A Neodoxian Week

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gravyten577 replied on Fri, Mar 8 2013 10:21 PM

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I didn't know that about Hayek

"If investors and consumers suddenly hoard half of there money then would any problems result? If the answer is "yes" then what would you call this. If the answer is no then why not?"

The point that I have been making is that the fall in consumption is a symptom and not the disease. On top of that a depression occurs because the production going on is against the will of the consumers, it is a case of trying to force square pegs into round holes producing things consumers don't want.

The very fact that people talk about a "housing bubble" suggests they think the problem is too many houses being built, do you think the problem was people simply need to keep buying houses? Mabye the government should buy houses and bulldoze them

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Neodoxy replied on Fri, Mar 8 2013 10:25 PM

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"The point that I have been making is that the fall in consumption is a symptom and not the disease. On top of that a depression occurs because the production going on is against the will of the consumers, it is a case of trying to force square pegs into round holes producing things consumers don't want."

1. Is it inconceivable that this could occur in a free market sans malinvestment?

2. Do you agree that this fall in demand in general which occurs during the recession is greater than it would be without hoarding?

If you agree with point 2 then we have the same view on recessions and you are admitting that Keynes had a basic point about general gluts. If you disagree with point 2 then please address my previous post to you.

Thank you.

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gravyten577 replied on Fri, Mar 8 2013 10:30 PM

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1) Entrepreneurs will usually make the right decisions if a central bank doesn't screw with interest rates and government incentives to loan to unworthy borrowers

2) Hoarding could actually be a good thing because it means people are not patronizing shaky banks. Allow the bad banks to fail faster. Greenspan in his essay on gold and economic freedom said the best way to collapse the fractional reserve lending system is if everyone held gold, silver, copper. Let it collapse then we can invest in a sound banking system. The collapse of the shaky system is required to build a sound system

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Neodoxy replied on Fri, Mar 8 2013 10:36 PM

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2. You dodged my question. Do you disagree that ceteris paribus a constant level of aggregate demand will speed up the recovery process while a decreasing level of aggregate demand will speed it up?

To clarify, I think you made a good point, but not one that was relevant to the current discussion

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gravyten577 replied on Fri, Mar 8 2013 10:40 PM

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Hoarding raises the value of money which allows people to buy more things with less money. It might be painful in a fractional reserve lending system, it might even paralyze the system, but in a world where banks are not overleveraged it isn't really a negative.

The ideal is to have the fractional reserve lending system collapse not sustain it

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Neodoxy replied on Fri, Mar 8 2013 10:42 PM

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"Hoarding raises the value of money which allows people to buy more things with less money."

1. In a recession why wouldn't this raise uncertainty?

2. In a recession why wouldn't this increase the time required for a readjustment period?

"in a world where banks are not overleveraged it isn't really a negative"

3. Why?

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Student replied on Fri, Mar 8 2013 10:47 PM

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@Neodoxy

Well, I can't speak for everything Dave has said in this page, but I would check out his blog post on general gluts and cash hoarding:

https://smilingdavesblog.wordpress.com/2013/02/14/how-mises-dismissed-that-whole-keynesian-thing-with-a-decisive-one-liner/

He makes himself pretty clear there. General Gluts are another name for "massive hoarding". And hoarding cash will not cause any problems because prices will adjust. 

Price adjust? Who knew. 

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Neodoxy replied on Fri, Mar 8 2013 10:51 PM

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"prices will adjust"

That's a new argument right?

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Smiling Dave replied on Sat, Mar 9 2013 4:18 AM

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"prices will adjust"

Who knew?

That's a new argument right?

1. Actually, it's Mises in Human Action, as noted in my article.

2. What Student and Neo mean is that some prices do not adjust in real life.

So their understanding of recessions, [and guys, correct me if I'm wrong], is this:

Normally, by some magic, prices perfectly match both supply and demand and also the stubborness of people who insist on a certain price for certain things. But when people start saving their money, although the laws of supply and demand will put pressure on prices to adjust to the new situation, some people will effectively resist this change. Then, of course, their wares will not be sold.

If this only happens with one type of good, that good only will not get sold. If it happens to every good, all goods will not get sold. If it happens to the price of labor, which is a component in the price of every good, we have a general glut, where nothing gets sold.

Thus the solution is to encourage dishoarding. Though people may not like this, too bad for them. It is more important to satisfy those who resist price changes than those who want to save for their retirement, or their children's college education, or other future needs. In fact, govt intervention is vital to make sure this gets done, because unless these hoarders sacrifice their savings and their future, the whole economy will suffer.

We won't go into the ethics of such a position. We merely point out the logical errors, which stare one in the face.

Their recipe for recession has two ingredients. One, people saving money. Two, some people resisting changes in prices. The flaw in their logic is the emphasis on the first component. Supply and demand change constantly. That is the nature of a free market. Thus, those who resist price changes will feel pressure all the time. No need to blame hoarding.

Now they may argue that only hoarding produces pressures to change prices across the board. But that very assumption is fallacious. When people save more money than they did before, do they buy less of everything across the board? I think it is foolish to make such an assumption. Maybe some people do, but many don't. They cut down on their spending of those things that are lowest in their scale of values, but keep spending on those things higher on the scale. Austrians will be familiar with the concept of scale of values; others may have to read up.

Another aspect of this flaw in their reasoning [focusing on savings as the culprit] is accepting the second component as a given. It is not a law of nature that people resist changes in price so stubbornly that they shoot themselves and the whole economy in the foot. Anyone who goes shopping sees sales all the time. And if Neo and Student think labor will just never see reason, they err. It is the laws that give unfair power to unions that cause this stubborness. And where unions have less sway, lo and behold, wages fall. In the current recession, people many complain that employers "take advantage" of the situation by forcing them to work longer hours for the same pay. Guess what that is? Wages falling. So yes, it happens. All the time.

Unions themselves are the first to admit this, declaring that they are fighting for "higher wages". Meaning they understand that without them, wages can and do fall.

Bottom line: Of course so called "sticky prices" will cause problems. But the presence of sticky prices is unrelated to people saving money.

In addition, there is a deeper flaw in their reasoning. They don't understand that saving is a great blessing to everyone, both directly and indirectly. We need not go into the advantage of saving to the saver. It is what he chooses to do with the money he worked for, and so of course it is a blessing for him. He is getting exactly what he wants from his money, i.e. saving it.

But when Mr A saves, he benefits Mr B and Mr C and everyone else. First of all, he usually [= way over 99 percent of the money saved] puts the money in a bank, meaning the money will be invested in increasing the capital stock, the source of all wealth and prosperity. Second ly, by saving, he is, by definition, not consuming. It may be hard for some to grasp why this benefits everyone else, so we will use a homely analogy.

Imagine a group of people who get together for a party. They agree that everyone will bring some food [=work for a living]. One person brings a huge delicious cake [=works]. When the time comes to eat, he explains that he is on a diet and will not eat anything at the party [= does not spend the money he earned, but saves it]. Everyone is else is now very happy, because they get to eat more than if he was stuffing his face [= consuming].

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Neodoxy replied on Sat, Mar 9 2013 5:17 AM

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Dave,

My response to your article on Mises is coming. I was going to let it be, but that was before I saw you seriously touting it as you have been doing. In the meantime I'll keep this post short.

"prices will adjust"

Who knew?

That's a new argument right?

"1. Actually, it's Mises in Human Action, as noted in my article."

"2. What Student and Neo mean is that some prices do not adjust in real life.

So their understanding of recessions, [and guys, correct me if I'm wrong], is this:"

I think that I've reiterated my point enough times to you that if you were serious in actually understanding my point then you would have done so by now. Some might resist wage decreases, others might resist new information.

"Thus the solution is to encourage dishoarding. Though people may not like this, too bad for them. It is more important to satisfy those who resist price changes than those who want to save for their retirement, or their children's college education, or other future needs. In fact, govt intervention is vital to make sure this gets done, because unless these hoarders sacrifice their savings and their future, the whole economy will suffer."

No. The hoarding that we are talking about here is strictly dealing with that caused by a sudden downturn. Savings that actually represents a legitimate change in time preference, and which does not occur to rapidly merely changes the direction of productive efforts away from consumer's to producer's goods. As I have expressed I consider hoarding in a recession to be a collective goods problem. The reason people are saving is because they fear for their jobs. If their jobs were secured to a "normal" level then the hoarding would not occur, but since it is more jobs are lost. It is a self-fulfilling prophecy. Everybody would be better off if no one hoarded, but everyone would be worse off if they did not hoard. I'm also assuming, as you implicitly do, that all "savings" comes out of consumption and not investment.

Finally, I have never advocated government intervention. I've expressed as much in the what, 15, 20 messages we've exchanged on this general topic?

"Austrians will be familiar with the concept of scale of values; others may have to read up."

It's unnecessary, presumptuous, and inevitably ignorant statements like this that make discussing topics with you such a delight, Dave.

"It is the laws that give unfair power to unions that cause this stubbornness. And where unions have less sway, lo and behold, wages fall. In the current recession, people many complain that employers "take advantage" of the situation by forcing them to work longer hours for the same pay. Guess what that is? Wages falling. So yes, it happens. All the time."

While I agree that government intervention is a serious source of price-inflexibility and that prices are not nearly as inflexible as many Keynesians assume, this does not mean they are not somewhat sticky. Most importantly I don't understand why you continually blame unions for price inflexibility when unions have been making up a smaller and smaller portion of the economy.

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Smiling Dave replied on Sat, Mar 9 2013 7:43 AM

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Neo,

I await your response to my article on Mises.

In the meantime, let me reassure you that when I wrote about people having to read up on their AE, I meant Student, who obviously is extremely deficient in basic Austrian knowledge, as he admitted himself a few times in this very thread. [Had no clue about what Say's law actually is. Thought Mises denied that people use money as a store of value].

Although I would not be remiss in going the sarcastic route, given the mocking replies of "who knew?" and "That's a new argument right?", I chose not to go there.

You wrote, "No. The hoarding that we are talking about here is strictly dealing with that caused by a sudden downturn."

What's happening is I am having to deal with two people at once, who have different nuances. Student was insistent that he is talking about something neither Mises nor I ever heard of, supposedly, that people use money as a store of value. Which I take to mean that they save it in order to spend in their retirement, etc. My summary was indeed based on my understanding of his thesis, the standard Keynesian one. I think that will answer most of your objections to my summary, including that you do not advocate govt interference. Others certainly do.

So let me devote the rest of this post to the points unique to your vision.

