The Political Economy of Trade Policy (Part 1)

Writing at EconLog, Scott Sumner makes the following point in his excellent blog post entitled “Keynesian Fiscal Policy is Dead“:

Many non-economists do not understand fiscal policy; they view it as something that can be applied on a sort of ad hoc basis. But things don’t work that way, as Keynesian fiscal policy requires a countercyclical (full employment) budget deficit.  It’s a full-fledged policy regime that must be maintained over time, not a gesture to be employed at a point in time.  You can’t say “let’s do fiscal policy this year”.

Scott’s point can be expanded to include trade policy as well.  Trade policy is, likewise, not something that can be applied on an ad hoc basis.  Consistent and predictable rules are necessary to maintain trade.  What’s more, theoretical economic trade management (eg, an optimal tariff) requires an extreme level of precision and consistency.

But can we assume such consistency in policy?  I think not, especially in a democracy/republic.  If one of the parties does not buy into said policy regime, then maintaining it is virtually impossible, unless that party is deliberately kept out of office.  Or, if the two parties have differing points of view on the goal of trade policy.  If one group wants an optimal tariff and the other wants tariffs to match international taxation regimes (both, in theory, legitimate tariff goals), those two policies will be at odds with one another.  How the regime is established will depend on who is in power at any given time.

How likely is it, even with the same party in power, that the policy remains consistent?  That is not so clear.  Politicians, especially in a system where they face voter pressure, are subject to various whims; as Adam Smith puts it: “[statesmen] whose councils are directed by the momentary fluctuations of affairs (WN 468).”  Even if we assume consistency in policial parties, inconsistency in various affairs should give us pause when assuming consistency over time in policy goals.

But, even if we assume consistency in policy goal over time, we run into the issue of policy adjustment.  For example, an optimal tariff depends on how sensitive domestic consumers are to changes in price; if they are highly sensitive, then an optimal tariff would be extremely low.  If they are not very sensitive, then an optimal tariff could be relatively high.  But, this sensitivity adjusts over time (Second Law of Demand).  This would mean that the optimal tariff level would need to be adjusted periodically (ideally, constantly) to compensate for this changing sensitivity.

However, firms and individuals adjust to policies.  With any policy, we run into Gordon Tullock’s transitional gains trap.  Firms and individuals will fully capitalize the monopoly gains they get from policy protections, leading them to do no better than before the policy was initiated.  What this also means is that if the policy were to be changed or removed, these firms/individuals would face the potential for major losses.  It would be strongly in their interests to keep the policy from changing.  Furthermore, since these losses to the entrenched firms/individuals would be highly visible and concentrated, but the benefits dispersed among the entire society, it would be a relatively easy pitch for these entrenched interests to keep the policy in place.

Another point worth quickly mentioning in relation to the previous paragraph: most trade policy models assume no resources spent on lobbying.  If we relax that assumption and assume that firms/individuals do indeed lobby, either for or against various trade policies, then any potential gains from these policies are quickly eaten up in the costs of lobbying.  Further, because of the aforementioned dispersed costs and concentrated benefits, the entrenched interests would be willing to spend more on lobbying than the people harmed by the policy,* which could potentially cannibalize all potential gains from the policy and then some.

*This point may require some explanation.  Assume a society of 10 individuals.  A policy is proposed that could improve the wellbeing of one member by $200, but only through the cost of the rest of society by $300 (or $33.33 per person).  Therefore, the one member would be willing to spend up to $200 to lobby for this policy, but each individual may only be willing to spend up $33.33 to lobby against.

47 thoughts on “The Political Economy of Trade Policy (Part 1)

  1. Keynesian fiscal policy is far from dead but it has been quite thoroughly overtaken by Keynesian monetary policy. There is no question that Keynes overestimated the effectiveness of fiscal policy and under appreciated the usefulness of monetary policy for his purposes.

    Keynes’ most fundamental and revolutionary insight was that the government can and should manage the economy in a counter cyclical way. Many libertarians conveniently forget that Milton Friedman and Scott Sumner are fully on board with this. They just want it done through monetary rather than fiscal policy.

    It’s true that Milton blamed the Fed for the Great Depression but what many libertarians conveniently forget about his analysis was that he blamed Fed INACTION in the face of a collapsing money supply, not Fed over involvement in money management.

    It is true that Republican Supply Siders are now pursuing pro-cyclical policies, not counter cyclical Keynesian policies. We will see how that works out. Already it’s not affecting the deficit the way they predicted.

    Most people make the mistake of thinking about Keynesian fiscal effects in terms of various stimulus bills but by far the biggest Keynesian fiscal effects are the more automatic stabilizers. So then, tax collections will always increase during a boom (unless you drop the rates) and decrease during a recession – especially if taxes are more progressive. Government spending and deficits will always rise during a recession if there is a social safety net because more people will qualify for this aid in bust times than in boom times.

    The death of Keynesian thinking has been much exaggerated. Especially by those who have done the most to keep it alive.

    Like

    • Greg

      Most people make the mistake of thinking about Keynesian fiscal effects in terms of various stimulus bills …

      You probably meant to write “most people who think about Keynesian fiscal effects at all”, (a relatively small number compared to the total group known as ‘people’) make the mistake of thinking about them in terms of various stimulus bills.

      And can you provide any examples of something a supposed libertarian has said or written that convinces you that they have conveniently forgotten the positions of Milton Friedman or Scott Sumner on the subject of monetary or fiscal policy?

      Like

      • Ron,

        First of all, yes, you are correct to assume that I did not mean to suggest that all people (or even most people) spend any time thinking about Keynesian fiscal effects. All successful communication takes place in the presence of a large number of shared assumptions. And it normally flows best when those assumptions are simply assumed rather than laboriously reiterated. So then, I did not “mean to write” about that differently than I did. I did mean to assume that you would understand what I meant about the issue by writing it the way I did. Which it seems you have.

        On a related point, I have a son who is a lawyer and normally an excellent writer. I once asked him why legal writing is always so stilted and mind numbingly boring to read. He had a surprisingly good answer. He pointed out the normal communication is a co-operative venture with a huge number of commonly understood shared assumptions. Legal proceeding are adversarial in nature. Legal writers must assume that every opportunity they give for their opponents to deliberately misconstrue common assumptions will be taken. So then, legal writers must laboriously shut down every opportunity for every pronoun or other reference to be misconstrued in any way. This never makes for fun reading.

        As for the examples you seek, Scott Sumer (who considers himself a libertarian and posts regularly on the libertarian blog EconLog) titled the post Jon links to “Keynesian Fiscal Policy is Dead.” But it is NOT dead. It is deeply embedded in the structure of the modern government sponsored social safety net and any system of taxation that relies as much as ours does on taxing income.

        If you overlay the history of post WWII budget deficits with the history of government deficits you will see this vividly illustrated. Especially if you do it in an inflation adjusted way that shows the shrinkage and growth of federal debt to GDP (which is the more relevant measure). What you will find is that federal debt to GDP tend to shrink in healthy economic times and grow rapidly in recessions. This is the counter cyclical fiscal result that Keynes wanted.

        The main exceptions to this trend that you will find are when boom time deficit shrinkage was reversed by Supply Side tax cuts under Reagan, GWB (“Reagan proved deficits don’t matter.”) and now Trump.

        As for Friedman, most people (yes, only most of that minority who think about the matter) view Friedman as the quintessential American libertarian hero. Recall that his writings were your own gateway drug to a much more radical libertarianism.

        Well, Friedman has some pretty solid statist and Keynesian credentials as well. Recall that he was deeply involved in establishing payroll deduction of income taxes which probably did more than any other thing to help institutionalize the acceptance of higher levels of taxation among the American people. Recall also that, as I have already explained, he also helped to institutionalize the belief that it is the government is responsibility to manage the economy through the money supply in order to smooth the business cycle.

        Like

        • Greg

          I did mean to assume that you would understand what I meant about the issue by writing it the way I did. Which it seems you have.

          And you were correct, but it never hurts to be sure. Just ask your son the lawyer.

          I am cursed with relatives and family members who regularly overestimate what someone else knows and assumes they will act or think in some certain ways, without any basis for that belief. Miscommunications and hurt feelings are a frequent result. I have found it better to ensure everyone is on the same page before proceeding, even at the risk of stating the obvious.

          I like your son’s explanation for the opaqueness of legal writing. I hadn’t thought about it that way before. And of course it provides job security for lawyers.

          I don’t see the national debt shrinkage and expansion you are talking about. the last time the national debt decreased yoy was in 1958. While there is some fluctuation in the debt/GDP ratio, that has increased every year since 2000. Perhaps you are referring to rate of change.

          https://www.thebalance.com/national-debt-by-year-compared-to-gdp-and-major-events-3306287

          It’s hard to say what, precisely, Scott meant when he wrote that ““Keynesian Fiscal Policy is Dead.” You could ask him at Econlog.

          I don’t know anyone who believes Friedman is a quintessential American libertarian hero.

          Yes, his Free to Choose was a real eye opener for me. Free choice! Liberty! Free markets! People making their own decisions! Heady stuff.

          It’s unfortunate that he was also a monetarist. Luckily his son David hasn’t inherited that particular blind spot, and has chosen a much more radical path.

          Like

          • Ron,

            >—“I don’t know anyone who believes Friedman is a quintessential American libertarian hero.”

            There is this guy named Mark Perry who identifies as a libertarian and writes a blog I think you would like. He probably cites Milton more than any other libertarian. Little more than a week ago he approvingly reprinted in bold type a Wall Street Journal quote about Milton saying “Few people in history have contributed more to the achievement of human freedom.”

            I would like to know how many libertarians you can name who are better known and respected than Milton or who influenced more people.

            >—“It’s hard to say what, precisely, Scott meant when he wrote that ““Keynesian Fiscal Policy is Dead.”

            It’s not hard at all. There is no mystery. He said what he meant. He meant that the current Congress and the Congress of the last few years have both been unwilling to approve Keynesian style discretionary spending. That is true but it ignores the fact that most Keynesian fiscal effects come from the automatic stylizers I described.

            >—“While there is some fluctuation in the debt/GDP ratio, that has increased every year since 2000. Perhaps you are referring to rate of change.”

            Your own figures show debt to GDP dropping from a high of 119% in 1945 to a low of 31% in 1981. Describing that as “some fluctuation” is transparently disingenuous. This was the period of the relatively most Keynesian fiscal policy in American history. The jumps in debt to GDP during Reagan, GWB and Trump have been due to explicitly Supply Side, not Keynesian policies. The jump during Obama was a Keynesian response to the most serious economic crash since the Great Depression.

            Like

          • Greg

            Thanks for the suggestion. I’ll check out this Mark Perry guy. Can you tell me the name of his blog, or can I find it using Google?

            OK, that’s one. I’ll give you that. Any others?

            I would like to know how many libertarians you can name who are better known and respected than Milton or who influenced more people.

            That’s a different question. Your original comment was that most people (who think about it) consider Friedman the quintessential American libertarian hero. You have found one so far. Of course I still have to verify that this Mark Perry fellow is a real person.

            He [Scott] meant that the current Congress and the Congress of the last few years have both been unwilling to approve Keynesian style discretionary spending.

            Well yes, there is that, but I thought (erroneously, I guess) that we already shared the assumption that Scott’s belief was that recent Congresses have been unwilling to approve Keynesian style discretionary spending, and that there must be something else that provoked the unusual assertion from Scott that “Keynesian Fiscal Policy is Dead.”

            It’s apparent to anyone (who thinks about it) that the Keynesian policy is about government *spending* and not so much about taxation. Government *spending* these days seems unrelated to economic cycles in any way.

            That is true but it ignores the fact that most Keynesian fiscal effects come from the automatic stylizers I described.

            May I assume we both know what word you intended to use instead of the one you actually wrote (stylizers)? Or would it be better if you explained it to ensure that we are on the same page?

            While it’s true that tax collections will rise during boom times and fall during the inevitable bust, that no longer seems to be an important influence on government spending, so it may not be as important for Keynesian fiscal policy as you think.

