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Wednesday, March 27, 2013

Inflation vs Deflation IX

Nate posts his first post-Cyprus response:
It is with no small amount of sadness that I must now face the fact that I am not going to get out of this debate without having to explain mal-investment.  It appears in order to counter Vox's deflation via credit reduction claim... it is absolutely necessary.

Ok so M1... TSM2... Z1...  what is it?

As I stated before...  you've already answered that question for yourself.  Vox can write poetic and convincing lines about the esoteric nature of credit money... and he can explain how the paper just represents a claim on this or that...  and none of it will change the fact that when you hear about what's going on in Cyprus... you have a primal urge to run to the bank and get all of your cash out.  You want the cash.

That's because the cash you want is money.  For now.

The debit card is very convenient.  No question.  But by now you are probably looking at it with much more cynical eye than you were a month or so ago.  Good.
Read the rest of it there.

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86 Comments:

Anonymous Noah B. March 27, 2013 1:22 PM  

What does Kristin have to say about this?

Blogger Nate March 27, 2013 1:26 PM  

She thinks its I'm stupid because everyone knows that my poop factory would create all kinds of jobs.

Duh.

Anonymous Salt March 27, 2013 1:30 PM  

That's because the cash you want is money.

Right. The kind that can't evaporate, or be frozen, at the keystroke. The other kind can. They both spend the same.

Anonymous Porky March 27, 2013 1:34 PM  

Are you hiring, Nate?

Blogger Nate March 27, 2013 1:41 PM  

"They both spend the same."

Yes. They do. Which is why I said TSM2 and not just M1. I explained that in the first part of the debate.

It absolutely would be deflationary if a bank up and disappeared.

Anonymous dh March 27, 2013 1:53 PM  

It absolutely would be deflationary if a bank up and disappeared.

What is this related to? I didn't catch this in the very beginning either.

Anonymous Toby Temple March 27, 2013 1:57 PM  

I await Vox's response.

And I must admit. I never thought that a blog post with so much .... would be so powerful.

Anonymous Salt March 27, 2013 1:59 PM  

It absolutely would be deflationary if a bank up and disappeared.

Same for consumer credit defaults and EDU loans, which last I heard had topped one trillion and still rising.

Blogger Conan the Cimmerian, King of Aquilonia March 27, 2013 2:00 PM  

This has been one of the better (perhaps best) debate/blog back and forth seen in these parts.

It is appreciated by one who is interested but obviously not as well versed as the two of you.

Blogger JaimeInTexas March 27, 2013 2:02 PM  

"It absolutely would be deflationary if a bank up and disappeared."

Only if money in its reserve also goes.

A thought just occurred to me. Credit is like light, that exhibits particle and wave properties. Credit, to me, is not money, but it can be used like money in that it is an asset that can be "carried" in the form a currency/certificate. It is "money" for bartering currencies.

Anonymous Porky March 27, 2013 2:05 PM  

Remember weeks ago when I said you'd have a hard time defending your assertion that governments don't create money?

That.

That's the corner you are painting yourself into, unless you've got some exit strategy I haven't seen.

Anonymous Salt March 27, 2013 2:07 PM  

Nate, how do you account for the specialty situation involved in Weimar's hyper-inflation -

From Wiki -

Beginning in August 1921, Germany began to buy foreign currency with Marks at any price, but that only increased the speed of breakdown in the value of the Mark.[9] The lower the mark sank in international markets, the greater the amount of marks were required to buy the foreign currency demanded by the Reparations Commission.

I'm not up on Zimbabwe so I'll not go there.

Blogger Nate March 27, 2013 2:08 PM  

"What is this related to? I didn't catch this in the very beginning either."

Vox is going to use that scenario to take you some where. It would be... almost cheating... of me to take you there first.

Some of Vox's traps can be disarmed. Some of them... you just have to armor up and walk right through.

Blogger Nate March 27, 2013 2:12 PM  

"Nate, how do you account for the specialty situation involved in Weimar's hyper-inflation -"

Why do I need to account for a special situation?

Did I not just provide you with 56 examples of credit money systems being Hyper-inflated?

Or are you suggesting that they aren't actually Credit Money systems?

Blogger James Dixon March 27, 2013 2:14 PM  

> A thought just occurred to me. Credit is like light, that exhibits particle and wave properties.

I made this analogy in one of the early threads, but it had already been abandoned. :(

Yes, the fiat/credit nature discussion of money is a lot like the wave/particle nature discussion of light.

Blogger James Dixon March 27, 2013 2:17 PM  

Oh, and since the discussion has reached title IX, does this mean Kristin gets to join in on the conversation?

Anonymous Salt March 27, 2013 2:24 PM  

Did I not just provide you with 56 examples of credit money systems being Hyper-inflated?

Yes, you did. Looking over the list I notice what appears to be, and I'll take the leap here, in all cases National political turmoil, even to the point of revolution or governmental collapse. Even France, 1796, was in The Terror.

Makes me think that when one perceives the end of the EU experiment and an imminent return to the Lira, Drachma, Mark, etc, the EURO will be dumped so fast it too could be hyper-inflationary on its road to oblivion.

Anonymous patrick kelly March 27, 2013 2:27 PM  

Vox Popoli ..... what a blog.... where else can you find drawings such colorful rabbits and dive into discussions like this one.....?

Blogger TontoBubbaGoldstein March 27, 2013 2:29 PM  

To put it simply (and please correct me if I am wrong):
If the banking sysyem collapses (speaking of the US banking system, for simplicity), the FDIC will kick in, paying depositers with newly created real money, thus increasing the supply of money---which is inflation, by definition.
That banks failed and depositers lost their money during the Great Depression is why we did not have inflation then....

Blogger JaimeInTexas March 27, 2013 2:38 PM  

TontoBubbaGoldstein: Only if the debt is not monetized?

