Krugman-DeLong Smackdown
Oh my gosh, the Great One has jumped in as well. And perhaps he will bring in enough extra ad revenue to pay my obligation to David?
This part of Krugman’s post made me literally laugh out loud, such that people in Barnes & Noble gave me the stink eye: “The fact is that while Keynesians predicting a fast recovery weren’t really relying on their models, the failure of that fast recovery has nonetheless prompted quite a lot of soul-searching and rethinking.”
But joking aside, Krugman at least gave a good reply to my last post. In other words, Krugman is at least trying to offer a rationale for why the people wrong about (price) inflation since 2008 should be tarred and feathered, whereas Christina Romer (for example) shouldn’t have her credibility harmed because of her bogus argument for the stimulus package.
I really have other work I have to be doing today, and then I’m traveling all day tomorrow, so it might be a few days before I respond to this.
I never predicted much inflation after 2008 because:
1. The “inflation” would show up as preventing further collapses in asset prices. Those distorted prices are not a good thing. We all need to know what those assets are really worth.
2. Artificially super-low interest rates would cause perpetual bad times and banks won’t lend that much new funny money into existence in perpetual bad times. We need to know what interest rates ought to be in an unadulterated market and we do not and cannot.
3. Aren’t we up near 10% inflation anyway using 1980 methods?
http://www.shadowstats.com/alternate_data/inflation-charts
4. Didn’t Bob Murphy predict perpetual bad times due to super low interest rates back around 2009?
5. It would kill these Keynesian s to note that Austrian analysis is primarily based upon prices as the crucial source of economic information and how Keynesian and other interventionist policies distort that information flow. Wasn’t Rothbard’s theory of the Great Depression that we had a distortionary monetary “inflation” that was not detected in the CPI?
I think the quote you are looking for is this: “because of the imperfection of the index number, these calculations would necessarily lead in time to errors of very considerable proportions”.
http://wiki.mises.org/wiki/Great_Depression
There is a reference to Ludwig von Mises making that statement, and a link to the PDF with essays, etc. I admit I haven’t read through it all.
Rothbard’s opinion seems to be (based on my reading) that Irving Fisher never was committed to a simple policy of stabilizing the value of the dollar, and hands off everything else. This is from America’s Great Depression; Rothbard talks about 1932 (yes, Bob made me read this for his online course):
Rothbard backs up his position with a huge amount of documented direct economic interference that went on, particularly at the hands of Hoover.
Needless to say, it is impossible to simultaneously have both a gold standard and a central bank that attempts to keep prices fixed. This impossibility is one of the things that encouraged them to resort to trickery and interference. Trying to have it both ways never works.
Keep in mind also that exporting inflation is still inflation.
And here’s Peter Schiff talking about the Boskin Commission’s skewing of the CPI, substitution, and hedonics:
Peter Schiff – The Fed Unspun: The Other Side of the Story
http://www.youtube.com/watch?v=zdB9I79BQRI#t=80m12s
As you noted regarding asset prices, there’re these:
Home Prices On Track for First Yearly Gain Since 2006
http://www.economicpolicyjournal.com/2012/12/home-prices-on-track-for-first-yearly.html
December 27, 2012
November New Home Sales Up 15.3% versus November 2011
http://www.economicpolicyjournal.com/2012/12/november-new-home-sales-up-153-versus.html
December 27, 2012
Pending Home Sales Rise Again
http://www.economicpolicyjournal.com/2012/12/pending-home-sales-rise-again.html
December 28, 2012
Lumber Prices Hit 8-Year High in 2012…
http://www.economicpolicyjournal.com/2013/01/lumber-prices-hit-8-year-high-in-2012.html
January 1, 2013
What am I missing?
What is so funny about that?
There has been a sea-change among Keynesians from the new consensus view of the 1990s that the Fed could handle any problems to the view that fiscal policy had an important role and monetary policy could be a lot weaker and contingent than we had thought, as well as the importance of liquidity traps – which had been virtually forgotten. DSGE models are being questioned now. There is a considerable amount of discussion of working financial markets into macro models.
Some people got this a little earlier if they were paying attention to Japan. Then there was a major conversion to this after the crisis.
“The fact is that while Keynesians predicting a fast recovery weren’t really relying on their models”
The Romer prediction wasn’t based on her models? I’m with you Daniel, I don’t find it funny either, I find it unrealistic.
Daniel, I think what is funny about that is, if the prediction of fast recovery wasn’t based on their models, why would the failure of the prediction lead to soul searching and rethinking, rather than just leading them back to their models? If the models didn’t lead to these false predictions, why rethink the models?
Krugman writes:
“On the other hand, the unfortunate Romer-Bernstein prediction of a fairly rapid bounceback from recession reflected judgements about future private spending that had nothing much to do with Keynesian fundamentals, and therefore sheds no light on whether those fundamentals are correct.”
and
“The fact is that while Keynesians predicting a fast recovery weren’t really relying on their models.”
The same exact principle applies to the Austrian model. The Austrian model DOES NOT “predict” that price inflation will be X% when the money supply increases by Y%. Krugman is being unfair. While he claims that Keynesians are immune from bad predictions, he doesn’t grant that same immunity to Austrian theory. To him, Austrian theory says that price inflation goes up Y% when the money supply goes up X%. But that is not correct. Austrian theory does not contain that argument at all. In fact, it holds the exact opposite.
Rothbard explains:
“Mises agreed with the classical “quantity theory” that an increase in the supply of dollars or gold ounces will lead to a fall in its value or “price” (i.e., a rise in the prices of other goods and services); but he enormously refined this crude approach and integrated it with general economic analysis. For one thing, he showed that this movement is scarcely proportional; an increase in the supply of money will tend to lower
its value, but how much it does, or even if it does at all, depends on what happens to the marginal utility of money and hence the demand of the public to keep its money in cash balances.”
Krugman is not correctly describing the Austrian theory. He wants his readers to believe that Austrian theory predicts hyperinflation whenever the Fed prints a lot of money, and that’s that. If it doesn’t occur, then Austrian theory is wrong. Krugman is repeating this lie over and over again, almost as if he doesn’t want his readers to look closely into Austrian theory lest they “convert”. So he keeps “reassuring” his readers that Austrian theory is wrong because we haven’t had hyperinflation yet, so don’t bother with it.
Bob Murphy for his part made a bet with Henderson about price inflation, yes. But this bet was NOT a consequence of any Austrian models. It was Bob Murphy’s model. Austrian theory does not make predictions of the form
Price inflation = a + b * (Money supply growth)
What Bob Murphy did was what Krugman claimed Romer and Bernstein did. They, like Murphy, made a prediction that did not turn out correct, but they were not Keynesian or Austrian models.
Good points
Exactly.
You would think this painstakingly obvious explanation would end this debate instantly. Of course, these exchanges are always about advancing political agendas and have almost nothing to do with truth, knowledge, or an honest inquiry into either.
RPM’s bet is useful to Krugman/DeLong as ammo to mock those “supply-siders who are resistant to learning!” and anything that does not contribute to that goal will be promptly ignored.
Admittedly, it’s often very difficult to distinguish a prediction from a theory from a man.
If Mr. Smith is a self-professed X-ist, and Mr. Smith predicts Y, then it is quite easy to conflate Mr. Smith, Y, and X-ism all together.
It’s almost as if Krugman is saying people who make bets in Vegas are “representing” the professional mathematical field of statistics and probability.
You’re basically admitting that Austrian theory doesn’t tell us anything useful about the world. Economics is a positive science, whose purpose is to make accurate predictions, which consumers, businesses and policymakers can use to make the world a better place. If Austrian theory can’t do this — or at least attempt to do this — then it’s not an economic theory.
Economics is not a positive science. Past experiences do not convey any laws the way experience does so in physics and chemistry.
Economics is a science akin to mathematics and formal logic. It is not meant to make predictions. It only tells us the logical relations between various concepts.
Economists who try and predict the market, using the tools of physicists and chemists, are engaging in astrology, not science. Humans learn over time. You cannot discern constancies by observing the history of a learning subject.
You can observe me buying a ham sandwich for lunch 364 days in a row, but that doesn’t mean I will buy one tomorrow. I can choose not to. Anyone who uses a formula of my past actions, to “prove” to my own self what I will do tomorrow, is a palm reader who is loud when they’re right, and silent when they’re wrong.
You need to get it through your noodle that economics is not a positivist science. That which studies nature by presupposing constancy, namely us, are necessarily, i.e. logically, denying such constancy in ourselves, because we are claiming to LEARN such constancies, and that learning changes who we are, which then eliminates any chance of the claimed constancy to actually be a constancy.
We simply cannot use the same method on ourselves and claim to be learning anything other than history.
There is a good reason why professional economists are not the wealthiest people in the world. If economics really was a positivist science, that enabled predictions, then economists would be the wealthiest people. Instead, they are more or less working class people who work out of windowless dank and dirty offices in dilapidated colleges and universities.
Where are the economic models that can enable me to make billions of dollars over and over again? There are physics models that stand the test of time, but in economics, 3 years ago is considered ancient.