            As for increases and decreases in those safety net payments designed for temporary assistance, those specific programs are less than 5% of the federal budget, so it’s not clear changing demand for them during business cycles makes a great deal of difference for Keynesian fiscal policy. Note that I’m not including social security, Medicare, or Medicaid in that 5% number, as payments from those programs remain relatively constant during both phases of a business cycle.

            Your own figures show debt to GDP dropping from a high of 119% in 1945 to a low of 31% in 1981. Describing that as “some fluctuation” is transparently disingenuous.

            What seems transparently disingenuous is for someone to pick a starting year (1946, not 1945) that is at the end of a global war during which massive amounts of government borrowing occurred, and after which the ratio of government debt/GDP steadily decreased for the next 35 years (except for some relatively minor fluctuations YOY) and then calling the term “minor fluctuations” transparently disingenuous.

            Like

          • Ron,

            >—“Any others?”

            This is too easy. In addition to the Wall Street Journal editorial board that Mark quoted, if you look up Milton at The Library of Economics and Liberty you will find that the first sentence in his bio there is “Milton Friedman was the twentieth century’s most prominent advocate of free markets.” Or search Milton on EconLog and you will find tributes to him as a libertarian hero by Henderson, Caplan and many of their guest bloggers, not to mention many of those who commented on those posts.

            You are missing an important point in understanding Keynesian Theory. It is government budget deficits, not spending that provides the stimulus. The presumption is that deficits put additional spending into the economy. It doesn’t really matter whether government or taxpayers do the additional spending. Either is expected to spur economic activity. Additional spending full funded by additional taxation would provide no additional stimulus at all. You could increase deficits by keeping spending level and decreasing taxation. Of course Keynes did not recommend increasing deficits during economic booms like we are seeing now.

            There are two reasons that the postwar period is the right one for looking at the effects of Keynesian fiscal policies. First of all, WWII deficits were not the result of Keynesian influence on policymaking. FDR was actually quite skeptical about Keynesianism. Those deficits were simply a result of the war.

            It was a after the war that Keynesian influences took over policy making. Except for those periods when it was interrupted by Supply Side Economics.

            Like

  2. Thought provoking, Jon. I especially like the explanation about why some people are willing to pay more for lobbying than other people.

    Just one comment about this . “Politicians, especially in a system where they face voter pressure, are subject to various whims.” Is that the same thing as elected representatives often have to enact policy (even bad policy) because that is what the people who elected them want them to do and they may lose their job if they don’t?

    It’s difficult supporting a position you personally think is not the best choice, but that comes with the job sometimes. Actually, a lot if you are part of a group. I use that case as a litmus test for employees — how much real effort and enthusiasm do they put into something they don’t want or don’t like to do.

    Make that two comments: “Another point worth quickly mentioning in relation to the previous paragraph: most trade policy models assume no resources spent on lobbying.” Likewise, most trade policy models don’t assume theft and government espionage reducing the imputed value of imports.

    Keep up the great work keeping us thinking.

    Like

  3. Greg

    Yes, everyone loves Friedman. He was a great believer in individual self determination – up to a point, free choice – up to a point, and free markets – again up to a point. His one and only significant failing was a persistent belief that Someone-Who-Knows-What’s Best-For-Us-All should have a monopoly on the creation of money and control the supply of it. Completely at odds with all of his liberty promoting ideas. It’s inexplicable. Therefore, while I would rank him very high on most measures of liberty, I wouldn’t be able to rank him as the “quintessential libertarian”. As popular as he was, he was, after all, still only one of us humans.

    You are missing an important point in understanding Keynesian Theory. It is government budget deficits, not spending that provides the stimulus.

    I think you are saying this backward. In your next sentence you will say that it *IS* spending that spurs economic growth. I understand Keynesian theory, I just think it’s wrong. I requires the belief that it is aggregate demand that produces economic growth, but that’s at best a temporary measure similar to spraying starter fluid into you car’s engine intake. It may cause minor activity, temporarily, but it isn’t a replacement for actual fuel, and as soon as the stimulus is discontinued, the engine ceases running once again.. It is capital investment from savings that drives real economic growth.

    The presumption is that deficits put additional spending into the economy. It doesn’t really matter whether government or taxpayers do the additional spending.

    Do you really believe government spending is as productive as private spending? If that were true, government could own all resources and do all the spending and get rid of all those pesky individual choices and the attendant frictional costs involved when so many individuals pursue their own diverse interests.

    The money government borrows in order to increase spending must come from somewhere where it already exists, unless you prefer to simulate with pure inflation. Money borrowed by government is money not spent or invested by the private sector including foreign investors in US assets who have US dollars from a trade imbalance.

    Additional spending full funded by additional taxation would provide no additional stimulus at all.

    That’s correct – just as money borrowed from the private sector is money not spent or invested by the private sector. The stimulation is mostly illusory and entirely temporary.

    “,i>You could increase deficits by keeping spending level and decreasing taxation. Of course Keynes did not recommend increasing deficits during economic booms like we are seeing now.”

    Maybe that’s what Scott Sumner meant when he proclaimed that “Keynesian fiscal policy is dead”.

    Like

      • Ron,

        >—“The money government borrows in order to increase spending must come from somewhere where it already exists, unless you prefer to simulate with pure inflation.”

        This is the main disagreement between Keynesians and Austrians. The idea that the “existence” of “money” is so easily and “purely” defined is an anachronism from the days long ago when there were many fewer forms of money and Austrian economists flourished on the earth.

        In reality there are a quite spectacular number of things that function in varying degrees as money. Paper money, coin, savings accounts, checking accounts, CD’s, stocks, bonds, and almost anything of value that will be accepted by someone in satisfaction of a debt all serve as forms of money. With a term that I love, no less of an Austrian than Russ Roberts, once described a particular instrument as “moneyish.”

        All this is vastly complicated by the fact that the speed at which things functioning as money circulate varies wildly at different points in the business cycle. Keynesians want the government to add money at the low points in the business cycle. This is NOT based on an expectation that government spending will be more effective than private spending. It IS based on an expectation that government spending will be more effective at sparking the economy than no increase in overall spending at all in the depths of a recession or depression.

        Whether or not any particular spending is wasteful malinvestment or wise and productive investment depends entirely on the specifics of the project itself, not on the perceived purity of how “real” the dollars invested were.

        Government does not have a monopoly on the creation of money. Government is the most powerful creator of money. Most of the new money that financed the housing bubble was created privately in the Shadow Banking System with a wide variety of new financial instruments that facilitated private lending. When THAT money was vaporized in the crash in 2008 and the shadow Baking System had a heart attack, the Fed stepped in and spectacularly expanded its balance sheet to replace that money. Austrians predicted this would lead to major inflation because they failed to recognize the creation and destruction of the privately produced money it effectively merely replaced.

        Every act of lending, government or private, expands the money supply in at least some small way. Every act of repayment or default on a loan contracts it. Let’s say I loan you a thousand dollars at 5% interest without the government involved at all. How does this change our subsequent behavior? You will likely spend it on the purpose you borrowed it for. No one borrows money just because they like to pay interest.

        Now you have engaged in more economic activity than you would have if you hadn’t gotten the loan. And the businesses you spent it with have also. But as the lender, I still view that loan an asset on MY balance sheet as well. I am making my own spending decisions based on the fact that I feel wealthier and more secure than if I didn’t have that asset which, by the way, is bringing me an income stream I didn’t have before.

        Money is quite fungible. Money that you regard as pure and real and virtuously saved invests just as easily as money you regard as illegitimately produced by government. Money that is virtuously saved can be squandered on malinvestments just as easily as any other money.

        Like

  4. Greg

    This is the main disagreement between Keynesians and Austrians. The idea that the “existence” of “money” is so easily and “purely” defined is an anachronism …

    I would say that that’s one of the least important disagreements, but while I can’t speak for all Austrians, my own preference would be for a free market in money, in which the term “money” is well understood as something that can stand in for and represent actual goods and services. I guess that’s a pretty narrow definition, but not in the way you suggest. As Austrians seem to prefer markets to government control, that might be closer to an Austrian perspective than the one you are describing.

    In reality there are a quite spectacular number of things that function in varying degrees as money. Paper money, coin, savings accounts, checking accounts, CD’s, stocks, bonds, and almost anything of value that will be accepted by someone in satisfaction of a debt all serve as forms of money …

    You’re absolutely correct. Anything that is recognized and accepted as money, is, in fact, money by definition.

    It might be useful to arrange all your examples of money into a hierarchy of liquidity so as to understand why someone might prefer one to another.

    [increasing the fiat money supply] It IS based on an expectation that government spending will be more effective at sparking the economy than no increase in overall spending at all in the depths of a recession or depression.

    This results from the erroneous belief that there is nothing fundamentally wrong in the economy, that aggregate demand drives economic growth, and that more of the same activity, activity of any kind, will renew the previous overheated level of activity and lead to economic growth. It will not. The recession itself is the correction phase of the previous unsustainable boom. Government manipulation may kick the corrective can down the road, as was done in 2000, but the inevitable bust which finally occurred in 2008 was all the worse as a result. In short, a stock market bubble which predictably burst was reinflated as a housing bubble to avoid the necessary correction at that time.

    Whether or not any particular spending is wasteful malinvestment or wise and productive investment depends entirely on the specifics of the project itself, not on the perceived purity of how “real” the dollars invested were.

    I’m not sure what that means. All dollars recognized and accepted as money are “real” in the broadest sense, but some rely more on blind faith than others. And an investment is wasteful if it relies on resources that don’t actually exist – the ‘greater fool’ theory notwithstanding. In other words investment not based on savings is malinvestment. Juggling money created out of thin air instead of money created by actual production is dangerous game – obviously.

    Please review the Hayekian Triangle. You might find this discussion of Keynes vs Hayek by Roger Garrison interesting. It includes numerous graphics and a good discussion of the Hayekian Triangle.

    Jon has some problems with Garrison that I don’t fully understand, but I didn’t see anything objectionable in this presentation. Perhaps Jon will jump in to enlighten me if he finds it necessary.

    I gotta tell you, it’s hard to listen to this guy, and if you’re at all sleepy, don’t do it. The actual presentation starts at 3:00.

    Government does not have a monopoly on the creation of money.

    In the strictest sense, money is only created out of thin air these days by the Fed through the fractional reserve banking system. That’s known as a ‘monopoly’.

    The shadow banking system created large amounts of liquidity through the creation of exotic instruments , some of which were insurance arrangement designed to distribute risk, but I challenge you to point to any actual creation of money. If I buy a bundle of mortgages, for example, and structure them into investment instruments, I have created a great deal of liquidity, but no actual money. If you and I agree to indemnify each other against some loss, we have created no money. If one of us suffers a covered loss and makes a claim on the other, actual money in some form recognized as such by other people besides just you and me will be required, even if neither of us had any when we made our agreement. Neither of us can just print up the required payment in our basement, and few if any of our employees will accept fractional pieces of an MBS in their paychecks, nor, understandably, will their grocers and house cleaners.

    Most of the new money that financed the housing bubble was created privately in the Shadow Banking System with a wide variety of new financial instruments that facilitated private lending.

    Please explain how that worked. How were loanable funds created where none existed before.

    When THAT money was vaporized in the crash in 2008 and the shadow Baking System had a heart attack, the Fed stepped in and spectacularly expanded its balance sheet to replace that money.

    And that is pretty much the entire problem. There was no risk in making promises that couldn’t be kept, because the Fed was rightly expected to bail everybody out. Unfortunately, the wrong firms were bailed out, causing much confusion. If people had been forced to assume their own risk, as they should, none of the dangerous financial arrangements would have been made.

    Austrians predicted this would lead to major inflation because they failed to recognize the creation and destruction of the privately produced money it effectively merely replaced.

    Yes. Increasing the money supply above the level of demand for money is inflation by definition, but the money never circulated in the general economy. Paying interest on excess deposits is a sure way to keep that money at the Fed and out of circulation. Why take risks when you have a sure thing?

    In any case, it appears that relying on the Fed to provide economic stability is a foolish idea.

    Like

    • Ron,

      >—“The shadow banking system created large amounts of liquidity through the creation of exotic instruments , some of which were insurance arrangement designed to distribute risk, but I challenge you to point to any actual creation of money.”