Blogger James Dixon March 27, 2013 2:42 PM  

> ...the FDIC will kick in, paying depositers with newly created real money

If the banking system actually collapses, the government doesn't have anywhere near enough money to cover it.

What they may do is open government run banks that take over the insured deposits from the failed banks. But honestly, no one has any idea what will happen.

Blogger TontoBubbaGoldstein March 27, 2013 2:55 PM  

If the banking system actually collapses, the government doesn't have anywhere near enough money to cover it.

My point, exactly.
The depositers will get their FRNs, though....and when you scrape away all the jargon and obfuscation, it will come down to the government creating FRNs out of thin air. End result...inflation. Lots of it.

Blogger James Dixon March 27, 2013 3:11 PM  

> ...it will come down to the government creating FRNs out of thin air.

Entirely possible, yes. Right now they're doing so by having he Fed be the lender of last resort. If it reaches that point, the Fed will be bankrupt too, and they'll have to change the law and take the right to print money back in house. In that case, the sky's the limit for the printing presses.

That's honestly what I expect to happen should the Fed refuse to keep lending money.

Blogger Nate March 27, 2013 3:12 PM  

"Yes, you did. Looking over the list I notice what appears to be, and I'll take the leap here, in all cases National political turmoil, even to the point of revolution or governmental collapse. Even France, 1796, was in The Terror. "

Yes.

Yes indeed.

Anonymous Porky March 27, 2013 3:12 PM  

Salt: "Looking over the list I notice what appears to be, and I'll take the leap here, in all cases National political turmoil, even to the point of revolution or governmental collapse. "

If you look at South America you'll find that it was simply greedy governments. Governments know that they can reap huge seignorage profits by printing and as the rate of inflation increases so does their profit margin. This is mitigated by a decreasing tax base which is why you currently see such a grab for increased tax revenue here.

Anonymous zen0 March 27, 2013 3:32 PM  

Interesting development in the Cyprus Euro front. ZH is arguing that the capital controls make a Cyprus Euro worth 91% of a "real" Euro. This is degradation of the money and therefore inflationary. Similar to printing money.

It is the same pattern that developed with gold, where the more worn gold coins made their way to the peripheries of the realm (or so I was told).

Anonymous Peter Garstig March 27, 2013 3:37 PM  

Housing was 1 example Vox gave.

Now, Nate, he gave 2 others and I'm sure there are countless more. What state are we in with those?

Don't let it out now.

Blogger Original George (There can be only one!) March 27, 2013 3:38 PM  

Just out of curiosity...and I am being serious. If you take your cash out Nate what is to keep them doing to you/us like they did in the Soviet Union, that is making Greenbacks illegal in 10 days and issuing a new currency called the Bernanke that is valued just sightly less than 75% of the dolla? Make you want to holla. Net effect is the same Da?

Blogger Nate March 27, 2013 3:48 PM  

O.G.

Nothing.

That's why I said the cash is money... FOR NOW.

Blogger Original George (There can be only one!) March 27, 2013 3:52 PM  

Yea...for now. Gottcha. I am getting this sinking feeling.

Will trade 40 cal hollow points for food I think.

Well ...actually since I have the ammo ...I think I can get the food.

Anonymous Vidad March 27, 2013 4:22 PM  

Nate proposes an entire industry based on "busting ass."

Who would've thought?

Anonymous Ferd March 27, 2013 4:23 PM  

Every time i go to the bank they want to see my debit card! I then have to explain the DC is spawn of the Devil. They look at me with mild disdain. I suppose "real" money will be gone in the next decade.

Anonymous The One March 27, 2013 5:06 PM  

http://cnsnews.com/news/article/cdc-110197000-venereal-infections-us-nation-creating-new-stis-faster-new-jobs-or

110M STD in America out of a population of how many adults?

Blogger TontoBubbaGoldstein March 27, 2013 5:44 PM  

110M STD in America out of a population of how many adults?

"Trick question. Not enough info to determine the Standard Deviation...."
---Kristin (Double major/Euro-traveller/butt of VD jokes)

Blogger Nate March 27, 2013 6:16 PM  

i had no idea kristin was starting a meme.

Anonymous Noah B. March 27, 2013 6:19 PM  

"Just out of curiosity...and I am being serious. If you take your cash out Nate what is to keep them doing to you/us like they did in the Soviet Union, that is making Greenbacks illegal in 10 days and issuing a new currency called the Bernanke that is valued just sightly less than 75% of the dolla? Make you want to holla. Net effect is the same Da?"

I've been saying this for a long time too. There is absolutely nothing that is safe from the hopelessly corrupt and lawless politicians.

Just like a bank could go away overnight, your cash could be declared worthless overnight, too, by government fiat. Such a move would effect far fewer people than raiding bank accounts, and the government could attempt to justify it by saying that people who hoard cash are responsible for putting our entire economy at risk.

The main downside from the regime's perspective is that such a move would probably do great damage to consumer confidence and international confidence in the dollar, but it's always possible that one of these idiots could see the opportunity to punish currency hoarders as worth the risk.

Anonymous Noah B. March 27, 2013 6:20 PM  

affect

Anonymous Ahmed March 27, 2013 6:26 PM  

WTF is CNN BREAKING NEWS talking about Stupid-ass Syria?

Possibility of futures in skunky-smelling some-sorta pantaloons?

Anonymous Other Josh March 27, 2013 6:49 PM  

NOAH B. How would the countries react who have significant dollar holdings?

... head down, go to sleep to the rhythm of the war drums

Eh. It's obvious World War III is 10 years away or less. Bring it on.

Anonymous Inane Rambler March 27, 2013 7:29 PM  

"Eh. It's obvious World War III is 10 years away or less. Bring it on."

What would the trigger for this incredibly unlikely event be anyways?

Anonymous zen0 March 27, 2013 7:34 PM  

Ferd boasts:

Every time i go to the bank they want to see my debit card! I then have to explain the DC is spawn of the Devil. They look at me with mild disdain.