1. First, I am not assuming that hoarding comes at the expense of consumption and not investment. As Mises pointed out in the article, the capital accumulation that benefits society has already taken place when the person actually works for a living and gets money to hoard. Even if he used to invest that money and now hoards it, he does not reduce investment per se by his act of not investing. What he does is change the course of investment. Say he used to buy pipes for his plumbing business, and now he stops. that just frees up raw materials for others to buy. previuosly they were not able to out bid him for the materials they need, so he got them. Once he drops out of the market, others will get what he no longer uses.

2. Even if people hoard out of concern for the future, fearing for their jobs, the line of reasoning stays the same. Money that is hoarded, is, by definition, not used to withdraw things from the market, be it consumer or producer goods. This frees them up for others to use. There is no getting round this conclusion.

Bottom line, the results of hoarding are the same no matter why people do it. If you admit it is a good thing sometimes, that same goodness exists at all times.

3. I understand you don't advocate govt intervention. Your focus is more on analysis of the causes of a recession than the methods presented as cures.

4. About unions. Indeed they make up a smaller portion of the private sector economy. But they make up the vast majority of the govt sector. And they are bankrupting their govt employers, the states, just as they bankrupted their private employers. 

In addition, I agree that unions are only one way govt interference in a free market promotes unemployment. After all, the potential employer has a say in whether someone will get a job or not. What counts, as far as he is concerned, is not what the worker gains by being hired, but what the employer loses by hiring him. And the govt can make it painful indeed to hire someone, even at low wages.

For example, I know of an employer who laid off a worker because he was drinking on the job to the point of unconsiousness. Not wanting to make waves, he told the worker he just doesn't have any more work for him. The worker went on to get unemployment insurance. As a result, the govt increased the amount of money the employer has to pay the govt per worker for unemployment insurance. After all, he's the kind of guy who fires people. Result? The employer decided to hire as few people as possible. He could not afford this new expense.

Be that as it may, there are many more ways the govt sticks it to the employer for hiring someone. Latest example is Obamacare, which led directly to layoffs by many firms.

So why did I talk about unions? First, because where they are allowed to thrive, like New York City, they are a huge problem. Second, because Keynes in his book used them as his reason for sticky wages. I was using a sort of shorthand by saying unions, following him.

5. Prices may be somewhat sticky. So what? It's not enough to cause a recession [see below]. Recessions, as you know from your studies of AE, are caused by malinvestments, which in turned are caused by meddling with the money supply.

And if prices are sticky, the only thing to do is wait until they unstick. A person doesn't sell his wares or his work at a low price today because he thinks tomorrow he will do better. It may take time for him to grasp that it's not going to happen, at least not before he needs money to live on. How long do you think it will take? Fifteen years, like the extent of the Great Depression? Six years, like the length of the current recession? I say a few months is ample. So that recessions cannot be explained by somewhat sticky prices.

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gravyten577 replied on Sat, Mar 9 2013 12:52 PM

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The problem with American wages not dropping is also caused by the welfare state. You can just go on food stamps instead of working thus raising unemployment

"Hoarding raises the value of money which allows people to buy more things with less money."

1. In a recession why wouldn't this raise uncertainty?

2. In a recession why wouldn't this increase the time required for a readjustment period?

"in a world where banks are not overleveraged it isn't really a negative"

3. Why?

1)  In the first place hoarding is caused by uncertainty. In the boom people act silly but in the bust the errors of the boom are revealed and long term and risky projects probably need to be abandoned. You even said that hoarding happens because of a downturn so people are acting rational when they hoard

2) By speeding up the liquidation of mal-investments it will speed up the healing process. Would you prefer that shaky banks be propped up? You are against government intervention but if individuals decided to just go out and buy things and invest in shaky banks it would be the same as a bank bailout whither or not individuals or the government is doing it. If people don't have enough faith in the system to invest there is probably a good reason for that and they shouldn't go out of their way to prop up shaky firms as patriotism

3) Because a rising value of money is only bad when everyone is in debt. A bank run can't happen in a 100% reserve lending system

My question to you is why do you think a depression could happen on a free market? After a period of time don't you think people will simply stop hoarding

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Neodoxy replied on Sat, Mar 9 2013 1:58 PM

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"I am having to deal with two people at once"

Then you should either specify this or not do this. I don't know exactly how you expected someone to react to this.

"1. First, I am not assuming that hoarding comes at the expense of consumption and not investment. As Mises pointed out in the article, the capital accumulation that benefits society has already taken place when the person actually works for a living and gets money to hoard. Even if he used to invest that money and now hoards it, he does not reduce investment per se by his act of not investing."

This is one area where I think you are absolutely wrong. All money taken out of investment decreases the extent of capital accumulation and decreases the capital structure. If we assume someone has the ability to: consume, save, and invest, then increasing consumption puts pressure on prices in the shortest stages nearest the production of consumer's goods, indirectly raising the interest rate, and thereby shortening the structure of production and capital consumption. If one invests then one puts pressure on decreasing the interest rate, increasing the length of production, and decreasing prices in stages closest to consumption while increasing them in areas further away from it.

Therefore, what you, and partly what Mises talked about is the short term process of:

Rothbard expressed this as a ratio. So for instance if, in a particular time period individuals were to invest 1 dollar for every 10 they consumed, then the ratio would be 10:1. If the inverse was true and the ratio looked like 1:10, then the second society would be far less rich in terms of enjoying consumer's goods over time, but very wealth in this respect in the long run, while the first society's productivity and standard of living would absolutely pale in comparison. This is where plain savings comes in. It is obvious that this matters based upon whether or not it goes into consumption or investment. Let's say that the consumption/investment ratio were 5:5, and consumers were deciding how to allocate their last bit of income which will change the ratio by 1 in either direction if fully spent in one area. If it is spent in consumption then it increases to 6:5, while if it is allocated to investment it becomes 5:6 towards investment. If it is allocated to neither of these and money is just plain saved then prices adjust downward through the board, but back to their old ratios in investment/consumption.

However, if hoarding "comes out" of consumption or investment then something slightly different occurs. If the money supply is 1 trillion and 500 billion is allocated to both investment and consumption then if 100B is saved, then what matters most, particularly in the long term, is WHERE this comes out of. Consumers save 100B then the ratio is now 4:5, increasing capital accumulation. Punch line: if investors hoard then the money the ratio is now 5:4, decreasing capital accumulation.

"Say he used to buy pipes for his plumbing business, and now he stops. that just frees up raw materials for others to buy. previously they were not able to out bid him for the materials they need, so he got them. Once he drops out of the market, others will get what he no longer uses."

I'm a little confused by the exact mechanics of this example. I'm assuming here that what you mean is that guy starts his own business with his own money and does plumbing, since if he's just a plumber there is no investment from him, so I'mma ignore the plumber and just talk about an investor who used to invest his money in plumbing. If the business fails and he pulls out his money then this decreases how much money in general is being invested in the economy, fewer loans are provided in the market as a whole and the interest rate rises, decreasing capital accumulation. What you are looking at is a short term concern.

Brief aside: This is why increasingly I'm finding myself disliking Mises' work in HA: it's not a very good book in explaining certain specific chains of causality, particularly in the area of capital. Mises describes the outcomes of most relationships perfectly, but the reasons for these are not clear. Hayek's work on the business cycle and capital accumulation was (IMO) infinitely superior, even if he did make some large errors. Regardless he laid the foundation for the more "perfected" work by Rothbard and De Soto on the matter. I think this is part of what is confusing your understanding in this respect.

What Mises seems to outline in the section you quoted (the only thing I could ever make sense of) is that because there are unsold consumer's goods the prices of these goods falls, increasing real wages and therefore increasing how much capital we can accumulate at any wage. However this aspect of it is a short term effect. In the long run there is no unsold surplus and real wages reach their old levels. Therefore the long run factor promoting capital accumulation is what I have outlined above.

Therefore in your example, perhaps for a short time investment will remain relatively unchanged because now all of the capital the plumber had is available for use, decreasing the costs of investment for a time. However, unless this somehow induces new lenders to enter in to the market then in the long run there is not enough money to invest in the same "level" of projects being undergone before the investor plumber left the market. This decreases capital accumulation. If this were not the case and your above scenario were true then ALL investors could leave the market and investment would not be changed. If this is not the case then ceteris paribus the plumber pulling out his money from production must decrease capital accumulation

Well jeez that turned into one big ass section about a single point, probably because this is the first thing I've seen you argue which is really explicitly wrong. I'll respond to whatever else later, I need eats now.

If you want to read back up on this then Rothbard's words on capital accumulation in MES, as well as a good deal of his words on savings in the chapter on money might help. As I said, I think that reading Mises' work on causality in this matter is just confusing and possibly even fallacious, whereas Rothbard goes about it in a much better way.

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Smiling Dave replied on Sat, Mar 9 2013 5:35 PM

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Thank you for the well thought out post, Neo. Here's my response:

All money taken out of investment decreases the extent of capital accumulation and decreases the capital structure.

I think this is the key sentence, and I think it's wrong. Capital and money are not the same thing. Here is a thought experiment to prove my point.

Say a country that used money suddenly decided to return to a barter economy. There would be many changes as a result, of course. For one, people who were rich because they had plenty of cash, but only cash, would become paupers overnight. For another, all the inconveniences and difficulties of barter would come back to life, things like difficulties finding double coincidence of wants, and the like.

But one thing that would not change is the productive capacity of the country. All the machinery is still there, all the land, all the workers, everything. Whatever capital [meaning already-produced durable goods that are used in production of goods or services. Wikipedia] existed before still exists. Whoever owned them before owns them now. Whoever needed them before needs them now. [And even if they change hands as a result of the elimination of cash, so what? They still exist]. Sure, things would be awkward and clumsy because of the limitations of barter that make smooth transactions impossible, but every pair of shoes that could have been made before can be made now.

If one asks, who will buy the shoes and all the goods made now that many people have not a penny to their name, the answer lies, of course, in Say's Law. I think there is unanimous agreement that it applies in a barter economy, and it ensures that whatever is made, someone will have the purchasing power to buy.

Bottom line, the existence of money does not increase the productive capacity of an economy. It also does not increase the demand [=ability and desire to buy] for what is produced. All it does is to merely greases the wheels of trading a bit. And all this is true both in the long and short run.

Ever so much more so does the above analysis apply when plenty of money still exists, but people are hoarding some of it. The exclusion of their cash from the economy does not change the productive capacity. Factories do not go tumbling down as if an earthquake struck merely because someone put a few dollars under his mattress.

