Believe those who are seeking the truth. Doubt those who find it. Andre Gide


Wednesday, March 23, 2011

Ron Paul's Money Illusion (Sequel)

As I promised to do here, I am posting a sequel to my original column: Ron Paul's Money Illusion. I want to thank everyone who took the time to comment and criticize the views expressed there because it has led to me to sharpen my thinking on the matter. I doubt that what I have to say here will sway opinion one way or the other, but I at least hope that the nature of my criticism will be more clearly understood.
 
The purpose of my original post was to critique a statement I've heard Fed critics repeat ad nauseam. The statement can be found in Paul's book End the Fed (p. 25):
One only needs to reflect on the dramatic decline in the value of the dollar that has taken place since the Fed was established in 1913. The goods and services you could buy for $1.00 in 1913 now cost nearly $21.00. Another way to look at this is from the perspective of the purchasing power of the dollar itself. It has fallen to less than $0.05 of its 1913 value. We might say that the government and its banking cartel have together stolen $0.95 of every dollar as they have pursued a relentlessly inflationary policy.
I think that the first part of this statement is true, so I do not wish to dispute this fact. On the other hand, I think that one might reasonably ask whether this fact alone should be a source of great consternation (especially in the presence of other, more pressing, policy concerns). As for the final sentence in the quote above, well, I think it is just plain false. Now let me explain why I think all this.
Let me begin with the picture most popular with end-the-fed types--a graph depicting the declining purchasing power of the USD. I use postwar data without loss of generality, since most of US inflation has happened since then.


This picture plots the inverse of the price-level (as measured by the consumer price index). I have normalized the price-level to $1.00 in 1948. It falls to roughly $0.11 in 2010. This corresponds to roughly a nine-fold increase in the price-level or about a 4.6% annual rate of inflation. (Note that the rate of inflation has slowed considerably since 1980).

The picture above is used by some end-the-fed types to great effect in generating anger and fear among some members of the population. Anger via the claim that the Fed has stolen 90% of (the purchasing power) of your money; and fear through the prospect of this purchasing power approaching zero in the not-too-distant future.

Graphs like the one above have their uses. But one should not get too carried away with a single picture. Let me draw you another picture. This one plots the inverse of the U.S. nominal wage rate (total nominal wage income divided by aggregate hours worked).


This graph plots the purchasing power of the USD, where purchasing power is now measured in terms of labor, rather than goods. This graph shows that you need a lot more money today than you did in 1948 to purchase 1 hour of labor. Another way of saying this is that the average nominal wage rate in the U.S. has increased by a factor of 25 since 1948. Is this a cause for alarm?

No. In fact, there is very little one can conclude from these pictures, which are plots of nominal variables. We need more information than this to make any substantive statements about the impact of nominal wage and price dynamics. In the absence of money illusion, people care about real variables--not nominal variables. To put things another way, people eat bread, not money. The nominal price of bread, in of itself, is an uninformative measure. What would be informative is its nominal price in relation to one's nominal income (or wealth). The first graph above has nothing to say about how nominal incomes have evolved.

Let me now combine the two graphs above into one picture, with both series inverted, and with both the price-level and nominal wage rate normalized to $1.00 in 1948 (the actual nominal wage rate was $1.43).


According to this (publicly available) data, the price-level (CPI) has increased by about a factor of 10 since 1948. But the average nominal wage rate has increased by a factor of 25. (There is, of course, considerable disparity in wage rates across members of the population. But I am aware of no study that attributes significant wage or income heterogeneity to monetary policy. Of course, if readers know of any such studies, I would be grateful to have them sent to me.)

The figure above implies that the real wage (the nominal wage divided by the price-level) has increased by a factor of 2.5 since 1948. This is undoubtedly a good thing because it implies that labor (the factor we are all endowed with) can produce/purchase more goods and services. More output means an increase in our material living standards (Though again, I emphasize that this additional output is not shared equally. But surely a laissez-faire world advocated by some is not one that would generate income equality either.)

Now, an interesting question to ask is how the picture above might have been altered if the price-level had instead remained more or less constant. Judging by the emails I receive, many people evidently believe that the nominal wage path depicted above would have largely remained the same (that is, they apparently seen no connection between nominal wages and the price-level).

If this was indeed true, then the average real wage in America would have increased by a factor of 25, instead of 2.5 under a regime of price-level stability. And if you believe this, or something close to it, then the conclusion would indeed be startling: the inflation generated by the Fed has apparently served only to reduce the purchasing power of labor (diverting resources to powerful capitalists). This claim--or some variation of it--is implicit in the quoted passage above.

I suggested, in my original post, that there is reason to believe that under an hypothetical regime of price-level stability, the nominal wage rate in the graph above would instead have ended up increasing only by a factor of 2.5 (more or less)--the factor by which real wages actually rose. This is what I meant by my claim of long-run neutrality of the price-level increase; and it is also what I meant by Ron Paul's Money Illusion (which is subtly different than claiming the superneutrality of money expansion; more on this later).

Some evidence in favor of my "long-run neutrality view" is to be found in the time-path of labor's share of income (GDP):


I see no evidence in the data here that  our higher price level today has whittled the share of income accruing to labor. Moreover, I see no evidence suggesting that episodes of high or low inflation are related in any systematic way to the resources accruing to labor. (In fact, I see some evidence of a rising labor share during the high inflation decade of the 1970s.) But perhaps other data tells a different story. If so, I'd like to see the data (i.e., instead of a short email claiming that I am wrong).

And what about the effect of inflation on the return to saving? I received many emails like this one:
Please, Mr. Andolfatto explain to me how this works out for someone who has been a careful saver of his money and now sees the purchasing power of that money destroyed? Please explain to me how this works out for a retired person on a fixed income who sees the declining purchasing power of that income?
These are good questions. The way they are asked suggests that I am in favor of inflation. I am not. It's just that I do not want to overstate the economic significance of inflation. Especially a low and stable inflation rate regime, like the one we have been living in for the past 30 years. And especially in light of what I view as potentially much more significant economic problems.

The concern expressed above would certainly be valid if the following was true: [1] if many people are forced to save in the form of zero-interest cash; and [2] if inflation is high and volatile. There are many episodes in history where savers have been hurt by an unexpected increase in inflation. I do not wish to defend the actions of any agency responsible for episodes of high and volatile inflation. And certainly, there are many economists within the Fed that are critical of past (and even current) Fed policies.

But this is not the regime we currently live in. As I said, inflation has been (relatively) low and stable for over 30 years now. And the Fed is committed to keeping inflation to keeping inflation "low and stable" (implicit inflation target is 2%).  The argument that a "careful saver" over the last 30 years "just now" sees the purchasing power of that money destroyed seems implausible to me. Most people do not hold the bulk of their savings in the form of cash. (And if people were holding their savings in the form of Treasury bonds, they would have experienced significant capital gains over the last couple of years with the decline in nominal interest rates.) I think its fair to say that most people, or the people who manage their money, expect inflation. Market-based measures of inflation expectations show that inflation expectations are currently around 2%; see here.

I might add, as an aside, that in the emails I received promoting this line of argument, the writer typically professed concern for the "poor and unsophisticated saver." It was interesting to note that in each and every case, the writer him/herself was always very eager to point out their own sophisticated saving behavior--having, for example, invested in gold and silver (as I show here, you would have done better investing in stocks).
Well, and what about those on fixed incomes? The writer above mentions retired persons on fixed incomes. I presume he means nominally fixed pension benefits? (These benefits are generally indexed to inflation, though perhaps imperfectly.)

I think that a lot of the concern here is with respect to the fact that the prices of some goods (like food and energy) have recently risen very sharply and that, for most people, there is no correspondingly sharp increase in nominal incomes. People are right to be concerned. Here is an interesting picture from the WSJ:
 
The data show that some prices are rising rapidly. Some prices are not moving much at all. And some prices are even falling. In short, there are economic forces at work that are changing the system of relative prices. These relative price changes reflect fundamental changes in the structure of supplies and demand in the world economy. These changes would occur whether the Fed was in existence or not. Indeed, we expect relative price changes to be a normal part of a laissez-faire economy.

Finally, someone posed the following question to me:

Please explain to me how this (inflation) works out for the rest of the country when Wall Street bankers are the first to get their hands on newly printed Fed money, so that they can bid up all kinds of prices, including rents on apartments, which makes it difficult for anyone but a Wall Streeter to afford to live in Manhattan?
There is no persuading the people who organize their worldview around a web of conspiracy theories, but let me try anyway. First, this makes it sound like the Fed simply hands out cash to people. It does not. The Fed is not permitted to hand out cash in exchange for nothing in return. When the Fed creates new money, it uses the new money to purchase assets from another party. The Fed engages in asset swaps; there are no "helicopter drops." (It is the government that injects money into the economy via purchases of goods and services.)

Indeed, the business of banking is mainly a business of creating liquidity through asset swaps (e.g., when you take out a mortgage, a private bank creates and lends you book-entry money in exchange for your house as collateral). Even in a private banking system, someone must be the first to get their hands on newly created money. Even under a gold standard, someone will be the first to get their hands on newly discovered gold. And as for the price of real estate in Manhattan...I'm not sure what to say. It is one reason why I live in St. Louis!
I want to return to the last sentence in the End the Fed quote above:
We might say that the government and its banking cartel have together stolen $0.95 of every dollar as they have pursued a relentlessly inflationary policy.
This claim is simply false. Let me explain why.

Monetary economists make a clear distinction between base money, broad money, and wealth. The layperson typically makes no distinction between "money" and "wealth." Wealth is denominated in dollars. But this does not mean that all wealth is in the form of dollars (most of it is in the form of physical capital). Most people will interpret "dollars" in the quoted passage above to mean "wealth." Thus, the statement de facto claims that the Fed bears responsibility for stealing 95% of our wealth. This is a preposterous claim.

It is true, however, that something has lost 95% of its value since 1913. But just what is this something?

Answer: It is the outstanding stock of base money in the year 1913. (One dollar created yesterday, for example, has not lost 95% of its value as of today.) This 1913 money stock constitutes a tiny fraction of our total wealth. Moreover, since it has been in circulation for almost 100 years (much of it held by banks themselves in the form of reserves), the loss in its purchasing power has been spread over countless individuals, agencies, and generations.

Having said this, it remains true that inflation constitutes a tax. Seigniorage revenue refers to the purchasing power the government creates through the act of creating new money. Seigniorage revenue is also sometimes called an inflation tax. As far as taxation goes, seigniorage in the U.S. is small potatoes; see here. It constitutes a tiny fraction of government revenue (the bulk of which comes in the form of direct taxation).

Some people wonder how this is the case today, given the massive expansion in the Fed's balance sheet. The short answer is that seigniorage comes from permanent increases in the supply of new money (where the new money is ultimately used to purchase goods, rather than assets). The Fed, in its commitment to keep inflation "low," has implicitly promised to unwind its balance sheet at some point in the future should circumstances dictate. (Unwind in the sense of selling off its accumulated holdings of income-generating assets in exchange for base money).

If the Fed maintains its credibility (and this will be the hard part going forward), then there is little reason to expect even a huge temporary increase in the supply of base money to have an explosive impact on inflation (Japan's own quantitative easing experience provides an excellent example of this). This is, of course, something that the Fed monitors very closely.

To conclude, I think that the "currency debasement hurting the poor unsophisticated saver and man-on-street wage earner" argument is largely overstated. The assertion that "the Fed has stolen 95 cents of every dollar" I view as absurd. There are legitimate criticisms one could level at the monetary institutions of this country, but these are not some of them.

There are fundamental market forces at work in today's world that are causing the return to labor, saving, and entitlements to vary over time. I think that there is good reason to believe that these fundamental or "real" factors are much more consequential than the monetary or "nominal" factors emphasized by some people. But this topic is best left for a future column.

Romanian language version here.
Polish language version here.

240 comments:

  1. I hear the horde coming David

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  2. Hi David, first thank you for taking a more balanced approach at criticism of your opponents this time around. Would you prefer if instead of saying the Fed "stole" 95% of the value of money since its creation, we were to say it "taxed" 95%? I would be happy to use that term instead, though as I've told you before, I don't think that is somehow a better justification. Nor am I comforted that government has expropriated far more by other means of taxation.

    Your indictment of Ron Paul relies on your inference of what he means, by your own admission, not on his actual words. And a "low, steady" rate of inflation is not innocuous precisely because money is not "super-neutral". I understand that you're trying to deflect poor arguments against ending the Fed. I look forward to reading your defense against the real arguments though.

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  3. Eitan: Let me be clear. The 95% loss in value (whether taxed or stolen) refers to the dollar bills printed up in 1913. The aggregate value of those dollar bills in 1913 was tiny in relation to total wealth. The quote suggests that 95% of wealth was taxed or stolen. (At least, many will interpret it that way). Thanks!

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  4. Of course, David, the long-run progress of real wages is largely independent of monetary policy. But that's true for the long-run progress of all real variables. It is precisely for this reason that we must hold central banks accountable, not for the observed trends of real variables, but for the observed behavior of nominal ones--like the purchasing power of money!

    And as for the nominal wages having risen by a far larger extent than the CPI since 1948, far from being proof that looking at nominal values is misleading, I would say it gives a better gauge of Fed misconduct than that suggested by looking at the CPI: as I argue at length in my pamphlet Less Than Zero (and as many very respectable economists have argued before me), the rate of wage inflation is actually a rough indicator of the extent to which excess money growth has prevented prices from adjusting downward in a manner consistent with falling real unit costs of production. The amount of wage inflation we've had has been made necessary by the failure of falling costs to be reflected in falling product prices, except in exceptional cases (e.g. computers) where costs have fallen spectacularly.

    Your suggestion that inflation hasn't really mattered much is also one with which real economists (and not just Ron Paul fans) might well disagree. For one thing, the post-Fed rise in average inflation has brought with it a considerable increase in price-level uncertainty, which in turn has had a chilling effect on the market for long-term capital. Go back to 1912 and you'll find many companies issuing 100-year debt. That's no longer the case, and the Fed deserves much of the blame for the fact.

    In any case, if your arguments about the irrelevance of changes in the dollar's purchasing power were correct, you should consider addressing them, not just to Ron Paul's fans, but to Fed officials themselves, including Ben Bernanke, who have made frequent public pronouncements to the effect that the Fed considers stabilization of that purchasing power to be among its most important duties!

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  5. Damn it man! You and your "logic." Think you are poke holes in every argument, eh?

    Seriously, very nice post. The conspiracy theory type arguments against the fed are not helping those of us who have serious concerns about the stability of central banking v. free banking.

    Jeremy Stein has a new working paper - just got it through NBER feed. It is about how short-term debt creation is naturally destabilizing. I've only read it once, but I don't think he is thinking about money the same way free bankers do. Anyway, here's the link if you have some interest: http://www.nber.org/papers/w16883

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  6. "when you take out a mortgage, a private bank creates and lends you book-entry money in exchange for your house as collateral"

    In other words, the banking system creates and allocates purchasing power without giving up any consideration of its own. (Not to say: out thin air, of course!!)
    So while I can agree monetary policy implementation with regards to the Fed and outside money is an asset swap, I would much rather argue that the distortionary effect and continuous deterioration of purchasing power comes from the banking system creating inside money -- made possible, of course, with fractional-reserve banking.
    The fact that banks can create and allocate purchasing power (in form of inside money) at will in a way that distorts the real economy is the first order issue of purchasing power loss; I think the trickling down issue of who gets the new money first is second order only.

    This is what I take issue with and I do not believe this is addressed in either this or the previous post on "thin air".

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  7. Here are some more pinheads:
    http://www.caseyresearch.com/editorial.php?page=articles/investment-legends&ppref=ZHB209ED0311D
    (Investment Legends: “Dollar Collapse Inevitable”)

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  8. Using mean income is little more than a trick.


    You are averaging in the bonuses of all those folks working at the primary dealers with all the 22 year old males with high school diplomas and things look pretty good.

    Try using the 25th percentile wage history...and adjust that for the growth in local/federal & payroll taxes then use a CPI that is based on expenditures of someone in the 25 percentile(something heavy on food/energy/housing/education and health care....with very little weighting on non-edible Ipads)

    Now see what has happened to "real" wages?

    I make a good salary and I make good returns on my investments due to a understanding of the Fed fueled booms and busts...so by all means keep squeezing the masses, but please don't be self righteous about it... as if stealing from the monetarily ignorant to give to the politically connected is for the GOOD of the masses.