Geez, Ferd. Ever heard of keeping a low profile? It's part of the "hard target" bag O' tricks.

Anonymous map March 27, 2013 7:45 PM  

I've been reading this debate sporadically, but I think I have the gist of what is going on. Let me see if I can cut this gordion knot.

Let's assume you have a cash-based economy. People work and save and only buy items that they have the cash money to pay for. No credit exists in such an economy.

Let's also assume that the general price level of this cash-based economy is increasing.

Given the facts above, of a cash-based economy and a generally increasing price level, what can be reasonably assumed about this increasing price level?

See, prices can be increasing for two reasons: the first reason is a debasement of the currency, what everyone on this blog seems to be talking about. The second reason is simply having too much money chasing too few goods. People want stuff, they have disposable income, not enough product is being produced, so prices go up as people bid up the value of the existing units.

How does one interpret which effect is taking hold when observing generalized price increases in a cash-only economy? You look to real wages. That is, if your income is rising faster than the general price level, then this indicates too much money is chasing too few goods. This means the economic circumstances are deflationary. If, on the other hand, income is rising slower than the general price level, then this indicates a debasement of the currency. Producers are putting in a price premium above the market-clearing rate because they are concerned about the value of the dollars they are being paid in.

It is not enough to simply observe the general increase in nominal prices and conclude that this is inflationary. A weighting factor is needed, just like a "good" salary depends on what the cost of living is.

Next, let's include a a credit-based economy (in a new post.)

Anonymous zen0 March 27, 2013 7:45 PM  

I hear tell that in the Weimar inflation situation, pianos became a medium of exchange. That got me to thinkin' that in Amerika, guitars would serve the same purpose, as well as other easily transportable acoustic musical instruments.

So along with ammo and other assorted commodities, I say acoustic musical instruments will prove to be a good investment. Homeland security is too dumb to think of buying up all the musical instruments.

People want music, not matter what the circumstances. Plus, it would probably be a big improvement, tribally speaking.

Anonymous Porky March 27, 2013 7:49 PM  

What would the trigger for this incredibly unlikely event be anyways?

Something like a 19 year old Yugoslav malcontent with a cheap pistol?

Blogger tz March 27, 2013 8:15 PM  

Some people are worried about terror drone blimps but I think the threat is inflated.

Vox and Nate have reached the final level. The key is "mal-investment", or as I termed over @PGGB, zombie investments. What is the FASB (fraudulent assessed silly basis) acceptable value these zombies have on the books of the various institutions?

(I really need to redo Stephen King's Sale of the Century, was it? The antiques that only cost a soul?).

Caveat lest your wallet be empty. Or end up with nothing of value.

Anonymous NorthernHamlet March 27, 2013 8:32 PM  

Nate (and Vox),

Forgive me if this question from another thread wasn't just overlooked, but is naive; it has been on my mind a lot so I was hoping someone more informed than I could help me with it.

Are there any positive aspects from a foreign policy perspective for the United States during recession/depressions or upon exiting them, thus making their timing important from a larger perspective? I am interested in this in regards inflating bubbles, etc.

Thanks.

Anonymous map March 27, 2013 8:36 PM  

Credit based economies re typically based on a fractional reserve system. This means that a lending institution is required to keep some fraction of depositors' money in reserve, usually 10-20%. So, for every $10,000 deposited, a bank can lend out $8-9,000.

Now, contrary to what people think, fractional reserve banking does not counterfeit or create money out of thin air. Money is usually lended against collateral that is typically a productive asset: unsecured income of an individual, a secured asset, both, etc. The result of lending creates a note that is itself an asset that can be borrowed against or sold, thus making money for the bank.

For example, A deposits $10,000 into Vox Bank. Vox Bank then lends out $8,000 to B at 6%. The loan to B of 6% becomes a note and thus, an asset, for the Vox Bank. This note can be held until maturity, sold to another entity, or borrowed against. Thus, if A wants to withdraw his $10,000, Vox Bank can make A whole by selling or borrowing against the note, like borrowing from the Federal Reserve at 0.5%.

Now, let's look at a situation where real wages are rising. The price level is rising but wages are rising faster. People are flush so they can borrow, which causes the price level to rise faster. Because this is a deflationary situation, borrowing and lending are done against quality assets and the system just hums along, even if real wages remain stagnant.

What happens when currency debasement occurs? Currency debasement calls into question the value of the notes being generated. The present discount value of a fixed-income security of $8,000 compounding at 6% is no longer formulaic because the investor is being paid in progressively cheaper dollars.

Because currency debasement is unpredictable, the value of these notes becomes unpredictable. Rather than risk a mispricing that costs money, lending effectively stops, as entities refuse to buy these particular notes. Credit market then seize and the acceleration of demand caused by borrowing stops.

(Incidentally, this is why the Fed is monetizing debt. It does not want credit market to seize so it is shoring up the value of those notes. Trouble is, lending gives way to hoarding of the dollars the Fed is giving out.)

This can have a massive deflationary effect. Let's say 50% of all transactions are done in cash and 50% are done in credit. If credit market seize, then 100% of all transactions need to be done in cash. To emulate the economic effects of pulling demand forward in a cash-based economy, prices would need to drop radically if the volume of business transactions needs to be maintained.

Thus, Vox is technically correct.

As for hyperinflations occurring in credit-based economies, keep in mind that extensive consumer credit of the kind that exists today is very new. The German hyperinflation did not involve extensive use of unsecured credit that exists in perpetuity.

Anonymous zen0 March 27, 2013 9:24 PM  

map opines:
If credit market seize, then 100% of all transactions need to be done in cash

But, as in Cyprus, if cash is restricted by capital controls, then what?

Both your scenarios are naive.

Blogger Nate March 27, 2013 9:27 PM  

Map... you've got the basics but you're missing a very important part of the equation... one that Vox has mentioned but is choosing not to focus on.

