I'm sure this question has already been debated to death around here, but I used the search option and couldn't find a thread on this particular question, so I'll start a new one.
Could an influx of new gold cause a business cycle under a 100% gold coin standard?My understanding of ABCT is that when there is an expansion in circulation credit, it makes it seem to investors as though there are more saved funds available for investment than there actually are (effectively, more consumer demand for longer processes of production). Investors then overinvest in longer processes of production, when in reality there is not enough demand (resources saved up) to make these investments profitable. Once the new money trickles down and spreads out across the entire economy, people reassert their correct savings-consumption ratio, the malinvestments are exposed as unprofitable, and the economy adjusts.
Now, if an economy were under a 100% gold coin standard, gold miners happened upon a large amount of gold in a cave, minted it into coins and put the coins into circulation, wouldn't this increase in the money supply also make it seem to investors as though real savings (demand for longer processes of production) had increased, causing them to overinvest in processes requiring more savings? And, once that new gold money spreads itself across the entire economy and consumers reassert their correct consumption-savings ratio, wouldn't these overinvestments be exposed as unprofitable and cause a recession?
The decrease of the price of newly minted coins would make banks able to buy more and lend it at lower interest rates.
Caley McKibbin: I can see where this is going. You have to specify whether there is FRB in this hypothetical "gold standard".
I can see where this is going. You have to specify whether there is FRB in this hypothetical "gold standard".
Indeed. But even with 100% reserves, an increase in the supply of money would still set off the ABC. Those who get the new money would increase their purchases, leading to Cantillon effects. The banks would get the new sums, and depress the market rate below the natural rate. The ABCT, in its most general form, focuses on the misdirection of resources towards unwarranted economic activities.
"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."
Esuric:Banks would pyramid additional credit on top of their new reserves.
Well now, but that wouldn't be a true 100% gold standard. You're talking about the semi-gold standard of the 19th century. That's not the gold standard in question.
Esuric: But even with 100% reserves, an increase in the supply of money would still set off the ABC.
But even with 100% reserves, an increase in the supply of money would still set off the ABC.
Not so.
http://mises.org/Community/forums/p/14357/303357.aspx#303357
DD5: Esuric: But even with 100% reserves, an increase in the supply of money would still set off the ABC. Not so.
A new influx of gold would indeed lead to Cantillon effects (would have be a large discovery). This misdirection of resources towards unwarranted economic activities, brought about by arbitrary changes in relative prices, is essential to Austrian theory--a key insight. Furthermore, if the newly found sums went into the banking system, there would be a right-ward shift in the supply of loanable funds, which would be lent out for investment purposes, but which wouldn't be backed by real capital. The extent of this inflationary process depends on the size of the newly found gold mines; but if it enters the banking system, it must necessarily suppress the market rate below the natural rate. Unless you're saying that gold = real capital. There would need to be a correction where prices adjust, restoring equilibrium.
100% reserves don't magically eliminate business cycles. It's merely one step towards the elimination of business cycles, but with its own economic ramifications (never mind the fact that it's impossible to enforce). The problem with fiduciary media is that it acts like money proper.
Esuric: Furthermore, if the newly found sums went into the banking system, there would be a right-ward shift in the supply of loanable funds, which would be lent out for investment purposes, but which wouldn't be backed by real capital. The extent of this inflationary process depends on the size of the newly found gold mines; but if it enters the banking system, it must necessarily suppress the market rate below the natural rate.
Not bad! A rare case of very good and precise observation , which however, I claim still leads you to an erred conclusion. Bear with me on this one.
If the new money is surrendered to investment then there will be no intertemporal distortion.
First, think about what this next quote by Hayek really means with respect to the case of fiduciary media:
All that is required to make our analysis applicable is that,
when incomes are increased by investment, the share of the
additional income spent on consumers’ goods during any
period of time should be larger than the proportion by
which the new investment adds to the output of consumers’
goods during the same period of time. And there is of course
no reason to expect that more than a fraction of the new
income, and certainly not as much as has been newly
invested, will be saved, because this would mean that
practically all the income earned from the new investment
would have to be saved.29
In other words, if economic agents were to save all of the monetary income that results from the creation of fiduciary media, then there would be no intertemporal distortion. Of course, this is an impossible situation for the case of fiduciary media. Econmic agents won't simply adjust their time pereference in accordance of with the creation of fiduciary media.
In the case of new gold that was surrendered by the individual as a time deposit, the above scenario of all the income being saved is precisely what happens. The monetary income that results from this new gold is saved for the obvious reason that the owner of this gold has already surrendered its use before it was loaned out.
