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jmherbener
ParticipantArbitrage brings all interest returns together as far as possible given differences among different types of investments, including uncertainty and maturity.
Monetary inflation through credit expansion has a two-fold effect on interest rates. The credit expansion increases the supply of credit which pushes interest rates lower. The monetary inflation reduces the purchasing power of money which pushes interest rates higher. These basic effects of monetary inflation and credit expansion on interest rates is complicated by changes in demand for credit and demand for money. For example, monetary inflation during the 1970s generated double-digit price inflation, in part, because money demand was falling while monetary inflation of similar magnitude recently has generated little price inflation, in part, because money demand has been rising.
ParticipantFor example, suppose investors view the credit worthiness of 10-year Treasury Securities and 10-year AAA Corporate Bonds the same and the interest rate on both is 2 percent. If the Fed cuts back its purchases of Treasuries their prices will fall and yields increase, say to 3 percent. Investors gain by shifting funds out of Corporate Bonds and into Treasuries. Their arbitrage activity will move the Corporate Bond rate up and the Treasury rate down until they are the same again, but at a higher level than the original 2 percent.
ParticipantIf a person is motivated to learn economics, he should aspire to progress as far as his interest and ability can take him. As everyone is unique in his interest and ability, a wide range of progress in learning economics will exist among different persons. I think all of us who have devoted some time and effort to learning economics have found at each step that we have been able to learn more readily from some authors rather than others. Progress, then, depends on reading widely to discover the authors who speak most effectively to a person at each step in the process of his learning.
Here are three introductory treatments of economics as a discipline:
David Gordon, An Introduction to Economic Reasoning:
http://library.mises.org/books/David%20Gordon/An%20Introduction%20to%20Economic%20Reasoning.pdf
Robert Murphy, Lessons for the Young Economist:
Shawn Ritenour, Foundations of Economics:
http://www.foundationsofeconomics.com/
If introductory treatments are too advanced, try monographs that focus on a few economics truths:
The classic is Henry Hazlitt, Economics in One Lesson:
http://library.mises.org/books/Henry%20Hazlitt/Economics%20in%20One%20Lesson.pdf
Another is The Incredible Bread Machine:
ParticipantYou are correct that government regulation is used by politically-connected businesses to hobble their competition. There is a large literature on this. Tom DiLorenzo has done a lot of work in this area.
http://www.lewrockwell.com/dilorenzo/dilorenzo173.html
The Fed is a massive cartelization device for banks. Murray Rothbard has written about this:
Bigness of business, however, is a red herring. The real issue is whether an enterprise is efficient or inefficient. Private enterprise is constrained by profit and loss to serve consumers efficiently. Government intervention allows enterprises to receive profit and avoid loss while not economizing resources for consumers.
ParticipantLike all exchange ratios in the market, interest rates are determined by demand and supply. So, to anticipate what would happen, one must conjecture about both sides of the market.
If the Fed quit buying MBS, their prices would fall and yields would increase. Private demand would likely fall because investors would attach a more realistic risk premium to them without the Fed’s support. There would be little incentive to arbitrage funds to other investments and so there interest rates would not be significantly affected.
If the Fed quit buying Treasuries, their prices would fall and yields would increase. Given that private investors did not reassess the credit worthiness of the securities, the difference in interest rates would generate arbitrage opportunities and therefore, change interest rates on other securities. Whether the effect would be large or small depends on the relative size of the Fed’s intervention. The average daily volume of trade in U.S. Treasuries in 2012 was $519 billion.
Of course, the above comments assume that banks do not change their credit creation as their reserves change.
ParticipantLudwig von Mises addresses the theory of such a case in his book, Theory of Money and Credit:
http://library.mises.org/books/Ludwig%20von%20Mises/The%20Theory%20of%20Money%20and%20Credit.pdf
The discussion is in Part Four Monetary Reconstruction, Chapter 3 The Return to Sound Money. Mises discusses both the large country case and the small country case in which a country unilaterally returns to the gold standard while other countries do not.
ParticipantDemand and supply schedules are constructed by making conjectures about the different amounts of a good buyers would prefer to buy at different prices, other things equal, and the different amounts of a good sellers would prefer to sell at different prices, other things equal.