Long story short... there is a point I am trying to force Vox to make... so I can then beat him over the head with it.

Blogger Nate March 27, 2013 9:29 PM  

"The German hyperinflation did not involve extensive use of unsecured credit that exists in perpetuity."

And the 55 other examples?

Again... is your point that they were NOT credit systems? or that they were not hyper-inflation.

Those are your only options at this point.

Anonymous Van March 27, 2013 9:32 PM  

Nate -

Kristin asked me to tell you she learned a little French on her trip to Europe. Even though it's pronounced like "meme," it's spelled memere. It means grandmother.

Blogger Nate March 27, 2013 9:33 PM  

"Are there any positive aspects from a foreign policy perspective for the United States during recession/depressions or upon exiting them, thus making their timing important from a larger perspective? I am interested in this in regards inflating bubbles, etc."

If you're suggesting that its possible that they could deliberately inflate bubbles so that the nation would be in a recession at a given time... then be recovering in a given time... to position itself to better deal with its enemies... I'm going to say...

1) That's insane.
2) They can't control the thing well enough to accomplish anything predictable... much less something as complicated as what you're suggestion.
3) That's insane.
4) How long a bubble takes to burts is all but impossible to predict. The housing bubble lasted for 20 years... and we all thought it was about to burst any minute for the last decade of that. Contrast that with the dot com bubble that only lasted a few years a popped very suddenly. Recovery can be very very short... or take decades. There is just no way to predict this stuff in such a way to make it useful.
5) That's insane.

Anonymous zen0 March 27, 2013 9:37 PM  

Northern Hamlet agonizes:

Are there any positive aspects from a foreign policy perspective for the United States during recession/depressions or upon exiting them, thus making their timing important from a larger perspective?

If I may. The track record of the U.S. suggests that only a Fallout Four Live scenario would possibly result in a slightly reduced military presence around the world.

Yes, it would be desirable economically, but no, it will never happen.

Anonymous map March 28, 2013 12:33 AM  

Zen0

"But, as in Cyprus, if cash is restricted by capital controls, then what?

Both your scenarios are naive."

Presumably, you mean cash is unavailable to use at all, or cash cannot leave the country?

If cash is unavailable, then the economy collapses, unless merchants and workers are willing to accept personal guarantees and IOU's to conduct business. I don't see that happening because of first-mover disadvantages.

I don't see how my scenarios are naive. All I am illustrating isa credit-based economy can lead to deflation if the government debases the currency.

Anonymous map March 28, 2013 12:38 AM  

Nate -

"And the 55 other examples? Again... is your point that they were NOT credit systems? or that they were not hyper-inflation. Those are your only options at this point."

My point is that they were not credit-based economies to the extent the USA is a credit-based economy. These were traditional hyper-inflations, right down to the printing of bills with large denominations and having to buy products with wheelbarrows full of money.

A similar scenario today would have a huge deflationary effect because credit markets would cease to function and the economy would be forced to move to cash. Prices would drop to accommodate that move.

Anonymous map March 28, 2013 12:48 AM  

""Are there any positive aspects from a foreign policy perspective for the United States during recession/depressions or upon exiting them, thus making their timing important from a larger perspective? I am interested in this in regards inflating bubbles, etc."

Actually, there aren't because America is in a unique position.

To understand this, one needs to realize that the world economy is built on mercantilist and not free-market principles. This means that nations focus on export led growth while restricting imports. America rebuilt Japan and Germany as the first mercantilist countries. Since then, the rest of the world has followed suit.

There is, however, one problem. If everyone is exporting and no one is importing, then who is buying all of the exports? The nation that becomes the importer of last resort, wins, because it anchors the entire world economy.

In effect, the US trade deficit is not really a deficit of any kind. It represents tribute that the US receives for bottlenecking the world economy. No nation can move from this prostion because no other nation will import the output that was earmarked to the United States...unless it is heavily discounted and subsequently sold to the USA.

We are the hub of an international network of tributary economies that have nowhere else to move their output. Predicting inflation/deflation for the US is almost impossible. What can be predicted is a lot of volatility.

Anonymous Anonymous March 28, 2013 1:18 AM  

The Euro and Yen are now percieved as on the edge of the ash bin of history. Supply and demand for safety fortells a higher price for the US dollar... and negative Swiss Franc interest rates... hence deflation in the US for Walmart instock items. This seems easy enough for even I to grasp.

The Fed is in a political pickle with Congress as it is so how now could they ramp up even more to satisfy this new global demand is beyond me and on top of that how could they send it abroad with a contracting import trade balance.

On the other hand, would not a global depression reduce demand for US dollars??? Yes/No inflation/deflation.

Credit vaporation in spades seems to be the new watch words now that it is out in the open that the rule of law will be upheld on Euro banks as to who suffers the losses... it wont be the printing presses (hmm which contradicts my whole thesis above). The bailout kick the can days are over. Everyman for himself... women and children last... as it should be.

And Santelli says gold is now paper so why not just own good portable paper... by the pound... like Helicopter Ben said all along.

Anonymous Ferd March 28, 2013 1:25 AM  

How will the North Korean banking system fair when the World System erupts into lovely but awful fireworks? Pugsley's regime is well isolated as it sits now. Might it be the last refuge for survivalists?
We could all learn to like kimchee, i suppose.

Anonymous zen0 March 28, 2013 4:22 AM  

Background noise:
And Santelli says gold is now paper

No he did not.

Anonymous Inverter March 28, 2013 4:50 AM  

thanks

Anonymous Other Josh March 28, 2013 9:50 AM  

Inane Rambler,

Look at the geopolitical trends occuring in the European Union and in Asia. They are converging towards economic depression & unrest. That is the recipe for war.

The EU will drive Europe towards war. Their hand is too heavy, too oppressive. The return to nationalism is rising.

In Asia, look at the developments in Korea, China, and Japan. Conflict is rising. Economies are sinking.