      The shadow banking system facilitated lots of lending that happened outside of the regulated part of the fractional reserve banking system. You ignored the example I showed of why every act of lending expands the effective money supply. This is true whether or not it’s the Fed or the fractional reserve banking system doing the lending.

      So then, consider the example I cited where I make a loan to you entirely outside of the banking system. You spend the money and it becomes an asset on the balance sheet of the business you spent it at. But it also remains an income producing asset on my balance sheet. If no loan had been made it would only exist on one balance sheet, not two.

      No doubt you will want to point out that I can’t spend the funds lent before they are repaid. But this ignores the fact that I will be much more willing to spend my other funds if I regard myself as holding that income producing asset than if I don’t own it. And both fractional reserve banks and other private lenders will be much more willing to lend to me if I hold that asset than if I don’t. This is how loanable funds are created where none existed before. It’s not clear to me whether you recognize that the velocity that money moves around the system with has a great deal to do with what the effective money supply is. Do you recognize that?

      >—-” investment not based on savings is malinvestment.”

      When I got out of college I started managing a store my father owned. After a few years he wanted to make sure that I stayed in that job and was incentivized to run to well so he lent me the money to purchase a 51% ownership share at the price he had paid in the recent past. I made a good living at it and paid him enough for his share of the business that he made so much over the years that it was his most successful investment and he had a lot of successful investments.

      By any rational definition my decision to invest in those shares was a great investment that provided a great return for me. Only now I learn that it was a malinvestment because my investment was not based on savings. He had loaned me the money to buy the shares despite the fact that I had saved no money at all at that point. My investment was based entirely on borrowing and not at all on saving.

      Consider another example: People who invested in Microsoft or Apple stock in the mid 90’s and held on made spectacular profits. Some of those people invested from their savings. Many others invested with borrowed funds. Were the actions of the latter malinvestments?

      >—-” Paying interest on excess deposits is a sure way to keep that money at the Fed and out of circulation. Why take risks when you have a sure thing?”

      For quite some time after the crash in 2008 the Fed was paying only 25 basis points a year in interest on excess reserves. Inflation during those years was about 1 1/2 %. Banks took risks in order to avoid the losses that would have resulted from settling for such low rates. To the extent they left excess reserves at the Fed it was because it was hard to find borrowers who were a good risk in a bad economy and money was flooding in from deposits because there was a general flight to the safest investments by depositors. There is nothing quite like a minus 50% return in the stock market to make mere 25 basis points suddenly look a lot more appealing. I am an outside director at a small community bank and during that time even the lowest CD’s we issued to depositors cost us more in interest than we earned at the Fed on excess reserves. The “sure thing” was a sure loss.

      Like

  5. BTW Greg, all the examples you gave of various forms of money are denominated in US dollars, and are technically exchangeable for USD in the form of green pieces of paper, which may only be created by the monopoly Fed.

    Like

  6. Greg

    Every act of lending, government or private, expands the money supply in at least some small way.

    Not exactly.

    Let’s say I loan you a thousand dollars at 5% interest without the government involved at all. How does this change our subsequent behavior?

    Absent a printer in your basement, you are loaning me $1000 you have acquired in another transaction. Nothing is destroyed or created, it’s only exchanges of property rights.

    You will likely spend it on the purpose you borrowed it for. No one borrows money just because they like to pay interest.

    That’s correct.

    Now you have engaged in more economic activity than you would have if you hadn’t gotten the loan.

    Correct again, And you engage in less economic than you would have absent the loan. You have exchanged something that is highly liquid for something that is not very liquid t all. You have essentially deferred the consumption of that resource by saving in the form of an interest bearing loan. we have bypassed the intermediation agent, but this scenario is not really different than your opening a savings account or buying a CD or a bond.

    But as the lender, I still view that loan an asset on MY balance sheet as well. I am making my own spending decisions based on the fact that I feel wealthier and more secure than if I didn’t have that asset which, by the way, is bringing me an income stream I didn’t have before.

    And that is the same dangerous assumption made by many homeowners who felt wealthier as their real estate values increased.

    Money is quite fungible. Money that you regard as pure and real and virtuously saved invests just as easily as money you regard as illegitimately produced by government. Money that is virtuously saved can be squandered on malinvestments just as easily as any other money.

    Money that facilitates an exchange of value for value represents something actual and real. That money goes on to represent subsequent exchange of value for value. Money created out of thin air by the banking system or by me in my basement does not.

    It’s impossible to tell the difference in the context of just a few transactions, but as more and more units of exchange are added to the existing supply without representing a comparable increase in the value of actual production, each one loses value in relation to the goods and services and other commodities against which it is exchanged.

    Why do you suppose a common wartime strategy is to flood your enemy’s economy with counterfeit money?

    BTW, speaking of buying CDs, I highly recommend the latest Rolling Stones album, ‘Blue And Lonesome’. It is a collection of new stones covers of some old blues classics, and was completed in 3 days. Great stuff. And also BTW, that is a perfect example of an emergent property. None of those guys performing by themselves is really all that specials, but together it’s magic. The sum is greater than the parts.

    Like

  7. And that 5% interest we agreed on represents the market value of our respective time preferences. At 5% I want to consume it now, and for 5% you are willing to defer consumption until some later time.

    Hurray for markets!

    Like

  8. Our interests are aligned at that 5%. At some an artificial interest rate as targeted by the fed, they are not aligned. Incentives matter.

    Like

  9. Ron,

    First of all, thanks for the tip on the new Stones release. I find your judgment in music to be much more reliable than in economics.

    >—-“And you engage in less economic (activity) than you would have absent the loan.”

    That is not necessarily true and this is one of the main disputes between Keynesians and Austrians. In fact loans are mostly made by very wealthy people and their decisions on whether to lend have a lot less to do with their personal consumption decisions than their judgments about the investment climate.

    Likewise, money that is saved rather than consumed is not always invested. It was just a moment ago we were discussing the massive amounts of money that depositors seeking safety put in fractional reserve banks which then put them into excess reserves at the Fed ALL PROMISING A RATE OF RETURN LESS THAN INFLATION. Keynes would call this hoarding both by the banks and their depositors.

    >—“Nothing is destroyed or created, it’s only exchanges of property rights.”

    In his most famous work, Milton Friedman showed that the Great Depression destroyed about 1/3 of the U.S. money supply. Do you disagree with his conclusion on this?

    Imagine a world where the only money anyone accepted was gold coin and the supply of that was fixed. Now imagine the total supply of goods and services (but not money) shrinks by 50% due to some natural disaster. I maintain this will produce 100% inflation destroying half of the value of the unchanged stock of money. Do you disagree?

    Like

  10. Greg

    So then, consider the example I cited where I make a loan to you entirely outside of the banking system. You spend the money and it becomes an asset on the balance sheet of the business you spent it at.

    Yes it does. The seller now has $1000 more in cash (in whatever form you prefer, but it is very liquid), and $1000 less of whatever he sold me. Perhaps shares of stock, or perhaps groceries. He and I both changed the form of our holdings, but neither of us has created anything and the bottom lines on our balance sheets remain the same. What he does with the $1000 is outside the scope of the exchange he and IU just completed.

    You didn’t create the money to loan to me (I don’t think), so it was transferred to me from your existing stock, and you now have $1000 less in cash and a new asset that you value at $1000. You have changed the forms of your holdings, but the bottom line on your balance sheet remains the same.

    I borrowed $1000 from you so I, prior to spending it, had $1000 more in cash and $1000 more in debt. Nothing has been created and the bottom line remains the same.on my balance sheet

    My $1000 debt balances your $1000 asset. Nothing has been created. These two transactions are all just exchanges of value (property rights) No doubt the three of us, you, me, and seller are all made better off by our trades..

    But it also remains an income producing asset on my balance sheet. If no loan had been made it would only exist on one balance sheet, not two.

    That is the nature of a loan. I will pay you for additional current consumption, and you will earn by deferring the same amount of consumption. Nothing is created.

    No doubt you will want to point out that I can’t spend the funds lent before they are repaid”

    Nope, you can exchange that asset for cash if you wish to spend now, and forfeit the potential earnings you expected. Just a different form of money, if we are calling all exchangeable items money. The difference is liquidity.

    But this ignores the fact that I will be much more willing to spend my other funds if I regard myself as holding that income producing asset than if I don’t own it.

    Your original asset in the form of $1000 cash could have served the same purpose.

    And both fractional reserve banks and other private lenders will be much more willing to lend to me if I hold that asset than if I don’t.

    You had the same asset value both before and after the loan. Cash vs an IOU from me.

    This is how loanable funds are created where none existed before.

    I must have missed that blessed moment of creation. all I saw was exchanges of property rights for liquid to illiquid forms of of money, with the bottom lines of three people’s balance sheets remaining the same.

    It’s not clear to me whether you recognize that the velocity that money moves around the system with has a great deal to do with what the effective money supply is.

    The velocity of money is just a number that is always derived. It’s a ratio between the money supply and total production (GDP). It is always derived from changes to the other three factors in the equation, and never changes first, by itself to cause changes in the other three.

    Keep in mind that money doesn’t really circulate any more than goods and services circulate. Every exchange is a discrete event with money moving from one owner to another, and goods and services move in the opposite direction.

    A higher velocity of money just means more exchanges of goods and services in the same period of time. The number of time a dollar changes hands in a year or whatever period has no particular useful meaning, although I know you Keynesians seem to think it does.

    https://mises.org/wire/money-velocity-myth

    When I got out of college I started managing a store my father owned. After a few years he wanted to make sure that I stayed in that job and was incentivized to run to well so he lent me the money to purchase a 51% ownership share at the price he had paid in the recent past.

    Did he loan you the money to buy the 51% ownership, or the 51% ownership itself? That ownership being an asset with a subjective dollar value at that time.

    The fact that he deferred consumption of that value by loaning it to you didn’t create anything. The fact that that asset rose in value over time is not unexpected or unusual. You paid him for the use of 51% of his shares, so to speak. This is little different than your example of loaning me $1000. It could have been $1000 in shares of a company.

    By any rational definition my decision to invest in those shares was a great investment that provided a great return for me./i>”

    That’s why we buy shares in companies on the expectation that future earnings and expansion will provide us with income or increased value of our shares. Congratulations on steering his and your investments to greater value.

    Only now I learn that it was a malinvestment because my investment was not based on savings.

    It WAS based on savings in the form of shares in the company. Your dad didn’t create 51% of the value of the company out of thin air to loan to you.

    He had loaned me the money to buy the shares despite the fact that I had saved no money at all at that point. My investment was based entirely on borrowing and not at all on saving.

    Your investment was based on your dad’s savings, unless he printed dollars in his basement..

    Consider another example: People who invested in Microsoft or Apple stock in the mid 90’s and held on made spectacular profits. Some of those people invested from their savings. Many others invested with borrowed funds. Were the actions of the latter malinvestments?

    You are using the word investment in the sense of saving or gambling. In the strictest sense, investment is production of something new, like a factory or a tract of houses, or the replacement of depreciated capital good. Buying shares of ownership in existing enterprises is merely exchanging property rights.

    To the extent they left excess reserves at the Fed it was because it was hard to find borrowers who were a good risk in a bad economy …

    There was also a lot of paranoia about not getting every ” I ” dotted and every ” T ” crossed. It has been hard even for people with top notch qualifications to get loans.

    Liked by 1 person

    • Ron,

      >—-” He and I both changed the form of our holdings, but neither of us has created anything and the bottom lines on our balance sheets remain the same. What he does with the $1000 is outside the scope of the exchange he and I just completed.”

      Hold on! The phrase “outside the scope of” is up to a lot of mischief right there. The newly created money is on the balance sheet of the person that you the borrower paid it to. THAT transaction could not have occurred if you hadn’t borrowed the money to spend with him. Remember that you have already conceded that you borrowed the money for the purpose of that spending you could not have otherwise done, not because you liked paying interest.

      >—“Yes it does. The seller now has $1000 more in cash (in whatever form you prefer, but it is very liquid), and $1000 less of whatever he sold me.”

      Not necessarily. What if you purchased his labor? If this transaction occurs during a time of high unemployment (which just happens to be exactly when Keynes wants to facilitate it) you probably used the money to purchase that labor from an unemployed person who had no other job offers. He has exchanged a day of unemployment and no income for a day of work and income. This is where the new real useful value you are looking for comes from. He does not have less of his labor available to sell today because he exchanged a day of idleness for a day of work yesterday.

