I have heard several times from different people who hold Austrian views of economics that inflation of the money supply is unsustainable and creates a boom and bust cycle that worsens with each downturn. To these individuals, eventually there will be a total calapse of the market when these swings become too extreme, resulting in something like the Great Depression. Is this a common belief of Austrian economists? If so, why is it enevitable? If not, why not?
In other words, is it possible to have a slow and controlled increase in the money supply over time without having major depressions?
"Concentrated power is not rendered harmless by the good intentions of those who create it." -Milton Friedman
"It is a mistake to think businessmen are more immoral than politicians." -John Maynard Keynes
histhasthai: Of course the market can and will correct for this imbalance. But the primary mechanism for doing so is the pressure put on the price of money, incentivizing increased extraction, and the like. If that is not possible, the only mechanisms are greater reliance on fractional reserves - reducing the reserve along with the concomitant risk - and, if money is sufficiently politicized, extra-market mechanisms such as outright fiat. Remove that mechanism by assuming a priori a fixed supply, and the market's ability to correct the imbalance is limited.
Of course the market can and will correct for this imbalance. But the primary mechanism for doing so is the pressure put on the price of money, incentivizing increased extraction, and the like. If that is not possible, the only mechanisms are greater reliance on fractional reserves - reducing the reserve along with the concomitant risk - and, if money is sufficiently politicized, extra-market mechanisms such as outright fiat. Remove that mechanism by assuming a priori a fixed supply, and the market's ability to correct the imbalance is limited.
You're basically saying government fiat may be required in order to avoid a credit crunch arising from persistent deflation.
I don't think that's correct. In a real free market, where currencies can be started up by anyone, if gold or silver become unfeasible as backings, some people will start their own currencies, with their own backings, perhaps consisting of other metals that are not as scarce.
Let's say we have several competing currencies within one geographical area. Let's call them A, and B.
A is 100% backed by gold, and has been experiencing persistant deflation of over 5% for many years. B is 100% backed by silver, and has experienced some deflation, but not as much because their market share is significantly lower than A's, and the areas of the economy using B are growing slower.
Let's say at some point in time, annual ROI falls to less than 5%, and it would require a negative interest rate for A's loanable funds. Suddenly nobody wants to save anymore, and so they switch to B. Now that more people are using B, A is not under so much pressure from economic growth anymore, and deflation slows down to below interest rates, while B is now the currency that will eventually overheat.
If both currencies overheat, in a free market, nobody is stopping anyone from starting a third, titanium-backed currency, or using any other metal. People might even try to use fractional reserve banking to cause inflation. Temporarily people may switch to such a currency due to higher nominal interest rates, bringing about relief for the other currencies, but eventually the inflation would incentivize them to move back to metal-backed currencies.
Basically I think governments aren't at all needed in this - competing currencies are.
"What we do in life, echoes in eternity."
Fred Furash:You're basically saying government fiat may be required in order to avoid a credit crunch arising from persistent deflation.
No, not required in a free market. But in a free market the money supply can expand in response to demand, and that's why persistent deflation is not a major issue. Only if that mechanism is unavailable would fiat become the only solution, and the only way that can be is some kind of coercion. In the hypothetical scenario where that method is assumed a-priori to be unavailable, yes, fiat would be the only way out, along with the severe and long-term problems and ultimate failure that come with it. But such a scenario is a red-herring, it could not exist (for long) in a free market, so arguing for it is a pointless exercise. I'm only pointing out what, if it were somehow possible, the result would be.
Fred Furash:Basically I think governments aren't at all needed in this - competing currencies are
I absolutely agree. And among the bases on which they would compete would be their expandability (neither too much nor too little), and the extent, if any, to which they are fractional reserve/receipt currencies. We can't know what the proper balance of either of these are, we have to let the market express its preferences. So there must be competing currencies.
The state won't go away once enough people want the state to go away, the state will effectively disappear once enough people no longer care that much whether it stays or goes. We don't need a revolution, we need millions of them.