It’s not that after observing you buy a ham sandwich for lunch 364 days in a row, you will definitely buy one tomorrow; it’s that you will be more likely, statistically, to buy one tomorrow.
I agree w/ you that point-estimate predictions are futile. But we have things in statistics called confidence/prediction intervals, which tend to hold up well over time, as they are based on formal probability laws.
“It’s not that after observing you buy a ham sandwich for lunch 364 days in a row, you will definitely buy one tomorrow; it’s that you will be more likely, statistically, to buy one tomorrow.”
Statistically just means you are as ignorant as before as to what I will do. The statistical probability is actually zero if I don’t actually plan on buying a ham sandwich tomorrow.
“But we have things in statistics called confidence/prediction intervals, which tend to hold up well over time, as they are based on formal probability laws.”
Human action isn’t random.
Why I should care that Keynesians think government spending cures anything much less a price structure distorted by them? Or that they now think it is the magic cure and didn’t before?
BobR, I think the correct position is,
“Why should anyone care what Brad DeLong thinks about anything?”
He says things that make his target market feel good?
As I point out in the final paragraph here, Krugman shouldn’t be so hard. His own model allow for relatively high inflation — Krugman thinks the Fed can inflate more, and he wants it to. The problem is that Bernanke hasn’t been following Krugman’s model, and has been sterilizing changes in the monetary base. If Krugman had his way, Murphy wouldn’t have lost this best (or, would have come much closer to winning it). Murphy’s fault isn’t in his model, but in his expectations of Bernanke’s intentions.
Murphy’s fault isn’t in his model, but in his expectations of Bernanke’s intentions.
That’s it. Predictions in economics necessarily relies on future human knowledge and choices. Who in their right mind would try to predict something that applies to others which they cannot even predict for themselves?
I know I don’t try to predict what I will learn next year.
Bob, too bad about losing the 500 bucks. As you pointed out before, I think the most unfortunate outcome is that this gives Krugman et al extra soundbite ammo against everything Austrian (“See how wrong they were on inflation?”). This was a PR own goal that could have been avoided.
Btw, I thought this comment on Henderson’s blog was subtly awesome:
“David,
Has anyone pointed out yet that the implicit odds of the bet were not really even money, but actually favored you in terms of expected value (presuming the real odds were a coin flip)? Mr. Murphy is ponying up $500. Had he won the bet, he would pocketing the same nominal amount of cash- but less actual value due to the higher rates of inflation he would have correctly predicted.
-Josh Wexler
New Orleans”
John S., yes, I knew at the time of the bet that higher prices meant a weaker dollar.
Greater love hath no man than this, that he give his friends odds.
Pretty sure Henderson would’ve taken this bet at 3-1 (maybe even 5-1) odds. From an EV standpoint, Bob left quite a bit of money on the table.
Bob,
Your view can be charitably described as incoherent. I’m pretty sure you don’t understand the Romer-Bernstein problem, which is that they fed particular inputs into a model, then made predictions based on those inputs and that model. As it turned out, the inputs were wrong (in other words, the imperfection of economic data worked against them; they worked from the assumption that the economy had contracted by about 4% during the acute phase of the slump, when in reality that contraction was more like 9%. In other words, the predictions were based on flawed inputs rather than a flawed model. It doesn’t seem like you understand that distinction, which is really really bad.
Your argument, on the other hand, makes negative sense. We can put aside the use of headline vs. core inflation (which is a basic mistake on your end, by the way; there’s a good reason monetary policymakers use the core number; making monetary policy based on Middle Eastern politics is a not-so-great idea), and focus on your claim for why your prediction didn’t come true. Supposedly, the Fed tripling the size of its balance sheet didn’t cause runaway inflation because of some other factors (Europe? Something else? I don’t really get it…).
But your implication, if we follow it through, is that, as I understand it, you seem to agree with the Krugman-DeLong argument that the Fed’s aggressive easing was inflationary and staved off heavy deflation. So then, if you understand the implications of that, you should be celebrating aggressive money printing by the Fed. But I think there’s something even worse going on here. I think you think there’s some “natural” price level that the Fed is battling against. that markets want to reach, and that enduring deflation is the only way to get there.
That’s a terrifying view for anyone who believes in good economics. It says that we can (and should) endure mass bankruptcies for unemployed workers, mass foreclosures of their homes, a collapse of the financial system and destruction of the credit channel that comes with it (as those workers default on their liabilities, driving down asset values on banks’ balance sheets), and a generation of high unemployment just so we can reach some price level that you think is a platonic ideal. In other words, we can live with a Great Depression because we need to get to a “natural” price level (which is itself a nonsensical idea; the price level itself is a function of supply and demand for the money supply, and there’s no coherent reason the money supply should be exogenous).
In other words, it’s pretty clear that Christy Romer’s prediction was wrong because her inputs about the output gap were wrong. Your prediction was wrong because your model was wrong. Or, worse, your model was right, but you don’t understand the implications of deflation. I can’t decide which is more terrifying…
Alex wrote:
We can put aside the use of headline vs. core inflation (which is a basic mistake on your end, by the way…
It’s my mistake for thinking DeLong should have shown the chart of the thing on which David and I were betting?
No, but I think betting on something of dubious economic value is more like betting on a football game than like betting on a model– if Saudi Arabia goes to war tomorrow, I promise oil prices will skyrocket. If there’s a drought in the Midwest, food prices will skyrocket. But I’m not going to bet on Saudi Arabia going to war or a famine occurring in the Midwest because I have no expertise in foreign policy or meteorology. But betting on something that is impacted by so many exogenous factors like global supply and demand, geopolitics, and the weather (all of which impact food and oil prices a whole lot) doesn’t make much sense for someone claiming to be betting on an economic model…
There is no Austrian model that predicts how high or low price inflation will be. What model are you talking about?
Alex,
Why should you promise that food prices will skyrocket if there is a drought in the midwest, or oil prices will skyrocket if Saudi Arabia goes to war? Shouldn’t the government intervene to prevent prices from rising less millions of people go hungry, or without heat during the winter?
I mean, it sounds like you are clinging to an economic model wherein rising prices in either case is some sort of ‘Platonic ideal’ …
“Your prediction was wrong because your model was wrong. Or, worse, your model was right, but you don’t understand the implications of deflation. I can’t decide which is more terrifying…”
You can’t decide which is “more terrifying” except for the part where you used the word “worse”?
“Really, really bad”, “terrifying”, “negative sense”, “terrifying”. Your post would make more sense if you lived on the south side of Chicago rather than your perception of what someone does or does not know.
Mostly the banks would have to close, but if the government stays out of the way, then many people would be able to make a run on the bank and get their money out.
Protecting the banks from bank runs turns a small problem into a national, and even a global problem.
Maybe we could also just stop taxing and regulating those whose projects must be liquidated in the correction, so that they could keep more of their money and not be burdened with bureaucracy? It was regulation that got them into the mess we’re in, anyway.
If you truly care about people, you’ll stop trying to take their money. The last thing someone needs to worry about during a crash is a collectivist infrastructure. The free market can handle roads and railroads and ports.
Maybe also stop the cronyism toward Unions which allows them to artificially keep the costs of production high? And stop the cronyism toward businesses which allows them to price out startups; and then let the market decide how much market share businesses will have.
If government is in people’s way during a correction, then it’s kind of hard to say that WE’RE the bad guys for wanting a return to free market prices.
I think you don’t understand how a banking system works. Banks, in part, provide liquidity transformation to an economy– they match those who want to save funds with those who want to borrow. They necessarily borrow short and lend long; they’re not warehouses for funds. So, in the case of a panic, they could well have a perfectly sound balance sheet, but if everyone comes running to withdraw their funds, they have to liquidate a bunch of assets to meet redemption requests. But if everyone is liquidating at once, that drives the value of those assets down. That’s why we generally think of bank runs as a bad thing– saying “Bank runs are OK because those who run to get their money out first will be able to do so” is perfectly wrong; bank runs are hugely value destroying, not just because they pull the plug on perfectly profitable projects, but also because they destroy the credit channel itself (Ben Bernanke in his academic days had a lot of good work on how damaging that was during the Great Depression).
In other words, yes, preventing banking panics is generally a good thing.
It seems to me that “preventing banking panics” by criminal entities such as the Fed has created the moral hazard that the banking system is operating under, i.e. fractional reserve banking, TBTF, etc. This is precisely the reason for the 2007/8 debacle, and why the next crash will be bigger and sooner than we think. But I don’t pretend to be an economist, just having a rudimentary understanding of basic economic laws and knowing how to run a lemonade stand is sufficient. Inflation (i.e. the expansion of the monetary supply, nothing to do with prices) is just a way for the unproductive forces in a market to skim any sort of productivity increases of the productive forces, nothing more and nothing less. The tendency of free markets is to do more with less, which leads in an ideal world to lower prices, and real prosperity for everyone. Why anyone would think that’s a bad thing, is a complete mystery to me.
CPI is a totally bogus way to measure inflation, I don’t care what’s included or not.
Bernanke should have been studying the 1920/21 depression, instead of wasting his time.
If the banks held 100% reserves, there wouldn’t be a problem.