In America, the idiot war hawks are utilizing a slow, steady strategy that will ultimately put the US at war with Iran. The effects of this military action will extend outside of the middle east.

It's all about trends. The world's pendulum swings towards times of peace & prosperity or towards hardship & war. We are not moving towards peace & prosperity.

Anonymous Slowpoke March 28, 2013 11:44 AM  

I am surprised no one mentioned the BRIC countries creating a replacement for the world bank/IMF, complete with trade agreements in native currencies instead of dollars. If they follow through that will lower demand for dollars; and even I know that will be inflationary for the dollar.

Anonymous Jack Amok March 28, 2013 12:47 PM  


Nate's highlighting of mal-investment is quite important, but in the long run, it actually helps Vox's case.

Let me reask a question I asked a while back. Suppose 10% of the dollars in circulation were found to be counterfiet. Would that be inflationary or deflationary? I assume Nate sees the trap (well, he does if he remembers a plot point he made back in chapter 1 or 2 of this debate).


Anyway, I expect dollar-denominated deflation but wouldn't be shocked by inflation, so I consider the nominal debate here not terribly interesting. But the actual debate is extremely useful and the process of working through what might happen and why is probably far more illuminating than a four year Econ degree.

Well, buying one of Nate's sculptures de merde would probably be more illuminating than studying four years of Keynesian economics, but you get the idea.

Something like a 19 year old Yugoslav malcontent with a cheap pistol?

You can perhaps characterize a FN Browning model 1910 as inexpensive, but I don't think anything John Moses Browning ever designed could be called cheap.

Anonymous Asher March 28, 2013 5:02 PM  

I guess the real question seems to be "what do we mean when we say inflation?". On Nate's blog he claims that prices have gone up for everything except real estate. Is that really the case? Prices seem, to me, to be going down for all sorts of manufactured goods, cars and electronic good being two off the top of my head. Further, if wage is just another price of some "thing" then hasn't that particular price been stagnant for quite awhile?

Prices also seem to be stagnant for all sorts of services, as well. My wife is an LMP, non-practicing, and the rate for a assembly-line type massage shop is pretty much the same as it was years ago, when she got out of the business. Nails, hair, babysitting ... don't see much change where I'm at over the past several years. That certainly doesn't seem to jive with inflation.

My assessment is that the primary cause of general increases in dollar, or whatever currency, denominated general price increases is a lost of confidence in the ability of the issuing central government to retain sovereignty, at least in the manner it's been functioning. Price increases are just an effect of that loss of confidence.

A couple weeks ago I pointed Nate to a study that central banking uniformly arises quickly after the formation of a modern nation-state. I challenged him to explain why people accept such things as the formation of fractional reserve banking leading to currency backed by nothing more than the faith and credit of the central government. His response was nothing more than "people are stupid".

Well, the entire "people are stupid" reasoning has been a core feature of leftist positions involving an enlightened, benevolent government nudging them in the directions that promote the public good.

No, there is a cause and effect reason, besides stupidity, that explains the rise of central banks, fractional reserve banking and, finally, unbacked currencies. Nate needs to offer an explanation as to why this happens that doesn't involve "people are stupid", because that's just handwaving.

Anonymous Asher March 28, 2013 5:13 PM  

Let me quote the libertarian economist Bryan Kaplan:

What I deny is that the artificially stimulated investments have any tendency to become malinvestments. Supposedly, since the central bank's inflation cannot continue indefinitely, it is eventually necessary to let interest rates rise back to the natural rate, which then reveals the underlying unprofitability of the artificially stimulated investments. The objection is simple: Given that interest rates are artificially and unsustainably low, why would any businessman make his profitability calculations based on the assumption that the low interest rates will prevail indefinitely? No, what would happen is that entrepreneurs would realize that interest rates are only temporarily low, and take this into account.

I may have missed it but that quote is over ten years old and I've yet to see it addressed by adherents of Mises. Presumably, possession of significant capital denotes some level of shrewdness. Therefore, doesn't it make sense that investors calibrate their investment decisions based on the assumption that interest rates will rise?

But there definitely seems to be malinvestment, so, that would indicate that we need to look for another source beyond merely the central banks keeping rates too low. I'd be really curious to know what percentage of the disappearance of wealth was experienced by investors compared to their profits during the boom years. What it looks like to me is that low rates coupled with the general sentiment that the government would just step in and make everything better should a black swan event occur is the culprit. It seems that a large portion of the wealth loss was experienced by individuals who are not in the investor class and who wouldn't have the foresight to account for eventual increases in rates.

Anonymous map March 28, 2013 6:29 PM  

Asher -

What is Bryan Kaplan talking about? The businessman is forced into a binary decision. If interest rates are going to go up and how much they go up is unpredictable, then the only solution is not to invest. Meanwhile, idle cash is losing value, both in real terms and in opportunity cost.

In fact, according to Kaplan's logic, lending at interest should not exist either. After all, why bother using interest rates and collateral requirements to make whole on a risky borrower? Why issue any unsecured credit cards at all with interest rates of 21% or more? Why not just wait for the ideal borrower to walk through the door of the bank and simply lend him money? Because the ideal borrower may not show up, just like the ideal interest rate environment for business may not show up. What is left is a probability distribution of business investments that is similar to a probability distribution of risky borrowers.

Anonymous NorthernHamlet March 28, 2013 6:40 PM  

Thanks for Nate and everyone else for their responses to my question.

Anonymous Asher March 28, 2013 6:53 PM  

@ map

The businessman is forced into a binary decision. If interest rates are going to go up and how much they go up is unpredictable, then the only solution is not to invest. Meanwhile, idle cash is losing value, both in real terms and in opportunity cost.

The investing/consuming decision for any particular dollar is binary no matter the interest rate. I'm not sure what your point is, here. If rates are well-below historical averages then it's entirely predictable that they will rise. It's doubtful that a period of below-average rates is going to affect that long-term profitability of projects in real terms.

according to Kaplan's logic, lending at interest should not exist either. After all, why bother using interest rates and collateral requirements to make whole on a risky borrower?