Solid_Choke:become too extreme, resulting in something like the Great Depression
I think the view held by Austrians about what made that depression "Great" and extreme where government policies, such as tariffs, price controls, supply control, etc to try to fight it. Otherwise, it wouldn't have last decades.
Equality before the law and material equality are not only different but are in conflict with each other; and we can achieve either one or the other, but not both at the same time. -- F. A. Hayek in The Constitution of Liberty
histhasthai:A growing economy - more people, more activity - requires a growing money supply, just as a growing population requires a growing food supply. If it always grew at the exact amount required, monetary-caused booms and busts wouldn't happen, and there would be no price inflation nor deflation. But that's impossible. Even on a gold (or any other commodity) standard, the changes in supply do not completely follow instantaniously the increases or decreases in demand. Gold can be effectively withdrawn from the system - temporarily at least - by people holding on to it, and new discoveries in places where extraction costs are below the going rate can happen any time.
When gold becomes scarce people have more incentive to search out more of it and when there is an abundance it is less economically feasible. Basic supply and demand, 'money' isn't different than any other good in this regard.
histhasthai:Secondly, fractional reserve banking can be done even in a currency backed by gold (sometimes called "fractional receipt banking" to distingusih it from FRB where the reserves are themselves fiat or credit-backed currency). This is legitimate, beneficial, and would likely be demanded by the market so long as the currency is not coercively monopolized, the reserve level is openly made known to depositors, and convertibility is maintained. But this can lead to expansions or contractions of the supply unrelated to the expansion and contraction of the underlying gold supply.
The legitimacy of this is extremely questionable but that's a topic for another thread.
I know I as an honest market actor would demand a illegitimate title to a backing commodity that is also shared by a few other people. Exclusive ownership is a bunk theory...
histhasthai:So does water, but you wouldn't argue that one household's supply of water is sufficient for a whole town. Money is neveri finally consumed, but it also does not have infinite velocity, nor is hard money infinitely divisible as a practical matter. Just as the water in your pipes, in your toilet tank, in storage tanks, or anywhere else en route from the supply back to the supply is out of circulation, money is taken temporarily out of circulation just by virtue of it being used. As more an more people use the same fixed amount of money, and necessarily hold it for even tiny periods of time, the less there is in circulation per person.
Except for cases of people genuinely taking money out of circulation, like burying it in the back yard (and even then it still has a value as a place in someones cash holdings), money is always owned by someone and is in use. Not like water at all which becomes unowned as soon it is released back into the 'wild'.
But this seems to be a case of treating money as different in some way from all other goods, I'm not too familiar with the whole velocity of money fallacy so can't comment too much on why you're wrong here.
histhasthai:Now you could argue that the only result would be falling prices, and even that such a situation might be managable, but it hits a limit when, for instance, a loaf of bread costs one one billionth of an ounce of silver. Even if you could divide an ounce reliably into billionths, handling and exchanging such quantities is subject to massive inefficiencies - either from measurement errors or from the cost of high precision equipment and methods to avoid them. And try finding that hundred-billionths of an ounce you dropped on the floor while trying to take it out of your pocket. Some of that could be relived by dealing with currency instead of the metal, and reconciling physical transfers into managable quantities, but that only relieves a subset of the problems. Or, you could use less precious metals for such things, but that is only a temporary fix until even they become so dear that you have to start dealing in microscopic amounts. In addition, the less precious metals have more competing uses that make demand fluctuations for non-monetary reasons more likely and more severe. And that is aside from any inefficiencies and distortions caused by the regularly falling prices themselves, which are numerous and potentially devastating.
Some of that could be relived by dealing with currency instead of the metal, and reconciling physical transfers into managable quantities, but that only relieves a subset of the problems. Or, you could use less precious metals for such things, but that is only a temporary fix until even they become so dear that you have to start dealing in microscopic amounts. In addition, the less precious metals have more competing uses that make demand fluctuations for non-monetary reasons more likely and more severe.
And that is aside from any inefficiencies and distortions caused by the regularly falling prices themselves, which are numerous and potentially devastating.