Esuric:Unless you're saying that gold = real capital.
Of course not. Think about the proportion between savings and consumption. Assume no change in timer preference as a result of new influx of gold, that is, the new gold is to be equally spent in the same proportion between consumption and savings. No change in the structure would take place. Prices would simply rise uniformly.
Now think about the case when the new gold is saved, then the proportion between savings and consumption will change. Time preference really has become lower. The new gold will be lent out but as stated above, the net amount of new income that is derived from it is obviously saved and not consumed since the use of the gold has already been surrendered. Relative prices will change and coordinate this process like any other change in time preference. No business cycle will take effect.
Esuric:There would need to be a correction where prices adjust, restoring equilibrium.
It won't be a correction phase but a coordination phase. If the new gold is saved, then of course relative prices will change, but precisely because time preference is changing. If there is no maturity mismatching, as there won't be with a true gold standard, then the new gold that is saved will induce a coordination phase, but not a business cycle.
Think about what Hayek is saying in the above quote about fiduciary media, but now simply reapply it to the influx of new gold, which can only be lent out if and only if, agents actually decide not to consume that gold.
DD5:Now think about the case when the new gold is saved, then the proportion between savings and consumption will change. Time preference really has become lower. The new gold will be lent out but as stated above, the net amount of new income that is derived from it is obviously saved and not consumed since the use of the gold has already been surrendered. Relative prices will change and coordinate this process like any other change in time preference. No business cycle will take effect.
Basically, only FRB or something effectively the same causes BC.
Otherwise, the theory of how price fluctuations direct resources to the best uses is flipped upside down, leading to a catastrophe singularity.
Caley McKibbin:Basically, only FRB or something effectively the same causes BC.
Yes, that's absolutely correct - "or something similar"
http://libertarianpapers.org/articles/2010/lp-2-2.pdf
DD5:Not bad! A rare case of very good and precise observation
Thanks?
DD5:In other words, if economic agents were to save all of the monetary income that results from the creation of fiduciary media, then there would be no intertemporal distortion. Of course, this is an impossible situation for the case of fiduciary media. Econmic agents won't simply adjust their time pereference in accordance of with the creation of fiduciary media.
If the ratio between the demand for current goods relative to future goods remains unchanged, then there is no inter-temporal disequilibrium. But why do you expect this to be the case? This may happen, but probably not. A change in either direction (favoring the latter or former) must necessarily distort the structure of production. Furthermore, if you approve of Hayek's analysis, then you should support a free banking system (or at least acknowledge its potential benefits) that's sensitive to the demand for cash holdings. This also means that you don't believe that an elastic money supply must automatically and necessarily lead to business cycles.
DD5:Of course not. Think about the proportion between savings and consumption. Assume no change in timer preference as a result of new influx of gold, that is, the new gold is to be equally spent in the same proportion between consumption and savings. No change in the structure would take place. Prices would simply rise uniformly.
Again, this is a major assumption which hasn't been substantiated. This assumption only holds if the ratio between the demand for current goods and future goods remains absolutely unchanged.
DD5:If the new gold is saved, then of course relative prices will change, but precisely because time preference is changing. If there is no maturity mismatching, as there won't be with a true gold standard, then the new gold that is saved will induce a coordination phase, but not a business cycle.
No. The time preferences of society won't change, but the time preferences of those individuals who mined the new gold will most certainly change. Let's say that it declines, even though we should expect the opposite to be true, and that they save the entire supply of newly mined gold. If the supply of this stock of gold is enough to change the interest rate, below societies time preference, then we would still see inter-temporal disequilibrium. So just to be clear: if party A mines X amount of new gold, where X is half of the entire money supply, and if they choose to save the entire sum of X, then we should expect a depressed market rate below the natural rate, causing forced investment towards more roundabout methods of production, without an adequate supply of real capital. The process would be practically identical to increasing half of the supply of money in the broader sense by creating fiduciary media (and that's the problem--fiduciary media acts as if it was money proper). But we wouldn't see a continuous expansion of the structure of production--just one round.
“It is quite conceivable that a distortion of relative prices and a misdirection of production by monetary influences could only be avoided if, first, the total money stream remained constant, and second, all prices were completely flexible, and, third, all long term contracts were based on a correct anticipation of future price movements.” -Prices and Production, pp. 304
All three conditions must be present, according to Hayek.
Esuric:If the ratio between the demand for current goods relative to future goods remains unchanged, then there is no inter-temporal disequilibrium. But why do you expect this to be the case?
I don't. I just started out with this scenario as an example. Later I change this assumption.
Esuric:A change in either direction (favoring the latter or former) must necessarily distort the structure of production.
