Sorry for some delay in replying to your reply!

I guess the problem I have with your position is that it assumes that the central money issuing authority would be corrupt, since it is the nature of human beings to be so due to man’s fundamental will to power.

We try and address this in society by recognising our weakness and designing institutions to protect us from ourselves. A market is just an institution.

The problem is that even if free markets are used to issue and control money, someone still has to create laws, rules and definitions for these markets. I fail to see why the market governance institutions in a market fundamentalist economy would be any less prone to corruption than in any other system. By your argument, some people will always try to effect corruption to suit themselves

Furthermore, institutions that are necessary even in a market fundamentalist economy such as the police and law courts would by definition be relatively more powerful in a libertarian system than in a more centrist system since the number of officially chartered institutions would be relatively low.

One could perhaps argue that the market fundamentalist system is more resistant to chronic corruption, while being more at risk from complete failure, and thus less robust.

The trouble with this of course is that now we enter the areas of ideologies and politics. It seems to me that to subscribe to the assertions of austrian economics one must first make a number of assumptions about these matters before arriving at the purported benefits.

I heartily agree with you that it is ridiculous to believe that there is a natural business cycle of any length. I heartily agree with you that the only business cycle is that which is created by monetary policy shifts at the Fed. That is the whole point. If the Fed did not abuse the interest rates by lowering them below the market rates, the inflation/credit bubble could never get started.

I agree with you that the Fed should never, ever raise interest rates. By the same token, the Fed should never, ever lower interest rates. Interest rates are market phenomena. Fed policy is merely price controls in the financial markets and can only lead to the distortion of normal market incentives.

If you believe that economic phenomena, such as supply, demand and prices, are subject to immutable economic laws, then if there is excess demand, there must be either artificial price ceilings or artificially restricted supply. If there is an excess supply, it must be either an artificial price floor or artificially restricted demand. Some type of manipulation of markets is occurring.

Free markets tend to clear when prices and quantities are allowed to adjust. While a market is never at equilibrium, it always tends toward equilibrium. If markets are continually out of balance over the long term, then look for the laws and regulatory restrictions that are causing the disruption and remove them.

Minimum wage laws, agriculture bills, import/export restrictions, and on and on. Government never seems to run out of ways to impede rapid market adjustment. The massive stimulus bill has as it ultimate motive to prevent asset prices from falling from their absurd heights to an equilibrium level. We are in for a long, painful adjustment.

The economy will never adjust if it is prevented from adjusting. The Japanese central bank has followed a low or 0% interest rate policy for more than a decade and a half. Instead of stimulating growth, they were in recession for a decade and still only progress in fits and starts. If they would just let the market decide, the rates would increase, the Japanese banking house of cards would crumble, all the bad debt held for many years would be cleared and the economy would be free to assume a normal path.

Artificial liquidity injections at specific dosages will not prevent mis allocations nor could it solve insolvency.

While I totally understand the invisible hand of the market, price stickiness and people’s inability to correctly comprehend deflation (for example, they prefer a 2% raise with 4% inflation over no raise and 2% inflation) seem to lead to a reduction in economic activity EVERY TIME the Fed increases interest rates and constrains the money supply. These reductions have led to global recessions and financial crises, which cause much more trouble than any benefit.

Again, if we have excess unmet demand, and excess supply, what is constraining economic activity? The only business cycle I see is the one created by monetary policy shifts at the Fed.

I think there is some general confusion in discussions about inflation because there are different definitions of it. Inflation is the increase in the money supply, but it is also thought of as the general increase in prices in an economy.

If the money supply is held constant, a rise in prices of one set of goods must necessarily cause decreases in the prices of other sets of goods. The higher prices on one set means that there is less money left over to buy the other goods and the price of the other goods will decrease.

Without an increase in the supply of money, there cannot be a general, overall rise in prices. If the money supply does increase, there are more dollars with the same set of goods. On average, the prices of the goods have to rise. That is the observable inflation that we can see as consumers.

Inflation affects everybody, because everybody buys things. The money traders are more like speculators, hoping they can predict the price relationships between the different types of currency with which they deal. The monetary policies of the countries has a lot to do with the relationships, so their doing well or poorly depends more on their predicting policy changes rather than in the actual performance of monetary units, at least as speculators.

The hyper-inflation that you are talking about in African countries is caused by those countries creating massive amounts of money, inflation in the technical sense, which causes the inflation in the popular sense, the rise in prices. It is not a new phenomenon and is not limited to African countries. Germany followed the same course after WWI. It eventually took a wheelbarrow full of German Marks to buy a loaf of bread. Argentina went through it. Zimbabwe is being devastated by it now. It arises from government policy of using inflation to finance itself and is an insidious form of tax. As massive amounts of money are pumped into an economy, the value of each existing monetary unit declines rapidly. Normal incentives and markets are extremely distorted.

