“Human Action” and Robert Murphy’s “Choice,” Part 11: Indirect Exchange and Money
This is Part 11 of a 17-part series of posts summarizing Bob Murphy’s indispensable book Choice: Cooperation, Enterprise, and Human Action
The purpose of these posts is to popularize and spread the word about Austrian economics and educate the public. Rather than list all the previous parts, I have created a category for all these posts, called “Human Action and Choice,” so that all these posts can be read (in reverse order) with a single click. Note well: any errors in these summaries are mine and not Murphy’s.
This is one of the longest chapters in the book, and I think it’s the toughest post in the series (at least so far). Some paragraphs may need to be read twice, or perhaps you should just read them more slowly than you’d normally read a blog post. But I think the concepts are among the most fascinating. You should learn something today.
INDIRECT EXCHANGE
Murphy begins by explaining the difference between direct and indirect exchange. We have explored simple examples of direct exchange before, in post 7 (trading one flavor of ice cream for another) and post 10 (selling ice cream for money). Let me illustrate indirect exchange while sticking with the ice cream example.
Say Milton has chocolate, but wants vanilla. Murray has vanilla, but wants strawberry. Ludwig has strawberry, but wants chocolate. No two of these men can trade with one another and have both sides directly obtain they want. But any two of the three can trade directly, and thereby have one side get what they want directly, and have the other side obtain what he needs to successfully trade with the third party. The party that uses the first transaction to get what he needs for a second transaction is engaged in indirect exchange.
For example, if Milton trades his chococate for Murray’s vanilla, Milton is immediately happy, because he wanted vanilla. Murray, exchanging his vanilla for chocolate, is not happy yet — because Murray wanted strawberry, and he has chocolate. But now Murray can go to Ludwig, and exchange strawberry for chocolate. After two transactions, everyone’s happy.
Here, Murray used strawberry ice cream as a medium of exchange. Trading something of value for strawberry did not satisfy Murray immediately, but using that strawberry ice cream as a medium of exchange allowed Murray to get what he wanted.
THE ORIGINS OF MONEY
Carl Menger, the father of Austrian economics, explained that money got its start with this sort of indirect exchange. People recognized that they could not always trade goods directly. But they also realized that if they could trade their goods or services in return for a widely accepted medium of exchange, they could get what they wanted.
Menger explained that money must of necessity emerge in this way. His was not a historical analysis, as there are no clear records of how this happened; rather, he argued from economic logic. Money could not have emerged because a wise ruler said: “everyone should start accepting these shiny rocks” (or pieces of metal, or whatever) “in return for the valuable stuff they have.” It seems very unlikely that people would have signed onto such a bizarre-sounding plan. And if a wise ruler had managed to pull this off, how would he know how many shiny rocks people should have to exchange for one sheep? for three cows? for one day’s labor picking crops? and so forth.
No: instead people started trading for things that they knew would be widely accepted, because they were useful commodities on their own. In some societies the initial medium of exchange was tobacco. It has been cocoa beans at times. (I explained the origins of money more fully in May 2014, and for a fuller description, I refer you to that post, but here we will just summarize it.) But over time, people gravitated towards previous metals like gold and silver, because they had the properties you would expect from a medium of exchange: they were recognizable, scarce, liquid, divisible, durable, easily stored, and transportable. The general idea, however, is that money was a commodity — and it cannot logically emerge any other way. (Gold is thus a “commodity money” — as contrasted with fiat money, which is money simply because government declares it to have value.)
Now comes the fun part — that I think is going to upset some of you, because it may run counter to the conventional way you have likely thought about money for most of your life. (Why “fun”? Well, where’s the fun if I’m not challenging your ingrained beliefs a little bit?)
ANALYZING MONEY USING SUPPLY AND DEMAND
Mises’s great insight into money (one of them, anyway) is that money is a good that is demanded by people, just as they demand any other good. It’s not just what’s left after you get through satisfying your other demands. It’s something you demand just as you demand traditional goods or services. Money is demanded, not so we can consume it (obviously), but because we can hold it, and it provides a flow of services to the person who holds it.
If you view money as a good, there are immediately some problems that need to be addressed. For one, how do you value it? Oranges might be said to be worth $2 per pound. Bicycles might be $200 each. What is money “worth”? The answer is: the reciprocal of all the goods and services it could purchase. If oranges are $1 for a half pound, then $1 is worth a half pound of oranges. If bicycles are $200, then $1 is worth 1/200 of a bicycle. Etc.
Viewing money in this way helps you to understand general price fluctuations as a function of the demand for money. If the price of money goes up (because the demand for money goes up), then the price of all these other goods goes down. When people demand money more, prices fall. Put another way, money’s purchasing power rises. Like any other good, as its price goes up, people will hold less of it, because they can get more for it. (As a side note — and this is my own observation, not endorsed by Murphy — this is why deflation is not worrisome. As people hoard money, it becomes more valuable, and naturally people will want to exchange it for goods, since they can buy more with it.)
By contrast, when money’s purchasing power (or price) falls, prices of other goods go up. This is what is typically thought of as “inflation” (price inflation, or rising prices) — and it is a function of money losing its purchasing power. Put another way, the price of money is falling, which is often a side effect of expansion of the money supply — the marginal utility of extra units of money decreases as the supply available increases.
Ultimately, then, the purchasing power of money is a function of the demand for money. (Remember, Mises liked to explain the economy in terms of demand.) The purchasing power of money throughout the economy adjusts so that the total quantity of money demanded by all people (taking into account what they would have to exchange to get it) equals the total amount of money in existence. (This is the same thing that happens with goods and services: the quantity of a good in an unhampered market economy tends towards the level equal to the total amount demanded at the market clearing price.)
Viewing money as a good collapses the artificial distinction between microeconomics and macroeconomics. It allows Austrian economists to analyze the macro economy according to the common-sense principles (incentives and purposeful behavior) that govern decisions on the individual level.
THE REGRESSION THEOREM
Other problems come to mind, however. Remember, we have said all value is subjective. How can we use subjective value theory to explain the value of money without engaging in circular logic? Before Mises, explanations of the purchasing power of money seemed to travel in a circle: money can buy stuff because people demand it . . . and people demand money it because it can buy stuff.
Mises introduced the time element to break the circle. He explained that money’s purchasing power today is based on people’s expectations of what money’s purchasing power will be in the future. We’re no longer explaining money’s current purchasing power by reference to money’s current purchasing power, but rather by referring to the purchasing power we expect it will have in the future. This evaluation of the future is crucially aided by knowledge of what money was worth in the recent past.
You might say: that breaks the logical circle, but it leads us into a another problem: of infinite regress. If today’s purchasing power is based on yesterday’s expectations, and yesterday’s purchasing power was based on the previous day’s expectations, where did the original purchasing power come from? That’s where Menger’s explanation of the origin of money, described above, comes in. Mises said all money started as commodity money, like gold. Mises called this the “regression theorem.” At some point in the past, the community was in a situation of direct exchange (as opposed to indirect exchange) and this explains the origin of the purchasing power of money.
Mises argued that, if everyone in the world suddenly forgot tomorrow what the prices had been for everything in the past, people could reconstruct the process of comparing the relative values of different goods or services (a Ferrari is worth more than an orange), but nobody would know what a “dollar” is worth anymore. This is why Mises says that money — a medium of exchange — must begin as an economic good for which people assign an exchange value. People who have commonly used nothing but fiat money in their lives may have a hard time accepting this. But there is no fiat currency in existence whose value can’t be traced backwards in time to a commodity money. (This may help explain why people are having such a hard time determining a stable value for Bitcoin. Murphy acknowledges in a footnote that Misesians are still debating whether Bitcoin can escape the logic of the regression theorem.)
THE NON-NEUTRALITY OF MONEY
Mises also argued that money is not “neutral.” As noted, many economists would explain prices through the examples of a barter system, and throw in money as an afterthought. Mises did not. One effect of this view is Mises’s views on the effects of new money entering the economy. Many people seem to assume that if you double the stockpile of money, prices will double and purchasing power will halve, but otherwise people’s relative economic positions will remain constant. First, it’s not so neat and mathematical as that — but more importantly, money enters the economy in different places, and the people who get to use it before the prices rise are benefited. So, during QE, for example, large investment banks received the new money injected in the economy first, and benefited at the expense of others.
Another Mises tenet was that the currently available quantity of money is sufficient. Many people assume that, as the population rises, it is necessary to expand the money supply to forestall that horrible bogeyman called “deflation.” Mises emphatically disagreed. Doubling the money supply does not make people richer, and halving it does not make people poorer.
THE GOLD STANDARD
Mises was also a fan of the gold standard, seeing it as a critical bulwark against government power — as important as a written constitution or bill of rights. (I hesitate to use the words “gold standard” in a post, as it is almost certain that the comment section will fixate on it, making arguments that have nothing to do with the points made in the post. Still, this is part of the chapter.) Mises did not want governments to have the power to take action (even war) without the political accountability that comes with raising the money for the government action through taxation or borrowing. Simply inflating the currency allows governments to pretend that the government action costs them nothing.
The gold standard sets an automatic brake on inflation. If countries tried to inflate their currency, gold would flow out of the country as the government would be forced to redeem the inflated currency for gold. The money supply would have to shrink (or, if you were insistent on inflating, you could just pull a Richard Nixon and kill the gold standard — the “to hell with everything” strategy — leading to the price inflation we saw in the 1970s).
This mechanism also keeps foreign trade in balance; if more Americans bought British products than vice versa, they would have to buy pounds to do so. The surfeit of dollars chasing pounds would cause pounds to increase in value relative to dollars. But the gold standard would keep this from getting out of control, because if the value of a dollar became too low vis-a-vis the pound (meaning it took more dollars to buy a pound), gold owners could simply sell gold to England, buy U.S. dollars with the pounds, exchange those dollars for gold in the U.S., and end up with more gold than they started with. The net effect is that gold would flow out of the U.S., causing U.S. prices to fall, which would cause the British to buy more American goods, bringing everything back into balance. This mechanism has been understood since the days of Hume and Ricardo.
THE MEANING OF “INFLATION”
Finally, Mises was very clear that we should use the term “inflation” to refer to the quantity of money, and not the rise in prices that an increased quantity of money causes. (In a slight concession to the widespread use of the term to refer to the latter concept, Murphy uses “price inflation” to refer to the rise in prices, and “monetary inflation” to refer to an expansion in the money supply, which is what Mises insisted inflation really means.) Mises reasoned: “It is impossible to fight a policy which you cannot name.” (Shades of Ted Cruz talking about radical Islamic terrorism!) The root cause of price inflation is monetary inflation, and if we call rising prices “inflation,” we are then left without a term to describe what the real problem really is.
That was a bear of a chapter; possibly the toughest one in the book. I may give you a few days to reflect on this one before moving ahead with the next post.
Whew!
Patterico (3cc0c1) — 9/1/2015 @ 7:43 amIndeed.
I’m a bit surprised at the scarcity of eureka moments for me in this. I suppose I have absorbed a lot more economics that I thought by osmosis and practical experience… and maybe gaming.
Some time in the past when playing A Tale in the Desert, a sandbox social game set in a fictional Egypt of the pharaohs, when society had evolved enough (through technological improvements and social organization) we created our own flat (paper) money. We went from a basic barter environment, through using commodities as mediums of exchange, then once we had invented paper and the printing press (and could print certificates), we came up with a commodities basket system to back the certificates. Players brought “baskets” of commodities (which we agreed upon would be x of A, y of B… and z of C) which were stored in a secure repository and a certificate of deposit was issued for each basket. Those were far more transportable than the commodities backing them, so allowed easier long distance and long (over) time based transactions that were near impossible before. The certificates were redeemable for the same basket used to allow their issuance.
One thing it really fixed in my mind is the necessity of trust for any flat money-based system. Even one backed by commodities. What was interesting is how few times we actually redeemed the certificates for the commodities. It did work much as a gold-based system where the gold exchanged for deposit certificates mostly sits in vaults. We had an initial hurdle to leap over in convincing the community this was not a scam (much politics involved) and we started slowly with one local community, but as it was shown to work and the benefits to trade were apparent, usage became more widespread and accepted. It did not, however, overtake the barter system, as distances and time still make it more practical to exchange common commodities via barter locally. (I’ll give you 1000 straw for 100 bricks, etc.) But when trading across distances that could take hours of walking for rare resources, the certificates had real advantages. Or to in effect transfer large amounts of commodities across those same distances.
That’s tangential to this, to some degree, but the process of thinking through how to make “paper money” work in a game that had no built in monetary system, one created and managed by players alone, was a practical education in economics and monetary policy… at least on a small scale.
