Its been pointed out to me that deflation causes incomes to fall and also that debt, in real terms, rises as a consequence. These two factors would combine to retard business investment and therefore economic growth. Is this true?
TY Adrian for clarifying that.
There remains only to point out that the amount of hoarded money under the mattress and not put in a bank or somewhre else it is moved right back into the economy is, as Hazlitt noted, trivial.
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It's easy to refute an argument if you first misrepresent it. William Keizer
Business investment is retarded in a more important way:
You have a thousand dollars. If you hold it and do nothing, in a year deflation will make your money worth more. It'll be as if you had $1050 in today's money.
You have an investment you might have made with that thousand dollars. You hope to make 10% off of that investment. So in a year you may have made an extra $100.
Because of the risks involved, you wouldn't have considered the investment if the payoff was only 6%. $60 wouldn't be worth the danger of loss.
But $100 sounds good enough to be worth taking a chance...except that you suddenly remember that you can make $50 just by holding on to your money and doing nothing...no risk at all.
$100 for investing, or $50 for doing nothing. You only gain an extra $50 if you invest and succeed. Now you're having to consider only making $50 from that same investment. That's below your minimum of $60, so you don't invest.
Five percent deflation is as if all investments you were going to consider are now going to return 5% less to you. This will have an anti-investment effect across society, reducing how much people do invest.
It's exactly the same as how inflation drives exaggerated investment, except in reverse.
Smiling Dave:Of course, Mises wrote in many places that the whole notion is totally ridiculous. Educate yourselves, guys and read the quarterly journal of economics, vol 1 number 4, pages 25-49. Do a search here for "qjae_1_1_4" to get your free copy. Somebody linked to it today, but I can't find his post anymore. Hats off to you, whoever you are.
Somebody linked to it today, but I can't find his post anymore. Hats off to you, whoever you are.
Here's a link to that paper: http://mises.org/journals/qjae/pdf/qjae1_4_2.pdf
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Kaz:Business investment is retarded in a more important way: You have a thousand dollars. If you hold it and do nothing, in a year deflation will make your money worth more. It'll be as if you had $1050 in today's money. You have an investment you might have made with that thousand dollars. You hope to make 10% off of that investment. So in a year you may have made an extra $100. Because of the risks involved, you wouldn't have considered the investment if the payoff was only 6%. $60 wouldn't be worth the danger of loss. But $100 sounds good enough to be worth taking a chance...except that you suddenly remember that you can make $50 just by holding on to your money and doing nothing...no risk at all. $100 for investing, or $50 for doing nothing. You only gain an extra $50 if you invest and succeed. Now you're having to consider only making $50 from that same investment. That's below your minimum of $60, so you don't invest. Five percent deflation is as if all investments you were going to consider are now going to return 5% less to you. This will have an anti-investment effect across society, reducing how much people do invest. It's exactly the same as how inflation drives exaggerated investment, except in reverse.
I fail to see how 1) at any given time, there's a particular level of investment that can be objectively considered "optimal", and 2) even granting the former arguendo, how investing under that "optimal" level is necessarily a bad thing. Can you please explain this further?
@ Kaz,
Not trying to hijack the thread, but what are your views on money? Do you believe in a free market in money, competing currencies? I read some of your links and have to say they were interesting. You seem to dislike government mandated money. As an aside don't be angry with me because of my Rothbard avatar :)
"It is easy to be conspicuously 'compassionate' if others are being forced to pay the cost." - Murray N. Rothbard.
Smiling Dave: In his intro to Prices and Production, page xiii, he writes that the goal of the book is 'to demonstrate the cry for an "elastic" currency which expands or contracts with every fluctuation of "demand" is based on a serious error of reasoning." Read it again, guys. Memorize it. Make it part of your nightly prayers.
Read it again, guys. Memorize it. Make it part of your nightly prayers.
I see that the parody of Austrian economics has decided to embarrass himself once again. Hayek is referring to the mechanical quantity theorists and their price-stabilization mandates, which do not distinguish between changes in the demand for money as money, and changes in the demand for money as capital. I suggest that you actually read the book rather than simply taking passages out of context, which you completely misunderstand. Specifically, you may find lecture four, The Case For and Against an “Elastic” Currency, especially interesting.