The construction of a demand schedule begins with an actual purchase that a buyer makes. For example, yesterday I bought one package of 500 sheets of printer paper at Wal-Mart at a price of $12. We can conjecture that at a price high enough, I would have foregone purchasing paper and at a price low enough, I would have purchased more than one, or at least not less than one, package of paper. This construction reveals the law of demand. The price elasticity of demand refers to how sensitive the buyer’s purchase is to a change in price. Elastic demand means that the buyer changes the amount he purchases a lot in the face of a given change in price. Inelastic demand means that the buyer changes the amount he purchases a little in the face of the same change in price.
Take a look at David Gordon’s treatment of demand and supply in his book, An Introduction to Economic Reasoning:
http://library.mises.org/books/David%20Gordon/An%20Introduction%20to%20Economic%20Reasoning.pdf
For a more conventional treatment, see Bob Murphy’s in his book, Lessons for the Young Economist:
ParticipantThe Fed regulates commercial banks. One of its regulations concerns reserves banks hold against their deposits. The Fed requires a bank to hold roughly 10 percent of the total that all of the bank’s customers have in their checking accounts at the bank. The Fed also dictates that banks can hold as reserves either Federal Reserve Notes (or currency) or checking account balances at the Fed.
Markets clear at the price at which the quantity of the good that buyers want to buy is the same as the quantity of the good that sellers want to sell. At higher prices there would be excess supply and at lower prices there would be excess demand. So each type of loan has an interest rate that clears the market, at which the quantity of credit borrowers want to borrow is the same as the quantity of credit lenders want to lend.
June 18, 2013 at 3:34 pm in reply to: Distortion of the capital structure is primarily monetary? #17871ParticipantBoth fiscal and monetary policy cause malinvestments in the capital structure. The difference is distortions from fiscal policy can be permanent but distortions from monetary policy are self-reversing.
Reduced government spending, as in winding down after war, does not cause a bust. Instead it frees entrepreneurs to reallocate investment into profitable lines and therefore, leads to an improvement in consumer satisfaction.
Take a look at Robert Higgs’s great article on the economy after the Second World War:
ParticipantWhen the Fed buys things it either prints currency or writes checks on itself. Commercial banks can use either currency or checking account balances at the Fed as reserves against the deposits their customers have. Banks trade reserves over night. The interest rate on these loans is called the Federal Funds Rate. The Fed targets this rate when conducting monetary policy.
Here is information on the Federal Funds Rate:
http://www.newyorkfed.org/markets/omo/dmm/fedfundsdata.cfm
On the free market, the fundamental interest rate is determined by people’s time preference, i.e., their preference for sooner satisfaction instead of the same satisfaction later. Because of this preference, present money commands a premium over future money. People with less intense T.P. will lend to people with more intense T.P. and the fundamental rate of interest will be at the level that clears the market. In addition to the fundamental rate, the interest rate on each type of loan will have components to account for maturity, uncertainty, and changes in the purchasing power of money. For example: the 3-month, treasury bill rate will be lower than the 30-year, BBB rated corporate bond rate.
Here is some data on market interest rates:
ParticipantThe state’s policies, both fiscal and monetary, generate unjust wealth transfers through trade. But not everyone is tainted by these policy sins. When my wife and I bought lunch at Hot Head Burritos today both we and HHB benefited. The value of the lunch to us relative to money exceeded the value of the lunch relative to money to others who did not buy it. The nature of our trade was not altered because we used fiat money.
I agree that fiat money and fractional reserve banking empower the state more than the power to tax. Ending the Fed and turning production of money over to private enterprise would restore more of our liberty than any other single reform. Even so, the power to issue fiat money is not the source of the other distortions. If we had a private monetary system, the state would still distort the economy by taxing and regulating our activity and running its own production facilities.
Economics helps us to discern the effects of each of the state’s activities.
ParticipantIt is true that the pattern of prices, production, and income on an unhampered market would be entirely different than the pattern of prices, production, and income on a market economy hampered by a central banking that issues fiat money.
But it doesn’t follow from that conjectural claim that the pattern of prices, production, and income on a market economy hampered by a central bank issuing fiat money bears no relationship to people’s preferences.