    Of course the Fed doesn't literally GIVE the money away...unless you count the millions in fees the primary dealers get every week. I know, it's chump change, but there are a lot of ways the money leaks first into the hands of the top 1% and the power borkers first and the initial fees are some of the most obvious that you willfully ignore.

    Are you really seriously proposing that the new money goes to a 25th percentile joe schmoe before it works it's way into the bank accounts of the CEO at General Dynamics, GE and JP Morgan?

    and strawman alert...I haven't seen anybody who actually thinks that nominal wages would be what they are today if we hadn't had the debasement of the dollar over the last 100 years. If people are emailing you saying that then I do feel bad for you, but that idea can only be attributed it to public schooling and general illiteracy...not Ron Paul or readers of Murray Rothbard and G Edward Griffin.

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  9. Ron Paul, and Gabe, are basically economically illiterate. Scare quotes around "real" doesn't make it any less real, dummy.

    God some people are stupid.

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  10. "Of course, David, the long-run progress of real wages is largely independent of monetary policy. But that's true for the long-run progress of all real variables. It is precisely for this reason that we must hold central banks accountable, not for the observed trends of real variables, but for the observed behavior of nominal ones--like the purchasing power of money!"

    I have both a question and a statement for George and any other interested parties concerning the statement I quoted above (made by George at 12:47PM).

    Question: In your opinion, do nominal variables matter in and of themselves? Why is the purchasing power of a dollar, for example, important in and of itself?

    Statement: Economists should care about nominal variables only to the extent that they affect real variables (at the aggregate and individual levels, of course). Thinking otherwise implies that you take money-in-the-utility function preferences seriously.

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  11. To answer joe's question, no, the nominal values don't matter "in themselves." But there are theories connecting erratic or otherwise unpredictable behavior of such variables to unwanted real effects. We know that as a matter of comparative statics, half a given stock of money will suffice just as much as the whole amount. We also know, as a matter of other kinds of theory, as well as experience, that we would not want our central bank to take steps that would result in a precipitous halving of the money stock and of equilibrium nominal prices. Finally, although real activity can change for many reasons, central banks are only responsible for those changes connected to its mismanagement of the money stock and related nominal variables such as the flow of spending. We cannot blame central banks for every unwanted change in output or employment, for example; but we can blame them for changes connected to fluctuations in the flow of spending that they are capable of preventing.

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  12. There are several academic papers available (I can find them if you like but I don't have them at hand right this moment) about the volatility of commodity prices under the various monetary regimes in US history (pure gold standard, Bretton Woods and fiat). Standard deviation of commodity indices under the gold standard and fixed exchange rate system of Bretton Woods were roughly half that of the fiat era. Interest rates show similar characteristics. As Mr. Selgin points out the uncertainty of these prices has an effect on investment as some amount of capital must devoted to hedging these price swings. Is it coincidence that the derivatives industry has expanded rapidly in the fiat era? I think probably not.

    I won't argue that inflation has stolen 95% of our wealth but the costs are not inconsiderable.

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  13. A very clear and levelheaded explanation, and I thank you for it. You seem to be making three points here:

    1. Inflation doesn't hurt wage-earners because their nominal wages simply reflect inflation magnifying the real increases.
    2. Inflation doesn't hurt savers because most people save by putting their money in savings accounts, CDs, stocks, etc, rather than sticking 1913 dollars in a jar under their bed.
    3. Inflation doesn't hurt those on fixed incomes because their pensions are typically indexed to the CPI.

    Now, this is pretty convincing and most of us can observe all around us that those claims seem true. But when you add them together, they very much imply that inflation is a very small thing to be worried about; so small as to be mostly insignificant compared to, say, the Federal income and payroll taxes in terms of percentage of income stolen, er taxed (oops, I put my libertarian hat on for a second).

    If we accept that inflation is generally harmful to few as long as its rate is low and steady, then doesn't that imply that monetary policies whose primary consequence is inflation actually have no real consequence at all so long as the level of inflation is carefully controlled?

    To use Japan's example that you brought up earlier, a central bank injected trillions of Yen with no inflationary effects at all. If indeed it is possible for a central bank to engage in policies that result in large amounts of new money from being created with few inflationary effects, when why in god's name is there a budget deficit!? How come I have to pay such high tax rates? If the Fed is able to inject such liquidity into the system to pay for government projects that, while they may push up inflation, this doesn't actually matter, why doesn't it? This whole print-money-causing-inflation-that-doesn't-actually-matter-in-the-long-run thing seems to be a golden goose here.

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  14. Like Dr. Selgin my comment disappeared so I'll try again.

    There are a number of academic papers available (which I can find if you need but don't have at hand right this minute) on the volatility of commodity prices under the various monetary regimes that have existed throughout the history of the US. Under the pure gold standard and the fixed exchange rates of Bretton Woods, the standard deviation of commodity indices is roughly half that under the current fiat standard. Interest rates show similar increases in volatility.

    Faced with this increased volatility, companies must devote a portion of their capital to hedging. It is not coincidence that the use of derivatives has risen under a fiat standard. Because a portion of capital is tied up in hedging activities, investment is reduced. It may not be a large percentage of total capital that is diverted but compounded over long periods of time, the effect on productivity is probably significant. I would also point out that there is a fine line between hedging and speculating as the shareholders of a number of bankrupt companies now understand.

    Increased volatility also increases speculative activities. Throughout history, inflation has been associated with speculation and derivatives. The Dutch were trading tulip futures and options on futures in the 1600s.

    Furthermore, inflation diverts capital from investment in productive investments to real asset such as commodities and real estate as investors attempt to maintain their purchasing power. It is probably not coincidence that a wide variety of institutional investors now devote a portion of their investable funds to commodities. There is no way that I know that this foregone investment can be measured. What innovations would have emerged over the last decade if so much capital had not been wasted in building excess housing or diverted to commodity speculation?

    Obviously, the fiat era has not stolen 95% of our wealth but the costs are surely not inconsiderable.

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  15. Given the comment I quoted above, it seems like you agree that money is more or less neutral in the long run. So would it be fair to say that your concerns about our current monetary policy are primarily focused on short-term effects?

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  16. Joe Calhoun makes a good point about derivatives markets rising as a function of inflation.
    But I am not getting why inflation diverts investment from real capital to real assets like commodities. How is capital any less "real" than commodities ?
    Also, I am pretty sure we can find asset bubbles under both commodity and fiat standards. Wasn't Britain on a commodity standard during both the canal and railway bubble booms?

    paul c.

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  17. To Joe: Yes and no. There are some persistent effects of erratic nominal changes. david mentioned the non-superneutrrality issues in his post; uncertainty-related matters are also long-term.

    But this is really asking me to rehearse the entire corpus of monetary thought! It can't be done on a blog. Suffice to say that, if money were neutral, we might as well let policy be determined by throwing darts at a board! Defenders of the Fed must do better than run behind arguments for money's neutrality--for those arguments make a koke of the Fed's claim to be playing an important role in managing the nation's money and credit conditions!

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  18. David, you have yet to comment on how central banks (adversely) affect income and wealth inequality. Fed policies disproprotionately benefits asset holders (the "rich") and raise the relative prices of goods that comprise a larger proportion of the consumption basket of those in lower income percentiles.

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  19. If you are trying to understand the anger of the masses you should really use the real-tax-adjusted-net-wages of the 25th-40th percentile of wage earners and a more appropriate CPI for this group to get an idea of why people are mad.

    This "Let them eat Ipads" attitude is only adding to the unpopularity of the Fed.

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  20. A few things here.

    1. David, great post. Really great post.

    2. If the people on this board don't like the Fed's inflation policy, then they should hold as little cash as possible. That way they avoid getting taxed.

    3. If people truly confuse nominal with real rates of return, as I guess many here do, then they should save like crazy when inflation rates rise -- and nominal rates of interest rise accordingly.

    4. Bankers intermediate deals between people or firms (= people) that want to save and people or firms (= people) that want to borrow. This intermediation requires time and skill, and compensation is required.

    I'm not defending the level of compensation to bankers, but noting that at least bankers facilitate the flow of capital from savers to borrowers.

    If people want to fly off the handle about other people's income, they should ask why professional basketball players get paid so much for playing a game.

    5. We would have fluctuations in price levels too if we were on the gold standard. Two reasons. First, the supply of gold is variable. Just ask the Spanish in 1492. Second, sometimes risk-premia move rapidly, which causes fluctuations in the prices of both risky (stocks) and less-risky (money/bonds) assets.

    Morris Davis

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  21. Morris: how many financial crises have baseball players caused?

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  22. Everyone:

    Nice discussion, thanks. A couple of things.

    First, I am not sure why this blasted site does not publish some comments (it holds them in a purgatory spam file, until I release them manually. Please do not think that I delete them; I do not delete comments here!)

    Second, I am travelling (in Europe at the moment) and so will not be able to comment as much as I like. But you all seem to be doing great without me, so no big deal.

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  23. new info released:

    Morgan Stanley borrowed from the Fed’s discount window during the crisis. The Fed propagandists said we weren’t supposed to know this, since if the identity of such borrowers were made public, the earth would roll into the sun.

    I suppose the Fed suporters here are all awaiting the appocalypse now that a fed secret has been revealed and they are no longer "independent"?

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  24. George:

    Of course, David, the long-run progress of real wages is largely independent of monetary policy.

    Of course? You obviously haven't read many of the blistering attacks made against me when I tried to suggest otherwise. Perhaps this is just "of course" to the economists. But my audience on this subject is a little broader this time around.

    As for holding central banks accountable for nominal variables, I'm fine with that. But I hope you don't mean that Ben Bernanke should be held accountable for the inflation of the 1970s. The Fed is implicitly targeting 2% inflation for a long time now. Major deviations away from this target for prolonged periods of time would constitute failure.

    And as for the nominal wages having risen by a far larger extent than the CPI since 1948, far from being proof that looking at nominal values is misleading, I would say it gives a better gauge of Fed misconduct...

    George, when I suggested that the Fed was responsible (I gave credit, you give blame) for this spectacular rise in nominal wage rates, I was raked over the coals! I want every one who did so to see here that George Selgin agrees with me!

    Your suggestion that inflation hasn't really mattered much is also one with which real economists (and not just Ron Paul fans) might well disagree.

    My suggestion is that the use of that picture to scare people is wrong; and to suggest that the Fed has stolen 95% of everyone's money, completely irresponsible. Do you agree or not?

    I also do not mean to say that inflation does not matter at all. It's just that I believe its effects are of second-order importance, relative to (say) fiscal policy. And when inflation is "low and stable," as it has been for the past 30 years or so, I think the effects of inflation are of 3rd-order importance. But this does not mean that I think we should ignore inflation or consider it unimportant. Personlly, I am in favor of an inflation target of zero.

    Go back to 1912 and you'll find many companies issuing 100-year debt. That's no longer the case, and the Fed deserves much of the blame for the fact.

    That's an interesting observation. Do you have a model that delivers some welfare cost estimate of these effects? I presume you think they are huge. I am curious to know how you support this belief.

    In any case, if your arguments about the irrelevance of changes in the dollar's purchasing power were correct, you should consider addressing them, not just to Ron Paul's fans, but to Fed officials themselves, including Ben Bernanke, who have made frequent public pronouncements to the effect that the Fed considers stabilization of that purchasing power to be among its most important duties!

    First (and again), I did not say "irrelevant." Second, nobody listens to me. Third, you should make good on your promise to visit us and tell them yourself! :)

    ReplyDelete
  25. Gabe: I am in favor of releasing all information, possibly with a time lag in the event of a financial crisis. I've written about this before; e.g., see here: http://andolfatto.blogspot.com/2010/04/information-disclosure-policy-for-fed.html

    vimothy: Blaming banks for a financial crisis is a bit like blaming engineers for building collapses during an exceptionally severe earthquake.

    Anon @6:36 What is the evidence for these claims you make? If you provide some, I will address it.

    Nate: Good questions! I will have to get back (must prepare slides for tomorrow's conference).

    Thanks, everyone.

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  26. David: even so, I think it's better than blaming baseball players for building collapses during an earthquake.

    But let me ask a few related questions then, because the implication of your analogy seems rather strange to me: whose fault was it that LEH collapsed--the "earthquake", or the engineers?

    If it's not the job of engineers to build structurally sound buildings, exactly what are they getting paid for?

    Also, the likelihood of an earthquake is independent of the design of a building. Is this also true in fenance?

    Our society and our economic system are built on personal responsibility. You say: don't blame the poor bankers, they're victims too. To that I say: let scoundrels swing: it's the American way.

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  27. Since I'm (implicitly) being a bit critical of you here, David, I'd also like to say that I think your original post is excellent. It is a pity that the topic is not better understood. Our discourse suffers as a result, and your efforts to remedy that here are commendable.

    I'm enjoying George Selgin's comments as well.

    Regards

    PS comments being v. weird

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  28. Comparing financial crises to earthquakes is disingenuous. Central banking fuels the boom-bust cycle by creating credit in excess of savings. The 95% thing only shows that on one measure of the Fed's efficacy, nominal price stability, it has been a major failure. If low steady inflation is the Fed's goal, then I guess it's failure by design. You're right though that there are much better reasons to be upset with the efficacy of central banking. Here's the real indictment of the Fed; I hope Professor Selgin doesn't mind if I link to his video: http://www.youtube.com/watch?v=yLynuQebyUM

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  29. David,

    Really great post. Let me pose a question to you and others here about "stealing of purchasing power."

    When the Fed increases its balance sheet, should we concentrate on CPI or the change in the actual money supply?

    Let me put this in context. I know an individual who was working for a major financial institution that had recklessly exposed itself during the housing bubble, and absent Fed intervention, would have gone under. In this case the institution was given a massive Fed loan, and this individual has received multi-million dollar compensation every year since, to stay on and help sort the mess out.

    With the new money, the individual finally built his dream mansion that he and his wife had been dreaming about all their lives. This building project that required millions in human labor and physical resources would not have occurred without Fed action. Instead the individual would have been laid off and those resources would have been put to other (many might argue, more productive) uses.

    Now, CPI has indeed been very low, but this one case highlights a huge shift in purchasing power away from savers and towards institutions and individuals that are granted access to the Fed.

    So again my question: When the Fed increases its balance sheet, should we concentrate on CPI or the change in the actual money supply?

    ReplyDelete
  30. Blaming banks for a financial crisis is a bit like blaming engineers for building collapses during an exceptionally severe earthquake.

    No, it is much more like (a) having a shaky bridge overseen by an agency which once used engineering, but now uses the "Efficient Bridge Hypothesis" to "prove" it is stable, and justify postponing shoring-up work / insufficient stabilizing fiscal policy
    (b)blaming people who own trucks carrying ever-increasing amounts of nitroglycerin over the bridge, who pay off the overseers to believe the EBH, denigrate real engineering / fiscal policy & look the other way.

    ReplyDelete
  31. This comment has been removed by the author.

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  32. A lot of us that believe in a central bank for the purposes of price stability were quite upset that the Treasury and the Fed bailed out AIG (to start) and then many other firms.

    That seemed un-American to me.

    However, lots of sensible people think that the economy would have collapsed, literally, without that intervention.

    ReplyDelete
  33. Morris: I tend to agree. But still I think that it's more reasonable to question the income of bankers given what happened than the income of baseball players. Or more understandable, perhaps.

    ReplyDelete
  34. "In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. ... This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard." -- Alan Greenspan

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  35. @ Nate

    Unlimited money printing has very bad consequences. I lived through a hyperinflation in Buenos Aires in 2001. Throngs of people storming grocery stores to get at the food they could not longer afford is not a happy memory. Also consider Germany in the 20s/30s and modern day Zimbabway.

    During a deleveraging, central banks can increase their balance sheets without effecting the CPI, but as I noted in my earlier post, there are other consequences. In my opion they are negative consequences.

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  36. @ Edward

    Oh, I fully understand and agree. But our author seems to be taking the position that "sensible" expansionary monetary policies will have non-existent to minimal effects on inflation, thereby opening the door to "safe" money printing.

    I've heard this argument a lot, but it seems that if you take it to its logical conclusion, you wind up at the idea that so long as the central bank works to keep inflation low, it can expand the money supply as much as it wishes, which begs the question of why it doesn't create enough money to cover all government debts or eliminate the need for taxation. Obviously this can't work, but I want to know how the explanation of why it can't work squares with the author's examples of massively expansionist monetary policies that didn't result in inflation (e.g. Japan) and his view that a fairly low level of inflation doesn't really hurt anyone. I for one would certainly be willing to see inflation double if the money printing that created it resulted in the elimination the income, payroll, sales, corporate, and capital gains taxes!</snark>

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  37. @ David: I made 2 claims.