Dan S (94f399) — 9/1/2015 @ 8:10 amWhat’s the point of acquiring political power if not to avoid accountability? Consider virtually every aspect of the current administration. So was Mises engaging in a forlorn hope? Which isn’t to say he was wrong.
And a couple of days to digest these last two chapters would be appreciated!
bobathome (279337) — 9/1/2015 @ 8:15 amI am guessing that the wise ruler required that all taxes, tributes, and fees be paid in shiny rocks, which is why people tried getting shiny rocks in the first place.
Michael Ejercito (d74b61) — 9/1/2015 @ 8:17 am… (As a side note — and this is my own observation, not endorsed by Murphy — this is why deflation is not worrisome. As people hoard money, it becomes more valuable, and naturally people will want to exchange it for goods, since they can buy more with it.)
During times of inflation people don’t stop spending money because it is less valuable. Instead they try to spend it before it loses even more value. By for example buying more stuff than usual that they don’t need immediately. Similarly in deflationary times people will try to delay purchases (until absolutely necessary) because they will cost less in the future.
Also note the positive feedbacks involved. If people in inflationary times are trying to hold less money this effectively increases the money supply leading to more inflation. Similarly if people in deflationary times are trying to hold more money this effectively decreases the money supply leading to more deflation.
James B. Shearer (667387) — 9/1/2015 @ 8:59 amIf the price of money goes up (because the demand for money goes up), then the price of all these other goods goes down. When people demand money more, prices fall. Put another way, money’s purchasing power rises.
Except this has been shown, many times to not be a true statement. While i have enjoyed a lot of austrian work, its a political, not an economic philosophy, as it gets quite a few large points regarding economics wrong.
Think about this statement above. If M2, the broadest current definition of the moneystock was approx 7 trillion USD at the end of December 2007 and today stands at 12 trillion USD – people have obviously demanded more “money”. But during that time where the broadest definition of “money” has nearly doubled, why has there not been a massive amount of deflation? Its only a 7.5 year timeframe where the moneystock has nearly doubled.
Even during the worst part of the recession, CPI never dipped below zero
http://www.usinflationcalculator.com/inflation/current-inflation-rates/
Not only that but the value of the dollar today being only worth the value of 0.002 from 150 years ago is trumpeted by Austrians, but is totally meaningless. What matters is what is the standard of living today vs 150 years ago. Who cares if a dollar today is worth only 0.002 from 150 years ago. The poorest 1% of Americans living today in the US are better off in terms of their living standards than J. Pierpont Morgan, Andrew Carnegie, Vanderbuilt, etc. was at the turn of the 19th century
Go back and look at the statements from the austrians back in 2008 about Quantitative Easing. How many times did we hear that this would lead immediately to hyperflation from the austrian school? Many times. Did it happen, no, because the model is wrong.
In addition, a central premise of austrian school is that low interest rates lead to over lending by banks. Again wrong. Supply of credit is impacted more by demand from credit from worthy borrowers than by the interest rate. In today’s world (in advanced economies at least), bank lending implosions happen not from banks lending to bad borrowers directly. THey happen because something allows banks to offload the loans to third parties who don’t care about repayment risk. Look at the housing bubble, look at the student loan bubble. I will say that late in the game in the housing bubble, banks started to drink their own coolaid.
I understand you appear to be enamored with the Austrian School. As a political philosophy, it has a lot going for it. As an economic philosophy, it leaves a lot to be desired and gets a lot of main points just wrong.
Jeffrey (2eddb6) — 9/1/2015 @ 9:03 amVon Mises is absolutely correct. If a change in tax policy causes taxes to be “embedded” in the prices people pay for goods/services, rather than added to them, one could accurately state that there was an overall increase in price levels, but to label that effect “inflation” is to confuse cause and effect. Unless there is an increase in the money supply relative to the goods/services in the market, it isn’t “inflation”.
The Monster (0ab45d) — 9/1/2015 @ 9:54 amJeffrey, Austrian economics would not have provided much insight on the yearly performance of the Soviet Union. It did, however, predict that other forms of government would do better. The fact that our economy no longer behaves in a predictable fashion should be of great concern. It suggests that our government has meddled too much.
When I was in college a long time ago, we were taught that the USSR performed miracles in reforming a backwards Russian economy. It turns out that we now have learned that one of the reasons for WWI was a German fear that Russia under the Czar would eclipse Germany economically by the mid-20s. Lenin and Stalin solved that problem for the Germans despite Germany’s loss of WWI and the resulting economic penalties imposed on Germany. The Soviet Union was mired in genocidal violence and mass starvation well into the ’30s.
bobathome (279337) — 9/1/2015 @ 10:06 amI thought “money” came from Obama’s magic wand?
CrustyB (69f730) — 9/1/2015 @ 10:10 amI am guessing that the wise ruler required that all taxes, tributes, and fees be paid in shiny rocks, which is why people tried getting shiny rocks in the first place.
That’s how Genghis Khan, the inventor of paper money, did it. Almost. He would only take gold and silver from the Chinese but he made them accept his script.
Patterico, that explanation of inflation and purchasing power is mmm mmm good. When I worked in a gas station at age fifteen, I had to pay a whole gallon of ethyl for your 30 cents, and a whole pack of twenty cigarettes for your quarter. Now, my successor (the place is still there) can get your thirty cents for one pint of gasoline and your quarter for half a cigarette*.
nk (dbc370) — 9/1/2015 @ 10:17 amMoney is the thing that is easiest to trade – something that there is no difficulty selling, and you never trade it at a loss. It got its start probably because for some reason, silver – later old maybe, and colored gems – were irrationally valued by some very rich people.
Sammy Finkelman (39761f) — 9/1/2015 @ 10:23 amJust to clarify: This is more of a statement about the definition of money than it is a statement about the historical origin of money. I gather that at least some archaeologists believe that coins came into being not as a medium of exchange, but rather as an IOU: It’s easier to promise someone that you’ll give them a sheep when your herd is large enough if you give them a token they can exchange for it, and a small piece of malleable metal formed into a distinctive shape would make an easy token.
CayleyGraph (dfcefe) — 9/1/2015 @ 10:38 amIn Austrian Economics, then, these coins would not count as “money” until people started exchanging them independently of the original debt. As such, the culture that used them could have invented coins before they invented money.
Of course, this is also dependent on my rather unreliable memory; I’m not quite sure where I came across this theory, so it could be that my source had no idea what archaeologists think.
why has there not been a massive amount of deflation? Its only a 7.5 year timeframe where the moneystock has nearly doubled… If M2, the broadest current definition of the moneystock was approx 7 trillion USD at the end of December 2007 and today stands at 12 trillion USD – people have obviously demanded more “money”.
No, the government has simply printed more money. There hasn’t been a proportional increase in economic output so there isn’t a corresponding demand for money.
Go back and look at the statements from the austrians back in 2008 about Quantitative Easing. How many times did we hear that this would lead immediately to hyperflation from the austrian school? Many times. Did it happen, no, because the model is wrong.
That should be the case if the increased supply of money was out in the economy chasing real goods. If the money was being socked away, because whether you need it now or not it is unlikely money will ever get any cheaper than 0% (though this is possible), you would not see the inflation in the cost of goods…yet. Thus:
First, it’s not so neat and mathematical as that — but more importantly, money enters the economy in different places, and the people who get to use it before the prices rise are benefited. So, during QE, for example, large investment banks received the new money injected in the economy first, and benefited at the expense of others.
Suppose (just suppose) banks, corporations, and other large institutions with access to this money before anyone else were to sit on it either waiting for the economy to show signs of improvement (or political change) before investing (spending on goods and labor). Or say, the reserve requirements of banks are increased. The dollar denomination of those institutions (i.e. stock price or other private valuation) would increase.
WTP (41d24a) — 9/1/2015 @ 10:46 amWTP, I like answers #2 and #3, but #1 could lead to more dollars chasing the steady supply of goods, leading to increased prices. However, with the opportunity cost of “hoarding” cash being essentially zero, your idea that the money is being salted away seems on track. This would certainly explain the low “velocity” of the money that was inserted into the economy. And Mises would also argue that the price of something would reflect the potential buyers’ views of the future. If there’s no reason to think the price will increase in the future, there’s no urgency in buying today.
bobathome (279337) — 9/1/2015 @ 12:18 pmI need some time to think about this, especially viewing price fluctuations as a function of demand for money. I think I understand but I would welcome examples that might help me grasp this point.
DRJ (521990) — 9/1/2015 @ 12:57 pmbobathome…yes, I agree. And I started to respond in that manner until I noticed that Jeffery was speaking of DEflation, not INflation. But to his point, if there was indeed a greater demand for money, there would indeed be deflation. Deflation is a rarity over the long haul as there is far more incentive to print money than do nothing.
Something to think about in regard to money that is touched on in this post is that for most of human history, while money almost always existed, it was nowhere near as commonly used as it is today. Think of the Western PA Whiskey Rebellion. They bartered mostly using whiskey for many of the reasons described int this post. The rebellion was partly due to the difficulty of acquiring hard currency (any currency, really) out in the west by which to pay the tax. I don’t know for sure and no time to check now, but I would presume there was some level of deflation, currency-wise, when trade with the east ebbed due to weather or other trade route interruptions.
WTP (41d24a) — 9/1/2015 @ 12:57 pmI begin to think that my econ teachers in the middle 1960s were all Misesians.
htom (4ca1fa) — 9/1/2015 @ 1:37 pm#15, WTP, the North Koreans are doing their mightiest to ensure that DEflation of U. S. currency is an impossibility. Of course, this puts Tiniest [Fat] Kim at odds with drug cartels who rely on the preservation of the value of the U. S. $100 bill. Every time the U. S. Navy intercepts another North Korean freighter loaded with counterfeits of Ben Franklin, they breath a sigh of relief. They haven’t exhaled in this fashion in six years.
We are now living in the country, and we find ourselves dealing with apples, grapes, and other perishable fruits. My sympathies for the Whiskey Rebellion has been growing. It takes a hell of a lot of work to simply preserve our fruit for our own consumption, and this is with refrigeration and a knowledge of bacteria. Making a living by exporting whiskey to NYC 220 years ago had to be a challenge.
bobathome (279337) — 9/1/2015 @ 6:29 pmI agree that inflation can cause people to spend money before it loses value — especially in a hyperinflation scenario. But that is because in a hyperinflation scenario, people expect the money to lose value. Expectations are always critical to people’s behavior.
For example, you say that in deflationary times people try to delay purchases until absolutely necessary. That is far too categorical a statement. Again, expectations are critical to people’s behavior. Deflation can cause people to delay purchases — if they expect the deflation to continue, and depending on the nature of the purchase, their stock of money, and (thus) the marginal utility expected from the purchase. But deflation can also cause people to buy now — if they see a dip in the price of a good they covet, and they don’t expect the dip in prices to last.
The downward deflationary spiral we hear so much about from economic models would be true only if certain assumptions about people’s expectations (that they will always expect more deflation) holds true. But those assumptions don’t always hold true in real life.
Also, one’s desire to hold money — for example, to have a “rainy day” fund to pay for 6 months’ of necessities — can be marginally decreased in deflationary times. Right? While the hyper-simplistic scenario you have described says people in an era of deflation will hoard like there is no tomorrow, this is not necessarily the case. The man who says he wants enough money to pay for necessities for 6 months may decide he needs $50,000 for that purpose. But then, if he watches the purchasing power of his money grow (which is what happens in that horrible, horrible scenario of deflation: your money gains in purchasing power), he may find he needs only $40,000 to pay for 6 months’ of necessities. He may also decide that $10,000 — the extra amount above what he needs for necessities — buys a lot more today than it used to, and now he can afford that whizbang deluxe pool table he always wanted with that $10,000. This is what I mean when I say: “As people hoard money, it becomes more valuable, and naturally people will want to exchange it for goods, since they can buy more with it.” It’s more of a marginal observation, in both senses of the word (I made a pun!).
Patterico (3cc0c1) — 9/1/2015 @ 7:21 pmPutting aside the dubious nature of your assumptions, you need to understand that my proposition had an unstated “all other things being equal” assumption. If the demand for money goes up, the price of goods goes down — all other things being equal. It’s almost definitional, in fact. But in a world where the government is monkeying with the money supply, interest rates, and all sorts of other aspects in the country, you can’t assume that changing variable x is going to invariably result in a predictable change to variable y.