I have no idea what you're talking about, here but I'm certainly willing to hear you out if you want to explicate it. This is just an unsupported assertion, at this point.

the ideal borrower may not show up, just like the ideal interest rate environment for business may not show up.

And here's where the flaw in your reasoning ends up. You are looking at the invest/not invest decision as if all investment in an economy is one indivisible bloc. It's not. the invest/not invest takes place at the margins. Some investments are still going to be profitable even at rates of 20 percent. The "ideal" rate on the borrower's side is zero for any investment, regardless of how lucrative. Let's say I have an investment that will produce a 20 percent ROI after interest payments on debt at 5 percent. Now, let's say that I get a 10 percent ROI after interest payments on debt at 7 percent.

In both scenarios I will still borrow to make the investment because both scenarios give me a real ROI. That I would rather be paying a lower interest rate and receiving a greater ROI is irrelevant to whether or not I make the investment.

Your entire argument ignores marginal analysis.

Anonymous Asher March 28, 2013 7:05 PM  

@ map

I don't dispute the possibility of malinvestment but it requires more than just low interest rates and monetary policy by the central bank. Let's say that the government decides to open a department of paper clips in the rural reaches of northeast Washington (the state). It pays a builder to build a large complex and employs thousands of government workers. Very quickly a network of private businesses spring up around that complex to feed, clothe, etc. those government workers.

Now, let's say that ten years later the government decides to close the department of paper clips due to budget constraints. At that point, the entire network of private businesses built up around that government complex is likely to collapse and the entire locale becomes a ghost town.

Now, it is entirely plausible that every privately-funded project in that area produced a net positive ROI, given the cheapness of land and labor. However, the contribution of that locale to GDP is gone and all of that plant is unused. Is this malinvestment? Looks that way to me. However, each private project has had a positive ROI, so where does the loss from the malinvestment get measured?

It can't be in the balance sheets of private individuals, as they all were profitable. The answer? The taxpayers foot the bill via the department of paper clips, since government doesn't have a market-driven balance sheet or income statement.

So, yes, malinvestment can occur. But Mises is simply wrong that it's the product of monetary policy - it requires significant regulatory and fiscal policy as well.

Anonymous Asher March 28, 2013 7:11 PM  

One thing that's really bizarre about VP is the slavish devotion to Mises and Rothbard. Mises stuff was mostly written prior to the 30s IIRC. Nate seems to think that his stuff is really dense and complex. It's not. I've looked at it and I've handled much more complex writing.

Just off the top of my head there are probably 50 living libertarian-type economists with Vox-level IQs who are quite aware of Mises and have glanced over the Misean theory of malinvestment. They don't buy it. I'm going with them over one guy writing about a century ago.

Anonymous Asher March 28, 2013 7:18 PM  

@ map

There are three types of arguments that have the appearance of an argument but are not:

A) People are evil
B) People are stupid
C) People are crazy

None of these are the basis for rational argument and if you find someone using them then they are just engaging in handwaving. Nate's position on the existence of central banks in modern nation-states meets two of these three types of pseudo-argument. He thinks that central governments are evil and that people are stupid.

Here's the problem: let's say he's right. If he is then everything is hopeless because government will always be evil and people will always be stupid and nothing can ever change. It's an argument that defeats itself because it can be equally used to promote opposing conclusions - at least the stupid part of it.

Anonymous Asher March 28, 2013 7:48 PM  

@ map

A few weeks ago I made the claim to Nate that central banking and fractional reserve banking is an inevitable effect of the formation of the modern nation-state. I don't claim that I can definitively demonstrate this but I think the evidence of the rise of a central bank quickly following the formation of every modern nation-state is evidence that this is a very likely explanation. Nate didn't really have an answer to this and just left the conversation.

Let's just say that the theory of malinvestment, as promoted by Mises, is correct. However, let's also say that my theory of the inevitability of central banking is also correct. What that means is that Mises theory is powerless to affect change and I get the distinct impression from my ample reading of the history of ideas that an theory that is "true but powerless" wasn't all that true to begin with.

So, central banks are always going to exist and always going to implement policy that will always cause malinvestment. Great! An unuseable theory. Next, please!

Anonymous map March 28, 2013 8:57 PM  

Asher -

Let's step back for a moment and focus on interest rates, specifically, this portion of Bryan Kaplan's argument:

"The objection is simple: Given that interest rates are artificially and unsustainably low, why would any businessman make his profitability calculations based on the assumption that the low interest rates will prevail indefinitely? No, what would happen is that entrepreneurs would realize that interest rates are only temporarily low, and take this into account."

Whether this happens depends on how the debt is borrowed: is it borrowed at a fixed rate or is it borrowed at variable rate? If debt is borrowed at a fixed rate of interest, then why does it matter if interest rates go up at a later point in time, especially if the debt is mortgage-like with it's 30 year amortization? It makes sense for a business to go into fixed rate debt for a long period of time if it secures cheap money for him now.

Conversely, if debt is at a variable rate then it matters how large it is and over what time period. In other words, there is a lot of flexibility in how debt is structured that seems to obviate the need for business men to anticipate future rate increases and somehow price that in. I don't see why Bryan Kaplan does not understand this.

Furthermore, it is easy to see how government monetary policy can cause malinvestment. Look at The Echelon Casino project. This was a $4 billion dollar casino that was announced in January of 2006. Construction halted in 2008, leaving an unproductive and unfinished hulk, on which interest payments are still being met until the monstrosity is sold off for $350 million. Steve Sailer had a good article on this:

http://isteve.blogspot.com/2009/09/how-krugman-got-it-all-wrong.html

You don't think the easy money and low interest rates set by government monetary policy did have a hand in creating that less than productive entity? Sure it did.

