Employing the wealth as cash, instead of "investments," to counter such tremendous uncertainty about the risk of such investments, makes absolute sense for the individual, even if the pontificating economists frown upon it in their macroeconomic musings.
Don't you wonder how many of those wise economists had the foresight to cash out before the crash last year?
In the words of Terry Pratchett, one of the most devastating curses you can lay on your enemies is, "May you live in Interesting Times."
Published: May 14, 2009 10:18 AM
Michael A. Clem
Why does it seem that some blog comments are used as jumping off points for new blog posts? ;-)
Anyway, while this doesn't answer my earlier question directly, it does cover it and a lot more in a surprisingly broad area, illustrating the holistic nature of economics. Great stuff!
Published: May 14, 2009 11:06 AM
Victor
I've always taken exception with this part of Mises' thought: if there is no money in the Evenly Rotating Economy, due to perfect foresight, then how is there a single interest rate? If there is no money, then there must be a myriad of interest rates priced in different goods. Or am I missing something?
Published: May 14, 2009 11:08 AM
fundamentalist
Victor, In equilibrium there is no money or savings because there is no uncertainty, which is a fictional construct. So interest = profit = marginal productivity. All interest rates/profits would equalize because investors would reduce investment in lower profit businesses and increase investment in higher profit businesses untill all profits equalized. Does that help?
Published: May 14, 2009 11:26 AM
Lee Kelly
This is now my favourite article on Mises.org. Excellent.
Published: May 14, 2009 11:46 AM
Jack Curtis
Expecting rationality in economic terms from actors operating with rationality in political terms seems itslef irrational.
Politicians need cover, not reality, from economists. Adam Smith was given a job as a bureaucrat; Keynes became a Lord.
Published: May 14, 2009 11:48 AM
Current
Kilmore - You are right, money is needed for day-to-day transactions.
That fact though is itself driven by uncertainty about the future.
Consider, I got to a Curry restaurant with my friends. The waiter welcomes me "Hello Current, I knew you would come today, so I've prepared your meal in advance, do sit down."
At the end of the meal I say "Here is your payment, one stapler, a computer mouse and a shock absorber for a Honda Civic. You will find you need the stapler for your paperwork. The owner of the restaurant will need the shock absorber next thursday when the one in his Honda Civic breaks. Since I have perfect foresight and you too have perfect foresight we can exchange goods of direct utility."
It is because of uncertainty and risk that money arises. Once it comes into use it must be used even in situations where these things do not come into play.
I'm currently in the fortunate position of being quite certain about the immediate future. However, I must still use money for purchases. I don't though have to keep much of it around.
Published: May 14, 2009 11:51 AM
Current
fundamentalist: "the uncertainty that causes people to hold more cash is uncertainty about future income."
Not only future income, also future prices.
Published: May 14, 2009 11:55 AM
Dick Fox
Victor,
I agree with Mises on the definition of money as a medium of exchange. If that is true money in the evenly rotating economy, even without uncertainty, will lubricate the exchange allowing the subdivision of unequal goods to different individuals over time. If the implication is that there is perfect memory, knowledge, and trust then you could make the case that money would be unnecessary, but making such assumptions changes the economics and the tool has no function.
I believe that Hoppe is correct that money held does have value, or yield as he states it, but instead of this running counter to free banking this actually supports the free banking position of White, Selgin, and Garrison. This is missed because Hoppe does not understand supply side economics.
Hoppe is a demand side economist, a monetarist. He implies from his lecture that the supply of money must remain the same. He does recognize that the demand for money will change benefiting the one who holds money, but this causes the exchange quality of money to change. Hoppe does not understand the implications of this change of quality.
A change in the exchange value of money changes the relationship between debtors and creditors. If the quality of money increases the debtor receives a windfall profit at the expense of the creditor. The supply model believes that the facilitation of exchange between traders is most important.
Those who hold cash balances do not wish, as Hoppe states, to see the purchasing power of a unit of money to increase. Rather they wish to hold enough at the current purchasing power to pay for what is causing them uncertainty. These people actually assume that the purchasing power of their money will not change.
The only way to prevent favoring debtors or creditors is to keep the quality of money stable, and this will also satisfy those who hold money. To keep the quantity of money stable it must be allowed to expand or contract with demand to prevent changing its value.
Because many Austrians follow a demand side model they miss this central principle of the supply model.
Published: May 14, 2009 12:36 PM
Lowell Sherris
fundamentalist
It's not just the uncertainty about future income that causes people to increase their cash balance. It is also the uncertainty about the safety of other investments. Basically holding cash is the safest way of preserving capital.
Published: May 14, 2009 12:48 PM
Victor
@Fundamentalist
Thank you for answering my question. Unfortunately, it wasn't the answer I was looking for. You mentioned that all interest rates would equalize in the E.R.E., due to the arbitrage action of investors. But this arbitrage action requires the interest rate to be priced in terms of one good viz., money.