Here are some quotes:
Hayek: If the considerations brought forward in the last lecture are at all correct, it would appear that the reasons commonly advanced as proof that the quantity of the circulating medium should vary as production increases or decreases are entirely unfounded. It would appear rather that the fall of prices proportionate to the increase in productivity, which necessarily follows when, the amount of money remaining the same, production increases, is not only harmless but is in fact the only means of avoiding misdirections of production. Prices and Production, Lecture 4, pp. 283
Here, he’s implicitly assuming a state of monetary equilibrium, where the supply of money neither exceeds nor falls below the demand for money. In such a state, there’s no need to alter the supply of money at all. He then goes on to explain when the supply of money should be altered:
Hayek: But I think that what I have already said on this point will be sufficient to justify the conclusion that changes in the demand for money caused by changes in the proportion between the total flow of goods to that part of it which is effected by money, or, as we may tentatively call that proportion, of the coefficient of money transactions, should be justified by changes in the volume of money if money is to remain neutral towards the price system and the structure of production. Prices and Production, Lecture 4, pp. 295
Hayek: In such a situation, therefore, the transition to more or less capitalistic methods of production may also require a change in the quantity of money, not because the physical magnitude of the goods-stream has changed, but because money has been transferred from a sphere where the coefficient of money transactions has been higher to one where it is lower, or vice versa. Prices and Production, Lecture 4, pp. 296
Hayek: No doubt that the statement as it stands only provides another, and probably clearer, formulation of the old distinction between the demand for additional money as money which is justifiable, and the demand for additional money as capital which is not justifiable. Prices and Production, Lecture 4, pp. 297.
Of course, you wont really understand his argument until you educate yourself.Thus, once again, Dave, I've done much of your homework for you. It's time for you to take a break from the forums and start reading. Now, you may not agree with Hayek's argument, many don't (Rothbardians), but at least you'll be familiar with it. Also, check out Chapter 17 of Mises' Theory of Money and Credit.
Mises: In fact, the development of the clearing system and fiduciary media has at least kept pace with the potential increase of the demand for money brought about by the extension of the money economy, so that the tremendous increase in the exchange value of money, which otherwise would have occurred as a consequence of the extension of the use of money, had been completely avoided, together with its undesirable consequences (pp. 333). Of course, all of this is true only under the assumption that all banks issue fiduciary media according to uniform principles, or that there is only one bank that issues fiduciary media. A single bank carrying on its business in competition with numerous others is not in a position to enter upon an independent discount policy… Thus the banks may be seen to pay a certain amount of regard to the periodical fluctuations in the demand for money. They increase and decrease their circulation pari passu with the variations in the demand for money, so far as the lack of a uniform procedure makes it impossible for them to follow and independent interest policy. But in doing so, they help to stabilize the objective exchange value of money. To this extent, therefore, the theory of the elasticity of the circulation of fiduciary media is correct; it has rightly apprehended one of the phenomena of the market, even if it has also completely misapprehended its cause (pp. 347).
In fact, the development of the clearing system and fiduciary media has at least kept pace with the potential increase of the demand for money brought about by the extension of the money economy, so that the tremendous increase in the exchange value of money, which otherwise would have occurred as a consequence of the extension of the use of money, had been completely avoided, together with its undesirable consequences (pp. 333).
Of course, all of this is true only under the assumption that all banks issue fiduciary media according to uniform principles, or that there is only one bank that issues fiduciary media. A single bank carrying on its business in competition with numerous others is not in a position to enter upon an independent discount policy… Thus the banks may be seen to pay a certain amount of regard to the periodical fluctuations in the demand for money. They increase and decrease their circulation pari passu with the variations in the demand for money, so far as the lack of a uniform procedure makes it impossible for them to follow and independent interest policy. But in doing so, they help to stabilize the objective exchange value of money. To this extent, therefore, the theory of the elasticity of the circulation of fiduciary media is correct; it has rightly apprehended one of the phenomena of the market, even if it has also completely misapprehended its cause (pp. 347).
"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."
"TY Adrian for clarifying that.
There remains only to point out that the amount of hoarded money under the mattress and not put in a bank or somewhre else it is moved right back into the economy is, as Hazlitt noted, trivial."
<= I'm not going to argue on the relevance of it, as such. I'm just/only saying that there is a difference which is praxeologically relevant. (Thanks for the kind words, by the way.)