You can take the price of a Model T and throw it into the government's online inflation calculator and find out that you can get a new car today for the same price that someone paid almost a hundred years ago. With all that 'regularly falling prices' one would expect the auto industry to be (non-morally) bankrupt by now.
Prices are generally stable over the long term yet the quality of the product has increased in too many ways to count.
Another point is that there was constant and continuous deflation during the 19th century (other than during the gold rushes) and that was arguably the most prosperous time in all of US history. People just dealt with it, interest rates were adjusted to account for this and life just went on.
And finally, the competing uses for whatever commodity backs money is where it ultimately derives it monetary value from. You make the assumption that non-monetary uses of the commodity would negatively effect its supply to the extent that is would be a problem when the opposite in probably more likely to occur -- the extra value that the commodity gains from its monetary role will make it non-economic to be used in previously profitable production methods. Substitutes will be found &etc...
histhasthai:The Great Deflation of 1873-1896 and William Jennings Bryan's "Cross of Gold" speech provide insight into this.
If I'm not completely incorrect the Greatness of the Deflation was mostly propaganda by those who wanted silver to be bought at a loss to the government thereby transferring wealth from the many to the owners of the silver mines. Or maybe it was to keep the peg to gold at an artificially low(high?) level so they could profit. Something like that, too lazy to look it up.
But industry was chugging along during this time at a pace almost unseen in all of human history... According to your statements the exact opposite should have occurred, how do you rectify the difference?
Wow, I don't think I managed to touch on the main topic at all in this post.
histhasthai:A growing economy - more people, more activity - requires a growing money supply, just as a growing population requires a growing food supply.
Indeed, a "growing" economy would tend to lead to "increased" demand for money and would require that the value of the money stock adjust accordingly. It is absolutely unnecessary (and undesirable) for the quantity of the physical money commodity to change.
histhasthai:If it always grew at the exact amount required, monetary-caused booms and busts wouldn't happen, and there would be no price inflation nor deflation. But that's impossible. Even on a gold (or any other commodity) standard, the changes in supply do not completely follow instantaniously the increases or decreases in demand.
Actually the change in the supply of value of the physical money supply does instantaneously change to reflect changes in demand. The two are equal by definition. The value of money is the very goods which are offered in exchange for it.
The trap "histhasthai" is falling into is his blatent misuse of the term "deflation". Deflation is a decrease in the physical quantity of the money supply, not a decrease in prices of goods. Prices of goods can fall for many reasons, just one of which is deflation. However, speaking of the "price level" of goods falling as "price deflation" is misleading doublespeak.
One problem is that in a growing economy, not all prices fall at the same rate. It is those goods produced in those particular industries which are experiencing the greatest increases in productivity whose prices will fall the most. Prices of other goods may rise or fall depending on consumer preferences and any number of factors. To the collector of Rembrandt paintings, "economic growth" is nil. Alternately, to the computer geek who's only standard of value is megabytes of computer memory, "economic growth" might be measured in 100's of percent!
There is no such thing as an objective "price level" for the economy. To define one based on some arbitrarily construed index of goods and to attempt to measure value in terms of this index completely distorts the underlying economic reality.
histhasthai:Fundamentally, monetary deflation (meaning money becomes more expensive in the future), if severe and persistent enough, can make any lending economically infeasible. If the future value of money becomes high enough above the present value to offset the risk and opportunity cost of lending, nobody will lend money.
This is circular logic and complete nonsense. Prices fall in certain goods because of investment in those industries increasing productivity and driving down prices. To say that investment wouldn't be forthcoming because of falling prices negates the cause of the falling prices. Obviously, the amount of investment in such an industry is limited by the expectation that prices will fall, but what's wrong with that? This expectation that prices will fall is precisely what prevents wasteful malinvestments (caracteristic of the business cycle) beyond what is necessary to satisfy comsumer demand.
To reiterate: If certain firms are driving prices down in an industry, it is highly beneficial that new firms (unable to profit at the expected future lower prices) withold their capital for better uses. It is precisely the "lure of the stable price level" which incourages wasteful malinvestment not based on economic reality.