What will change is the same as in the above thought experiment, who gets what slice of the pie, because money leaving the economy changes the purchasing power of money [=increases it] and the prices of commodities [=lowers them]. But the capital accumulation stays the same. What is produced may change, because the shifting of wealth to Mr A from Mr B  might mean more pizzas made and less birthday cakes, because Mr A likes pizza and can now afford them, while Mr B can no longer afford cake, but so what? Consumer tastes change all the time anyway, and wealth moves around all the time, too.

Your long post deserves a longer reply, but the weekend buzz has set in. Besides, a lot will depend on how the issues raised in this post are concluded. If you agree things will go one way. If you have objections they will move in another direction.

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Student replied on Sat, Mar 9 2013 6:30 PM

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In the meantime, let me reassure you that when I wrote about people having to read up on their AE, I meant Student, who obviously is extremely deficient in basic Austrian knowledge, as he admitted himself a few times in this very thread. [Had no clue about what Say's law actually is. Thought Mises denied that people use money as a store of value].

I agree that you think my understanding of Say's Law is different than your own (though you have not been very clear about what you actually think it means). But my understanding of Say's Law is perfectly consistant with Austrian economists like Steve Horowitz and Tyler Cowen, who support their interpretations pretty well imo.  If you think Horowitz or Cowen are too impure to call himself "Austrian", I can live with that. I am less interested in labels and dogma and more interested in good economics.

As far as Mises goes, I will let other people read the essay and decide for themselves.

I know I personally couldn't find any mention in that essay of people choosing to hoard cash, as they might do in times of uncertainty if money is viewed as a store of value. This seems like a very odd omission from an article that is nominally about Say's Law and how it relates to Keynesian economics. 

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Student replied on Sat, Mar 9 2013 8:21 PM

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Horwitz is in this camp, known as the Monetary Disequilibrium Theorists. They pretend that Say, and Austrian Economics in general, is on their side. Their mascot is Hayek, since he  was wishy washy on this point until 1974 [when he got his Nobel Prize for being an Austrian, and ditched the Money Cranks for good].

”Hayek went through three phases. His first is the Hayek's Overcoat phase. Then he became a turncoat, excuse the pun. Phase three was after he won the Nobel prize, and put his overcoat back on.

In case anyone is interested, I just want to say this characterization of Hayek's intellectual biography is pretty unfounded. If you want the real scoop, try Bruce Caldwell's book, Hayek's Challenge. In the mean time, here are a few choice quotes.

Now, obviously, you can argue that Hayek's views evolved with time (whose doesn't).  But you can't get around the fact that over much Hayek's career he openly admited that aggregate demand problems were possible. And later in his career he believed they were not only possible, but correctable through monetary intervention. If it makes you feel better to say Hayek was not really an Austrian or that he was only pretending to believe aggregate demand problems were possible to advance his career or whatever, all I can say is follow your bliss.

And that's all I have to say about that.  I really don't enjoy discussions like "what did Economist X really believe 80 years ago". I prefer to talk about economics, not economists.

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Neodoxy replied on Sat, Mar 9 2013 8:49 PM

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Dave,

I think what you overlook in your post is time preference. To produce more capital-intensive and more productive longer-term projects resources that could have been used to produce current projects, or shorter term projects, have to be used to instead produce projects in the future.

Let's take your barter example. Let's put this down to a two good example. Let's say that I am the barter equivalent of a capitalist. I will lend you my massive stockpile of canned goods. By providing your workers to live off the canned goods you to make a pin factory. In return you promise me 10,000 pins in a year after your factory has been completed (let's say that this is a decent pay off in terms of what I could acquire through barter). If my time-preference is low, then I will accept that deal, but if my time preference is extremely high, then it might take 100,000 pins to induce me to give you my canned goods instead of selling them for, say, 9,000 pins today from current producers instead of a year from now.

Furthermore with the viewpoint you express above I don't understand exactly how you think capital accumulation comes about. By investing and decreasing the interest rate and the "price" of money one makes longer-term production viable. This is the essence of Austrian capital theory on the free market. The way that money is used: consumption or investment, directly affects how the market is organized. Indeed I don't understand how you explain ABCT in the absence of this, because for mal-investment to occur the decrease in the interest rate must lead to deviations in real production. If this were not the case then why does this lead to investments that are not sustainable?

"Capital and money are not the same thing. Here is a thought experiment to prove my point."

In the quoted passage I did not claim that they were the same. It has nothing to do with hoarding per se, indeed in this instance I will argue that prices are perfectly flexible because it doesn't actually change my argument about the long term consequences. If everyone decreases the amount of money they are putting into investment and consumption by half and hoards that money instead then actual production will not change, prices will just fall by 50% across the board. However, if this money comes out of investment then capital consumption will occur because the interest rate will rise dramatically, the supply of loanable funds will shift dramatically to the left but without a corresponding change in consumption, therefore resources will be allocated more towards short-run productive processes and capital will not be accumulated to nearly the same extent. This is because long-term production is now so much more expensive that long term capital intensive projects are unprofitable.

Hoarding does not magically increase capital accumulation. It does so through a series of specific steps. If hoards come out of loanable funds, or if they do more so than out of consumption then this will decrease capital accumulation after prices adjust. I don't feel like you really addressed this concern. It would seem instead that the barter example served to obscure the role interest and money have in the moneyed economy. Money does affect real factors, and investment and capital accumulation are certainly cases of this.

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Jargon replied on Sun, Mar 10 2013 3:46 PM

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Hey Dave

Smiling Dave:

All money taken out of investment decreases the extent of capital accumulation and decreases the capital structure.

I think this is the key sentence, and I think it's wrong. Capital and money are not the same thing. Here is a thought experiment to prove my point.

Say a country that used money suddenly decided to return to a barter economy. There would be many changes as a result, of course. For one, people who were rich because they had plenty of cash, but only cash, would become paupers overnight. For another, all the inconveniences and difficulties of barter would come back to life, things like difficulties finding double coincidence of wants, and the like.

But one thing that would not change is the productive capacity of the country. All the machinery is still there, all the land, all the workers, everything. Whatever capital [meaning already-produced durable goods that are used in production of goods or services. Wikipedia] existed before still exists. Whoever owned them before owns them now. Whoever needed them before needs them now. [And even if they change hands as a result of the elimination of cash, so what? They still exist]. Sure, things would be awkward and clumsy because of the limitations of barter that make smooth transactions impossible, but every pair of shoes that could have been made before can be made now.

If one asks, who will buy the shoes and all the goods made now that many people have not a penny to their name, the answer lies, of course, in Say's Law. I think there is unanimous agreement that it applies in a barter economy, and it ensures that whatever is made, someone will have the purchasing power to buy.

This sounds like a big big copout to me - meaning that, yes, an economy can run without a common media of exchange and Say's Law applies wherever production and exchange takes place. But you're thought experiment is not merely removing the influence or the institution of money. In your thought-experiment you are confiscating the purchasing power of all cash-holders. Now, other holders of goods still have purchasing power because goods can be exchanged against one another. If goods on opposite sides of an exchange are not valued proportionately, then a discount will occur. For example if you have 100 pairs of flipflops and want my toolset, I might accept those flipflops but I will ask for more of those flipflops (a higher price for the toolset) than if you were just paying in cash, because flipflops are less marketable than cash and I value the time I might spend trying to find a buyer. Money helps out this problem by smoothing out the inconvenience of exchanging goods many times before one actually gets the desired one.

In your example, you neglected to reimburse those cash-holders with whatever goods or resources they would have bought with said money. When money is invested or given to a bank for lending, it represents the entrepeneurial employment of resources. Money is not a consumable good, it is a medium of exchange, a link from one point to another. When Neo (correct me if I'm wrong Neo) talks about taking money out of investment and putting it into hoarding, what is of significance in this example is not that pieces of paper or gold coins are taken out of an interest bearing deposit account and then stuffed under the mattress, but that resources are diverted away from investment and then sit in unemployment, exemplified by the "inactivity of the money".

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Neodoxy replied on Sun, Mar 10 2013 4:53 PM

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Jargon,

"When Neo (correct me if I'm wrong Neo) talks about taking money out of investment and putting it into hoarding, what is of significance in this example is not that pieces of paper or gold coins are taken out of an interest bearing deposit account and then stuffed under the mattress, but that resources are diverted away from investment and then sit in unemployment, exemplified by the "inactivity of the money"."

I think that while you're looking at the matter fundamentally differently (not necessarily incorrectly) than I am in the rest of your post, I agree fully with the statement right until you start talking about unemployed resources. While I think that you can make the case that this would happen in the short run, this is not what I'm focusing on right now exactly because what we are talking about would seem to show a fundamental misunderstanding of an important aspect of the Austrian framework.

To go back to the usual example, Robinson Crusoe can either enjoy five fish today by fishing without a net, or he can just catch one fish a day and spend the rest of his time making a net for a week which will then allow him to catch seven fish a day. Depending upon Crusoe's time preference he will either invest in the net and enjoy a better standard of living tomorrow, or he will enjoy a better standard of living today.

In our economy the interest rate communicates to entrepreneurs how oriented they should be towards the production of more future vs. more present goods. The more money is spent on consumption the higher the "lower" stages of production climb, attracting more resources to those stages and away from higher ones. This increases output today, but decreases it in future, either relatively or absolutely. Meanwhile the more that is invested the more the opposite occurs.

Plain savings causes deflation and increases the purchasing power of money. therefore by a large number of investors taking their money out of the loan market and saving it they bring about a decrease in purchasing power, but since consumption has not decreased it means that consumption will increase in absolute terms leading to more present production. This may or may not lead to unemployed resources, but it will lead to lesser capital accumulation than would have otherwise occurred.

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gravyten577 replied on Sun, Mar 10 2013 5:15 PM

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Here is an infamous quote from Rothbard in America's Great Depression

http://mises.org/rothbard/agd.pdf

Electronic P. 86

Keynesians maintain that if the “speculative” demand for cash rises in a depression, this will raise the rate of interest. But this is not at all necessary. Increased hoarding can either come from funds formerly consumed, from funds formerly invested, or from a mixture of both that leaves the old consumption–investment proportion unchanged. Unless time preferences change, the last alternative will be the one adopted. Thus, the rate of interest depends solely on time preference, and not at all on “liquidity preference.” In fact, if the increased hoards come mainly out of consumption, an increased demand for money will cause interest rates to fall—because time preferences have fallen.

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Neodoxy replied on Sun, Mar 10 2013 5:20 PM

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Gravy,

While I think that Rothbard really overlooks time in the quoted section of AGD, the quote nontheless perfectly states that basic Austrian relationship. His work on it in MES, particularly in the money chapter, goes over it in even more depth. What you and I are arguing here is by no means an obscure Austrian relationship, which is why I don't understand why it seems so unknown around here.