I’ll grant you that some Austrian economists predicted hyperinflation from QE. Others did not. Certain Keynesians predicted wild success from Obama’s stimulus. I suppose some didn’t — though I haven’t heard about them yet. I think the confusion stemmed from treating the reserves in the banks as part of the money supply before that money actually entered “circulation” (a loose term, since technically referring to money as being in “circulation” was considered inaccurate by Mises).
I don’t believe you’re correct that “a central premise of austrian school is that low interest rates lead to over lending by banks.” Link, please? My understanding is that an artificially low interest rate causes businesses to engage in malinvestment, by putting too many resources into higher-order goods.
I agree (if this is what you’re saying) that interest rates can be affected by differing factors — an easy-money policy could be the reason, but so could low demand for credit.
“Reasoning from a price change” can be dangerous if you don’t know the cause of the price change. If I say prices will be higher next year, can you tell me whether consumption will be up or down? No, you can’t. The answer depends on whether the demand curve has shifted, or whether it has remained constant and you are simply moving along the curve.
You have yet to show one. You are long on assertions and short on links and compelling arguments.
Patterico (3cc0c1) — 9/1/2015 @ 7:51 pmJames Shearer,
Put another way, when a person demands to hold money in a cash balance, then: the greater the purchasing power of his money, the lower the quantity of money demanded in the cash balance.
For the reasons I explained.
DRJ,
I agree that this demands a lot of study and thought. Trust me: it’s that way for me.
Patterico (3cc0c1) — 9/1/2015 @ 8:02 pmIn an “uncertain economy” money becomes more “in demand” becomes it is not, or does not appear to be, as easy to come by. So if you want to get people to part with their money, you have to give them more goods for the same dollars — lower your prices.
Of course, the value of money is also subjective, in any economy, and that’s how you get Scrooges. But then that’s how you get St. Francis’s too. Or the Prodigal Son.
nk (dbc370) — 9/1/2015 @ 8:15 pm@Patterico:The gold standard sets an automatic brake on inflation. If countries tried to inflate their currency, gold would flow out of the country as the government would be forced to redeem the inflated currency for gold.
Every government debased the currency at some point, and no government was forced to redeem for anything because they had a monopoly of force, and this would go on for decades. Commodity money is not immune to inflation or deflation. The Spanish and Portuguese imported gold and silver for centuries and all they did was make themselves poorer while inflating the currencies of everyone they traded with. The Chinese only accepted silver in trade for centuries and never made themselves richer thereby, just produced inflation.
If we’d been on the gold standard the last 40 years we’d have had to debase the currency because the world market has outgrown the gold supply many times over. There’s only a few trillion dollars worth of it.
Suppose you wanted to maintain a modest economic growth of 3% per year. Every 23 years (ln 2 / 0.03, for those who’d like to check my work) the gold money you kept in circulation would have to double. You’d have to repeatedly debase the currency to keep up. If you failed to keep up you’d cause contraction at first, then stagnation.
Just about every kind of money has been tried, commodity or not–the large stones used by Yap islanders being probably the polar opposite of commodity money, but lots of ancient societies used cows and sheep, and later metal objects representing those things, and Spartans used markers of wood and leather. The first really new thing is Bitcoin, based on encrypted records of Bitcoin transactions , which you have to admit is pretty abstract.
The fact that such a wide variety of things has been used as money by so many different people over so many centuries strongly suggests that by adopting fiat currency we have simply cut out the middleman by not attaching it to a physical object of some sort. In the end it doesn’t matter why people value it so much as the fact that they do. Fiat money can be done reasonably well, as the US does, or spectacularly badly, as Zimbabwe and Weimar did and Venezuela is now doing.
Most of the other things you’re saying are not, of course, controversial and not specifically associated with Mises.
Gabriel Hanna (13a147) — 9/1/2015 @ 8:28 pmFor example, you say that in deflationary times people try to delay purchases until absolutely necessary. That is far too categorical a statement. …
Okay to be more precise there is a tendency for people to delay purchases compared to inflationary times (with stable money times falling in between). If I am thinking about buying a TV and I expect prices to rise in the next month or so I am more likely to buy immediately than if I expect prices to fall in the next month or so.
The downward deflationary spiral we hear so much about from economic models would be true only if certain assumptions about people’s expectations (that they will always expect more deflation) holds true. But those assumptions don’t always hold true in real life.
Sure (as with inflation) it matters whether people expect the trend to continue. Prolonged deflation seems unlikely with a fiat currency but could occur with a strict gold standard.
Also, one’s desire to hold money — for example, to have a “rainy day” fund to pay for 6 months’ of necessities — can be marginally decreased in deflationary times. Right? While the hyper-simplistic scenario you have described says people in an era of deflation will hoard like there is no tomorrow, this is not necessarily the case. The man who says he wants enough money to pay for necessities for 6 months may decide he needs $50,000 for that purpose. But then, if he watches the purchasing power of his money grow (which is what happens in that horrible, horrible scenario of deflation: your money gains in purchasing power), he may find he needs only $40,000 to pay for 6 months’ of necessities. He may also decide that $10,000 — the extra amount above what he needs for necessities — buys a lot more today than it used to, and now he can afford that whizbang deluxe pool table he always wanted with that $10,000. This is what I mean when I say: “As people hoard money, it becomes more valuable, and naturally people will want to exchange it for goods, since they can buy more with it.” It’s more of a marginal observation, in both senses of the word (I made a pun!).
Sure deflation benefits creditors by making them wealthier and as with any increase in wealth there is a tendency to spend some of your gains on consumption. On the other hand deflation hurts creditors by increasing the amount they owe and the amount of their repayments (in real terms) which will tend to cause them to decrease consumption.
James B. Shearer (667387) — 9/1/2015 @ 8:33 pmJames,
Put yet another way, as the purchasing power of money increases, the opportunity cost of holding money increases (i.e. there’s more and more stuff you could buy with the money you insist on holding) and thus less money is demanded to be held.
Similarly, in the labor market, the greater the purchasing power of money, the lower the quantity of money demanded in return for labor.
Patterico (3cc0c1) — 9/1/2015 @ 8:40 pmJeffrey,
Your analysis appears to ignore the issue of the relationship between the total stock of money and the demand. This affects the marginal utility of extra units of money. As the stock increases, the purchasing power of money (i.e. the demand for money) declines — again, all other things being equal!
However — and this is important — money is useful only as a medium of exchange. It need not be an immediate exchange — and as nk notes, in times of uncertainly, there is greater demand for money, because it serves a purpose when you hold it: to wait for the best time to make an exchange. However, understanding that its only use is for exchange (now or in the future), then there is no such thing, monetarily, as too little or too much money. The supply of money is always used to its maximum extent, and so society does not benefit monetarily from increasing the supply. (There may be a social benefit from having more available to serve as a medium of exchange, but in strict theoretical monetary terms, there is no benefit.)
Patterico (3cc0c1) — 9/1/2015 @ 8:40 pmthe experience of Argentina, 1923 Germany, Zimbabwe do not make the point, btw, the notion that inflation brought Hitler to power, is dubious, it was the post 1931 deflation typified by the collapse of the CreditanStalt, which Hayek was witness to,
narciso (ee1f88) — 9/1/2015 @ 8:42 pmAs I just said, monetarily speaking, the Austrians distinctly disagree. They say that the value of money varies with the demand and the total stock of money. If the stock remains the same, but demand increases, the purchasing power of the money increases. However, as with any other commodity, as it becomes more valuable, the opportunity cost of holding it increases, which keeps the deflationary spiral boogeyman at bay.
You can argue with me about it, as a knee-jerk reaction, I suppose, but you’d get more value out of reading Mises or Rothbard, as they explain it better than I do. If you’re interested I can direct you where to look, for free. I have been doing some outside reading tonight myself, in Man, Economy, and State by Rothbard (primarily Chapter 11) to make sure I am getting it right.
Patterico (3cc0c1) — 9/1/2015 @ 8:45 pm@Patterico:You can argue with me about it, as a knee-jerk reaction, I suppose
My knee-jerk reaction is to use math to solve problems. It’s math that is against you, not me.
In 1900 the world economy was about $1.1 trillion in constant 2005 dollars. In 2014 it was about $78.9 trillion, again constant 2005 dollars. That’s an average annual growth rate of 3.8%. That means the world economy doubles every 18 years.
If you use x gold in circulation throughout the world in one year, and you never change the value of that currency, you need 2x in 18 years, 4x in 36 years, 8x in 54 years, 16x in 72 years. If you can’t keep up with the mining, the economy can’t grow, because you set it up so it can’t.
And something like 50% – 75% of all the worlds gold has been mined. It can’t keep up. You will have to debase the gold currency to allow growth or there won’t be any. You will have fixed the maximum goods and services that can change hands per year by the amount of metal that people have available to change hands. That’s literally insane.
The rules of the game will change long before then: i.e. inflation. Some government will decide that 1 oz of gold now trades for 5 barrels of oil instead of 4, and their economy will have more goods and services changing hands as a result. The others will follow suit.
There’s simply not enough metal to keep up with humans’ ability to meet other humans’ needs. That’s a good thing. Why hamper it with superstition?
Gabriel Hanna (13a147) — 9/1/2015 @ 8:56 pmGabriel, I think the problem with gold as a basis for money is overstated. Those who advocate inflationary policies take it as a given that individuals will adjust to the changing prices with little trouble. Yesterday a loaf of bread cost $4, today it costs $6. Life goes on. The same flexibility could exist going the other way. Today a loaf of bread costs $6, tomorrow it will be $4. Life goes on.
The big difference is in the treatment of debt. If the debt is denominated in currency, then inflation helps the debtor. Last year I owed $1000, and $1000 bought 250 loafs of bread. This year, 250 loafs of bread are worth $1500, and I can pay of my debt and still have 83 loafs of bread.
Curiously, the popular economic bias is to the inflationary/debtor side AND the government has been running a deficit almost constantly since FDR’s time. You’ve been a very good little student in our government school! Another A+!! Good boy!!!
bobathome (279337) — 9/1/2015 @ 8:59 pm@bobathome: I notice you ignore the math. Where does the gold come from to keep pace with economic growth?
If the economy–value of goods and services changing hands–doubles, where does the gold come from that is equal in value? If the amount of gold cannot keep up, what do people do?
How many times can the productions of mines double?
Gabriel Hanna (13a147) — 9/1/2015 @ 9:02 pmMaybe you should read what I have written, and contrast it with the portion of your comment that I have placed in bold.
Please understand, as you do so, that the gold standard favored by Mises favored paper currency, or other forms of non-gold representing gold, that represented a particular weight of gold and not a particular “dollar value.” (Names for currency and coins originated with weights.)
And no, you don’t have to have the actual metal changing hands at all times, as long as there is a trusted representation of that metal that people can rely on.
Monetarily, you don’t “need” more gold as the population grows. The amount available simply becomes more valuable. Again, call it “superstition” or “literally insane” or pretend it’s beyond argument, or do some learning on your own. To my way of thinking, such comments add little value.
You might be a kind of smart guy in some ways, but if we’re going to play argument from authority, you are airily dismissing people who I submit were way smarter than you — no offense — without having even read them. Which you clearly haven’t.
If we’re not going to play argument from authority (I would prefer we don’t), then try familiarizing yourself with the concepts, listening to what I am saying, and maybe tone down the “I’m obviously right” rhetoric. Would be my suggestion.
Patterico (3cc0c1) — 9/1/2015 @ 9:06 pmYou’ve heard the phrase “begging the question,” I assume.
You keep doing that.
Patterico (3cc0c1) — 9/1/2015 @ 9:07 pm@Patterico:that represented a particular weight of gold and not a particular “dollar value.” (Names for currency and coins originated with weights.)that represented a particular weight of gold and not a particular “dollar value.” (Names for currency and coins originated with weights.)
OBVIOUSLY. I never said otherwise.
No one can answer the question because it is unanswerable. Here I have an economy. It consists of goods and services changing hands. The value V of these goods and services is represented by x oz of gold.
Next year, 3% growth. If V = x and I have 1.03 V, how much x do I have to have? 1.03. If my gold supply did not grow by 3% MEASURED BY WEIGHT then my gold CHANGED VALUE.
Gabriel Hanna (13a147) — 9/1/2015 @ 9:09 pmSimilarly, in the labor market, the greater the purchasing power of money, the lower the quantity of money demanded in return for labor.
There is a problem with this in that people are reluctant to accept cuts in their nominal wage even if this will leave their real wage unchanged. This may be in some sense irrational of them but it is an empirical fact. So deflation causes problems in the labor market.
James B. Shearer (667387) — 9/1/2015 @ 9:12 pmIf the economy grows, and the supply of money (here gold) remains constant, then your gold “changed value” by gaining in purchasing power.
