[jmherbener]

The Fed’s QE1 was designed to restore solvency to banks. It bought mortgage backed securities and other assets from banks and paid for them by crediting checking accounts banks hold at the Fed. In the Fed’s estimation, it took $1.6 trillion of MBS off banks’ books to restore solvency. The Fed realizes, just as the rest of us do, the price inflationary potential of $1.6 trillion of excess reserves. (The ratio of M2 to require reserves is 100 to 1.) So, the Fed must control how banks use these excess reserves. Otherwise, when banks return to the normal process of issuing fiduciary media and creating credit on top of these reserves, price inflation will explode. The Fed thinks it can control the extent to which banks lend on top of their excess reserves (thereby converting them to required reserves) by paying banks interest on ER. If banks start to create too much credit, the Fed will raise the interest rate on ER.

In short, to save the banks and bailout the holders of MBS, the Fed has created the potential for massive price inflation. Now it must control how that potential gets actualized.

[jmherbener]

Yes, Mises is applying an argument that is true in general to the case of money. People will evade and defy government decrees to engage in normal concerted efforts to have their preferences satisfied.

[jmherbener]

The most important statistic about the federal budget’s impact on the economy is its size relative to the economy. If the federal government is taking a smaller portion of society’s resources, then more are left in private hands to be used efficiently.

Under Clinton, the federal budget as a percent of GDP fell steadily from around 23% in 1992 to around 18% in 2000. That’s more than a 20% reduction.

Under Reagan, it rose from 22% in 1980 to 24% in 1983 and then fell to 21% in 1988. Overall, it fell 5%. Under Bush I, it rose from 21% in 1988 to around 23% in 1992. A rise of nearly 10% in just four years.

Clinton was clearly the fiscal conservative even compared to the overrated Reagan.

Part of the explanation for the greater prosperity of the 1980s and first half of the 1990s (before the dot com boom and bust) was the reestablishment of a workable international monetary system based on the dollar after the debacle of the 1970s. Under this system international trade finally reached the level of world integration that had been attained under the classical gold standard before 1914.

The monetary inflation and credit expansion of the Fed found outlets around the world during this time, which permitted American companies to earn profits (and stock markets to soar) while price inflation at home was kept in check. This started to unravel first with Japan in the early 1990s and then southeast Asian countries in the middle part of the decade. After that the boom was felt here at home in the dot com debacle.

Of course, you’re right that people are naturally engaged in economic progress through the market economy, which continues to raise our standards of living even with government’s depredations. It’s not bad enough that politicians rob us of the prosperity we could have enjoyed, they insist on taking credit for the prosperity left to us that we ourselves are producing.

[jmherbener]

The reason demand for money increases during economic progress is that as a person becomes wealthier he typically desires to hold a larger amount of assets, including money. Of course, people don’t have to do this, but it seems that during the economic progress of the latter part of the nineteenth century, they did hold more money and their standards of living rose. (The money supply was increasing at roughly the same rate as the rate of increase in real GDP.)

Saving and lending money earns the rate of return on investment. Holding money earns no rate of return since a person keeps the money in his possession instead of investing it. A person decides how to disburse his income between consumption and saving-investing by his time preference and into money holding by his preference to hold money as an asset. Of course, a person could have preferences such that he always holds a minimum amount of money and consumes and invests as much of his income as possible. But this is done to satisfy his preferences, not to produce a stable PPM. The PPM, like any price is a social phenomenon which no one person can control by his actions.

[jmherbener]

Mises’s view is that if gold is actually money in the world economy, then nothing a government, or governments in concert, of some segment of the world economy can do will eliminate the role of gold in the world’s monetary system. Even if they establish fiat money regimes in their own territory, they must use gold in inter-country exchange with counties still using gold as money. This was the situation of the world, under Bretton-Woods, at the time Mises wrote Human Action in 1949 and revised it for the last time in 1963.

And even today with no country using gold officially as money, gold is still used in inter-country exchange and thereby, retains a monetary role. Mises goes on to write (p. 473) that in the future if technological advance makes gold less suitable as a medium of exchange, then people will adopt something else. Clearly, he didn’t have a gold fetish, but was arguing a general point, that governments cannot eliminate by force people making concerted efforts to have their preferences satisfied, applied to the particular case of money.

