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Krugman's MMMF Question

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10/08/2012Mark ThorntonPeter G. Klein

Let Me Google That for You, Paul

By Mark Thornton

Paul Krugman attacked Ron Paul, Paul Ryan, and "honest money" and also took a shot at Austrian economists on his blog recently. He called honest money a "Ron Paul dog whistle" and then went on to query Austrian economists on their position on money-market mutual funds (MMMF). He doesn't expect a serious answer.

How do the Austrians propose dealing with money market funds? I mean, it has always been a peculiarity of that school of thought that it praises markets and opposes government intervention — but that at the same time it demands that the government step in to prevent the free market from providing a certain kind of financial service. As I understand it, the intellectual trick here is to convince oneself that fractional reserve banking, in which banks don't keep 100 percent of deposits in a vault, is somehow an artificial creation of the government. This is historically wrong, but maybe the actual history of banking is deep enough in the past for that wrongness to get missed.

But consider a more recent innovation: money market funds. Such funds are just a particular type of mutual fund — and surely the Austrians don't want to ban financial intermediation (or do they?). Yet shares in a MMF are very clearly a form of money — you can even write checks on them — created out of thin air by financial institutions, with very few pieces of green paper behind them.

So are such funds illegitimate?

In the Austrian view MMMF are not technically money and so deposit holders do not hold full reserves, but rather invest those deposits in short-term commercial paper. MMMF can lose value and owners may get back less than they deposited without the deposit holder going bankrupt. Technically they are not instantly redeemable and are not a final means of payment.

According to Joseph Salerno,

Although MMMF share accounts at first glance look like MMDAs [money-market deposit accounts], they are clearly excludable from the TMS [true money supply], because they are neither instantly redeemable, par value claims to cash, nor final means of payment in exchange. This requires a brief explanation of the nature of MMMFs.

Each MMMF share represents a claim to a pro rata share of a managed investment portfolio containing short-term financial assets, such as high-grade commercial paper, certificates of deposit, and U.S. Treasury notes. Although the value of a share is nominally fixed, usually, at one dollar, the total number of shares owned by an investor (abstracting from reinvested dividends) fluctuates according to market conditions affecting the overall value of the fund's portfolio. Under extreme circumstances, such as a stratospheric rise in short-term interest rates or the bankruptcy of a corporation whose paper the fund has heavily invested in, the fund's investors may well suffer a capital loss in the form of an actual reduction of the number of fixed-value shares they own. Unlike a check drawn on a demand deposit or MMDA, therefore, an MMMF draft does not simply represent a direct transfer of current claims to currency, but a dual order to the fund's manager to sell a specified portion of the shareowner's asset holdings and then to transfer the monetary proceeds to a third party named on the check. Note that the payment process is not finally completed until the payee receives money, typically in the form of a credit to his demand deposit. (Austrian Economics Newsletter 6, no. 4)

No Paul, we do not want to ban MMMF.

This quote from Joseph Salerno is from the first item to appear on a Google search for "Austrian economics money market mutual fund."

First, They Ignore You …

By Peter Klein

Paul Krugman writes a typically silly column on the Austrian School's approach to defining the money supply. As usual, his purpose is not to inform, or analyze, or explore, but to ridicule anyone who disagrees with The Paul. A few reactions:

  • The substantive question, do Austrians consider money-market mutual funds as part of the money supply, is easily answered with 30 seconds of research, which is apparently more than Paul could muster up. Paul, use The Google!

  • Krugman frequently mocks ideas he does not understand, so his tone and style here are hardly surprising. But it's interesting that he finds Ron Paul's "hard-money" views influential enough to mention.

  • Krugman seems to believe that the Republican establishment, and Paul Ryan in particular, are in thrall to the economic teachings of the Austrian School, which would be news to everyone in the Republican establishment and the Austrian School. In his defense, I think Krugman recognizes only Krugman and non-Krugman, so he cannot quite grasp that there may be some diversity among his critics.

  • Krugman dimly recognizes that Austrians have some objections to fractional-reserve banking in connection with government intervention, and sneers that "this is historically wrong, but maybe the actual history of banking is deep enough in the past for that wrongness to get missed." He also seems to think that Austrians want to ban the use of money-market mutual funds. Of course, Krugman has never read anything written by an Austrian economist, and he offers no citations or quotes, so it's hard to know where he gets these ideas. To my knowledge, no Austrian has called for banning MMMFs. On fractional-reserve banking, the opinion among Austrian scholars ranges from those who think fractional-reserve banking is inherently unworkable and illegitimate and could not survive apart from government intervention (most Rothbardians) to those who think that private fractional-reserve banking is legitimate and workable but that the current system of government deposit insurance, government fiat currency as the base money, the Fed as the lender of last resort, etc., is inefficient and illegitimate (Larry White, George Selgin). Needless to say, Austrian scholars have written thousands of pages on these issues, including detailed studies of the history of banking. Krugman apparently thinks Austrians are merely journalists or propagandists, as he himself has become.

A Question to Krugman — from an Austrian "Renegade" Professor

By Joseph Salerno

Paul Krugman's jejune column1 querying Austrians on their view of MMMFs — as if they have never thought or written about the subject — has been roundly skewered by Austrians. But I have a question for Krugman: Why, Paul, would you be interested in the least about what Austrians think about anything?

To understand the significance of this question and the momentous implications of Krugman's answer, we need to go back to Krugman's typology of economists. This question is significant because, according to Krugman's view in his book Peddling Prosperity (1994), "there are two different kinds of economists … professors and policy entrepreneurs," and they are "radically distinct species."