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Smiling Dave replied on Sun, Mar 10 2013 8:06 PM

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Student,

My humble article proves Horwits mangled Say's Law. I quote Say directly. https://smilingdavesblog.wordpress.com/2012/12/12/j-b-say-rises-from-the-grave-to-refute-steve-horwitz/

Mises writes in HA that money serves as a store of value.

Mises doesn't mention it, because historically it never happened. There's something called "a bank" that people use instead of "mattresses" for storing money.

But if you think you have shown that you understand AE with this last post, I won't argue with you. I'm not here to change your opinion of yourself.

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Smiling Dave replied on Sun, Mar 10 2013 8:22 PM

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1932 quote: He doesn't say it is undesirable either. Proves nothing.

1933 quote: Not sure what you want with this one. He says it's bad short run, good long run. So what?

1978: This proves my point, actually. Key word here is "temorarily", meaning bad and/or useless in the long run. Shows he is not in love with printing money.  It's a temporary fix. The problem is that it destroys the economy long run. 

More evidence that you need to brush up on your AE.

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Student replied on Sun, Mar 10 2013 9:25 PM

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My humble article proves Horwits mangled Say's Law. I quote Say directly.

That's great. So you quote one passage from Say and interpret Say's Law one way. Horowitz quotes a different passage from Say and other authors and interprets Say's Law differently. So where does that get us? "Smiling Dave understands Say's Law differently than Steve Horowitz". I'm pretty sure I already knew that. :P 

Am I going to have a detailed discussion with you about who is right? Where we dive together into original source material and see who comes out the victor? No. 

I am not going to pretend I am an economic intellectual historian. Not even on the internet. :P 

Mises writes in HA that money serves as a store of value.

That's great too, I guess? But irrelevant.

My point is that he was ignoring this possibility in an essay where it is very important to recognize that people can hold money for reasons other than as a medium exchange.

By ignoring the fact that people can hoard cash Mises is able to "debunk" general gluts and demand-driven recessions by basically assuming them away. If your point is that Mises knew better, then I can only take that to mean he was using crude arguments to score political points  in "Lord Keynes and Says Law". :-/

Mises doesn't mention it, because historically it never happened. There's something called "a bank" that people use instead of "mattresses" for storing money.

So your explaination for why Mises doesn't mention that people can hoard cash is because people never actually hoard cash, they deposit their money in banks (and have done so for all of time)???????????????????? If only someone had told Keynes there was such a thing as a bank! Intellectual history would be changed!  Never mind that not all money deposited in banks is treated equally or loaned out to investors. For example, banks typically do not loan out most of the money people deposit in checking accounts and other demand deposits. This is why people have historically had to pay checking account fees instead of earning interest (you don't earn interest on money just sitting in a vault). It is also why checking account deposits are included in most definitions of money (M1 and above). 

But never mind that! Keynes just never heard of Banks. And Mises just happens to forget to explain that people will never hoard cash because....uh....Why? I guess he forgot because it was so critical to his argument. That makes sense to me!

So Mises was either a bastard that used crude arguments to win political points (even when he knew better). OR he was just really bad at explaining himself. 

If this is you defending Mises, I would hate to see you attacking him. 

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Smiling Dave replied on Sun, Mar 10 2013 9:54 PM

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First, apologies to everyone if I respond a bit slowly. You are raising deep questions, which need time to answer.

1. Here's my understanding of Neo's argument, based on all his recent posts:

In the modern world, businesses usually need to borrow money if they want to expand. If money that used to be lent to them is now hoarded, then someone who used to get money is no longer going to get it, because the money he used to get is now hoarded.

Put another way, when the supply of available money for loans is cut in half, say, then, by the laws of supply and demand, the price of it will go up. The price of money is the interest rate. So if people hoard that portion of their money that used to be put into investment, the interest rate will go up, which will cut off some businesses from getting it. Not only that, the really long range projects that are usually only started when interest rates are low will now not get off the ground.

2. Here is my reply. First of all, even if we grant for the moment that interest rates will go up, that does not change the fact that commodity prices and wages will go down. Less money in circulation means higher purchasing power for the money that is still out there. The increased interest rate may be offset by having to borrow less money in the first place. Numerical example: Before hoarding Mr A needed $100 to expand his business, and he could get it at 4%. Total outlay $104. After hoarding, since prices and wages have gone down he needs only $95. Although he has to pay 5% interest now instead of 4%, his total outlay is $98.80.

Second, it is not clear that the interest rate will go up at all. Mises expands in Human Action on what is the cause of the interest rate being what it is. He claims that supply of, and demand for, loanable funds, do not determine the interest rate. On the contrary, he says, and I quote, emphasis mine:

Originary interest is not a price determined on the market by the interplay of the demand for and the supply of capital or capital goods. Its height does not depend on the extent of this demand and supply. It is rather the rate of originary interest that determines both the demand for and the supply of capital and capital goods. It determines how much of the available supply of goods is to be devoted to consumption in the immediate future and how much to provision for remoter periods of the future.

People do not save and accumulate capital because there is interest. Interest is neither the impetus to saving nor the reward or the compensation granted for abstaining from immediate consumption. It is the ratio in the mutual valuation of present goods as against future goods.

The loan market does not determine the rate of interest. It adjusts the rate of interest on loans to the rate of originary interest as manifested in the discount of future goods.

Perhaps in a future article I will explain his argument in detail, meaning on what basis he makes these assertions. For now, You'll have to read Chapter 19 of Human Action.

Bottom line, the interest rate is determined by the degree of time preference people have at the moment. If people hoard, what does that tell you? That their preference is directed, if anything, more towards the future than ever [otherwise they would spend now, not hoard], aka interest rates will sink, not rise.

3. Rothbard is saying something similar. The rate of interest, he says, is determined by rate of preference of present goods over future goods. The act of hoarding per se, he is assuming, doesn't tell us that this preference rate has changed. [I argued that if anything it shows increased preference for the future. He is saying that you can't really assume that, because hoarding and investing in a business both direct money towards the future]. Since hoarding per se does not tell us the preference has changed, why assume it did? Thus there is no basis for saying the interest rate will rise just because of hoarding. 

4. I think Jargon's objections are answered by the above, as well.

5. A note to Student: Applying the concept of time preference to money, an idea so basic to Mises's writings, implies that money is a store of value.

6. One may ask, "But what about the fact that, after everything, there is less money to lend? Doesn't this mean that some people just won't get the money they used to?

Answer: What counts isn't money per se, but the purchasing power of money. That will adjust so that less money is needed to buy stuff, ensuring an adequate supply of money in the banks to lend to everyone they used to.

7. One may also ask, "But won't the banker, seeing the same amount of people fighting over a smaller pool of money, up the ante? What will stop him from raising the interest rate, just as when more people start wanting Ipods, the prices of Ipods will rise? Doesn't supply and demand apply to money just like everything else?"

Answer: The laws of supply and demand apply to money, but not to loans of money. When a person really really wants an Ipod, he is willing to give up on something else in order to afford it. But a business does not work that way. He has nothing to give up. There is a fixed rate of profit he can have [and Mises explains why this rate is related to time preference and originary interest], which determines how much interest he can pay on a loan. If, for example, his profit is 5%, he will obviously never borrow money at 6%. So although the banker might try to raise the rates, the borrowers will have no choice but to refuse. The banker, in turn, will have no choice but to lend at the old rate.

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Smiling Dave replied on Sun, Mar 10 2013 10:25 PM

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Student.

1. Horwitz has no quotes from Say that support his position. Put thy cards on the table. Show me the quotes.

2. I already explained why he did not bother with Keynes' notion of mass hoarding.

3. (and have done so for all of time)

Who is talking about for all of time? Keynes is trying to explain recessions, which existed only after there where central banks, which in turn have existed since some time in the 1600's.

4. If only someone had told Keynes there was such a thing as a bank!

Oh, he knew there were banks. He didn't understand them, or thought he could fool you, which he apparently did.

BTW, if you claim there is hoarding, prove it. Enough of your wild, unsupported claims. Samuelson, [of all people!] has done the research proving there was no hoarding during the Great Depression. I mention it in this article which you will no doubt enjoy: https://smilingdavesblog.wordpress.com/2013/01/23/summary-of-keynes-theory-and-the-flaws-in-it-that-any-layman-can-spot-a-mile-away/

But I think your question is a deeper one. Keynes is God, you are saying. He never makes any mistakes, never lies. The high priests in your university have assured you this is true. I get it.

5. Never mind that not all money deposited in banks is treated equally or loaned out to investors. For example, banks typically do not loan out most of the money people deposit in checking accounts and other demand deposits. This is why people have historically had to pay checking account fees instead of earning interest (you don't earn interest on money just sitting in a vault). It is also why checking account deposits are included in most definitions of money (M1 and above).

I guess you never heard of fractional reserve banking. For every dollar someone puts in a bank, the bank has ten dollars to lend. So if someone puts a dollar in a bank and the bank just keeps it there, the money supply has not been reduced by one, but increased by nine.

6. And Mises just happens to forget to explain that people will never hoard cash because they will deposit their money in the banks. Why? I guess he forgot because it was so critical to his argument.

I'll explain so that everyone can understand. Let's assume for the moment that if the moon is made of green cheese, that Mises is somehow refuted. So you are asking me why Mises did not even bother mentioning that the moon is not made of green cheese [in a short article that surveys the topic]. After all, you seem to be arguing, it is incumbent upon him to refute every possible argument, even those based upon assumptions that exist in Bizzaro World, but not on Earth.

I admit, I don't know what to reply to such a thing.

BTW, it's not my argument that people put money in banks, but Hazlitt's. Just mentioning it for those who don't give much weight to my arguments, but do respect Hazlitt's. I don't mean you, Student.

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Student replied on Sun, Mar 10 2013 10:39 PM

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 Horwitz has no quotes from Say that support his position. Put thy cards on the table. Show me the quotes.

WTF?

Dude. The quote is in the article I linked. The article is a scanned image so it is not easy to copy and paste, but even if it was easy I would not go get the quote for you. Two reasons. First, I think it speaks volumes that you have not actually read the link I posted but criticize Horowitz anyways. Second, like I already said, I am not interested in parsing the words of a dead French economist. If you want to write another lengthy blog post explaining why you feel like Horowitz misquoted Say or needed to read him in a wider context, feel free. But don't expect me to weigh in. 

