[jmherbener]

Nathan Rosenberg and L.E. Birdsell, How the West Grew Rich (New York: Basic Books, 1986).

http://www.deirdremccloskey.com/docs/pdf/Article_63.pdf

Thomas DiLorenzo, How Capitalism Saved America (New York: Crown Forum, 2004).

https://mises.org/journals/qjae/pdf/qjae8_1_6.pdf

McCloskey has written quite a bit about the industrial revolution. Here are a few examples:

http://www.deirdremccloskey.com/docs/pdf/Article_62.pdf

http://www.deirdremccloskey.org/articles/revolution.php

The cause of economic progress is not merely free trade. Free trade simply allows for an extension of the division of labor, which does raise productivity as people and places are rearranged into their areas of comparative advantage. But the steady improvements of living standards are the result of capital accumulation which requires saving by people and investing by entrepreneurs.

[jmherbener]

If you define liquidation as “traded” then if housing prices fell and the quantity traded declined, there must have been a stronger leftward shift of the demand curve for housing than rightward of the supply curve of housing. So it was the drying up of demand for housing, not the flood of supply that caused housing prices to fall while at the same time “liquidation” declined.

[jmherbener]

Like the prices of all goods, housing prices move up and down with changes in demand and supply. Housing prices plummeted because demand fell and supply rose. The reduced volume of house sales came from the fact that demand fell more than supply rose. Under those conditions, both the price and quantity traded of a good will decline. If the increase in supply was more than proportional to the reduced demand then price would fall the quantity traded would rise. So, in the housing collapse, demand fell relative to the increase supply. Demand for houses fell from investors pulling out and mortgage credit drying up.

[jmherbener]

Monetary inflation and credit expansion raise money incomes, but lower real incomes. Wealth refers to real incomes, i.e., people’s standards of living or the consumer goods people have. Wealth increases through capital accumulation which raises productivity of inputs and results in the production of more and better consumer goods. To accelerate capital accumulation, people must lower their time preferences, releasing resources from producing consumer goods more directly and reallocating them into more indirect production of consumer goods. Monetary inflation and credit expansion shift resources into more indirect production processes even though people do not prefer them as they have not lowered their time preferences. The ensuing alteration is called a “boom” instead of economic growth because it involves a building up of the economy’s capital structure, seemingly aping the process of economic growth, which proves to be unsustainable. Because the build-up is not justified by lower time preferences, it must be torn down in the bust.

[jmherbener]

Whether or not it’s reasonable to hold foreign currencies as a hedge against the collapse of the dollar depends, as you suggest, on the likelihood of the collapse of those currencies as well. It may be more reasonable to hold precious metals or other real assets. There could be some foreign currencies, however, that foreigners rush into as the exit their dollar holdings. These currencies might appreciate relative to the dollar even more than real assets.

As you note, the collapse of the dollar is not inexorably linked to a proportionate collapse of foreign currencies. The reason is that foreigners outside the U.S. hold a significant portion of physical dollar currency, around 60 percent, which is much higher than the percent of any other currency, such as the Euro, held by persons outside the Euro zone. Therefore, the collapse of the dollar is much more likely, under your scenario, since those bound to accept the dollar legally, namely Americans, are not holding most of the dollars. Foreigners can easily dump large quantities of dollars on the American economy in a short period of time. Whereas, Americans cannot divest themselves completely of dollars, at least not legally. But, I dare say, only an insignificant portion of Australian dollars are being held by foreigners. So the downward pressure on the Australian dollar is less than that on the American dollar, given that Australians also face legal tender laws for the Australian dollar.

[jmherbener]

In our current circumstances, there are two factors that will push up interest rates despite the Fed’s efforts to hold them down.

First, a return to normalcy on the demand-side of credit markets. Entrepreneurs are still holding back their investments in the face of uncertainties they perceive. When demand for credit returns to normal, it will put upward pressure on interest rates. Of course, the banking system has plenty of excess reserves upon which it can create credit, which would moderate the upward pressure on interest rates. Whether or not banks begin to lend normally depends on their assessment of uncertainty in extending loans.

