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September 22, 2012

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On the 'Austrian' Hatred of Fractional Reserve Banking

Posted: 20 Sep 2012 12:10 AM PDT

Brad Delong on Ludwig von Mises:

...whenever I see something like:

Ludwig von Mises: Attempts to carry out economic reforms from the monetary side can never amount to anything but an artificial stimulation of economic activity by an expansion of the circulation, and this, as must constantly be emphasized, must necessarily lead to crisis and depression. Recurring economic crises are nothing but the consequence of attempts, despite all the teachings of experience and all the warnings of the economists, to stimulate economic activity by means of additional credit...

I find myself under a mysterious but inexorable and irresistible compulsion to waste what would otherwise be productive work time trying to make some kind of sense of it--to at least understand wherein lies the error, and how somebody trying very hard to understand the economy (never mind that he is a big fan of the political leadership of Benito Mussolini) can go so pathetically wrong.

It is, of course, not the case that every expansion of the circulation is an "artificial" (and unnatural) "stimulation of economic activity" that must "necessarily lead to crisis an depression". So why does Ludwig von Mises think that it must?

Here is my current guess as to where von Mises is coming from:

Let us start out with a world of publicly-known technology and constant returns to scale in everything. People happily make things and trade them. And everything sells at its resource cost.

One of the things people make is little disks of gold, usually decorated with pictures of bearded men on one side and allegorical female figures on the other, with lettering saying things like: "Fecund Augustae" or "Concordia Militum" or "Fides Exercituum" on them. These little gold disks trade--like everything else--at their cost of production: the cost of digging the ore out of the ground, extracting the metal from the ore, and stamping the disk into the right shape.

Then somebody has a bright idea: Because these little metal disks are valuable and easy to carry, they are subject to theft. I will offer to perform a service: I will keep everybody's little metal disks in my stronghouse, and let's write out signed, notarized declarations that people have little metal disks in my stronghouse and they can trade those rather than the disks directly. And--as long as 100% of the circulating medium is backed by gold--everything goes on as before, with everything selling for its cost of production.

Then somebody else has a bright idea: They write out a whole bunch of signed declarations that they have little metal disks in the stronghouse, even though they actually do not have any such. They then buy things with these pieces of the circulating medium that they have written out.

These people, Ludwig von Mises says, are thieves: thieves pure and simple:

They have bought useful things.

They have claimed that they have done so by trading (claims to) valuable little metal disks (in the warehouse) for useful commodities.

But they have lied.

They did not have any valuable little metal disks for trade.

And, Ludwig von Mises would say, these lying thieves come in three forms:

  • governments that print dollar bills without having 100% gold bullion backing for them in Fort Knox.
  • banks that issue bank notes.
  • banks that allow depositors to write checks in amounts that exceed the specie reserves they the banks have in their vaults.

The problem, I think Ludwig von Mises would say, is that the wealth of society is the amount of work has gone into creating the commodities in the economy: the food, the clothing, the houses, the little gold disks. The sum of past work crystalized in commodities is society's wealth. The food is wealth, the housing is wealth, the clothing is wealth, and the little gold disks are wealth. Then add unbacked fiat money and bank credit--either public or private, it doesn't matter--to the mix. The fiat money and the bank credit are counted as wealth, as if they were claims to little gold disks that took sweat and tears to create, but they are not wealth at all. They are fictions: false promises that there is somewhere some valuable gold that you have title to.

And, Ludwig von Mises would say, the larger the unbacked circulating medium the bigger the lie and the theft. It is all guaranteed to end in tears. Whenever society thinks that it is richer than it is, plans will be inconsistent and unattainable. When that unattainability becomes manifest, that will trigger the crash and the depression.

That is, I think, where von Mises is coming from.

And, of course, this is wrong--so so so so so so so so so unbelievably wrong.

It is simply not the case that we can cheaply and easily buy things with money because it is valuable. It is, instead, the case that money is valuable because we can cheaply and easily buy things with it.

One way into the tangle of understanding why it is wrong is to ask each of us: Why are you happy accepting money in exchange when we sell useful commodities?

Hint: It's not because we are looking forward to going down to the bank, exchanging our bank notes for the little disks of gold usually decorated with pictures of bearded men on one side and allegorical female figures on the other with lettering saying things like "Fecund Augustae" or "Concordia Militum" or "Fides Exercituum" on them, taking our little disks home, and feeling happy looking at them.

That's not why we accept money.

We accept money because if we don't have any money we have to buy commodities with other commodities, and when we do so we are unlikely to receive the cost of production for what we sell. Have you ever tried to buy a latte at Peets with a copy of Ludwig von Mises's Money and Credit? It does not go well.

The fact is that your wealth is only worth its cost of production if you are liquid--if you can wait to sell until somebody willing to pay full cost of production comes along, which is not every minute. The use-value of money is that it allows you to time your other transactions so that you can realize the full exchange value of what you sell, rather than having to sell it at a discount.

Thus there is no paradox: no sense in which the existence of fiat money creates a situation in which society must necessarily think that it is richer than it is, with claims to total wealth valued at more than the value of total wealth itself. You think--correctly--that your fiat money has value, and that value is just equal to the discount from its cost of production that your other wealth incurs because it is illiquid. But what if the government prints more fiat money than the illiquidity gap in your other wealth? Well, then people will say: "I don't need to hold all this extra money. I would be liquid enough with less." Everybody will try to run down their money balances, and so the price level will rise until the real money stock is just what people think covers the illiquidity gap between their other wealth and its cost of production.