Now, I would agree that this is trivial, but I'm interested in your take on Horwitz his argument with this new shed of light. I don't think I agree with the idea behind it - I've asked him my problems with it before and he couldn't really answer them (he literally said 'I don't know, I should think about that') - but I do feel that just saying 'well, he's saying that saving is bad, the damn Keynesian!' doesn't cut it. >;<
It's not 'savings' that's the problem, it's 'the demand for money as a liquidity'. The way I see it; Horwitz sees a problem when (1) the demand for money raises, whilst at the same time (2) they want to keep buying the same stuff. The problem he sees is that this has effects on the price level. We all know that the price level will have to go down in this case - because there isn't enough money available to buy all the stuff at the current prices, because the demand for money raises (without the supply of savings goes up). What he's saying - if I construct it correctly - is that this lowering of the price level isn't 'necassary' and is very costly to the economy. It would be better to increase the money supply, so people can have more liquidity, whilst at the same time the price level can stay the same, so there is no need for costly adjustments.
My peef with this is simply this: but aren't these 'costly' adjustments just adjustments to new market preferences, that entrepreneurs should have estimated? If people don't want to buy the stuff at the current price level, well, that means they were bad investments.
But for some reason; they make a distinction. And that's what I don't get.
The state is not the enemy. The idea of the state is.
Esuric,
as probably the best economist on this forum, could you please comment on my above post? It's one of the few things I'm still struggling with.
What he's saying - if I construct it correctly - is that this lowering of the price level isn't 'necassary' and is very costly to the economy. It would be better to increase the money supply, so people can have more liquidity, whilst at the same time the price level can stay the same, so there is no need for costly adjustments.
It’s not that the price level will remain the same. Monetary equilibrium theorists don’t really care about the price level as much as they care about real cash balances. They want to increase the supply of money so that real cash balances are restored without a forced deflation. You can either restore cash balances by increasing the supply of money (where it perfectly corresponds to the demand for money, and enters the system in such a way that it does not alter the structure of production), or by allowing the objective exchange value of money to rise, i.e., deflation. The problem with the latter is that there are many rigidities and this yields, at least in the short-run, relative structural imbalances, involuntary unemployment and negative output (a recession). The former (increasing the supply of money towards the demand for money) may yield the ABC depending on how the money enters the economy and where it goes/is used.
No. Preferences are arbitrarily altered due to external factors, namely monetary disequilibrium. If the supply of money contracted by 99% tomorrow the vast majority of firms in the U.S. would fail (and this is true for every national economy, in every historical period). Does this mean that the entire U.S. economy is just one giant malinvestment? Absolutely not. The same is true in the opposite direction, namely when the supply of money exceeds the demand for money (or when the market rate of interest is pushed below the natural rate). Individuals have more money than they wish to hold and they begin to spend. This is not a natural change in preferences; it is a forced change due to monetary disequilibrium. The point is to create a structure of production that (a) actually matches real individual preferences, and (b) is not continuously altered (again, away from real preferences) due to arbitrary changes in monetary variables.
Kaz: You buy a house for $100K Your house payment is $900, safely within your means to pay. Each year, your house declines in raw dollar value, due to deflation. Each year, your income declines in raw dollar value, due to deflation. Soon, your house is worth $50K, but you still owe $75K on it. Soon, $900 per month is more than your entire income. See, your original loan remains in the original units, that are getting more valuable every day. Even if you paid cash, you'd be throwing away your money, as your house would decline in value every year, You should have kept the cash, and rented for the rest of your life...but I can't imagine where you'll find someone willing to own the house and be your landlord, since the price he pays for the rental property is money he should have just held onto, the way you are.
You buy a house for $100K
Your house payment is $900, safely within your means to pay.
Each year, your house declines in raw dollar value, due to deflation.
Each year, your income declines in raw dollar value, due to deflation.
Soon, your house is worth $50K, but you still owe $75K on it.
Soon, $900 per month is more than your entire income.
See, your original loan remains in the original units, that are getting more valuable every day.
Even if you paid cash, you'd be throwing away your money, as your house would decline in value every year,
You should have kept the cash, and rented for the rest of your life...but I can't imagine where you'll find someone willing to own the house and be your landlord, since the price he pays for the rental property is money he should have just held onto, the way you are.
In your scenario, a lender would be more inclined to extend a loan that he or she knows would be repaid. In other words, 30 year mortgages wouldn't exist in the environment you just described. Mortgages would be set up more like auto loans are, where the term and paymount amount falls more in line with the loss in value of the property over time, again, decreasing the chance of the borrower to give up paying and walking away from the loan and increasing the chance of the lender eventually being paid back in full.