    1) Fed policies boost asset prices which disproportionately benefits asset holders (the "rich"). It is empirically demonstrable that the "rich" own more assets (particularly equities). Bernanke has gone out of his way to claim that QE boosted stock prices. Brian Sack of the NY Fed went as far as to admit that equity prices were artificially boosted by the Fed. So what part of claim #1 do you need evidence for?

    2) Bernanke himself said in a speech that loose monetary policy boosted non-sticky prices first (and he cited commodoties as an example). Again, it is empirically demonstrable that the consumption basket of the "poor" has a higher proportion of commodities in it. Again, what evidence do you need?

    If you believe that loose monetary policy does not / did not boost equity or commodity prices, please let us know.

    ReplyDelete
  38. Anon @636 here again:

    Consumer spending on energy by income quintile: http://www.clevelandfed.org/research/trends/2011/0411/01houcon-2.gif

    Consumer spending on food by income quintile:
    http://www.clevelandfed.org/research/trends/2011/0411/01houcon-3.gif

    Will look for data on equity holdings, and provide you references to the Fed speeches I mentioned.

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  39. From Bernanke's most recent Humphrey Hawkins speech:

    "in August 2010 we announced our policy [QE]... Since then, equity prices have risen significantly, volatility in the equity market has fallen...these developments are what one would expect to see when monetary policy becomes more accommodative, whether through conventional or less conventional means."

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  40. Lots of graphs showing distribution of incomes/wealth/asset holdings (and it uses data from the Fed!)

    http://www.rbcgam.com/investment-insights/research-publications/_assets-custom/pdf/consumers-research-paper-en.pdf

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  41. Hi David, good post.

    I make a living evaluating businesses and suggesting to clients whether to invest in them or not. It's already difficult to select good investments, but having to consider changes in the price level infinitely complicates to process. That's because price level changes have all sorts of differing effects on the industries to which I may choose to allocate capital. Some industries are better places for investment when prices are rising, and vice versa. The net effect of all this is that I must divert my time from evaluating what is the *best* company in an industry to watching the relevant central bank to estimate the trend in the price level that said central bank creates. Something will suffer - after all I only have so much time - that being the final company-specific capital allocation I settle on. In other words, I may end up allocating funds to an inferior business. Of course I could outsource my analysis of the central bank, but that means I will be able to spend less dollars on researching the best company in its industry.

    In sum, the Fed's influence on the price level creates significant informational inefficiencies that corrupt the capital allocation process. Capital allocation is important.

    Would I prefer a Ron Paul style gold standard? Not necessarily, since I'd still be forced to divert some of my attention from analyzing companies to watching the gold industry, mine supply, etc.

    A free-banking scenario would allow me to divert the least amount of my time to caring about the price level and the most to good old fashioned investment analysis. With multiple brands and units of account, I could fall back on the rule of thumb that the good ones will rise to the top through the process of competition.

    So rather than diverting my attention from investment analysis to Fed-watching, why not just trust the Fed to maintain price stability? After all, that would free me up to focus on pure capital allocation. I can't afford to be complacent because the Fed brand is not a good one, just look at the 30s (deflation) and 60s-70s (inflation). This should come as not surprise, the Fed survives through its monopoly privilege, and not because it serves the end user. You hold up the last 30 years as proof of brand quality due to price stability. But you're focusing only on CPI and forgetting asset price inflation. No professional can ignore the latter.

    In sum I agree with your points against Ron Paul, but I think the "End the Fed" argument has much stronger underpinnings than you choose to give it credit for in your post.

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  42. Mr. Koning said, "That's because price level changes have all sorts of differing effects on the industries to which I may choose to allocate capital. Some industries are better places for investment when prices are rising, and vice versa."

    Why? Explain, please.

    Economists spend a fair amount of time considering the effects of inflation. I'd like to hear your problems in more detail.

    Given that the US year-over-year inflation rate has been basically within 1.5 percentage point of 2 percent for about 20 years, how much difference would it make if it had been within 1.5 percentage points of 0 percent?

    Given that we have no modern experience with free banking, what makes you think that prices would be more stable? Do you have some relevant data from the free-banking period?

    It is my understanding that free-banking currencies were "discounted" geographically. That is, a bank's currency was worth less the farther away was the Bank's HQ. What do you think this would do to your planning?

    ReplyDelete
  43. @ Anon March 25 at 4:45 AM.

    "1) Fed policies boost asset prices..."

    M policies boosted equities to some extent by stabilizing the economy and preventing us from going into a Depression. That helps rich, poor and middle-income Americans.

    Because low income Americans are more likely to become unemployed in downturns, it would be much easier to argue that QE helps the poor more than the rich. But I guess that doesn't sound like a popular argument.

    "2) loose monetary policy boosted non-sticky prices first... the consumption basket of the "poor" has a higher proportion of commodities"

    So, your point is that recent M policy is hurting the poor by raising commodity prices? A few problems with that...

    First, it isn't clear that the poor's C basket is more volatile. Asserting it doesn't prove anything.

    Second, even it is, it falls faster as well as rising faster. So, there is no systematic effect on the real incomes of the poor from very low and stable inflation, as we have had.

    Third, although some prices have risen recently, inflation has been low.

    Fourth, the recent loose M policy hasn't been the thing that has raised commodity prices, except by supporting the world economy and preventing Depression. I will grant you that commodity prices would be much lower if the world were in a Depression. I don't think that would help the poor though.

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  44. You mentioned: "But I am aware of no study that attributes significant wage or income heterogeneity to monetary policy. Of course, if readers know of any such studies, I would be grateful to have them sent to me.)"

    Please refer to the following article by James K. Galbraith et al 2007.

    "The Fed’s Real Reaction Function
    Monetary Policy, Inflation, Unemployment, Inequality—and Presidential Politics"

    Abstract: Using a VAR model of the American economy from 1984 to 2003, we find that, contrary to official claims, the Federal Reserve does not target inflation or react to “inflation signals.” Rather, the Fed reacts to the very “real” signal sent by unemployment, in a way that suggests that a baseless fear of full employment is a principal force behind monetary policy. Tests of variations in the workings of a Taylor Rule, using dummy variable regressions, on data going back to 1969 suggest that after 1983 the Federal Reserve largely ceased reacting to inflation or high unemployment, but continued to react when unemployment fell “too low.” Further, we find that monetary policy (measured by the yield curve) has significant causal impact on pay inequality—a domain where the Fed refuses responsibility. Finally, we test whether Federal Reserve policy has exhibited a pattern of partisan bias in presidential election years, with results that suggest the presence of such bias, after controlling for the effects of inflation and unemployment.

    Available at http://www.levyinstitute.org/publications/?docid=947

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  45. You seem to have entirely missed Dr. Paul's point. He doesn't argue that, ceteris paribus, wages fail to be inflated more or less in concert with economy-wide price inflation, or that Fed policy "whittle[s] the share of income accruing to labor". Rather, he correctly points out that such falls in the purchasing power of the dollar represent a theft of savings, as a saved dollar from a worker's wages will purchase less 10 years on than if he had spent it immediately. He also argues that this "inflation tax" on savings is hugely regressive as it falls primarily on the working and lower middle classes, who tend to hold their savings as cash or in dollar-denominated bank accounts; while the wealthy and upper middle classes invest a greater proportion of their savings in assets, be they stocks, bonds, or real property, and thus are more protected from the effects of inflation.

    If you wish to dismiss Dr. Paul's views as "absurd", you would do well to understand and rebut what he actually says, not what you wish he had said.

    ReplyDelete
  46. Inkblots: "[H]e correctly points out that such falls in the purchasing power of the dollar represent a theft of savings...it falls primarily on the working and lower middle classes, who tend to hold their savings as cash or in dollar-denominated bank accounts;"

    Many in the working class have used a sophisticated financial instrument, known as a "savings account" that pays interest on savings. For example, I had one when I was a teenager and worked as a landscaper. In fact, savings accounts are commonly used to introduce children to the concept of savings.

    http://www.money-rates.com/savings.htm

    Most banks offer savings accounts with no minimum balance and the interest varies over time with the inflation rate and other interest rates.

    Some of the savers in the working classes even use "certificates of deposit" -- or CDs to the cognoscenti.

    http://www.bankrate.com/cd.aspx

    http://research.stlouisfed.org/fred2/series/CD3M?cid=121

    Many banks offer CDs with no minimum investment or an investment of only a few hundred dollars.

    Even in the absence of any inflation, saving in the form of cash would forfeit interest and so would be an unwise long-term investment.

    Inkblots: "If you wish to dismiss Dr. Paul's views as "absurd", you would do well to understand and rebut what he actually says, not what you wish he had said."

    I think that David is doing the best that he can to understand Dr. Paul's viewpoints.

    ReplyDelete
  47. @ mask:

    "Because low income Americans are more likely to become unemployed in downturns, it would be much easier to argue that QE helps the poor more than the rich. But I guess that doesn't sound like a popular argument."

    Maybe it would be a more popular argument if it were actually working out that way.

    Unemployment
    http://data.bls.gov/pdq/SurveyOutputServlet

    U6
    http://data.bls.gov/pdq/SurveyOutputServlet

    "Third, although some prices have risen recently, inflation has been low. "

    See anon's post on 3/25, 4:55 a.m. to see what this means to the poor.

    Way back on 3/23 Gabe made a point about wealth distribution and unequal effects of price increases on various income quintiles. But some anon called him dumb, so it's pretty much been ignored.

    Pity, since increasing wealth disparity is really the big story of the last 30 years.

    I'd love to see a scholarly treatment about how that has enabled growing and persistent asset misallocation.

    Cheers!
    JzB

    ReplyDelete
  48. JAZZbumpa, you write: "increasing wealth disparity is really the big story of the last 30 years."

    One of the big stories, certainly, but I think it was the result of the policy called trickle-down economics. Do I have that right?

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  49. Jazzbumpa,

    "Maybe it would be a more popular argument if it were actually working out that way."

    My point was that it is difficult to claim that QE benefits the rich when it is designed to reduce unemployment, which disproportionately hurts the poors.

    What is your point? I could take a guess but maybe you could actually construct an argument instead of indulging in (incorrect) snark.

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  50. Jazzbumpa,

    "Way back on 3/23 Gabe made a point about wealth distribution and unequal effects of price increases on various income quintiles. But some anon called him dumb, so it's pretty much been ignored."

    You might think it unfair to call Gabe "dumb", as someone did. I think that anon probably got fed up with Gabe's paranoia, conspiracies and lack of understanding of economics or central banking. Unfortunately, the description of Gabe as "economically illiterate" is correct.

    The reason that the comment has been ignored is that M policy doesn't change relative prices over any significant period. If the low-income basket price rises faster than the high-income basket price, that will still hit lower quintiles harder than high-income quintiles, no matter what the inflation rate.

    I.e., M policy does not determine the relative price of oil in terms of other goods, it determines the average price increase for all goods and services over long (i.e., years) periods.

    If the Fed was tight enough to lower gas prices, that policy would also lower all other prices and wages in the economy proportionally, at least over a decent interval.

    ReplyDelete
  51. The Arthurian,

    Inequality is not my field but my understanding is that researchers in the field think that a number of factors might have contributed to rising inequality. The factors might include family structure, the relative quality of education, the role of technology, and changing demographics, including immigration and the age distribution of the population.

    I would note that the unequal distribution of income in the United States is present in pre-tax income statistics, so I would think that it is difficult to ascribe to "trickle down" tax policy, unless the alternative tax policy simply discouraages much effort by upper income earners.

    In fact, the highest decile in the United States pays the highest proportion of its income in taxes of any such group in the OECD:

    http://www.taxfoundation.org/blog/show/27134.html

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  52. Not my field either, Masked Man. But Emmanuel Saez shows a striking change in the trend of income distribution, beginning right around 1978. I see that change as a result of changes in policy.

    Art

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  53. "The Fed is not permitted to hand out cash in exchange for nothing in return. When the Fed creates new money, it uses the new money to purchase assets from another party."

    True, except the Fed can buy assets that no one else wants at prices no one else is willing to pay (e.g., mortgage-backed securities), and the Fed can buy large amounts of Treasury debt when others are increasingly unwilling to.

    Say what you will about the complexity of his arguments, but Ron Paul understands two things that many "economists" don't: 1) Increasing the supply of money is not necessary and does not confer any general benefit, and 2) The laws of supply and demand apply to money and credit.

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  54. I have a question, a simple one. It may be more for George than for David, but anyone should feel free to answer it.

    What are the theoretical and empirical arguments suggesting the following statement should be accepted as correct?

    "Had the Fed not been around since (say) 1946, the nominal wage would have increased of X% while the nominal price level would have increased of Y%, where X/Y > 2.5"

    Feel free to pick the X and Y you like best in answering my question.

    Once you're done explaining why I should trust this would have been the case, make sure you clarify both the alternative institutional arrangement you have in mind and the set of policies that should have been followed by those institutions.

    Without such a clear, and convincing, counter-factual, the whole discussion about "abolishing" the Fed is just a waste of time.

    ReplyDelete
  55. Alright Inkblots, explain to me why I should be concerned about this;


    " a saved dollar from a worker's wages will purchase less 10 years on than if he had spent it immediately"

    If you want something, get it now. There are NO GUARANTEES that what you want will be available ten years from now at the same relative price.

    I dont know what else to say but if thats what a "saver" expects from his money system, the problem is a YOU problem and not a money system problem.

    ReplyDelete
  56. @Greg,
    With that kind of attitude, I'll be disappointed if it turns out that you a retirement account, an emergency fund, or heck, any savings at all! I could agree with a counter-argument that explained how most people save by depositing their money in a bank account that earns interest rather than stuffing it in a jar under their bed, but are you really disparaging the value of saving? Saving isn't about delaying consumption of needed goods, it's about increasing your future purchasing power so you can afford more later and insulate yourself from financial hardship. I want a house but can't yet afford a down payment; how am I supposed to buy that now? If I have a medical emergency not covered by my insurance but I have no money because I blew it all on past consumption, what am I going to do? You're ignoring all the biggest reasons to save!

    ReplyDelete
  57. Michele,

    Of course one cannot say with any certainty what the values of X and Y would have been. This is no way to frame the debate.

    My simple question for you is: Why is it necessary for a group of experts to manipulate money and credit, and how can these experts possibly achieve results superior to the market?

    ReplyDelete
  58. Dont distort my position Nate. I save plenty, but I dont expect my monetary system to continue to provide for me at the same level I could have had in the past. I dont expect other people to have to suffer austerity, losing their only means of financial support, so that my returns stay where I think they "should" be. The way the current crop of people in charge of the system manage the system, its a zero sum game where anyone else getting something comes at someone elses expense.
    It doesnt need to be this way.

    I'm quite content to simply consume what I want and if I really want to save something "real" I buy something real and put it aside. I dont expect my savings account to keep my purchasing power of money constant. That is a very unrealistic expectation of this world.

    ReplyDelete
  59. Steve,

    Michele is asking you to specify an alternative to a central bank and discuss the consequenes of that alternative and why you think what you do.

    You ask, "[H]ow can these experts possibly achieve results superior to the market?" I would ask what market incentives exist to provide an elastic currency, stable and low inflation and countercyclical M policy?

    There was an era of free banking -- very long ago -- in this country. Are you suggesting a return to that or a gold standard or something else?

    If you want to have a serious discussion about the necessity of a central bank you need to specify your alternative. That is what Michele was asking for.

    ReplyDelete
  60. @mask -

    If you found snark in my comment you need to grow an epidermis.

    If you don't see my argument, you need to learn how to read with comprehension. Following the links would help, too.

    I'll try again.

    Unemployment is still high, and has only budged slightly. QE benefit to the poor has been small to negative. Meanwhile corporate profits are at record levels, but companies aren't hiring. (OK, they're starting - a little) However, in some sectors at least, they're giving out record bonuses. Shortly after we bailed these geniuses out with tax dollars.

    QE dollars seem not to have done much of benefit to the economy as a whole, but they seem to have been concentrated in the financial sector, which enables speculation in commodities, and rising equity prices.

