We are developing the social individualist meta-context for the future. From the very serious to the extremely frivolous... lets see what is on the mind of the Samizdata people.
Samizdata, derived from Samizdat /n. - a system of clandestine publication of banned literature in the USSR [Russ.,= self-publishing house]
|
Samizdata quote of the day I would love to hear from AEP, or from Prof Congdon, exactly how creating money is supposed to create wealth.
If the Central Banks of the world buy private sector bank debt, they create new demand-deposit money that the private sector banking system can then lend. So more money units chase the same goods and services? Where is the new wealth?
– Toby Baxendale
|
Who Are We? The Samizdata people are a bunch of sinister and heavily armed globalist illuminati who seek to infect the entire world with the values of personal liberty and several property. Amongst our many crimes is a sense of humour and the intermittent use of British spelling.
We are also a varied group made up of social individualists, classical liberals, whigs, libertarians, extropians, futurists, ‘Porcupines’, Karl Popper fetishists, recovering neo-conservatives, crazed Ayn Rand worshipers, over-caffeinated Virginia Postrel devotees, witty Frédéric Bastiat wannabes, cypherpunks, minarchists, kritarchists and wild-eyed anarcho-capitalists from Britain, North America, Australia and Europe.
|
I think we’ve all tumbled to the fact that a country cannot grow rich just by turning out bits of paper with £20 or $20 imprinted in them. However, every economy (larger than desert islands with three families on them) benefits from some form of money. There is also an optimum amount of money. When amount is inadequate, unemployment ensues. When the quantity is excessive, inflation ensues. At the moment we have excess unemployment – certainly in the U.S. In contrast, in the U.K. inflation is more of a problem.
Therefor it is good idea to print extra money – certainly in the U.S.
Well fine, just as long as you realise that is no different to saying:
It is also worth noting that such actions do not in reality fall within the purview of “economics” but rather “political science”.
I don’t really agree with Toby Baxendale. See the discussion thread below the Cobden centre article for more about that debate.
Ralph is quite right that there is an optimum quantity of money at any one particular time. But, I don’t agree that unemployment is a perfect indicator for whether the amount is too great or too small.
Everyone agrees that if the state reduces the quantity of money then that requires prices to fall. That fall can’t happen quickly due to rigidities, and as a consequence a fall in output occurs, and a fall in employment.
But, that doesn’t mean that every fall in employment is caused by a change in the supply of money. At the beginning of this recession there was no change in that supply, but there was a fall in employment and output anyway. In my view the recession is two separate effects superimposed and intertwined. In the first place there is the real effect of fall in employment due to business errors that built up during the boom. That causes a fall in employment in construction, banking and related services. This is what Arnold Kling calls the “recalculation”. Secondly, there is the fall in employment caused by the unexpected fall in the purchasing power of money below it’s trend line, the “secondary recession”, “Keynesian” or “aggregate demand” effect.
As I said over on the other thread I don’t think that the main problem is the current quantity of money. The main problem is trusting how it will change. The central banks have expanded the existing quantity or reserves to deal with the recession. Nobody is really sure if once the recovery begins they will reduce that quantity again. If they don’t then price inflation will wipe out many investments. Because of this risk the markets are reluctant to invest now, so recovery never begins.
Another major problem in the US is that price deflation and falling incomes has caused the real value of the minimum wage to rise. Currently the US median wage is $13.50 per hour and the minimum wage is $7.25. That causes a loss of employment.
I suppose the idea is that when people are damaged by confiscation (taxation) and debasement (inflation) that they will strive even harder to be productive over and above what they were before – and new wealth (over and above lost wealth due to obsolescence and wear) will be created. The risk, of course, is people may become so dismayed that they don’t attempt the reclamation of what they lost, much less create new wealth by extra efforts. Using a variation of the broken window fallacy as an economic and monetary policy might fail when people finally give up trying to fix the window.
Keynes’ argument was basically a pure confidence game. The early stages of inflation look a lot like prosperity, and making people think that prosperity is starting up again should, in principle, get them to stop hoarding money and start participating in the wider economy again. He was even right in a narrow sense, that is genuinely one effect of inflation during a recession. The only problem is, the number of situations where the confidence boost is more relevant than the damage done by monkeying with the economy is absurdly small, certainly smaller than the Krugmans of the world would have you believe.
“There is also an optimum amount of money. When amount is inadequate, unemployment ensues. . . . At the moment we have excess unemployment – certainly in the U.S. . . . Therefor it is good idea to print extra money – certainly in the U.S.”