Credit based economies exist because credit allows one to take advantage of opportunities now, both for productive and consumptive purposes. Without credit, most economic activities would not be possible because they would have to wait for surplus cash positions to accumulate before transactions can occur. Borrowing and lending emerged to solve this problem of waiting in the same way money emerged as a way to get around the problem of coincidental expectations.

As useful as credit is, it has a downside: an exponential growth function, the curse of compound interest operating against you when you are a borrower instead of a lender or an investor.

In credit based economies, consequently, the natural rate of interest will always be slightly higher than the growth rate of the economy. This is because if businesses generated a higher return than finance, then nobody with capital would bother lending. Those with capital would start businesses themselves.

The result of having two exponential growth functions where one exponent is slightly higher than the other exponent means the two will run away from each other, until the debt overhang consumes business activity. At this point, recessions occur to clear out the companies that are no longer sustainable. This is why we have business cycles.

Trouble is, the government interferes in that process, does not allow a recession to clear marginal companies and prevents resources from being freed to do other things.




Anonymous Asher March 28, 2013 9:23 PM  

@ map

You don't think the easy money and low interest rates set by government monetary policy did have a hand in creating that less than productive entity? Sure it did.

Try reading comments a little more closely, please. I don't deny that central banks can play a role in potential malinvestment but I deny that they can be a sole cause. Hell, the very post you link to by Sailer doesn't attribute malinvestment solely to low interest rates, but also attributes it other government policies like immigration.

Low rates almost certainly do play a role but they are not capable of causing malinvestment on their own and require other government policies to create the necessary environment.

Here's the libertarian-ish Tyler Cowan:

The Austrian story is that "the government distorted price signals to the market." Are those two accounts really so different? Do we need metaphysics to resolve that question? Take the classic "thin skull" case in the law. Austrians won't describe it this way, but they are postulating a very thin skull for markets and then blaming government for the disaster which results from government's glancing blow to that skull.

The Austrian story is that "the government distorted price signals to the market." Are those two accounts really so different? Do we need metaphysics to resolve that question? Take the classic "thin skull" case in the law. Austrians won't describe it this way, but they are postulating a very thin skull for markets and then blaming government for the disaster which results from government's glancing blow to that skull.


What Cowan is saying is that the ABC theory holds that markets are robust and predictive but that they have this big blind spot in the area of gauging long term interest rates and responding to them. He doesn't buy it and neither do I. Now, I do buy that low interest rates combined with other non-monetary policies might induce malinvestment but that simple monetary policy, by itself, cannot create such a thing.

I haven't wasted a bunch of time researching it but I have happened upon several other libertarian-leaning economists who all pretty much say the same thing. Look, this theory has been around for quite a bit and it has been rejected by quite a few economists with distinct libertarian leanings. Why do you think that might be?

Anonymous Asher March 28, 2013 9:24 PM  

More Kaplan:

Why does Rothbard think businessmen are so incompetent at forecasting government policy? He credits them with entrepreneurial foresight about all market-generated conditions, but curiously finds them unable to forecast government policy, or even to avoid falling prey to simple accounting illusions generated by inflation and deflation... Particularly in interventionist economies, it would seem that natural selection would weed out businesspeople with such a gigantic blind spot.

It should be noted that other Austrians, particularly Roger Garrison, attempt to handle the expectational objection. Garrison astutely notes that "[M]acroeconomic irrationality does not imply individual irrationality. An individual can rationally choose to initiate or perpetuate a chain letter... Similarly, it is possible for the individual to profit by his participation in a market process that is - and is known by that individual to be - an ill-fated process."[50] This is definitely a possible scenario. But does it make sense in this particular case? It does not. Naturally, entrepreneurs will not turn down lower interest rates. Rather, the rational response to artificially low interest rates is to (a) make investments which will be profitable even though interest rates will later rise, and (b) refrain from making investments which would be profitable only on the assumption that interest rates will not later rise. If entrepreneurs followed this rule, then there would be no tendency for policy reversals to produce malinvestments.


Finishing with:

The roots of the business cycle lie not in praxeology, but in psychology.

The notion that one guy writing a hundred years ago figured something out that many subsequent intellectuals with similar political leanings have missed just doesn't pass the smell test.

Anonymous map March 28, 2013 9:37 PM  

Asher -

I don't subscribe to the theory that central banking, fractional reserve banking, or other variants of government-centered monetary activities are somehow fraudulent or the result of human stupidity.

At it's most basic, government creates common currencies to facilitate trade and avoid fraud. Even a gold standard economy like ancient Rome's minted gold coins.

Anonymous Asher March 28, 2013 9:43 PM  

@ map

It may be that mismanagement of monetary policy can make the malinvestment worse on the margins but it is not the primary source of the business cycle as the Mises school seems to suggest.

Anonymous Asher March 28, 2013 10:37 PM  

@ map

I don't subscribe to the theory that central banking, fractional reserve banking, or other variants of government-centered monetary activities are somehow fraudulent or the result of human stupidity.

But you are subscribing to it without realizing you are doing so.

The ABC/malinvestment theory has been around for about a century and Hayek won a Nobel Prize for his work on it. At this point, if the ABC theory is correct then the only possible explanation for the existence of central banks executing monetary policy is a combination of stupidity and fraud.

I suspect that the following is true:

A) Central banking plays some crucial role of an organized financial sector within the greater political context of the modern nation state
B) Monetary policy can create some malinvestment along the margins of the business cycle but are not central to it.

This means that central banking is inevitable a long as we have modern nation states and that they will inevitably create some malinvestment on the margins of the business cycle. In fact, this seems very obviously true. The only way to eliminate this marginal malinvestment is to politically reorganize in political arrangements that are not nation-states.

But is not an economic theory but a political science/economy/whatever theory.