If there is no money in the E.R.E., then what will serve as the common denominator? Without money, how will investors be able to undertake accounting, and by extension, be able to compare the interest rate of one line of production to another?
If one line of production, Process A, requires $100 of investment, and in a year gives a return of $110, then the interest rate is 10%. If another line of production, Process B, also requires $100 of investment, and in a year gives a return of $105, then the interest rate is 5%. Investors, as you said, will divest themselves from Process B and invest more in Process A. This will cause interest rates in Process B to rise and in Process A to fall until they both reach equilibrium.
However, this arbitrage action can only happen when there is an interest rate priced in terms of money. If there is no money, then there is no common denominator. Process A may provide us instead with 100 apples in the future, and Process B may provide us with 75 oranges in the future. How can we tell which process is more profitable without comparing apples to oranges?
I hope I've made myself a little more clear.
Published: May 14, 2009 1:08 PM
Fallon
The current epic of forced wealth transfer via bailouts, monetary base expansion, borrowing and government subsidy is what the politically connected can do to satisfy their increased demand for cash during more uncertain times.
Keynes, then, was mostly rationalizing and moralizing theft designed to benefit political elites.
We have an ongoing situation where, to play on Orwell, the pigs have not only moved into the farmhouse- but are putting on expensive additions. Is it too late to burn down this facade? Let's get 'em while they are still inside.
Published: May 14, 2009 1:23 PM
George
Doesn't just sitting on cash lower competition for things so that investments which are being made can be made at a lower cost.
And later there will be lower priced goods from the investment. All-in-all a very very safe holding with a return matching the productivity of the economy.
Unless someone is inflating, taking the productivity returns of the cash holders.
So it's not the price increases which cost you in inflation, it's the price decreases not seen....
Published: May 14, 2009 1:36 PM
Nelson
Unfortunately holding cash does not "scale." It only works up to a point. If everyone valued holding cash over purchasing goods/services (lets say they really want to save a lot for retirement), then nothing is produced beyond the bare necessities (because no-one is buying) and we get deflation (because dollars are relatively more scarce compared to non-dollar goods/services) and an unproductive economy. Conversely, if everyone tries to spend their saved up cash as the same time (say if everyone decided to retire at once), this causes inflation and all of those saved dollars are suddenly worth less. Decide for yourself if this represents a healthy economy.
Granted, this is only a thought exercise to expose the limits of the theory. In real life people tend to be more rational and don't generally all hoard dollars or spend dollars at the same time.
Published: May 14, 2009 2:10 PM
Rush
Nelson - You're neglecting the tendency for an economy to reach equilibrium between prices and value of holding money. In the situation you described, prices would at first fall as everyone holds on to their money and spends as little as possible. However, as people see prices drop, they begin to lose the fear of uncertainty as they realize their cash holdings can now purchase much more than before.
Eventually, a threshold is reached where some people begin to spend again since they no longer need to hold on to all of their cash and the low prices are too attractive to pass up. This slows down the decrease in prices and puts pressure on everyone else to begin making more purchases before prices possibly start increasing and eventually an equilibrium would be reached between holding on to cash as a hedge on uncertainty and on the prices of goods.
Published: May 14, 2009 3:02 PM
Jonathan Finegold Catalán
Huerta de Soto, in my opinion, puts it the best in his book Money, Bank Credit and Economic Cycles.
When there is savings there is investment in higher orders of production, farther away from the consumer. And so, there is a decrease in demand. The goods not purchased are used by the industry to survive while it's expanding its production both horizontally (elongating phases of production) and vertically (more phases of production), which ultimately leads to an increase of supply in the market (the ultimate product).
This does lead to the deflation of the general price level (not deflation of the money supply, though; or inflation), which means that there is an increase in real wages and the economy has progressed.
Of course, people don't save their entire wage. There is always some spending. The benefits of saving does not require saving everything, it just requires spending less than your paycheck. In the end, it's in terms of aggregate savings, as well. Deflating price levels also allow consumers to buy more for the same price, or the same for a lower price and save more, which just leads to greater economic progress.
Published: May 14, 2009 3:20 PM
Nick Bradley
Another excellent piece by Professor Hoppe.
Although I've always understood that an increase in the demand for money pushes prices down (and vice-versa), I've never put "two and two" together to realize that uncertainty drives up the demand for money.
Couldn't one look at the boom-bust cycle as a confidence-uncertainty cycle? As an economy becomes more and more uncertain, actors "cash out" of unproductive assets; this "cashing out" causes further uncertainty and more "cashing out" by other actors still in the game. Once everything is liquidated, confidence/certainty is restored and actors can once again "invest" in producer and consumer goods.
Published: May 14, 2009 3:46 PM
fundamentalist
Victor, I'm sorry! Money does exist in equilibrium, just not cash balances. Money becomes more of an accounting thing to keep track of transactions and not currency where people actually hold cash. You're right that money is necessary even in equilibrium, but perfect foresight means that we can get the cash we need by selling something at the moment we need it, so we don't need cash balances.