    Bernake claims it raised equity but not commodity prices.

    http://seekingdelta.wordpress.com/2011/02/09/ben-bernanke-taking-credit-for-the-good-and-not-the-bad/

    I know the counter argument.

    http://macromarketmusings.blogspot.com/2011/02/bernanke-and-commodity-prices.html

    Evidently, correlation is causation, except when it involves the QE of 2009.

    Meanwhile Republicans are cutting unemployment benefits and various kinds of help for the poor.

    If the low-income basket price rises faster than the high-income basket price, that will still hit lower quintiles harder than high-income quintiles, no matter what the inflation rate.

    Which it always will, since necessities are a huge part of Q1 expenses and a small part of Q5 expenses. For Q1, Food + energy costs = 44% of income. Then they have to pay the rent and buy shoes.

    So, what QE has done for the poor is make their lives more difficult. What it's done for employment is trivial. What it's done for the rich, who own most of the equities, is manifest.

    http://finance.yahoo.com/q/bc?s=^DJI&t=2y&l=on&z=l&q=l&c=

    And you can rationalize all you want about income distribution. Fact is COE/worker pay ratio has gone from about 30 to >300 over 40 years. Financial sector pay has mushroomed. Here is the result.

    http://jazzbumpa.blogspot.com/2011/03/presimetrics-and-great-stagnation.html

    While all the wealth has gone to the top, we've had the great stagnation.

    Did I construct an argument? Do you see my point?

    Cheers!
    JzB

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  61. Jazz,

    "Reading with comprehension" doesn't help when there is nothing to read. I could guess at your argument and try to piece it together through links but I expect grownups to actually make their arguments themselves.

    Links can provide evidence or more complex arguments, they are not a substitute for making your point.

    Jazz said, "Unemployment is still high, and has only budged slightly. QE benefit to the poor has been small to negative."

    What would unemployment have been in the absence of QE? Where is your evidence to support this claim?

    Event studies show that QE lowered long-term interest rates, slightly depreciated the dollar and slightly boosted equities. (Event studies help us sort out causality from correlation.) All of these changes boost growth and employment in standard theoretical and empirical models.

    Economists have measured the effects of QE on asset prices fairly precisely with event studies. The same sort of study shows that QE did not produce much commodity inflation.

    The commodity inflation comes from several sources: Adverse supply shocks like weather, growing global demand--of which the US is a very modest part--and increased use of biofuels. Not QE, except to the extent that QE prevented a deeper recession.

    You still don't seem to get the point that monetary policy doesn't change relative prices and so doesn't increase the cost of the Q1 bundle relative to the Q5 bundle.

    I've no desire to either agree or disagree with your rant about the "evil" Republicans, unemployment benefits and income distribution. Today I am concerned with a simpler matter: Money illusion.

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  62. The-Masked-Economist,

    My point is that, contrary to Michele's assertion, the burden of proof rests upon those who believe it is necessary and beneficial to manipulate money and credit to demonstrate exactly why these interventions are necessary and exactly how they can achieve results superior to the market.

    The market has provided and will provide money, which is subject to the laws of supply and demand just like the production of everything else.

    Why must the state monopolize money? Why must the state attempt to fix the prices of interest rates?

    Without clear and convincing proof as to why these things are necessary and beneficial, there is no justification for the existence of fiat money, central banking, etc.

    ReplyDelete
  63. Steve,

    "the burden of proof rests upon those who believe it is necessary and beneficial to manipulate money and credit "

    No, I don't think so. The US has a central bank that has practiced "modern" monetary policy at least since 1950. Every other developed country has a similar central bank or equivalent institution. The burden of proof is on those who would like to radically shift the rules and create institutions that we have no experience with.

    The Federal Reserve developed out of the 19th century's experience with banking panics and the lack of a lender of last resort. We have some idea of what life is like without a central bank and that experience led to the development of a central bank.

    A much less demanding version of Michele's question would be: What do you propose?

    You say that markets have supplied money. I've little doubt that some institutions would arise to replace money if we eliminated FR notes or just stopped creating new ones, but in what manner? What period in history do you look at as a model?

    You talk about "manipulating credit" as if it were some kind of conspiracy. It is just debt management.

    Governments issue two kinds of liabilities: 1) a highly liquid liability that pays no interest, known as money. 2) Less liquid liabilities that pay interest in the future but can't usually be directly exchanged for goods and services (bonds).

    Most of what central banks do during normal times is vary the relative quantities of money and bonds. That is, central banks just manage the government's portfolio. A central bank is not some Soviet central planning agency.

    Given government taxing and spending decisions, someone must decide how much of each of these liabilities to issue.

    ReplyDelete
  64. @ mask -

    "Reading with comprehension" doesn't help when there is nothing to read. I could guess at your argument and try to piece it together through links but I expect grownups to actually make their arguments themselves.

    Unemployment is still high, and has only budged slightly. QE benefit to the poor has been small to negative. Meanwhile corporate profits are at record levels, but companies aren't hiring. (OK, they're starting - a little) However, in some sectors at least, they're giving out record bonuses. Shortly after we bailed these geniuses out with tax dollars.

    Nope. Nothing to see here.

    Further, things like facts and data don't mean anything to you. You have just revealed yourself as not being worth talking to. But for the sake of completeness, here are the rest of my thoughts.

    Links can provide evidence or more complex arguments, they are not a substitute for making your point. Yes. Evidence.

    Event studies show that QE lowered long-term interest rates

    I guess you'll have to take that up with David Beckworth.

    http://macromarketmusings.blogspot.com/2011/01/qe2-and-rising-yields-again.html

    Not to mention the actual movement of interest rates.

    QE I Spring '09: 10-Yr bond rares were rising and continued up and stayed up for about a year.

    QE 2 Fall '10: 10-Yr bond rates bottomed and rose sharply.

    http://finance.yahoo.com/q/bc?s=^TNX&t=2y&l=on&z=l&q=l&c=

    Facts and data, my friend.

    What would unemployment have been in the absence of QE? Where is your evidence to support this claim?

    Likewise.

    You still don't seem to get the point that monetary policy doesn't change relative prices and so doesn't increase the cost of the Q1 bundle relative to the Q5 bundle.

    I get the point. I dispute it on it's merits. It's a worth-while discussion that I might have some day with a worthy disputant. You are not that guy.

    Cheers!
    JzB

    P.S. BTW, a line and a half of text stating a simple fact is not a rant. You and I do not live in the same universe.

    ReplyDelete
  65. The-Masked-Economist,

    The fact that central banking currently exists has no bearing on where the burden of proof rests. Supply and demand are perfectly capable of coordinating the production of all other goods and services, so why is money any different? The existence of an institution dedicated to manipulating money and credit must be justified.

    Money is a market phenomenon. As people overcome barter through indirect exchange, they come to value goods as media of exchange. The tendency is for a single commodity to emerge as the most easily and widely salable of all, and this commodity is money.

    Regarding history, I need to quote Mises:

    "The history of the natural sciences is a record of theories and hypotheses discarded because they were disproved by experience. Remember for instance the fallacies of older mechanics disproved by Galileo or the fate of the phlogiston theory. No such case is recorded by the history of economics. The champions of logically incompatible theories claim the same events as the proof that their point of view has been tested by experience. The truth is that the experience of a complex phenomenon—and there is no other experience in the realm of human action—can always be interpreted on the ground of various antithetic theories. Whether the interpretation is considered satisfactory or unsatisfactory depends on the appreciation of the theories in question established beforehand on the ground of aprioristic reasoning.

    History cannot teach us any general rule, principle, or law. There is no means to abstract from a historical experience a posteriori any theories or theorems concerning human conduct and policies. The data of history would be nothing but a clumsy accumulation of disconnected occurrences, a heap of confusion, if they could not be clarified, arranged, and interpreted by systematic praxeological knowledge."

    Regarding manipulating credit, my point is that interest rates are prices. Economists recognize that attempts at price fixing are disastrous, so why is attempting to fix critical prices such as interest rates any different?

    ReplyDelete
  66. Jazz,

    My "reading comprehension" line was aimed at your previous post (10:50 AM), not your 7:43 AM. I congratulate you on finally stating your views at 7:43 AM.

    I do strongly believe in facts and data. They just have to be relevant to the discussion.

    I partly agree with Beckworth -- QE would ultimately raise rates if successful. (Ulitimately means after an initial decline.) But I think that he ignores or misunderstands the immediate portfolio balance effect that the Fed was looking for and got. He is pretty terse so I am not 100% sure what he believes. He should read this, if he has not.

    http://www.newyorkfed.org/research/staff_reports/sr441.pdf

    How much did QE affect output? The original QE was worth about 250 bp of short-term interest rate cuts (see Dudley (2010), Rudebusch (2010)
    Gagnon et al below, and Fuhrer and Moore (1995)
    on relative long- vs. short rate effects). These produced about 2.5% GDP growth, relative to no QE (see Ball as reference). That reduced unemployment by about 1 percentage point, relative to no QE, using a common rule of thumb called Okun's law.

    Laurence Ball, 1999. Efficient Rules for Monetary Policy, International Finance, 2(1), 1468-2362
    http://web.pdx.edu/~ito/Ball_IntlFinance.pdf

    William C. Dudley, The Outlook, Policy Choices and Our Mandate, October 1, 2010

    Fuhrer, Jeffrey C., George R. Moore. 1995. “Monetary Policy Trade-offs and the Correlation between Nominal Interest Rates and Real Output.” American Economic Review 85, pp. 219–239.

    Glenn D. Rudebusch, The Fed’s Monetary Policy Response to the Current Crisis, FRBSF Economic
    Letter, Number 2009-17,May 22, 2009.

    Glenn D. Rudebusch, The Fed's Exit Strategy for Monetary Policy, FRBSF Economic Letter, 2010-18
    June 14, 2010.

    Now that I've shown you the research that I've relied on for my views, please feel free to enlighten me with opposing research.

    Jazz: "I get the point. I dispute it on it's merits. It's a worth-while discussion that I might have some day with a worthy disputant. You are not that guy."

    OK, now you've hurt my feelings. I will go cry now over my shortcomings.

    ReplyDelete
  67. @ The Masked Economist -

    "Event studies help us sort out causality from correlation". What does "sort out" mean? One cannot prove causality outside of a controlled experiement, which we don't have here.

    "Economists have measured the effects of QE on asset prices fairly precisely with event studies." - I think this is what Hayek would have called "scientism". No, economists have not "fairly precisely" measured the effects of QE; "loosely estimated", perhaps.

    Finally, commodity prices are not exogenous - much as you or the Fed might like to pretend otherwise. Loose monpol boosts commodity prices. Even Bernanke said so, and he's the last person I'd expect to admit that (especially in writing while a Fed governor).

    ReplyDelete
  68. Steve,

    Steve: "The fact that central banking currently exists has no bearing on where the burden of proof rests."

    The precautionary principle suggests the opposite. The side seeking radical change with no precedent has a considerable burden.

    Steve: "Supply and demand are perfectly capable of coordinating the production of all other goods and services, so why is money any different?"

    Well, no, actually supply and demand get some help in many areas. Pollution, for example, is a good (a bad, if you will) that has no market. So we create an artificial market by taxing it, putting a negative price on its production. National defense is another example. We don't observe nations being defended by demand from individuals because people could free ride and not choose to buy their share of an F22 this year.

    Now, I suspect that you are a hard-core libertarian and you will now explain to me why we don't need a national army or taxes on pollution or police or a dozen other examples of (IMHO) useful government activity that I could cite.

    So we will have to agree to politely disagree.

    ReplyDelete
  69. Anon 1:21: "Finally, commodity prices are not exogenous - much as you or the Fed might like to pretend otherwise. Loose monpol boosts commodity prices."

    I can't speak for the Fed but I would never claim that commodity prices are completely exogenous. They are partly exogenous, being affected by weather which is pretty damned close to exogenous, I think that you will agree. But world growth explains them reasonably well, I think. (I've got no cite for you.)

    I do like to "pretend" that I am a spaceman, roaring around the rings of Jupiter. But only after business hours.

    Loose M policy does boost commodity prices in a very modest fashion but that is a long way from saying that the QE had a substantial impact on commodities in a quantitatively important way in the present situation. I would agree that by preventing a much deeper recession, QE did prevent the world economy from collapsing and taking commodity prices with it.

    There is lots of evidence that other factors -- world growth, weather -- drove commodity prices recently.

    Been good chattin' with ya.

    ReplyDelete
  70. Anon 1:21 ""Event studies help us sort out causality from correlation". What does "sort out" mean? One cannot prove causality outside of a controlled experiement, which we don't have here."

    Of course one can prove causation outside of a controlled experiment. Rain forecasts are correlated with people carrying umbrellas the next day. Do you think that we understand that causality? Have you proved it with a controlled experiment?

    Statisticians/econometricians think hard about how to prove causality from "uncontrolled" data. To critique such methods properly, you really need to understand them. This would require that you take a few years of statistics, including a couple years of grad level econometrics.

    As far as Hayek's criticism of "scientism" goes, I stand by my "fairly precisely estimated" statement. If Hayek shows up from the afterlife I will listen respectfully to any comments that he has on the subject.

    Cheers.

    ReplyDelete
  71. "Rather, he correctly points out that such falls in the purchasing power of the dollar represent a theft of savings, as a saved dollar from a worker's wages will purchase less 10 years on than if he had spent it immediately. He also argues that this "inflation tax" on savings is hugely regressive as it falls primarily on the working and lower middle classes, who tend to hold their savings as cash or in dollar-denominated bank accounts; while the wealthy and upper middle classes invest a greater proportion of their savings in assets, be they stocks, bonds, or real property, and thus are more protected from the effects of inflation."

    Again, the stupidity rises. Try understanding the connection between expected inflation and nominal interest rates, then return. You people would all fail intermediate macroeconomics, and really shouldn't be speaking about it in public.

    For the record, Ron Paul is a pinhead and also would fail intermediate macro.

    ReplyDelete
  72. @Nate:

    "I've heard this argument a lot, but it seems that if you take it to its logical conclusion, you wind up at the idea that so long as the central bank works to keep inflation low, it can expand the money supply as much as it wishes, which begs the question of why it doesn't create enough money to cover all government debts or eliminate the need for taxation. Obviously this can't work,"

    Why not? the debt part, I mean.

    James Galbraith seems to believe that there is no need for the government to issue interest-bearing debt, as opposed to non-interest-bearing debt.

    http://krugman.blogs.nytimes.com/2010/07/17/more-on-deficit-limits/

    It seems to be an attempt to pull some liquidity (in the form of savers' federal reserve notes) out of the economy by agreeing to pump even more back into it later (in the form of payment on these loans). If I understand the process correctly, the Fed auctions off treasuries, which in effect shrinks its balance sheet (compared to a world where it simply held them). But it does so with the understanding that it will pour the money back into the economy, either through taxation or expanding its balance sheet again.

    I'm not sure why that is less inflationary over the long term.

    I'm also not sure why it would help lower the tax burden on the rest of us. In fact, if you could eliminate the interest we're paying on debt, that would free up a good chunk of revenue.

    Furthermore, see an excellent explanation of why the price of both gold and dollars are set by fiat here:

    http://blogs.ft.com/maverecon/2009/11/gold-a-six-thousand-year-old-bubble/

    One consequence of this perspective is that wealth doesn't have to be transferred to the government because of inflation. Suppose the government changed taxation and legal tender laws to encourage controlled inflation. If the rest of the economy went along with it, the value of money would simply decrease at a controlled rate every year, say 20%. If you're worried about printing too many zeroes on bills, just print the logarithm of the value of a bill (i.e., the date it was printed).

    If you pumped too much liquidity into the system, of course, people might stop holding it. I don't think you'd be able to do away with taxes. But the idea that a nation benefits by borrowing in its own currency is a little paradoxical. I'm willing to accept that it does, but it's not a simple idea.

    Intuitively, inflation seems preferable to servicing permanent debt.

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  73. The-Masked-Economist,

    I am talking about economics, not political philosophy. Economics is a value-free science.

    Economics demonstrates that: 1) money is a market phenomenon; 2) increasing the supply of money is not necessary and confers no general benefit; 3) the laws of supply and demand apply to money and credit; and 4) interest rates are prices that play a critical role coordinating the activities of consumers, savers, investors, and producers, while fostering a sustainable distribution of scarce resources and satisfying as many consumer wants as possible.

    To date, no one has demonstrated that the manipulation of money and credit is necessary or generally beneficial. The fact that fiat money and central banking exist says nothing of their validity.

    ReplyDelete
  74. Steve,

    I am not sure what your comment on political philosophy means. I don't think that I said anything that relies on a specific value system or a particular political philosophy.