I have spent a lot of time in this thread fleshing out the implications. They are more subtle than a bald claim that, given growth, we “need” more gold because otherwise one’s money would become more valuable, and we would be able to purchase more with it — and then God help us! where would we be?
Patterico (3cc0c1) — 9/1/2015 @ 9:12 pm@Patterico: Ok, do you see 100% that I am not confusing dollar values with weights of gold?
If the economy really does grow by some percentage: that there are more goods and services changing hands this year than last year, and their aggregate value is really more, then one of two things happened:
The same amount of gold is chasing more goods and services, also known as deflation. People will have to bid more stuff to get the same amount of gold. This will make trade more expensive. People will be less likely to engage in it. Growth slows.
OR
More gold was mined to make up for it, so that the value didn’t change and the growth can continue. But not indefinitely because next year we have the same problem and eventually the mines cannot keep up. So we get deflation eventually
OR
we all have to make the same gold cheaper in terms of goods and services in order to keep up, and we have to do that by agreement, which is of course inflation.
Gabriel Hanna (13a147) — 9/1/2015 @ 9:16 pmYour link-free “empirical facts,” in a world of minimum wages, giant government-constructed safety nets, and other government intervention, do not move me, you’ll be shocked to learn. Bring some empiricism to the table in the form of links showing us what happens in the unhampered market economy, why don’t you.
Patterico (3cc0c1) — 9/1/2015 @ 9:16 pm@Patterico:we would be able to purchase more with it
No, we WOULDN’T. The exchange of goods and services would be made more expensive because the medium of exchange would keep increasing its value. Trade would increasingly cost more and thus be engaged in less.
It has actually happened before that people ran out of money because money was too expensive. Many, many times. And then trade slows down, and hence the economy contracts.
Gabriel Hanna (13a147) — 9/1/2015 @ 9:20 pmI should have said this before:
Oh wait. I did, in comment 27. You’re just arguing past me because you have not read and considered what I already said in this thread.
As I noted before, I have spent a considerable amount of time reading and thinking about this tonight, and trying to distill what I have read in this comment thread. Could you do the courtesy of trying to understand what I have written, and respond to it, rather than continuing to chatter in such a way that I get the distinct impression you have skimmed what I wrote?
I mean, I appreciate the fact that you’re discussing it with me — I really do — but I would appreciate it an awful lot more if you gave some indication that you were digesting and responding to my previous comments, which represent almost as much work as I put into one of these posts.
Patterico (3cc0c1) — 9/1/2015 @ 9:21 pm29.Gabriel, I think the problem with gold as a basis for money is overstated. Those who advocate inflationary policies take it as a given that individuals will adjust to the changing prices with little trouble. Yesterday a loaf of bread cost $4, today it costs $6. Life goes on. The same flexibility could exist going the other way. Today a loaf of bread costs $6, tomorrow it will be $4. Life goes on.
There is a psychological factor here. Workers (in general) are much happier receiving a 3% pay raise in times of 3% inflation than a 3% pay cut in times of 3% deflation. This may in some sense be irrational of them but it is what it is and employers have to take it into account. For example giving a worker a small pay cut is generally a bad idea, the small amount you save isn’t worth the bad will. Failing to raise pay as fast as inflation does not generate the same animosity. So mild inflation allows the labor markets to function more smoothly by making cuts in real wages when needed more palatable.
James B. Shearer (667387) — 9/1/2015 @ 9:23 pmI don’t understand why “trade” would be more expensive because the value of units in one side of the transaction increased in value. That makes no logical sense. What makes logical sense is that, as the value of units in one side of the transaction increases, fewer of those units must be exchanged for the goods and services on the other side of the transaction. Meanwhile, the total “cost” of “trade” does not change.
Please provide cites.
Patterico (3cc0c1) — 9/1/2015 @ 9:24 pm@Patterico:Oh wait. I did, in comment 27.
The fact that an unsupported assertion did not convince me does not mean that I did not understand it.
During the Great Depression rural areas could not get money. It was too expensive for them. Their goods and services could not purchase it. So they had no medium of exchange. So trade slowed. So they made scrip: i. e. fiat money, inflated currency. (See Amity Shlaes, The Forgotten Man
Gabriel Hanna (13a147) — 9/1/2015 @ 9:28 pmThere is a psychological factor here . . . in a world where we have gone off the gold standard and people’s expectations are that there will be single-digit inflation every year. You have provided zero evidence that this psychological factor would be at play if there were constant deflation at the same rate that we typically see inflation. Indeed, logically, one would expect the psychological factor to reverse.
Of course, you have provided zero evidence that it does not.
Patterico (3cc0c1) — 9/1/2015 @ 9:29 pm@Patterico:Please provide cites.
Oklahoma 1933.
Salt Lake City 1931, The Forgotten Man by Amity Shlaes.
England in the 17th century.
So will you acknowledge that the supply of money can cramp an economy, or not?
Gabriel Hanna (13a147) — 9/1/2015 @ 9:32 pmYou’re citing me the era of FDR’s New Deal, with its unprecedented government meddling in the economy, as evidence of what would happen in an unhampered market economy with a fixed stock of gold?
Really?
FDR seized everyone’s gold, allowed companies to cartelize to set minimum prices, threw people in jail for trying to provide lower prices, and set the price of gold every morning on a whim while sitting there in his PJ’s.
Don’t cite what happened in his world of Big Government Intervention as proof of what would happen in an unhampered market economy.
Patterico (3cc0c1) — 9/1/2015 @ 9:33 pm@Patterico:You’re citing me the era of FDR’s New Deal, with its unprecedented government meddling in the economy, as evidence of what would happen in an unhampered market economy with a fixed stock of gold?
Not unless FDR had a time machine that affected Cromwell’s England.
What I am describing has happened in real life. Many times. You said “cite please” and now you are trying to wave it away. Dirty pool, sir.
Gabriel Hanna (13a147) — 9/1/2015 @ 9:38 pmI used to think what Gabriel does, but I’ve come around to Patterico’s point of view. Here’s how I see it: The quarter I carry around today is the same exact hunk of cupro-nickel I carried in 1971. In 1971, I could buy a pack of cigarettes with it. Today I need about 60 of them. If it was worth 60 times as much in 1971 (at least for cigarettes) why can’t it be worth 60 times as much in 2016? Saving the U.S. Mint the cost of making the other 59 and me from having to carry them around?
nk (dbc370) — 9/1/2015 @ 9:38 pmAs for England in the 17th century, the country was on an official government policy of bimetallism during that period. Bimetallism does not work because there is a government-imposed artificial equivalence drawn between two metals that never remain equal in value at the level artificially set by the government, which creates arbitrage opportunities and means that one metal will end up in shortage. Here, it was silver in short supply, which caused a small-change shortage.
So 1) it was caused by government policy and 2) it was not a monetary phenomenon, but a social one (see comment 25). In these days of computers, without the monetary issue, we would not be as hampered by the physical restraints.
Patterico (3cc0c1) — 9/1/2015 @ 9:41 pmNo, I gave part of the analysis in one comment, and then busied myself with responding to the second part of the comment, even as you were accusing me of bad faith.
Picture it: me on one computer, working to address your comment, as you sat there on another computer, at the very same moment, baselessly accusing me of failing to do exactly what I was doing.
This is what I mean when I say you need to tone it down, take a step back, and make it about the ideas and stop the “you are insane!” and “you are acting in bad faith!” rhetoric.
Patterico (3cc0c1) — 9/1/2015 @ 9:44 pm@Patterico:Please provide cites
13th century China. In that case the collapse of the scrip, intended to help the deflation, dragged the metallic currencies down with them.
How many cites until you agree that I have understood what you wrote and made a valid counter-argument?
Gabriel Hanna (13a147) — 9/1/2015 @ 9:44 pmYour link-free “empirical facts,” in a world of minimum wages, giant government-constructed safety nets, and other government intervention, do not move me, you’ll be shocked to learn. Bring some empiricism to the table in the form of links showing us what happens in the unhampered market economy, why don’t you.
Here is a recent Federal Reserve publication which states:
Downward nominal wage rigidities are a well-documented feature of the U.S. labor market (see, for example, Akerlof, Dickens, and Perry 1996 and Card and Hyslop 1996). …
Of course this concerns the actual world. The only empirical statement that can be made about “unhampered market economies” is that they don’t appear to exist. Or am I wrong, are there examples of what you would consider an unhampered market economy?
James B. Shearer (667387) — 9/1/2015 @ 9:45 pmI am happy to respond to that, but it would take research, and I am afraid that while I am doing that research, you will be here accusing me of failing to do so.
I admit that I know little about 13th century China. They had the only unhampered market economy in human history, did they? If you are willing to warrant that they did, I’ll do some research to see how the only unhampered market economy in human history failed to empirically reflect the arguments that make sense to me in theory — arguments that you have provided no counter-argument other than (so far) flawed empiricism to counter.
We’re getting dragged back into our fundamental disagreement: you think you can take “data” from the “real world” and apply it to deductive principles that apply to the unhampered market economy, even though no real-world example of an unhampered market economy has ever existed.
Which brings us back to your inevitable objection that this is all a useless thought experiment. I happen to disagree, and believe that your constant resort to “data” is misguided, because there is so much noise and zero theory, such that you are constantly missing the consistent thread (government intervention) that causes the theory not to line up with the “data.”
Patterico (3cc0c1) — 9/1/2015 @ 9:50 pm@Patterico: Your advice for calm is wise. I will take it, and perhaps you can too. You did first accuse me of not reading what you had written; and you now accuse me of being hot-tempered when all we are doing is cross-posting, which is relatively common. So let us both assume the good intentions of the other, agreed?
I am making a very simple point–if the medium of exchange is hard to acquire, trade slows down, hence contraction. I give examples when demanded.
Your replies: nothing done under FDR counts. Bi-metallism enforce by a government doesn’t count. What you have said would count is an example from an unhampered world market using only a fixed supply of gold as money.
If I agree to that, then I ask for your citations: when did those conditions ever operate? And if they never did, then whence the Austrian certainty that given those conditions the situation I describe can never take place?
I will wait until morning to reply to whatever you have posted in the meantime after giving it careful thought and reflection.
Gabriel Hanna (13a147) — 9/1/2015 @ 9:51 pmWell done. You’ve shown that in an economy in which government interference causes people to expect regular inflation, people expect regular inflation and react accordingly.
*golf clap*
Patterico (3cc0c1) — 9/1/2015 @ 9:51 pm@Patterico:Which brings us back to your inevitable objection that this is all a useless thought experiment.
Which I have never stated or implied; you cannot quote me saying any such thing. Take, sir, the advice that you gave me.
arguments that you have provided no counter-argument other than (so far) flawed empiricism to counter.
Keep in mind that my profession is science and yours is the law. Facts matter to a scientist, arguments only in so far as they agree with facts. The universe is not swayed by arguments. An economic policy has real world consequences. Bad economics kills people. Those people can not be argued back from starvation and misery, their suffering is empirical fact.
I do not allow you to retreat into “facts don’t matter, this is Truth.” No one else will either if it is going to cost them anything to take your advice.
Gabriel Hanna (13a147) — 9/1/2015 @ 9:56 pmYou’re right. I should not have assumed you didn’t read what I wrote. I should have simply noted that you were not engaging with what I wrote. Rather, you dismissed it all out of hand. But I should not have cast aspersions on you regarding whether you read what I wrote.
I am making the logical point that “hard to acquire” just means “expensive.” But when the medium of exchange is “expensive” that just means that it is valued more highly, which means that it has greater purchasing power. You might have to accept less of it in exchange for a fixed amount of labor/goods/services — but then, having acquired it, you can then exchange it for more. So it’s really six of one, and a half-dozen of the other.
I very specifically explained why I think the experience of the Great Depression under the New Deal policies under FDR are not relevant to our question of whether, in an unhampered market economy, a greater supply of the stock of money is necessary to address “growth” in the economy.
I will concede that my statement concerning bi-metallism is my theory, but it is backed up by the reading I have done. The bi-metallism of England is beyond dispute (with the pound on a bimetallic standard from 1600-1797). I also know that England had a small-change shortage around that time. If you have read Murray Rothbard’s “What Has Government Done to Our Money?” (my first foray into Rothbard) you would know that, logically, bimetallism will cause one of the two metals to be overvalued, and the other to be undervalued, causing a shortage in one. My theory is that silver was overvalued and became scarce, with concomitant problems in small change — but I concede that I don’t know whether this is borne out by historical analysis.