I would be more cautious with using the term distortions in this case. Since when are changes in prices that reflect changes in real supply and demand distortions? Sure, they require energy and effort by economic agents. Nobody likes change. A change in either direction of the real time preferences of economic agents does not "distort", more then a [sharp] change in preference from hot dogs to hamburgers ! The changes in relative prices will be indicative of the real change.
Esuric:Furthermore, if you approve of Hayek's analysis, then you should support a free banking system (or at least acknowledge its potential benefits) that's sensitive to the demand for cash holdings.
That's a strange conclusion.
First, Hayek himself never recognized any benefit for Fractional Reserve Banking whatsoever. So your logic here doesn't compute.
Second, Of course I support free banking. Free banking without the special government privileges that no other business enjoys. But Let's avoid this argument right now.
Esuric:This also means that you don't believe that an elastic money supply must automatically and necessarily lead to business cycles.
Elasticity as in Monetary Equilibrium Theory? You see the similarity, which is good, but it's not quite the same.
First, if you agree with the above assertion of yours, then you should acknowledge that my explanation is sound and that indeed, the new gold, if saved under a 100% gold standard, will not cause a business cycle. Even the free bankers acknowledge this.
Second, it's not the same because MET suffers from serious theoretical flaws.
Esuric:Again, this is a major assumption which hasn't been substantiated. This assumption only holds if the ratio between the demand for current goods and future goods remains absolutely unchanged.
Why did you stop reading the post in the middle? Continue another line and I change this assumption. I made the assumption only as part of the theoretical analysis, where I later talk about a change in time preference. Read it again.
Esuric:No. The time preferences of society won't change, but the time preferences of those individuals who mined the new gold will most certainly change.
Again, I know it will probably change. I specifically addressed this.
Esuric: Let's say that it declines, even though we should expect the opposite to be true,
Why? Why should the opposite be true. The owners of the new gold may either consume it, hold it, or invest it. How do you know what they will do?
Esuric:Then we should expect a depressed market rate below the natural rate, causing forced investment towards more roundabout methods of production, without an adequate supply of real capital.
I see where you are going with this .... Let me wait for the next comment:
Esuric:But we wouldn't see a continuous expansion of the structure of production--just one round.
OK, I hope I am not misunderstanding the point you are trying to make here. Of course if they save for say one year, and then when they receive their income (principle + interest) they consume it all (or part of it) instead of reinvesting, then we have a problem. But there is nothing special about this hypothetical example with respect to the influx of new gold, although there probably will be some practical differences, which I'll address below. You can also save existing stock of Gold for one year, signal a lower time preference, and then after a year change your mind, and signal back a higher time preference. All you are saying is that if people were to flipflop with their time preference, then we couldn't see a "continuous expansion of the structure of production". Of course! But theoretically, your "just one round" scenario is not unique for the influx of new gold.
Practically, if you want to make the case that new gold has the potential to cause more confusion and errors, I'll certainly give you that. But it doesn't change the fact that due to the inherent soundness of the 100% system, there can be no wide spread systemic crisis for the banking industry. There is no maturity mismatching so it's not as if all the banks are suddenly all revealed to be bankrupt. According to your example, people who have previously saved may upon maturity of the loan decide to reallocate some of that gold (or all of it if you wish) back to consumption as they may experience a fall in real wages. I would be very cautions in describing the above as distortion. Rather, it is simply a change in preference, although, as I have acknowledged, it may be a more volatile and less stable upon the influx of new gold, as oppose to simply a change based on current stock of gold. But again, there can be no wide spread banking crises, which is after all, a major ingredient of the ABCT.
Esuric:All three conditions must be present, according to Hayek.
First, In my original post of this thread, I said that any new money will initially distort prices. Misdirection of production also refers to intratemporal distortions and not just intertermporal. Remember also that Hayek in Prices & Production is considering a monetary system with fractional reserve banking. Not one with a 100% gold standard.
more deposits = lower time preference
less deposits = higher time preference
deposits = credit
= no distortion
DD5:Elasticity as in Monetary Equilibrium Theory? You see the similarity, which is good, but it's not quite the same.
The term "elastic money" means different things. For example, for the banking school it meant a supply of money which only reacted to the general business environment and to the demand for cash holdings (they held a purely passive view of the banking system and an endogenous view of the money supply). Mises, on the other hand, exposed the fact that an elastic money supply only means one which isn't invariable. My point about free banking is that you at least acknowledge that if the ratio of the demand for current goods and future goods remains unchanged, then there can be no inter-temporal allocation. Hayek explicitly states this but claims that it would be nearly impossible to implement (impossible with a central bank, of course).