    I am also not sure how to intepret your point #1. I would dispute #2 as a general truth, though it is sometimes true. I agree with #3 and #4.

    I would not use the term "manipulation" in connection with M policy as it is pejorative.

    I think -- and it is a mainstream view among economists -- that central banks can provide a general benefit by transacting systematically in money and bonds, as compared to alternative policies. I guess that you are not convinced.
    We can agree to disagree.

    I am not sure what it would mean for central banking to be "valid."

    ReplyDelete
  75. Steve,

    One last thing: I note that I neglected to respond to your much earlier question "...attempts at price fixing are disastrous, so why is attempting to fix critical prices such as interest rates any different?"

    When governments fix prices, they often do so by fiat (excuse the pun). For example, a government could declare a minimum price of milk. This creates gluts (in this case) or shortages and welfare losses.

    There are ways to influence prices that do not result in these welfare losses, however. If the government wanted to raise the incomes of dairy farmers, for example, it could buy a lot of milk, dehydrate it and give it away as foreign aid. That would also raise dairy farmers incomes but it would not create a shortage or a glut.

    In the case of money/bonds and interest rates, the government/central bank must choose some combination of money and bond liabilities, so there is no "manipulation" of a formerly pristine market, the govt/central bank must make some portfolio choice.

    I wish you good luck in your investigations of these issues.

    ReplyDelete
  76. Steve,

    The sinktrap apparently ate one of my responses. Here it is, briefly.

    I am not sure what you mean by your comment on poltical philosophy or values. I don't think that I was invoking any particular philosophy or values in my answer.

    With respect to your 4 points, I don't understand #1; I would dispute #2 as a general truth, though it is true some times; I agree with #3 and #4.

    I don't know what you mean by a central bank's "validity."

    We will have to agree to disagree with each other on the possible usefulness of a central bank's M policy. I believe that my views are well within the mainstream of the economics profession: I think that a central bank can usefully vary money and bonds to achieve positive results for the whole economy.

    ReplyDelete
  77. ECB Inflation MonsterMarch 30, 2011 at 1:24 AM

    http://www.youtube.com/watch?v=pbgY0dYoBvA

    ReplyDelete
  78. "Of course one can prove causation outside of a controlled experiment."

    Care to provide a reference?

    ReplyDelete
  79. To pick up on something you wrote earlier: "...M policy doesn't change relative prices over any significant period."

    I don't know how you define "significant period" and perhaps it doesn't matter --- it's clear that monpol affects relative prices in ways that have been very harmful to the real economy (e.g. the housing boom/bust).

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  80. The-Masked-Economist,

    The government can not attempt any form of price-fixing without negative effects. These policies can only divert production from locations in which the output per unit of input is higher to locations in which it is lower. In your example, the privileged group benefits at the expense of everyone else: consumer satisfactions are thwarted as resources are wasted that would have been employed more productively elsewhere, and the general standard of living is lowered. The fact that this is financed through taxation additionally distorts the allocation of the factors of production, the types of goods produced, and the pattern of incomes.

    There is indeed manipulation of the market when the central bank attempts to fix the price of the prevailing rate of interest. These attempts do not change the fundamentals of the economy: they simply create the illusion that the fundamentals are different than they actually are. In short, the interest rate is prevented from playing its critical coordinating role.

    I need to quote Jesus Huerta de Soto here:

    "Given that in the market many actions are carried out using money as a generally-accepted medium of exchange, the interest rate is the price one must pay to obtain a certain number of [money units] immediately; this price reflects the number of units one must return in exchange at the end of the set term or time period. . . .Therefore the interest rate is the price established in a market in which the suppliers or sellers of present goods are precisely the savers; that is, all those relatively more willing to relinquish immediate consumption in exchange for goods of greater value in the future. The buyers of present goods are all those who consume immediate goods and services (be they workers, owners of natural resources or capital goods, or any combination of these). Indeed the market of present and future goods, in which the interest rate is determined, consists of society’s entire structure of productive stages, in which savers or capitalists give up immediate consumption and offer present goods to owners of the primary or original factors of production (workers and owners of natural resources) and to owners of capital goods, in exchange for the full ownership of consumer (and capital) goods of a supposedly higher value once the production of these goods has been completed in the future.

    In a modern economy, present and future behaviors are reconciled through entrepreneurial activity in the market where present goods are exchanged for future goods and the interest rate, the market price of one type of goods in terms of the other, is established. Thus the more plentiful the savings, i.e., the greater the quantity of present goods sold or offered for sale, other things being equal, the lower their price in terms of future goods; and consequently, the lower the market rate of interest. This indicates to entrepreneurs that more present goods are available, which enables them to increase the length and complexity of the stages in their production processes, making these stages more productive. In contrast, the fewer the savings, i.e., other things being equal, the less economic agents are willing to give up immediate consumption of present goods, the higher the market rate of interest. Thus a high market rate of interest shows that savings are relatively scarce, an unmistakable sign entrepreneurs should heed to avoid unduly lengthening the different stages in the production process and generating as a result discoordination or maladjustments which pose a great danger to the sustained, healthy and harmonious development of society. In short the interest rate conveys to entrepreneurs which new productive stages or investment projects they can and should embark on and which they should not, in order to keep coordinated, as much as humanly possible, the behavior of savers, consumers, and investors, and to prevent the different productive stages from remaining unnecessarily short or becoming too long."

    ReplyDelete
  81. The-Masked-Economist,

    I commented on political philosophy because you suspect that I am a libertarian, and my political philosophy is not relevant to economics.

    With respect to my first point on money, I am saying that money can only originate on the market. Government is powerless to create money without reference to money previously chosen by the market.

    My point about the central bank's "validity" also relates to your comment that your views are "well within the mainstream of the economics profession". The fact that something currently exists or is "mainstream" is not a testament to the validity of the ideas supporting that existence or those views.

    You say that we need to agree to disagree regarding the usefulness of central bank monetary policy, but my previous point was that no one has demonstrated that the manipulation of money and credit is necessary or generally beneficial. The arguments in favor of such manipulations have been refuted by economic science.

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  82. Steve,

    "Social engineers engineer" is the self evident axiom from which the Chicago schoolers and Keynesians derive all of their science. This premise is not to be questioned.

    The implications are a little different than what comes out of Mises' axiom of action, however. Instead of principles of value, prices, capital, interest, etc, that we get from economic science, the social engineers provide us with graphs--lots of graphs and, oh yeah, another crude form of knavery attempting to justify the police power of the state and its soldiers.

    ReplyDelete
  83. "You say that we need to agree to disagree regarding the usefulness of central bank monetary policy, but my previous point was that no one has demonstrated that the manipulation of money and credit is necessary or generally beneficial. The arguments in favor of such manipulations have been refuted by economic science."

    This statement is false. In the absence of complete markets, it has been shown repeatedly that varying the money supply systematically has desirable welfare effects. Just because you don't understand modern economics doesn't mean anything.

    And Rudy Dekkers is a complete moron. Just thought I'd make sure everyone sees that indisputable fact.

    ReplyDelete
  84. "Rudy Dekkers is a complete moron. Just thought I'd make sure everyone sees that indisputable fact"

    There was a civil debate about central banking going on. Feel free to join in. But please don't poison the debate with ad hominen attacks.

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  85. Rudy,

    As of 2008, about 53% of economists were employed by the government. Of course, many others work as consultants for the government. Assuming nothing other than self-interest, it is clear why modern "economics" consists largely of justifications for government intervention in the economy.

    I will say it again: economic science has refuted the claims that manipulation of money and credit is necessary or can possibly be generally beneficial. Mainstream "economists" have been unable to rebut these refutations, or have simply ignored them. Until these refutations can be rebutted, the existence of fiat money, central banking, etc. can not be justified.

    ReplyDelete
  86. P.S. Robert Murphy will address this blog post on Monday.

    ReplyDelete
  87. David I'm not sure why your bothering arguing with people who will not change their view point under any circumstances. You've broached at topic that is religious fervor with many people. I would do your self favor and find a more productive use of your leisure time.
    -Economics graduate student.

    ReplyDelete
  88. "There was a civil debate about central banking going on. Feel free to join in. But please don't poison the debate with ad hominen attacks."

    There has been no debate. A few economists foolishly tried to explain some basic economic concepts to ideologues who view the subject as a matter of faith.

    Bad idea. It wasted everyone's time.

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  89. @ Steve. where are you getting your statistics from. Many government economists are not qualified to call them selves economists in Academia or in Federal Reserves. Vast majority of Ph.D. in America's are employed by universities, and a good chunk by private sector firms in various roles. I'm wondering where you are getting your facts from. Our market is very well organized and we generally know where our students are ending up.

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  90. Steve

    "Economics demonstrates that: 1) money is a market phenomenon; 2) increasing the supply of money is not necessary and confers no general benefit; 3) the laws of supply and demand apply to money and credit; and 4) interest rates are prices that play a critical role coordinating the activities of consumers, savers, investors, and producers, while fostering a sustainable distribution of scarce resources and satisfying as many consumer wants as possible."


    Economics "demonstrates" nothing of the sort! #1 is quite dubious, if by market phenomema you mean, "the citizens decide what to use as money". In virtually every advanced economy today a central authority has decided what will be used as money within its currency zone and MOST people have gone along with it. #2 Is like saying, "As more people enter a poker game we dont need more chips we just have them borrow chips form people who are already playing and have extra ones" . This is gold standard thinking and is dangerously wrong. #3 is correct ..... to a point. #4 depends on what interest rates you are talking about. The central bank SETS the prime interest rate, all others kind of work off that.

    ReplyDelete
  91. "There has been no debate. A few economists foolishly tried to explain some basic economic concepts to ideologues who view the subject as a matter of faith."

    The subject is, in part, a matter of faith. What is the fiscal multiplier? Economists don't even know what the correct sign is, let alone the magnitude, so they decide based on unprovable theories. Sounds a lot like faith to me.

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  92. Hey everyone: interesting discussion. Sorry that I could not participate (I have been travelling).

    Steve: You say,

    I will say it again: economic science has refuted the claims that manipulation of money and credit is necessary or can possibly be generally beneficial. Mainstream "economists" have been unable to rebut these refutations, or have simply ignored them. Until these refutations can be rebutted, the existence of fiat money, central banking, etc. can not be justified.

    How can you be so bold in your claim that "economic science" has done this or that? The science is not settled; and no self-respecting scientist would ever make a claim like this.

    Btw, I can refer you to many papers in the field that demonstrate the circumstances under which a fiat money instrument is necessary to facilitate exchange (the same literature lays out the circumstances in which private money can be expected to do a good job on its own). The claims you make here suggest to me that you are unaware of the research that is currently taking place on the subject, which is fine, but if so, then perhaps a bit more modesty is in order.

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  93. Masked Economist: Thanks for picking up some of the slack here during my absence.

    ReplyDelete
  94. Commodities rise more relative to other prices when the central banks seek to "improve the economy" soley by increasing the quantity of money. The mechanism is not that hard to understand. There are people who have jobs make asset allocation decisions. They decide look at Bonds,Equities and to a growing but lesser extent Commodities. When they see that the only remaining trick of the US government and Fed is to devalue the dollar, they start allocating more to commodities.

    This is what we are seeing...WTI is not $107 due to a changes in quantities consumed or produced...it is up to $107 because of asset allocation decisions. It is not a "supply shock".

    I suppose you guys think Simon Johnson (MIT prof) is alsO a conspiracy nut? he has explained it pretty clearly: There is a financial Oligarchy that is running things for their own benefit. The people telling us that all of the benevolent Fed Operations are for the benefit of the masses are propaganda artist(whether they know it or not). Face it David, "let them eat Ipads", is not a good monetary policy and your stance that QE1,2 and expectations of 3 have nothing to do with broad commodity price increases is obtuse at best.

    Yes I agree as you have pointed out that real food prices have decreased around the world since 1913 or 1940 or 1950....that is not the question. What about the last 5, 10 years 20...eal prices of of the basics have started increasing with the onset of the great stagnation other things have happened that have made things even worse. It is illogical for a fan of our current corrupt system to try and credit for economic rwth that was set in motion with the industrial revolution and rise of the United States...thinks are changing..the Fed has bought 2 trillion dollars in crap loans the last three years...without this funding, the interest rates would have sored on US debt and the too big too fail banks wouldn't have made record profits ....this is a policy of "Extend and Pretend".


    All that said...I'm making bets on QE3 so please please continue to inflate...the worst part for us is when you try to head fake us in each direction...but I understand that you have to let your friends(I assume not yours literally David, you seem like a true believer) at Goldman Sachs and JP Morgan front run the major shifts in policy...otherwise the big fed guys would be making 500 k speeches at the big banks...need to maintain the value of that insider knowledge right?

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  95. Gabe: Your post reminds of something Mark Twain once said:

    What gets us into trouble is not what we don't know, it's what we know for sure that just ain't so.

    You seem to be sure of a lot of things.

    ReplyDelete
  96. Anonymous,

    As of 2008, 53% of economists were employed by government, according to the BLS: http://www.bls.gov/oco/ocos055.htm

    Greg,

    My first point is that money can only originate on the market. As people overcome barter through indirect exchange, they come to value goods as media of exchange. The tendency is for a single commodity to emerge as the most easily and widely salable of all, and this commodity is money.

    Government is powerless to simply create money without basing it on a money previously chosen by the market. In terms of modern currencies, they were all originally expressed in terms of weights of silver and gold.

    Your critique of my second point displays a severe lack of economic understanding. I can't explain the whole of monetary theory here. Suffice it to say that, as David acknowledges in his post, money is not wealth. As the economy becomes more productive, the money prices of goods and services fall. It is not necessary to increase the quantity of money as the economy becomes more productive.

    My fourth point seems to be the critical one being misunderstood here. I understand how the Federal Reserve System works. My point is that, regardless of the central bank's activities, there exists a real interest rate that reflects the actual supply of and demand for savings. The artificial rate created by the Fed's manipulation is like white noise to businesses, who are prevented from knowing the real price of obtaining present goods. This attempt at price fixing is powerless to change the amount of real resources in the economy; it can only cause resource misallocation.

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  97. David,

    I suspect you are trying to get me to "admit" something that is usually dismissed out of hand in these circles, but my answer to your criticism is that no self-respecting natural scientist would make such a claim. The natural sciences employ the scientific method, and as a result, their history is a record of theories and hypotheses discarded because they were disproved by experience. Economics, on the other hand, has no such history.

    In the words of Mises:

    "The champions of logically incompatible theories claim the same events as the proof that their point of view has been tested by experience. The truth is that the experience of a complex phenomenon—and there is no other experience in the realm of human action—can always be interpreted on the ground of various antithetic theories. Whether the interpretation is considered satisfactory or unsatisfactory depends on the appreciation of the theories in question established beforehand on the ground of aprioristic reasoning.

    History cannot teach us any general rule, principle, or law. There is no means to abstract from a historical experience a posteriori any theories or theorems concerning human conduct and policies. The data of history would be nothing but a clumsy accumulation of disconnected occurrences, a heap of confusion, if they could not be clarified, arranged, and interpreted by systematic praxeological knowledge."

    Please link me to the papers demonstrating the necessity of fiat money instruments to facilitate exchange. Despite the personal attacks leveled at me in this forum, I am a very open-minded individual who has explored many different schools of economic thought, and I am always open to new insights that challenge my views.

    Also, please point me to refutations of Mises's Regression Theorem and Mises's Calculation Problem (Lange-Lerner-Taylor did not refute it, and Hayek-Robbins did not make Mises's argument).

    In addition, I am unaware of any business cycle theory other than the Austrian Business Cycle Theory that explains the general "cluster of errors" and why it is that capital goods industries, not consumer goods industries, suffer the most.

    P.S. I am told that Robert Murphy will be posting a response to your post on Mises.org on Monday, so please address his criticisms and keep the debate going.

    ReplyDelete
  98. Steve


    What market did the Euro originate on? The euro was created out of thin air by a Central Authority, it was pre determined what an exchange rate would be for the various sovereign currencies that were being replaced and it was distributed to the various citizens and banks. Money is not a commodity, it hasnt been since 1971.


    "Government is powerless to simply create money without basing it on a money previously chosen by the market. In terms of modern currencies, they were all originally expressed in terms of weights of silver and gold."


    Powerless huh....... hmmmmmmm. It matters not what commodity pegs currencies used to have, they have none now and govts can and do create at will, restrained only by the political mechanisms of their various countries.


