[jmherbener]

If U.S. Treasuries were downgraded, then interest rates would rise, or be higher than otherwise, on U.S. Treasuries. Because the rise of rates on Treasuries would be compensation for the greater risk of holding Treasuries, it would not necessarily lead to arbitraging into other bonds and higher rates for them. There were no wide-spread ill effects on bond markets from the Standard and Poor’s downgrade of Treasuries from AAA to AA+ in August 2011.

For banks that held Treasuries, if the downgrade raised their rates it would evaporate bank equity. Whether or not it made them insolvent would depend on the extent of their Treasuries holdings and equity. Even if it made banks insolvent, the Fed would probably intervene to keep them in operation.

I don’t see that it would have an effect on the dollar, unless investors thought that the federal government would rely more heavily on monetary inflation in the future to finance its expenditures.

[jmherbener]

1. There is doubt because the Fed can invoke policy to eliminate the potential for fiduciary issue. The most obvious case would be to raise the required reserve ratio to convert excess reserves into required reserves.

2. If investors see gold as a hedge against price inflation, then a dollar collapse is bullish for gold. Rising interest rates, under your scenario, are necessary to compensate for price inflation. The higher rates, then, do not imply higher real returns and thus, are not bearish for gold.

[jmherbener]

But most disputes today in our system are handled in private arbitration. For help in answering your questions, I suggest you read Bruce Benson’s book, The Enterprise of Law (Pacific Research Institute, 1990).

[jmherbener]

I suggest you re-post your comments and question on the “General Discussion” forum. You’re likely to get more discussion there than you will on this forum, which is dedicated to economics.

Having said that, I will venture a few comments. Economic theory demonstrates that the market economy arranges production in the manner that most fully satisfies people’s preferences. For the market economy to be sustained, private property and voluntary contract must be given the sanction of law and people must accept the legitimacy of private property and voluntary contract. Given that people prefer to have legal sanction of private property and contract, it doesn’t seem implausible that the services of adjudicating and executing those legal sanction could be done by private enterprise instead of by a state enterprise. If people don’t prefer to have legal sanction of private property and contract, then injustice will reign regardless of how the adjudication and execution of legal sanctions is organized.

[jmherbener]

The argument of your Keynesian friend is illogical. He is saying that the volatility in the dollar price of gold, which is not money, is due to the vagaries of the valuation people make of gold but not the value they make of the dollar, which is money. But if the value of money cannot be the source of the volatility of the prices of goods, then in a gold standard, i.e., when gold coins are money, the valuation of gold coins cannot be the source of volatility in the prices of goods either.

As to the “prediction” that the Fed’s expansionary monetary policy in the wake of the crisis would cause price inflation, the jury is still out. The Austrian theory of money explains that the purchasing power of money is determined by the Total Stock of money and the Total Demand to hold money, just as the price of any other good is determined. The money stock in our economy is money proper (i.e., Federal Reserve Notes printed by the Fed) plus money substitutes (i.e., on demand, at par redemption claims for money proper) issued by banks and other financial institutions. In the wake of the crisis, the Fed bought assets from banks and paid with reserves (cash and demand deposits at the Fed). In normal times, the banks would issue a multiple of fiduciary media on top of their reserves. But instead, banks have held excess reserves. Thus, the money stock has not expanded as some anticipated it might. Moreover, the demand for money has increased, as it often does during a downturn. This has moderated the reduction of money’s purchasing power. The jury is still out on whether the potential for monetary inflation in the form of excess reserves in the banks and a reduction of money demand will yet result in a significant monetary inflation when economic normality returns. That it hasn’t happened yet may be a strike against the historical acumen of those who predicted it would, but it doesn’t bear at all on the efficacy of the theory of money held by Austrians.

Finally, the claim that the economy cannot reach its highest production potential without continuous monetary inflation, which cannot occur under the gold standard, is both theoretically dubious and historically false. The fastest sustained period of economic growth in American history was during the latter part of the 19th century under the classic gold standard. The basic theoretical problem with this claim is that production depends not on prices of output, but on the spread between output prices and input prices. Such price spreads depend not at all on total spending in the economy.