Besides. The one thing I do know about economic intellectual history is that it is not easy when it is done right. It requires not only pulling choice quotes, but spending a lot of time with original sources, understanding not only the historical context, but sometimes even the particulars of translation. It is history as much as it is economics. This might be why Horowitz does not only build his case on the basis of a single quote, but also by citing other scholars that have written more exentisevly on the topic. That being said. If you think you actually have a legit beef with Horowitz based on the extensive time you've spent with the source material, take it up with him. He is pretty responsive to e-mail I hear. 

Oh, he knew there were banks. He didn't understand them, or thought he could fool you, which he apparently did. Samuelson has done the research proving there was no hoarding during the Great Depression.

But I think your question is a deeper one. Keynes is God, you are saying. He never makes any mistakes, never lies. The high priests in your university have assured you this is true. I get it.

WTF?

Dude. My point is not that Keynes is never wrong. My point is that if you honestly think Keynesians had never heard of fractional reserve banking, and that their arguments are so vulernable to such simple attacks, then you are the one being fooled. 

I guess you never heard of fractional reserve banking. For every dollar someone puts in a bank, the bank has ten dollars to lend. So if someone puts a dollar in a bank and the bank just keeps it there, the money supply has not been reduced by one, but increased by nine.

WTF?

Dude. Re-read that paragraph. I understand what fractional reserve banking is. But you need to understand that not all deposits in the bank are treated equally. The fraction of reserves held in the bank for demand deposits (like checking accounts) is much much higher than the fraction of reserves held in the bank for savings accounts or CDs and the like. This is why checking account deposits are *defined* as part of the money supply. It is also why you typically PAY banks for the privledge of having a checking account instead of them paying you money for the privledge to loan out the "savings" you store in that account. 

I'll explain so that everyone can understand. Let's assume for the moment that if the moon is made of green cheese, that Mises is somehow refuted. So you are asking me why Mises did not even bother mentioning that the moon is not made of green cheese [in a short article that surveys the topic]. After all, you seem to be arguing, it is incumbent upon him to refute every possible argument, even those based upon assumptions that exist in Bizzaro World, but not on Earth.

WTF?

Dude. If everyone agreed that hoarding cash was impossible, then you might have a point that failing to mention cash hoarding would be like not mentioning the moon was made of green cheese. But the fact of the matter is that the potential for people to hoard cash is the CRUX of what he was talking about. Failing to mention the most crucial piece of your argument seems pretty strange.

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Neodoxy replied on Sun, Mar 10 2013 10:56 PM

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Dave,

I really don't understand what you think the chain of causality is here, and this just goes to (in my mind) advance the idea that Mises' words obscure rather than illuminate.

First of all you shoot yourself in the foot with your specific example. Prices go down by approximately .0526% (1.0526*95=99.997). The interest rate rises to 5%. His costs are now $95. At interest this is $99.75, NOT 98.8 (95*1.05=99.75). In terms of the original price level his costs have now gone up to $105 (99.75*1.0526=104.99685). If he is working on the margin he will not be able to continue production at his increased costs. I don't understand why you thought the results would be different. Prices have adjusted downwards proportionally, but the interest rate has risen. Therefore real costs will be higher. If your example is supposed to be a major point then you have proven my point.

What you continually seem to avoid is the consumption vs. investment ratio, present goods vs. future goods. Other than this factor your summation of my point is perfect, but if you ignore this then it's all moot. Remember, consumption drives production towards current goods while investment shifts it to future goods. It is a constant tug-of-war between these two factors. If money is taken out of investment and hoarded then the price level will fall, but the real value of money on the consumption end increases.

In the quoted sections by Mises he seems to basically be saying that originary interest determines what occurs on the loan-market, not the other way around.

I think your interpretation of Rothbard is exactly the opposite of what he is saying, or your comments here are absolutely irrelevant to what we are talking about, because Rothbard comes a hairs breadth away from what I've been saying this entire time. This whole discussion has not been about hoarding per se. We agree that hoarding per se will, in the long run, merely decrease the price level and everything will be as it was, but instead we are talking about hoarding that comes out of INVESTMENT SPECIFICALLY. Hoards that come out of either investment or consumption specifically or more so than the alternative, will change the ratio and will change the rate of interest. This is exactly what Rothbard says:

Increased hoarding can either come from funds formerly consumed, from funds formerly invested, or from a mixture of both that leaves the old consumption–investment proportion unchanged. Unless time preferences change, the last alternative will be the one adopted. Thus, the rate of interest depends solely on time preference, and not at all on “liquidity preference.” In fact, if the increased hoards come mainly out of consumption, an increased demand for money will cause interest rates to fall—because time preferences have fallen.

Rothbard is saying that if plain savings occurs primarily from consumption then interest rates fall, time preference falls, and capital accumulation increases. This necessarily implies the inverse: that if hoards come primarily out of investment then interest rates will rise. This is the exact opposite of the second underlined part of the passage. Hoarding that comes out of investment signals a decreased time preference because individuals no longer care as much about future goods.

If you still disagree in your next response then please include the investment-consumption ratio in your analysis.

Edit

But seriously dude, check your math next time.

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Smiling Dave replied on Sun, Mar 10 2013 11:44 PM

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Neo,

1. OK, so we agree about everything except the one case where people stop investing as much and instead keep the formerly invested money at home.

You argue that this causes interest rates to rise, and that Rothbard agrees with you. Thus, in the one case where hoarding comes out of investments and not savings, interest rates will rise.

But that is confusing the cart with the horse. Interest rates rise for one reason only, a shift in time preference. A shift in time preference is something that happens inside a person's head. When a person hoards, or does any other action, that does not magically affect what his emotions are. On the contrary, his emotions cause his actions. It his change in time preference, if there is any, that makes him hoard, not vice versa. And once he has changed his time preference, whether he hoards or not, interest rates will rise. Thus, an act of hoarding cannot be responsible for higher interest rates. All this is laid out in Chapter 19 of HA.

So I don't see how it is possible to say "Hoards that come out of either investment or consumption specifically or more so than the alternative, will change the ratio and will change the rate of interest." Hoards can only change the rate of interest if they change a person's internal state of mind, and his internal state of mind will then change interest rates. But as I said, it works the other way round. His state of mind determines his actions, including how much and from which part of his previous budget he will hoard, and at the same time, how much the interest rate will be.

A careful reading of that paragraph from Rothbard that Graveyten quoted will show that he is making the same argument I made here.

Summary:

1. Rate of interest is determined by a certain time preference, an internal state.

2. Once the internal state changes to be more future oriented, interest rates will rise, whether hoarding exists or not.

3. Hoarding, without a change in time preference, will not change interest rates.

4. Thus, a change in time preference is neccesary and sufficient to change interest rates.

 5. Also, hoarding is neither neccesary nor sufficient.

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Smiling Dave replied on Mon, Mar 11 2013 8:14 AM

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1. Dude. You have apparently not read your own link, because he only quotes four lines of Say. Those four lines do not mention the topic Horwitz and I disagree about [=existence of money shortages, their influence on production].

I think it speaks volumes that you have not actually read the link you yourself posted but criticize me anyways.

I know you are not interested in finding out what Say actualy wrote, despite being presented it on a silver platter. Which is fine. You do not have to know everything.

However, if, as you admit, you don't know what you are talking about, it behooves you not to express an opinion. It's called "intellectual honesty" and "integrity" and "basic humility".

You certainly have every right to say "I read that Horwitz thinks such and such, and as a matter of religious faith I believe everything he writes without examination and despite others proving he is wrong, because I never bother to read what they write." Because in that case you are telling us something about your personal belief system, not presuming to assert anything about the real world. And it may be of psychological interest to some.

BTW, what Say wrote is not important because he was French or not French, or because he was alive or dead when he wrote it. It's important because blindness to Say's Law is the very cornerstone of Keynes's failure, as economists of all schools have agreed [although the Keynesians praise him for it. Their take is that although Say's Law refutes Keynes' from the get go, Say's Law is wrong. This was because they did not bother to read Say and Mill and see that all Keyne's's silly objections to Say's Law were anticipated and refuted by them. Exactly the blunder you are making.].

2. Dude. So your position is that Keynes must be right because he he was so smart and so intellectually honest that he could not possibly make simple blunders or try to fool his ignorant readers who never bother to actually read Say's Law, although he is not God and therefore might miss some complictaed and subtle things. I agree with the second half of your statement, but not the first.

In any case, it is besides the point. I'm not sure if you are familiar with intellectual discussion, so forgive me if I state the obvious to make sure we are on the same page:

The truth or falsity of an idea or a fact does not depend on who said it. One does not successfully attack nor defend an idea by talking about the excellence of it's originator [= Such a smart guy. Never misses the obvious. So many people agree with him. The ceiling cannot support us. Has heard of fractional reserve banking. Considers himself an Austrian.] nor by belittling him [Dead. French.]. That's why I never bring up Keynes's many distressing personal deficiencies in these discussions.

An idea is to be judged on its own merits. Does reality contradict it, or not? Is there a logical flaw in it, or not? Is it correctly deducible from first principles, or not? Thus, when you see something that contradicts Keynes, the way to go is not to tell us how smart he was, but to address the idea itself.

3. Dude. You err in thinking that banks do not lend out money in demand deposits. You probably think that since it's a demand deposit, and the customer may withdraw his money at any moment, the banker would not dare lend it away, or ten times it. In other words, you don't know what fractional reserve banking is.

4. Dude. CRUX of what who was talking about? Not Mises in that article. As I pointed out earlier, he said that the money shortage thing was handled by Adam Smith, and he is going to talk about Say. 

5. I think that after seeing the way our back and forth is going, we disagree too much on the very basics to have a fruitful discussion. Good luck to you in pursuing these fascinating topics.

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Smiling Dave replied on Mon, Mar 11 2013 8:51 AM

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Well, nobody's perfect, not even Smiling Dave.

I found Chapter 20, Section 7, of HA discusses the effects of deflation on the [gross market] interest rate. Some of what he wrote shows me wrong in some of I wrote. Everything he wrote there applies to the [non existent in reality] case of hoarding as well, and takes care of Neo's objections.
 
Turns out that what I wrote was correct about originary interest, but not about the gross market rate of interest. Neo nailed it about the gross market rate. So Neo, you have won the battle.

But don't think you have won the war. Mises, though he grants that the gross market rate will rise temporarily, yet he explains why no real damage will happen as a result. As he puts it, no protracted scars are left.

Some highlights. [Fun quiz: I made up one of the quotes in italics. Can you spot which one it is?]

1. Neo was right short term:

...a cash-induced rise in the gross market rate of interest produces a temporary stagnation of business. Deflation and credit contraction no less than inflation and credit expansion are elements disarranging the smooth course of economic activities, and sources of disturbance.