But frankly I feel this is a waste of time because a) my arguments are being waved away in any event, and b) like I said, this all comes back to your (in my view misguided) opinion that . . . well, I don’t know what you’re contending. Because I recall that you acknowledged the value of deductive disciplines, and acknowledged that an inability to make perfect predictions does not render those disciplines unworthy of study, so I’m not sure what you’re saying other than “sure they’re worthy of study but how can we ever know they’re right and the only way is empiricism and absent empiricism I refuse to discuss the logic with you.”
Patterico (3cc0c1) — 9/1/2015 @ 10:17 pmWell, there we agree. Bad economics kills people.
People obsessed with “data” think maybe Lenin was right but just ahead of his time. People like Mises who said socialism would never work were falsely accused of arguing “facts don’t matter” — and millions of millions of dead bodies later, we hear the same dangerous crap.
The same Krugmanesque arguments that maybe socialism could work, and if you think differently then you are saying “facts don’t matter” . . .are being advanced by people who have never bothered to read a single word of Mises or Rothbard.
By the way . . .
Have you read any Mises or Rothbard?
Patterico (3cc0c1) — 9/1/2015 @ 10:22 pmPeople are. And people affect how the universe works, in the economic realm. Ideas are very important. Very.
Economics is not physics. It never was. It is not now. It never will be.
You need to break out of your narrow way of looking at the world and contemplate a different perspective for a different set of problems.
Patterico (3cc0c1) — 9/1/2015 @ 10:24 pmAt the very least, you owe it to yourself to read the primary sources in this area before you aggressively dismiss them.
Patterico (3cc0c1) — 9/1/2015 @ 10:30 pmWe’re getting dragged back into our fundamental disagreement: you think you can take “data” from the “real world” and apply it to deductive principles that apply to the unhampered market economy, even though no real-world example of an unhampered market economy has ever existed.
Well if no real-world example of an unhampered market economy has ever existed one has to question whether an unhampered market economy is possible. At a minimum it must require unusual circumstances to arise.
And do these deductive principles only apply to unhampered market economies? Do they have anything at all to say about our actually existing market economies?
It is easy to make claims about the wonders of an utopian society for which there are no real-world examples. Liberals similarly like to make all sorts of fanciful claims about what a society without racism would look like.
James B. Shearer (667387) — 9/1/2015 @ 10:44 pmThe same Krugmanesque arguments that maybe socialism could work …
Well if you can dismiss all empirical evidence from actual market economies on the grounds that they deviated from your ideal case why can’t Krugman do the same and claim socialism would work if properly implemented?
James B. Shearer (667387) — 9/1/2015 @ 10:52 pmAs I said in an earlier post, any argument that we should do things differently from the way we have done it in the past requires a thought experiment.
If government insisted on introducting regular distortions to real-world implementations of geometry, it would not render geometry incorrect to say: look! Geometry did not work in this society that outlawed geometry!
And if every government did so, you could arrogantly wave your hand and demand a proof of geornetry in real life and sneer if one could not be provided.
That would not make you right. It would make you a sneering supporter of an incorrect status quo.
Patterico (3784a5) — 9/1/2015 @ 11:01 pmBecause of the socialist calculation problem. You’re ignorant of it but don’t worry, I’ll explain it in a future post so you can sneer at it without any basis to do so. As you do.
Patterico (3784a5) — 9/1/2015 @ 11:03 pmHere’s your empiricism, fellas: Mises said socialism was doomed. Everyone laughed. Then the Soviet Union collapsed.
They stopped laughing about that. But they still said Keysianism rocked, and laughed at the Austrian economists who said Obama’s stimulus would not turn the economy around. And who predicted a housing bubble in 2000, while Krugman was positively calling for one.
Who’s laughing now, empiricists?
Patterico (3784a5) — 9/1/2015 @ 11:11 pmThe empiricists have a bogus argument that raising the minimum wage does not disemploy people.
Are they right?
Why did you answer that way?
Patterico (3784a5) — 9/1/2015 @ 11:12 pmOh I forgot. Obama’s stimulus was awesome but just needed to be bigger, because data!
Patterico (3784a5) — 9/1/2015 @ 11:13 pm65.The empiricists have a bogus argument that raising the minimum wage does not disemploy people.
Are they right?
I believe there have been some empirical studies that claim that in certain cases where the minimum wage was increased by a small amount the net increase in unemployment if any was too small to detect. I haven’t examined these studies in detail but this seems possible. However I don’t think there is any serious dispute that large increases in the minimum wage would decrease employment and I expect one can also find empirical studies to that effect.
James B. Shearer (667387) — 9/1/2015 @ 11:35 pmSee my comments @ 12 & 15. The problem of there not being any money for exchange vis-a-vis Cromwell’s England or 1933 Oklahoma (can’t reach specific article due to firewall right now) pertain to times and places where cash (or viable cash) was hard to come by due to the remote nature of the location relative to where the problem was. In today’s modern world where we can send money around the world (or I should say “money”) at the blink of an eye this is only a problem for Outer Mongolian yak herdsmen, Afghani goat herders, and Laotian rice farmers. If that. In the absence of money, trade continues. Even in the modern era, prisoners use cigarettes. Or I presume this is still the practice, if smoking bans are in effect they’ve moved on to some other medium of exchange.
This is not to say that a lack of cash isn’t a problem as cash greases the wheels of the trade machine. But it’s mostly a matter time of adjustment from one “currency” to another.
WTP (8894aa) — 9/2/2015 @ 6:56 amheh…that should read “of the location of sources of cash (thinking banks, etc.)
WTP (8894aa) — 9/2/2015 @ 7:26 amAs a scientist, you’re aware of how it’s possible that experiments require rigorous controls in order to match their theoretical models?
CayleyGraph (dfcefe) — 9/2/2015 @ 7:27 amAs such, your examples are insufficient to disproving Patterico’s models, because, as he pointed out, your examples did not follow his models.
Unfortunately, since we also don’t have any real-world examples of an economy that does match his theoretical models, we don’t have any proof that Patterico’s models are sufficient to describe real economies. It’s still possible that one of his assumptions is false, or (more likely) that he has omitted an assumption that is true, but cannot be derived from the others, and has important effects on trade using a gold standard. Granted, since he hasn’t finished his series, it might be unfair to criticize incompleteness.
Basically, what I am being asked to do in defending the notion of money as a commodity is to defend the notion that supply and demand exist, and that these concepts extend to money, as they do to everyone else.
The laws of supply and demand are logical. They don’t work mechanically due to relative elasticity and inelasticity, but the basic concept of marginal utility is simply ingrained in human behavior.
And yet, when people focus on empiricism without a proper respect for the limitations of what they can learn from data, they are willing to repeal the laws of supply and demand when it comes to the minimum wage (for example). All of a sudden the laws of supply and demand are thrown out the window. Google “does the minimum wage kill jobs” and you’ll see dozens of people arguing that it doesn’t.
Part of the problem is that the pernicious effects of small changes (like burgers costing more) are hard to notice and hard to measure — but still very real. When you charge people more for burgers (and gas, and hammers, and everything), it adds up. But it’s hard to see.
I contend that the laws of supply and demand are not repealed in the labor market just because some lefties who favor a minimum wage increase are able to give me studies that claim they are. Maybe folks who are wowed by simplistic empiricism, to the point where they throw logic out the window, are saying: “Hey, they’re right!”
That’s not going to be me.
Patterico (3cc0c1) — 9/2/2015 @ 7:43 am71 I contend that the laws of supply and demand are not repealed in the labor market just because some lefties who favor a minimum wage increase are able to give me studies that claim they are. …
That’s not what the studies are claiming, they are claiming that in some cases the decrease in employment in the short run is too small to detect. This is perfectly consistent with supply and demand holding in the labor market.
Also you have to be careful about what the laws of supply are actually predicting. $11 per hour workers are better than $10 per hour workers. For some jobs they are more than 10% better and it makes sense to hire them (by offering $11 an hour). For other jobs they are less than 10% better and it doesn’t make sense to offer more than $10 per hour. But if you are forced to offer $11 an hour then you will hire $11 an hour workers. If they are say 8% better for your job then your labor costs will go up by about 2% rather than the 10% you might expect so predicting the effects of a forced wage increase is a bit complicated.
James B. Shearer (667387) — 9/2/2015 @ 9:06 amMinimum wage laws don’t force an increase in the supply of $11/hour workers. It would only have an effect on the supply of jobs that pay $11/hour. In the short run, it gives an increase in the number of 11$/hour less than the number of positions that previously paid less than $11/hour; the other positions would be eliminated, either because the employers make due with fewer people, or because the employers go out of business because they can no longer afford the labor necessary for their business plan.
If there exist a population of workers who could bring benefits to their employers worth $11/hour, but who either lack the negotiating skills to secure the wage or have employers who don’t recognize the potential increase, then the minimum wage increase will result in improvements for those employers who have/get members of this population.
Of course, it will also decrease the negotiating leverage of workers who were worth $11/hour, or indeed any amount between $11/hour and the previous minimum wage, since they’ll no longer be able to compete on price. It also means that any effort they may have put into attaining the skills into becoming worth (Previous minimum wage, $11/hour] to their current/prospective employers will be mostly wasted.
That’s a bit understated.
CayleyGraph (dfcefe) — 9/2/2015 @ 9:46 amI missed the conversation last night, but I enjoyed reading the arguments this morning. I have one question for Gabriel that relates to his assertion the a particular increase in the economy must be matched by an equal increase in the amount of money in circulation. Since “money” is used as a medium of exchange and a store of value (cash under the mattress,) if the exchanges occur more frequently, then the same amount of money will facilitate an increased total value of exchange. Also, most “money” held by businesses and individuals is in the form of savings or checking accounts, and is not hidden away in the freezer, as advocated by a recently disgraced (?) Democratic Congressman. So the linkage between the size of the economy and the amount of actual “currency” is not a simple ratio. And yet you make the following calculation (#28):
What is the basis for this assertion?
In a gold-based currency, the treasury typically issues dollars that are redeemable in gold, but most people would not choose to do so. Indeed, they would have to convert the gold back into dollars if they wanted to buy something. So the amount of gold underlying the currency need not be close to 1:1. That is to say, the “x” in your equation would not be equal to the gold equivalent of the money in circulation. The only time that an individual would want to change his dollars into ounces of gold would be when he foresaw that the dollar would be worth less than the redemption amount in the future. And a growing redemption trend would be signal to the treasury that it needs to get its house in order. And this doesn’t mean it needs to raise taxes. It means that it has to behave in a fashion that allays fear about the future, which may mean taxes have to be raised, or it may mean that a transcontinental railroad must be authorized by Congress, as Lincoln did during the Civil War.
And if we want to dabble in history, one must wonder why Spain collapsed during the century when it filled its coffers with gold from the “west indies.” If Krugman is right, this should have been a time vast economic improvement. The government of Spain had an unimaginable windfall which should have resulted growth and progress. Instead, it was a time of decay and corruption.
bobathome (279337) — 9/2/2015 @ 9:57 am… So the amount of gold underlying the currency need not be close to 1:1. …
It is my understanding that Patterico doesn’t approve of fractional reserve banking and would require paper currency to be 100% backed by gold.
James B. Shearer (667387) — 9/2/2015 @ 10:14 amI contend that the laws of supply and demand are not repealed in the labor market just because some lefties who favor a minimum wage increase are able to give me studies that claim they are. Maybe folks who are wowed by simplistic empiricism, to the point where they throw logic out the window, are saying: “Hey, they’re right!”
Being an empiricist doesn’t mean accepting the unexpected results of a single study. People sometimes make mistakes or fail to account for important factors and get things wrong. According to this review article (which I have not read) most minimum wage studies show employment losses as expected.
But if most studies were not showing the predicted employment losses this would be evidence that the theory was wrong (or was being wrongly applied). Many a beautiful theory has turned out to not match reality.
James B. Shearer (667387) — 9/2/2015 @ 10:40 amThere are studies that claim this. You just haven’t looked. For example, the Center for Economic and Policy Research released a post on their blog claiming: 2014 Job Creation Faster in States that Raised the Minimum Wage. This was repeated uncritically in USA Today: States with higher minimum wage gain more jobs. Plenty of Robert Reich style policy wonks trotted out their Keynesian explanations, which amounted to how great it is to shower money on people because then they spend it, yada yada yada.
It turned out that this was all B.S. — as anyone who understands supply and demand already knew. But if you’re willing to toss first principles aside any time something calling itself a “study” claims to present “empirical data” to the effect that the laws of supply and demand have been repealed, then you’ll fall for anything — rather than saying: “That must be wrong. Let’s scrutinize it more closely to see why.” And if you fall for anything, you make bad policy, and people suffer.