Let me congratulate you for your consistency, if not for your civility.
Yep, looks like you nailed me about Hayek. Oh well, so he thought that way, maybe. I don't have a copy of his books, or the time to waste reading them. So I cannot double check your quotes to see if you misunderstood them and/or twisted them out of context, as you did with the Mises quotes [as I will show later in this post]. So I stand corrected, for now.
As for Mises, take a look at this from Human Action.
. The notion of "normaI credit expansion is absurd. Issuance of additional fiduciary media, no matter what its quantity may be: always sets in motion those changes in the price structure the description of which is the task of the theory of the trade cycle. Of course, if the additional amount issued is not large, neither are the inevitable effects of the expansion.
Here's another:
The Banking School failed entirely in dealing with these problems. It was confused by a spurious idea according to which the require-
ments of business rigidly limit the maximum amount of convertible banknotes that a bank can issue. They did not see that the demand of the public for credit is a magnitude dependent on the banks' readiness to lend, and that banks which do not bother about their own solvency are in a position to expand circulation credit by lowering the rate of interest below the market rate. It is not true that the maxi- mum amount which a bank can lend if it limits its lending to discount- ing short-term bills of exchange resulting from the sale and purchase of raw materials and half-manufactured goods, is a quantity uniquely determined by the state of business and independent of the bank's policies. This quantity expands or shrinks with the lowering or rais- ing of the rate of discount. Lowering the rate of interest is tantamount to increasing the quantity of what is mistakenly considered as the fair and normal requirements of business.
And from Money and Credit:
Thus it is easy to see what little justification there is for ascribing to the clearing system the property, without affecting the objective exchange-valueofmoney, of correcting the disparities that may arise between the stock of money and the demand for it,
As for your quote, you little weasel, you left out what Mises considers the ONLY undesirable consequence of
the increase in the exchange value of gold dollars. And that undesirable consequence is none of the crap you and others are worried about.
It is the following: That when the price of gold gets high enough, and it is used for money, people will get out there and mine gold, diverting workers from other jobs. Also, that there will be less gold used for jewelry, and more for money. That's it. No collapse of Western Civilaztion as we know it.
And of course, weasel, none of that passage applies to fiat money, as Mises says explicitly in another piece that you conveniently left out. And guess what, Esuric. We all live in counrtries that have fiat money.
Here is the full text of the passage you so conveniently chiseled to make it seem like you found something:
Ifmetallic money is employed, then the advantages ofa diminu- tion of the demand for money due to the .extension of such other meansofpayment areobvious. Infact thedevelopmentofthe clear- ing system and of fiduciary media has at least kept pace with the potential increase of the demand for money brought ab9'lJt by the extension of the Money Economy, so that the 'tremendous increase
in the exchange-value of money, which otherwise would have occurred as a consequence of the extension of the use of money, has been completely avoided, together with its undesirable conse- quences. Ifithadnotbeenfor this theincreasein theexchange-value ofmoney, and so also of the monetarymetal, would have given an increasedimpetus totheproductionofthemetal. Capital andlabour would have been diverted from other branches ofproduction to the production of the monetary metal. This would undoubtedly have meant increased returns to certain individual undertakings; but the welfare ofthe communitywould have suffered. The increase in the stock ofprecious metals which serve monetary purposes would not have improved the position of the individual members of the com- ~ munity, would not have increased the satisfaction oftheirwants; for the monetary function could also have been fulfilled by a smaller stock. And, on the other hand, a smaller quantity of economic goods wouldhave beenavailable for the direct satisfactionofhuman wants ifa part ofthe capital andlabour power that otherwisewould have been used for their production had been diverted to mining precious metals. Even apart from the diversion of production, a decrease of prosperity would result from the fact that as a conse- quence ofthe rise in value ofthe precious metals caused by the use for monetary purposes the stock available for industrial employment would decrease, since certain quantities would be transferred from the latter employment to the former. This all becomes particularly clear ifwe think of an economic community which does not itself produce the precious metals, but imports them. Here the amount of their cost is expressed by the quantity ofcommodities that must be surrendered to foreign countries in order to obtain the supple- mentaryquantityofmonetarymetal inexchange. Ina country that itselfproduces thepreciousmetals, thematteris thesame inprinciple; all that is different is the way of reckoning the loss of welfare through the sacrifice of the other branches of production and the preference for mining the precious metals; it is perhaps less per- ceptible, but it is just as comprehensible in theory. Themeasure of the additional harmdone by the diversion ofmetal tomonetaryuses is always givenby thequantityofmetal that is withdrawnfromother uses in favour of themonetary use.