Unfortunately, no country is immune to it if they follow the same policies. If America follows the path it is on, it, we, will bear the same result at some point in the future. American politicians seem intent on setting us up for disaster.

In a free market, any amount of money is as good as another. There is no right amount of money. If the price of oil or labor or anything else increases, it will affect the prices of everything else. Given a constant money supply, there will be less left over and the other prices must necessarily decrease.

If prices are prevented from decreasing to adjust to the new market conditions, whether through minimum wage laws, regulations or price controls, the result will be unemployment of either people or resources. It is the regulation and price controls that cause the problem, not the supply of money. If you want to alleviate the results, you must remove the cause.

Also, is it necessarily inflation that is driving up the price of goods or does policy drive up inflation and the need for more money? If we are going to increase the minimum wage every couple of years it seems that it would be necessary to increase the amount of money in the market (supposing that the number of workers in the work force remains constant). Some might say unemployment has increased so we don’t need to pump more money in for a minimum wage increase, but unemployment will not remain high for forever and I have never seen a minimum wage decrease. Don’t these changes increase the need for inflation?

Ray

I think that the overall discussion is not so much Austrian versus Keynesian, but rather Austrian versus central planning. While Keynesianism is at the heart of many of the issues, other schools, such as monetarism, assume that someone in government should be in charge of making things work.

Mainstream economic thinking has, in most respects, become a repudiation of economic laws in favor of economic control by authorities. Central banking, minimum wages, price gouging laws and price controls, windfall profits taxes and on and on. You can find support for thousands of these policies in mainstream economics, even though they ignore the markets and the importance of prices and profits in directing economic activity.

There are a couple of related questions regarding money and banking : 1. Should there be a monopoly in the creation of money or should there be competition in money, and 2. Should banks be bound by the normal laws of society or should they be able to create money and profit from it by lending assets that don’t belong to them.

When Austrians promote a gold standard, I believe they are, at the root, really promoting a free market in the creation of money. The assumption is that, in a free market competition among competing currencies, gold would be the winner because it has all of the qualities that make a stable money that is less subject to arbitrary devaluation. It has, historically, been the choice of money where free people have been given the choice.

I have not read James Robertson’s proposal yet, but the middle ground you describe would maybe make it somewhat harder to inflate as rapidly. History shows, however, that money monopolies will always inflate because they benefit directly from it.

The only reason that it would be harder to inflate rapidly with what you describe is because it also includes the 100% reserve requirement for banks. That has always been an important issue in Austrians economics. New money can’t be leveraged to many times the original about by bank inflationary credit.

I am not sure what you mean by “most of the money supply bears interest and thus requires growth to remain stable”. The Fed carries out its interest rate policies by buying or selling government debt (and now toxic investment assets). The money itself, however, doesn’t bear interest. If new money wasn’t created, interest rates would be market rates under any monetary regime.

The whole idea that the system would make it easier for people in a democracy to affect whether policy should favor savers or borrowers is a very significant weakness. The markets are held hostage to the endless manipulation for political advantage. It is a similar weakness to the present system.

Democracy is not freedom in any sense of the word. In a free society, people participate by being a part of the market. They vote for what products and services they prefer with their dollars. The problems we are having at this very moment with the housing bubble and meltdown are the result of manipulation of the relationship between borrowers and savers.

Normal market signals would have raised interest rates years ago before the bubble began. Those signals would have favored savers and discouraged borrowers. That is, in fact, exactly what was needed. Instead, the central planners thought they knew better and favored borrowers at the expense of savers. Less money was saved as a result, and massive amounts were borrowed. The inevitable result was the bubble market.

The point is not finding a middle ground. It is rather to establish a monetary system that, to the greatest extent possible, lets markets decide rather than politicians and central planners.

It is a little long again, but I don’t know how to discuss it any more briefly. Please bear with me.

I believe that you are right that prices of some goods change in relation to the prices of other goods when there are supply and demand shocks. If the price of gasoline doubles, that means that people have less money left over for other goods. The prices of those other goods have to decrease, given a constant money supply. Those decreased prices will require sellers to reduce their various costs, including labor. If all we are talking about is just how money works, then that really is the whole story. Over time, the prices of all goods and services adjust to the new reality of supply and demand.

As you say, though, in reality, things are not that simple. There are minimum wage laws and long term contracts that everyone has to deal with, so let’s look at the implications. In the case of minimum wage laws, say the prices for the employer’s products go down. In order to remain profitable, wages must decrease. The marginal revenue product of each employee has decreased, so the marginal wage needs to decrease. If the employees were at minimum wage levels before the adjustment and the wages are now stuck above the marginal revenue product, the only alternative is to lay workers off.