What’s the point of depositing something if you don’t expect it to be there when you want to take it out? Conversely, what’s the point of earning that which is to be used as money if it doesn’t function well as the money, due to its purchasing power continually being lost?
Here’s a good article on how banking would work under a true gold standard.
Interest Rates in a Gold Coin Standard
http://lewrockwell.com/north/north1075.html
And here is Peter Schiff taking on Ben Bernanke’s recent lecture series on the Great Depression and the recent housing crash:
Peter Schiff – The Fed Unspun: The Other Side of the Story
http://www.youtube.com/watch?v=zdB9I79BQRI
Herbert Hoover was an interventionist, and not laissez faire:
Is Budget Austerity Modern-Day Hooverism?
http://mises.org/daily/5215/Is-Budget-Austerity-ModernDay-Hooverism
Here’s Peter Schiff addressing Ben Bernanke’s misunderstanding of the Hoover/Mellon/liquidationist issue (preceded by a couple of minutes about the causes of the 1929 crash):
Peter Schiff – The Fed Unspun: The Other Side of the Story
http://www.youtube.com/watch?v=zdB9I79BQRI#t=13m29s
Peter Schiff recommended this video regarding Ben Bernanke’s understanding of the recent housing bubble before it crashed:
Ben Bernanke was Wrong
http://www.youtube.com/watch?v=9QpD64GUoXw
This is Tom Woods addressing issues of deflation, deflationary spirals and sticky prices/wages from the Austrian perspective:
Answering the Same Old Arguments Against Sound Money | Thomas E. Woods, Jr.
http://www.youtube.com/watch?v=h-PxMzSyujw#t=18m59s
Besides, if the banks weren’t able to lend, and if the government would get out of the way, our neighbors who had extra real wealth (not paper) would be able to loan it out.
The problem really is government interventions every step of the way.
There we go, that’s just the problem– you have an idea of banks as warehouses for funds rather than liquidity transforming institutions. And that view is just oh so badly wrong.
The idea is that banks aggregate savings and deploy them to MORE productive uses than sitting in vaults. Holding 100% reserves would make them… Warehouses for funds. The point is that that structure is socially useful but necessarily prone to panic. Which is why things like deposit insurance and a lender of last resort were created in the first place. Is there a potential moral hazard problem there? Sure. Which is why deposit insurance comes with strings attached that restrict how deposits can be used.
But holding 100% reserves is a painfully awful idea– it’s like arguing that, because ovens are prone to catching fire, we should eat exclusive raw food and ban them rather than, you know, trying to make them safe…
Dan,
I know there’s nothing as complicated as a model. But I do know that the Murphys and the Schiffs insist that the Fed expanding the money supply is inflationary (which Keynesians, monetarists, and anyone else who actually DOES have a model, all things being equal, agrees with). Or, if that’s not the case, then there’s no reason for them to care about what the Fed does at all, right?
And Richard, the promises I make are based on simple supply and demand. The government can’t intervene to drive down food or oil prices across the board because those are scarce resources. It could subsidize those prices, but that’s simple redistribution– it gets paid for through taxes. It can try to increase the supply of food or oil, but that’s kind of hard for government. On the other hand, inflation as economists measure it is rather more straightforward– it’s a function of the supply and demand for money itself, as well as demand for goods. Think of it this way– in a simple equilibrium model, Apple could easily build enough iPhones for every American to have 2 or 3 or 5; there’s no supply constraint. The constraint is demand; how much people can afford to pay for those phones, and how much Apple’s inputs cost. The price of the iPhone reflects a rough equilibrium that maximizes Apple’s profits. Charge too much and people will substitute other phones. Charge too little and they’ll be leaving money on the table. Food and fuel are inherently supply constrained because there’s only so much we can create.
Money itself is more like an iPhone; the Fed can print as much or as little money as it wants. There’s a platonic ideal there, though; if prices are falling, credit won’t be extended, since people will have to repay loans with dollars worth more than the ones they borrowed in. On net, that’s really bad for the economy, since it discourages investment in productive long-term activities. High inflation is bad too because it rapidly erodes savings, encourages consumption at the point of purchase, and discourages lending. There’s a happy medium there of steady core inflation somewhere between 1 and 5% (most central banks unofficially shoot for 2, but there’s little evidence of corrosive effects at less than 5%), which encourages borrowing and lending, discourages hoarding of cash, and is consistent with long-term growth.
Austrians seem to think that making the supply of money itself exogenous is somehow a good idea; in other words, that the amount of money shouldn’t be set consistent with a target level of inflation and employment, but that inflation and employment should respond “naturally” to the supply of some physical resource– maybe gold or silver or platinum or I don’t know what. But just a little bit of thinking reveals that determining the cost of capital based on how much shiny metal comes out of the ground in a given year is a bit nonsensical…
Not so fast there. The measurement of inflation is far from straight forward. Which goods, and why? For example the Producer Price Index measures completely different things to the Consumer Price Index. There’s also commodity data, and the price of labor. There’s also just good old fashioned prices of gold, silver and copper (if you go by those measures, inflation has been huge).
Figuring out what goods and services to measure is a rather difficult technocratic task, but it’s not impossible, and core CPI tends to do a decent job (as does MIT’s “billion price project”). Labor costs are wages, and inflation certainly plays a part in those (though they are also taken into account in setting consumer prices; the price of a cheeseburger reflects the wages of the burger flipper too, among other things).
But commodity prices are a poor measure of inflation for the same reason as food and oil; they’re supply-constrained. Only they’re even worse measures because the markets, especially for gold, are tiny. A few rich people can themselves drive gold prices pretty substantially. Which, in itself, is a good reason not to pay attention to those prices when making monetary policy. Realistically, the only coherent reason to hold gold is to hedge against tail risk (complete economic collapse).
A “difficult technocratic task”? Laughable… you might as well say, “just trust the experts, we know what’s best.” The same experts who got us into this mess.
Core CPI is useless to the average family for whom food, and fuel make up a significant proportion of their budget. It is even more useless to producers who don’t buy consumer goods.
The gold and silver market are large in India and China, driven by the aspiring middle class, not by a handful of rich people. In Western nations silver used to be the friend of the working class (more than a century ago), but governments beat it out of them. Copper in modern times is not supply constrained at all, the US is running at about half of its historic peak capacity, and there’s no shortage of available copper in the ground, just lack of incentive to dig it out. Copper prices represent a mix of high volume trade, industrial demand, and all sorts of supply side factors (like wages, electricity prices, fuel price, etc).
Using LME prices from USGS report (2012 price is my eyeball estimate at all of 2012 on LME graph, prices are US per pound):
2007: $3.228
2008: $3.155
2009: $2.336
2010: $3.417
2011: $4.000
2012: $3.628
Note the dip in 2009 due to debt-deflation, and the catchup in the 2011 and 2012 due to money injection. Probably copper prices are the most closely watched of all economic values, far more meaningful than core CPI.
You’re confused about why these measures are used. Sure, core CPI is a poor measure of the cost of living… which is why it’s not the measure used to calculate cost of living adjustments for things like social security. It IS used by central banks to gauge their monetary policy, since that requires filtering out prices that are jumping because of supply shocks– put in other words, it makes little sense to raise interest rates to stave off a jump in headline inflation if that jump is driven by, say, war in the Middle East causing an oil supply shock or climate change bringing about a drought that causes a food supply shock.
As for the market sizes– the best estimate I’ve seen is that the financial market for gold is about $2.5 trillion. Or a sixth the size of the US economy. For a national currency, that’d be exceptionally small. For a global economy, that’s miniscule. But, putting aside size, there’s no coherent reason why your medium of exchange should itself be a commodity, whether it’s gold, silver, or copper. All that represents is backsliding into barter…
What if the supply is being shocked by inflation, rather than turmoil in the Middle East?:
The truth about rising gas prices, the stock market, & Warren Buffett’s taxes
http://www.youtube.com/watch?v=eQYy25kLijA
Time to Lay the 1973 Oil Embargo to Rest
http://www.cato.org/publications/commentary/time-lay-1973-oil-embargo-rest
I strongly suspect that these Middle Eastern conflicts are manufactured by the Progressives in order to cover up the effects of inflation.
Yeah, liberals manufacture unrest in the Middle East to cover up for Fed policy…? Maybe it’s the black helicopters at Area 51…? Are the liberals manufacturing a drought too to drive up food prices? Jesus, man, this isn’t even worth arguing with you if you think that nonsense is gonna get you anywhere…
The reason that it’s clear that it’s supply shocks driving food and oil prices and not increases in the monetary base is pretty straightforward– because those goods and services which aren’t supply constrained are barely budging. There’s no reason the Fed “printing money” should be pouring into food and oil exclusively while leaving, say, wages for hairdressers, restaurant servers and lawyers flat, and the prices of microwaves, refrigerators and TV sets stagnant at best, too.
When too-loose monetary policy is causing uncomfortably high inflation, that inflation feeds through the entire system, not just particular goods (especially not, coincidentally enough, the ones that are traded on global markets and happen to coincide with shocks to their supply).
“I know there’s nothing as complicated as a model.”
Then why did you say this,
“…doesn’t make much sense for someone claiming to be betting on an economic model”?