Well, I don’t know what is meant by “forced to offer” $11 an hour. Nobody (yet) is forced to offer anyone $11 an hour. If the minimum wage is raised to $11 per hour (and it has been raised higher in some places), then employers who believe that the employee’s labor is worth paying $11 an hour will be forced to pay them at least $11 if they decide to hire them. But if you think they’re worth only $10 an hour, you won’t hire them at all — whereas before, you would have had the option of paying them $10 an hour.
Nobody is “forced” to hire anybody, though.
P.S. It should go without saying that all this is predicated on the assumption that the business owner makes his business decisions based on what he believes will maximize his profit. I think we should realize that while he will always take that action that he believes will best satisfy his desires, his desire will not always be to make the most money. He might hire someone not worth $11/hr, and pay them $11/hr anyway, because they are the boss’s son, or because he thinks they’re pretty, or because they’re a felon and he believes in rehabilitating people, or for any other number of reasons. So this is not always purely a mechanical process. But assuming that business owners typically want to maximize their profits is generally a fairly safe generalization.
Patterico (3cc0c1) — 9/2/2015 @ 6:00 pmNo, studies showing that a higher minimum wage did not result in disemployment does not necessarily mean that the laws of supply and demand are wrong, or being “wrongly applied.” It could mean that the studies are flawed. And in fact, that is invariably what it is going to mean. Trouble is, people like you fail to see that the most obvious possibility (flawed study) is even a possibility, and you may leap to the wrong conclusion (supply and demand wrong!) because of that blind spot of yours.
Patterico (3cc0c1) — 9/2/2015 @ 6:07 pmThat’s another discussion, but yes, in a system where people are told that their deposits are demand deposits that can be withdrawn at any time (as opposed to time deposits where the right to withdraw is limited), I believe it is fraudulent and dangerous to allow banks to lend out the same money that they are also making available for immediate withdrawal.
Nothing about that position means that there is not enough gold in the world to support our economy.
Patterico (3cc0c1) — 9/2/2015 @ 6:08 pmGabriel Hanna,
I second bobathome’s request that you explain why you seem to think that growth in the economy means you need an ever-expanding supply of money.
Patterico (3cc0c1) — 9/2/2015 @ 6:12 pm@Patterico, bobathome:
Did you agree with me that an economy that grows at 3.8% annually will double every 18 years? Do you need to see that worked out?
What I mean by that is, the aggregated value of exchanged goods and services. Nothing to do with dollar values or nominal values. If every year the amount of real economic activity grows by 3.8%, then every 18 years it will double.
So then in 36 years, 4 times as much activity, measured by value. In 54 years, 8 times as much. In 72 years, 16 times as much.
If everyone agrees on that, I’ll go to the next part. If people want to see it worked out I’ll work it out.
Gabriel Hanna (7d0155) — 9/2/2015 @ 6:28 pmPatterico, so you’re basically advocating three types of bank deposits: a standard checking account with suitable (competitive) fees; an insured deposit account yielding a competitive (assuming competition) interest with a guaranteed (see the next item) return of principal; and bank stocks that are redeemable at market values on demand at the bank during business hours (or something equivalent.) Correct?
bobathome (279337) — 9/2/2015 @ 6:29 pmGabriel, I learned the “Rule of 72” before you were born (perhaps, I’m guessing here.) And Einstein also had some thoughts on compound interest, which is known as exponential (or geometric) growth in your field of study.
bobathome (279337) — 9/2/2015 @ 6:33 pmLet’s assume that to be true for the sake of argument. Please move on to the next step.
Patterico (3cc0c1) — 9/2/2015 @ 6:39 pmI’m not sure I follow all that. Let me put it in plain English: I’m saying a bank should not be able to tell people they can come get their money any time, and lend out that same money to someone at the very same time.
Patterico (3cc0c1) — 9/2/2015 @ 6:41 pm78 … Trouble is, people like you fail to see that the most obvious possibility (flawed study) is even a possibility, …
The paragraph before the one you quoted said:
Being an empiricist doesn’t mean accepting the unexpected results of a single study. People sometimes make mistakes or fail to account for important factors and get things wrong. According to this review article (which I have not read) most minimum wage studies show employment losses as expected.
So it looks like I’m not the one who is failing to see things.
James B. Shearer (667387) — 9/2/2015 @ 6:49 pmI read your entire comment, Shearer, and your point was that one study might be wrong, but if “most” studies contradict your theory, your theory is wrong or being applied wrong.
What I had to explain to you was that many or even “most” studies can be flawed. For example, they can all rely on a flawed assumption.
Patterico (3cc0c1) — 9/2/2015 @ 6:53 pmnk (dbc370) — 9/1/2015 @ 8:15 pm
What an unexpected, but wonderful point.
felipe (56556d) — 9/2/2015 @ 7:02 pmPatterico, my third type of deposit (a stock purchase) would expose the depositor/stock holder to all the risks that accompany owning stock (cf., ANV sigh.) So if the bank goes teats up, the “depositors” lose everything. Meanwhile, the type 2 depositors are earning a tad less than the Fed pays the bank for its mandated reserve. This would make the nature of the transaction a bit more transparent, to use one of the administrations most abused words. On the plus side, the 3rd type of depositor stands to earn dividends and even capital gains if the bank makes wise loans.
bobathome (279337) — 9/2/2015 @ 7:02 pmA fellow named Michael Longuet-Higgins observed that most flawed studies went wrong at the very first assumption. Which is to say, algebra is easy, physics is another story.
bobathome (279337) — 9/2/2015 @ 7:07 pmAnd the 3rd type of depositor can redeem something immediately, depending on the current stock price. It might be pennies on the dollar. No guarantees, period.
I’ll admit I’m jumping ahead here, but this would seem to support your idea for a market based banking system. I find I’m quite revolutionary in my old age …
bobathome (279337) — 9/2/2015 @ 7:12 pmYeah, I liked it too.
Did you know the price of a Coke was 5 cents for 70 years?
Patterico (3cc0c1) — 9/2/2015 @ 7:15 pm@Patterico, bobathome:Please move to the next step.
Think for a moment of an simplified economy where there’s just food traded, no services or manufactures, it will be easier to see.
I grow wheat, bobathome catches fish (by noodling, I guess) and Patterico grows oranges, and all the other peasants are growing whatever their land and skills are good for. We all trade for what we need, and we never get fully satisfied because we have to keep eating.
For each trade we can’t say how much richer we got–we only know we got richer because the trade wouldn’t have taken place if we didn’t feel subjectively richer. We can’t measure how much richer we feel, because our feelings aren’t measurable, and we can’t measure how much stuff we have because we keep eating it and having to replace it. But we CAN count the number of trades taking place, and the more trades are taking place the bigger our economy has gotten.
Is everyone agreed up to this point? If so, let me know and I’ll go on to the next part.
Gabriel Hanna (7d0155) — 9/2/2015 @ 7:16 pm87.I read your entire comment, Shearer, and your point was that one study might be wrong, but if “most” studies contradict your theory, your theory is wrong or being applied wrong.
That isn’t what I said, I said it would be evidence that the theory was wrong (or was being wrongly applied) which it would. Do you grant the global warming folks similar freedom to ignore any and all empirical evidence that contradicts their pet theory?
James B. Shearer (667387) — 9/2/2015 @ 7:25 pmOnly if the studies are not flawed. If the studies are flawed, they are evidence of nothing. Worse, they are misleading.
Patterico (3cc0c1) — 9/2/2015 @ 7:28 pmPatterico (3cc0c1) — 9/2/2015 @ 7:15 pm
You, sir, are on fire!
felipe (56556d) — 9/2/2015 @ 7:33 pmI used to fill up my Travelall at the PX for a quarter a gallon. Most of the quarters were still silver (1970.)
A silver quarter will still buy a gallon of gasoline. And a year ago it bought almost 2 gallons.
I would not recommend a Travelall having been there, done that.
bobathome (279337) — 9/2/2015 @ 7:33 pmI’m not sure I agree. I don’t know that an economy is subject to being measured in “size.” I know that economists purport to do this with GDP numbers (which I have argued extensively are flawed in several important ways). I’m not trying to be difficult for the sake of being difficult, however, and I will agree that if this is a free market in your example, then greater trade tends to indicate greater satisfaction of desires, for the reason you mention: the more trade takes place, the more prosperous we will tend to feel. If that’s what you meant, I will tentatively sign on to that as making logical sense to me.
Patterico (3cc0c1) — 9/2/2015 @ 7:36 pmWhich leaves us where?
Patterico (3cc0c1) — 9/2/2015 @ 7:37 pmSpeaking of silver, I have a silver certificate – a $1 bill – payable in silver!
felipe (56556d) — 9/2/2015 @ 7:38 pmCome to think of it, the type 2 depositor might not earn anything. If the bank’s loans were all based on stock purchases (type 3 deposits,) then the Fed has no business sticking its nose into the transaction(s). Perhaps the type 2 deposits could be moved back and forth between the type 3 deposits with no “brokerage” fees. The depositor could move the principal between type 1 and type 3 as needed. Deposit insurance for type 2 would basically be fraud and embezzlement insurance.
bobathome (279337) — 9/2/2015 @ 7:41 pmWhich leaves us where?
Patterico (3cc0c1) — 9/2/2015 @ 7:37 pm
Never argue empirically in an a priori land!
Or
Never ask for Chung-king in a chow-mainland. (ugh)
felipe (56556d) — 9/2/2015 @ 7:43 pmHeh. Not in my lifetime! (Missed it by about a month.)
Reminds me of one of those famous lines uttered by a government official (here, LBJ — the same guy who screwed you out of redeeming your certificate for actual silver):
Those who ignored the President’s warnings profited handsomely.
Patterico (3cc0c1) — 9/2/2015 @ 7:44 pmAnother good quote from a government official (FDR) on “hoarding” metals (here, gold):
The “emergency” began on May 1, 1933 and lasted until December 31, 1974.
Patterico (3cc0c1) — 9/2/2015 @ 7:49 pmGabriel, the number of trades is not a useful measure an the economy. One could imagine four or five farmers, each having a few pounds of a different grain – wheat, rye, etc. – and they sit down in the tavern and begin trading. Five grains of wheat for 3 grains rye, do I hear 4 … yada yada? If each brought five pounds of grain this could go on all night, encompassing thousands of trades.
Transaction costs are just as significant as transportation costs.
bobathome (279337) — 9/2/2015 @ 7:51 pmYes. Bird, hand, bush.
felipe (56556d) — 9/2/2015 @ 7:51 pmOkay, Patterico, you’re willing to go along and bobathome isn’t yet.
I’m not saying yet that we can MEASURE the economy. I’m saying that the more trades that happen, the bigger it got. I’m not saying that twice as many trades means twice as big. Because, as you say, a lot of them will be small exchanges of value and a few will be large.
All I’m asking you to agree to is that all else being equal, measured over some long period of time like a year, the number of trades is going to be bigger the bigger the economy is. Especially because people are not going to waste a lot of time on things unimportant to them–as you point out there are transaction costs, which would basically involve just time in this economy.
bobathome, you willing to go with that yet?
Gabriel Hanna (7d0155) — 9/2/2015 @ 8:04 pmGabriel Hanna (7d0155) — 9/2/2015 @ 8:04 pm
Don’t do it, it’s a trap – I can feel it.
felipe (56556d) — 9/2/2015 @ 8:06 pmBut I said I don’t think the “size” of the economy can be measured in any meaningful way. Re-read what I said.
Patterico (3cc0c1) — 9/2/2015 @ 8:06 pm“Okay, Patterico, you’re willing to go along and bobathome isn’t yet.”
But Gabriel said….
felipe (56556d) — 9/2/2015 @ 8:08 pmI don’t understand the importance of arguing about the “size” of the economy but I don’t think Austrians would see “size” as something measurable. But if you’re happy enough with my tentative acknowledgment that more trades logically means more satisfaction, all other things being equal, we can move forward.
Patterico (3cc0c1) — 9/2/2015 @ 8:12 pmIt would be a lot quicker if Gabriel would lay out his idea and let us look at it. I’ve been trying to explain my (brand new … for me) idea of a banking system that wouldn’t rely on magical assurances of liquidity using the idea of buying stock in the bank to provide the capital that the bank would have to load out. My idea has been evolving, but it seems to have some merit. Particularly when compared to the present system.
bobathome (279337) — 9/2/2015 @ 8:18 pm95. Only if the studies are not flawed. If the studies are flawed, they are evidence of nothing. Worse, they are misleading.