2. But not big picture. Also, the monetray disequlibrium guys missed the boat:

However, it is a blunder to look upon deflation and contraction as if they were simply counterparts of inflation and expansion.

3. And why?

Deflation and contraction are less likely to spread havoc than inflation and expansion not merely because they are only rarely resorted to. They are less disastrous also on account of their inherent effects.

4. What inherent effects?

C'mon guys, read the section.

5. Bottom line:

No protracted scars are left...

6. Despite Student's protests, historically there never was hoarding:

Deflation and credit restriction never played a noticeable role in economic history.

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Smiling Dave replied on Mon, Mar 11 2013 9:13 AM

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One thing still bothers me. Rothbard's argument only applies to the originary rate, no? Why did he ignore the gross market rate? Is it because medium to long term, it too is not influenced by hoarding, for the same reason as with originary interest? Was he only trying to refute Keynes assertion that permanent unemployment is in the cards for wealthy countries?

Would appreciate any enlightenment.

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Student replied on Mon, Mar 11 2013 2:59 PM

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 I think that after seeing the way our back and forth is going, we disagree too much on the very basics to have a fruitful discussion. Good luck to you in pursuing these fascinating topics.

Yah, that sums it up. 

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Jargon replied on Mon, Mar 11 2013 4:51 PM

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EDIT: Oops, didn't see your most recent post Dave. I'll hang my neck out though.

Smiling Dave:

The loan market does not determine the rate of interest. It adjusts the rate of interest on loans to the rate of originary interest as manifested in the discount of future goods.

Bottom line, the interest rate is determined by the degree of time preference people have at the moment. If people hoard, what does that tell you? That their preference is directed, if anything, more towards the future than ever [otherwise they would spend now, not hoard], aka interest rates will sink, not rise.

Dave I'm just going to quote these sections because I think the central issue is here.

If societal time preference goes down, meaning people start to discount the future against the present less severely than before, then the structure of production will be lengthened, as people will withdraw their money from consumption (lower order goods) and towards savings. The ratio after this of savings vs. investment is not determined, but a time of economic stability will be a greater inducement to devote savings towards investment. But it does follow that a ratio exists, as long as there is any opportunity for investment available anywhere. Can we agree that this is the case? It follows then, that any lowering of societal time preference does indeed increase the supply of loanable funds, though the degree to which it does varies greatly.

The originary rate of interest, then, determines the supply of loanable funds. The demand for capital, then, determines the demand for loanable funds.

If people hoard, it tells us precisely nothing about their time preference insofar as we don't know how much they have retracted from investment., as time preference is essentially a measure of abstention. Societal time preference may have changed not at all but funds have been transferred from investment to hoarding.  If people start to hoard and more of that hoarding comes from consumption than from investment, the cost of capital is reduced more than the interest rate (as much as the interest rate is reduced by the reduction of supply of loanable funds, ignoring the rise which may follow given new cheapness of capital). If people start to hoard and more of that hoarding comes from investment than from consumption, the supply of loanable of funds is reduced and capital remains relatively devoted towards the lower stages of production. The relative scarcity of capital which follows this then means a reduction in capital accumulation.

You point to the increased purchasing power of money as some sort of counterbalance to a new capital scarcity which hoarding from investment would induce, but who are the beneficiaries of this increase in purchasing power? Consumers store the cash under their mattress and retailers, in an attempt to get them to buy, will lower their price. So this increase of purchase power augments the consumer because it is the consumer who is usually the source of capital and who has just retracted it.

Even if this were not so, let's take an experiment:

On an island, there are 9 people. A cobbler and his apprentices, a fisherman and his, and a shepherd and hers. Each of them abstains from consuming a portion of their daily produce of the work of the lower orders of production, so that on sundays they can build and repair tools. This is akin to banking in a capitalist system. They have a system of money. One day the fisherman decides not to use sundays to build tools and he also abstains from buying any of the materials he usually buys on sundays to do so. Yes his handful of coins will gain in value as an abstention from buying things in general will lower the price level. But the stock of capital goods is not at all increased from this increase in purchasing power. Nor has capital in general increased, as goods are now simply nominated differently by money.

If purchasing power is a source of capital accumulation, then why was 1930 not the greatest year for capital accumulation, seeing as the value of gold soared? By your logic the increase in purchasing power should have trumped the sucking of resources out of investment and into hoarding.

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Smiling Dave replied on Mon, Mar 11 2013 5:43 PM

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Deep stuff, Jargon.

Just to make sure we have the context clear, the following is a discussion of the influence of hoarding on the originary interest rate. See Human Action Chapter 19 at length for the requisite background info.

If people hoard, it tells us precisely nothing about their time preference insofar as we don't know how much they have retracted from investment., as time preference is essentially a measure of abstention.

Isn't hoarding, by definition, abstention? Especially the kind of hoarding Keynes is talking about, long term hoarding. If the hoarding was of money used to invest, then maybe time preference is not lengthened [=more future oriented], but I don't think it has been obviously shortened. If it comes from money used to consume, then that is definately an indication that their time preference is more future oriented.

 ...but who are the beneficiaries of this increase in purchasing power? Consumers store the cash under their mattress and retailers, in an attempt to get them to buy, will lower their price. So this increase of purchase power augments the consumer because it is the consumer who is usually the source of capital and who has just retracted it.

Everyone will benefit, because commodity prices go down as well, benefiting the producers who use them.

On an island, there are 9 people...But the stock of capital goods is not at all increased from this increase in purchasing power. Nor has capital in general increased, as goods are now simply nominated differently by money.

It has increased for everyone else but the fisherman, in the sense that what he used to buy and he now abstains from buying becomes available for everyone else.

If purchasing power is a source of capital accumulation, then why was 1930 not the greatest year for capital accumulation, seeing as the value of gold soared?

Increased purchasing power is a result of increased production, or of increased abstention, which is effectively the same as increased production for the non abstainers. In other words, it's not a source of capital accumulation, but a symptom of it happening.

The value of gold may have soared, but the value of the dollar didn't. Besides, 1930 was suffering from a decades long orgy of malinvestment, starting with the incredible destruction of capital of WW1, so how could it possibly be a time of record capital accumulation? The malinvestments had to be washed away first.

By your logic the increase in purchasing power should have trumped the sucking of resources out of investment and into hoarding.

Who says there was any hoarding? See earlier posts that it never happened.

A final question. Why is all this being addressed to me? Am I not merely repeating what Mises wrote in Human Action, Chapter 18, Section 9?

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Neodoxy replied on Mon, Mar 11 2013 11:59 PM

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Dave,

As happy as any red-blooded person is to hear these words "you have won the battle", I think that what you think I was right about is indeed, as you suggest, only a short run detail and it wasn't the thrust of my point. In what I believe you are talking about Mises was talking about the effects of a decreasing the money supply and how this runs something of the reverse of effect of ABCT.

At any rate, I've finally gone through the trouble of digging up a quote from Rothbard where he explicitly reiterates what I've been saying this entire time. I'm particularly disturbed that you posted a mathematical example that was supposed to prove your point, and yet when I showed it proved the opposite you moved straight past it, nor did you deal with the investment-consumption ratio which is essential to understanding capital theory even when I directly asked you to. Therefore I feel like I have just been reiterating myself, and that you have not in any way provided a real critique this whole time; nor am I even convinced that you fully understand the theory you advocate. For these reasons I'm not going to spend much more time on this, so here are three simple reasons that demonstrate what I have been saying in simple terms or terms that directly deal with the way you've been phrasing things:

1. Hoards that come out of investment can be seen as a shift in time preference. While I reject that time preference per se always determines the interest rate (due to things like risk), this isn't directly applicable here. I don't understand how you could believe I would seriously think:

"Hoards can only change the rate of interest if they change a person's internal state of mind, and his internal state of mind will then change interest rates."

This isn't a coherent line of thought. Someone has to change their preferences (time or otherwise) before they make a change in the way their money is allocated, hoarding is no different from this. How could hoarding cause someone's mind to change when this change in preferences must have necessarily occurred first? I understand that you are arguing against this point of view, but nonetheless it should have been obvious from the get go that you were erecting a strawman. You also seem to have a somewhat mystical view of the interest rate here in that you are not looking about how it is determined by market interactions (which you can argue ultimately come down to time preference quite effectively), but it's not as simple as:

"His state of mind determines his actions, including how much and from which part of his previous budget he will hoard, and at the same time, how much the interest rate will be."

His time preference (and other things) determines how much he hoards which in turn determines the interest rate. Hoarding is an expression of time preference (if we define the term broadly which is my only beef in a way) because it signals that this individual doesn't desire future goods greatly enough relative to future goods to continue playing a part in the market, he would rather hold on to his money. Through the interplay of market interactions this then leads to an increase in the interest rate as there is more spent on consumption relative to investment than was previously the case.

2. If I am right then money hoarded from investment increases the interest rate and leads to more current production. If what I believe you are saying (if you are indeed opposing me) then this is not the case and hoards from investment leave the ratio constant and leave the interest rate stagnant or are somehow offset by price decreases through net deflation. Let's say prices are perfectly flexible and that currently 500 billion is being invested and the same amount is being spent in consumption.

Now let's say tomorrow all investors become total hoarders and there's only a single dollar, $1 left in investment. How could that single dollar being loaned out fund the economy? Bullshit, it couldn't. Net deflation would be 50%, prices would fall by half, but the amount being invested would fall by the full brunt of the spending decrease. The interest rate would skyrocket to thousands of percentage points and that single dollar would be holding of consumption for one more day, all other processes would have to be extremely short, obliterating capital accumulation.

If hoarding from investment doesn't affect the interest rate then this example would have to be false. Any other hoards that come from investment just see the above happen on a much smaller scale.

3. Rothbard in the house:
 

"Admitting, then, that time preference determines the proportions of consumption and investment and that the demand for
money determines the proportion of income hoarded, does the
demand for money play a role in determining the interest rate?
The Keynesians assert that there is a relation between the rate of
interest and a “speculative” demand for cash. Should the schedule of the latter rise, the former rises also. But this is not necessarily true. A greater proportion of funds hoarded can be drawn
from three alternative sources: (a) from funds that formerly went
into consumption, (b) from funds that went into investment, and
(c) from a mixture of both that leaves the old consumption investment proportion unchanged. Condition (a) will bring
about a fall in the rate of interest; condition (b) a rise in the rate
of interest, and condition (c) will leave the rate of interest
unchanged. Thus hoarding may reflect either a rise, a fall, or no
change in the rate of interest, depending on whether time preferences have concomitantly risen, fallen, or remained the same."