Call it a “belief system” if you will. That’s a more accurate description of what they do anyway.
Alex,
Thanks for the economic lessons, but I can’t say agree with what you are saying.
And that’s the point I was trying to make. In your responses to Bob you are acting like all this stuff is just obvious, when it isn’t at all.
For example, I don’t see how it is possible that credit can’t be extended or investments made when prices are falling – assuming a constant money supply and demand to hold money, prices couldn’t be falling unless more goods were being produced, which requires increasing investment and extension of credit. (And that has happened in the past). And, if people can price future costs of goods (and debt) based on expected inflation, they can certainly do it under expected deflation. (Never mind your comparison of Apple with food or oil suppliers, which I don’t find convincing at all).
I think you should at least read some of the stuff Austrians actually say instead of just thinking their policies are obviously wrong before you start claiming they would only obviously lead to mass suffering.
Credit CAN be extended, but it’s discouraged. In a very simple example, if I want to borrow, but I expect prices to fall by 2% year over year instead of rising by 2%, the dollars I borrow in will be worth less than the dollars I have to pay back the investment in. That’s a pretty terrible proposition for me, especially if my income is falling with prices (as happens under deflation). Same thing with any investment that requires borrowing.
And deflation also discourages investment on the part of lenders. If prices are falling, lenders can sit on cash and the cash will be worth more in a year than it’s worth today. Which makes them even less inclined to lend to borrowers, who are a greater credit risk when their incomes are falling along with prices. That’s a pretty bad outcome in the aggregate, since there’s a whole lot less long-term investment happening than is optimal.
The difference between inflation and deflation, in part, is that nominal interest rates are unbounded on the top end, but bounded on the bottom– expected inflation is built into any long-term borrowing; the interest rate is the sum of default risk, the time value of money, and inflation risk (OK, that’s a simplification, but that’s most of it). When deflation is expected, no lender will ever charge a negative nominal rate of interest; they’re better off just holding cash. That huge disincentive to invest and borrow is why 2% inflation is close to optimal, while 2% deflation is catastrophic.
And if you think my comparison of products whose price is set overwhelmingly by demand and those whose price is set by both natural supply and demand is unconvincing, it’s useful to know what about it you find unconvincing…
This is ridiculous. The borrower and lender simply agree on an interest rate that takes inflation/deflation expectations into account. They are neither encouraged nor discouraged from trading, they merely negotiate a price between themselves.
The only things that can really discourage trade completely, are unworkable regulations imposed from above, and/or high risk and uncertainty preventing the borrower and lender from being able to trust one another sufficiently to make a deal.
This is ridiculous
Funny. I always thought Austrian Business Cycle Theory said that inflation encouraged investment beyond the production possibility frontier.
Ah, now you really demonstrate your confusion. Please explain what nominal interest rate someone will be willing to borrow at if they expect wages and prices to fall? In other words, if the dollars I have to repay my loan in are worth more than the dollars that I take out the loan in, taking out that loan is a terrible proposition for me. Under modest inflation, the process is pretty straightforward– you just price the modest inflation into the interest rate. But the whole point, which is at the heart of your confusion, is that YOU CAN’T PRICE DEFLATION INTO AN INTEREST RATE. This is because the option always exists to just hold cash rather than lend it out in that circumstance. If you want to borrow $10 from me for a year, and markets expect that $10 to be able to buy as much as $8 does today in a year, I’m not going to lend you $10 and tell you to repay $8; I’ll just put my $10 under my pillow.
Are you getting it now?
“YOU CAN’T PRICE DEFLATION INTO AN INTEREST RATE”
Please explain.
Isn’t it all just a matter of time preference? If I am holding money, and I expect my money to be worth 8% more next year because of deflation, why wouldn’t I be willing to lend it out to you at 15%? And conversely, if you expect that the money you’re looking for some investment is expecting to return 30%, why would you be willing to borrow it from me at 15%?
Doesn’t discounting work both ways?
I guess I’m just not getting it.
Oh, the lenders are more than happy to lend at that positive interest rate– it’s the borrowers that are the problem. Borrowers pay positive interest rates not just because of the time value of money, but in part because they expect some steady amount of inflation to erode the real value of that debt over the long run(it’s part of the rationale behind the 30-year mortgage).
But here’s where the mismatch happens on the borrower’s end– if the borrower is expecting deflation, the dollars she has to pay her loan back in are worth more than the dollars she borrows. The lender is never going to loan her money at a zero nominal rate– that would be a stupid proposition on the lender’s part. So the borrower would have to pay back not just the principal, but also an interest rate in dollars that are worth more than the ones she borrowed, AND her wages will likely have fallen in the meantime, since, you know, that’s what deflation encompasses. Just to be able to pay back the loan, the borrower’s return on the investment would have to be pretty dramatic, and that chills even the most promising borrowers.
So, in the aggregate, deflation makes borrowers quite unwilling to take out loans, and that’s bad for the economy in the aggregate, since there are a whole lot of great business ideas and investments that aren’t being undertaken because of deflation. Sure, some of those investments might go bust… but plenty of them won’t, and in the aggregate, we want an economy producing more rather than less, even if some number of investments end up being lemons.
Why not just offer a higher interest rate, then?
You said:
What you’re describing is a reduction in purchasing power, which is price inflation, not deflation.
If the SAME good COSTS me $10 now, but $8 later, that is price deflation – an increase in purchasing power.
And yet what you are inadvertently admitting is that loaners don’t want to be repaid with devalued currency unless they can get a higher return than by simply holding their money (or whatever they will loan).
But so what if people don’t want to loan, right? It’s not like we’re entitled to borrow other people’s property.
Let’s not say that the “problem” with deflation is that government isn’t tricking enough people into loaning their stuff out closer to our terms.
That’s just the point– a higher rate of interest is how you price in INFLATION expectations. That rate is unbounded because you can charge as much interest as you want. But you can’t charge a NEGATIVE nominal rate of interest to price in expected deflation. In other words, no one will ever lend someone $10 for two years, under the stipulation that they be repaid $8– heck, they won’t even lend anyone $10 for two years under the stipulation that they be paid back $10, since it’s more profitable just to hold the $10.
Yes, deflation is an increase in purchasing power– but price deflation tends to come with wage deflation (or, more typically, high unemployment, since wages tend to be sticky downward). but all that tells you is that deflation benefits capital, not that it’s a good thing in the aggregate (in fact, it’s really really bad).
Then the dogma at the heart of your ideology comes out– the idea that no one is “entitled to borrow someone else’s property”. Well, sure. But in a given economy, there are net savers and net borrowers. Some people want to invest more than they can afford to at the present (whether in education, starting a company, buying a home, etc.) and those who want to consume less than they can afford to. The purpose of a financial system is to match savers with excess capital but a shortage of profitable projects and borrowers with potentially profitable projects but a shortage of capital. The reason a low, positive level of inflation (again, probably between 1 and 5% a year) is a good thing is that it encourages that kind of investment. It discourages financial institutions or savers from sitting on their cash (by slowly but predictably eroding the value of cash held as cash) and encourages borrowers to take out loans to fund their projects.
I’ve heard the assertion that this is “stealing” because your dollar buys less in 10 years than it does today. But that’s a silly idea; all a dollar promises is that it will purchase a dollar’s worth of goods and services; if markets reasonably expect that purchasing power to decline slowly over time, they should invest it; over the long run, that’s been a pretty good way not just to protect savings from inflation, but to outperform it pretty substantially (compare average returns in the S&P 500 to average annual inflation, for instance, over the last 50 years). And it’s no more “stealing” than, say, if you hold oil and Canada makes a giant discovery that drives down the value of your oil by 25%.
Either that or expectations of greater profit from investment.
If I’m a bank and I think I can make a greater profit in one year than the increase in purchasing power of gold, then I would be willing to offer a higher interest rate.
People still loan money in a commodity money standard.
Not a problem, if wages are decreasing slower than prices.
The high unemployment is the result of a separate issue; Price deflation doesn’t lead to high unemployment.
For example, there was no Long Depression:
Answering the Same Old Arguments Against Sound Money | Thomas E. Woods, Jr.
http://www.youtube.com/watch?v=h-PxMzSyujw#t=18m59s
The high unemployment is due to a correction of malinvestments, the profitability of which was an illusion created by prior credit expansion:
Neoconservative David Frum Hearts the Fed
http://www.youtube.com/watch?v=1d1rcaX-lzU
(On Mises vs. Friedman regarding the cause of the crash of 1929)
Also, it doesn’t help that Hoover and FDR were hindering the free market.
Who cares what price deflation does to a meaningless aggregate number? It’s individuals who matter.
Those who invested in such a way as to hold real value will find that they are wealthier, after the crash, than the government-subsidized fiat system led others to believe.
Those who were misled by the government into putting faith in worthless paper will find the opposite.
Not everyone is effected in the same way after a crash. There’s no “us” as far as economic decisions are concerned.
If you want to have the best chance at your own personal recovery, if you lost wealth after a crash, then agitate for getting the government off our backs, because they are not only in your way, but they actually caused the crisis to begin with.
If the free market thinks that’s good, then it will offer that without central planning.