Bollocks. (I’ve become fond of that Britishism!) Anyone who thinks there is any truth to that assertion should simply consider the recent massive growth in the US money supply (discussed in Midwesterner’s article a few months ago and kindly reposted in another thread recently) and compare it to our unemployment rate. The two have gone up in tandem.
An inadequate money supply could, in theory, lead to deflation. That could lead to increased unemployment if wages weren’t permitted to fall commensurately, which could be the consequence of rigid union contracts (no longer very prevalent in the US outside of the government sector) and the minimum wage laws. But that’s just a theoretical problem. I doubt that we’ll ever be able to test it, because the Fed has never shown any sign of doing anything but massively increasing the money supply. And it’s absolutely no justification for increasing it still further.
Clearly printing more money does not increase real wealth. It is absurd to suggest that it does. I do believe that central banks can take action, including printing money in one form or another, that stabilises the financial system in a time of crisis (although this is invariably for the benefit of the profligate at the cost of the prudent). The notion that we can somehow boost ‘nominal demand’ by printing more money assumes that the money printed actually gets spent. All quantitative easing has done is rearrange bank balance sheets, swapping government bonds (in the UK, all kinds of crap in the US) for cash. If this does not get lent out it is not inflationary or stimulative. If it does get lent out this will only be because demand for cash has increased (i.e. the ‘string’ is pulling). This can then start the next boom phase of the boom and bust cycle.
Wealth creation is separate from the monetary instrument used to enable the circulation of the wealth created. Insufficient money is a drag on wealth creation as other prices have to adjust to be able to incorporate the new wealth. Too much money leads to inflation.
Would that we could have a way of creating money at the same point where wealth was created.
Our crude central banking mechanisms are a top down mechanism that are continually guessing how much and where wealth is being created. It requires the crude instrument of interest to act as a brake on excessive use of the tool by governments.
The validation of wealth creation is at the level of the individual transaction between two parties – how can money be created in the transaction in accordance with the wealth created?
If such a method could be created, it would only require the validation of the buyer who would not have any interested in allowing more wealth to be created than necessary. Imagine each buyer is, in effect, his own central banker and he has all the motivation in the world to not pay too much and hence not recognize too much wealth creation.
The audience here is far more sophisticated in such matters to I appreciate any thoughts on this.
There is no such thing as an absolute total amount of money in any interesting sense. Money keeps track of relative wealth. If the issuers decree (as they sometimes do) that a zero should be removed or added to the currency there will nominally be ten times more or less money but this has no effect. A zero will just be added or removed from all prices too and that’s that.
Printing money does not create more money; it distributes money from some people to other people.
Alan,
I think you are saying that the amount of money does need to adjust somehow to accomodate the level of economic activity. I do not think that money can or needs to be created in advance of real wealth creation. Real growth occurs through technological advances which lowers prices. Growth thus has deflationary effect.
It may be true that a contraction in the broad money supply is highly damaging to the economy and will lead to a contraction in the real economy. Certainly this is the premise on which all recent central banking activity has been based. I am not so sure. A forced reduction in the money supply will, assuming the money multiplier does not change, lead to a reduction in the credit supply and be immensely disruptive. However, if broad money measures fall as a result of a failure of investment projects (e.g. mortgage backed bonds) this should not of itself lead to a reduction in the supply of base money.
As for the last point you make. While a transaction between two individuals increases wealth it does not create money. I am not even sure that the transaction creates wealth in a gdp accounting sense, although of course it increases the well being of the individuals involved as otherwise it would not have taken place.
Apologies for the profusion of terms. By ‘base money’ or plain ‘money’ I mean bank notes and central bank reserves. This would be equivalent to gold under a gold standard. By ‘broad money’ or ‘credit’ I mean some measure of the aggregate amount of money lent (invested) in the economy.
What Baxendale touches on in the quote (that seems to be skipped over in the comments) is the question of the proper consideration of what constitutes the composition of “Money.”
That, in turn, would involve the function assigned to a particular use of “money,” – as for example: a store of value.
The major transactional uses of money functions have been in credit forms serving as money. The “values” of credits have become unstable as volumes and variations have increased.
Most of what would be regarded as “wealth” would require some characteristics of a durable transferrable asset, which could include some forms of credits – but not any or all.
There has been an accepted theory in the U S to the effect that: ” private consumption drives the U S economy.” A contrarian view would be that: ” private consumption reflects the expectations within the economy. “
As a result, it currently appears that what people expect from increasing certain forms of credits to serve as “money,” is not yet being reflected in return to earlier consumption levels, at least in the U S.