Few if any studies are without flaws. This does not they are all worthless just that known flaws should be taken into account when weighing the evidence. But if multiple empirical studies by different authors are all obtaining results inconsistent with theory this suggests there is some problem with the theory.
James B. Shearer (667387) — 9/2/2015 @ 8:23 pmNot if they are flawed. But this is going in circles and I am more than bored with the topic.
Patterico (3cc0c1) — 9/2/2015 @ 8:41 pm@bobathome:It would be a lot quicker if Gabriel would lay out his idea and let us look at it.
When I did that you claimed it made no sense. I would prefer a ratchet: at every step you agree that I haven’t pulled a fast one. If we go in small steps we get there…
But there is a really big problem if neither of you will concede that numbers and math can describe an economy. Patterico has already thrown away checking implications against facts; throwing out math too doesn’t leave us with very much to work with.
OK I will register the provisional agreement.
At this point we discover a chunk of gold, say it’s about a ton (1000 kg). We’ve had a lot of trouble with transaction costs and with coincidence of wants that slowed down our barter system. So we immediately see the advantages of this medium of exchange. We’ve never seen or heard of it before, so to get started we break it up into chunks so we can trade it about. It’s on Patterico’s land and he’s tired of oranges all the time, so he ends up trading most of it to all the rest of us for the stuff he wants, over the course of a year, and we trade it too.
Not all trades happen at the same time. So we don’t need the gold to represent every possible trade, just a percentage of them that could plausibly happen within a short time of each other. So we’ll say that n is the number of trades that are close enough in time that distinct chunks of gold need to be available for. N is the total number of trades in a year. N / n * 100 kg is the size of our economy measured in kg of gold. Notice I’ve said nothing about coins or anything yet: just saying that if we use gold as our medium of exchange we have immediately declared that our economy will be representable by a number that is proportional to the 100 kg of gold that we have available; we don’t for the moment care what the proportion is.
At this point I think you both have to make one of two choices:
1) Declare the whole thing out of bounds because numbers can’t represent an economy. I think this would put you out of the economics business almost entirely, because in fact humans do use numerical values every day, units of currency or masses of gold or big rocks with holes in them, we use numbers and counting. If you’re going to say that all humans everywhere except the Austrians are doing our economies wrong, it’s going to be a hard sell.
2) Accept for the moment that something like this is what has happened historically with commodity money: there’s so much of it to go around, and as it circulates from hand to hand trades happen but the commodity does not disappear, and so the number of the trades has something to do with how much the economy is worth in terms of the medium of exchange. However we decide to value the commodity that represents our money, however we decide to value all the trades that are enabled, the value of the actual money is less to some degree than the value of the economy.
Kindly indicate which of 1 or 2 you prefer, or propose a 3rd, and I will continue if I have your patience.
Gabriel Hanna (7d0155) — 9/2/2015 @ 8:43 pmI’m not sure that pronouncements can be made about “how much the economy is worth.” So the underpinning of whatever you’re saying is eluding me. I see no reason that a stock of money cannot serve the function it is supposed to perform by simply having each unit gain value as more people enter the economy.
Patterico (3cc0c1) — 9/2/2015 @ 8:54 pm116 … I see no reason that a stock of money cannot serve the function it is supposed to perform by simply having each unit gain value as more people enter the economy.
Well it has to be easily subdivided or the units may become inconveniently large.
James B. Shearer (667387) — 9/2/2015 @ 9:17 pmAgain, that is a “social” issue and not a monetary issue. Monetarily, any amount can serve any purpose.
Patterico (3cc0c1) — 9/2/2015 @ 9:24 pmI think someone pointed out above that with our modern economy, with computers and whatnot, social issues that may have presented problems before just don’t any more.
Patterico (3cc0c1) — 9/2/2015 @ 9:29 pm@Patterico:I see no reason that a stock of money cannot serve the function it is supposed to perform by simply having each unit gain value as more people enter the economy.
I am gradually getting there. I was going to lead you, but fine we’ll skip to the end.
It can, but transaction costs go up. You are right, monetarily any amount can serve any purpose.
But with physical gold, small units get more costly to handle, even in coin form. Fine, we do it electronically or with gold-backed securities or whatever.
Two problems: who keeps the supply honest if we allow representations or even coining of gold? As the price of gold relative to other items gets higher the motive to cheat gets more and more powerful. Somebody will cheat, and that debased money will circulate in preference to gold, i.e. inflation. This has happened too many times to count (Gresham’s Law) and you are free to get your own citations.
Secondly, what stops other commodities that are cheaper from stepping in? Silver, for example? You’ve said you don’t want governments declaring the value of money, so what stops people from using other commodities? Inflation again, and convertibility problems.
Adam Smith describes how in his day the shortage of coin was so severe that merchants exploited the float time of short-term banknotes and circulated them instead of money. They had to pay 8% annual interest and the consequences of being caught with a hot potato were legally severe–but it was cheaper to do this than to acquire enough coin to do business.
The American colonies used any coin they could get their hands on for this reason, money was too expensive to come by. Our word “dollar” comes from a German coin, and the $ symbol from the Spanish “pieces of eight”.
So when money gets expensive, transaction costs go up. Your choices are economic contraction or some kind of inflation.
Paper money wasn’t invented to rob people. It met a very gravely felt need. Gold standards have been historically rare because gold is very expensive to use as money.
Gabriel Hanna (7d0155) — 9/2/2015 @ 9:40 pmThe US gold dollar coin of the 19th century is smaller than a dime and it can be bent in half if you are careless with it. It is about 1.6 grams of gold, about $36.50 in today’s money. So about 1/40th of that amount would be a dollar coin today.
Okay, obviously we need symbolic representations, and that will get us through today. But every 18 years the economy doubles and our smallest unit is worth twice as much. We’ll need to deal in symbolic representations, or we won’t be able to trade anything but large quantities. But the motive to cheat gets more and more powerful, and cheating only a little yields a huge advantage to the cheater and only a tiny cost to society. Inflation again, or otherwise contraction.
Gabriel Hanna (7d0155) — 9/2/2015 @ 10:03 pmGresham’s law is a function of how government values money. It is why bimetallism never works, and did not work for 17th century England. Gresham’s law makes an appearance more than once in Rothbard’s “What Has Government Done to Our Money?” I remember it well.
I believe (unlike Rothbard and the other anarchists) in a limited government to prevent fraud. A free market will tend to gravitate towards those firms that provide reliable assaying of metals, but I also think government should prosecute fraudsters. Why should the possibility of fraud (which exists in any system) condemn one system over another? We have counterfeiters now. We will always have them.
In a free market, absolutely nothing prevents people from choosing a different commodity. Only government can cause that problem, and only government can cause the choice of a different commodity to be a problem. I hold no particular brief for gold. If people choose something else on their own, more power to them.
As long as paper money is backed by something real, I have no problem with it. I have said this repeatedly: there is no need for actual pieces of gold to change hands in every transaction. It is government unmooring money from anything backing it that concerns me.
I don’t see why this is, especially in this world of computers. I feel like I keep having to say everything two or three times.
Patterico (3cc0c1) — 9/2/2015 @ 10:31 pmYeah, I am just failing to see the issue. Consistent, predictable deflation seems no more problematic to me than consistent, predictable inflation. Why can’t every single argument that has been made here be flipped on its head? Or, as nk suggests, why can’t it mean that our past (where money was worth more) was something we survived — so we could survive a horrible, horrible deflation where our money regained that purchasing power? Especially with our new tools of technology that could help us cope with the almost unthinkable phenomenon of the return of the 5 cent Coke. Sure, they barely managed back then with money with such tremendous purchasing power — but today, with technology, we could weather the storm.
Patterico (3cc0c1) — 9/2/2015 @ 10:36 pm@Patterico:Consistent, predictable deflation seems no more problematic to me than consistent, predictable inflation.
Because it makes trade itself harder to engage in when you have sustained deflation. You have not found anything wrong with what I have said so far.If you want predictable deflation whats wrong with clipping a zero from the fiat money every 30 years?
Gresham’s law is a function of how government values money.
All this time I never once mentioned “government”. Why would people use paper over silver? Why would people use silver or copper over gold? Why did peasants pay rent in kind instead of in cash? Because they couldn’t get money. The smallest size of money was too big for the transactions they were engaging in. This has been true even in places where the government did not or could not regulate money: like the American colonies. In the US Spanish coins were legal tender for the first 50 years since independence.
In a free market, absolutely nothing prevents people from choosing a different commodity.
And right here you have admitted inflation! Silver will trade alongside gold, and be the functional equivalent of it. More money will chase the same amount of goods. As the economy grows other commodities have to step in and the commodities used for money fluctuate against one another. Eventually we are back to barter, if all the commodities float against one another, or we have convertibility problems and inflation if they are kept nominally constant relative to one another.
A free market will tend to gravitate towards those firms that provide reliable assaying of metals, but I also think government should prosecute fraudsters.
You admit right here that transaction costs are going to go up. I have “assayed” metal before, meaning I weighed my wedding ring on an expensive scale, measured its dimensions with expensive calipers, and matched the stamped purity within two digits. It took about an hour but might take less with practice.
Who’s going pay for all the auditing? And smaller cheating becomes more profitable with economic growth, so more expensive auditing trying to catch smaller discrepancies as time goes on.
And it’s not even fraud if it’s just banking–Adam Smith’s example of the banknotes. Floating banknotes backed by gold and silver still cause inflation. They will still be traded as money unless you make it illegal to do so. But if you give the government the power to investigate banks and regulate banks, you are giving the government power over the money supply. And when people are clamoring for cheaper money the government will eventually give it to them, if it’s democratic government, and if it’s autocratic government it will already be cheating anyway.
I don’t see why this is, especially in this world of computers.
Who keeps the computers honest and at what cost, when the motive to cheat is doubling every 18 years? Again, transaction costs are going up.
I feel like I keep having to say everything two or three times.
But it doesn’t get less wrong every time…
I would be very surprised if commodity money turned out to be central to Austrian economics, but we’re getting into “New Soviet Man” territory here, with all the conditions that have to apply before a standard that works according to your specifications can exist. Computers are not going to solve all these problems, someone has to keep them honest and that’s not even counting, say, the risk of solar flares.
We need a government with power but not too much, people who always stay happy with it and never agitate for cheaper money, and hand-waving away of transaction costs.
Gabriel Hanna (7d0155) — 9/2/2015 @ 11:12 pm@Patterico: When Americans had a gold standard, they agitated for silver coinage. They wanted cheaper money.
This didn’t happen under bimetallism and it didn’t happen under FDR. I know they didn’t have the perfectly free market economy in those days, nowhere did ever. But why did people want cheap money? You’ve been blithely asserting that no one wants debased money but unquestionably as a historical fact large numbers of people did because they thought money was too expensive.
So how do you explain it? Did they have logically impossible desires because banknotes circulated, or perfectly free markets didn’t exist yet, or because banks could lend more gold than they had in possession, or is this just when you fall back on you don’t need facts because you’re deriving conclusions from postulates and predictions don’t need to conform to reality?
Gabriel Hanna (7d0155) — 9/2/2015 @ 11:27 pmwhy did people want cheap money?
While people, for the most part being ignorant of the difference between money and wealth, will always want cheap money, there was good reason for the appeal to bimetallism due to the scarceness of currency in remote areas. Again, per my posts above re Whiskey Rebellion, etc. In such cases, an (effective) increase in the money supply represents a true “demand for money” as a commodity and thus not necessarily possessing the inflationary impact it has today. This due to the efficiency the availability of money introduces to an economic sub-system mostly dependent on barter due to the lack of…money.
It is easy to forget, living as we do in times when “money” can be sent anywhere that electricity flows, how prominent barter systems were until just the last 100-150 years or so. Back in the day money, as a commodity, was not easy to come . Such is also why “wiring” money via Western Union or whatever, was a very profitable business.
WTP (bb50a1) — 9/3/2015 @ 6:46 amSure you did, when you mentioned Gresham’s law Because Gresham’s law is a function of government overvaluing one form of money compared to another. Look it up.
Competing forms of money does not mean inflation. It means different forms of money compete. I’m fine with that. If the government gets out of money (other than providing its general function of providing a stable rule of law) different monies should compete.
Do you believe that everything done by firms in the free market is as inefficient as you doing it alone? Firms will specialize in assaying metals. (Firms already do.)
Patterico (3cc0c1) — 9/3/2015 @ 7:38 am“They”? All Americans did? Or debtors did? I thought it was a controversial notion.