      Now consider the possibility that you used part of the loan to buy a pair of work shoes at my former store. It is true that I had to replace those in inventory and that part of the transaction did not account for any new money. But a significant percentage of that sale was profit that I would not have made if the original loan had not made your purchase possible. THAT part of the sale stays on my balance sheet as retained earnings. I assure you from long experience that making more sales results in higher retained earnings than making fewer sales.

      >—“You had the same asset value both before and after the loan. Cash vs an IOU from me.”

      If you want to see the additional money creation you have to not just compare what MY balance sheet looks like before and after the loan with itself but also with another person who does not hold any loan as an asset on his balance sheet. In your analysis there should be no real difference in how non-government lenders view us once the loan is out the door of my personal accounts. But in the real world actual lenders do and should view a person holding a lot of income producing loans as a vastly better credit risk than the same person without those assets. I know you think they shouldn’t. But they do!

      >—“Keep in mind that money doesn’t really circulate any more than goods and services circulate.”

      It can. Haven’t you already conceded that it can flow into excess reserves at the Fed and be effectively sterilized?

      >—‘ Buying shares of ownership in existing enterprises is merely exchanging property rights.”

      Buying anything can easily be described as “merely exchanging property rights.” So what?

      Like

  11. Greg

    In his most famous work, Milton Friedman showed that the Great Depression destroyed about 1/3 of the U.S. money supply. Do you disagree with his conclusion on this?

    Not at all. When banks fail as they did during the Great Depression, Some of the money created out of thin air just disappears. It’s one of the hazards of fractional reserve banking when your customers lose faith and demand their money – now – and there’s no lender of last resort. Well, there was one but it didn’t act like one, so it might as well have not existed.

    The cause of the GD, by the way, lies in the unsustainable boom of the ‘roaring 20s”. The depth and length of it resulted mostly from failure of the Fed and extremely asinine federal government programs designed to cure it.

    Imagine a world where the only money anyone accepted was gold coin and the supply of that was fixed. Now imagine the total supply of goods and services (but not money) shrinks by 50% due to some natural disaster. I maintain this will produce 100% inflation destroying half of the value of the unchanged stock of money. Do you disagree?

    Nope, 100% price inflation would result for those items that had become twice as scarce as before, while demand remained at the same level. Using your conditions, that would be all goods and services, and I assume we are ignoring the effects of substitution.

    If the money supply remained the same, by definition, no monetary inflation has occurred. It doesn’t matter whether gold coins or some other form of money is used, as long as the supply is fixed.

    Like

    • Ron,

      >—“A higher velocity of money just means more exchanges of goods and services in the same period of time. The number of time a dollar changes hands in a year or whatever period has no particular useful meaning, although I know you Keynesians seem to think it does.”

      Prosperity “just means” a thriving and healthy volume of exchanges of goods and services in a given period of time.

      Economic depression “just means” a very low volume in the number of exchanges in goods and services in a given period of time.

      Like

  12. Ron,

    >—“If the money supply remained the same, by definition, no monetary inflation has occurred. It doesn’t matter whether gold coins or some other form of money is used, as long as the supply is fixed.”

    OK I’m pretty sure we both agree that Friedman was right about the quantity theory of money. That is to say, we agree that inflation (or deflation for that matter) is caused by a change in the ratio of the total supply of money to the total supply of goods and services on offer. I think you are using the term “momentary inflation” simply to refer to inflation caused by increasing the money supply without an increase in the supply of goods and services on offer, right?

    IF this is the case and IF you believe in the law of supply and demand, THEN an increase in the velocity of money must result in an increase in demand for goods and services. THIS increase in the demand for goods and services must cause some inflation if the money supply stays fixed. If not, why not? If so, why isn’t the increase in velocity causing inflation even with a fixed volume of money circulating at varying speeds?

    Like

  13. Greg

    Hold on! The phrase “outside the scope of” is up to a lot of mischief right there. The newly created money is on the balance sheet of the person that you the borrower paid it to.

    You’re right. Please read “outside the scope of” as ” I don’t want to create and explain an unlimited number of imaginary transactions beyond the ones that I hypothetically have any knowledge of”. I don’t want to explain what the imaginary seller does with the imaginary $1000 I gave him in exchange for … some imaginary good or service.

    THAT transaction could not have occurred if you hadn’t borrowed the money to spend with him. Remember that you have already conceded that you borrowed the money for the purpose of that spending you could not have otherwise done, not because you liked paying interest.

    Absolutely correct, but where’s the money creation? There is no more money in the world than there was before our agreement.

    Not necessarily. What if you purchased his labor?

    He has then produced something – a good or service. He may want to exchange his labor for food, clothing, shelter, etc. but I don’t have those things to exchange with him. Instead I give him 1000 magical certificates that can represent anything he wishes, in an amount that we have both agreed is a fair exchange for his labor.

    The certificates already existed. No one in this story has created them. You acquired them in some exchange outside the scope of* that we haven’t yet created in our imaginations, and you loaned them to me. Those magical certificates represent whatever real goods or services we wish, and saves us from a world of direct barter.

    Production of goods and services is real, and represents things that didn’t exist before. The money is just a medium of exchange, and in our case it already existed in some form.

    If this transaction occurs during a time of high unemployment (which just happens to be exactly when Keynes wants to facilitate it) you probably used the money to purchase that labor from an unemployed person who had no other job offers. He has exchanged a day of unemployment and no income for a day of work and income.

    That’s right. He has produced something that didn’t exist before with money that did exist. He may exchange that money for necessities that didn’t exist before (assuming food is made to order and there is no existing inventory).

    His production has created demand for the production for which it will be exchanged. “it is production which opens a demand for products. . . ” — J. B. Say

    https://fee.org/articles/understanding-says-law-of-markets/

    It might be helpful to understand WHY this guy is unemployed, and avoid the “lump of labor fallacy”. Perhaps he is a skilled carpenter who has been working for a construction company building houses for the past 8 years, and the builder has gone broke because manipulation of interest rates by the Fed, among other things, has obscured the fact that the homebuying public didn’t relly want that number of houses after all.

    There are NO jobs available for a skilled carpenter at this time, and there probably won’t be for several years, so he has accepted a string of odd jobs, including the one I’ve offered him, just to put food on the table. There are plenty of job openings for software designers, petroleum engineers, and fast food servers, but none for skilled carpenters.

    If we only look at the government numbers, we might see 500,000 unemployed and 500,000 job openings, and think “problem solved”, but that’s not the reality.

    This is where the new real useful value you are looking for comes from. He does not have less of his labor available to sell today because he exchanged a day of idleness for a day of work yesterday.

    That’s correct but the handy medium used to facilitate our exchange did already exist, as we don’t have direct complimentary needs. I don’t have food to pay him with.

    Now consider the possibility that you used part of the loan to buy a pair of work shoes at my former store.

    I’m sure I will be extremely happy with my purchase, and I will enjoy my time spent interacting with one of the hot young women you employ. I may have to try on several dozen pairs just to make that experience last.

    It is true that I had to replace those in inventory and that part of the transaction did not account for any new money. But a significant percentage of that sale was profit that I would not have made if the original loan had not made your purchase possible.

    Rewards to factors of production: Labor earns wages. Land earns rent. Capital earns interest, and entreprenuership earns profit (or loss). That last one is you. You are rewarded for your efforts with profit if you anticipate fickle consumers demands correctly. That profit is given to you by customers who value what you have done to make their lives better using money that already exists.

    In my case, while it’s true that I might not have bought shoes, absent the loan, it made me feel confident enough to spend some money I held from other sources. I had previously hidden some of it in my mattress. The loan from you, of money that already existed (perhaps in the form of retained ernings) merely allowed me to reassess my priorities and opportunity costs. I still have that $1000 in my cookie jar. Yes, money is extremely fungible, but none was created in this case.
    THAT part of the sale stays on my balance sheet as retained earnings. I assure you from long experience that making more sales results in higher retained earnings than making fewer sales.

    There’s no doubt in my mind that making more sales is better than making fewer sales. I’m not an accountant, but would you say that ‘retained earnings’ is another way of saying ‘deferred consumption’?

    If you want to see the additional money creation …

    Your loan as an asset represents something you prevbiously held in another form. you didn’t create the money you loaned. In your example I’m assuming you held cash prior to loaning it to me, because that is the form in which I would want to borrow it. I didn’t want to borrow shares in your company, or part ownership in your home. I couldn’t spend those directly. I wanted a liquid medium of exchange that can represent whatever I wish it to represent.

    But in the real world actual lenders do and should view a person holding a lot of income producing loans as a vastly better credit risk than the same person without those assets. I know you think they shouldn’t. But they do!

    The key term here is “income earning”. I suspect that any income earning asset, all else equal, would produce the same nods of approval from lenders. Your holdings of assets were the same before and after the loan to me. Generally people with higher incomes are better credit riskes than people with lower incomes. I assume you’re not comparing people with assets to people without assets.

    It can. Haven’t you already conceded that it can flow into excess reserves at the Fed and be effectively sterilized?

    That is the opposite of circulating, and is done with accounting gimmicks.

    Buying anything can easily be described as “merely exchanging property rights.” So what?

    So what nothing. Exchanging property rights is not creating money.

    Prosperity “just means” a thriving and healthy volume of exchanges of goods and services in a given period of time.

    Economic depression “just means” a very low volume in the number of exchanges in goods and services in a given period of time.

    Right. The higher or lower frequency of exchanges with an unchanged money supply *causes* each unit of money to be used more or less often. It’s just arithmetic. The frequency of use of money units doesn’t cause prosperity or depression, it is a *result* of those conditions causing changes in the ‘velocity of goods and services”.

    OK I’m pretty sure we both agree that Friedman was right about the quantity theory of money.

    Well, no we don’t. That’s an overly simplistic view. In your simple example, I’m reading that the supply of goods and services was instantly reduced by half and everyone knew it. They could reasonably expect that all prices would rise by ~100% due to the doubling of scarcity of all goods and services. In the real world things aren’t that simple. Increases in the money supply don’t enter all points of the economy uniformly or at the same time, all prices don’t increase uniformly, and people’s expectations of future inflation and price changes vary greatly, influencing changes in buying patterns in different ways, and causing the demand for money to vary considerably over time.

    There is no 1:1 relationship between the money supply and prices.

    What we CAN say is that if the money supply is reqularly increased at a rate faster than any increase in demand for money (due to increased population, perhaps) for 100 years, the average buying power of each dollar will be equal to the buying power of 5 cents at the begining of the 100 year period.

    That is to say, we agree that inflation (or deflation for that matter) is caused by a change in the ratio of the total supply of money to the total supply of goods and services on offer.

    I agree that monetary inflation (or deflation) is caused by a change in the money supply at a rate greater than (or less than) changes in the demand to hold money as cash or cash equivilents instead of spending or investing it. A change in the ratio of the total supply of money to the total supply of goods and services is merely an arithmetic ratio sometimes known as the “velocity of money”.

    Especially in this age of electronics and the internet when units of money need not have any physical reality, when the electrons representing money are absolutely indistinguishable from one another, and when transaction costs are approaching zero, this “velocity” thingy has no useful meaning.

    I think you are using the term “momentary inflation” simply to refer to inflation caused by increasing the money supply without an increase in the supply of goods and services on offer, right?

    That’s “monetary inflation”, and no I’m not.

    IF this is the case and IF you believe in the law of supply and demand, THEN an increase in the velocity of money must result in an increase in demand for goods and services.

    Nope.

    “THIS increase in the demand for goods and services must cause some inflation if the money supply stays fixed. If not, why not? If so, why isn’t the increase in velocity causing inflation even with a fixed volume of money circulating at varying speeds?”

    Because there is no difference in the rate of money changing hands and goods and services changing hands. For every exchange of goods and services there is an equal and opposite exchange of money. The volume of those exchanges in a given time is a measure of production (GDP). The odd notion that a given dollar may be used X times in a year is Uninteresting Except to those fascinated by numerical trivia.