However, the manner and levels of those kinds of increases in what passes for money have not yet reached the point where people expect that it will e best to exchange that kind of money for tangible goods, as a defensive action.
Currently, creating more money dilutes the value of existing money at different rates in different parts of the economy/for different participants due to the non-instantaneous propagation of that dilution. It is likely to result in varying shifts of wealth from the many to the few, the few tending to be market participants and institutions, including governments, but wealth “creation”? I have yet to see a place that this happens. If anything, it causes disruption, unpredictability and therefore risk, which I think it would be reasonable to suggest it would tend to increase the cost of doing business and so reduce disposable wealth in the general population.
As mentioned elsewhere, deflation shifts wealth to savers and, in the sort term at least, wage earners. Shifting wealth from the few to the many is no more ethical or valid than from the many to the few IMHO.
If it were possible to reduce or increase the money supply uniformly, without favouring any particular participant, I’d be all ears, especially in a framework attempting to maintain sound money.
Laird,
The Fed has not massively increased the supply of money. The Fed has massively increase the supply of base money, but that is not the same as increasing the supply of money. In fact, conventional money supply estimates (M1 and M2) have grown rather steady on their pre-recession trend. Meanwhile, nominal gross domestic product (NGDP) fell 3% between Aug ’08 and May ’09, the most dramatic decline since the Great Depression, and it is now over 10% below its pre-recession trend. The problem does not appear to be too much money but too little, i.e. an excess demand for money.
Why is there an excess demand for money? Well, there are two equivalent ways of framing the matter.
Money demand can be broken down into the demand for currency, demand for chequing deposits, and demand for other financial assets that serve monetary purposes. This last category is somewhat fuzzy. When should an asset be considered money? Some goods may function as money on a limited basis: within a particular community, at a discount, for a short time, all of the above, or some other consideration. Wherever the line is drawn, some money-like asset will not be included, the existence of which is important for monetary policy.
I bring this up because I think there was an unrecorded decline in the money supply in late ’08. The repossession agreements created by the shadow banking sector were functioning as money, but were not included in the conventional money supply estimates. (They were included in M3, but it was discontinued in ’06.) The collateral used back up these quasi-deposits were predominantly mortgage backed securities; when the value of these assets fell depositors immediately demanded their money back.
In short, there was a run on the banks. However, it wasn’t a run on ordinary chequing deposits, but shadow banking quasi-deposits, mostly held by large corporations and financial institutions.
One way to interpret these events is a decline in the money supply. But if one chooses not include shadow banking quasi-deposits in the money supply, then an alternative interpretation is in an increase in money demand. Both explanations are logically equivalent. In both cases, the demand for traditional forms of money increases as the supply of safe quasi-deposits falls, i.e. depositors withdraw their funds and hold traditional money instead.
@ Tim Carpenter:
“Deflation” if defined as general decline of price levels or as a general increase in the value of currency due to decreased supply, does not necessarily “shift wealth to savers.”
It depends on the nature of of assets held as savings.
If the savings have been accumulated in farmland, say DeKalb County, IL. at $280/A, and deflation drops the acre price to $200/A, there is no shift. Not a loss necessarily, but a reduction in “credit-worthy” assets for working capital.
Just an example.
Again – as Lee Kelly points out, the issue has been what kinds of credits have been functioning as “money.”
I wonder if anyone will come up with a theory of :
The Velocity of Credits.
Creating more money does indeed not create more wealth – nor does increasing the velocity of circulation of credit money (or whatever).
Indeed as the money does not appear in exact proportions all over the place at once (i.e. a “ten percent increase in the money supply” does NOT mean everyone opens their wallets and finds ten percent extra money has magically appeared), but actually appears in certain places and to certain people, it REDUCES wealth.
It does this by messing up the economy – by some people suddenly having a lot more money and thereby being able to send bogus price signals for resources (malinvestments not “overinvestment”).
I have philosophical differences with F.A. Hayek but his economic examination of this is first rate.
See his “New Studies in Politics, Philosophy and Economics” (1978) where (in the short essay on this) he observes that the money supply is not the gushing water the Chicago School seem to assume – it is more like the flow of treacle.
It appears in certain places (distorting the capital structure) and piles up there (flowing out in a messy sort of way) and certain connected people get sticky fingers.
Paul Marks,
I have neither philosophical nor economical differences with Hayek. Overall, his examination of money and the business cycle is first rate, and that is precisely why I find your comments wanting.