    You are right money isnt wealth but it is what wealth is denominated in. We only give an agreed-to value to our wealth via the use of money. So they are kind of intertwined.... unfortunately.

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  99. Greg,

    The Euro, like all fiat currencies, had to be based on previously existing currencies. Money prices need to develop on the market. See Menger on the origins of money and Mises's Regression Theorem.

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  100. "In addition, I am unaware of any business cycle theory other than the Austrian Business Cycle Theory that explains the general "cluster of errors" and why it is that capital goods industries, not consumer goods industries, suffer the most."

    Wow, you're really poorly informed then. Every standard business cycle model predicts investment fluctuates far more than consumption, as it does in the data.

    And really, who gives a crap what Mises thought or said? Substitute Keynes for Mises and you're just a wacky post-Keynesian. Neither one matters anymore.

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  101. "I can't explain the whole of monetary theory here."

    Or really any part of it. Mainly due to a lack of understanding on your part.

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  102. Anonymous,

    I am familiar with standard business cycle theories. Apparently you are not familiar with Austrian Business Cycle Theory or capital theory. My question is more specific than aggregate categories of "investment" and "consumption."

    Care to advance economic arguments rather than making personal attacks? Care to refute Menger on the origin of money or Mises's regression theorem?

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  103. Steve,

    As a mere amateur reader of Rothbard and Mises, it seems to me that Mises' regression theorem explains how "honest" money emerges on the market and how a commodity that ends up being valued "100%" for exchange purposes must have at some time in the past been valued "100%" for direct use value. But isn't it true that a mafia-like organization such as the state can cause individuals to value any commodity by using its hitmen to threaten individuals with violence who don't present the designated commodity on demand as tribute? (I recall that Andolfatto actually mentions this in a recent post--but not in this context of thinking clearly and seriously about the origins of money that we're talking about here)

    As a once-amateur mouther-backer of algebraic equations for the purpose of getting Bs in Fed Gov Fred Mishkin's macro-"economics" classes, it seems to me that these social engineers care nothing about why or whence money is valued by individuals. They've got their lab coats on and all they care about is their positivist-arithmetic. Do you know of anywhere that any of them have ever addressed Mises' regression theorem?

    Do you know if Milton Friedman or any of the others ever responded to Rothbard and Mises, or did they also not give a crap either and not go beyond mocking it and calling it "religion?"

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  104. @ Steve. The BLS considers economists as anyone with the title economist in a company or government. Two be employed as an economist by government you need only 4 courses in the subject. Those people are little more than ordinary analysts/forecasters. Actual economists among economists is someone with a Ph.D. I can assure thats far less that number is far less than 53%. I can also tell you that most of the people work for the fed enjoy far more freedom of speech than you do.

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  105. Steve why would anyone bother conversation/discussion with you when you are so sure of your opinions as you are yet have demonstrated you have understanding of economics less than the average sophomore economics major. Its a waste of anyones time, when someone is as dogmatic as you are. Its clear to anyone with even a little bit of economics training that you have no background in the subject. You have read a few books by commentators on the fringes of the field. That you agree with religiously and then take the time to argue with people who are far more read and have contributed far more to the subject. You claim to have knowledge of business cycle theory, but fail to realize that the very people who are claiming you don't have knowledge of a large portion of the influential economic literature for the past 50 years. In addition have witnessed directly how much the literature has changed over the course of that time.


    I would hate to sit in a class room with someone like you, or ever have to witness you in public. You are the person that the rest of the room is hitting their foreheads every time you speak. I have to say I have amazing respect for David, even though his views some times irks me, for trying to engage with the general public to the level he does. Here is one of the most influential monetary theorists in the world, a senior employee of one of the feds spending his leisure time to try to share insights with the average joe. Even more trying to actually answer your questions. You've spent most of your time trying to show off how you somehow have more expertise in his field than he does. Get off your high horse. Seriously. If you think you so much why not try to pursue his career. Humility can go a long way.

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  106. Hey everyone, let's try to keep the personal barbs to a minimum (I will try to follow my own advice here...lol). And if we are to poke each other about, let us do it in good humor. I am learning a lot from this discussion. The varied backgrounds and contexts that people use to organize their thinking fascinates me.

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  107. Steve:

    I've heard that line of reasoning from Mises before. Not sure I entirely agree with it. In any case, I'm not sure what the point is. You made a claim that "the science has demonstrated." I made the counterclaim that no such claim is warranted. I doubt that many would disagree with me, though apparently you do?

    You asked for references to the modern money literature. Take a look at some of the articles listed here: http://artsci.wustl.edu/~swilliam/

    On the essentiality of fiat money, see Narayana Kocherlakota, Federal Reserve Bank of Minneapolis Quarterly Review, dated 1998, called "The Technological Role of Fiat Money." You might want to start with this one.

    Also, please point me to refutations of Mises's Regression Theorem and Mises's Calculation Problem.

    I did a quick Google search here and found no statement of the theorem in question. Can you provide it for me? As for the so-called Calculation problem, I think that most economists are likely to have sympathy for this view. The one thing that strikes me about "Austrian" thinking, however, is how "price" appears to be the only coordinating mechanism in their view (correct me if I am wrong). In fact, markets likely "equilibrate" along several dimensions, one of which is price.

    Having said this, I'm not sure what it has to do with my post here.

    P.S. I am told that Robert Murphy will be posting a response to your post on Mises.org on Monday, so please address his criticisms and keep the debate going.

    I am not sure what there is to debate as far as this post is concerned. The point I am making here is that the claim that the Fed has stolen 95% of our wealth through currency debasement is false. The claim is made to frighten and anger people. Who is going to "debate" this?

    If he wants to debate other things, I will be more than happy to engage.

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  108. I think the whole discussion has gone kind of off base here in relation to the post.

    The comment I believe is most spot on is Inkblots (March 27, 2011 9:10 AM) and my own (March 23, 2011 12:21 PM ), both of which have, to my disappointment, not been addressed by anybody following after and kind of gone under in the noise.

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  109. David,

    Thanks for the response and the links. I will be looking at them in detail.

    Regarding economic science, I think you would have to admit that, at the very least, it has not been demonstrated that manipulating money and credit is necessary. Money is half of every transaction, and interest rates play a critical role in coordinating the structure of production, so the existence of an institution that systematically interferes with these things has to be entirely justified by economic science. There are many critical objections to the necessity of these manipulations, and, in nearly 100 years of operation, the Fed has not come anywhere close to eliminating the business cycle.

    Mises's Regression Theorem completes Menger's explanation of the origin of money. Menger explained money's exchange value through marginal utility, and Mises solved the apparent circularity of this explanation. Why do people have a marginal utility for money? People value units of money because of their expected purchasing power, and hence are willing to give up goods and services now in order to attain cash balances. Thus, the expected future purchasing power of money explains its current purchasing power. This is not a circular argument due to the time element: people today expect money to have a certain purchasing power tomorrow due to their memory of its purchasing power yesterday. This analysis is not an infinite regress because the purchasing power of money can be traced back to the point at which it emerged from barter. At that point, money's purchasing power is explained in the same way as the exchange value of any other commodity, since money must originate as a good valued for its own sake before becoming a medium of exchange.

    I brought up the Regression Theorem and the Calculation Problem mostly in response to other posts in this forum, so they don't directly relate to your post. My point in bringing them up along with Austrian Business Cycle Theory was to list a few things related to the money supply, the determination of prices, and the fixing of interest rates that are relevant to the general debate about manipulating money and credit, yet seem to be uncritically dismissed.

    As for Robert Murphy's upcoming response to your post, you will have to read his objections to your analysis and respond from there.

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  110. Cosmo: I'm sorry that I did not reply. Let me try now. Your comments are italicized below.

    "when you take out a mortgage, a private bank creates and lends you book-entry money in exchange for your house as collateral"

    In other words, the banking system creates and allocates purchasing power without giving up any consideration of its own. (Not to say: out thin air, of course!!)

    I do not think of the banking system as creating purchasing power, as much as enhancing it. If people could, they would issue IOUs against their own personal property, and these IOUs may circulate. A more cost effective way to do this is to have a bank do it on your behalf (this is why we call banks intermediaries). The banks take your collateral, or your IOU, and create their own money that is backed by the promises you have made. This is called liquidity creation (and destruction, as money loans are repaid). What is all the fuss?

    So while I can agree monetary policy implementation with regards to the Fed and outside money is an asset swap, I would much rather argue that the distortionary effect and continuous deterioration of purchasing power comes from the banking system creating inside money -- made possible, of course, with fractional-reserve banking.

    I'm not sure that you understand "fractional reserve" banking. The liabilities that banks issue are fully backed with the bank's capital (and in modern economies, by government insurance, but this is another matter). The demandable liabilities that banks issue are only partially backed by cash (this is what you mean by fractional reserves). But this does not mean they are not backed. They are backed by the IOUs people "deposit" as collateral. This is the essential function of liquidity creation.

    The fact that banks can create and allocate purchasing power (in form of inside money) at will in a way that distorts the real economy is the first order issue of purchasing power loss; I think the trickling down issue of who gets the new money first is second order only.

    Banks cannot create purchasing power "at will." The same is true of all private firms; they cannot issue shares "at will" without be punished for it in the market place. You are making unsubstantiated claims here. The banking system may not work perfectly, and there may exist legislation (including free banking) that may improve its workings, but I would like to know on what evidence you base your claim about the "first order" issue of purchasing power loss.

    This is what I take issue with and I do not believe this is addressed in either this or the previous post on "thin air".

    Well, I hope that I have gone some way to address your questions.

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  111. Steve:

    Regarding economic science, I think you would have to admit that, at the very least, it has not been demonstrated that manipulating money and credit is necessary.

    When have I ever suggested otherwise? My claim has always been that the science is not settled. Many self-described Austrians and Krugman/DeLong types appear to think otherwise.

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  112. David,

    You did not say this. You seemed to implicitly support people in this forum who attacked me for asserting that this has not been demonstrated. My entire point is, given that this has not been demonstrated, how can the systematic manipulations currently taking place possibly be justified?

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  113. Steve:

    I was making my own arguments; I was not trying to support others.

    Your entire point is a good one. There is an analogous point to be made: It also has not been demonstrated conclusively that zero manipulations are in the social interest.

    And so, as a science, we stand somewhere in between, trying to figure things out. Certainly there are examples of private clearinghouses (like the Suffolk Bank system) that have arisen spontaneously and that have discounted paper and fixed the exchange rates between different bank paper and have otherwise behaved in a manner that the Fed has operated recently in the financial crisis. You might want to entertain the possibility that the Fed is an institution that is trying to replicate the best features of what a private market seeks to accomplish in the way of payment and settlement systems. Those private systems did not work perfectly either.

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  114. Anonymous with a brainApril 2, 2011 at 9:56 AM

    Steve, thanks for keeping this a high-brow thread, despite Anonymous' erroneous and egregious character assassinations.

    David, thanks for engaging in the debate. I look forward to reading your response to a supposed Robert Murphy rebuttal. Here's my suggestion for future articles: instead of attacking Ron Paul and "End the Fed types", perhaps you should try to refute the economic theories of Ludwig von Mises. If you could logically refute Mises' regression theorem, for instance, you would take away Dr. Paul's credibility. I've not seen Austrian Theories refuted before, so I have no choice but to accept them as good theories. Consider it a challenge. For the meantime, I'll enjoy your responses to Steve and Robert Murphy.

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  115. David,

    I appreciate you taking the time to discuss these things here. It says a lot about your integrity.

    I am not claiming that any system works perfectly. My criticism of your point is that this is not a purely academic debate: the effects of central bank manipulations are very real. Absent proof that these manipulations are absolutely necessary, it is unacceptable to force a grand experiment on society.

    Thanks again for engaging, and I look forward to your thoughts on Robert Murphy's upcoming article.

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  116. Steve:

    Yes, the effects of central bank interventions are very real. But then, the absence of such interventions are also very real. We know what business cycles look like in the absence of central banking too.

    It is not necessary, in my view, to demonstrate that central bank manipulations are "absolutely necessary." Personally, I do not think they are. It is sufficient to show that the net social benefit is positive. I'm not sure if this has been done either, however.

    Anyway, thanks for the conversation. I'm sure we'll have more in the future.

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  117. "Absent proof that these manipulations are absolutely necessary, it is unacceptable to force a grand experiment on society."

    A central bank we've had for almost 100 years is a "grand experiment" but removing it for an unnamed alternative with which we would have no experience at all is the safe default. Absolutely bizarre reasoning.

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  118. "Regarding economic science, I think you would have to admit that, at the very least, it has not been demonstrated that manipulating money and credit is necessary. Money is half of every transaction, and interest rates play a critical role in coordinating the structure of production, so the existence of an institution that systematically interferes with these things has to be entirely justified by economic science. There are many critical objections to the necessity of these manipulations, and, in nearly 100 years of operation, the Fed has not come anywhere close to eliminating the business cycle."

    This argument presupposes that the allocation in the absence of monetary policy is efficient; that is, it essentially assumes that all deviations from efficiency are due to the Fed. There is no reason to think this statement is even approximately true; credit markets suffer from asymmetric information/limited commitment problems that have nothing to do with whether the Fed moved the short-term nominal interest up or down. The same problems plague labor markets, insurance markets, some goods markets.

    The evidence is that Fed has a limited ability to influence real quantities in the short run, almost none in the long run, and the theory says the Fed can operate in a way that improves on the competitive allocation. It is unclear whether the Fed has operated in that fashion, but that isn't Steve's argument.

    Steve just fervently wants it to be true that the Fed is useless. Typical spouting from a person unfamiliar with modern economy theory. I do find it hilariously hypocritical that an Austrian is making reference to economic science, though.

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  119. Murphy's response -

    http://blog.mises.org/16346/is-inflation-harmless-or-even-good/

    I really enjoyed this comment as well:

    "What I find interesting in these statistical stunts with data over time, like the graph of wages vs. prices (CPI) since 1948, is that they always assume (and seem to believe) that all else is constant. Well, it isn’t. We can assume things like technology and the productivity of labor (these concepts are related, of course) are constants so as to identify correlations and, perhaps, causation. But Andolfatto seems to say (not having read the original piece) that: “Look, wages increase more than CPI, therefore nobody’s hurt by inflation.” Well, that’s like saying any laborer in 2010 would have to work three hours to be able to buy a DVD for his home theater, just like any laborer in 1920 would also have to work [only] three hours to buy a DVD for his home theater.

    Obviously, this doesn’t cut it. There were no such things as DVDs in 1920 – we’ve seen enormous progress 1920-2010. And even if there were such things as DVDs back then, they would have cost a fortune (assuming cost drives price, which mainstream economists do) simply because there was no technology to efficiently produce DVDs.

    The problem here is that (a) CPI does not measure the real increase in the “price level” (whatever that is) since all products are not included and availability as well as buying habits change, and (b) prices tend to go down over time. Prices fall because labor gets more productive and therefore the trend must be that we should be able to always afford more stuff working fewer hours. All change is mysteriously gone in these statistical analysis, and mainstream economists relying on them seem to actually believe (considering their arguments) that things are exactly the same today as they were 100 years ago – only all dollar amounts are bigger (20x bigger)."

    He should have read your post first, but the question still stands, to me at least. Given an absolutely stable monetary supply (zero inflation) prices will fall with technological advances and innovation. Everyone's standard of living is then increased with each incremental advance.

    I also think it's interesting to think "does inflation drive innovation?" Perhaps some of these innovations wouldn't have occured without the pressure placed on it via inflation. If we want to give any credit to the fed it's amount of continual pressure upon companies to keep their prices low certainly does cause innovation such as this:

    http://www.cnbc.com/id/42315625/Food_Inflation_Kept_Hidden_in_Smaller_Bags

    Innovation is not always good for the consumer, hence people's issue with it.

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  120. Robert Murphy's response: http://mises.org/daily/5172/Is-Inflation-Harmless-or-Even-Good

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  121. David, am I misremembering that prior to the Fed, recessions were relatively mild? That yes, we did have cyclic change, but that nothing comparable to the Great Depression happened prior to the invention of the Fed?

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  122. Anon

    Considering that prior to the Depression, we had no macro economic measurements to speak of, people mostly worked their own land or had a job at a factory where you worked 7 twelve hour days at least AND we had a gold standard, I dont think there is much relevant in comparing the two times.

    What Austrians call dollar devaluation, I call getting more and more people up to a decent standard of living.