    IF the velocity of money was a constraining factor, the existing supply of dollars would cause each unit to be MORE valuable, not less. Why would using specific dollars more often cause them to lose value?

    Like

    • Ron,

      >—“The newly created money is on the balance sheet of the person that you the borrower paid it to.” (G)

      >—You’re right. Please read “outside the scope of” as ” I don’t want to create and explain an unlimited number of imaginary transactions beyond the ones that I hypothetically have any knowledge of”. I don’t want to explain what the imaginary seller does with the imaginary $1000 I gave him in exchange for … some imaginary good or service. (R)

      So you ask me over and over again to show you the new money created by the loan and just when I tell you where to look you insist on averting your eyes on the grounds that we are discussing an “imaginary” situation? This is an unexpected and untenable move.

      We have been using various hypothetical or “imaginary” examples literally for years in discussing economic issues without any objections from you and now you want to maintain that an entirely mundane and plausible hypothetical is out of bounds because it’s “imaginary.” This is shameless goalpost moving.

      Precisely because my hypothetical is so mundane and plausible, I can easily illustrate the same point by pointing to something I am confident you will agree happens regularly in the real world.

      A corporation wants to borrow money. They issue a bond. The purchasers of that bond are lending them money. Now they have money they didn’t have before that they go and spend in various places on whatever purpose they borrowed it for. The loaned money is now at those places where they spent it.

      But it ALSO still exists as a real income producing asset on the balance sheet of the lenders who purchased the bond. You will want to point out that those purchasers can’t spend the loaned funds until until the bond comes due. But they can. There is a thriving secondary market in bonds where they can sell it at any time for money they are free to spend right away. This demonstrates the reality of the asset also existing in a second location. In BOTH places the assets are now being used as “money.” Before the loan was made that only happened in one place.

      No doubt you will be eager to point out that the secondary market purchasers of the bond must now defer consumption. Well, one of the features of money is that it can function as a store of value. It’s real money doing that there. The important point is that, if the loan is made, a growth in real economic activity will occur that wouldn’t have happened in the absence of that event.

      A healthy and sustainable growth in the velocity of money moving around the economy is prosperity itself. A depressed level of the velocity at which money moves around the economy is an economic depression itself. Too high a velocity of money moving around an economy is an unsustainable economic boom that will end badly.

      It’s not all all clear to me how you think the volume of money increases in an economy in the absence of fiat money or if you even believe it could. How did the volume of money increase before we had fiat money and do you even believe it could?

      Like

  14. Ron,

    I loved the explanation of Say’s Law that you linked to for a number of reasons, not the least of which was its implicit endorsement of fractional reserve banking which you take to be illegitimate. Your link correctly describes it as a crucial mechanism in facilitating investment by those seeking to defer consumption.

    I thought it did a great job of dispensing with the straw man version of Say’s Law that you sometimes hear advance by Keynesians. I would remind you though that you have never heard me advance that straw man version of Say’s Law.

    I also liked the fact that it refrained from straw manning the Keynesian position as often happens in defenses of Say’s Law. The author frankly admitted to being unsure of exactly what Keynes thought of Say’s Law.

    Of course it is true that “Wealth is created by production, not consumption.” Keynes understood that. His point is that economic depressions can sometimes be greatly lengthened the what he would have called hoarding of money or what Say would have called excess demand for money. Both describe the same situation where widespread fear leads the kind of sharp drop in the demand for goods and services that will result in a widespread preference for holding money instead of spending it.

    Below is where the article describes this:

    >—-“Because all market exchanges are of goods or services for money, all markets are money markets, and the only way there can be an excess supply or demand for goods is if there is an opposite excess supply or demand for money. Take the more obvious case of a glut of goods, such as one might find in a recession. Say’s Law, properly understood, suggests that the explanation for an excess supply of goods is an excess demand for money.”

    The article goes on to say that “Recessions and depressions are, therefore, fundamentally monetary phenomena.” Right again. An “excess demand for money” in this analysis is merely another way of describing a drop in (gasp)…dare I say it…aggregate demand!

    Like

  15. Greg

    So you ask me over and over again to show you the new money created by the loan and just when I tell you where to look you insist on averting your eyes on the grounds that we are discussing an “imaginary” situation? This is an unexpected and untenable move.

    We have been using various hypothetical or “imaginary” examples literally for years in discussing economic issues without any objections from you and now you want to maintain that an entirely mundane and plausible hypothetical is out of bounds because it’s “imaginary.” This is shameless goalpost moving.

    OK, OK, calm down. Your entire story about loaning me $1000 and my spending it is imaginary – as far as I know – because I don’t remember getting the $1000. Strange lapses of memory have occurred as I get older but I don’t think this is one of them. We can make up as many imaginary transactions as you wish both before and after the loan to me. We can discuss them all. Nothing will be “beyond the scope”.

    You created an asset out of the $1000 by loaning the money to me. There was no money creation in that exchange or in my purchases of whatever from the seller. What do you want seller to do with the money? What do you want the next party to do with the money? Just imagine those transactions, tell me what you imagined, and I will explain why there was no money creation. Only a deposit of money into a fractional reserve bank and the subsequent lending of a multiples of that deposit creates money. (or an increase in the ban’s reserves by the Fed)

    You didn’t explain where you got the $1000 dollars to lend to me, and we can examine as many exchanges as you wish leading up to that loan, but unless one of those transactions includes borrowing from a fractional reserve bank, there is no money creation. Only a bank loan creates money.

    The money was almost certainly crated by a bank loan at some point in time, but every subsequent transaction outside the banking system does not.

    Instead of loaning me the money, you could have built a new factory, or a tract of houses, or a private bridge or road. Those would all be new assets that you had created using money to facilitate the mixing of materials and labor, and all those assets would have a potential value measured in money, but the money doesn’t stay in the assets, but moves on to builders, material suppliers, insurance companies, government permitting agencies, etc. etc. They all in turn use the money for additional exchanges ad infinitum, and around and around. In that way money can be said to circulate, but at one discrete step at a time. in equal and opposite amounts for goods and services (or assets).

    A corporation wants to borrow money. They issue a bond. The purchasers of that bond are lending them money.

    Money the purchasers didn’t create.

    Now they have money they didn’t have before that they go and spend in various places on whatever purpose they borrowed it for. The loaned money is now at those places where they spent it.

    Correct. This is pretty much identical to your loan to me. The bond holders now have financial assets that didn’t exist before, just a you did after loaning me $1000. the corporation now has the money that was NOT created by the buyers of the bonds.

    But it ALSO still exists as a real income producing asset on the balance sheet of the lenders who purchased the bond.

    Yes.

    You will want to point out that those purchasers can’t spend the loaned funds until until the bond comes due. But they can.

    They can spend the proceeds from the sale of a bond, unless they exchange something directly for the bond, but that’s probably very common. Bonds are less liquid than cash, and more liquid than real estate. Where did you place them on your liquidity hierarchy list

    There is a thriving secondary market in bonds where they can sell it at any time for money they are free to spend right away.

    Of course, just a there is a thriving market for most types of physical and financial assets including residential and commercial real estate, equities, and bonds of all types – except the special bonds issued to the Social Security Trust Fund. Those re not marketable, and therefore have no market value. They are IOUs only. (not sure why I made that detour)

    This demonstrates the reality of the asset also existing in a second location. In BOTH places the assets are now being used as “money.” Before the loan was made that only happened in one place.

    Each bond is only one bond, and it only has one owner at a time, just as the money used to buy it only has one owner at a time. The asset moves from owner to owner, as the money moves in the opposite direction from owner to owner. The total number of bonds issued by the company is the same from first issue until redemption. You wouldn’t say that the number of houses in a tract increases as they change hands from one owner to the next, would you?.

    Assets are created by lots of people, money is created only by the banking system. I would compare the assets created by the shadow banking system, and their value, to the concurrent bubble in the housing market prior to the great recession. Many agencies and organizations conspired, perhaps unwittingly, to overestimate the value and security of those assets, just as a perfect storm of policies and events created the housing bubble.

    Well, one of the features of money is that it can function as a store of value. It’s real money doing that there.

    Opinions differ on whether non-commodity money is real money, and I’m not sure I would describe something that loses 1 – 2% or more of it’s value each year as a store of value, at least not a good one.

    The important point is that, if the loan is made, a growth in real economic activity will occur that wouldn’t have happened in the absence of that event.

    Sure. The money has been transferred from someone who wants to consume later to someone who wants to consume now. Increased business activity will occur temporarily, but unless that money is invested in productivity and efficiency enhancing capital improvements, no actual growth can occur.

    Like

  16. Greg

    I loved the explanation of Say’s Law that you linked to for a number of reasons, not the least of which was its implicit endorsement of fractional reserve banking which you take to be illegitimate.

    I like Steve Horwitz’s explanation of say’s law, not because he’s the purest Austrian around, but because it is the correct one. He advises us that : “If we want to get a more accurate understanding of Say’s Law, perhaps we should consult what Say himself had to say about his supposed law.”

    Great advice. Steve goes on to provide that consultation. Unfortunately he also goes on to embellish the basic concept of Say’s Law with connections that are his and not Say’s – like the fractional banking bit you like. I’m not sure Say himself ever addressed the concept of fractional reserves, and it certainly isn’t part of his basic claim about production creating demand. While Steve’s discussion of money isn’t necessary to a correct understanding of Say’s Law (although Say never called it that) it doesn’t harm it either. It just hardly seems necessary to point out that most people join production to demand through the medium of money, and not directly through barter.

    I thought it did a great job of dispensing with the straw man version of Say’s Law that you sometimes hear advance by Keynesians. I would remind you though that you have never heard me advance that straw man version of Say’s Law.

    That’s true, I haven’t. Thanks for that. I’m not sure we’ve ever discussed Say’s Law before now. I’m glad you enjoyed Horwitz’s essay. It said more than I needed, but it made the basic point I wanted to make.

    In reading the article, did you realize that this:

    “Unlike Keynesian critics of Say’s Law of Markets who saw deficient aggregate demand resulting from various forms of market failure as causing economic downturns, we have argued that a more accurate understanding of Say’s Law suggests that there is no inherent flaw in the market that leads to deficient aggregate demand, nor is the existence of real-world recessions a refutation of the Law. Rather, once we understand the role of money in making possible the translation of our productive powers of supply into the ability to demand from other producers, we can see that the root of macroeconomic disorder is most likely monetary, as too much or too little money will undermine that translation process.”

    – can be interpreted as an implicit statement of ABCT? Too much or too little money, due to the imposition of artificial interest rates can “undermine the translation process between production and demand, leading to malinvestment.

    Perhaps “deficient aggregate demand” really means “excess aggregate production ” due to lack of accurate information about consumer time preferences that would have been provided by market interest rates.

    Like

  17. Ron,

    >—–“Only a deposit of money into a fractional reserve bank and the subsequent lending of a multiples of that deposit creates money.”

    Well that’s an totally unexpected definition of money coming from anyone but especially coming from someone who denies both the legitimacy the state and the legitimacy of fractional reserve banking. It only takes moment’s notice to realize that definition of money is untenable. If it was correct, there would have been no money in the world before the development of fractional reserve banking. Surely you don’t believe that. Obviously we need to back up and see if we can agree on a definition of “money.”

    The first thing to say about defining “money” is that it is a lot more complicated than people expect who have never tried it. The most important and most widely agreed on functions for money are: to serve and a medium of exchange, to serve as a unit of account, and to serve as a store of value.

    The first thing to say about THAT list is that NO form of money meets all those requirements all the time. You often complain to us how U.S. dollars fail to meet your needs for money that is a reliable store of value. A very wide variety of instrument meet these functions of money to widely varying degrees in widely varying situations. They all need to be considered when thinking about the total supply of money in an economy.

    Almost anything can serve as money for various purposes as long as there is a widespread agreement that it does. I’m pretty sure you have read Milton Friedman’s ‘The Island of Stone Money” which proves this point indisputably in four pages.

    To say that one form of money is more liquid than another is just to say that a higher percentage of people will accept it as money. The liquidity of every form of money is constantly changing and that includes U.S. Dollars although they are clearly currently the most liquid form of money.