DD5:First, if you agree with the above assertion of yours, then you should acknowledge that my explanation is sound and that indeed, the new gold, if saved under a 100% gold standard, will not cause a business cycle. Even the free bankers acknowledge this.
I don't see how. We're increasing the supply of money by 50% without an increase in the supply of real capital, depressing interest rates, stimulating more roundabout methods of production--if it's all saved. There would be inflation, but not FRB induced inflation (creation of fiduciary media--but again, fiduciary media acts as it it were money proper).
DD5:Why? Why should the opposite be true. The owners of the new gold may either consume it, hold it, or invest it. How do you know what they will do?
When people hold more cash than they deem necessary, for whatever reason, then they begin to increase their purchases--an increase in time preferences. With an invariable money supply, prices can only rise at the expense of other goods. But when the money supply is variable, then you get inflation (in the general sense). If party A spends all of its money then it must necessarily depress the structure of productions towards more direct and less capital intensive methods of production (relatively, and towards the products it chooses to buy--Cantillon effects).
DD5:All you are saying is that if people were to flipflop with their time preference, then we couldn't see a "continuous expansion of the structure of production". Of course! But theoretically, your "just one round" scenario is not unique for the influx of new gold.
No, but the influx of gold (if all of the new gold was mined instantaneously and then saved immediately) would lead to one round of expansion. When the money fully permeates amongst the rest of society, then those who have engaged in overly lengthened productions would realize that they aren't truly profitable. With FRB and a central bank, there is perpetual and incremental money expansion, reducing the market rate below the natural rate, supporting the malformed capital structure. If the banks allow the market rate to rise towards the natural rate, then interest rates would rise (demand for consumption goods rising relative to producer goods) expressing true time preferences, causing a depression (correction).
DD5: There is no maturity mismatching so it's not as if all the banks are suddenly all revealed to be bankrupt.
I've never heard this mentioned in anything I've read. Banks with 2% reserves lasted for 200 years without bankruptcy. 100% reserves would prevent the tension between the higher stages and lower stages of production, at least at first, since the money used for investment is not also used for consumption (favoring the former at first). But once the newly created sums permeate amongst the rest of society, then the interest rate will rise towards the natural rate (mentioned this already), leading to crises.
Esuric:My point about free banking is that you at least acknowledge that if the ratio of the demand for current goods and future goods remains unchanged, then there can be no inter-temporal allocation.
Yes. However, the FRB free bankers have greatly mistaken in theorizing that their system can maintain this ratio. Also, no elasticity of money is required to meet any demand beyond the natural influx of gold (or whatever is the market chosen money). And holding money serves the same function as investing in terms of the productive structure.
Esuric:When people hold more cash than they deem necessary, for whatever reason, then they begin to increase their purchases-
What does this have to do with the question. The influx of new gold will reach wage earners. You don't know what they will do with these wages; consume, hold, or invest.
Esuric:No, but the influx of gold (if all of the new gold was mined instantaneously and then saved immediately) would lead to one round of expansion.
Even in this hypothetical extreme example, no banking crisis can occur. Your error is in associating any potential bubble with a crisis.
Loans that are retracted can be so only upon their maturity without FRB. There can be no wide spread systematic banking crisis. All you're saying is that an influx of new gold may cause only a temporary fall in interest rate. Fine, but that fall was genuine for as long as it lasted because the saving was voluntary. This behavior by savers of new gold may be short lived for the various reasons you mentioned, but it is real for as long as it lasts. The situation is equivalent to investing the new gold in bonds, stocks, or whatever, and then selling them after certain period of time. It may create a little "bubble", but a bubble is not tantamount to ABCT. You don't possibly associate any bubbles with ABCT, do you?
Anyway, in the real world, a permanent gradual and predictable influx of new gold is expected. This rate of influx of new gold that will be channeled into and/or out of savings is directed by the voluntary action of market participants. Your example, therefore, is only hypothetical.
Esuric:I've never heard this mentioned in anything I've read.
Maturity mismatching in the world of finance describes a situation in which the time structure of a firm's assets is longer then the time structure of its liabilities. This is always the case for FRB in its present (and historical) form.
I recommend this. Glance over it.
Esuric:But once the newly created sums permeate amongst the rest of society, then the interest rate will rise towards the natural rate (mentioned this already), leading to crises.
It is not a crisis. There are no systemic bank failures.
Esuric:Banks with 2% reserves lasted for 200 years without bankruptcy
Oh, please.. You don't really believe that, do you?
Our big Wall Street Banks have also survived with a similar record. What's wrong with using that for proving your point.