Patterico (3cc0c1) — 9/3/2015 @ 7:52 amWhy is the world I envision any different from the world we have now? What prevents fraud now? What prevents transaction costs from swallowing up the system now? Simply the fact that we have fiat money instead of a gold standard? I’m still not sure why the demand for physical gold would be much greater than it is now. If it were, the market could respond to that.
Patterico (3cc0c1) — 9/3/2015 @ 7:58 amI have “assayed” metal before, meaning I weighed my wedding ring on an expensive scale, measured its dimensions with expensive calipers, and matched the stamped purity within two digits. It took about an hour but might take less with practice.
nk (dbc370) — 9/3/2015 @ 8:02 amEureka! I imagine that there are machines that tell you the weight and density of an object at the push of a button, and you don’t need a bathtub of water anymore. If there aren’t, I have a couple or three ideas of how they can be made for any engineers who are interested.
And minted coins don’t even need that — just a sizer and a scale.
nk (dbc370) — 9/3/2015 @ 8:04 amI’m still not sure why the demand for physical gold would be much greater than it is now.
If a true gold standard (there are many viable options of such so I’m going with the more fundamental one I believe you refer to based on your other writings) were put into effect, you do not expect the demand for gold to go up? Even as a competing currency? Also, gold has industrial purposes in addition to it’s use as a store of value. The impact on the electronic industry would likely be quite dramatic.
WTP (bb50a1) — 9/3/2015 @ 8:08 am123 … Consistent, predictable deflation seems no more problematic to me than consistent, predictable inflation …
Deflation increases real interest rates. Suppose you have stable money. Then a lender will charge interest that covers their expenses, the risk of default and provides a profit. Suppose for the most credit worthy borrowers this amounts to 3% then the most credit worthy borrowers will be able to borrow at 3%. But suppose you have predictable deflation of 5% a year. This won’t lead lenders to charge any less (they still have to cover their expenses, the risk of default and expect a profit) so the real interest rate for the most credit worthy borrowers will now be 8% a year.
On the other hand if you have predictable inflation of 5% a year lenders will now charge 8% (to account for the fact that they are being repaid in cheaper dollars) and the real interest rate will remain 3%.
You can quibble that this is simplified but I believe the end result will still be the same, real interest rates will increase.
James B. Shearer (667387) — 9/3/2015 @ 10:22 amJames, if you have 5% deflation, then the dollars you borrow this year will buy 5% more next year, so what’s the problem with a lender charging you more? The lender could just keep the money and be 5% wealthier next year without undertaking the risk of borrowing to a guy who appears to want something for nothing.
bobathome (279337) — 9/3/2015 @ 10:29 amnk, there are some relatively inexpensive devices that allow you to determine the content of “gold” objects. One does a bit of surface chemistry, and wouldn’t be suitable for rare coins or jewelry, and it is limited to the surface of the object. So it wouldn’t detect plated higher grade gold over lower grade gold. The other uses high frequency radio waves and measures the complex impedance of a coin or bar of bullion, and it is very good for detecting deviations from the specific alloys it has been calibrated to detect. Its signal penetrates a mm or more into the object, so simple plating wouldn’t fool it. It can be used on gold, silver or platinum, if memory serves.
The idea of measuring density using Archimedes Principle requires extremely high precision and accuracy in both the volume measurement and the weight. You can get around the volume measurement by weighing the object in the air and in the water, but this just increases the needed accuracy and precision of the weight since you are now using the difference of two weights to determine the volume, and this difference shows up in the denominator of the specific gravity (gm/cc.) I wish I could say that I figured this out ahead of attempting to do it, but like most things, I learned it the hard way.
Ignoring gold-plated tungsten forgeries, gold is sufficiently dense that it is easily recognizable in minted coins with scales that cost less than $100, as you mentioned. It is an ideal substance for money for this reason. Silver is very close to lead in its density, and so it is more readily forged. But the ring of the coin would be hard to duplicate. But circulating coins leads to all sorts of problems. My father-in-law supervised workers on Hawaii in the ’50s, and he said they could be seen filing minute quantities off the silver coins then in use in their off hours. All the details and sculpting on the coins were meant to discourage this, but a tiny bit could be harvested and the coin could still be used as change.
I think the best use of gold is as a backing to printed currency. Dollars in the wallet, or dollars in a bank account are much more useful than a gold coin. But having a way of detecting the public’s confidence in the dollar ought to be of use to responsible democratic government. Dictators would find such redemptions a nuisance and would dispense with them.
bobathome (279337) — 9/3/2015 @ 10:59 am134.James, if you have 5% deflation, then the dollars you borrow this year will buy 5% more next year, so what’s the problem with a lender charging you more? The lender could just keep the money and be 5% wealthier next year without undertaking the risk of borrowing to a guy who appears to want something for nothing.
The problem is it makes less sense to borrow money for use in a business if the real interest rate is 5% higher.
Suppose the government imposed a 5% a year tax on loans. Do you see that that would decrease business activity? But 5% annual deflation would have a similar effect.
James B. Shearer (667387) — 9/3/2015 @ 11:34 amJames, if you’re borrowing the money to run a business over the course of the coming year, your costs are going to decrease as time passes. So you don’t need to borrow as much based on current prices. Just as people can figure out how to live with inflation (up to a point …) so too can they figure out how to live with deflation.
bobathome (279337) — 9/3/2015 @ 12:16 pm137.James, if you’re borrowing the money to run a business over the course of the coming year, your costs are going to decrease as time passes. So you don’t need to borrow as much based on current prices. Just as people can figure out how to live with inflation (up to a point …) so too can they figure out how to live with deflation.
Another example, suppose you are a rich man and you have $100,000 in cash. You are considering buying a house and renting it out. Suppose house will cost $100,000, can be rented for $8000 for the year and will require $4000 in maintenance to maintain its condition. If money is stable at the end of the year the house will be worth what you paid and you will have made $4000 or 4% on your capital. On other hand suppose there was 5% deflation. Then the house will only be worth $95000 at the end of the year so you will actually have lost $1000 or 1% of your capital. Deflation encourages hoarding money rather than putting it to productive use.
Of course people will try to adjust to deflation (or inflation) but that doesn’t mean they will effectively end up in the same place. Deflation discourages investment by increasing the opportunity cost (what you can obtain just by sitting on money).
James B. Shearer (667387) — 9/3/2015 @ 1:15 pm@Patterico:Finally, Mises was very clear that we should use the term “inflation” to refer to the quantity of money, and not the rise in prices that an increased quantity of money causes
And today now you say
Competing forms of money does not mean inflation.
How does adding the supply of silver to the supply of gold, and calling them both “money”, not increase the money supply? How did the quantity of money not change? How is it any different from mining more gold and adding it to the money supply?
Gabriel Hanna (7d0155) — 9/3/2015 @ 6:06 pm@Patterico:If the government gets out of money (other than providing its general function of providing a stable rule of law) different monies should compete.
So how is “getting out of money” compatible with
a) requiring all circulating currency to be backed by a commodity
b) forbidding fractional reserve banking
In a free market banks engage in fractional reserve banking and citizens use currency that is not backed by a commodity. I know you don’t think facts have any place in economics but these are historical facts. They have been observed in an extraordinarily wide variety of conditions from ancient times to the present day.
If you think the government will enforce these things, how does the government NOT control the money supply?
If you think the government will not enforce these things, then who will, considering that these practices have been engaged in by humans every time they were permitted to?
Gabriel Hanna (7d0155) — 9/3/2015 @ 6:13 pm@Patterico: I’m still not sure why the demand for physical gold would be much greater than it is now.
Because the economy keeps growing. It will grow until the price of physical gold results in contraction.
Every 18 years the money has to do twice as much work because the economy has doubled in size. $1 of gold at today’s prices is 1/40th of a gram. It’s a function of how much gold is available in the world along with the size of today’s economy. Most of the gold ever mined and ever to be mined is being used right now.
If we converted to gold right now, with a wave of a wand, you’d have to manipulate these tiny quantities of gold. Every 18 years this quantity would reduce by half. Would you concede that these exceedingly tiny quantities of gold will be hard to work with?
So of course we’d circulate symbolic representations of this money. And every 18 years tiny errors in accounting and auditing become twice as expensive, so accounting and auditing are going to get more and more expensive. The transaction costs will go up. The temptations to cheaper money will get higher. They will be met by inflating the currency, whether it means debasing the gold representations or by adding other commodities–or there will be a contraction.
The capability of easily trading in any amount is itself an economic good subject to the laws of supply and demand. As that capability gets more expensive, either the economy has to contract or the money supply has to increase, which according to Mises is the definition of “inflation”.
Gabriel Hanna (7d0155) — 9/3/2015 @ 6:33 pmThanks, bobathome 135.
nk (dbc370) — 9/3/2015 @ 6:40 pm@James B. Shearer:Deflation discourages investment by increasing the opportunity cost (what you can obtain just by sitting on money).
This is of course exactly right.
Suppose I wish to borrow money. I need 5000 g of gold to buy a house. I agree to make monthly payments over 30 years. The bank needs a real return of 3% because the people who work at the bank gotta eat. If they have shareholders or want to retire they probably need to charge more if they can.
At no inflation, my monthly payment is 21.08 grams of gold.
At 3% inflation, the interest rate that guarantees a real return of 3% is 6.09%. That makes my monthly payments 30.267 grams of gold.
At 3% deflation, the interest rate that guarantees a real return of 3% is practically zero. That means that my monthly payments are basically 13.889 grams of gold.
But why should the bank lend to me if they make 3% real value sitting on the money? With inflation the bank needs to lend because their stock of gold purchases less and less every month. But with deflation they have no motive to lend at all.
And what is happening to me, the debtor, assuming I was able to blackmail the bank into lending me the money? Each monthly payment gets harder and harder to make. After 22 years of 3% inflation my monthly payment has doubled in real terms. If my income doubles along with it I will be okay, but if I’m not actually producing double the value-added at my job or business it’s going to be hard fro my income to keep up. Instead, I should have just sat on the gold and got 3% for doing nothing.
Of course I’ll purchase food, I can’t eat gold. But I’m going to delay big purchases. Multiply that by everyone and you get contraction.
Gabriel Hanna (7d0155) — 9/3/2015 @ 7:06 pm“After 22 years of 3% DEflation” is what I meant there.
Gabriel Hanna (7d0155) — 9/3/2015 @ 7:08 pmCorroborating the motivation:
http://www.zerohedge.com/news/2015-09-03/why-economics-matters
DNF (c70dac) — 9/4/2015 @ 3:44 am141. The reason the price remains ‘low’ for physical gold is the BIS stomps the paper ETF price at EU open and central IMF banks are meeting the demand for bullion–to the tune of 430 tons so far in 2015.
DNF (c70dac) — 9/4/2015 @ 3:51 am#138 Hanna, you and Shearer are of course correct, and I explained this very dynamic to Pat in an email months back, to which he never acknowledged. I’m sure he’s busy. There is no rebuttal of your point… though I’d of course be curious to see it attempted… and therein lies a whiff of the danger of the disposition of ‘a priori for me, empiricism and citations for thee’ (though of course empiricists can’t be relied upon). You make a perfectly good a priori case. Big picture, inflation/deflation rates adjust the conditions for risk-taking (investing or crediting), yet should be balanced with as stable a price level as possible. It’s a dance. I’d much rather read, and I think it’s much healthier to have, that kind of an honest search for understanding, rather than lawyering over little bits of language and evidence. This might be a decent econ 101 series for anyone who hasn’t thought about these things (and, kudos to Pat for trying to learn through teaching, I do the same), but no one will actually gain a high level understanding from this content, and will probably be missing a few important considerations on how money works (I guess we’ll see).
Tbh, I had hoped and still hope for Pat to eventually develop a better understanding, but I’m only seeing it in bits and pieces. The big picture is still off. There are problems and criticisms with the socialist and Keyensian approach to economics, and with what gov’t and the Fed are doing. In seeking a critique, and with a good, wholesome libertarian mentality, some people get attracted to a gold standard or anti-fiat argument. But this is not the answer… because it isn’t the problem. The problem is gov’t waste, favoritism, and cronyism, which can be (and is being) assisted by monetary policy but is wholly distinct from it. Monetary policy can be problematic, but our currency system isn’t especially the source of what ails us. It’s a shame if some conservatives or libertarians don’t focus on that bigger picture, and fail to aim the discussion on our true problems with conservative or libertarian ideas. I’m sure this discussion, being what it is, won’t change that. But there’s always hope that people and ideas will grow.
Joseph D (bdb6fc) — 9/5/2015 @ 4:15 amNope. That’s not what I said. Please stop saying that.
Patterico (3cc0c1) — 9/7/2015 @ 4:05 pm