But the kind of investment that is undertaken with a centrally planned low interest rate is malinvestment; The free market didn’t prefer to save resources in order to pursue that particular investment, but the central planners mislead investers with artificial credit expansion.
New money does not equal new wealth, but people who don’t know better treat it like it is, and so they invest in the inherently unsustainable, artificially stimulated investment.
Since saving and consumption preferences hadn’t likewise changed to facilitate the artificially stimulated projects, they will have to be liquidated.
Bailing out these companies eventually leads to price inflation, and price controls lead to shortages (and certainly the destroying of food in order to keep prices from falling qualifies as a shortage).
Except that when we try to invest it in gold and silver so that our purchasing power will increase, the government taxes or confiscates it.
And really, the whole point of fractional reserve lending is so that the note issuer can get something for nothing:
The Founding of the Federal Reserve | Murray N. Rothbard
http://www.youtube.com/watch?v=Ta7q1amDAN4
War and the Fed | Lew Rockwell
http://www.youtube.com/watch?v=Tl9lS5k7H5M
Forgot to address this one.
Lower prices are good for me. If I lose money on the particular store of oil I have, but my standard of living just went up because everyone’s costs just went down, then I’ll be recouping those losses in no time.
Oops, that second block quote is from this link:
Interest Rates in a Gold Coin Standard
http://lewrockwell.com/north/north1075.html
Alex,
You wrote;
And if you think my comparison of products whose price is set overwhelmingly by demand and those whose price is set by both natural supply and demand it’s useful to know what about it you find unconvincing…
I am responding to this comment;
Think of it this way– in a simple equilibrium model, Apple could easily build enough iPhones for every American to have 2 or 3 or 5; there’s no supply constraint…
Of course there are ‘supply constraints’. The factors of production that are required to make up an iPhone are limited. Plastic? (petroleum based), maybe gold (perish the thought) – for circuits?
Perhaps you are saying that the demand for ‘natural’ products (like oil) is inelastic, vs elastic (like iPhones)?
If that is the case, I still don’t see how it follows there is no ‘supply constraint’.
It’s interesting you mention the iPhone given the context of our discussion over deflation. The computer and consumer electronics industries are arguably the most dynamic and vibrant industries in the economy despite yielding products that not only get better and better, but also less and less expensive
Given your position on inflation vs. deflation, perhaps you think it’s a wonder that anyone would want to invest in making such products.
Richard,
in an environment of 10% annual deflation, what nominal interest rate would you charge me for borrowing money from you for a year?
Christopher,
Well, more than 10% anyway.
My point was that economies do not need ‘mild’ inflation (Alex said 1-5%) in order to expand. They can expand perfectly well under mild YoY deflation ( I would consider 10% YoY deflation a ‘bust’ type of deflation. Perhaps necessary to re-allocate mis-allocated capital- but not a ‘normal’ YoY deflation in a growing economy).
See http://mises.org/books/less_than_zero_selgin.pdf
There’s a supply constraint, sure, but supply isn’t driving the price. The point isn’t that plastic is utterly value-less, but that the price of my iPhone isn’t moving based on the price of the physical materials that go into making my iPhone; the same is the case with microwaves, refrigerators, haircuts, etc. It’s not that labor markets, consumer goods markets or electronics markets aren’t supply constrained, it’s that they’re not very volatile. You don’t see, for instance, plastic supply shocks that send the prices of refrigerators and microwaves skyrocketing, or bubonic plague that gives us a shortage of servers at restaurants. We do, on the other hand, regularly see oil supply shocks due to turmoil in the Middle East, or food supply shocks due to drought.
Alex,
Yes, some prices are more volatile than others.
But low volatility isn’t always explained by a lack of supply constraint (which I interpret as supply elasticity), but also demand elasticity.
And the demand for Apple products and iPhones is elastic. (I think more elastic than their supply).
http://blog.garven.com/2010/04/07/the-price-elasticity-of-demand-for-the-apple-ipad/
http://robertghansen.blogspot.com/2009/06/apple-iphone-price-elasticity.html
You forget that plastic is a byproduct of oil… I would argue that since our food supply is global, it is much less sensitive to droughts than before. One way around the “volatility” issue would be to take a moving average (pick a period), which is what stock investors do.
But never mind all that, looking at prices is just a silly way to measure inflation, since inflation is clearly defined in terms of the supply of money, and not in terms of prices.
Therefore, the only way to measure inflation is to measure how much money is counterfeited, period.
Trying to centrally plan an economy by targeting some mystical price level of washing machines or iPhones or whatnot is like trying to control the weather.
The people at the controls of the money printing scheme of course know that targeting “inflation” is just a sophisticated way of cheating the poor and middle classes out of their earned productivity gains, in favor of the privileged and politically connected. It’s downright tragic that the powers that are supposed to stand up for the poor have no issue enthusiastically defending this.
Wait, what…? Sorry, making up your own lexicon is silly– inflation is a rise in wages and prices. Increases in the monetary base are increases in the monetary base; they’re two things that are often related, but they’re distinct. Printing money isn’t inflation– printing money is printing money.
And you’re confused about the whole “central planning” thing (confusion is a central theme among the “Austrian” crowd); all a central bank does is match the supply of money to the economy’s productive capacity. What the last 5 decades of economics have taught us is that the economy is capable of producing a certain amount of goods and services without inflation accelerating (we call that the Non-Accelerating Inflation Rate of Unemployment, or NAIRU). That depends in large part on the money supply. Print too much and you end up with very low unemployment but spiralling inflation, and that’s bad. Print too little money and you end up with high unemployment and borderline deflation, and that’s even worse a whole lot of the time.
The idea that there’s some “natural” supply of money is a byproduct of a serious misunderstanding– what’s exogenous is the level of employment and inflation; those things are, in turn, influenced heavily by the money supply. If you make the money supply exogenous (in other words, if you replace the central bank with “currency” backed by commodities or precious metals, you’ve got a money supply that’s determined by how much of that commodity you extract in a given year. There’s nothing “natural” about that– it’s just random. That way the money supply depends not on the judgment of technocrats, but on miners’ luck. Which is a pretty transparently nonsensical way to build a monetary system.
“But I do know that the Murphys and the Schiffs insist that the Fed expanding the money supply is inflationary ”
So you clearly “know” it all wrong. The Austrian position (which I guess I can attribute to Murphy) is that the Fed expanding the money supply is inflation itself. The “bet” (which I believe he should never have made) was about “price inflation” which is a secondary consequence of inflation.
Gold isn’t just a shiny metal. It’s a commodity, unlike paper notes.
And commodities are precisely what should determine the cost of capital, since the reason we trade at all is to eventually acquire something of tangible value.
Commodity money already has value on the market as a commodity, so it has the best ability to represent prices in terms of every individuals’ preferences – which is how real value is determined. From this real value is where natural prices come – it is completely subjective to the valuations people place on those things which they have to trade.
Pretending that paper notes are valuable skews people’s ability to perceive the value of their trading goods in terms of goods that they will buy with the paper money.
Where paper money has misrepresented people’s individual preferences, those projects are unsustainable (being against individuals’ preferences), and so they must be discontinued in order to be sustainable – or else people must be bullied into sustaining the preferences of those who were able to first use new money.
Our current structure of production is highly based on fraudulent paper, even extending around the world due to our ability to export inflation (the Fed’s notes being the reserve currency of the world). So a full correction will mean the replacement of a worldwide politically constructed structure of production (new money having been handed out based on politics) with one that is based on the preferences of every individual.
This will be chaotic and necessary, but the alternative is much worse. The alternative is tyranny.
Ah, this is the heart of where this whole movement’s confusion comes from. You think there’s some kind of fraud being perpetrated on people because they can exchange paper notes that don’t have “real” value for things that do have “real” value– in other words, we should be able to trade money for things because money has value. In reality, the opposite is true– money has value because we can trade it for things.
We don’t “pretend” that paper notes are valuable– paper notes ARE valuable because we believe that they’re valuable. I don’t go to Starbucks and meditate about what a fool the barista is because he gave me a delicious coffee and all I gave him was a piece of paper with a picture of a dead President on it, and neither do you. And we can go a step further– why does gold have value to us? Is it because we can turn it into shiny jewelry to give to our wives and girlfriends? If we decide that it’s also money, won’t that “artificially” drive up its price way beyond its value to us as pretty shiny yellow metal…?
The part of the economic system that the Austrian religion can’t comprehend is the notion that money can itself be valuable just because, in an advanced economy, it facilitates liquidity, and that it’s not a “fraud” for people to rationally prefer to hold “fiat” money.
Of course, that system can always break down– if the monetary authorities are irresponsible, you can end up with fiat money that no one has any faith in because it’s not scarce; that’s how you end up with Weimar or Zimbabwe-style hyperinflation. But, generally speaking, even when we’ve had not so great monetary authorities, they’ve never been quite that bad.
But then we can compare that to the alternative, where the amount of money circulating depends on how much shiny yellow metal, shiny gray metal, or anything else comes out of the ground at a given time. That’s a nice recipe for instability…
This is false. The function of money is to acquire a liquid equivalent of that which you expect to be able to buy with it, IN TERMS OF that which was given up for the money.