Published: May 14, 2009 3:47 PM
Jonathan Finegold Catalán
Nick,
Liquidation of unhealthy assets happens all the time. The bust period is not brought about arbitrary liquidations in the market in certain sectors, which are natural. It comes from a collective cluster of errors, as termed by Murray N. Rothbard. The bust is the inevitable conclusion to the credit expansion during the boom, which causes malinvestment (in higher orders of production, whereas there is no actual demand for goods in the long term because there has been no actual increase in savings).
Published: May 14, 2009 4:06 PM
Eric
Arguing about what happens in a mythical perfect foreknowledge world is like asking if God needs cash holdings. Or it's like George Carlin asking if God can create a rock so large even he can't pick it up.
If the queen had rocks she'd be the king. So arguments about how the queen would act in near rock situations is a poor argument.
If everyone had perfect foreknowledge, would they have demand for anything? They wouldn't even think about any economic issues. It'd be a waste of time. One would simply be acting in a predetermined play.
I realize that argument is only to show that the more foreknowledge one has the less need to hold cash. And so the argument proposes that the relationship between knowledge and cash demand is a smooth continuous function. This is done so that one can extrapolate beyond the normal situation wherein we don't have complete foreknowlege.
However, there is nothing in the argument that proves there is not a discontinuity nor that the function doesn't act wildly as it approaches the limit of 100% foreknowledge. This is the same problem with the Laffer curve which also assumes a smooth, continuous function.
In other words, we can't really prove anything about approaching a limit if we don't approach it continuously. Perhaps at 99.99% foreknowlege, people despair and all commit suicide because they know they can't do better than some pre-ordained lifestyle.
But as to cash holdings (which are not the same as cash lent out at interest), it seems that the price one pays for less uncertainty is the time preference value of holding cash today vs. spending it today. And as Mises etc. have said, this is what determines the interest rate in a free market.
If one eventually spends the cash holdings in the future, instead of now, what has changed is that he has foregone consumption today for more certainty plus consumption delayed to the future.
But I don't believe these artificial perfect knowledge constructions really prove anything, since they argue that one can precisely state what it would be like in a situation that cannot possibly occur (except for the supernatural).
Published: May 14, 2009 4:24 PM
Chris Cook
I agree with E C Riegel's view of Money that it is a relationship, not a currency object, whether a credit object, or something inherently valuable like gold.
Riegel speculated that money exists only in motion -in the transient instant of exchange - and that everything else, whether credit obligations or property rights, is merely potential money.
In this view, Money could be seen as dynamic value and Capital as static value.
I agree with Riegel that credit is not money - although it may indeed be monetised - but rather that credit is inherent in a monetary relationship.
Wherever there is a barter system with in-built credit (ie 'time to pay') such as the Swiss WIR, and proprietary systems like Bartercard, then the result is a monetary system requiring what I refer to as a "Value Standard".
So in the Swiss WIR, goods and services change hands not in exchange for fiat Swiss francs, but by reference to the Swiss Franc as an abstract Value Standard, or unit of measure.
John Law hit the nail on the head when he said that money is not the value we exchange goods for but rather the value we exchange goods by.
Published: May 14, 2009 6:34 PM
B. Ranson
Professor Hoppe presents an excellent argument.
In my opinion, the best line in the whole essay is: "The first natural response to the thesis that money held in or added to cash balances is unproductive is to counter, why, then, if money held in or added to cash balances is unproductive of human welfare, do people hold them or add to them?" What a clincher!
Professor Hoppe could extend this line of thinking by pointing out, in his section on the origin of money, that gold and silver have always been in great demand for non-monetary uses. Persons holding precious metals in cash balances refrain not only from using this money to obtain other goods and services. They also withhold this precious metal from non-monetary purposes.
Published: May 14, 2009 8:41 PM
Nelson
Rush,
Thank you for your response. I am aware of the tendency for economies to reach equilibriums. It is one of the fundamental bases of Economics. I was only pointing out that the "savings as an investment" theory, while generally good advice, has its limits. No one should put too much faith in savings (or any other one particular investment). I'm not trying to discourage it, in fact I save a lot relative to my peers if you include buying equities and paying off mortgage principal as savings. But I'm also aware that events outside of my control, such as inflation, tax policy or merely the behavior of others, can destroy savings.
Published: May 14, 2009 11:03 PM
Peter
If there is no money in the E.R.E., then what will serve as the common denominator?
In the hypothetical ERE, the common denominator is hypothetical money - actual money isn't needed, because you already know all the valuations that comparison via money will allow.
Published: May 14, 2009 11:30 PM
Peter
Unfortunately holding cash does not "scale." It only works up to a point. If everyone valued holding cash over purchasing goods/services (lets say they really want to save a lot for retirement), then nothing is produced beyond the bare necessities (because no-one is buying)
But the savings will go into a deepening of the structure of production, so more goods can be produced cheaper and what you pay now for the bare necessities will then buy luxuries. No problem.