    But, there were many deep financial crises prior to the inception of the fed. Many didnt spill as far into the real economy because Wall St hadnt financialized or "marketized" everything on the planet.

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  123. So, the conditions that existed prior to the creation of the Fed offer no insight into what has changed since the creation of the Fed? So I guess we'd need to deconstruct it just to learn what effect it has? One effect it has is monetizing debt [I am pretty sure] which lowers my purchasing power; inflation certainly doesn't cause a real increase in wages - that is caused by increases in efficiency, productivity or resources.

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  124. "an unnamed alternative with which we would have no experience"

    free banking? that's been tried. commodity standard? that's been tried. to suggest we "have no experience" of alternative monetary systems is simply wrong.

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  125. "free banking? that's been tried. commodity standard? that's been tried. to suggest we "have no experience" of alternative monetary systems is simply wrong."

    Michele Boldrin asked for an alternative and its expected performance. Masked Economist tried to explain why an alternative was necessary. Steve doggedly refused to name his favored alternative, except to cite a faith in some unexplained market mechanism.

    Are there alternatives to a central bank? Sure. Do we have much experience with them in modern economies with modern finance? No.

    We haven't had free banking since the 1863. We haven't had a true commodity standard since the Great Depression. (Hint: There is a reason many major countries went off the gold standard in the 1930s.)

    To suggest otherwise is simply wrong.

    But Steve calls central banking a "grand experiment" while refusing to name an alternative. Bizarre.

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  126. Anonymous,

    What was the reason why major countries went off the gold standard in the 1930s?

    What is your response to Robert Murphy's criticisms?

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  127. Please re-explain your position in light of this critique:

    http://mises.org/daily/5172/Is-Inflation-Harmless-or-Even-Good

    Thanks!

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  128. The classical gold standard broke down because governments broke their promises to redeem their currencies in gold. They inflated their currencies so drastically that they had to go off the gold standard, i.e., declare bankruptcy. The United States was the only country that did not engage in reckless inflation during World War I, and as a result, inflated pounds, francs, marks, etc., depreciated in relation to gold and the dollar.

    Instead of recognizing reality and returning to the gold standard at a redefined rate, Britain insisted on returning to gold at the old par of $4.86, which depressed their exports and caused severe unemployment, while the rest of the world was experiencing a boom. In order to induce other governments to go back to gold at overvalued pars, Britain led the Genoa Conference of 1922, which led to the gold-exchange standard.

    The U.S. remained on the gold standard, redeeming dollars in gold, but Britain and other Western countries returned to a pseudo-gold standard. Britain redeemed pounds in gold only for large international transactions, and redeemed pounds in dollars, while other countries redeemed their currencies in pounds. Basically, dollars were pyramided on gold, pounds were pyramided on dollars, and other European currencies were pyramided on pounds.

    The gold-exchange standard prevented the gold-standard mechanism from operating. When Britain inflated and had a deficit in its balance of payments, other European countries didn't redeem pounds for gold: they kept the pounds and inflated on top of them. Britain and Europe inflated unchecked. Britain was also able to induce the U.S. to inflate dollars so that they would not lose many dollar reserves or gold.

    This system could not last: the piper had to be paid in a disastrous reaction to the inflationary boom. This is exactly what happened in 1931: Britain had to go off the gold standard completely when France tried to cash in its sterling balances for gold, and other European countries soon followed.

    Governments breaking their promises to redeem their currencies in gold is what led to the monetary chaos of clean and dirty floating exchange rates, competitive devaluations, exchange controls, trade barriers, etc., which were major causes of World War II.

    Along came Bretton Woods, which set up essentially the same system as the gold-exchange standard, with the dollar as the only key currency. The U.S. pyramided dollars on top of gold, and all other countries pyramided on top of dollars. Like the gold-exchange standard, this system could not last. The U.S. inflated, and as countries became increasingly restless that they were piling up overvalued dollars, they began to redeem their dollars for gold.

    Despite political pressure, economic law caught up with the U.S. In order to maintain the gold price of $35 an ounce, the U.S. was forced to send gold to the free gold markets in Europe. When they realized they still couldn't maintain the price, they decided to ignore the free gold market and maintain the artificial price of $35 an ounce forever. However, this only bought a few years of time. Gold continued to flow out of the U.S., and the rising free-market price of gold revealed the increasing loss of world confidence in the dollar.

    On August 15, 1971, Nixon imposed a price-wage freeze in a vain attempt to check inflation, and severed the dollar's last link to gold. The Smithsonian Agreement soon followed, which was even more unstable than the gold-exchange standard of the 1920s. Fixed exchange rates are doomed to rapid defeat, and this standard collapsed in just over a year.

    Since the establishment of a complete fluctuating fiat system in March 1973, the world has suffered the most intense and sustained bout of peacetime inflation in the history of the world.

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  129. David:

    Once we understand that the Fed gets $1 worth of assets when it issues a new dollar, we should realize that the Fed's issuance of new money is like a corporation's issuance of new stock: As long as assets rise in step with the new liabilities (stock or money) there is no effect on the value of the stock or of the money. When money or stock does lose value, it's because the issuer's assets have not kept up with its liabilities.

    For example, suppose the Fed blows 1% of its assets on economists every year. That would cause 1% inflation.

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  130. "The classical gold standard broke down because governments broke their promises to redeem their currencies in gold. ... Instead of recognizing reality and returning to the gold standard at a redefined rate, Britain insisted on returning to gold at the old par of $4.86..."

    Which? Was the problem that governments broke their promises or kept them?

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  131. ""The classical gold standard broke down because governments broke their promises to redeem their currencies in gold."


    Uhhh no. They didnt have enough gold to meet their obligations..... and then slowly.... governments realized how stupid commodity standards on money are. Money is not a commodity, it is that which a commodity is priced with. It is the numeraire.

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  132. Anonymous,

    Britain had inflated so much that the pound had depreciated to about $3.50. If they recognized the existing money supply and price levels, this would have been the required adjustment. If they wanted to maintain the old par of $4.86, they would have had to drastically deflate the money supply and price levels, because export prices were far too high to be competitive. They chose not to do this for political reasons, largely because trade unions and unemployment insurance made wage rates rigid downward. They actually continued to inflate money and prices, and this is what caused Britain to suffer all during the 1920s while everyone else was experiencing a boom.

    If you think trying to maintain an artificial par constitutes keeping a promise, you are mistaken. The promise was broken by not keeping the currency redeemable in gold, and then Britain tried to have its cake and eat it too.

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  133. Greg,

    Why do you think they didn't have enough gold to meet their obligations?

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  134. Steve: You say that the classical gold standard broke down because governments broke their promises. In my earlier post, I made exactly this point about commodity money regimes (or any other regime, for that matter). The issue is credibility; not whether a Fed exists or not. We see how easily it is to break promises even without a Fed.

    Mike Sproul: I would agree with you, if one assumes that the economists hired by the Fed produced zero output. The other thing I should like to point out is that in the absence of money creation, these same Fed economists could have been paid out of general tax revenue. Again, I do not see why the Fed is the issue here. I keep trying to stress this point, but it evidently continues to fall on deaf ears.

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  135. David,

    Precisely. It is dangerous for any government to have a monopoly over money and banking. The original purpose of this arrangement was to extract money from people in an insidious way.

    William Paterson's arrangement with the English Parliament in the late 1600s was essentially the same as the Fed's arrangement with the U.S. government. The Bank of England was granted the monopoly privilege to issue notes, in order to finance the government's deficit. The BOE bought interest-bearing government bonds, and paid for them with newly created bank notes.

    What happened? The BOE inflated, and was insolvent within a couple of years, after a bank run. The English government then granted the BOE the exact same privilege that the U.S. government granted the Fed: it allowed the bank to suspend specie payments.

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  136. Steve:

    You missed my point.

    Imagine that we have a regime with free banking -- no government monopoly. In short, the government has made a promise (out of thin air) that it will respect free enterprise in the business of banking.

    And now imagine the government reneging on this promise. (In 1863, during the "Free" Banking Era, for example, private bank notes were suddenly taxed out of existence).

    The issue I am highlighting here is credibility. It has nothing to do with monopoly supplier of this or that, of whether there is a Fed or not.

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  137. Steve, so you are saying that the UK was right to break its promise to go back to the old gold parity as it had done after wars for the previous 300 years or so.

    Thanks for the clarification. You believe government promises about the value of money are made to be broken.

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  138. David,

    Please check your memory hole folder :)

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  139. Anonymous,

    I do not believe that it was right for Britain to break its promise. The broken promise was not keeping the currency redeemable in gold.

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  140. Kyle: O.K., I just did. Situation rectified?

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  141. David,

    I understand your point. You are saying that it's about the credibility of the government, and that it could just as easily not respect property rights as inflate the currency.


    What policy has the Fed pursued? Constant inflation. Which brings me to my previous points: Why is this necessary? How is this generally beneficial?

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  142. Steve:

    OK, good. So now we understand each other. This is something the "End the Fed" types do not generally appreciate. Now on to your next question.

    The Fed has recently (past 30 years) pursued a policy of "low and stable" but positive inflation. Generally, a success (esp. relative to the 1970s experience).

    Why is positive inflation necessary? Why is it generally beneficial?

    Let me be clear. No where in my writings have I ever defended positive inflation. The only claim I made was that low positive and stable inflation is no big deal relative to the other problems we face in the economy.

    Having said this, there is a literature that argues for the societal benefits of low but positive inflation. There are sticky wage stories. There are stories based on hitting the zero lower bound and the need to drive the real rate of interest temporarily lower to its "natural" rate (negative).

    In short, there are people arguing for positive inflation. There are people arguing for zero inflation. And there are people arguing for deflation. The Fed has to balance all of these views.

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  143. David,

    On this point, has any government ever not used the monopoly power over money and banking to enrich itself at the expense of its people? What reason is there to believe these powers would not be used in this way?

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  144. "I do not believe that it was right for Britain to break its promise. The broken promise was not keeping the currency redeemable in gold."

    So, it is OK to assume away wars? Or to just assume that it is OK to lose them because of lack of finances?

    You must be an economist with those ideas.

    (No offense intended. Well, not much of an offense.)

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  145. Anonymous,

    I am not assuming away war. If fighting a war requires high levels of taxation and the incurrence of debt, then people will only support it when it is absolutely necessary. If the government has the power to inflate at will to finance its activities, it makes it largely independent of the will of the people, and increases the likelihood of war.

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  146. David:

    "these same Fed economists could have been paid out of general tax revenue. Again, I do not see why the Fed is the issue here."

    You lost me there. You had said that when the Fed issues new money, it gets assets in return, but then you went on to admit to the Ron Paul types that the fed's issuance of money does cause inflation. My point was that when the Fed's money issuance rises in step with its assets, the fed does NOT cause inflation as the Ron Paul types claim.

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  147. "If the government has the power to inflate at will to finance its activities,..."

    Whether either of us likes it or not, government has that power, as David has pointed out. Clearly, a gold standard did not prevent the UK from inflating.

    "If fighting a war requires high levels of taxation and the incurrence of debt, then people will only support it when it is absolutely necessary."

    The UK repeatedly went off the gold standard during major wars and then went back on -- at previous parities -- after the wars.

    But you seem to give the UK's perfidy a pass after WWI. Why do you excuse this theft?

    I am a bit disappointed in you; I had hopes that you were a hard money type.

    (The UK fought lots of small wars without leaving the gold standard, so the gold standard didn't seem to deter war.)

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  148. Mike: I seem to have misunderstood you. I agreed with the analogy to stock overissue. Not sure what running down assets to pay economists had anything to do with it. Like a firm using its assets to pay employees. Whether this is dilutive depends on the return generated by the expense. That's all I meant.

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  149. Steve,

    The easiest way out of a hard choice is to assume it magically away. That is what you are doing when you blame the Brits for inflating during the Great War. They didn't have a choice; they had to raise money every way they could.

    Arguing otherwise is just ignoring historical reality.

    You are assuming a can opener, just like the economist on the desert island.

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  150. Anonymous,

    The gold standard did prevent them from inflating excessively. They went off the gold standard. Of course, governments have always found ways to remove checks on their power.

    I am not arguing in favor of any government theft. What I am saying is that going off the gold standard was the point at which Britain broke its promise. Later, it could either face the reality that it devalued its currency, or it could pretend that the devaluation didn't take place and impose the consequences on its people. It opted for the latter.

    People are not perfect. A commodity standard can't prevent war, but it certainly imposes far greater constraints on war than handing the government a monopoly over money and banking.

    I'm not sure what you are arguing. I am arguing that giving government a monopoly over money and banking is contrary to the general welfare of the people, and that economics does not demonstrate why it is necessary or generally beneficial for government to manipulate money and credit.

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  151. Anonymous (are there more than one of you?),

    I am not assuming anything away. Inflation is not a magical way of raising money; wars need to be fought with current resources. If the people of Britain wanted to enter the war, they could have paid higher taxes and/or taken on debt in order to do so.

    Since the British government opted for inflation, they devalued their currency. The necessary consequence of this was that the pound was worth about $3.50, but Britain refused to accept this.

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  152. "wars need to be fought with current resources. If the people of Britain wanted to enter the war, they could have paid higher taxes and/or taken on debt in order to do so."

    I think that the Brits could have reasoned with the Kaiser. I am sure that he would have listened to reason if they used positive mental imaging. It is very effective.

    All this war stuff is just a bunch of testosterone poisoned old men who want to wave flags anyway.

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  153. Anonymous,

    I have no idea what your sarcastic remarks have to do with my quote. It is a fact that wars need to be fought with current resources, and it is also a fact that inflation is not the only way of financing war.

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  154. The British government should have kept its promise to go back to parity.

    If property is stolen, it should be returned to its owners.

    I cannot believe that you can justify and defend this larceny.

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  155. "sarcastic" ?

    If you think that wars are glorious or that they cannot be averted by reason, then I feel sorry for you. You are a negative, cynical thinker. People like you are why we are fighting 3 wars right now.

    But I will think positive thoughts about you.

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  156. Anonymous,

    The theft occurred when the government went off the gold standard and inflated away the purchasing power of the money. Returning to a par of $4.86 can't magically undo the theft. The theft already occurred. Ignoring the economic reality that the pound had been devalued to about $3.50 simply imposed further harm on the people.

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  157. Anonymous(2?),

    Perhaps I took your post out of context. Of course I do not think that war is glorious. I have been arguing this whole time that restricting the government's ability to inflate to finance its activities is a good thing that limits the possibility of war.

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  158. Nothing magic required. Reduce the price level and you undo the harm. You raise everyone's purchasing power. Duh.

    Require the government and its banking cartel to give back their ill-gotten gains.

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  159. I am sorry if I misunderstood you, Steve. I apologize. I try to be a peaceful person and I guess I didn't live up to that.

    The constitution provides for a permanent navy but says that the army must be reauthorized each year.

    What do you say that we get rid of the army? That would surely slow down the war-mongers in DC. Tough to invade a middle-eastern country with a navy.

    Say, I have a question for you. How much revenue does the federal government get from inflation in a typical year? How much do all these wars cost?

    -- Anonymous(2)

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  160. Anonymous (how many of you are there?),

    Did you read my post above? "If they wanted to maintain the old par of $4.86, they would have had to drastically deflate the money supply and price levels".

    Even if they did this, however, this wouldn't "[r]equire the government and its banking cartel to give back their ill-gotten gains." The theft already occurred.

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  161. I wish we'd had you back in 1914, Steve, old chap. I could have used a steady hand like you to slow down all those easy-money-live-for-today types in my cabinet.

    I must admit that we knew we didn't need to print money to pay for the war but it just seemed like such fun at the time. Buiding battleships, conscripting millions, manufacturing poison gas, digging mass graves. It is so easy to get caught up in the excitement of the thing.

    Hard to believe that we won without you.

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  162. Steve, my friend, use your head. If raising the price level gives the government our money, lowering it gives it back to us.

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  163. Anonymous,

    The government devaluing money through inflation raises the price level. We both know that I didn't say what you are pretending I'm saying.

    Lloyd George, very funny!

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  164. "The government devaluing money through inflation raises the price level. We both know that I didn't say what you are pretending I'm saying."

    I am not sure what you are talking about.

    All I am saying is that if raising the price level gives the government our money lowering the price level reverses this.

    Not hard. What don't you understand about this?

    The UK stole some of their people's money and they should have given it back. That is just common sense.

