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?
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Solid_Choke: In other words, is it possible to have a slow and controlled increase in the money supply over time without having major depressions?
I imagine that if governments allowed recessions to pass every decade or so, rather than inflating their way out of them, then an increase in the money supply with regular recessions but no great depressions is probably possible. The bigger question though, is why the hell would we want that?
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Fred Furash:I imagine that if governments allowed recessions to pass every decade or so, rather than inflating their way out of them, then an increase in the money supply with regular recessions but no great depressions is probably possible. The bigger question though, is why the hell would we want that?
Right, and the regular deflations, purges of malinvestment would definitely lead to people being a lot more cautious and educated about such cycles.
What is scary, is that the system has continued to help itself out, by adding workers, exploiting new foreign markets that will import western inflation, etc. "They" have been able to manipulate the other variables, in an insane economic juggling act.
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If the amount of inflation was kept constant, there would be no economic contraction. What creates booms and busts are the changes in policy of the central bank. When it chooses to inflate, it creates a boom. When it can no longer tolerate inflation, it creates a bust.
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Solid_Choke: is it possible to have a slow and controlled increase in the money supply over time without having major depressions?
is it possible to have a slow and controlled increase in the money supply over time without having major depressions?
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.
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.
And lastly, booms and busts can be and are caused by normal business activity. Just as the supply of money has to match the demand, so does the supply of everything else. Oversupply causes manufacturing to slow, causing workers to be laid off, and this circles back and further reduces demand for goods. The opposite can happen if inventories get too low, if new technologies are invented for which there is a sudden new demand, etc. The market can adjust to these fairly well, makes it unlikely to happen across all industries sumultaneously, and has even innovated practices that, while not necessarily the intent, tend to mitigate the ability of such cycles to build on themselves, such as "just in time manufacturing".
The Federal Reserve was established to do two primary and related things. First, it was to be the "lender of last resort", effectively a backstop against runs caused by banks too aggressively lowering their reserve fraction. Second, it was to try to anticipate market demand for money and proactively increase or decrease the supply.
Predictably, in a coercively monopolized fiat currency and with a bank that is both isolated from market forces and designed to "protect" regular banks from market forces, it has caused more damage than it has prevented. It has repeatedly exacerbated organic booms and busts by mis-timing its expansions and contractions. This is completely forseeable in that the Fed has less information than the markets in aggregate have - and it acts explicitly to distort the price information that is available. In addition, it quickly became politicized to the point where, rather than simply trying smooth out business cycles, it has been used to try to create booms and eliminate busts. Instead of contracting and expanding the money supply, it has operated in two modes: expand the money supply slowly or expand it quickly. The problem is that this creates booms all out of proportion to any normal business cycle, such as the massive housing price inflation of this decade, and so the busts are proportionally more dramatic. And this happens against a background of continual inflation in both the money supply and prices - as we've seen with things like oil and commodities continuing to climb even though we are currently in a bust cycle.
So your answer is that we cannot avoid a boom and bust cycle entirely, but only corecive intervention and market distortion is likely to cause anything on the scale of the Great Depression - or even the recent housing and credit bubble/bust.
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.
This is the basic idea behind Monetarism, and no it doesn't work because while you can control Money Supply, you can't control or measure Money Demand or Money Velocity, which are quite sensitive to fiscal policy.
"He that struggles with us strengthens our nerves, and sharpens our skill. Our antagonist is our helper." Edmund Burke
histhasthai:A growing economy - more people, more activity - requires a growing money supply, just as a growing population requires a growing food supply.
No, money has the distinct property amongst commodities of never being finally consumed. It's only purpose is to exchange. Because of this, any amount of money will work for any size economy. What you mean is that an increase in Money Demand must be matched my a proportional increase in Money Supply in order to retain a stable "Price Level" (though the term "Price Level" has its own complications when looked at via methodological individualism).
maxpot46:No, money has the distinct property amongst commodities of never being finally consumed. It's only purpose is to exchange. Because of this, any amount of money will work for any size economy. What you mean is that an increase in Money Demand must be matched my a proportional increase in Money Supply in order to retain a stable "Price Level" (though the term "Price Level" has its own complications when looked at via methodological individualism).
My understanding (which may be totally incorrect) is that artificially stablized prices (by manipulations of the money supply) distort entrepreneurial decision making. We need high prices to communicate scarcity, profitability etc, as well as low prices to purge inefficient over investment.
Does this sound right to you Max? I'm an amateur when it comes to economics.
liberty student: My understanding (which may be totally incorrect) is that artificially stablized prices (by manipulations of the money supply) distort entrepreneurial decision making. We need high prices to communicate scarcity, profitability etc, as well as low prices to purge inefficient over investment. Does this sound right to you Max? I'm an amateur when it comes to economics.
Pretty much. Without correct prices to guide them, entreprenuers make malinvestments that both cause the boom/bust cycle and also a reduction in the overall amount of available goods (and thus the overall standard of living).
maxpot46:No, money has the distinct property amongst commodities of never being finally consumed.
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.
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.
histhasthai:Now you could argue that the only result would be falling prices,
Correct.
histhasthai:but it hits a limit when, for instance, a loaf of bread costs one one billionth of an ounce of silver.
Incorrect. There is no such limit on silver, because if there was, it would not have been chosen as money. Gold and silver are the best money precisely because they have the properties best suited for it, including being distributed amongst the planet's crust in such abundance such that they hold their values remarkably well against monetary demand (being readily available to find for those prospectors incentivized by the higher price that results from increased demand).
Solid_Choke: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?
It's inevitable because malinvestment involves real goods going into the hands of people who are really unproductive with them. Correcting the situation requires getting the goods out of the hands of those people first, which requires a bankruptcy of some sort. Mass bankruptcy of some sort = extreme recession/depression. Look at the mortgage market -- real houses were placed in the possession of people who really can't afford them. Getting them out of their possession and into the hands of people who really can afford them involves a messy process of foreclosure and resale at a lower (less inflated) price. The more malinvestment, the more extreme the correction
These being?
-Jon
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maxpot46:There is no such limit on silver
On its face, that's just a denial of reality, there's no arguing with it. What I think you mean below is that the limit is mitigated or avoided altogether by the ability to put more money into circulation:
maxpot46:Gold and silver are the best money precisely because they have the properties best suited for it, including being distributed amongst the planet's crust in such abundance such that they hold their values remarkably well against monetary demand (being readily available to find for those prospectors incentivized by the higher price that results from increased demand).
Gold and silver are best suited, yes, but not infinitely so. Gold or silver in the ground are not money, and are not part of the money supply until they are extracted. That you cite the fact that there is more to be extracted seems to concede that one of the properties that makes them suitable is the ability to expand their usable supply as money in response to demand (and, importantly, not by fiat).
If you want to call the entire pool of metal still in the ground as part of the money supply, I think it is another class of error, making our disagreement on supply expansion moot.
Jon Irenicus: And that is aside from any inefficiencies and distortions caused by the regularly falling prices themselves, which are numerous and potentially devastating. These being? -Jon
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.
Looked at another way, the interest rate at which someone will loan money is the subjective opportunity cost of forgoing the immediate use of the money, plus a risk premium, plus the expected rate of price inflation. Should the rate of inflation be far enough negative, it would imply a negative interest rate. Since keeping it under the mattress pays 0%, it's a better deal than loaning it at a negative percentage.
I don't think I have to explain the ramifications to the economy of essentially all lending drying up.
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.
The Great Deflation of 1873-1896 and William Jennings Bryan's "Cross of Gold" speech provide insight into this.
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.
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.
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.
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.
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.
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".
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