Published: May 14, 2009 11:35 PM
Anita Vacca
Holding cash now means profiting of the ultimate bull market, the bull market in cash determined by deflation, which restore the purchasing power the central banks policies of reinflating the financial system subtracted from citizen's wallets.
Saving is a strategy of survival very common in Nature: Think about the behavior bees and ants display, they collect more food than they need and store it, the same do squirrels. Would you think this is a bad strategy, or a waste of time? Nature is unfamiliar with the term "waste", everything is re-cycled.
Leonardo da Vinci wrote: "If you do not rest on the good foundation of nature, you will labour with little honour and less profit"
Central Banks do not rest on the good foundation of nature, so they could be swept away by the unfolding Bear market, and no one would complain their fate: People should understand they are dangerous, because if you assume that Bear markets follow naturally Bull markets, in a dynamic of punctuated growth, then Central Banks can only make things worse, by trying to make things go on(in this case) the old trend of expansion, when it is naturally over, thus creating giant bubbles, instead of milder boom-bust waves. If gold were the Money, and not currencies created out of thin air, it would be impossible to reflate.
Anita
Published: May 15, 2009 1:45 AM
Anita Vacca
Holding cash now means profiting of the ultimate bull market, the bull market in cash determined by deflation, which restore the purchasing power the central banks policies of reinflating the financial system subtracted from citizen's wallets.
Saving is a strategy of survival very common in Nature: Think about the behavior bees and ants display, they collect more food than they need and store it, the same do squirrels. Would you think this is a bad strategy, or a waste of time? Nature is unfamiliar with the term "waste", everything is re-cycled.
Leonardo da Vinci wrote: "If you do not rest on the good foundation of nature, you will labour with little honour and less profit"
Central Banks do not rest on the good foundation of nature, so they could be swept away by the unfolding Bear market, and no one would complain their fate: People should understand they are dangerous, because if you assume that Bear markets follow naturally Bull markets, in a dynamic of punctuated growth, then Central Banks can only make things worse, by trying to make things go on the old trend (in this case of expansion), when it is naturally over, thus creating giant bubbles, instead of milder boom-bust waves. If gold were the Money, and not currencies created out of thin air, it would be impossible to reflate.
Anita
Published: May 15, 2009 1:47 AM
Carlos Novais
Increased hoarding by someone means that the person is producing valuable things for others but not consuming resources itself, so what that means is that the rest of the world is gaining because someone is producing but not consuming, so the fact that prices go down with hoarding is only the monetary expression of that.
Published: May 15, 2009 3:06 AM
Anonymous
"an (unanticipated) increase in the demand for money 'pushes the economy below its potential,' (Garrison) and requires a compensating money-spending injection from the banking system."
I'm a huge fan of Garrison's work. I didn't know that Garrison held this view? I know Garrison's ideas are more Hayekian than Misesian, but I would expect Garrison to know better. I never considered Garrison a member of the Free Banking wing of the Austrian School. I need to check into this.
Published: May 15, 2009 3:14 AM
Current
Peter: "In the hypothetical ERE, the common denominator is hypothetical money - actual money isn't needed, because you already know all the valuations that comparison via money will allow."
Just to back up Peter's point.
Imagine a electronic huge table on a wall. Like those in large railway stations. This table shows the price of every good. An ERE hypothesizes that this table is available to everyone at all times. Everyone has perfect knowledge of prices and perfect foresight.
Money is therefore not needed. Once the table is in place the price on any good can be denominated in terms of any other good. A person can measure houses in terms of carrots, or currys in terms of shock absorbers.
There is still a "money price" but it can be constructed in terms of any good taking the place of the denominator.
Published: May 15, 2009 4:25 AM
Jyoti
"No one cares about the nominal number of money units in his possession". - not really. As it would suggest that intra-marginal utility of money (in the form of cash) is zero and is not diminishing. The amount of nominal cash that one holds would - besides other things - be dependant on the marginal utlity derived from it in this form.
Published: May 15, 2009 4:51 AM
Current
Jyoti - I don't understand you. What do you mean by "intra-marginal utility of money"?
Published: May 15, 2009 6:45 AM
Nelson
Peter,
This can't be if producers don't know what to produce. The consumers are not signaling the market with spending. The rational producer would also keep resources liquid (save) until the consumers'/savers' wants are known. For example, one doesn't build a new auto plant when people aren't buying the cars that are already on full lots.
Published: May 15, 2009 8:08 AM
Current
Nelson, is right here.
Capital equipment is not immediately salable. Contracts must be fulfilled by both workers and producers. To some extent both workers and businesses have limited choices in the short term.
What supports economic stability is the lack of infinite liquidity preference. In a recession, agents will not *always* prefer money over other purchases. In some circumstance the products will be cut to a price they find acceptable.