In other words, I decide how much money to accept in return for my goods or services based on my valuations of that good and also on those goods which I expect to have when I trade the money for something else.
If the money has no value in and of itself on the market, then it can’t possibly function as the money. You can trick people into thinking that painting your fence is better than an apple, but that’s not sustainable at all, without force.
In fact, our current fiat system was BASED on a gold standard, which is the only reason why it kind of works:
Why the Greenbackers Are Wrong
http://www.tomwoods.com/blog/why-the-greenbackers-are-wrong/
You said:
The instability of which you speak was because of deviations from the gold standard.
We’ve never had a pure gold standard in America; but to the extent that we were, we were better off:
Smashing Myths and Restoring Sound Money | Thomas E. Woods, Jr.
http://www.youtube.com/watch?v=HAzExlEsIKk#t=29m26s
(29:26)
Economic Cycles Before the Fed
http://www.libertyclassroom.com/panics/
This one’s short:
No, Rick Santorum, We Don’t Need a Little Inflation
http://www.youtube.com/watch?v=J6a10UuQFOM
This is false. The function of money is to acquire a liquid equivalent of that which you expect to be able to buy with it, IN TERMS OF that which was given up for the money.
In other words, I decide how much money to accept in return for my goods or services based on my valuations of that good and also on those goods which I expect to have when I trade the money for something else.
So how does that contradict “money has value because we can trade it for things”?
If the money has no value in and of itself on the market, then it can’t possibly function as the money.
Really? What “value in and of itself on the market” do dollars, euros and yens have?
The instability of which you speak was because of deviations from the gold standard.
No. He doesn’t say “look what happened when we were on a gold standard”, he says: “if we institute a gold standard, so and so will happen”.
“money has value because we can trade it for things”
That’s the Austrian view also.
“guest” either doesn’t agree with the Austrian view on money or else doesn’t quite understand it.
That’s not really accurate. Saying “money has value because we can trade it for things” leaves out a big part of the story.
http://mises.org/daily/1333/The-Origin-of-Money-and-Its-Value
“Even though Menger had provided a satisfactory account for the origin of money, this process explanation alone was not a true economic theory of money. (After all, to explain the exchange value of cows, economists don’t provide a story of the origin of cows.) It took Ludwig von Mises, in his 1912 The Theory of Money and Credit, to provide a coherent explanation of the pricing of money units in terms of standard subjectivist value theory.
In contrast to Mises’s approach, which as we shall see was characteristically based on the individual and his subjective valuations, most economists at that time clung to two separate theories. On the one hand, relative prices were explained using the tools of marginal utility analysis. But then, in order to explain the nominal money prices of goods, economists resorted to some version of the quantity theory, relying on aggregate variables and in particular, the equation MV = PQ.
Economists were certainly aware of this awkward position. But many felt that a marginal utility explanation of money demand would simply be a circular argument: We need to explain why money has a certain exchange value on the market. It won’t do (so these economists thought) to merely explain this by saying people have a marginal utility for money because of its purchasing power. After all, that’s what we’re trying to explain in the first place—why can people buy things with money?
Mises eluded this apparent circularity by his regression theorem. In the first place, yes, people trade away real goods for units of money, because they have a higher marginal utility for the money units than for the other commodities given away. It’s also true that the economist cannot stop there; he must explain why people have a marginal utility for money. (This is not the case for other goods. The economist explains the exchange value for a Picasso by saying that the buyer derives utility from the painting, and at that point the explanation stops.)
People value units of money because of their expected purchasing power; money will allow people to receive real goods and services in the future, and hence people are willing to give up real goods and services now in order to attain cash balances. Thus the expected future purchasing power of money explains its current purchasing power.
But haven’t we just run into the same problem of an alleged circularity? Aren’t we merely explaining the purchasing power of money by reference to the purchasing power of money?
No, Mises pointed out, because of the time element. People today expect money to have a certain purchasing power tomorrow, because of their memory of its purchasing power yesterday. We then push the problem back one step. People yesterday anticipated today’s purchasing power, because they remembered that money could be exchanged for other goods and services two days ago. And so on.
So far, Mises’s explanation still seems dubious; it appears to involve an infinite regress. But this is not the case, because of Menger’s explanation of the origin of money. We can trace the purchasing power of money back through time, until we reach the point at which people first emerged from a state of barter. And at that point, the purchasing power of the money commodity can be explained in just the same way that the exchange value of any commodity is explained. People valued gold for its own sake before it became a money, and thus a satisfactory theory of the current market value of gold must trace back its development until the point when gold was not a medium of exchange.”
That’s not really accurate. Saying “money has value because we can trade it for things” leaves out a big part of the story.
That’s like objecting to “a bridge has value because it enables us to cross the river” with a detailed account of the history of bridge building.
“Money has value because we can trade it for things” is a description of the current situation, not an explanation of how the current situation came into being.
As a description of the current situation it is accurate, and in accordance with Austrian theory as far as I know.
Based on the things Alex was saying, a more thorough explanation of money was needed if you were going to agree with him.
The point wasn’t that I agree with him, the point was that I disagree with his view that the fact that “money has value because we can trade it for things” is lost on Austrians.
Maybe I should have made that explicit.
So if you accept the proposition that money has value because we can trade it for things, then you should also accept the proposition that that’s a perfectly fine state of affairs, provided the supply of money is managed competently.
The whole “history of money” thing is a story the Mises/Rothbard folks tell themselves to feel special, but it doesn’t actually make any sense, or have much, if any, relevance. Yes, paper by itself has no “intrinsic” value, but then nothing else has intrinsic value either. We value things because of their use value or their sentimental value (that’s a simplification, but it makes the point)– we value oil because it makes our cars run, we value food because we eat it, and we value gold because we can make pretty necklaces and rings out of it. I’ve got a $2 bill my grandparents gave to me when I was 8 that I wouldn’t trade for anything in the world, but its “intrinsic” value is close to zero.
But the problem with carrying around things that have use value is that it makes commerce really uncomfortable to trade three heads of lettuce for a bucket of gasoline. So, at some point, people decided making coins out of metals was a good way to facilitate commerce. And it kind of got the job done for awhile. But then the economy evolved and commerce grew. Research from people like Keynes and, later, Milton Friedman pointed out that the supply of money has a real effect on how much business people do; that we can be collectively poorer just because we don’t have enough money in circulation to facilitate all of the production we’re capable of doing. The conclusion that that inescapably led to was that, in a complex economy, a money supply that’s determined by how much shiny yellow metal we dig out of the ground is neither necessary nor coherent.
Yes, for a few centuries people accepted gold for things like food and shelter and labor… but there’s no reason that’s a good idea in a modern economy, where we can skip the step of digging a lot of shiny yellow metal out of the ground and forging it into coins for our exchange. AND we get the added benefit of being able to match the supply of money to demand for money, instead of letting the money supply depend on how good or how lucky some miners in Africa and South America happen to be in a given year. It’s really kind of a nice benefit, when you come right down to it…
Alex, by your statements it is obvious you have not actually read any Austrian book on money.
The Austrian argument against fiat money is not that it doesn’t have “intrinsic value.” In fact, the whole Austrian school of thought is based on subjective value theory.
No “efficiency” arguments on money can be grounded on naked aggression, while at the same time claiming to be more optimal, and yet that is exactly what fiat money is based on.
Gold money isn’t superior to fiat money because it has to be dug up (I guess as opposed to the cotton and linen, required for dollar bills, which only has to be “picked” from above ground?).
Gold is superior when it is chosen in accordance with peaceful, market activity. Fiat money was not chosen by the peaceful market. it was imposed by force on society by the state, who first redeemed gold, then reneged on the promise, and yet have since kept taxing people in fiat dollars, thus perpetuating the artificial demand for them in exchanges.
All of your arguments are like spitballs bouncing off the great wall of china. They’ve been refuted a zillion times, and yet you keep repeating the same fallacies over and over again, which proves you don’t take the effort to read that which you choose to criticize.
So if you accept the proposition that money has value because we can trade it for things, then you should also accept the proposition that that’s a perfectly fine state of affairs, provided the supply of money is managed competently.
Well sure, but I happen to think that the supply of money is best “managed” by the market, not by a state assigned monopoly.
Contrary to Major_Freedom’s post above I do think gold is superior to fiat money because it has to be dug up – it’s not easy to produce more of it. As more of it is dug up, its exchange value drops, so mining it will become less profitable and less will be dug up.
There is so much wrong with that reasoning. I’m no expert but it basically boils down to the following, even though it’s not apparent on the surface:
Interventionists – how can we manipulate “other” people into doing what we want instead of letting them act according tho their free will.
This part is especially funny in a sad way:
How can anyone make a prediction without a model?
I mean the fact that you are predicting anything at all, must imply that you have some grounds for belief based on something. Possibly Krugman could be arguing that there exists a basic Keynesian model, plus whatever personal embellishments they might have tacked onto that. Either way, a model must exist (if only a personal model).