-Murray Rothbard: Man, Economy, and State page 789

Edit

I'm pretty done in this conversation if this doesn't convince you, but I thought this was an interesting way to look at things. This is addressed to you too Jargon.

Consumption is choosing to consume goods today rather than goods tommorrow. Investment is choosing goods tommorrow over today. As you suggest, if one takes money formerly used in consumption and saves it, this is abstention in consuming today, an extension in time preference. If one is investing and saves it then one is abstaining from consuming tommorrow.

If we use Mises' "consumer democracy" hypothesis here then investment is literally a vote for tommorrow. By saving one removes one vote altogether, he is no longer casting his vote in the consumer's democracy, but this does mean less support for whatever he was previously voting for. Therefore the side he was originally voting against won't recieve as much support as they would have if he had switched sites, but they will recieve more real support than they otherwise would have.

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Smiling Dave replied on Tue, Mar 12 2013 2:15 AM

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Neo,

I indeed made a mistake in my numerical calculation. I pressed a 4 instead of a 5, or something. In any case, I didn't continue looking for new numbers to mess with, because I saw Mises dealing with the whole question in Chapter 20 section 7. What he says basically is that a deflation, though it will affect everything eventually, need not affect everything at the same time. In some instances it will affect commodity prices more forcefully [at first] than the lonable funds rate, in other cases the opposite. If we accept that assumption, then it seems clear to me that the numbers can vary in every possible way, so there is no point in making up cases.

To your other points:

1. You write: "Hoards that come out of investment can be seen as a shift in time preference." I think the more precise statement is that they may be a symptom of shift in time preference, or equivalently, or that they may be a result of a shift in time preference. But time preference remains a state of mind, not an action like hoarding. One cannot see a time preference, because it is a thought or emotion. One can see the act of hoarding.

Note that I said that hoarding "may be" a symptom, or result of a shift in time preference. Sometimes it is and sometimes it isn't. Rothbard seems to be saying that they way to tell is to look at the ratio of consumption to investment before and after the hoard. I am not sure whether he is right, to be honest. Why is the hoarded money suddenly removed from the equation? In my [provisional] opinion, the hoarded money should show up in the equation, given a weight that would depend if it was taken from consumption, or from long term investment or from short term investment. [More on this in 6. below].

2. You write: "His time preference (and other things) determines how much he hoards which in turn determines the interest rate."

I take issue with the second half of that statement. It will determine the gross market rate, yes. But we have agreed to put that aside for now. It will influence the interest rate because it will result in a shift of prices of commodities, which means by definition almost a shift of who has how much money. What I mean is, if the hoarder used to buy feathers and now stops, the price of feathers will drop. The owners of feathers will be poorer. The poorer a man is, the less influence he has over the rate of originary interest, because his time preference is not as influential in the markets as that of a rich person.

But other than that, hoarding doesn't influence the originary interest rate at all. The originary interest rate is tracable ultimately to time preference, a mental phenomenon. And the mental phenomenon exerts its influence on the interest rate without having to resort to intermediaries such as hoarding. You say that hoarding signals his time preference. But no signals are needed. All the person has to do is act according to his time preference and his influence is exerted on the interest rate. If he is a businessman, and the originary interest rate in his head is 5%, he will not expand his business unless it will get him a profit of 5% in his estimation. If he has money, he won't lend it to anyone unless he gets his 5%.

In particular, you write that "it signals that this individual doesn't desire future goods greatly enough relative to future goods to continue playing a part in the market, he would rather hold on to his money." There is obviously some typo there. Not sure how to correct it.

3. You attribute to me the following: "...hoards from investment leave the ratio constant and leave the interest rate stagnant or are somehow offset by price decreases through net deflation." Yes to the first part. I retract the second part, as above.

4. In the extreme case you mentioned, remember that we are not talking about short term effects. Initially the reduction of the money available for lending to a single dollar may definately influence the interest rate. But the interest rate will not rise to thousands of percentage points after things have queited down. It's impossible, for the simple reason that the profits from running a business, say selling frisbees, do not rise to thousands of percentage points just because there is only only dollar available to be borrowed. If he makes 5% profit on a frisbee, he still makes only 5%, not a thousand percent. Thus he will only borrow at less than 5%, because he will go broke if he borrows at a higher rate.

Not only that, if thousands of percentage points are out there for the taking, there will be a rush of money into the loan business to take advantage of that great opportunity, until, as Mises says, it will start tending to the profit rates of all businesses, which, in a free market, all tend to the same rate of profit.

No capital would be obliterated, either. Who would obliterate his capital just for a dollar?

What would happen is people would go back to barter to get their loans. If our frisbee maker needs to borrow money to buy red dye, he will approach the dye maker directly, find out what he wants a year from now, say cabbages, and offer him 4% more than the going barter price for cabbages, i.e. pay him 4% interest. Yes, it will all be very clumsy and inconvenient. But nobody will obliterate their capital.

5. The key phrase in the Rothbard quote is "...hoarding may reflect..", and the key word there is "reflect". He does not say "cause". He does not say "determine". He says "reflect". "Reflect" means "is a byproduct of". In other words, this quote from Rothbard is supporting what I wrote in 1. and 2. above, that hoarding is at most a symptom, never a cause.

Also, he clearly says in the last sentence that changing time preference is what causes the change in interest rates, and the hoarding only reflects [not causes and not determines] the change in interest rates.

6. You write "By saving one removes one vote altogether...". I totally disagree with this. Savings, even if not invested, but just hoarded, are a vote for tomorrow. Ask someone why he is not spending his money today, but putting it aside. "Because I would rather use it in the future." Why did he work in the first place? Because he wants the money for something. And if he wants nothing today, but he does want something, obviously he wants it tomorrow.

Now to be honest, that quote from Rothbard seems to support you, not me, as I mentioned above. And if that's what he means, then I disagree with him. Hopefully someone will find an answer.

7. I understand if you are weary of this subject. That's what happened to me with bitcoins. I can't talk about them anymore.

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Neodoxy replied on Tue, Mar 12 2013 10:46 AM

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Dave,

Thank you for your in-depth reply. Nonetheless I still don't believe you have displayed a clear knowledge of capital accumulation in the market economy. So for this reason I'm going to keep this post as brief as possible and I may or may not decide to post any replies to anything you post in return.

1. You seem to think that time preference just magically determines the interest rate. It doesn't. The only way that this is reflected on the market is through the interest rate and the factors that determine it. If I abducted and tied up the people in society with the highest time-preference before they could invest their money, then even though time preference of society hasn't fallen one iota at the time the market rate of interest would still change and capital accumulation would be affected.

If time preferences changed dramatically but for whatever reason no one's actions changed then interest and capital accumulation wouldn't suddenly change. Time preference doesn't directly affect interest and capital accumulation, rather it does so through the market. It is only because their actions are reflected on the  market that this is at all the case, and hoarding is one case of this because it will cause interest rates to rise regardless of the motivation for removing the hoards.

2. In my one dollar example, if people reverted to barter then there would be massive capital consumption. Every step of your provided example is wrong:

"It's impossible, for the simple reason that the profits from running a business, say selling frisbees, do not rise to thousands of percentage points just because there is only only dollar available to be borrowed. If he makes 5% profit on a frisbee, he still makes only 5%, not a thousand percent."

Loanable funds shifts dramatically to the left, dramatically increasing the interest rate. The interest rate rises dramatically. Stages farthest away from production fail en masse and production is now almost entirely presently oriented. This means that the profit margins for some goods or some quantities of goods rise dramatically because the supplies of many goods shift leftward or stop existing altogether. Profits are not the same. You are right that it probably wouldn't rise that high, however, since even then there are limits.

"Not only that, if thousands of percentage points are out there for the taking, there will be a rush of money into the loan business to take advantage of that great opportunity, until, as Mises says, it will start tending to the profit rates of all businesses, which, in a free market, all tend to the same rate of profit."

This would occur with any dramatic increase in the interest rate. If I assume no one has any real time preference except for the investors it wouldn't. What really scares me is the bolded section. That's not how it goes. Profit reflects the interest rate. The interest rate doesn't reflect profit. The reason why even in the ERE there is accounting profit is because this is how much firms must be provided in monetary compensation to induce any investment. As the interest rate increases the "normal rate" (although most Austrians would swat me for using the word) of profit increases. The interest rate is, in the long run, unaffected by profit margins. Profit margins are affected by the interest rate, however.

An increase in the interest rate increases general profits, but shortens the production structure and the supply of final stage goods. The opposite occurs with a fall in the interest rate. There's a reason why the Austrian theory of interest is known as the "pure time preference" theory

"No capital would be obliterated, either. Who would obliterate his capital just for a dollar?"

The capital stock is ultimately obliterated through massive capital consumption because of the increase in the interest rate. People aren't comsuming capital because of a dollar, but because of the absence of 500 Billion dollars that makes long run operations unprofitable.

"What would happen is people would go back to barter to get their loans. If our frisbee maker needs to borrow money to buy red dye, he will approach the dye maker directly, find out what he wants a year from now, say cabbages, and offer him 4% more than the going barter price for cabbages, i.e. pay him 4% interest. Yes, it will all be very clumsy and inconvenient. But nobody will obliterate their capital."

Barter would obliterate capital. Rothbard says as much in MES. Advanced production structures cannot exist under barter because providing for the coincidence of wants of the workers would be more or less unmanageable. The amount of overhead and administrative oversight needed to ensure this would certainly decrease the real profitability of long-run firms in the first place to near oblivion. Modern society could not function off of barter, and with the loss of that there's a massive loss in capital accumulation.

I hate to ask this but have you read Man, Economy, and State? I've seen you cite it before but you're not representing a knowledge off of what Rothbard spends the longest time discussing: capital accumulation and interest rate determination. You instead seem to be focusing on Mises, and as I keep saying Mises never provides a step-by-step analysis of events. He outlines the real results of what happens, but he does not show clearly why. Hayek made the Austrian framework really workable and Rothbard clarified the work of both infinitely.

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Smiling Dave replied on Tue, Mar 12 2013 12:42 PM

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Deep stuff, Neo.

0. If you are going with Rothbard, what are you going to do with the Rothbard quote in your previous post that states hoarding "reflects" [meaning "does not influence"], interest rates?

1. I don't understand what you wrote here. "You seem to think that time preference just magically determines the interest rate. It doesn't. The only way that this is reflected on the market is through the interest rate and the factors that determine it." What is the noun that the word 'this" stands for? I know you didn't mean what I'm about to say, but the sentences seem to be saying that time preference determines the interest rate through the interest rate.