This is a very tricky area however.
Published: May 15, 2009 10:43 AM
Lawrence H. White
The theme and title of Prof. Hoppe's lecture recall an earlier paper by George Selgin, "The Yield from Money Held Revisited: Lessons for Today," which originally appeared in Market Process and was reprinted in Peter J. Boettke and David L. Prychitko, eds., The Market Process: Essays in Contemporary Austrian Economics (Aldershot, U.K.: Edward Elgar, 1994), pp. 139-65.
Hoppe's discussion suggests that Selgin's view (and mine, and Roger Garrison's) is opposed to that of Hutt's classic article. Not so. Selgin and I are both big fans of the article, and I assume Garrison is as well.
Hoppe writes:
"The second example is from closer at home, i.e., from the proponents of 'free banking' such as Lawrence White, George Selgin, and Roger Garrison. According to them, an (unanticipated) increase in the demand for money 'pushes the economy below its potential,' (Garrison) and requires a compensating money-spending injection from the banking system.
Here it is again: an 'excess demand for money' (Selgin & White) has no positive yield or is even detrimental; hence, help is needed. For the free bankers help is not supposed to come from the government and its central bank, but from a system of freely competing fractional-reserve banks. However, the idea involved is the same: the holding of (some, 'excess') money is unproductive and requires a remedy."
The second sentence of Hoppe's first paragraph quoted is correct. The second paragraph contradicts the first, and makes no sense.
Let's be clear about terms. An "excess demand" generally means an excess of quantity demanded over quantity supplied, i.e. a shortage at the current price. An "excess demand for money" -- not a phrase original with Selgin and me -- accordingly means a deficiency of money held, existing when the current quantity of money units falls short of the quantity demanded at the current purchasing power per unit, which can be alleviated by an injection of additional units.
In the second paragraph Hoppe takes "excess demand for money" to mean "the holding of (some, 'excess') money", or in other words a surplus of money units held. This is the reverse of its meaning.
On the correct understanding, being concerned about difficulties arising from an unsatisfied demand to hold money is fully consistent with embracing Hutt's point that money held is productive of the holder's welfare.
Published: May 15, 2009 11:54 AM
newson
professor white:
your fellow free-banker, professor selgin, believes a pure specie monetary regime can also engender the abc (for example, by the discovery of a large gold deposit under a gold standard) - do you share this view?
i believe the effect would merely be inflation, not systemic distortion.
Published: May 16, 2009 2:11 AM
newson
dick fox says:
"The only way to prevent favoring debtors or creditors is to keep the quality of money stable, and this will also satisfy those who hold money."
stable against what? price-indices are arbitrary; your answer in the past has been gold - but this is meaningless because in the past gold was money! maybe we should arbitrarily choose gold and then execute all geologists so as to maintain a constant money supply.
Published: May 16, 2009 2:17 AM
newson
chris cook says:
"John Law hit the nail on the head when he said that money is not the value we exchange goods for but rather the value we exchange goods by."
i'd refer you to this demolition job on law's "assignment theory of money" (p.49 on), which hulsmann regards as the most enduring monetary fallacy.
http://mises.org/journals/qjae/pdf/qjae6_4_4.pdf
Published: May 16, 2009 2:27 AM
Inquisitor
"This can't be if producers don't know what to produce."
Who says they will merely sit back passively and wait for consumers to act?
Published: May 16, 2009 3:17 AM
Inquisitor
And anyway, as prices fall from absention from present consumption "spending" will eventually pick up anyway...
Published: May 16, 2009 3:20 AM
Ludwig van den Hauwe PhD
On the critique of fractional-reserve free banking see now also my (2009) _Three Essays in Monetary Theory_, available from BoD Germany and BoD France.
Published: May 16, 2009 3:58 AM
Ludwig van den Hauwe PhD
The position of the fractional-reserve free bankers hinges upon a certain notion of "neutral money" and "monetary equilibrium". In this respect it may be useful to re-read not only Hutt´s paper but also Koopmans´ "Zum Problem des 'Neutralen' Geldes", to which both Hayek and Selgin refer. Attention: this is _not_ Tjalling C. Koopmans but Johan G. Koopmans.
Published: May 16, 2009 4:23 AM
Jonathan
The expression "excess demands for money" is reminiscent of the neo-classical conceptualization of Walras´ Law. (See e.g. Patinkin.) In a world with only commodities and money, an excess demand for money will be reflected in an excess supply of commodities: Dm - Sm = Sc - Dc.
Now as regards free banking, it will be noted that even if we would agree - if only for the sake of the argument - that excess demands for money must be accommodated by quantity adjustments rather than by relative price adjustments, it is _technically impossible_ for a free banking system to accomplish this.
