I think the question is pretty self-evident. If we required 100% Reserve Banking, we would wipe away massive amounts of money that are artificially sustaining growth in many parts of the economy. Without a Fed setting target rates, time preference would necessarily mean a steep hike in interest rates, especially since money would now be a much scarcer resource. What would that do to entrepreneurship? Wouldn't a savings glut also giove further impetus to a negative feedback loop where less and less money is out there for investment or consumption? And with Fiat money gone, governments would have no way of circumventing that behaviour and propping up investment and consumption with govt projects.
How can there be any growth or progress for that matter, without investment and consumption?
I'm interested in hearing the Austrian view on this.
What a peculiar question (as are all the assumptions it entails). What you're saying is that there would be no entrepreneurship if government and central bank didn't force people to do it.
The exact amount of money in the economy is irrelevant and by multiplying the money in the economy by 10 times you can't magic into existence any additional resources or savings (which is exactly what would be required in order to undertake additional investment). You can make money less scarce, but what would that do? Would it mean there was any more steal to build power stations? Would it mean there was any more wood for houses, or any more labour to build these? Certainly not.
The only thing that government and central banks can do is redistribute wealth from one party to another.
In the absence of government, perhaps there would be more incentive to save (higher interest rates) and thus more real resources and savings available for real investment. Eventually, of course, there would be more savings than the market demanded and the price of these savings (in the form of interest rates) would come back down again until they hit a natural market price.
Now, I think I hardly need to make the case that government is completely incapable of setting the price of any other goods in the market place - so what makes you think it should be able to accurately set the price of money?
Investment would most certainly occur in the free market, but it would not do so in the absence or insufficience of the real savings that were required in order for the ultimate goals of that investment to be realized - investment would occur at a rate that could be sustained by the quantity of savings that were available (and necessary) in the market place to undertake such investment.
Jimmy answerd it right. You fall into the trap of making money a good rather than a medium of exchange.
Reserve Banking does not sustain growth in any way. It only can be a means of redistribution.
In the begining there was nothing, and it exploded.
Terry Pratchett (on the big bang theory)
Agreed-
What I assume the premise that the monetarist crowd holds however, is that if government inflates the money supply, it can get the result of a free market X times over. How? By socializing the losses, and then externalizing the debt via government-sponsored paper, that the Chinese, Arabs etc. are willing to buy.
Why are they willing to buy it? Because the U.S. essentially beat the crap out of everybody in WWII, and established its currency as the global standard.
So, ( I again assume) the thinking goes, "since we conquered the whole world, and have all these suckers willing to buy what we externalize, why not do it?".
You'd say that this can't go on forever...But until that time isn't the US better off by using this scam? Can't it always go back to a free market when push comes to shove?And how near is that anyway? I don't see any other currency subsituting the dollar as the global reserve currency, nor do I see any other country experimenting with free money.
Jimmy,
I wanted to get back to this thread. In your statement about "making money less scarce" don't you assume that the value of money is exactly inversely proportional to the quantity in circulation?
Wouldn't that mean that the U.S. dollar, measured in everything from Forex, to PPP to Big Mac indices, would have to fall by as much as the Fed has inflated the money supply during these past years?
Clearly this hasn't hapenned, which leads me to believe that they've done a pretty good job of fooling everyone (until now). I haven't debated a Chicagoan on this specific issue, but I would imagine that this would be their argument - that they're able to mostly get away with it, especially when the U.S. tailor-made the world to its own measure following WWII and established the dollar as the global reserve currency.I'm not arguing for it because I think this has an expriation date, but what I'm saying is, hasn't the scam suceeded up until now?
And if it had never happened, and we didn't have this glut of credit swashing around, wouldn't progress necessarilly be slower (albeit more sustainable)?
The problem is that money supply inflation is misreported as economic growth. The CPI understates inflation dramatically.
If you use M2, M3, or the price of gold as your index of inflation, instead of the CPI, then the US economy is shrinking! Follow the link for a detailed calculation.
If you use the price of gold as your deflator, instead of the CPI, then the US economy is shrinking at a rate of 8% per year since 2001!
The CPI is less than the true inflation rate. If you report "inflation-adjusted GDP", using the CPI as your deflator, you're confusing money supply expansion with economic growth. Over the long term, the price of gold should track true inflation. I consider 2001-2007 to be a non-trivial time period.