The 1920's and 1990's were characteristic periods of massive malinvestment as direct consequence of an inflationary "stable price level".
No. In fact a collapse of the economy in the US and or the anywhere else in the Western world is not likely either. The more likely scenario given the sizes of the economies and the perpensity of their governments and central banks for desctruction is to have these economies go down with a whimper.
Look at some of the nations of Europe, France is the usual suspect, they are just going along with their socialism in a never ending slow growth mode. Just as the US blew past them the other countries of the world India, China and Brazil in particular will do the same.
India, China and Brazil will blow by the US as well as the US is hardly immune from the Triple Towers of Destruction: Fiat Money, Government Spending and a Militant Foreign Policy.
Anonymous Coward: ...
I'll just quote and respond inline, since there's a lot to deal with here.
So you agree that the ability to increase the supply is beneficial, and will be demanded by the market? Good.
I can't find any way to relate this to what I said.
No, I'm treating it the same as all other goods. There's nothing at all special about money. Are you saying the idea that money has velocity is a fallacy? Or are you arguing against some other pet peeve that you think I am implying?
Again, I'm finding it hard to tease a point out of this...
Another point is that there was constant and continuous deflation during the 19th century
Simply false.
You make the assumption that non-monetary uses of the commodity would negatively effect its supply to the extent that is would be a problem when the opposite in probably more likely to occur -- the extra value that the commodity gains from its monetary role will make it non-economic to be used in previously profitable production methods. Substitutes will be found &etc...
Wrong again. I said nothing about supply, I specifically mentioned demand. Nor did I say anything about any specific effect on demand, up or down. I said that competing uses leave the commodity you are using for money subject to non-monetary fluctuations in demand, with the resulting non-monetary fluctuations in market price. This makes it unsuitable (or less suitable) as money, for one thing because to use it as a storage of value, you are effectively also holding a speculative position in some industrial commodity. As to it's monetary value causing it to be less desirable for industrial uses, that is also true. But then that is just a case of a poor choice in money interfering with other uses.
It might help to be less lazy. There was in fact a deflation that lasted over twenty years. This had an effect on farmers, who more than most small businesses (which they mostly were at the time), relied on borrowing to fund their seasonal cycle of planting and harvesting. Bryan's populist remedy was bimetallism, adding a silver standard to the already existing gold standard so as to inflate the money supply and allow farmers to more easily repay their loans.
No doubt there was propoganda on both sides, and neither had the best answer to the problem (keep government away from currency issuance and management), but understanding what happened during that time is still informative.
A-R:The trap "histhasthai" is falling into is his blatent misuse of the term "deflation". Deflation is a decrease in the physical quantity of the money supply, not a decrease in prices of goods. Prices of goods can fall for many reasons, just one of which is deflation. However, speaking of the "price level" of goods falling as "price deflation" is misleading doublespeak.
I was very clear that I was talking about a reduction in the supply (though relative to demand, not in absolute terms, if that's your quibble), and used the qualified "price de/in-flation" whenever speaking about prices. Sorry you chose not to notice that.
The rest of your post is apparently arguing against someone else, (and I agree in principle with your main points). I was talking specifically about a hypothetical and nonsensical scenario someone else posited in which increased productivity of the commodity used for currency backing was a priori ruled out. He was arguing for a permanently fixed money supply.
Guys, the last couple of responses I replied to sound like people arguing against what they expect to hear, rather than what I am actually saying. Is there any way we can clear that up so we are at least arguing about the same thing?
histhasthai: When gold becomes scarce people have more incentive to search out more of it and when there is an abundance it is less economically feasible. Basic supply and demand, 'money' isn't different than any other good in this regard. So you agree that the ability to increase the supply is beneficial, and will be demanded by the market? Good.
Yeah, but not increased through some Ponzi scheme like you're proposing. Increased like every other good, by mixing land and labor -- the only known way that real wealth can be created.
histhasthai: No, I'm treating it the same as all other goo
No, I'm treating it the same as all other goo