Anonymous map March 28, 2013 11:25 PM  

Asher -

Look at Kaplan's obvious flaw in the argument he makes:

"Rather, the rational response to artificially low interest rates is to (a) make investments which will be profitable even though interest rates will later rise, and (b) refrain from making investments which would be profitable only on the assumption that interest rates will not later rise. If entrepreneurs followed this rule, then there would be no tendency for policy reversals to produce malinvestments."

But this is exactly how it does not work in a credit-based economy because interest rates and profits are not divorced from each. The profitability an enterprise is a function of the interest rate.

Let's take the Echelon Casino, for example. Let's assume the Echelon had an operating profit margin of 10%. This means that, for a $4 billion investment, the Echelon returns a profit of $400 million a year. Is The Echelon a good investment? Probably so, if you have $4 billion in cash lying around and your profit estimates are correct. After all, everything on the revenue side is an educated guess. The business is not a bond.

But what if you don't have $4 billion in cash lying around? Let's say you have to borrow money, just to keep it simple. Let's say the natural rate of interest is 7%. So, out of $400 million in estimated profit I would have to pay out roughly $280 million, at least (I'm ignoring the rate of compounding to keep it simple.) Is Echelon now a good investment, or is it merely a marginal investment? Chances are, given the risk, at this natural rate of interest, the Echelon project would've never gotten off the ground. The spread between the cost of capital and the estimated profit was too narrow to risk such a venture.

Now, let's say the government lowers the rate of interest to 2%. Is Echelon still a marginal investment? Or, is it now worth undertaking? Well, the spread between the cost of capital and the estimated profit margin is now 2.5 times greater. Just like businessmen will borrow money if loans are sufficiently cheap, they will also pursue otherwise marginal business opportunities that have the thin veneer of being profitable.

Kaplan seems to think that businessmen should pursue businesses sufficiently profitable to hedge against increases in the interest rate. But that profitability is a function of the interest rate so that is not possible. What is to be avoided is giving operating profit estimates more credibility then they are due by manipulating the cost of money and creating artificially wide spreads that risk the kind of malinvestment Echelon represents. At 7% interest, Echelon would've never been attempted, if only because that money would've been better invested elsewhere.

Anonymous map March 28, 2013 11:36 PM  

Asher -

Central banks are legitimate entities. Monetary policy executed by the bank is typically fraudulent. Basically, central banks should not screw up. That they do is an inevitable part of any politically determined entity.

What's important is not to give legitimacy to this fraud by calling it Keynesianism or Monetarism and pretending that its a good function of the state, as opposed to merely beneficial to special interests.

Anonymous map March 28, 2013 11:45 PM  

Asher -

"The notion that one guy writing a hundred years ago figured something out that many subsequent intellectuals with similar political leanings have missed just doesn't pass the smell test."

The econ profession is heavily compromised. On the one hand, you have government employment, which skews in favor of Keynsianism. On the other, you have heavy empricism where assumptions have to be narrowed enough to create parametric values within linear regressions.

Anonymous Asher March 29, 2013 8:55 AM  

@ map

Central banks are legitimate entities. Monetary policy executed by the bank is typically fraudulent. Basically, central banks should not screw up. That they do is an inevitable part of any politically determined entity.

So, basically, you agree with me and, by implication, with Kaplan. I'm quite certain that Kaplan shares my basic premise that the current forms of political organization are rather ineffective and that things like central bank mismanagement are simply a product of that general ineffectiveness.

You don't really think that the actions of central banks are fraudulent, you think that their actions are ineffective. Your use of the term "fraudulent" is just pure preachiness on your part, just moral shaming language and no different than what you see from feminists and their shaming language.

Of course, the difference between yourself and feminists is that feminists are plugged into the power system and represent its interests while you are at odds with that power system. This means that their shaming language is effective and yours is ineffective.

pretending that its a good function of the state, as opposed to merely beneficial to special interests.

Read Nietzsche. Then read him again. And again. And again, and again, and again.

What you are doing is setting up an ideal notion of general interest and then comparing that to how the concept is utilized. The solution is to look at the evidence for whether or not something is of the nature of a general interest and test things to see whether or not they meet the criteria.

My suspicion is that in a mongrel empire like the US there is no such thing as a general interest, only special interests.

The econ profession is heavily compromised.

Read your Bible. Then read it again. Then read it again, and again, and again.

All human beings are compromised.

Anonymous Asher March 29, 2013 8:59 AM  

@ map

Central banks are legitimate entities. Monetary policy executed by the bank is typically fraudulent.

I need to address this statement further.

If the activity of some entity is evil then that entity is evil. It's like the wife with a husband who beats her, drinks all day long and molests the kids but she keeps saying that she sees the kernel of goodness in him.

Um, no, the guy is worthless.

Anonymous Asher March 29, 2013 9:08 AM  

@ map

Consider the following quote I ran across recently at a libertarian website:

Humanity has tried using coercion to organize society for millennia. Perhaps it is time to give peace and freedom a chance.

So, coercion has been the norm for many a millenia ... don't you think that tells us something about human nature? Doesn't that statement, in itself, imply that coercion is natural to man and everything he does?

Anonymous map March 29, 2013 5:10 PM  

Asher -

By "fraudulent" I am claiming that the government is not doing what it claims it is doing.

Look, I have a degree in economics from the University of Chicago. Econ at the U of C is not taught as a series of policy prescriptions. It is taught as a mental framework on which to evaluate economic decisions.

I've also read a lot of Hayek's work and found it impressive. It dovetails nicely with the tools I've gained at the U of C and I can spot where a public intellectual like Paul Krugman is wrong.

What do you think you are telling me that I do not already know?

Anonymous Asher March 29, 2013 7:59 PM  

@ map

I have remarked before that if the only experience with economics that someone had was this blog they would come away thinking that the history of economics is comprised of two people: Ludwig v Mises and Paul Krugman.

One doesn't have to subscribe to the strict ABC theory of the business cycle to consider Krugman either a fraud or a fool. I'm quite certain that both Cowan and Kaplan are dismissive of Krugman without subscribing to that century old theory.

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