Published: May 16, 2009 10:11 AM
George Selgin
I'm grateful to Larry White for referring to my article "The Yield from Money Held Revisited." I was frankly shocked to see Hoppe attribute to me views precisely opposite those I had put forward at length in an article published years ago, in what was then a prominent "Austrian" publication, and later reprinted in Peter Boettke's "Market Process" compilation. In point of fact his "complaint" against me and Larry repeats my own complaint against what was (ca. 1985) mainstream monetary thought, except that (as Larry observes above) Hoppe blunders badly on basic monetary economics concepts. A very sorry performance all told.
Published: May 17, 2009 10:01 AM
George Selgin
I'm grateful to Larry White for referring to my article "The Yield from Money Held Revisited." I was frankly shocked to see Hoppe attribute to me views precisely opposite those I had put forward at length in an article published years ago, in what was then a prominent "Austrian" publication, and later reprinted in Peter Boettke's "Market Process" compilation. In point of fact his "complaint" against me and Larry repeats my own complaint against what was (ca. 1985) mainstream monetary thought, except that (as Larry observes above) Hoppe blunders badly on basic monetary economics concepts. A very sorry performance all told.
Published: May 17, 2009 10:03 AM
gene
Excellent article and very sensible.
Basically, it gets down to control, power exerting control. And printing money devalues people's decisions over their own personal property, money, and tries to force them to act as the powerful interest wish, which would benefit those same interests.
Published: May 17, 2009 11:45 AM
Current
This is being debated on the Austrian Economic blog too. See:
http://austrianeconomists.typepad.com/weblog/2009/05/larry-white-on-hoppe-on-the-yield-on-money-held.html
Published: May 17, 2009 2:40 PM
ganpalou
Hoppe's basic assumption of an economic goal of "human welfare" came as a shock to me. I have not heard it debated; rather the debate has been between "wealth" creation and preservation, and "jobs" creation and preservation. I enjoy the concept.
Hoppe is wrong about the difference between uncertainty and risk. I am not a good underwriter or actuary, but have known some. The only fairly acurate insurance underwriting is life insurance. All else is winging it. In most ventures, the accurate term for determining insurance risk is "PFA," plucked from air. In my youth, I knew some underwriters who worked on Three Mile Island, before and after it became famous. I also had the opportunity, as the "kid at the table" to break bread with the inspectors. Just as the capital committed to insure Three Mile Island was PFAed, so, ultimately was the loss. The entire industry had no clue, and the ultimate risk and liability was determined politically.
As a grown man, I was chairman of a Health Benefits ERISA trust in 1987, the year that the Federal Accounting Standards Board issued a letter that U.S. corporations must show the present value of promised future medical benefits on their bottom line. They delayed to 1989, then reneged entirely, as the net value of the NYSE, assets minus present value of future promised benefits, was zero.
That brings me to my criticism of economics. We use the wrong math. Stochastic regression of data, followed by Newtonian analysis, will produce an illusion of linear determinism, but has nothing to do with the subject being studied. ( Newton was aware of the limitations of his calculus, and got into wierd cultures and religions looking for some answers.) When cosmologists go far enough beyond Newton to solve three body, four body, five body, etc., to turbulence, problems, we can borrow the math. Until then, we are reduced to doing what FASB did, pretend there is some cause-effect between prosperity and our decisions, and play the game according to the rules.
Published: May 18, 2009 7:55 AM
George Selgin
Jonathan: "even if we would agree - if only for the sake of the argument - that excess demands for money must be accommodated by quantity adjustments rather than by relative price adjustments, it is _technically impossible_ for a free banking system to accomplish this."
First of all, it isn't a question here of "relative" price adjustments: the shortage of real money requires either an increase in the nominal stock of money or a uniform decline in _all_ money prices, with relative prices unchanged; this is the classical neutrality doctrine (a counterpart of the classical quantity theory), which is also very much an aspect of Walrasian analysis. Of course, the theory doesn't imply that prices will adjust uniformly in actual fact, at least in the short run. On the contrary, most who accepted the logic of the quantity theory (and Mises should be reckoned among them) understood that the process of nominal price adjustment following a disturbance to money supply or demand would involve potentially large short-run distortions to relative prices. Such non-neutralities play a crucial part in the ATBC. But the suggestions that short-run relative price distortions are only relevant in the case of adjustments in response to an excess supply of money, and not in that of adjustments in response to an excess demand, is a view peculiar to Murray Rothbard and a select group of his followers.
Second: your claim concerning the "technical impossibility" of nominal money stock adjustments in response to excess demand for (or supply of) money under free banking only serves to show that you don't know the free banking literature at all. My (1988) "Theory of Free Banking" is subtitled "Money Supply under Competitive Note Issue" for good reason: it is mainly devoted to explaining just how the adjustments you carelessly declare to be "impossible" will occur. I also offer a more formal analysis of the same topic in my _Economic Journal_ article, "Free Banking and Monetary Control." If you think these theories don't make sense you are invited to explain why. But be forwarned: they have a provenance going back to Edgeworth, and to dismiss them you have to dismiss the whole modern theory of the precautionary demand for money balances--a theory that's intimately connected to the very "yield on money" notion that HHH defends, and which I defended long before him (without confusing "demand for money" with "excess demand for money").