Second, renewed price inflation will push up interest rates. Entrepreneurs are still holding money in the face of the uncertainties they perceive. When their normal money demand is restored, price inflation will pick up. When banks begin the normal process of creating credit on their excess reserves, then the money stock will increase which also puts upward pressure on prices.

There’s not much the Fed can do to control an entrepreneurial decline in money demand and there’s not much their willing do to control renewed credit creation by banks. Reversing their QEs and thereby, removing the excess reserves from banks, risks igniting a secondary downturn. With Yellen in charge, the Fed will undoubted err on the side of price inflation and not risk price deflation. Significant price inflation will boost interest rates.

[jmherbener]

In actual history, these three factors (population growth, technological improvement, and capital accumulation) have been intertwined in rising standards of living. Before standards of living began to rise around 1200 A.D. in western Europe, population rose very slowly, technology progressed very little, and capital per head did not accumulate significantly. Presumably, more people were added to the existing trade nexus, but that didn’t seem to raise standards of living appreciably.

Theoretically, the difficulty in answering your question comes from the contingent conditions involved in holding technology and capital accumulation constant while increasing population. For example, what complementary capital goods will the rising population work with if there is no capital accumulation? Presumably, the productive activity of the additional population would be placed on less productive land since the most productive land sites are already in use. So unless there was some reason to think that the larger populations enhanced the comparative advantage of different people in different places as they, too, came into trading relationships, then it seems unlikely that merely having more people to trade with would raise everyone’s productivity and therefore standards of living.

[jmherbener]

The great American “Austrian school” economist, Frank Fetter (who was chairman of the economics department at Princeton in the first half of the 20th century) wrote his dissertation on Malthusian population theory. In his presidential address to the American Economic Association in 1913, he was pessimistic on the likelihood of continuing increases in standards of living under the strain of population growth:

http://onlinelibrary.wiley.com/doi/10.1111/j.1728-4457.1999.00577.x/abstract

But, like those of Malthus himself, such pessimistic predictions have so far proven unwarranted. The main causes of standards of living continuing to rise are technological advance and capital accumulation. As long as these factors continue to progress, even population growth that would put human population beyond the point of covering the entire surface of the earth with productive activity, would not necessary reduce standards of living. Fortunately, you and I are unlikely to personally experience such a state of affairs to witness the results firsthand.

Ludwig von Mises analyzes this point of “over-population” in his discussion of the Law of Association in his book Human Action. There he points out that any population growth beyond the point at which the entire surface of the earth is filled with productive activity will result in unemployment of the least-productive people. They could be kept alive only by the charity of the producers.

http://library.mises.org/books/Ludwig%20von%20Mises/Human%20Action.pdf

His discussion is in chapter 8.

[jmherbener]

The best exposition of the capital structure is in Murray Rothbard’s book, Man, Economy, and State:

http://library.mises.org/books/Murray%20N%20Rothbard/Man,%20Economy,%20and%20State,%20with%20Power%20and%20Market.pdf

Take a look at chapters 5 and 6.

[jmherbener]

Here are a few brief points of rebuttal:

1. Human action is forward looking, not backward looking. Therefore, how capital came into existence cannot matter for human action today. The price of a piece of equipment today cannot be affected by the “embodied” labor from its production in the past.

2. Austrians do not claim that capital is “embodied” time. They argue that the value of capital is in advancing a person in time toward the end he aims to attain in the future.

3. In claiming that the pure rate of interest is uniform across both the credit markets and the capital structure, Austrians do not assume “perfect knowledge” or overlook the distinction between “real” capital and financial capital. Austrians argue that savers have the alternatives of investing in either the credit markets or production process and therefore, they will arbitrage away any difference in the pure rate of interest between the two alternatives.