Sure, let’s go have a look at those Keynesian fundamentals:
Hmmm, seems that Keynes is claiming that inflationary expectations will stimulate employment. What about the old “full employment” dictum:
Seems pretty clear that Keynes believed it was possible to boost employment by lowering interest rates. Well, the interest rates have been falling (check the graph of 30-year home loan) but employment has remained stale. As far as I can find, Keynes never talked about a “liquidity trap” but he did say this:
Keynes basically spells it out that propensity to “hoard money” acts as a force to drive up interest rates, and this is how liquidity-preferences can be observed (by upward pressure on interest rates). Tipping more money into the system fixes this (according to Keynes) and so in effect this whole “zero bound” crap is quite the opposite of what Keynes proclaimed. Just keep printing money and everything else is sorted — that’s the Keynesian fundamental model.
But Keynes posited a situation where there is a horizontal demand curve for money (when bond yields are so low that they become close substitutes for money), so Keynes didn’t believe that there is limitless potential for downwards movements in the rate of interest.
I’ve seen those diagrams with “Quantity of Money” on the horizontal axis and “Interest Rate” on the vertical axis and some sort of approximately hyperbolic curve ( e.g. f(x)=1/x ) such that as the total quantity of money increases, the interest rate drops toward zero. Some of them put a floor on it so the horizontal curve happens at some small but positive interest rate.
I think it is important to say that those curves are complete crap, and easily demonstrable to be complete crap. Consider the common “dollar doubling” thought experiment where new legislation proclaims that on some set future date every dollar will double into two new dollars. Prices will double, wages will double, bank accounts will double, mortgages will double, etc.
Would the “dollar doubling” cause interest rates to fall? There’s no reason why it would. Yet now we have twice the quantity of money so we should be further along the curve.
Having pointed that out, I feel reluctant to blame such idiocy on Keynes himself, until I’ve found a reference that shows Keynes drawing one of these curves. I rather suspect the idea came after Keynes, but I guess I need an expert economic historian to track it down for me.
It’s probably also fair to point out that in the modern world we don’t have a free market in banking, nor in money either (people are not free to choose an alternative money) so interest rates are pretty much arbitrarily manipulated. Hard to fit that back to Keynes original theory.
It was Hicks who developed IS/LM, which is the diagram you’re talking about.
“but I guess I need an expert economic historian to track it down for me.”
Hire LK for the job. He’s a very good economic historian.
Of course there’s a reason the dollar doubling should cause the interest rate to fall– the interest rate is a reflection of the cost of capital. The more capital there is, the cheaper that capital is to borrow, and therefore the lower the interest rate is. To put it another way, dollars chase investment opportunities. If there are more dollars chasing a constant number of opportunities, that’s a favorable market for the borrower, who can get a lower interest rate.
More money does not mean more capital. So stop and take a breath.
Such a fixation with full employment with these guys.
Isn’t it better to work LESS and earn more? Personal acquisition of capital will do that for you.
The whole POINT of working is to acquire. Sheesh.
“How can anyone make a prediction without a model?”
So this one of the religion threads then?
Major Freedom, you kicked some serious ass in this thread.
Tel, I like the brutally concise way you cut through Alex’s hyperbolic bullshit.
Daniel Kuehn and Alex, feeble dudes, really feeble.
I guess an Austrian being able to predict the housing bubble 7-8 years before isn’t more important than this false prediction.
The Austrian’s beliefs must be completely incorrect! Let’s throw Austrian theory out the window and move forward!
“I guess an Austrian being able to predict the housing bubble 7-8 years before isn’t more important than this false prediction.”
Which Austrian was that?
RP.
Sample quote:
“The conviction that stock prices will continue to provide extra cash and confidence in the economy have fueled wild consumer spending and personal debt expansion. The home refinance index between 1997 and 1999 increase 700 percent. Secondary mortgages are now offered up to 120 percent of a home’s equity, with many of these funds finding their way into the stock market. Generous credit and quasi-government agencies make these mortgage markets robust, but a correction will come when it is realized that the builders and the lenders have gotten ahead of themselves”
Maybe not his best quote from 1999, but I am lazy to search up better ones. I’m surprised you haven’t seen this before, or perhaps you are just waiting to respond haha. Anyway, I think his 2001 video is more commonly cited:
http://www.youtube.com/watch?feature=player_embedded&v=KONpt9a6HrI
If RP was able to predict a coming housing collapse, I’m sure other Austrians were as well but I am unaware of anyone specifically.
I read Lord Keynes’ blog regularly and he has posted examples of how there were several Post Keynesians who made predictions as well as economists from various different schools of thought. Just saying.
This seems to be a good place to look up Ron Paul quotes from 1999 and earlier; All of the links are bad, though, so you’ll need to do further searching:
Ron Paul’s Brain
http://www.ronpaulsbrain.com/1999/01/
(The archive page for January of 1999)
Just treat it like Wikipedia and verify.
Lots of annoying things in that Krugman post but this is the worst:
“The prediction that huge increases in the monetary base will cause large increases in the price level, and that big government deficits will cause big increases in interest rates, are more or less inescapable if your model of the economy is one in which recessions are supply-side problems, not the result of inadequate demand. Conversely, the prediction that neither of these things will happen if the economy is in a liquidity trap is a fundamental prediction of Keynesian models.”
This supposed fundamental prediction of the Keynesian models is not a prediction at all. Whether the economy is in a liquidity trap or not is determined by the lack of big price level/interest rate rises in response to large increases in the money supply. Boasting you can predict something wont happen on the condition it doesn’t happen is not very impressive and it calls your entire model in to question is if it’s the kind of thing you regard as fundamental to it.
Huh? You don’t understand the argument. Whether we’re in a liquidity trap is determined by whether cutting interest rates (in other words, increasing the monetary base) drives up inflation and employment. Under normal circumstances, cuts in interest rates stimulate both employment and inflation. That’s why, in a simple IS-LM model, shifting the LM curve (changing the size of the monetary base, or lowering the interest rate) is the normal response to a garden-variety demand-side recession. The liquidity trap occurs when short-term interest rates are at zero (in other words, investors have virtually no preference between cash and short-term Treasuries) and employment is still below full employment, with inflation remaining low. The prediction is that continuing to increase the monetary base in this circumstance won’t produce inflation. Given that the Fed has almost quadrupled the size of its balance sheet, and core inflation has stayed right around target (or lower), that’s a pretty bold prediction for someone to make without a model explaining why it should be so…
Don’t start your post with “Huh?” and then proceed to tell him he doesn’t understand something by essentially agreeing with him.
What are you talking about? “continuing to increase the monetary base in this circumstance won’t produce inflation”. Of course it does, by its very definition. You probably meant to say “won’t produce an increase in CPI”, but again, that has nothing to do with inflation. It just means that good resources are continuing to be funneled to unproductive politically directed (or “misdirected”) uses. This will lead to a continuation of boom/bust cycles and a continuing erosion of the standard of living for the many (and a massive increase in standard of living for the connected few).
Sorry, making up our own definition of inflation isn’t gonna get you very far.
That’s the original definition of inflation.
Just because inflationists have succeeded in convincing people to focus on prices rather than their own actions, doesn’t mean Peter is making up definitions. It means you and inflationists are making them up, and have been doing so since.
Is it possible to stimulate wealth destroying projects in this way?
If so, is it wise to continue stimulating such projects when people want to abandon them?
Until foreigners tire of their money losing purchasing power and they cash out and spend that money.
Consider that gas and food prices are rising. Consider also that the government wants to tax us more to pay off our debt (inflation in the price of government).
Inflation numbers are skewed:
Peter Schiff – The Fed Unspun: The Other Side of the Story
http://www.youtube.com/watch?v=zdB9I79BQRI#t=1h20m12s
(1:20:12)
I would like to extend CONGRATULATIONS to Bob.
First step toward victory!!
Krugman took bait. Not “the” bait. Just bait. But it will suffice! Game on!
It is rather unfortunate that he went for some low hanging fruit, yet that is v-e-r-y telling in itself. Can’t you see the fellow crouching in private and reading up on the opponent’s every utterance, and then, at last, instead of meeting on common intellectual ground, taking a swat at the simplest of circumstances — it is like “nailing” someone for an off-by-one error!!
Economics, being a predictive line of intellectual pursuit, would require one to never make a prediction in order to keep one’s career hermetically sealed and surgically clean. So there is a lesson to be learned here about keeping predictions of this particular nature in check to some degree while flushing out the opponent for a Big Match. This tactical misstep has already been bought and paid for, by having anticipated it long ago (and written about it extensively [ok, exhaustively] for anyone who cared to read it). Not exactly hiding under the covers hoping the opponent would not notice! Embarrassingly easy bait …
Imagine Krugman’s unenviable position — time is running out before his credibility (and career) fizzle. He is wedded to honkin’ Keynesianism (and yet distancing himself from it, under the guise of “learning”). He has stepped on to the Retrofitting-of-Keynesianism Bus as if that were the intellectually earnest and learned thing to do. (“All the other kids are doing it!”)
If the underlying principles were sound, he would not need to backpeddle with refashioning of his theory (oops, “learning” does sound so much better, doesn’t it?) He is now adopting “learning” (retrofitting) of his own theory’s principles this Keynesian Economist’s personal version of Plausible Deniability!