I am not going with magic here, and I don't think we disagree by much in principle. A person has a certain time preference in his head. Faced with any economic decision he has to make, he asks himself "Is doing this going to suit my time preference?" In particular, he will only accept an interest rate that suits his time preference. As markets tend to do, they will bend to his will depending on the power he has. The resultant of all the bendings made to everyone is what the market looks like.

I agree with most of your second paragraph. Of course sitting in ones armchair and meditating on ones time preference will not determine anything. Certainly it is through his actions [and important inactions] in the market that the market changes. What I do disagree with is your seeming assertion that hoarding changes the interest rate if nobody's time preference has changed.

My position is that if people have changed their preferences, their actions will eventually change the rate. If they haven't, it won't, because they will not take actions in the first place that will cause the rate to change, since such actions are not compatible with their time preference.

Where does hoarding fit in in all this? Simple. It is just like any other market action. It's nothing special, and has no magical power to change interest rates [beyond temporary stuff etc as we agreed on earlier] if time preferences have not changed. That's because the hoarding, like everything else a person does, will be done in a manner consistent with his time preference.

And if time preferences have changed, everything a person does will reflect the change, and everything he does will put pressure on interest rates to conform to his new preference. And if hoarding is one of those things that influence the rates to change in a manner that reflect his preference [which I doubt, but will accept for the sake of argument for now], why is hoarding such a villian? Why declare that is causes recessions and destroys capital? The new rate is exactly what people want. Blame it on them, not on hoarding.

Whatever change happens in the market in such a case is ultimately because people have changed their preference. And I don't think anyone has ever claimed that a change in time preference per se is what caused the Great Depression. Or maybe they have. Who knows what outlandish things they are concocting out there? But the reality is that people change their minds about things all the time, and no harm done.  

Why pick on poor hoarding? Why not declare riding the bus to work as the cause of recessions? After all, the decision whether to ride the bus, or walk, or drive, or take a cab, reflects his time preference. Why didn't Keynes decide that we should outlaw buses?

2. I'm not saying that barter is great for the economy. Of course it has problems of double coincidence of wants etc. And they may be insuperable in a modern economy. But my point is that those problems are problems of a barter economy per se, and do not set in until the money supply is so low all trade must be done through barter.

Perhaps I should have said that if loanable funds dropped to a single dollar, people would find an alternate currency. Maybe gold, maybe whiskey, maybe euros, whatever, it doesn't matter. Something will turn up. But they will not pay a thousand percent interest, and profits will not rise to a thousand percent because there was only a dollar of loanable funds. They will only pay a rate consistent with the originary rate, which is determined soley by time preference.

3. You write: "Loanable funds shifts dramatically to the left, dramatically increasing the interest rate."

I think that's begging the question. We agreed that would happen for a short time. We are discussing whether it will bounce back or not. So how can you just assume it won't to prove it won't?

"The interest rate rises dramatically. Stages farthest away from production fail en masse and production is now almost entirely presently oriented. This means that the profit margins for some goods or some quantities of goods rise dramatically because the supplies of many goods shift leftward or stop existing altogether. Profits are not the same."

All true in the short run. But new people will then enter into that part of the market, reducing the profit rates to roughly what they used to be. As long as time preference is the same, the originary rate stays the same, and it determines what profits people will settle for. And because it's a feee market, a higher profit rate than the originary rate will draw people into that market until the profit is lowered to be compatible with the originary rate of interest. Thus there is both a lower bound and an upper bound for profits in any industry, and they tend to converge to the same number.

The interest rate, too, will settle down to conform to the originary rate [as it must, because time preferences have not changed], and so the opportunities for profit in longer stage methods of production will return.

4. "Profit reflects the interest rate. The interest rate doesn't reflect profit...The interest rate is, in the long run, unaffected by profit margins. Profit margins are affected by the interest rate, however."

I think that's turning a cart into a horse. The correct version is that there is one horse, time preference. How does one state precisely what the time preference is? After all, we won't get very far just saying things like "People really really prefer the future lately." One way is to say "They would give up one dollar today only if they get $1.05 a year from now". From this way of describing time preference, we can abstact a number, 5/100. We call that number the rate of originary interest. It is not a measure of profits, nor of what banks are charging to lend money. It is a measure of one thing only; what is going on in people's heads.

As we said, time preference, something in people's heads, is the horse, meaning the cause of everything else. It pulls two carts, meaning it affects two things. It affects what profit will be acceptable to people, and what interest rate will be acceptable to people. Both those rates are manifestations of what is going on in people's heads. Not by magic, but because people act based on what is in their heads.

So that profit margins and interest rates, meaning what banks charge one for borrowing money, are twin sisters, both the daughter of the rate of originary interest, a number which exists in people's heads. But neither is the parent of the other. Profit margins do not beget interest rates, nor vice versa.

BTW, how can you say that the interest rate is unaffected by profit margins? If I know I can make 50% on some sudden opportunity, I will borrow at 40%. But if the best I can do is 5%, I will never borrow at 40%. [This does not contradict the above analysis of the mother and her two daughters, because this is a one-off exceptional case, called entrepreneurial profit, as Mises explains. It cannot last, and will revert right back to to conform to the originary rate eventually]. 

5. "An increase in the interest rate increases general profits, but shortens the production structure and the supply of final stage goods. The opposite occurs with a fall in the interest rate."

But the increase in the interest rate happens because of a change in time preference. It is this change in time preference that is also the cause of the increase in general profits [beyond the short term], because the change in time preference that caused the rise in interest rates also causes people to not settle [in their heads] for less than a new, higher, rate of profit. If they can't get it, they won't invest.

If people are still willing to settle for a lower profit margin, that's exactly what will happen, due to competitiors entering the field who will settle for that lower rate. The rise in interest rates cannot force up profits if that rise in profits is incompatible with time preferences.

And that's why the Austrian theory is called the pure time preference theory, BTW. Because time preference, absent sudden surprise temporary opportunities clever people discover, is what makes the whole thing run.

6. "People aren't comsuming capital because of a dollar, but because of the absence of 500 Billion dollars that makes long run operations unprofitable."

Long run operations turning unprofitable does not induce capital consumption. It induces diversion [= changing to a new use] of capital from one use to another, from long range to short range production schemes. Diversion and consumption are not the same thing, although the diversion may of course mean some of the capital becomes useless until long range production becomes profutable again. But even that does not mean its "consumed". Nobody consumes it.

BTW, even if an economy only has very short range production schemes, it can accumulate capital. As Crusoe makes more and more fishing nets, he is accumulating capital.

7. As for MES, I have not read it cover to cover. I've heard he doesn't contradict what Mises wrote, except for some details here and there. So I don't think you are going to find something in Rothbard to refute what I write, which is basically just a summary of Mises [you'll remember I've cited Chapter and Verse of HA]

8. After all that said, I do feel that  need to hit the books for a while. You raise intricate subtle issues, Neo. So I too may have to take a break.

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Neodoxy replied on Tue, Mar 12 2013 4:11 PM

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Dave,

Your response was a good one, nonetheless I'm pretty done with this discussion. I'll answer any questions you have though.

"If you are going with Rothbard, what are you going to do with the Rothbard quote in your previous post that states hoarding "reflects" [meaning "does not influence"], interest rates?"

What are you talking about here? Rothbard said directly that hoarding may or may not influence interest rates. All that matters is where the hoards come from. This is explicitly what he said in my quote, and what was necessarily implied in the quote in gravy's post.

"What is the noun that the word 'this" stands for? I know you didn't mean what I'm about to say, but the sentences seem to be saying that time preference determines the interest rate through the interest rate."

I'm saying that the only way time preference is reflected in the market is through the interest rate which is in turn dependent upon the investment-consumption ratio.

"We are discussing whether it will bounce back or not. So how can you just assume it won't to prove it won't?"

You make a good point here I find it wholly unlikely that the interest rate will bounce back to it's old rate, because for this to happen actors with funds numbering 250 billion would have to have the same time preference as the old investors.

"BTW, how can you say that the interest rate is unaffected by profit margins? If I know I can make 50% on some sudden opportunity, I will borrow at 40%. But if the best I can do is 5%, I will never borrow at 40%. [This does not contradict the above analysis of the mother and her two daughters, because this is a one-off exceptional case, called entrepreneurial profit, as Mises explains. It cannot last, and will revert right back to to conform to the originary rate eventually]."

I was talking about long-term effects, which is what I assumed was what we were discussing. Economic profit is a short-run phenomenon which eventually reverts to just accounting profit that equal to the rate of interest.

"Long run operations turning unprofitable does not induce capital consumption. It induces diversion [= changing to a new use] of capital from one use to another, from long range to short range production schemes. Diversion and consumption are not the same thing, although the diversion may of course mean some of the capital becomes useless until long range production becomes profutable again. But even that does not mean its "consumed". Nobody consumes it.

BTW, even if an economy only has very short range production schemes, it can accumulate capital. As Crusoe makes more and more fishing nets, he is accumulating capital."

Time needs to be taken away from current projects to produce projects in the future. In order to produce his net Crusoe needs to take time away from fishing now. Even if the production structure isn't lengthened in the sense of more production 5 years from now, there could still be a greater amount moved from 1 year in the future to 2 years in the future. In this respect the production structure is indeed "lengthened"

As the interest rate increases capital consumption necessarily occurs in a few ways:

1. Capital values decrease

2. Non-durable capital is not replaced

3. Durable capital is used up more swiftly than it would have otherwise been because of 1

This leads to a shorter production structure. When the new ERE is reached it will be less capital intensive than the previous state because the difference in the capital between the two will have been consumed.

"7. As for MES, I have not read it cover to cover. I've heard he doesn't contradict what Mises wrote, except for some details here and there. So I don't think you are going to find something in Rothbard to refute what I write, which is basically just a summary of Mises [you'll remember I've cited Chapter and Verse of HA]"

To my knowledge Rothbard never directly contradicts Mises, yet as I have said several times I am not convinced you understand these essential Austrian concepts:

1. Capital theory and the structure of production

2. The investment-consumption ratio and how this determines the interest rate

You have consistently failed to address the second factor despite the fact that I have repeatedly asked you to, and these two aspects are almost wholly absent in HA. Mises gives the outline of the relationships (higher interest rate less capital intensive projects, lower time preference lower interest rate, more capital higher living standards), yet he doesn't explain how one really gets there and the investment-consumption ratio, an essential clarifying element, is entirely absent from his work.

Please read MES, I think that it would make you a much better economist. If nothing else read chapters 5-8, because this is exactly where your misunderstanding seems to lie. Chapter 8 in particular would be extremely helpful here.