Let me quote Hayek from an article he wrote for the Encyclopedia of the Social Sciences in 1933 called “Saving”:
When fractional reserve banks increase the money supply proportional to an increase in demand for chequing deposits (i.e. a fall in velocity), the additional money does not send “bogus price signals”, but genuine signals that better coordinate the plans of borrowers and savers.
The first price altered by an increase in the supply of credit is the interest rate offered by banks (and not whatever capital goods are purchased by the entrepreneur). The lowering of the interest rate sends a true signal that people are deferring consumption by increasing their holdings of bank liabilities (chequing deposits, banknotes, or other financial assets). The capital goods purchased by the entrepreneur are not a distortion but a coordination, i.e. the composition of spending has shifted toward capital goods in response to greater savings. Thus any lengthening of the structure of production is sustainable.
Hayek understood this, but you (and Toby Baxendale) do not.
Arrogance is both unattractive and is a weak basis for articulation of an argument, so when you say:
You make a category error: you mistake disagreement for incomprehension.
Hayek normally begins his analysis of monetary expansion with the implicit assumption that money demand is constant, and only occasionally does he make this point explicit. (Some Austrian scholars believe the same is true of Mises.) This had led many fans of Hayek to induce his insights to all instances of money creation and therefore misunderstand his argument.
@RSS – that is the first time I have heard someone interpret the term “savings” to mean holding land! That, to me, is an asset, or an investment, not “savings”. When I said savings, I mean holdings of currency either in note and coin or in a bank and in that case, I believe my assertion holds true.
Janine,
I was not being arrogant, but merely expressing what I believe is true: Toby and Paul do not understand how fractional reserve banking can coordinate the plans of savers and borrowers by expanding and contracting credit issuance. While it is also accurate to say Toby and Paul disagree, if they are actually wrong, as I believe, then it follows they do not understand FRB.
I apologise if my comment came across as arrogant. It was certainly not intended to belittle Paul or Toby, both of whom have clearly given the matter serious thought. Although I disagree with their conclusions, I respect their arguments — after all, once held similar views.
As with the other thread I mostly agree with what Lee Kelly has said.
Some may say “printing money, even if to meet a demand for money, cannot create wealth”. This though ignores the problem of adjustments. When the demand for money holdings rises without a rise in supply that cause prices to fall, but not immediately. Before prices fall output falls.
The Fractional Reserve Free Banking theory that Lee Kelly and I have mentioned some of here is essentially a *symmetrical* form of the Austrian Business cycle theory that Paul Marks mentions above. Problems occur whenever the demand for money and supply are not well matched.
Current,
Perhaps there is a better way to describe the situation.
Consider that an increase in the demand for money is an increase in demand for real money balances. Now deflation can be described as process that increases the real supply of money until the increased demand for real money balances is satisfied. In other words, deflation increases the real money supply while keeping the nominal money supply constant.
An alternative way to satisfy an increase in demand for real money balances, and the policy we have advocated, is to increase the nominal supply of money by printing it. Both satisfy the increase in demand for real money balances by increasing the money supply, but whereas deflation increases the real money supply, monetary expansion increases the nominal money supply.
For various reasons I believe monetary expansion is superior, but regardless, both increase the money supply to establish monetary equilibrium. Both “print” money, in a sense.
@ Tim Carpenter:
Sorry if I came on as pedantic. It is probably a failing of age and erroneous assumptions.
“Savings” to me (and I had thought to most others) are what is left of the net returns for one’s efforts after deduction of consumption.
Now what one does with such “savings” does involve holding them as some form of asset, quite commonly Fiat Currencies (are there any other kinds), which are forms of credit assets, or even further, those forms of credits as a right to demand such currencies. But, that certainly is not the only form in which savings are held.
However, when you think about it, few would want to hold idle “money” (currencies) or accounts for same, much beyond anticipated but deferred consumption.
So, I think a case can be made that “investments” are comprised of “savings.” My guess would be that in normal (not “new normal’) times most “savings” do not reside in currencies, although much did reside in other forms of credits – Gone With the Wind.
Another juicy Hayek quote (courtesy of Lawrence White):
Were Hayek alive now, I firmly believe he would prefer monetary expansion. The “income stream”, to us Hayek’s phrase, actually did shrink in late ’08 and early ’09, and it is still well below its pre-recession trend. The real supply of money is still well below the demand for real money balances, i.e. there is monetary disequilibrium. Since money is one half of every transaction, a monetary disequilibirium is transferred to a disequilibrium in all other goods and services. That is the primary cause of the recession and its unusual depth.