What von Mises misses completely is that the size of this illiquidity gap can and does change suddenly and drastically--and it is the business of the central bank and of the government to alter the quantity of money to keep such changes from disrupting the real economy. ...

Links for 09-20-2012

Posted: 20 Sep 2012 12:06 AM PDT

Fed Watch: Fisher Turns to Fear Mongering

Posted: 19 Sep 2012 05:17 PM PDT

Another one from Tim Duy:

Fisher Turns to Fear Mongering, by Tim Duy: Dallas Federal Reserve President Richard Fisher is quick to continue his fear mongering about inflation. Via Bloomberg:

"I do not see an overall argument for letting inflation rise to levels where we might scare the market," Fisher said on Bloomberg Radio's "The Hays Advantage" with Kathleen Hays and Vonnie Quinn. "We have seen a sharp rise in inflation expectations. If you let this get out of hand, then I think we will have a market reaction."

Let's go to the chart:

Stocksinf

You really can't say that inflation expectations are surging beyond anything we have seen in the past six years. Moreover, supporting inflation expectations was an expected outcome of Fed easing. And financial markets seem to like it.

Also, it is not clear that TIPS-derived expectations are the best measure (a point I don't make enough). The Cleveland Federal Reserve works on teasing out inflation expectations, and on September 14th reported:

The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.32 percent. In other words, the public currently expects the inflation rate to be less than 2 percent on average over the next decade.

Expyield

Yes, near term expectations have gained but from a too-low 1.2% to 1.8%. Moreover, this would be expected not just from anticipation of QE3, but from the rise in gas prices (and note that oil prices are now falling again). By this measure, the more important longer term expectations remain mired well below the Fed's 2% inflation target. Let's at least agree to stop worrying about inflation until we get expectations back up to the Fed's target.

Bottom Line: Fisher stays true to form, clutching to his fears of inflation like a drowning man grabs onto a life preserver. My guess is that he doesn't need to be marginalized by the doves; he does a fine job marginalizing himself.

Fed Watch: Hawks Are Marginalized

Posted: 19 Sep 2012 10:39 AM PDT

Tim Duy:

Hawks Are Marginalized, by Tim Duy: There has been a lot of Fedspeak over the last few days as policymakers expand upon the shift to open-ended QE. See Cardiff Garcia at FT Alphaville for an overview of some of the dovish talk, and see Pedro Da Costa at Reuters for some thoughts on the hawkish talk, described as a "vocal minority." See also Reuters for an interview with St. Louis Federal Reserve President James Bullard, who claims that he would have voted against QE3:

"I would have voted against it based on the timing. I didn't feel like we had a good enough case to make a major move at this juncture," said Bullard, who has been viewed as a centrist on the spectrum of Fed officials, though in recent months he has sounded opinions that have sounded more hawkish as he has expressed doubts about the need for further stimulus.

Bullard does acknowledge his preference for open-ended QE, had he believed it was needed:

Even so, Bullard said some of the contours of the plan, which has no set end date, were in keeping with how he thinks monetary policy should be conducted with interest rates already near zero. Leaving end dates off a bond buying program can make the policy "more effective," he said.

Bullard is also reported to have expressed support for dropping the dual mandate, although I am not seeing a direct quote. Same for concerns about commodity prices:

He also voiced concern that QE3 could spill over into higher commodity prices, as happened with the previous rounds of Fed bond-buying, although he said the soft tone of the world economy would help curb price rises.

The reporter reaches the conclusion:

In discussing his views on more monetary stimulus, Bullard said, "We should take a little bit more (of a) wait-and-see posture." His comments, in an interview with Reuters Insider, highlight potential dissent on the Fed's policy committee next year when he will be a voting member.

Should we be concerned about this warning? I would say no. I think it is easy for Bullard to say that he would have dissented, but a lot harder to actually dissent if he was seated in the meeting. Indeed, he gets the best of both worlds - he gets to display his hawkish credentials by saying he would voted against QE without the pressure of the actual vote. Might he get more vocal next year? Maybe. I suspect his comments will be a function of which way the political winds are blowing. All of his comments to Reuters - anti-QE, concerns about commodity prices, desire to dump the employment mandate - sound like attempts to position himself for a role in a Republican Administration. The more he needs to position himself in that direction, the more hawkish he will appear.

And note that fundamentally, whatever Bullard (or other hawks) say is for the time largely irrelevant. As a group, they were small to begin with, and by now have been intellectually marginalized. Via Cardiff Garcia, Credit Suisse provides a summary chart of policymakers:

Fedsummary

The hawks are all bark, no bite. They are more than overwhelmed by dovish-leaning policymakers, even if Bullard joins Kansas City Federal Reserve President Esther George in hawkish dissent. What remains important heading into 2013 (aside from the data, of course), is Federal Reserve Chairman Ben Bernanke. He can pull the moderates where he wants to go. And it obviously is not in a hawkish direction.

Bottom Line: Fed hawks are largely marginalized. Their views have not and will not have a significant impact on policy making. They will only appear to have an impact on policy if the data signals that a policy shift is needed. Given the current set of policymakers on the Fed, the hawks will only have a voice if Bernanke is replaced with one of their own. And that is when it would get interesting, as I am not sure that the moderates would follow a hawkish Chairman.

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