I have my own blog at FSK's Guide to Reality. Let me know if you like it.
whitespiral:And if it had never happened, and we didn't have this glut of credit swashing around, wouldn't progress necessarilly be slower (albeit more sustainable)?
Capital would get allocated to the most pressing uses and in the most efficient way instead of the massive malinvestments that need to be liquidated on a regular basis as we have today.
If you increase the efficiency of a system it can either run faster or consume less resources at the former level of production which would free up capital for other uses.
This would lead to consumers having extra money to spend on other things and more choices to spend their money on which would create even more overall economic growth.
And as the very fact that business cycles exist can attest to the current system of cheap credit isn't very sustainable at all.
Well, I could argue that you conveniently picked the one period where gold has had a serious bull run to fit your thesis. For example, I know of no serious period in US history where the money supply shrinked or remained steady for more than a few months. If you plotted the price of gold against true money supply you would find little correlation.
I agree that part of it is price manipulation by the central banks (as you said), but that again goes to prove that you can't use gold to track inflation.
If an economy banned (or allowed the free market to kill) frax reserve banking, then there would necessarily be less credit available for businesses to start, consumers to buy, companies to produce etc. The whole question is, does this enormous leverage our economies operate on (has anyone even calculated how much the whole economy is levered?) represent an equivalent rise in the price of everything? I would argue most necessarily not, because then we would be beyond the hyperinflation episodes seen in many countries during the past century.
My (unsupported) argument is that the US is the first country to be able to pull this off because it has achieved a global check-mate, allowing it to pass all its new money to guys like China, and OPEC. I don't know if this scam is soon to end, or how badly it will end, but the minute these guys have an alternative sounder currency to buy, that whole game is over.
Question is, does the safer, more conservative ECB survive by simply doing what the fed does on a considerably lesser scale? If so, does that prove that fiat currencies, frax reserve and central banking can work if there are less demands imposed on them? (e.g. less welfare/warfare)
I am not convinced about any of the above I am saying, - I'm just trying to generate some debate because I've never heard the point of view of a true Chicagoan who can slug it out with an Austrian without resulting to ad hominem or a ton of other fallacies.
whitespiral:If we required 100% Reserve Banking, we would wipe away massive amounts of money that are artificially sustaining growth in many parts of the economy. Without a Fed setting target rates...
Frational Reserve Banking/Currency and the Federal Reserve are not the same thing. The Fed is just the universal reserve for the single coercively monopolized FR currency we are allowed to use in this country, and is there to insulate that currency from market forces.
Fractional reserve banking does not require a fed, it does not require coercion, it does not require a monopoly, and it does not require immunity from market forces. It can be done by Joe the Barber entirely on his own if he should start taking deposits in the back room. The harm and benefit of FRB in itself is debatable (one area I seem to have a bit of disagreement with most Austrians on) but it does not imply a Federal Reserve or anyone "setting" interest rates. They're two related but separate issues.
The state won't go away once enough people want the state to go away, the state will effectively disappear once enough people no longer care that much whether it stays or goes. We don't need a revolution, we need millions of them.
Ok, but isn't the FED there to add "faith" to the system? It has been shown that without a Fed, and with FRB, people would panic at the first case of trouble because they knew that they couldn't withdraw all of their money.
Today they trust that the government is there to back it up. If that were not the case, than the only alternative I can think of is insurance to both the bank and the saver. But what would likely ensue is that this form of bank, when competing with other, 100% reserve banks, would probably end up catering to those in need of "easier" credit, but with a higher premium attached to it (their risk premium plus all the necessary FRB insurance rates). So we would have normal banks and loanshark banks. Either this, or they wouldn't even survive in the marketplace and we would lose the (purported) benefits of a FRB system. Hence, the government needs to prop it up. Is this close to the Chicago POV?
whitespiral:Either this, or they wouldn't even survive in the marketplace and we would lose the (purported) benefits of a FRB system. Hence, the government needs to prop it up.