It is really quite sad to observe the tendency of so many commentators to this blog to make assertions about free banking that only serve to reveal their lack of familiarity with the literature on the subject. You can't make a reasoned choice between two positions after having only familiarized yourself with one. Nor can you tell when someone is misrepresenting another person's thought.
Published: May 18, 2009 10:05 AM
Carlos Novais
To be sure, i am just learning here although i have the position that in an honest and full disclaim FRB system (not sure if historic examples could be classified as such) good money will drive out bad money through discounts between "promisses to pay " gold (or other) and gold or 100% certificates.
Seems to me that "excess" demand or "excess" supply are dangereous terms, In reality we cannot say that there is excess supply or demand for anything.
But when money costs near "0" to produce, the "excess" classification is more accurate since would mean more easily that more money is being "produced" than full market forces with marginal costs to mining of gold and silver or other.
in FRB, "promisses to pay gold" would be evaluated by the market and competing with 100% reserve certificates and physical gold itself
In the end, they are credit money in which to retain value (FRB theory claim that they are vallued at par value), the creditor must be very good and not expanding too much.
If some bank goes bankupt demand for physicall money and 100% RB notes will go up, but this will not constitute "excessive" demand. Why "excessive " if there is a very good reason to increase monetary balances?
Published: May 18, 2009 10:57 AM
Ludwig van den Hauwe
I would like to thank you for your comments which I much appreciate. I am actually a proponent of free banking, but I prefer the variant proposed by Mises, which I believe deviates somewhat from your own variant. I also believe that the arguments for 100 per cent reserve free banking are worth being considered but these are, in my opinion, more of an ethical or/and legal-theoretic nature rather than strictly economic.
Mises avoided a few claims about the working characteristics of free banking, which you make, and to some his picture of free banking will therefore appear ultimately more credible. But I am prepared to reconsider your arguments. As I read Mises he believed that _in practice_ free banking would remain close to 100 per cent reserve banking; credit expansion would remain very limited. It seems to me he did not argue (1) that changes in the demand to hold bank money must and/or would somehow be offset by new issues of bank liabilities and (2) he did thus not argue that
free banking would guarantee monetary equilibrium and/or lead to the implementation of a productivity norm. At least there is no active role for the banking system in view of implementing any such norm.
I also believe that if he would have made claims of this kind, he would have taken greater care than you do to describe in more detail the microeconomic processes involved, in particular relative price and injection effects.
Part of the problem I have with your proposal is of a purely semantic nature. It is not by renaming certain phenomena that their fundamental nature can be modified.
It is not clear to me for instance why the fact that one or more market participants increase their holdings of bank-issued money is in and by itself to be considered evidence of a shortage of money that must somehow be accommodated or offset by new issues of bank-issued money. If A (or B or C) wants to change his/her spending patterns and increase his/her holdings of money, his/her increased demand to hold money can be satisfied simply be refraining from spending. It is not obvious there is anything further to be offset.
That the supply of money is under free banking so to speak "demand-elastic" creates the impression that free banking has a definite advantage in this respect but it is far from obvious that this is more than a semantic trick.
Published: May 18, 2009 11:11 AM
Geoffrey Transom
@ganpalou -
You wrote "Hoppe's basic assumption of an economic goal of "human welfare" came as a shock to me. I have not heard it debated; rather the debate has been between "wealth" creation and preservation, and "jobs" creation and preservation."
Then whoever taught you ECO101 ought to be taken out and SHOT. Everything in economics has, at its absolute core, the notion that consumers maximise utility (or felicity, or HAPPINESS). Producers maximise profit in order to use that profit as income, with which to fund their consumption... to enable them to augment their happiness. (And no, nobody says that utility/felicity/happiness comes only from the consumption of goods, or that interpersonal utility is irrelevant).
I'm also intrigued that you think that, under conditions of absence of uncertainty (i.e., all CDFs for all variables have 100% of probability mass at the actual outcome) that there could still be risk.
To put that in context, consider securities pricing via discounted cash flows. IF all future cash flows are known with certainty, and all discount factors (interest rates and rates of time preference of consumption) are likewise perfectly known, then there is one, and only one, invariant valuation for the stock under consideration.
Personally, the moment I read Keynes' assertion that holding cash balances did NOT stem from an intertemporal optimisation problem, I knew that this work was not goingto be worth studying except as an exercise in polemic. (I was taught consumer theory in a relatively 'math-ish' way, but by a VERY good economist... far better that, than to be taught it in a hand-waing way by a half-talented mathematician like Keynes)
What Keynes is saying is that people somehow just 'wind up with' money balances after having performed their optimisation. They then decide to let sit idle when there are consumption possibilities available. These mythical people are not even 'satisficing' in anything except a single-period world (because if they discovered that they made a mistake by kleaving unexploited consumption possibilities, then they would change their behaviour at t=2).