Austrians are in an enviable position, having a rich, broad set of principles in which their economic thought is embedded. The use of opportunism and pragmatism are not looked kindly upon when applying these principles. When was the last time Austrian economics had to be retrofitted?
Congratulations and carry on!
Also, what does it cost to be included among the first words of prime editorial NYT real estate? We’re working with a small data set here, but apparently, exactly $500!
I think the core confusion on you people’s part is that you have an idea of some “natural” rate of interest that is oh so badly wrong.
Economy-wide interest rates depend in large part on the money supply; the Fed influences that by purchasing short-term ultrasafe assets (Treasuries). Those act as a floor, since all other fixed-income assets carry default risk that Treasuries don’t carry. But that interest rate itself depends on the supply of money. If the Fed isn’t doing it, it’s exogenous, and there’s no reason why that’s “natural”– there are actually plenty of reasons why it’s actively harmful. Because, whatever the currency in use is, there’s still a supply of it. The difference is that instead of the Fed setting it based on employment and inflation data, it depends on really sophisticated factors like how much shiny yellow or gray metal is dug out of the ground. That’s a spectacularly bad way to determine the price of credit since it has nothing to do with any economic fundamentals.
Your confusion is that you don’t seem to be able to separate market driven interest rates with non-market money production driven interest rates.
No. You can’t understand that there’s nothing “natural” about a money supply driven by “the market”. That idea is itself nonsense. The interest rate reflects, in large part, the supply and demand of loanable funds. This idea that this supply should be exogenous (determined by how much stuff we can dig out of the ground) makes no sense at all– in essence, you folks have this idea of the economics profession as some racket that doesn’t understand your golden laws. The reality is that they all understand what you’re saying– it’s just laughably, denonstrably wrong, and the profession moved on when it was proved wrong by reality a good… 70 years ago.
News flash: the Earth isn’t flat, fellas…
Uh, what are you talking about? You’re not trying to play the Holocaust Card, are you?
No. You can’t understand that there’s nothing “natural” about a money supply driven by “the market”.
Wrong. You don’t seem to grasp that by “natural”, it is MEANT peaceful exchange in accordance with respect for property rights.
The interest rate that prevails on a free unhampered market is what is being considered “natural” here.
The interest rate reflects, in large part, the supply and demand of loanable funds.
The particular interest rates on loans are themselves byproducts of the natural phenomena of time preference. It is because people desire to consume some positive portion of resources, that they value future goods at a discount relative to present goods.
Interest rates on loans should not be understood as “the” interest rates. They should be understood as natural interest manifesting in future money sums being sold at a discount relative to present money sums, because present money buys present goods.
This idea that this supply should be exogenous (determined by how much stuff we can dig out of the ground) makes no sense at all– in essence, you folks have this idea of the economics profession as some racket that doesn’t understand your golden laws. The reality is that they all understand what you’re saying– it’s just laughably, denonstrably wrong, and the profession moved on when it was proved wrong by reality a good… 70 years ago.
You cannot made “efficiency” arguments backed by gunpoint at innocent people. If on a free, peaceful market, people value gold more than defaced paper notes, then it is a gain to people to use gold rather than defaced paper, despite the fact that you have to dig up gold, whereas you only have to pick cotton and linen above ground.
I do not hold the economics profession to be, contrary to your claims, a “racket”. it is full of people who have varying degrees of knowledge and critical thinking ability. Your critical thinking ability is deficient.
What I am saying is not “laughably, demonstrably wrong.” It is right, it is just that thugs like you haven’t evolved past the primitive billy club social behavior stage, and you pathetically believe that the existence of violence somehow makes it justified and “modern”.
What you are preaching goes back thousands of years, and yet hilariously you are claiming that my position, which is the newest social ethic so far discovered by mankind, where semblances of peaceful free markets are a recent phenomenon, a blip in the course of human history, are wrong because they’re 70 years old.
Your worldview of monetary manipulation dates back to 300 AD at least, when Emperor Dioclitean devalued the Roman money supply by coin clipping, to finance his lavish lifestyle and demands.
Here’s some advice: Central banking is nothing but ancient counterfeiting redux, grounded in antiquated coercion, beneficial to the elites, and presented with a sheen of “official law”, and a fake air of “modernity” when it is anything but.
You’re still horrifically confused. “The” rate of interest depends, in large part, on the supply of money. If there’s a whole lot of money floating around, capital is cheap and interest rates will be low. If there’s not enough money floating around, capital is expensive and interest rates will be high. That’s inescapable. If you go a step further to a time before money, interest rates still depended on supply of loanable funds or goods. Which themselves are typically exogenous. And there’s no good reason why the price of credit should depend on factors like the supply and demand of gold, silver, copper, or whatever is being used for currency.
Once you break down that intellectual roadblock, you’ll understand why the view of a “market” rate of interest is itself nonsensical; all that “market” rate means, in your view, is that the the supply of currency is determined by some factor beyond anyone’s control. So that rate of interest is random, not “natural”. A “natural” rate of interest is one at which the economy is at the lowest possible rate of unemployment without inflation accelerating.
And the whole “gunpoint” stuff is also nonsense. No one forces you to hold dollars. Sure, you have to pay taxes in dollars, but you’re more than welcome to take the non-taxable portion of your salary, buy up a whole bunch of gold and sit on that. It’s a painfully dumb idea, but you’re welcome to do it. I just doubt when you go to the grocery store to do your shopping, they’ll be excited to trade their chicken for your ingots.
Now, where you REALLY go wrong (well, you go wrong everywhere, but here’s another place) is your claim that someone forces anyone to take dollars at gunpoint. That’s just wrong. It’s why inflation happens– market prices are set in terms of dollars at varying levels of acceleration. The central bank can control the supply of dollars, but it can’t control what those dollars buy. Which is why we’ve had periods of rather high inflation that had to be wrung out of the system (1981-82, for instance). Now, people do have to pay taxes on their wages in dollars, but that’s almost perfectly beside the point; the number of dollars they earn in salary is itself established in a market, and they can unload those dollars as soon as they want to.
No, the reason people value dollars isn’t because they’re forced to– it’s because dollars still buy them stuff. Why that’s somehow “unnatural” or a “fraud” is beyond anyone who can really think about it with a clear head– paper currency has worth because we believe it has worth. And that tends to be good enough for people who don’t tie themselves in knots confusing themselves.
I don’t know if you caught my explanation before, but I explained why the price of credit (and everything else) should depend on individuals’ preferences for commodities and not paper.
Money isn’t just an accounting unit. The function of money is to be a liquid store of the value I desire to recieve from the sale of my goods and services.
In other words, I need the money to represent the value of goods I want to buy GIVEN my valuation of that which I have sold.
If the money has no value of its own, apart from being the money, then I can’t make preference-based calculations with it because I have no basis for believing that it should hold the value for which I acquired it.
Commodities, by definition, already reflect preferences on the market – I just need to pick one that is widely traded, durable, has a high value-to-weight ratio, uniform (or easily made so), etc., to use as money.
No. “Market rates” of interest (there are many; and not solely in terms of money) are rates which reflect the time preferences of individuals.
Non-market rates of interest are those which do not reflect those preferences:
Basic Economics Lesson 4 – Time Preference, Interest Rates, and Production
http://www.youtube.com/watch?v=g2OK5D_3TzM
Time preferences change all the time, and are subjective to the individual. Therefore, interest rates based on them are both random *and* natural.
And numerous.
1. Since the government isn’t entitled to my property, the attempt to tax it is theft.
2. If I refuse their demand for my property, then they will [already have] threaten me with imprisonment and/or forced confiscation. That would be a threat of kidnapping and/or robbery.
3. If I resist detainment or confiscation, I will be killed.
Applying this to Federal Reserve Notes, first of all, the Constitution doesn’t give Congress the authority to tax either in the form of paper money (it is restricted to gold and silver) or in the form of an income tax (the 16th Amendment was not lawfully ratified, and the Constitution prohibits direct capitation);
So, even under the terms of the Constitution, forced taxation in the form of fiat money is theft.
For reference:
“What is Constitutional Money?” with Edwin Vieira — Ron Paul Money Lecture Series, Pt 2/3
http://www.youtube.com/watch?v=k6gMkKmQSW4
A shorter video for reference:
Is Ron Paul Wrong on Money and the Constitution?
http://www.youtube.com/watch?v=40MBdt1BQgE
But beyond that, the government may not do to someone that which is wrong for another individual to do:
The Law by Frédéric Bastiat
http://www.constitution.org/cmt/bastiat/the_law.html
So, since other individuals are not allowed to prevent someone from homesteading a commons, then the government may not justly claim eminent domain or territorial monopoly such that if one were to secede from that government then the government could lay claim to his property.
That applies to land and taxes.
This is why there’s no such thing as a “public good”.
That’s circular. WHY do dollars buy them stuff?
Is it because “People value them because they buy stuff due to people valuing them because they buy stuff ..”?
Oh, and that confusion isn’t in any way profound or unique– it’s the economic equivalent of the people who sit around and wonder why, if the Earth is round, people at the equator don’t fall off.