The unemployment is not due to the lack of money supply. It is due only to artificial floors on wages. The other side of the coin is that employees in the industry that is doing well because of the high prices may get raises and have extra money. The businesses themselves have profits that add to the economy in other ways. The economy is never static. It is in a constant state of flux as it adjusts to shocks and to new technology and tastes. The lesson is not that money needs to increase, but rather that government needs to quit manipulating supply, demand and prices for goods, services and wages, and just let the markets adjust as they need to. It is the manipulation that causes the unemployment, not the markets themselves.

In the case of business contracts, one of the purposes of contracts is to mitigate risks of things that will happen in the future. While both sides would presumably profit from their agreement at the time it was made, any time there are changes in prices or conditions, it may hurt one side or the other. Being an entrepreneur is inherently risky. Those that are able to predict customer demands and market conditions better than others will be more profitable. If a company commits to a long term contract and later is badly hurt by rising or falling prices, the other side is that someone else is helped by the rising or falling prices of the same commodity. Inflating the money supply to help those who had bad judgment only introduces moral hazard and distorts the markets, so that successful entrepreneurs will not be able to predict as well. The manipulation only helps the political entrepreneurs who try to use government to their advantage, and to the disadvantage of everyone else. That is our current stimulus package being discussed by our political entrepreneurs and politicians.

With regard to the tech bubble, think about the violently displacive technology. Where did it come from? Someone had to develop the various technologies to make it work. If the money supply remained constant, where would those entrepreneurs have to get their capital to build and develop? It would come from savings, wealth that people actually possessed, wealth that represented people’s prior production. It would be in limited supply and as that supply was used, interest rates would rise.

If the financial markets had actually been allowed to work, interest rates would have reflected savers’ and investors’ and entrepreneurs’ actual preferences. Rates would not have been artificially lowered to induce credit expansion. The higher rates would have induced more people to save, creating a greater pool of actual wealth to invest. The higher rates would have prevented foolish dreamers from believing that money was cheap so they might as well go for it. Higher rates would have put the brakes on explosive growth in a natural way that would not have caused distortion and dislocation.

The way that it did work, for the tech and housing bubbles, and every other credit inflation bubble, is the Fed artificially lowered rates through open market operations, making vast new reserves for the fractional reserve banking system. Because a bank only has to keep, at most, 10% reserves, for every dollar of reserves that the Fed created, the banks created ten more dollars of new money by lending out demand deposit money that was owned by someone else.

The easy credit, low interest rate policies encouraged entrepreneurs to jump in head first When investors saw the increase in prices of financial assets, due to credit expansion, they took money from savings and plopped in into the stock market. Why earn a measly few percent on your savings account when you can earn 30% playing the market. I remember people saying “why pay off our credit cards. We are only paying 15 or 18%. We can take our cash and make 30% on the market. Even those businesses without a business plan could get millions of dollars to play with. It was an incredible time. I could only shake my head in wonder.

The explosion of the technology markets had nothing to do with the inherent economics of saving, investing or technology. It had everything to do with artificially low rates and rapid expansion of money and credit. Without the expansion of money and credit, there would not, could not, have been the stock market bubble.

Without the artificially low rates and the expansion of money and credit, there would not, could not, have been a housing bubble.

As we agreed at the beginning of this discussion, with a constant money supply, an increase in the price of one thing is offset by a decrease in the price of other things. In the housing market, if the price of housing increased, the price of everything else should necessarily have decreased, because housing is such a large expenditure. Without new money, mortgage interest rates would have been driven up as the pool of savings that supported it started to dwindle. The high rates would have put the brakes on the bubble before it got started. That did not happen because money and credit expansion worked with the incentive of artificially low mortgage rates to induce irresponsible buyers to engage in a bidding war in a game of “who is the greatest fool.”

In the discussion of time value and half life, the issue is that it is not money itself that has a time value, but rather wealth that has a time value. Money is only a representation of wealth that someone has accumulated. If you were going to inherit a million dollar mansion from your rich uncle, would you rather receive it today or would you rather receive it 10 or 20 years down the road? Today, of course. That is time value.

It happens that we often think in terms of money, because that is the most tradable form of our wealth. There is nothing special about money, though. The implications of what you are saying is that all of our wealth should have a half life just because we would like to receive it now rather than later.

The short answer is no, neither money nor any other form in which we hold wealth, should have a half life. Our wealth will change in value, depending on economic conditions, but it is not right that our wealth should be systematically decimated because we tend to prefer to have any good now rather than later.