By exercising its legal monopoly of printing fiat money, the state unjustly transfers resources from producers in the economy to itself. State officials and those who produce goods for the state, then, earn income unrelated to the satisfaction of people’s preferences in society. But this effect cannot extend to every producer in the economy unless the state adopts central planning. So in a hampered market economy their are lines of production support by the coercive power of the state and other lines of production not so supported. In the latter lines, the producers do earn incomes from the value of their productive services in satisfying the preferences of others and entrepreneurs do earn profit from their superior foresight in satisfying the preference of others. Consumer electronics would be an example of such a line of production.
The coercive taint on fiat money is not a character trait of the money as a medium of exchange it is in the use of the money by the state to unjustly transfer resources from producers to itself. And this effect is limited unless the state takes over all production.
ParticipantBonds issued in the past have stipulated interest payments that do not change over the life of the bond. For example, suppose a twenty year bond issued in 2000 had a face value of $10,000 and paid $600 a year in interest to the holder. Then the interest return on that bond when it was issued was 6 percent. Now suppose that a twenty year bond issued today with a face value of $10,000 paid $200 in interest to the holder for an interest rate of 2 percent. Investors today would want to buy the 2000 bond and not the 2013 bond. They would bid for the 2000 bond until its price rose to approximately $30,000 so that the interest return on that bond was also 2 percent. If interest rates in 2016 have risen back to 6 percent, then the price of the 2000 bond will have fallen back to $10,000 (making its interest return conform to the market rate of 6 percent) and the price of the 2013 bond will have fallen to approximately $3,333 (making its interest return conform to the market rate of 6 percent).
The general principle is that the interest return on all bonds issued in the past must conform to the current interest return, which will also be the interest return on newly issued bonds. The interest return itself is determined by people’s willingness to save and invest.
ParticipantThe value a person places on a good is not “based” on money, but expressed against the value he places on money. If I value an iPad more than I value $500, then I gain if someone sells me an iPad for $500. The seller must also gain by the trade, i.e., he must value $500 more than he values the iPad, otherwise he would not trade. If there is another person who values the iPad more than $400 but less than $500, then we can conclude that if the seller sells to the first buyer instead of the second buyer, the iPad has been allocated to the person who values it the most compared to money.
If people do not use money in trade but whatever barter goods they happen to have, then it cannot be determined which of the buyers values the good he has to sell more than another. One offers two beaver pelts for the iPad and another offers a chord of wood. The seller can tell which offer by the buyers he himself values more. But which buyer values the iPad more highly is indeterminate.
Labor, also, cannot be used to determine who values something more highly. The units of labor are different from person to person. If one person values the iPad for 6 hours of his labor and another person values the iPad for 12 hours of his labor, nothing can be inferred about which person values it more. The different units of money, however, are homogenous. So it is possible to say whether one person values something more highly relative to money compared to someone else.
ParticipantCarl Menger, the founder of the Austrian School of economics developed the economic theory of the origin of money. He argued that for something to emerge as a medium of exchange, it must have existing exchange value. Otherwise, people would not know how much of it to give in exchange for things they buy or take in exchange for things they sell. In order for something to have existing exchange value, it must currently be traded on the market or be introduced as a claim to something currently traded on the market. So gold originated thousands of years ago as a medium of exchange because it was already being traded as a good in markets, was highly marketable, and had desirable properties as a medium of exchange, e.g., durability, divisibility, portability, and so on. Once gold coins existed as money, claims to gold coins can come into existence. Bank notes or checkable deposits are money substitutes as long as people trust that the issuer will make good on his claim to redeem them for gold coins. Fiat money comes into existence first as a money substitute claim for existing money and then the issuer of the claim, namely, the state, breaks its claim. From that point on fiat money can continue as money without any reference to its past backing. It continues as money solely because people anticipate that other people will continue to accept it as money in trade. Federal Reserve Notes came into existence in 1914 in exactly this manner. The Fed redeemed FRNs at par with gold coins and claims to gold coins. The government completely broke its promise to redeem FRNs for gold money in 1971. From that point on the FRNs have been fiat money. The Euro also came into existence in the same way. It started as a redemption claim for each of the national currencies of the EMU countries. Over a few years, each of the countries broke its promise to redeem Euros for its national currency. From that point on the Euro has been a fiat money.
Here is Menger on the origin of money:
http://library.mises.org/books/Carl%20Menger/On%20the%20Origins%20of%20Money.pdf
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