    What Keynes describes as hoarding of money, a liquidity preference among most people, or a shortage of aggregate demand are all different terms for the same thing and the same as what Horwitz describes as “an excess demand for money.” If you think there is a difference in what these terms refer to I would like to know what that difference is.

    >—-” – except the special bonds issued to the Social Security Trust Fund. Those re not marketable, and therefore have no market value. They are IOUs only. (not sure why I made that detour)’

    Every bond or debt of any kind can just as easily be described as an IOU. They are “only” instruments that record the fact that one party owes the other something.

    Social Security Bonds are not marketable simply because the law says they aren’t. I’m not sure why you think that is such a big deal. If the law was changed tomorrow to make them marketable there would instantly be plenty of buyers. The U.S. government is still regarded by the financial markets as the best risk of any borrower in the world. You do realize this right? Surely markets wouldn’t “fail” in this case.

    Like

  18. Greg

    correction:> >—–“Only a deposit of money into a fractional reserve bank and the subsequent lending of a multiples of that deposit creates NEW money OUT OF THIN AIR.”

    In the context of your example the only type of transactions between two parties that could have resulted in money creation would have resulted from you or me or seller or any one of the other parties in the long string of transactions, depositing the existing $1000 into an account at a fractional reserve bank, thus increasing reserves, followed by the bank lending multiples of the new reserves to other parties, thereby creating new money out of thin air.

    I don’t think fractional reserve banking is illegitimate, but I think it is a dangerous idea to juggle money so that several people at the same time have a claim on a single dollar. This is only slightly less risky than issuing multiple titles to the same car in hopes that none of the “owners” will want to use it at the same time. Bank runs, insolvency, and yuge decreases of the money supply have resulted from this practice. People have gotten hurt.

    If it was correct, there would have been no money in the world before the development of fractional reserve banking. Surely you don’t believe that.

    Surely I don’t. Money has existed in the world since people figured out how to avoid the constraints of direct barter. In earlier times, however, the supply of commodity money could only be increased by digging more out of the ground, in the case of gold, thus limiting the ability of those in charge to inflate the money supply. As demand for money grew, each unit of the existing money supply grew in value against the goods and services exchanged for it, making it more lucrative to dig more out of the ground to be refined and minted into coins.and bullion. It was a pretty good self-regulating system except for occasional large, inflation causing injections of metal into economies such as the Spanish thievery in the New World, and the several gold rushes in the US.

    Obviously we need to back up and see if we can agree on a definition of “money.”

    OK, this is fun. I think we already agree except for who, if anyone, should have a monopoly on the creation of money and control of the money supply.

    The most important and most widely agreed on functions for money are: to serve and a medium of exchange, to serve as a unit of account, and to serve as a store of value.

    Yes, I totally agree. I particularly like this somewhat lengthy and very basic discussion of the question “What Is Money”, as it pretty much covers all the bases in sufficient detail except for the origins of money and the characteristics of money. The first “Heads Up” box is notable for it’s contrasting of physical assets and money.

    https://open.lib.umn.edu/principleseconomics/chapter/24-1-what-is-money/

    And I particularly like this explanation of the origins of money:

    https://mises.org/library/origin-money-and-its-value

    The desirable characteristics of money are:

    Notice that gold and silver have all of these characteristics. That’s probably why those metals have been used as money by most societies world wide since the beginning of time. Obviously, fiat money lacks limited supply and can be produced in any amount, making it less desirable.

    The first thing to say about THAT list is that NO form of money meets all those requirements all the time.

    Gold does – when our masters allow us to use it..

    You often complain to us how U.S. dollars fail to meet your needs for money that is a reliable store of value.

    Money that may be devalued on a whim, and which in fact IS systematically devalued over time is not as good a store of value as one that does not. At different times in US history a person could bury $100 in a can in their yard and dig it up 20 years later to find it had the same or even higher value than when it was buried. A depreciating money forces people to store value in forms that carry a higher level of risk than money itself.

    A very wide variety of instrument meet these functions of money to widely varying degrees in widely varying situations. They all need to be considered when thinking about the total supply of money in an economy.

    Yes, but most carry a higher level of risk than cash, and there is an entire hierarchy of levels of liquidity and wide acceptance. In a very simple form:

    You can fit any other type of asset you wish into this pyramid at the point you think it belongs.

    Almost anything can serve as money for various purposes as long as there is a widespread agreement that it does.

    That’s correct, and I already said that much earlier in this conversation.

    I’m pretty sure you have read Milton Friedman’s ‘The Island of Stone Money” which proves this point indisputably in four pages.

    I have. It’s a great, thought provoking story.

    To say that one form of money is more liquid than another is just to say that a higher percentage of people will accept it as money.

    Or that it has more or fewer of the other characteristics of money – divisibility or portability, for example.

    The liquidity of every form of money is constantly changing and that includes U.S. Dollars although they are clearly currently the most liquid form of money.

    I don’t think that’s true except within narrow ranges, and I can’t imagine cash, in the form of dollars or any other currency ever being less liquid than some other form of money. Money in savings accounts will never be as liquid as cash in checking accounts, for example.

    BTW cash in bank accounts is more liquid than ever before. We no longer need to write checks or withdraw cash, or even present a plastic card to move money, we can move money from almost anywhere in the world with just a few keystrokes on our ubiquitous internet attached devices. Life is good.

    What Keynes describes as hoarding of money, a liquidity preference among most people, or a shortage of aggregate demand are all different terms for the same thing and the same as what Horwitz describes as “an excess demand for money.” If you think there is a difference in what these terms refer to I would like to know what that difference is.

    If by “hoarding of money” and “excess demand for money” you mean increased deferred consumption by millions of individual consumers, then I agree they mean the same thing as “shortage of aggregate demand” with the following caveats: I wouldn’t use the term “excessive” to describe an increased demand to hold cash nor would I use “shortage” to describe a decrease in aggregate demand, as both words imply something gone wrong, when all three phrases are just ways of describing changes in consumer preferences, particularly changes in time preference. There can’t be anything wrong with the individual choices made by millions of consumers.

    Every bond or debt of any kind can just as easily be described as an IOU. They are “only” instruments that record the fact that one party owes the other something.

    Exactly. However, the ones issued by the Treasury to the SS Trust fund have no market value, while most others are Traded feverishly on secondary markets. as I wrote, I’;m not sure why I made that detour. It’s not relevant here.

    Social Security Bonds are not marketable simply because the law says they aren’t. I’m not sure why you think that is such a big deal.

    In the context of our current discussion, it has no bearing at all. In other contexts it’s important to note that those particular bonds can only be redeemed by the Treasury, which only receives money from government borrowing and taxpayers. When we read that there is ~ $2.8 trillion in the SS Trust Fund available for making SS benefit payments, that means that US taxpayers, and later their children, will now start making up the shortfall in SS payroll taxes from workers. It is an accounting entry with no current value.

    Like

  19. Greg

    It’s not all all clear to me how you think the volume of money increases in an economy in the absence of fiat money or if you even believe it could. How did the volume of money increase before we had fiat money and do you even believe it could?

    Sorry, I failed to respond to this earlier.

    The answer is simple. The supply of a commodity money such as gold is increased by digging more of it out of the ground. The cost of creating more refined gold vs the price expected for the finished product in terms of goods and services, determines whether and how much will be produced.

    As the demand for money increases vs the available supply of money the value of each existing unit increases, incentivizing people to create more of it. This is no different than any other commodity. Prices dictate how much, if any, will be produced. When it becomes less profitable to produce more, production will decrease. Supply and demand regulated by price. Who would have thought!

    Like

  20. Ron,

    OK. There’s a little less we disagree on than I thought but still some very important points of dispute.

    >—“I don’t think fractional reserve banking is illegitimate, but I think it is a dangerous idea…”

    High risk, high reward. Most people do fail to understand how much risk is involved in fractional reserve banking. One of the first lessons of economics is there are always tradeoffs and the best results usually come when real risks are taken. The modern standard of living we all enjoy would not have been remotely possible without the financing of fractional reserve banking. We have all of human history to observe that that kind of economic growth never happens without it. The absence of economic growth in economies where capital is much more restricted hurts a lot more people than fractional reserve banking does.

    >—“And I particularly like this explanation of the origins of money…”

    Classic example of the Austrian privileging of theory and fantasy over historical facts and data. Yes it’s true that commodities that were easily traded for other things acquired additional value over other things because of that feature as humans exited a barter economy. But the fantasy that individual voluntary choices were the road to gold and silver coins is historical fiction in support of a policy agenda.

    Governments invented gold and silver coins and caused their use to become prevalent by paying their armies with them. Markets then sprung up around these armies and followed them as the use of these coins spread to the general population when soldiers spent them with merchants.

    Even before that, debts of various kinds based on the human instinct for reciprocity began to replace direct barter.

    >—-“The first thing to say about THAT list is that NO form of money meets all those requirements all the time.” (G)

    >—-“Gold does – when our masters allow us to use it.” (R)

    You can use gold to pay anyone you make a contract with who will accept it as payment. But most people won’t because they actually prefer U.S. dollars.

    Gold does NOT always hold its value well. Between 1980 and 2000 gold lost about 2/3 of its purchasing power compared to the dollar and most other goods and services.

    The government does NOT have monopoly on the creation of money. You and I can make an exchange using anything we like as money. The government DOES have a monopoly on what must be considered legal tender. That is to say, if you want o pay your taxes or have the government legal system settle a contract dispute for you, you then government does have a monopoly on the money used for THAT. But the vast majority of transactions do not fall into those categories and private parties can use whatever they want to serve as money in those. You are conflating the fact that most other people like using the dollar with their being required to use it for most transactions.

    For much of U.S. history there was a shortage of U.S. dollars to facilitate transactions and merchants accepted a wide variety of things including a vast number of different state banknotes all discounted to varying degrees by different merchants. That was a system few people would return to voluntarily.

    >—“I don’t think that’s true except within narrow ranges, and I can’t imagine cash, in the form of dollars or any other currency ever being less liquid than some other form of money. Money in savings accounts will never be as liquid as cash in checking accounts, for example.”

    You don’t have to imagine it. You just have to open your eyes. It’s already happening in some places. You can’t spent cash on an airplane any longer. Only credit cards are accepted now. I am confident hr future will bring many more places that don’t accept cash as merchants seek to avoid the risks and costs of having employees handle cash.

    >—-“Money that may be devalued on a whim…’

    U.S. dollars cannot be devalued on a whim. The process by which the Fed changes rates is quite slow and bureaucratic and there has been NO TIME since the Fed has been managing the money supply that the U.S. dollar has seen a drop in purchasing power like gold suffered from 1980 to 2000. There is a reason that international MARKETS view the U.S. dollar, not gold as the best money there is.

    >—-” There can’t be anything wrong with the individual choices made by millions of consumers.”

    That depends entirely on what kind of result you consider to be wrong. Of course if you start by defining all such results as not wrong before you even see them (in classic Austrian fashion privileging theory over reality) then you won’t see anything “wrong.” Individuals CAN make individual choices that result in a prolonged economic depression which you may then choose to describe as good economic medicine.

    Like

    • Ron,

      Correction:

      You CAN find a 20 year period including the inflation of the 70’s where the U.S. dollar lost as much purchasing power as gold between 1980 and 2000. The point remains that your description of the virtues of gold is not compatible with its performance in those two decades.

      Like

  21. Greg

    High risk, high reward.

    And high risk, big losses. Not everyone has a high risk tolerance, but everyone is forced to accept risk they otherwise wouldn’t due to the intentional devaluation of the USD over time. Here is no legitimate reason to create inflation as a monetary policy from the viewpoint of consumers, savers, and investors.

    One of the first lessons of economics is there are always tradeoffs and the best results usually come when real risks are taken.

    And the worst results as well. Ask those who lost their life savings due to bank failures during the Great Depression. What was that you wrote about Friedman and the disappearance of 30% of the US money supply? .

    The modern standard of living we all enjoy would not have been remotely possible without the financing of fractional reserve banking. We have all of human history to observe that that kind of economic growth never happens without it.

    Lots of things changed in the 17th century. I wouldn’t give too much credit to that one. If memory serves, there were several far more fundamental changes than fractional reserve banking.