[jmherbener]

If foreign demand to hold dollars collapses, then the foreign exchange value of the dollar will fall, which will prompt a repatriation of the dollar resulting in price inflation in America. But this scenario has nothing to do, per se, with U.S. trade deficits, foreign Treasury holdings, and so on. Accounts such as these result from people acting on their preferences. If their preferences change, then the patterns of exchange and production change, which then change the accounts. If their preferences do not change, then the pattern of exchange and production do not change and the accounts do not change.

Foreigners prefer to sell us more goods than we sell them and to buy from us dollars. They want to hold additional dollars and until that preference changes, the dollar’s exchange value will not collapse, no matter what the size of our trade deficit. If our trade deficit grows it means that foreigners want to hold additional dollars. Here is a story about the significant increase in foreign holding of dollars since the crisis:

http://www.federalreserve.gov/pubs/ifdp/2012/1058/ifdp1058.pdf

What checked profligate monetary inflation and deficit spending under the classical gold standard was the redemption of each currency at a fixed rate for gold. When people called into question the fixed rate of redemption of a currency for gold (e.g., after a government inflated its currency), this led to adverse trade flows, devaluations, and so on.

When the U.S. runs a trade deficit with China, the dollars the Chinese do not desire to hold they use to make financial investments in the U.S. Markets bring people with different preferences into mutually advantageous relationships. Americans save little and consume lots. Chinese save lots and consume little. When we come together in a market economy, the Chinese will produce more goods for us than we do for them and they will invest more in America than we invest in China. That’s what both groups of people want to happen. Our trade deficit is balanced by our capital inflow and China’s trade surplus is balanced by their capital outflow. These trade accounts are sustainable because they reflect people’s preferences. There is no problem here until the government crowds out Chinese investment in American private enterprise with Treasuries. That’s where the problems originate, not in imbalances in trade accounts.

[jmherbener]

A standard work discussing the different views on macroeconomics is Brian Snowdon and Howard Vane, Modern Macroeconomics: Its Origins, Development, and Current State (Edward Elgar, 2005). Here is a short review of the book:

http://mises.org/journals/qjae/pdf/qjae9_1_6.pdf

[jmherbener]

Efficient allocation of resources means that they are being used to produce goods that satisfy people’s highest-valued ends in the least-cost manner. It is not efficient to merely produce more stuff.

During the boom, monetary inflation and credit expansion results in a pattern of demands for goods and resources that results in the build up of the capital structure that proves to be unsustainable. Once the pattern of demands for goods and resources change in the crisis the efficient thing to do is to re-allocate the mis-allocated resources and mal-invested capital structure into those lines of production that best satisfy people’s preferences. For example, once the housing boom is over and demand for housing and the resources to produce housing throughout the capital structure have collapsed, the efficient thing to do is for some construction workers to find jobs elsewhere, some factories producing roofing shingles to be re-configured to produce other materials, and so on. Having build too many houses in Vegas during the boom, it is not efficient to use the resources to produce too many houses in Reno. If Keynesians are really against unemployment and excess capacity, they should favor eliminating all government impediments to the re-allocation of labor and capital goods.

[jmherbener]

Your points are well taken, but they require thinking about the problem of wage setting in the markets of the real economy. New Keynesians think about the problem within their models. The models are specified to generate sub-optimal equilibria under sticky-wage assumptions. The justification they give for this method is that the phenomenon of an “under performing” economy is experienced in the real world. If their explanation seems fishy to you, then go to the head of the class.

On the reasons for sticky wages in the real world, take a look at Joe Salerno’s blog post:

http://bastiat.mises.org/2012/03/whose-afraid-of-sticky-prices/

[jmherbener]

The old Keynesians left out micro-economics altogether. By doing so they implicitly assumed that prices and wages were sticky, i.e., did not adjust rapidly. They were criticized by the New Classical economists who asserted that if prices and wages adjust rapidly, then changes in aggregate demand with not adversely affect production in the economy. The New Keynesians came up with micro-economic arguments for sticky prices and wages.