The "professors" are academic economists. Like "ostriches and penguins" the professors are "slightly ridiculous." They write papers that are densely packed with indecipherable mathematics and jargon, and "most of these papers are not worth reading." In fact they are written not to be widely read but merely to impress the author's colleagues with his cleverness. The ideas advanced in these papers are not original or definitive explanations of how the economy actually works, but rather "ingenious elaboration without fundamental innovation" — "old wine in new bottles, usually with fancier mathematical labels."

All of this Krugman freely concedes.

Ah, but if one would only back up far enough and view the proceedings from a distance, he would see that the professors are engaged in an "enterprise that steadily adds to our knowledge." The truth is that economics is a "primitive science," akin to medical science at the end of the 19th century, when physicians knew basically how the body worked and not much more. True these primitive medical scientists were able to advise how to prevent some diseases and what quack procedures and medicines to avoid, but they could not cure very many diseases. So it is with economics professors today who know a lot about how the economy works. They can even definitively advise how to prevent hyperinflation and in most cases how to avoid depressions. But there is much that remains a mystery to these primitive practitioners of the dismal science. In particular, "they don't know how to make a poor country rich or bring back the magic of economic growth when it seems to have gone away."

Oh yeah, and one more thing about members of the professoriate: they mainly write for other professors and rarely make appearances on TV. When they do address the lay public they seldom make definitive pronouncements on policy issues. They are nothing if not humble in the face of their acute awareness of the limitations of knowledge imposed by the primitive state of their science. (By the way this hardly sounds like Krugman the New York Times "Conscience of a Liberal" columnist so beloved of the Democratic left — but that is a story for another day.)

"Policy entrepreneurs," according to Krugman, are a different breed altogether. They write books mainly for the public and appear on TV. They strive to influence public opinion and economic policy. While many are journalists, financial pundits, and lawyers, some have PhDs in economics and jobs as economics professors, just not at the right kinds of academic institutions. For example, they may habitate at "unorthodox environments like Harvard's Kennedy School." But the feature that essentially distinguishes a policy entrepreneur from a professor is the language that he speaks and the audience that he mainly addresses. When addressing the public, the former speaks plainly and offers "unambiguous diagnoses" where the latter is "uncertain." The mind of the policy entrepreneur is unclouded by "existing economic theories," while that of the professor is teeming with inhibitions imposed by these theories against expressing anything with certitude. Krugman points to supply-siders Arthur Laffer and Robert Mundell on the right and Lester Thurow, Robert Reich, and John Kenneth Galbraith on the left as epitomizing the academic qua "policy entrepreneur." He at one point refers to supply-side academics as "renegade professors."

Now, in Krugman's aforementioned column, it is clear that he regards Austrian economists as nothing more than the benighted "policy entrepreneurs" orchestrating Ron Paul's campaign for sound money and a free-market banking system. So to reiterate my question to Krugman in a slightly different form, Why would an eminent, Nobel laureate, Ivy League "professor" like yourself care one whit about the views of putative "renegade professors" like the Austrians who reject modern macroeconomics root and branch and aggressively seek to disseminate this view to the public as well as to the rest of the economics profession?

However Krugman chooses to answer this question — and I hope that he does — it is clear that the "existing economic theories" that he so vehemently defended in the 1990s have failed abysmally in preventing or explaining the financial crisis. As a result Krugman and the rest of the establishment macroeconomic "professors" have been catapulted back in time to embrace the crude and discredited ultra-Keynesian policy of inflating our way back to prosperity. Indeed we renegade Austrian professors have the only correct diagnosis and cure for the present economic stagnation — and I am certain of that.

  • 1. George Selgin to Paul Krugman: I Am a Former Austrian and I Do Believe in Fractional-Reserve Banking — Honest! Well, not exactly his words, but this was the gist of George's bizarre and irrelevant comment on Krugman's column asking Austrians what their position is on money market mutual funds. In his haste to establish his mainstream bona fides to Krugman, however, George was blind to the fact that Krugman has been forced to recognize and address Austrian arguments precisely by those who George denigrates in his comment as "the anti-fractional reserve crowd among self-styled Austrians, taking its lead from Murray Rothbard." But it was due to the prodigious efforts of the Rothbardians including and especially Ron Paul that we have begun to see a radical change of opinion among the public, the establishment media, finance professionals, and even some academic economists concerning the alleged beneficence of the Fed and the effectiveness of conventional macroeconomic policies. It was this challenge that worries Krugman and prompted his insipid column. He could care less about George's support for fractional-reserve banking and would not bat an eye even if he knew that George supported QE1 and (maybe) QE2 and advocates an aggregative nominal income target for Fed monetary policy, albeit at a lower level than most contemporary macroeconomists are comfortable with. One more point: Both Rothbard and Krugman would have had a good belly laugh together over George's peculiar notion that, in the absence of a central bank and government deposit insurance, a fractional-reserve banking system would be stable and flourish on a free market.

Contact Mark Thornton

Mark Thornton is a Senior Fellow at the Mises Institute and the book review editor of the Quarterly Journal of Austrian Economics. He has authored seven books and is a frequent guest on national radio shows.

Contact Peter G. Klein

Peter G. Klein is Carl Menger Research Fellow of the Mises Institute and W. W. Caruth Chair and Professor of Entrepreneurship at Baylor University's Hankamer School of Business.

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