    The absence of economic growth in economies where capital is much more restricted hurts a lot more people than fractional reserve banking does.

    Economic growth is restricted in economies without protection of property rights and enforcement of contracts. FRB is a side issue.

    The most benefit from FRB accrues to the banks themselves. I would see tremendous economic growth in my personal economy if I could lend the same money several times concurrently.

    Classic example of the Austrian privileging of theory and fantasy over historical facts and data. Yes it’s true that commodities that were easily traded for other things acquired additional value over other things because of that feature as humans exited a barter economy. But the fantasy that individual voluntary choices were the road to gold and silver coins is historical fiction in support of a policy agenda.

    You have offered no alternative explanation. Surely you aren’t going to suggest that some truly forward looking king saw his people struggling to achieve coincidence of wants through barter and was smitten with a vision of substituting some widely used commodity as a medium of exchange. You may cite instances of kings declaring some form of metal with their face on it to be the official currency, but surely you don’t think people had no clue before that.happened. Minting coins created a widely recognized standard weight of some metal used as money, but they didn’t spring into being fully formed

    You can use gold to pay anyone you make a contract with who will accept it as payment.

    Yes, that’s trivially true, but you are picking on a nit here. As we have both said several times now, anything that will be accepted by a trading partner *could * be called money. And I’m going to walk that back a bit.by invoking one of the properties of money – widely accepted – and a function – medium of exchange – to prevent our calling just any old thing “money”. a direct exchange of one thing for another is barter, and anything accepted as a medium of exchange is expected to be widely accepted as such.

    But most people won’t because they actually prefer U.S. dollars.

    There’s that “legal tender” thingy, and there’s Gresham’s Law.

    ————————————————————————————————
    https://www.thesprucecrafts.com/norfed-liberty-dollar-coins-768362

    Gold does NOT always hold its value well. Between 1980 and 2000 gold lost about 2/3 of its purchasing power compared to the dollar and most other goods and services.

    Gold as a commodity, but set adrift from its role as money, understandably doesn’t track the value of other goods and services against which it was previously traded. There is no reason to expect it to do so. For much of the 19th century, when gold was money and the ability of government to inflate the money supply by counterfeiting money substitutes was much more limited than it is today, money (gold) was a much more reliable store of value over time than it is now.

    The government does NOT have monopoly on the creation of money.

    I’m sure Bernard van NotHaus will disagree with you. It seems he had some trouble promoting that notion. I don’t think I can print my own currency, and I.m pretty sure any attempt to add zeros to my bank account balance will get me in trouble. I’ve had no success getting my grocer to accept Ron Bucks .

    https://www.thesprucecrafts.com/norfed-liberty-dollar-coins-768362

    But the vast majority of transactions do not fall into those categories and private parties can use whatever they want to serve as money in those.

    Again, Mr. van NotHaus used to believe that, but has since changed his mind.

    You are conflating the fact that most other people like using the dollar with their being required to use it for most transactions.

    Most people like using public streets and highways. I’m sure it’s not related to their lack of other reasonable choices. What do you think people would choose if the two choices were between a form of money that is easy to depreciate and another that is not?

    For much of U.S. history there was a shortage of U.S. dollars to facilitate transactions and merchants accepted a wide variety of things including a vast number of different state banknotes all discounted to varying degrees by different merchants.

    For much of early US (and colonial) history the most widely used form of money was the Spanish Real.

    That was a system few people would return to voluntarily.

    The reasons for distrusting long distance money no longer exist.

    You can’t spent cash on an airplane any longer. Only credit cards are accepted now.

    Plastic cards are just another form of cash. I suspect you will balk at my calling credit cards cash, but that distinction is a minor point.

    I am confident the future will bring many more places that don’t accept cash physical currency as merchants seek to avoid the risks and costs of having employees handle cash physical currency.’

    There. FIFY. Can we agree that cash, as we have used the term for the purposes of this discussion, includes both physical currency and electronic bank balances?

    U.S. dollars cannot be devalued on a whim. The process by which the Fed changes rates is quite slow and bureaucratic …

    A slow and bureaucratic whim then? I’m not sure that makes much of a difference. The fact is that the value of a fiat currency can be changed by large amounts that would be virtually impossible with a commodity based money, makes the notion of a “good store of value” pretty much dependent on the whims of the Fed.

    … and there has been NO TIME since the Fed has been managing the money supply that the U.S. dollar has seen a drop in purchasing power like gold suffered from 1980 to 2000.

    Your subsequent correction is noted. Since gold is not officially money, changes in value against other commodities, goods and services, and various forms of money is not surprising. I believe the price of wheat, coal and oil fluctuate over time also.

    There is a reason that international MARKETS view the U.S. dollar, not gold as the best money there is.

    There is a reason why drivers view public streets as the best form of roadway there is (there is essentially no other choice. Do you think people would choose certificates backed in gold or green pieces of paper with no backing if they could choose either one?

    Individuals CAN make individual choices that result in a prolonged economic depression which you may then choose to describe as good economic medicine.

    Like what?

    Do you mean like when people quit buying houses because everybody already has three of them due to artificially low interest rates, government policies tailored to increase American home ownership, and GSEs buying up new mortgages as fast as the ink on them can dry? And then the housing market and banking systems collapse due to insufficient aggregate demand? Those kinds of individual consumer choices?

    Like

    • Ron,

      >—“Sorry about the misuse of italics. Hopefully you can figure out what is quote and what is me responding.”

      I can’t even figure out which comment you are referring to. Did one fail to post last night? You appear to have ignored a lot of things that would normally provoke you.

      >—“BTW I can buy a basic new car today for 15oz of gold. I could do the same thing in 1925. Hows that for store of value?”

      It’s fine for a store of value if the main thing you want to do with your money is store it for almost a century.
      I don’t really understand why you are so much more concerned with which monetary policies facilitate storing money as money as opposed to which monetary policies facilitate economic growth and an overall increase in standard of living.

      There have been many periods in human history where the value of money was preserved or even increased while the overall standard of living declined. You look at the period between 1925 and 2018 and see a horrifying decline in the value of money as the thing that stands out. I look at the same period and see a spectacular increase in the standard of living for all economic classes in America as the thing that stands out.

      There is a reason that most economists see slow and steady inflation as a good thing, not a bad thing. It provides a slight incentive towards investment and risk taking and so supports the kind of entrepreneurship that makes for real economic growth. If, in 1925, you had invested in the stock market average the money that would have bought one basic new car, you would have been able to use the proceeds in 1918 to buy cars for everyone you know today. Turns out the American stock market was a much better store of value than gold.

      Like

      • Greg

        I can’t even figure out which comment you are referring to. Did one fail to post last night?

        Yes, I have a comment “awaiting moderation”. I will speak to the moderator.

        You appear to have ignored a lot of things that would normally provoke you.

        Don’t worry, just be patient. )

        Like

      • Greg

        I don’t really understand why you are so much more concerned with which monetary policies facilitate storing money as money as opposed to which monetary policies facilitate economic growth and an overall increase in standard of living.

        I am mostly concerned that there ARE monetary policies by central planners. It is deferred consumption – not consumption – that allows economic growth. Savings and investment for future consumption are encouraged by high interest rates, while low interest rates encourage borrowing and current consumption. Hopefully we agree on that.

        Promoting higher “aggregate demand” discourages saving for the future and limits long term economic growth. The optimum policy in this regard would be NO policy. Allow the market – consumers and borrowers themselves to determine the market rate of interest. What could be simpler than that? I have faith in individual choices and markets, not central planners who are cursed with “the
        knowledge problem” as Hayek has described it.

        You and I may have a basic disagreement on that point that will never be resolved.

        You look at the period between 1925 and 2018 and see a horrifying decline in the value of money as the thing that stands out. I look at the same period and see a spectacular increase in the standard of living for all economic classes in America as the thing that stands out.

        You are trying to make a connection that probably doesn’t exist.

        There is a reason that most economists see slow and steady inflation as a good thing, not a bad thing.”

        Those are Keynesian economist who believe manipulation of free markets will make them perform better, and they are just flat wrong. This is another example of what may be our basic insoluble disagreement.

        It provides a slight incentive towards investment and risk taking and so supports the kind of entrepreneurship that makes for real economic growth.

        A second disagreement: I don’t believe it is the role of government planners to decide for individuals whom they don’t even know, what is in those individuals best interest, or how much risk those people should take. Pushing them toward higher risk / reward investments is just wrong. Some people just want to save for the future without having to choose between investment vehicles they know nothing about. cash was once that vehicle, but not anymore. Cash may now be one of the savings methods through which one loses the least.

        Entrepreneurs are willing to take risks because they are sure of their own vision. They aren’t gamblers out looking for the highest payoffs. Entrepreneurs aren’t those buying promising equities or playing the lottery. They are willing to risk their own and other people’s resources on an idea they are confident in.

        If, in 1925, you had invested in the stock market average the money that would have bought one basic new car, you would have been able to use the proceeds in 1918 to buy cars for everyone you know today.

        Hindsight is 20-20. Predicting is hard, especially about the future. What would you have told someone in 1930 who had bought the whole stock market (to get the average) in 1925″?

        “I told you not to gamble on that risky stuff, you dumbass! Keep your money in the cookie jar for safety.”

        Turns out the American stock market was a much better store of value than gold.

        No one would have predicted that outcome in 1925, nor would they have predicted discarding the gold standard. There have been way more losers in the stock market than winners in the last century. It’s fun to look back and say “Oh! If only I had bought [filllintheblank] in {fillintheyear} I would be a gazillionaire today.” but it’s pointless. On the other hand if you had bought [fillinanothername] in various years you would have lost your shirt. that’s why it’s known as ‘risk’.

        BTW I’m not fixated on gold as money, any commodity with all the desirable qualities of sound money, including “hard to inflate’ would work as well.. Gold has been a great example of a commodity money used through out history all over the world, so I use it as a familiar example.

        Like

  22. Ron,

    >—” Ask those who lost their life savings due to bank failures during the Great Depression.”

    I’m pretty sure that if we did ask them they would say it would have been a lot better if FDIC Insurance had been in place then. And that would be right. That program has been a huge success.

    >—-“I’m sure Bernard van NotHaus will disagree with you.”

    I don’t doubt that he is a very disagreeable guy. He was not prosecuted for trying to get people to trade with him in exchange for offering them gold. He got prosecuted for deliberately trying to pass off a coin that was designed to defraud people into thinking it was legal tender when it was not.

    >—” I would see tremendous economic growth in my personal economy if I could lend the same money several times concurrently.”

    It’s harder than you think. It only takes a few big losses to lose all the profit made on a lot of good loans. Lots of people screw it up. If it’s really true that you could make tremendous profits at it you could make a lot of money from a job in banking. I don’t know of any industry that pays better.

    >—“There is a reason why drivers view public streets as the best form of roadway there is (there is essentially no other choice. Do you think people would choose certificates backed in gold or green pieces of paper with no backing if they could choose either one?”

    The reason there is effectively “no other choice” is because there are so few people who agree with you on these issues and want other choices. There are many hotly contested issues of public policy. None of them are these issues. Whether or not to have public roads and a government responsible for the currency are two things there is huge consensus in favor of. You’re damned right I think people don’t want to go back top some previous era of monetary policy. These issues were fought out long ago and decisively settled. Few people even see them as controversial today.

    Voluntary choice can be a double edged source. When too many people voluntarily choose a money you don’t like their free choices can effectively limit your options. A couple years ago Planet Money did an episode on some libertarian festival in New Hampshire where they asked everyone to use some other method of paying for things than our legal tender fiat currency. People used a wide variety of things but the payment situation was a hilarious debacle and more than a few people began to see the advantage of a government monopoly on legal tender.

    >—“You have offered no alternative explanation.”(to individual voluntary choices being decisive in establishing money based on precious metals)

    I did offer an explanation. Governments paying armies with this money and sometimes insisting on payment of taxes with it was the decisive thing. Governments liked money based on precious metals because it was easier for them to control and hard to counterfeit. They often controlled the mines and/or the commerce in it. You don’t have to become pro-government to give up the Austrian myth about money creation. You can buy my explanation and still tell it as a story about tyrannical governments.