4. Contrary to the author, if people become more uncertain of the future and as a consequence hold more money, this results in a higher purchasing power of money and not a higher rate of interest.

5. Austrians argue that both the pure rate of interest and the amount of saving-investing are determined by time preferences. Any of a number of factors can change the rate of time preference and therefore, change the pure rate of interest and the amount of saving-investing. Austrians make no claims about any relationship between “real” interest rates and the amount of saving-investing.

6. Regardless of whether there are unemployed resources or not, people in society always must make a choice between allocating resources into shorter production processes (“consumption “) and longer production processes (“investment”).

7. Technology is not “embodied” memory. It is knowledge of production. Technology, applied in production, is an objective feature of capital goods and not of labor.

8. The capital structure as used in Austrian economics is not a metaphor but a stylistic description of the real economy.

[jmherbener]

Your scenario raises several interesting issues.

First, the transition from one pattern of demand for things to a different pattern will depend precisely on the extent to which entrepreneurs anticipate the new pattern. In the Austrian approach, we adhere to the realistic view that entrepreneurs have the incentive of earning profit and avoiding loss in making accurate predictions of the future, that entrepreneurs with superior foresight gain command over resources and entrepreneurs with inferior foresight lose command over resources, and that there exists a spectrum of foresight among entrepreneurs from less to more accurate. The transition in the real world from a state of lower demand for money to a state of higher demand for money can neither assume perfectly accurate anticipation nor perfectly inaccurate anticipation on the part of entrepreneurs.

Second, because the capital structure is an integrated system of production, continuously changing demand for some goods leads to changing demands for other goods across the entire capital structure. The effects of changes in demand for money, in this respect, are not different than the effects of changes in demand for other goods.

Third, the transition depends on the money production system in the economy. If the economy has a market monetary system, then as the PPM rises from the increased demand for money the production of money would increase, which moderates the rise in the PPM.

Given these points, let’s suppose that demand for money increases to a new higher level but time preferences stay the same. Entrepreneurs with inferior foresight will see their profits cut and maybe suffer losses. Entrepreneurs with superior foresight will maintain their profits. Those with less profit or losses will not need to immediately reduce production. All entrepreneurs hold equity as a buffer against their inability to forecast accurately every contingency. During the period of drawing down their equity, they revise their expectations. If they perceive, as those with superior foresight have already done, that their demands for inputs must fall in the wake of the reduced demand for their output, then input prices will fall and restore their net income. Even if entrepreneurs are duller in formulating more accurate expectations, the fact that demand for their outputs have fallen reduces their revenues which requires them to reduce their demand for inputs. Their reduced demand for inputs causes input prices to drop which restores the net income of production.

Only if the price spread between input prices and output prices were systematically and generally altered would the transition affect the length of the capital structure (instead of merely reconfiguring the composition of production within the capital structure. If the increased demand for money caused the spread between output prices and input prices to shrink, then the capital structure might be lengthened out because the interest rate in production would have fallen. Conversely, if the spread between output and input prices increased, then the capital structure might be shortened. In either case, the capital structure would return over time to that dictated by time preferences.

As to the composition of production within the capital structure, an increase in the demand for money would shift resources out of the production of some goods and into the production of money (given a market monetary system as noted above.) More generally, production would shift away from areas of lower relative demand and toward areas of higher relative demand. This is the same process going on continuously in the market economy as people shift their demands away from some goods and toward other goods.

[jmherbener]