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  165. Anonymous 2 (or the same person messing with me?),

    Part of the reason inflation is so insidious is because its effects are difficult to quantify. The Fed monetizing debt by buying government bonds enables the government to run perpetual deficits, and the more bonds the Fed purchases, the cheaper it is for the government to borrow. But it's even worse than that, because almost all of the interest paid on government bonds is remitted back to the Treasury, so the Fed enables deficit spending at the expense of everyone holding dollars and assets denominated in dollars.

    There are limits on this process in terms of how much price inflation people will accept, etc., but in general, it doesn't much matter to the government how much things cost: it doesn't have to directly raise taxes or entice people to buy its bonds in order to finance its activities.

    So not only does inflation lower the general standard of living in a way that is difficult to measure, but it enables the government to extract far more from its people than they would otherwise tolerate.

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  166. Hey Lloyd, you didn't become PM until 1916. I am afraid that being dead is interfering with your memory.

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  167. Steve:

    Fast approaching 200 comments...thanks! Allow me to get a word in here with respect to your most recent post.

    The argument that inflation is an insiduous tax because its effects are hard to quantify seems like a rather strange argument to me.

    If an effect is hard to quantify, it is quite likely because it is small, as I have been arguing is the case for low and stable inflation.

    The costs are more easily measured when inflation is high (e.g. above 10%).

    In light of this, your final paragraph is almost certainly not true. People get upset about inflation when the costs get out of hand, like in the 1970s. And at a 2% inflation, the seigniorage tax is small. People may not like it. But imagine replacing it with a small sales tax. People will not like that either. But it does not constitute the foundation for revolution.

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  168. Steve, how much money does the government make on all these inflation things? I hate to ask but you seem very well informed on these things.

    -- Anonymous (2)

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  169. "So not only does inflation lower the general standard of living in a way that is difficult to measure, but it enables the government to extract far more from its people than they would otherwise tolerate."

    Yes, exactly! Now you see.

    So if the Brits reduced the price level to meet pre-war parity, then all that stuff would go in reverse. The standard of living would have climbed, the government couldn't squander their money on war and there would have been no Depression and no World War II.

    Are you with me now? Don't you see the logic?

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  170. All you hippies should get a job.

    By: Lieutenant Colonel John McCrae, MD (1872-1918)

    Canadian Army

    In Flanders Fields the poppies blow
    Between the crosses row on row,
    That mark our place; and in the sky
    The larks, still bravely singing, fly
    Scarce heard amid the guns below.

    We are the Dead. Short days ago
    We lived, felt dawn, saw sunset glow,
    Loved and were loved, and now we lie
    In Flanders fields.

    Take up our quarrel with the foe:
    To you from failing hands we throw
    The torch; be yours to hold it high.
    If ye break faith with us who die
    We shall not sleep, though poppies grow
    In Flanders fields.

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  171. Anon @ 1:51PM

    Well, I guess we have to be careful here about what we mean when we say "in reverse."

    A lump-sum transfer financed by printing money is one thing. Reversing this would entail a lump-sum tax to finance the deflation (destruction of money).

    A new government expenditure financed by printing money is one thing. A reversal would entail a contraction in government expenditure, with the released resources (tax revenue) used to purchase and destroy money.

    Anyway...maybe this conversation is getting a little too far off topic...lol.

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  172. The sidetracks to WWI and WWII are hilarious. If the Brits had actually been trustworthy in following the gold standard, they wouldn't have gotten so involved with making ridiculous alliances. The stupid "we must go to war because other countries got invaded" ideas points out the proper foreign policy of trade with everyone, ally with none. Entanglements are death. The entire point of commodity backed money is that it is a restraint on ALL of government, not merely it's finances. It obviously didn't work. Government has a way of expanding its powers...

    All of this is amazing. Arguing whether or not government can indeed be trusted is the most hilarious thing ever. Of course it cannot. The entire run of history bears that out.

    2% inflation or not, government as a whole is parasitic. Inflation is small potatos compared to the outright theft pursued in every other sector of government; it does not make it any less immoral.

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  173. "And at a 2% inflation, the seigniorage tax is small. People may not like it. But imagine replacing it with a small sales tax. People will not like that either. But it does not constitute the foundation for revolution."

    2% inflation so that means the seignorage 2% + productivity...or around 3%. Someone is stealing 3% of GDP. I'd say that is a big deal. Of course you are paid by the thieves so I can see how you'd minimize it.

    If someone steals $1 million a year by counterfeiting in their basement could it be debated they are actually helping the economy?

    Are you in favor of arresting the guy who was coining 100% silver coins(Bernard von NotHaus)? it seems the governemnt and their apologist minimize the problems that eventually occur when you make it legal to steal 2-3% of GDP every year...but have no problem arresting a guy who is doing something completely harmless like shaping peaces of real silver into coins.

    It is truly amazing.

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  174. "...government as a whole is parasitic. Inflation is small potatos compared to the outright theft pursued in every other sector of government; it does not make it any less immoral."

    Fight the power!

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  175. Kyle, there is an "e" in potatoes. Trust me on this one.

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  176. Gabe:

    The tax base for the inflation tax is currency in circulation, not the GDP. Typically small potatoes.

    In any case, I've said repeatedly that I am not in favor of inflation. What is truly amazing is your inability to grasp this.

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  177. Gabe, I think that you mean "pieces", not "peaces."

    "It is truly amazing." The school you attended?

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  178. "If the Brits had actually been trustworthy in following the gold standard, they wouldn't have gotten so involved with making ridiculous alliances."

    And if you knew bupkus about history, Kyle, you would know that shifting alliances to thwart a major competitor on the continent were at the heart of British international strategy for 300 years. And they were on the gold standard for all but a few of those years.

    Breaking from gold was the post hoc, not the propter hoc.

    Why do I have to respond from beyond the grave?

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  179. David,

    You might have Steve defending the theft of hard-earned money by breaking from gold but you won't catch me doing it.

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  180. "If someone steals $1 million a year by counterfeiting in their basement could it be debated they are actually helping the economy?"

    I suppose the point could be argued if they use the money for public goods.

    I would not make the argument, but it would be possible to do so.

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  181. Gabe:

    "If someone steals $1 million a year by counterfeiting in their basement could it be debated they are actually helping the economy?"

    First off, Congress (on behalf of the American people) created the Fed and prescribed its powers (and even its mandate). A part of its mandate, as currently construed, entails an implicit 2% inflation target. Is this a tax? Yes. Does it constitute counterfeiting and theft? No more than any other tax.

    Second. The answer to your question depends on a lot of things. For example, does the government, representing society, have a comparative advantage in managing the supply of small denomination paper? Our experience under free-banking (1836-63) suggests that counterfeiting was a significant problem (1000s of different types of money in circulation). As well, we could ask whether the inflation tax is an efficient tax (from the perspective of public finance). In short, there are many ways in which the answer to your loaded question might be "yes."

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  182. David,

    Inflation is insidious because its effects are similar to counterfeiting: it is redistributive, and it is difficult or impossible to know its actual effects. Inflation doesn't simply raise the price level: it affects the kinds and quantities of goods produced, and changes income distribution, spending, relative prices, and production. I don't see how you can draw a connection between an effect being hard to quantify and being small.

    I acknowledged that there are limits on government inflation in terms of what people will accept. As far as inflation being the most effective means of extracting wealth from people, I think this is pretty clear. My example of William Paterson's founding of the Bank of England illustrates the point that central banking was conceived precisely to extract more wealth from the people than they would otherwise tolerate. Earlier in feudal Europe, debasement was practiced for the exact same reason.

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  183. Steve:

    I grant you that historically governments have used control of the money supply to extract wealth. Whether this describes modern day USA is debatable; I have argued repeatedly that the infaltion tax is small relative to the direct taxes imposed by Congress.

    I do not understand your first point. What if I claim that the business cycle is caused by periodic visits from hard-to-detect aliens who like to disrupt our economic activities? I don't see the aliens, but I am convinced they are there. You find this a persuasive argument?

    And what is the *evidence* backing your claims that " Inflation doesn't simply raise the price level: it affects the kinds and quantities of goods produced, and changes income distribution, spending, relative prices, and production."

    I'm not saying that such evidence does not exist. But it would be good if you could point to the paper or papers you have in mind when you make such claims (I apologize if you have already done this...but no harm in reminding us).

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  184. "What if I claim that the business cycle is caused by periodic visits from hard-to-detect aliens who like to disrupt our economic activities? I don't see the aliens, but I am convinced they are there."

    David, if you make this scurrilous charge again, I shall disintegrate you.

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  185. David:

    "I agreed with the analogy to stock overissue. Not sure what running down assets to pay economists had anything to do with it."

    As you guessed, if economists are productive employees then paying them causes no loss of assets and no inflation, while if they are unproductive there is a dilution, just like with any firm and its employees.

    The heart of the matter is that if you agree with the stock/money analogy, then the Fed's issuance of money causes no more of an inflation tax than GM's issuance of stock causes a stock tax. Your argument against the Ron Paul types is thus stronger than you claim.

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  186. Mike,

    Isn't that a tad of a stretch? Most people aren't forced to use GM stock as legal tender. The person who isn't a holder of GM stock is completely unharmed by the dilution of stock via your stock tax.

    Also +1 for the word verification word: poopers. lol hilarious.

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  187. David,

    Inflation causes artificially low interest rates, which stimulate long-term investment, resulting in a lengthening of the structure of production (investment tends toward lengthier production processes). The prices of factors in the higher-order stages rise as businesses enter those industries with their newly acquired credit and bid up resources. The new money doesn't create resources; it raises the prices of producers' goods, and the prices of original factors.

    Business calculation is distorted by inflation, which makes the cost of replacing capital goods seem artificially low, and leads to overstated profits and even capital consumption. The illusory profits lead businesses to spend money in ways they otherwise wouldn't have, and cause them to consume capital without realizing it (particularly businesses with the oldest equipment and in the most capitalized industries). The seemingly greater profits induce people to invest in these areas, at the expense of underinvestment elsewhere.

    When the new money that was loaned to businesses eventually reaches the public, malinvestments are revealed. The artificially low interest rates weren't consistent with the real consumption/saving proportions of the public, and consumption was not foregone to support the adjustment of the productive structure. The capital stock that needed to be maintained and replaced was consumed, and resources were wasted. In order for the structure of production to adjust to the real consumption/saving proportions of the public, resources need to shift from capital goods industries into consumer goods industries.

    In terms of redistributive effects, inflation benefits the creators and early recipients of the new money at the expense of the later recipients. Over time, the new money spreads through the economy, unevenly, bidding prices up, and the later recipients find prices rising before their incomes. People on fixed incomes, creditors, landlords, people holding cash, etc., suffer the most.

    Inflation alters spending because the new money doesn't spread throughout the economy evenly. Some prices rise more than others, some people permanently gain and some permanently lose, and everyone responds differently to their gains and losses. Inflation also penalizes saving and incentivizes borrowing.

    My insights come mostly from studying so-called Austrian economics (I highly recommend reading both Mises's "Human Action" and Rothbard's "Man, Economy, and State"). Austrian economics has made particularly important contributions to monetary theory and capital theory, and the emphasis on the time structure of production I believe to be very important as well.

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  188. Xenu: lol

    Mike Sproul: John Cochrane is the primary advocate of this point of view. Search for his paper "Money as Stock." It's a good read.

    Steve: I asked for evidence; not theory. Do Austrians not believe in taking their theories to the data?

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  189. David,

    Of course Austrians believe in looking at data. But data must be interpreted with theory. Do you we need to go around measuring triangles to confirm that the Pythagorean Theorem is correct? Does empirical data "prove" that when the money supply increases, other things equal, prices rise?

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  190. David,

    In the case of counterfeiting, would you argue that we don't know whether other people holding the money and with assets denominated in the money are affected? The counterfeiter really is able to buy things with the new money, yet it is difficult or impossible to trace the precise effects of the operation.

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  191. The empiricist at the San Francisco Fed recently released a paper clearly explaining how the Fed buying treasuries and monetizing our debt is actually making commodity prices go DOWN!

    http://www.frbsf.org/publications/economics/letter/2011/el2011-10.html

    So I guess your right. Linear regressions > logic. Counterfieting is good for the economy if done by altruistic scientists who have high IQs. I'm now convinced the Austrians are complete buffoons.

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  192. Gabe,

    You are missing the point that when theory says that prices or interest rates are pushed up or down, they are pushed up or down from what they otherwise would have been.

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  193. Gabe,

    And obviously, different prices move up or down for all kinds of reasons. Prices are determined by individual valuations.

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  194. Steve:

    You made a number of claims, claims that I can envisage as being the logical consequence of some coherent theory. I can construct equally coherent theories that deliver conclusions opposite to those you state. So I am not disputing the logic of your claims.

    I am asking you for the empirical evidence you use to support the claims you make (i.e., that are generated by your preferred theory). Are the effects you describe big or small? Do they exist at all?

    I am asking you for the evidence that supports your beliefs. This is the last time I will ask. If you do not supply it, then you are talking religion, not science.

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  195. David:

    I agree about John Cochrane's paper, but that still leaves the question: If you believe the stock/money analogy, then you have to conclude that the Fed's issuance of money is not generally inflationary (unless the Fed's liabilities outrun its assets). So the best answer to give to the "inflation tax" folks is that there is NO inflation tax. But you answer them just by saying that the inflation tax is small.

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  196. Kyle Davidson:

    I'm skeptical of the actual significance of legal tender laws. If it's a case of the government saying "The government accepts this bill for taxes at the rate of 1 oz of silver per dollar", then I'd have no objection, and the government effectively backs the dollar with taxes. But if the government declares that anyone who contracted to be paid 1 oz can be paid with $1, then that's objectionable. But history's hyperinflations usually happened under the objectionable type of legal tender laws, and the currencies lost all value despite all the legal declarations.

    So I'm not exactly forced to carry dollars. I hold them voluntarily in spite of losing 2% of their value every year. As for deposit dollars, those pay interest, and that compensates for the 2% inflation.

    Maybe you'll like the following better than the stock/money analogy: A bank accepts 100 oz. of silver on deposit, and issues 100 paper receipts ('dollars') in exchange. Each dollar is clearly worth 1 oz. Now the bank accepts another 200 oz. on deposit and issues another $200. Each dollar is still worth 1 oz. Now what if the bank trades 200 oz of silver for other assets that have a combined value of 200 oz. I say the dollars will remain worth 1 oz. each, because the bank's assets (worth 300 oz.) are exactly enough to buy back every dollar the bank has issued at 1 oz/$

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  197. David,

    You didn't answer my objections to your line of thinking, specifically the counterfeiting scenario.

    People can and do point to the exact same data to "prove" their theories, but two opposing theories cannot both be correct; they cannot be equally coherent. To say that an economic theorem arrived at through logical deduction is "religion, not science" is false. You wouldn't tell Pythagoras that his theorem was based on religion if he didn't go out into the world and measure triangles as "evidence."

    Here are a few items:

    "Out of Work: Unemployment and Government in 20th Century America" by Gallaway and Vedder

    "Empirical Evidence on the Austrian Business Cycle Theory” by James Keeler (www.ubirataniorio.org/emp.pdf)

    "An Empirical Examination of Austrian Business Cycle Theory" by Robert Mulligan (https://mises.org/journals/qjae/pdf/qjae9_2_4.pdf)

    "The Recession of 1990: An Austrian Explanation" by Arthur Hughes (https://mises.org/journals/rae/pdf/RAE10_1_5.pdf)

    "Explaining Japan's Recession" by Benjamin Powell (http://mises.org/journals/qjae/pdf/qjae5_2_3.pdf)

    "A Hayekian Analysis of the Term Structure of Production" by Robert Mulligan (https://mises.org/journals/qjae/pdf/qjae5_2_2.pdf)

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  198. But if we found a single triangle that didn't obey the Pythagorean Theorem, we would know that it was wrong.

    What we think of as geometry is based on axioms. These axioms need not be true in every possible universe. In some spaces, the Pythagorean Theorem is not true. In some spaces, the shortest distance between two points is not a straight line. (In fact, it is not true in our physical space; gravity bends space-time.) Reasoning is only as good as the axioms on which it is based. Even for Pythagoras. And you are not Pythagoras, my friend.

    Some follower of Pythagoras--historians know that it wasn't really Pythagoras's theorem -- probably measured some triangles before coming up with the Pythagorean Theorem.

    We observe the world before we theorize about it. We check scientific theory with data.

    On the other hand, we don't need to check religion; the faithful do not expect the Almighty to provide proof.

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