In sum, Keynes' view stems from the rather abhorrent view that the mass of mankind are simpletons who cannot be trusted to make their own decisions: it is the thinking behind the Raj and the Sepy massacre.
And - no surprise - Keynes was a whore to politicians, and he got his Cambridge job through nepotism.
If it were up to me I would dig him up, grind his bones to a paste and feed it to pigs - thereby forcing Keynes to finally make a (sall) positive contribution to the globe having been the charlatan that furnoshedthe economic theology that underpinned the rampant rise of the parasitic, murderous State in the 20th century... and by dint of that, massive, large scale industrial War.
Cheerio
GT
Published: May 19, 2009 2:32 AM
Gil
"In sum, Keynes' view stems from the rather abhorrent view that the mass of mankind are simpletons who cannot be trusted to make their own decisions: it is the thinking behind the Raj and the Sepy massacre." - G. Transom.
Puh-lease! Triple H (and most Libertarians concur) believe the masses are irrational simpletons hence Democracy doesn't work. Triple H further states that "Monarchy is better than Democracy" as Monarchs have a private interest in being rational. But, of course, he then states that "private actors are better than Monarchs to rule" hence successful business people/private landowners are better still than Monarchs.
Published: May 19, 2009 2:53 AM
Jonathan
I have been absent from my PC for a little time and apparently in the meantime Ludwig van den Hauwe has already responded in my place. I very largely agree with van den Hauwe´s comments but I would like to add that contrarily to your allegation I am familiar with most of your writings. By "technically impossible" I simply meant that banks do not respond to (what you characterize as) an increase in the demand to hold money (or an excess demand for money) in the same way that, say, producers of cars respond to an increase in the demand for cars (or excess demand for cars) and that it simply has to be that way in virtue of a few simple principles of monetary economics. However, your own semantics tends to conceal some of these facts, as is also pointed out by van den Hauwe. I agree that I could perhaps better have used the expression "economically impossible" or simply "impossible". I certainly did not mean that a central bank would render it possible. An elementary introduction to monetary principles, as well as further references to the literature, can be found in e.g. Rabin´s Monetary Theory, and also in the somewhat more advanced writings of Leland Yeager. On excess demand the work of Patinkin remains a must.
Published: May 20, 2009 7:55 PM
Ludwig van den Hauwe
On the Austrian Economists blog Steve Horwitz asked me why it is so difficult to conceive of the productivity norm as an emergent outcome of the maximizing behavior of the banks under free banking. The point is that even if this would be true - i.e. that free banking would tend to lead to the "implementation" (so to speak) of the productivity norm - it is doubtful whether this would indeed guarantee macroeconomic stability.
In a nutshell this can be explained as follows, and it has everything to do with the maturity mismatch problem and fractional-reserve banking.
Concentrate on the left-hand side in MV=PQ.
Fluctuations in V reflect mainly decisions about changes in spending patterns (decisions to spend or not to spend by market participants holding bank- issued money). Via a transmission mechanism involving the interbank clearing process, this leads to offsetting changes in M (supposedly so as to keep MV constant) via changes in the lending patterns by banks (the granting of loans by banks). These loans will often serve to buy investment goods in the context of composite (roundabout) production processes that require time to be completed, and that require an extended forthcoming flow of credit. They cannot easily be reversed without causing substantive economic losses. The spending decisions to the contrary can easily be reversed (daily or even continually) and they affect the behavior of the quantity of money in opposite direction, that is, in case of a diminution of spending, the quantity of money is expanded, and in case of an incease of spending, it is contracted.
Free banking would thus actually worsen the erratic, volatile behavior of the quantity of money which is so conducive to crises and macroeconomic instability.
Published: May 27, 2009 1:15 AM
Jonathan
George Selgin: "First of all, it isn't a question here of "relative" price adjustments: the shortage of real money requires either an increase in the nominal stock of money or a uniform decline in _all_ money prices, with relative prices unchanged; this is the classical neutrality doctrine (a counterpart of the classical quantity theory), which is also very much an aspect of Walrasian analysis. Of course, the theory doesn't imply that prices will adjust uniformly in actual fact, at least in the short run. On the contrary, most who accepted the logic of the quantity theory (and Mises should be reckoned among them) understood that the process of nominal price adjustment following a disturbance to money supply or demand would involve potentially large short-run distortions to relative prices. Such non-neutralities play a crucial part in the ATBC. But the suggestions that short-run relative price distortions are only relevant in the case of adjustments in response to an excess supply of money, and not in that of adjustments in response to an excess demand, is a view peculiar to Murray Rothbard and a select group of his followers."
In the hypothesis of a uniform decline in all money prices, what is problematic about saying, after the adjustment has taken place, that the relative price of money versus non-money goods has changed?
Published: May 27, 2009 10:12 AM