Where fiat or credit money is employed, these reasons in favour ofthe extension of clearing methods of payment and of the use of
fiduciarymedia do not arise.
Your second quote also is a masterpiece of misunderstanding. Mises is talking about something that does not exist in the USA, or anywhere else nowadays. He is referring to a situation where banks can compete against each other in setting the interest rate. In other words, there is no central bank with crushingly powerful methods to set the interest rate where it wants. Oddly enough, you left out the part of that Mises quote that makes that point perfectly clear. Here is the full text:
Of course, all of this is true only under the assumption that all banks issue fiduciary media according to uniform principles, or that there is only one bank that issues fiduciary media. A single bank carrying on its business in competition with numerous others is not in a position to enter upon an independent discount policy. Ifregard to the behaviourofits competitors prevents it from further reducing therateofinterest inbank-credit transactions, then - apart from an extension ofits clientele - it will be able to circulate more fiduciary media only ifthere is a demand for them even when the rate ofinterest charged is not lower than that charged by the banks competing with it. Thus the banks may be seen to pay a certain amount of regard to the periodical fluctuations in the demand for money. They increase and decrease their circulationpari passu with thevariations inthedemandformoney, so far as thelackofa uniform procedure makes it impossible for them to follow an independent interest policy. But in doing so, they help to stabilize the objective exchange-value ofmoney. To this extent, therefore, the theory of the elasticity of the circulation offiduciary media is correct; it has rightly apprehended one of the phenomena of the market, even if it has also completelymisapprehended its cause.
Now for your other post:
If the supply of money contracted by 99% tomorrow the vast majority of firms in the U.S. would fail
What proof have you of this silly assertion. You are saying that if an atomic bomb blew up all the banks and all the money in them, but left all the factories alive and kicking, that the vast majority of firms in the US would fail? Why? GM still has its cars, Apple still has its Ipods. Some way would be found to sell them. There is always something that evolves as currency. Sheesh.
Of course one way to acheive the scenario you described is to listen to you and your fellow quacks and print money like there is no tomorrow. That will destroy the currency as nicely as an atomic bomb.
Smiling Dave:I don't have a copy of his books, or the time to waste reading them.
I don't either, but I probably wouldn't call Hayek on economics time wasted, as much as a lower preference activity.
Now Hayek on the state, that is truly time wasted ...
1) Obviously, there is some level of investment that would work best. An Austrian expects this level to be best determined by the free market; if people are left free, they will be able to determine what is the ideal level of investment. For example, it takes a certain amount of money to create enough shoes, of the correct kinds, for the economy. Optimal investment produces the right amount and type of shoes, while malinvestment produces too many shoes, too few, (or both at once), the wrong kinds, et cetera.
2) I guess I already answered this with (1): malinvestment produces too much, too little, or the wrong kind. Investing under the optimal level, obviously, creates too little wealth (shoes, for example) in the society. It not only means a shoe shortage, but a resulting shortage in comfort, shoe-related employment, et cetera. Underinvestment across the economy generates a shortage of new wealth, of resources, of jobs, et cetera.
Like we are suffering now.
Yep, looks like you nailed me about Hayek. Oh well, so he thought that way, maybe. I don't have a copy of his books, or the time to waste reading them.
Wow, you are the master of cognitive bias.
A rational man spends as much time learning his opponents' positions as his own, and learning about ideas in the realm of his interest in general, in case he hasn't accidentally stumbled upon the perfect set of knowledge by default.
You don't really know anything about monetary theory at all, if you've only read Rothbard/Mises, or only read Keynes, or only read Marx, or only read Hayek/Selgin, or only read Friedman/Timberlake.
You have to have some real understanding of all of the competing ideas, or you're actually pretty clueless.
In this case, you're dismissing the monetary theorist who got farthest, and produced what is now the most advanced Austrian monetary theory. You haven't time to "waste" reading him, you'll just stick to your existing knowledge set, without any way of knowing if it's correct.
So only people who could afford to nearly pay cash for a house, and are willing to throw that cash away on something that will plunge in price, could own a home.
So when everyone realizes they should not bother buying homes, or anything else in the world that could possibly be rented, who are the fools who WILL buy those things, and rent them out to everyone else while their investment's price flies out the window?