Here is Greg Mankiw, a leading New Keynesian, on New Keynesianism:

http://www.econlib.org/library/Enc/NewKeynesianEconomics.html

[jmherbener]

Rothbard was referring to old Keynesianism that ruled the intellectual roost in the 1950s and 1960s. Stagflation made that version of Keynesianism unpalatable to intellectuals. So they invented sophisticated versions, New Keynesianism, Post-Keynesianism, and so on. The old orthodox Keynesianism still lives on in the textbooks. But until Paul Krugman appeared on the scene, intellectuals considered old Keynesianism fit only for undergraduates as a gateway to their more sophisticated versions. And even in the era of Krugman, the sophisticated Keynesians tend to cringe at his old Keynesianism.

Whatever the debates on arcane points of contention between them, all Keynesians agree that aggregate demand is the key to economic prosperity. Thus, their policy prescriptions are much more uniform than their explanations of why the market system fails to sustain prosperity. Politicians are never loath to accept the advice that the government must spend more to keep the economy prosperous.

[jmherbener]

The money stock decreases only if the bank decides not to issue fiduciary media by extending another loan to another borrower. As long as the bank desires to hold no excess reserves, then the money stock will not shrink.

Even if there is no central bank increasing the reserve of money upon which the banking system issues fiduciary media, the banking system can still steadily increase the money stock by reducing the reserve ratio. In a fractional-reserve system, the reserve ratio is set by the practical limits of redemption of bank money substitutes. Under some configurations of fractional-reserve banking, the banking system can progressively lower the reserve ratio even without a central bank.

Take a look at the relevant sections (e.g., chs. 16-18) of MIses’s Theory of Money and Credit:

http://library.mises.org/books/Ludwig%20von%20Mises
/The%20Theory%20of%20Money%20and%20Credit.pdf

For a configuration of free banking on 100 percent reserves, take a look at Joe Salerno’s article in Guido Huelsmann’s new book, Theory of Money and Fiduciary Media:

http://mises.org/document/7018/Theory-of-Money-and-Fiduciary-Media

[jmherbener]

Fundamentally, international trade is no different than domestic trade. The principles of economics transcend political boundaries.

The reason two persons trade with each other is that they both benefit from obtaining something they value more highly. In other words, they recognize a difference in the value of two alternatives and act to gain from this difference. In trade all moveable goods, consumer goods, producer goods (i.e., labor and capital goods), and money move from where they have less value to where they have more value. This process continues until there are no more value differences to exploit. Trade statistics merely account for (but are not the cause of) these movements.

If a government has a policy with respect to international trade it’s typically to help exporters and not importers. It usually does this through protectionism, i.e., high tariffs on competing foreign produced imports or artificial devaluation of the countries currency to stimulate foreign purchases of domestic exports.

I’ve never heard of a government that inflates its money with the intention of stimulating imports, although one could conceive of such a policy. Perhaps one reason governments attempt to stimulate exports and not imports is that net exports (exports minus imports) are part of GDP, i.e., the production of final goods and services in the economy. So to make the economy appear more productive, the government could attempt to stimulate exports or restrict imports.

[jmherbener]

The purchasing power of money (i.e., the inverse of prices) is determined by the stock of money and the demand for money. The stock of money consists of money proper and money substitutes. In a fractional reserve banking system, banks issue fiduciary media, i.e., money substitutes for which they hold only a fraction of money in reserve for redemption. It follows that the banking system can expand the money stock by issuing fiduciary media and thereby, generate price inflation.

Your friend has not thought through the logic of his example. If the 1st bank keeps $100 dollars and lends out the other $900 of the original $1,000 in cash deposited, then the borrower spends the $900 and the merchant receiving the money deposits it in his bank. The 2nd bank then keeps $90 and lends $810 (now the banking system has created $1,900 of money substitutes already on the $1,000 in cash). And so on the process continues until the banking system creates $10,000 in fiduciary media on top of the $1,000 cash reserve. So even if the original depositor doesn’t spend his $1,000 deposit, the fractional-reserve banking system is inflationary. Of course, instead of going through this indirect process, it’s more likely that the 1st bank simple issues a loan of $10,000 to a customer and puts the funds in his account in which case it would be meeting the reserve requirement ratio of 0.10 and yet it has created $9,000 additional dollars of money substitutes.

[jmherbener]

Here’s a short piece addressing consumer protection on the free market. Take a look at the citations for more sources.

http://www.econlib.org/library/Enc/ConsumerProtection.html

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