The solution, if any, would be found by competing banks/currencies finding the best risk/reward balance(s) in the marketplace. If the market cannot/does not support any form of FRB, then there won't be any. We don't need the government to impose one. If it's as valuable a practice as you say - if the benefits outweigh the risks - (and I tend toward thinking it is), then the market would support it. But it's not a market failure if it doesn't, it's the market deciding it's not worth the cost. The only failure would be in your a-priori judgement that the market should value it.
whitespiral:Wouldn't that mean that the U.S. dollar, measured in everything from Forex, to PPP to Big Mac indices, would have to fall by as much as the Fed has inflated the money supply during these past years?
These things would not have to be directly proportional to the increase in money supply, no. One good reason being improvements in the productive powers of labour in the economy (due to things like improved technology).
As far as Forex is concerned - do you think the US government is the only one inflating their money supply? They actually inflate their money supply much less than quite a few other governments (if people are concerned about the US dollar now it's not because they're printing cash - they've always done that - it's because pretty soon they're going to have no choice because their trade deficit and public debt is going parabolic with no end in sight). But yes, if a government does print too much cash then it will certainly be reflected in their Forex (Zimbabwe being a case in point - a funny link on that subject in case you're interested: http://www.hartgeld.com/inflation.htm).
whitespiral:Clearly this hasn't hapenned
whitespiral:I haven't debated a Chicagoan on this specific issue, but I would imagine that this would be their argument
Chicago school economists like Friedman are the first to point out that (in his words) "inflation is always and everywhere a monetary phenomenon"). So I don't think you'd find much argument on this point from the Chicago school. I think Hazlitt has a much more down to earth (and realistic) view of inflation however: http://mises.org/story/2916
That's a fascinating article if you have time to read it and he deals with what you're talking about - which is people's inflationary expectations.
I don't think so no. As I say, by creating money the Fed can't make real resources (like steel and wood) any less scarce. All they can do is change the way those resources are distributed. Inflation is nothing more than the reallocation of wealth (i.e. control over resources) from people who save to those creating the new money (the banks, directly, and indirectly all those people borrowing from the banks to buy houses and setup businesses, and indirectly again all of the people those guys pay for the goods/services they need to setup their businesses). The result is not a more efficient economy at all - it's an economy with a whole bunch of unsustainable industries which exist (and can only exist) on the back of the subsidies that inflation dishes out to them.
These are market distortions and are pretty much the focus of the Austrian Business Cycle Theory. I don't think you'll find any of the Chicago school economists arguing that subsidies lead to more efficient market (mostly the arguments that are made for subsidies concern reasons of "national security" or self sufficiency - which is rather similar to saying everyone should grow their own carrots rather than being dependent on the grocer to bring them to you but this is usually conveniently overlooked by those making arguments for subsidies). However, from what I understand (and I'm far from an expert on the subject) the Chicago School economists are not in agreement with the Austrians as to whether monetary inflation simply constitutes a subsidy. The Chicago School tries to use arguments about products creating demand that didn't exist to justify the Fed setting interest rates low to make lending available to businesses that wouldn't otherwise exist (since they wouldn't be willing to pay the going interest rates in a free market) and "create" markets that wouldn't have otherwise existed - "forcing" productive improvements on a market that was too stuborn to find such improvements of its own accord... However I think Mr Bastiat would probably have a few words of warning about trying to make such arguments (and I'd be inclined to agree with him). Once again, they cannot make the REAL resources required to start and run businesses any less scarce - by creating or destroying money all the monetarists can do is redistribute wealth and shift production away from some goods that the "stubborn market" seems to want to create to the creation of other goods, which are made by people who have a more direct link in the capital structure with those doing the money making (i.e. the bankers).
whitespiral:If you plotted the price of gold against true money supply you would find little correlation.
Here's an interesting thing though... check out the following: http://www.mises.org/markets.asp#monetary
The chart you should see is TMS (true monetary supply). Right above that is the a chart showing the price of oil. Try to tell me that you don't see any correlation between those two? The price of all always went up either immediately prior to or immediately after official rates of inflation went up... there's a very close correlation between these two charts (note that the scales are difference at the bottom as well - that might trick you so you have to look carefully). Now do you wonder why they leave "volatile" energy prices out of the CPI? Maybe it's because oil prices are simply far too accurate a measure of inflation!