    Like

  23. Greg

    I’m pretty sure that if we did ask them they would say it would have been a lot better if FDIC Insurance had been in place then. And that would be right. That program has been a huge success.

    Deposit insurance is a great idea, but there’s no particular reason a for it to be a government monopoly service with taxpayers on the hook as a final resort. Private companies provide all manner of other insurance products quite efficiently. No doubt they would be happy to insure against this type of loss also.

    He was not prosecuted for trying to get people to trade with him in exchange for offering them gold. He got prosecuted for deliberately trying to pass off a coin that was designed to defraud people into thinking it was legal tender when it was not.

    NotHaus introduced new currencies backed by gold and silver, to compete with the ever depreciating one backed by … nothing, that is pretty much forced on us by the Fed. There was no attempt to claim legal tender status, and the coins and bills were widely accepted to the tune of $20M . It was the success of the Liberty Dollars that drew the wrath of the Feds and resulted in his arrest and conviction. There was no fraud involved. The coins contained the face amount in silver.

    We have already agreed that we can use anything we want as money as long as the parties accept it. Are you now changing yout tune?

    It’s harder than you think.

    Probably easier than selling the same car to several different people.

    The reason there is effectively “no other choice” is because there are so few people who agree with you on these issues and want other choices.

    Well that’s not the problem. People like to use streets and highways that are paid for by others. There’s a reason why builders of new housing tracts most often turn over the streets and utilities within a new tract to the local government. That way lots of people who don’t even know they exist can be forced to pay to maintain them by the city.

    There are many hotly contested issues of public policy. None of them are these issues.”

    These are the issues we mutually decided to talk about at this time. Do you want to stop, or talk about something else? I’m disappointed to see that you are beginning to pull out the “consensus” and ‘”so few people agree” assertions, which of course are irrelevant.

    Whether or not to have public roads and a government responsible for the currency are two things there is huge consensus in favor of.

    There’s one now.

    Few people even see them as controversial today.

    And another…

    Voluntary choice can be a double edged source. When too many people voluntarily choose a money you don’t like their free choices can effectively limit your options.

    I’m not sure I understand what you mean. You’re not suggesting that lots of people, given free choice among several forms of money chose federal reserve notes without any coercion, are you?

    … advantage of a government monopoly on legal tender.

    There is no more advantage to having a government monopoly on legal tender than having a private monopoly on legal tender. Both are terrible ideas. Do you believe people in government, operating without market constraints, are for some reason more saintly and public spirited than people opeerating in the private sector?

    I did offer an explanation. Governments paying armies with this money and sometimes insisting on payment of taxes with it was the decisive thing.

    That sounds like a snapshot of one of the government excuses for wanting to control the money. I didn’t see an explanation of how “money” as a medium of exchange began. I understand Roman soldiers were paid in salt. How would anybody know those soldiers would accept salt as their salary if it wasn’t widely accepted already as payment for goods and services?

    Governments liked money based on precious metals because it was easier for them to control and hard to counterfeit. They often controlled the mines and/or the commerce in it.

    Except it’s most often been governments that do the counterfeiting in order to finance those expensive wars. It’s hard to counterfeit salt too, come to think of it.

    You don’t have to become pro-government to give up the Austrian myth about money creation.

    I didn’t realize the origin of the money creation “myth” was Austrian in origin. It just seems to make sense. I suppose I’ll have to look something up to refresh my memory and to have references ready to use if I need them.

    You can buy my explanation and still tell it as a story about tyrannical governments.

    I can’t buy your explanation of the origins of money because it doesn’t make sense. It sounds like something that might happen after money was already in use in one form or another as a medium of exchange. Something that might have begun about the time towns and cities began forming as people began trading and specializing on a larger scale, and found direct barter more and more cumbersome.

    Like

    • Ron,

      >—“Deposit insurance is a great idea, but there’s no particular reason a for it to be a government monopoly service with taxpayers on the hook as a final resort.”

      There is a reason that nothing really comparable with the FDIC developed in the private markets in the centuries preceding that program. No private insurance company could possibly put away enough reserves to guarantee they could stop a run on many banks simultaneously (which is exactly the way losses are likely to happen) and still make a profit.

      Precisely because only the government can create money, only it can offer a credible guarantee that depositors will not be better off by running. The FDIC has been a spectacular success and has been entirely funded by the banks it insures for its entire history. It has cost the taxpayers nothing but saved them all the pain of another 1930’s style series of bank runs.

      >—“There was no attempt to claim legal tender status,”

      The attempt was in the deliberate mimicking of U.S. currency. If he had minted coins with his own face on them that didn’t mimic U.S. currency he would have been fine.

      >—” I’m disappointed to see that you are beginning to pull out the “consensus” and ‘”so few people agree” assertions, which of course are irrelevant.”

      I thought you agreed that the quality most desired in ‘money” is that it be widely accepted. Of course how many people agree to accept it is crucial to that. That makes it the MOST relevant thing. You want to have to both ways here.

      Wiliam Jennings Bryan got a major party nomination for President three times on a platform of inflating the currency. There used to be much less of a consensus than we have today on monetary policy. Yes, it’s true that the resolution of that controversy fell well short of the unanimous agreement that you think should be required but it did result a very broad consensus that most people prefer a single dominant government managed currency. You think they shouldn’t but they do anyway. That makes it hard for you to find people who want to contract with you using competing currencies even though you could do that for most transactions if you could find willing trade partners.

      >—“You’re not suggesting that lots of people, given free choice among several forms of money chose federal reserve notes without any coercion, are you?”

      Yes of course I am. And I’m repeating that over and over, not just suggesting it. U. S. Federal Reserve Notes are the most popular form of money in many foreign countries even where their use is illegal in some cases.

      If there are so many people who want to trade with you using other currencies, then it should be easy for you to find those people and trade with them using some alternative currency.

      >—” It sounds like something that might happen after money was already in use in one form or another as a medium of exchange.”

      You misunderstood me. I did not claim that government minting of coins using precious metals and paying their armies with those coins was the very first time precious metals were used as a form of money in trade.

      I did claim that was the decisive factor in its widespread use and acceptance.

      Like

  24. Greg

    There is a reason that nothing really comparable with the FDIC developed in the private markets in the centuries preceding that program.

    Well, Lloyd’s of London that has successfully underwritten various types of losses since 1686 comes to mind right away. And In 1913 US banks and financial firms themselves, with government approval, created a cartel to act as a ‘lender of last resort’ for just that purpose – essentially an insurance/reinsurance company. Why didn’t that work as planned?

    I know part of the answer. The Fed had already inflated the gold backed currency as much as it could during the 1920s. There was little wiggle room left. That’s one of

    No private insurance company could possibly put away enough reserves to guarantee they could stop a run on many banks simultaneously …

    That is an argument with some merit, but I’m not sure it’s good enough because:

    – The mere act of assuring customers that their money is insured up to $X is enough to prevent most runs due to lack of confidence in the banking system – runs and failures that are the inevitable risk in a fractional reserve banking system.

    – Interstate branch banking would have prevented many of the insolvencies and closings hat occurred during the GD. Note that 0 Canadian banks failed at that time, although the US financial problems certainly engulfed the Canadian economy as well.

    – Other types of large losses are covered by private insurance through reinsurance, on the premise that most major losses are localized, not global. This was true of rural banks during the GD, which were the majority of those that failed.

    – The federal government, of course, has unlimited reserves as long as it can collect taxes and/or sell bonds, but consider 2 things: First, if private insurers won’t assume a particular risk – and their continued existence depends on their accurate assessments of risk – (unlike government) it’s probably not good business for anybody to insure against it. Why should private banks and their depositors be protected at the potential expense of taxpayers? Second, if the FDIC system has performed so well at no cost to taxpayers, and I agree it has, then it’s not true that a private insurer couldn’t have done at least as well, and probably better. I firmly believe that private markets outperform government enterprises every time. Incentives matter.

    The [Liberty Dollars] attempt was in the deliberate mimicking of U.S. currency. If he had minted coins with his own face on them that didn’t mimic U.S. currency he would have been fine.

    I think the issue is still open to debate as to whether there was a deliberate attempt to deceive anyone, and I suppose that liberty head was a bad idea. As Brian Doherty at Reason Magazine wrote:

    “His conviction was based on the premise that a minted round of nearly pure silver that is neither the same size nor denomination as any existing U.S. coin and does not display identical imagery is nonetheless a counterfeit of U.S. currency.”

    The coins contained a silver content valued at the face value in USD, and the gold and silver certificates – redeemable in gold and silver – look nothing like any US currency. They were described truthfully as what they were when offered in exchange. NotHaus, for instance, described one coin in his hand as a $10 silver coin, and offered one for inspection when making a purchase. They were exactly what he said they were, and we agree that what people are willing to accept as money is money. As such, it doesn’t require government approval.

    Being cynical of government motives (surprise!), I suspect it was the threat of competition from a currency that had been readily accepted by people until $22M was in circulation. Not fraud, but competition was the problem. Something similar happened to Spooner and his superior and cheaper mail service. Monopoly government WILL maintain its monopolies at all costs.

    I thought you agreed that the quality most desired in ‘money” is that it be widely accepted. Of course how many people agree to accept it is crucial to that. That makes it the MOST relevant thing. You want to have to both ways here.

    You’re right: widely accepted being one of several important characteristics. I was just being overly sensitive. I’m better now, after spending some time in my safe room.

    My objection is to the notion that people “chose” federal reserve notes over commodity backed money, or any other type of money. People didn’t “choose” to have their gold (money) confiscated in 1933 by executive order. They didn’t “choose” to have their paper money depreciated by 40% at the stroke of a Presidential pen. People didn’t “choose” to have the gold window closed by Nixon in 1971. By no stretch can those actions be called “the will of the people”. They were diktats from above, pure and simple.

    Notice what happened with inflation in the US immediately after the currency was cut completely loose from its mooring.

    Wiliam Jennings Bryan got a major party nomination for President three times on a platform of inflating the currency.

    No surprise there. Democrats and Progressives like that sort of thing.

    Yes, it’s true that the resolution of that controversy fell well short of the unanimous agreement that you think should be required but it did result a very broad consensus that most people prefer a single dominant government managed currency.

    To no currency at all, their alternate choice. Essentially, no other currency is allowed, as we have seen. There wasn’t even a narrow consensus, just decisions made by those in power.

    Yes, the USD is the strongest, most widely used and highly regarded currency in the world, which is a sad comment on the state of other countrys’ currencies. Of course foreign governments love it as a reserve currency, it is relatively stable and allows them to create inflation on top of the inflation already inherent in the USD. I suspect many non-US fiat currencies have so little backing in the form of actual reserves as to be virtually worthless. Talk about juggling risk!

    That makes it hard for you to find people who want to contract with you using competing currencies even though you could do that for most transactions if you could find willing trade partners.

    Au contraire! NotHaus had little trouble finding willing trading partners for Liberty Dollars, nor did they subsequently have trouble finding additional trading partners. A piece of silver that can be exchanged for a $10 Federal reserve note isn’t a hard sell.

    Yes of course I am.” [suggesting that people freely chose federal reserve notes other currencies] I’m repeating that over and over, not just suggesting it.”

    They have been allowed no other real choice.

    U. S. Federal Reserve Notes are the most popular form of money in many foreign countries even where their use is illegal in some cases.

    Yes. Us dollars are far more desirable than Venezuelan Bolivars, among others. A sad comment indeed.

    If there are so many people who want to trade with you using other currencies, then it should be easy for you to find those people and trade with them using some alternative currency.

    The use of alternate alternate currencies discouraged by the powers that be. People have gone to jail for trying it. You can understand why that would dampen people’s enthusiasm for alternate currencies. We use what our masters tell us to use.

    >—” It sounds like something that might happen after money was already in use in one form or another as a medium of exchange.”

    You misunderstood me. I did not claim that government minting of coins using precious metals and paying their armies with those coins was the very first time precious metals were used as a form of money in trade.

    I did claim that was the decisive factor in its widespread use and acceptance.

    It’s good to be king. Telling people they will get paid in the currency with your face on it or not get paid at all is a great boost to its wide spread use. I agree that minted coins were first used widely by government edict, but we were talking about the origins of money.

    Like

Comments are closed.