The “economy” is all of us cooperating by arranging our resources in a division of labor by which each person produces to satisfy the consumption ends of other people and has his consumption ends satisfied by them. What improves the economy, then, is letting people self-select into different tasks under entrepreneurial organization of teams of producers. Entrepreneurs can use economic calculation to determine which techniques of production are lower cost and which set of consumer goods are higher valued. If everyone self-selects into their area of efficient production, then we can produce the greatest output with our given inputs. What harms the economy is violent interference with this self-selection process. Protectionism uses state coercion to criminalize trade between people that is perfectly licit, e.g., buying and selling clothes. When the state criminalizes trade in textiles, then less efficient textile producers continue to specialize in that area instead of their area of efficiency and more efficient textile producers must specialize in areas in which they are not efficient. With our given resources, we can produce less output. While protected textile workers may be better off, society is worse off. State coercion has forcibly transferred wealth from non-protected to protected workers. (For consumers to pay the higher prices for clothes which allows higher wages for inefficient textile workers, consumer must decrease their demands for other goods which suppresses wages of efficient workers in other industries.) This is not only immoral, it is inefficient. Furthermore, where does the application of protectionism end. if it’s good to protect textile workers, why not workers in other industries? According to the protectionist logic, then, it would be better if Americans consumed only what Americans produced and, with the same logic, it would be better if Pennsylvanians consumed only what Pennsylvanians produced, and so on down to self sufficiency for each person. At that point, each person would have all the jobs for himself, but his standard of living would be subsistence.

Take a look at Henry Hazlitt’s book, Economics in One Lesson:

http://library.mises.org/books/Henry%20Hazlitt/Economics%20in%20One%20Lesson.pdf

[jmherbener]

It’s important to emphasize that the Fed generated monetary inflation and credit expansion lengthens out the capital structure beyond what is sustainable given people’s time preferences. This mis-match between the capital structure and time preferences is what reverses the boom. So, the steps might be listed out as below:

1. Fed buys assets from banks increasing the banks’ reserves.
2. Banks create credit by issuing fiduciary media on their new reserves.
3. The greater supply of credit pushes down interest rates and funds riskier investment projects.
4. Demand for higher-order capital goods increases relative to lower-order capital goods because more timber must be cut and milled before more houses can be produced and more iron must be mined and milled into steel before more cars can be produced.
5. Resources shift toward higher-stages and away from lower-stages, but this shift is not supported by a lowering of people’s time preferences.
6. People reestablish their time preferences by spending and saving their incomes, which are larger with the greater stock of money, according to their time preferences. This restores interest rates to their higher levels, which collapsed asset prices.
7. Asset prices also decline because investors perceive the greater risk of investing further in the boom lines of production.
8. Lower asset prices reveal the mal-investments of the boom.
9. The collapse of asset prices makes banks insolvent since their assets are financial claims on the assets whose prices are falling, e.g., mortgages on houses.
10. Profits exist in reallocating resources to shorten the capital structure in a way that satisfies time preferences.
11. Entrepreneurs liquidate the mal-investments and reallocate resources. Once the capital structure is reconfigured, economic normalcy returns.

Take a look at Rothbard’s summary of business cycle theory in chapter 1 of America’s Great Depression:

http://library.mises.org/books/Murray%20N%20Rothbard/Americas%20Great%20Depression.pdf

[jmherbener]

It means that the financial claim is written in dollars as opposed to euros, yen, etc.

For example, GMC issues a $10,000 bond with a coupon rate of 3 percent. Whereas, Seiko issues a
¥ 1,000,000 bond with a coupon rate of 3 percent.

[jmherbener]

Yes, the dollar is still a world reserve currency. Primarily, it means that foreign central banks hold dollar denominated financial assets as a reserve against the issue of their own currencies. They do so because, just like under Bretton-Woods, that’s how monetary inflation can be coordinated (or managed as our leaders like to say) for the entire world. Secondarily, it means that foreign commercial banks hold dollar denominated financial assets as reserves also. They do so because the largest capital markets in the world are denominated in dollars. Also, foreign businesses and persons hold dollar currency in conducting international trade and, in some places, as a medium of exchange superior to their domestic currencies.

Here are some statistics on foreign currency reserves:

http://www.imf.org/external/np/sta/cofer/eng/

Here are some statistics on central bank balance sheets:

http://www.yardeni.com/pub/peacockfedecbassets.pdf

Here is a Fed paper on dollar currency held overseas:

http://www.clevelandfed.org/research/commentary/1996/041596.htm

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