As for gold, this is really difficult to analyze. For the greater part of the last century it was illegal for US citizens to own gold in any form other than jewelery... which I imagine would have had some affect on it's price. The value of gold also would have changed as a result of it's change in status from being legal tender to not being legal tender (during the bankruptcy of the USA in the late 70s and early 80s). So basically, looking at the nominal price of gold over the last 100 years probably won't get you far... you'd have to look at the price of certain goods, measured in gold, over the last 1000 or 2000 years to note that it has held a very stable value over the long haul - something you couldn't say about any fiat currency that has ever existed - the USD included.
whitespiral:My (unsupported) argument is that the US is the first country to be able to pull this off because it has achieved a global check-mate, allowing it to pass all its new money to guys like China, and OPEC. I don't know if this scam is soon to end, or how badly it will end, but the minute these guys have an alternative sounder currency to buy, that whole game is over.
I think I'm with you on that one.
whitespiral:Question is, does the safer, more conservative ECB survive by simply doing what the fed does on a considerably lesser scale? If so, does that prove that fiat currencies, frax reserve and central banking can work if there are less demands imposed on them? (e.g. less welfare/warfare)
The sole advantage of the ECB is that none of the Europeans governments using it's currency can agree upon anything. On the one hand you have the Scandanavian and the Germanic states that are running trade surpluses and on the other hand you have the Mediteranean states that are moving swiftly towards national bankruptcy and are completely unable to make their people wake up and smell the coffee. Obtaining political support to make the changes that are required to bring a country like France or Italy around is nigh on culturaly impossible. These countries will not change - not until they're broke and they have to... i.e. not until the very worst time that they possibly could. Thankfully the Germans and Scandanavians don't want to budge for the time being - hopefully that holds out. I've read quite a few political analysts that think the EU will break up over this very point - the poor/mediteranean states will want to break off (or at least break away from the ECC, if not the EU) to create their own currencies in yet another sorry attempt to make themselves rich by printing cash (as though this would make more planes, trains and automobiles as well, as if by magic).
If the Euro does immerge as a practical alternative for the Gulf states or the Chinese then that could certainly have some serious implications on the US dollar... which in my mind would be a good thing since the Americans would finally be forced to wake up and smell the coffee - and correct some serious market distortions that have grown out of the global market for US bonds over the past few decades. It'd certainly be painful and likely it would not require simple structural changes but cultural ones as well - Americans would have to change their values and the way they live in order to accomodate such a tectonic shift in their economy. But I don't think the Chinese are overly keen on racing into that either, since they have entire industries that were built on the back of these market distortions as well. Still, it will be easier for the Chinese to go from making iPods for Americans to making various products for the Chinese and other Asian markets than it will be for the Americans to go from borrowing to saving.
Just a minor correction - Scandinavians are subsumed under Germanics. Essentially, European economies are so disparate that most EU policy is like a straightjacket, trying to dictate a one-size-fits-all policy. What is interesting is that the Germanic economies, for all their vaunted success, are overheating and maturing. And it should be no surprise given how interventionist they are. They will end up on the same level as the Mediterranean countries eventually. I recall an article that places most European countries alongside the poorest US states. Eastern Europe, by contrast, is far more forward-looking. This is quite illuminating, as is this.
-Jon
Freedom of markets is positively correlated with the degree of evolution in any society...
Jon Irenicus:Scandinavians are subsumed under Germanics
Ah, I wasn't aware. I was probably thinking in terms of language ancestry rather than economic systems.
Jon Irenicus:What is interesting is that the Germanic economies, for all their vaunted success, are overheating and maturing. And it should be no surprise given how interventionist they are
I hear you there - I've just moved to Austria where the people are rejoicing because they're finally "allowed" to put flags on their cars (for the European Cup football)... i.e. up until now such a practice has been illegal. The fees that real estate agents charged as commission on the apartment we rented were prescribed by law (so zero competition in that little market, for example). The University of Vienna has on it's website that it has a whole bunch of Post Grad courses that it has prepared to be taught in English - but it can't currently teach them becuase it's illegal - they're hoping a new law will be pushed through in mid-2008 that "allows" them to offer such course. Austria is a fantastic country (people, food, drink etc.), but I can't help but feel I'm in a police state - and those are just a few examples... there are thousands more. If ever there was a free market, this is not it.
I wonder how long it's going to hold together. I hadn't actually put two and two together to draw the inference that that is why the ECB is so guarded in its activities. I remember, though, my economics professor mentioning something to the effect that the prospects for the continuation of the ECB are limited, given the variety of economies in the EU.