[jmherbener]

In the market economy, people devote resources to developing technology and embodying it in capital goods only when it improves efficiency. As a result labor becomes more productive. In other words, real wages or standards of living rise. With higher standards of living people can choose to take more leisure. If economic progress makes it possible for people to produce the same set of consumer goods with eight hours of labor a day instead of twelve, that’s a good thing. And this is precisely what has happened under capitalism over the last 200 hundred years. The work day and work week keep getting shorter and our standards of living keep getting higher. That we are “out of work” for four extra hours a day and one extra day a week compared to people 200 hundred years ago is a good thing.

Technological advance and economic progress do not make people unemployed even if it reduces the number of people working in some line of production. (They won’t necessary reduce the number of workers since the greater efficiency reduces costs and permits a lower price and therefore, a greater volume of sales and production.) In a market economy, they shift into other lines of production in which their labor is relatively more valuable. While their nominal wages might be lower, their real wages might be higher because of the greater productivity from the technological advance and economic progress. Whether their real wages rise or fall, society at large has more and better consumer goods.

Wages and prices adjust in a market economy to bring about the array of production processes that best satisfy our preferences.

[jmherbener]

As this introduction to the book Charity, Philanthropy, and Civility in American History demonstrates, there is a large literature on the topic.

http://catdir.loc.gov/catdir/samples/cam033/2002025655.pdf

A general point to keep in mind is that the market economy has raised standards of living to heights unimaginable just 200 years ago. If there was less charity before the nineteenth century, one reason might be that people were poor. Imagine the efficacy charity could achieve today if governments didn’t interfere with it. Even bearing the enormous burden of their destructive welfare programs, we are so productive through market activity that most everyone can be charitable.

[jmherbener]

I suppose the first step is to see if he thinks like an economist about markets in general. For example would he agree that if the supply of a good is larger on Friday than Monday, then the price on Friday is lower than it otherwise would have been if the supply had not been larger regardless of whether or not the actual price goes up or down?

If he agrees with this, then the second step is to demonstrate how the Fed’s expansionary monetary policy increases the supply of credit through credit creation by banks.

If he agrees with this, then you can lead him to the conclusion that the monetary inflation and credit expansion generated by the Fed makes interest rates lower than they would be otherwise.

If having accepted this conclusion, he still insists that the Fed is powerless to affect interest rates, he’s probably a hopeless case.

[jmherbener]

For useful statistics the the period, Tom Woods cites Kenneth Weiher, America’s Search for Economic Stability: Monetary and Fiscal Policy since 1913 (New York: Twayne, 1992), pp. 26-37.

Here is a NBER paper on unemployment in the U.S. from 1900-1954:

http://www.nber.org/chapters/c2644.pdf

The historical data on the St. Louis Fed’s website is FRASER, not FRED. You might search FRASER for data on production and GDP.

http://fraser.stlouisfed.org/

[jmherbener]

Here is Tom Woods on TR, including comments on Northern Securities Company:

http://mises.org/daily/4462/Theodore-Roosevelt-and-the-Modern-Presidency

Note the citation to Dominic Armentano’s book, Antitrust and Monopoly.

[jmherbener]

It would be helpful in formulating a response if you could give the page number of the quote so we can read its context. In the meantime, below is a general comment on the process of adjustment in the market to more saving and less consumption.

When people save more and consume less. demands for consumer goods fall and their prices decline. As their production become unprofitable, entrepreneurial demand for the specific capital goods produced in the lower stages declines and their production becomes less profitable. At the same time, the additional saving lowers interest rates making other investment projects more profitable. The demands for resources to produce these capital projects increases. Their production lengthens out the structure of production as its buildup will prove to be profitable in the future with the new array of prices.

This entire processes of price adjustment is difficult to condense into a paragraph. I suggest you read Murray Rothbard’s discussion of the same phenomenon in Man, Economy, and State, chapter 8, and then post any followup questions you have. Rothbard systematically explains how prices and production adjust throughout the production structure to restore the interest return in all production processes after a voluntary increase in saving-investing.

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

Also, take a look at Bob Murphy’s study guide to Man, Economy, and State, for chapter 8.

http://library.mises.org/books/Robert%20P%20Murphy/Study%20Guide%20of%20Man,%20Economy,%20and%20State.pdf

[jmherbener]

Dorian,

The Pure Theory of Capital is notoriously difficult. I would recommend you read the sections on production in Murray Rothbards’s, Man, Economy, and State. The relevant chapters are 5-9.

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

Then tackle, Hayek’s, Prices and Production and Other Works, edited by Joe Salerno.

http://library.mises.org/books/Friedrich%20A%20Hayek/Prices%20and%20Production.pdf

Then give Pure Theory of Capital another try.

http://library.mises.org/books/Friedrich%20A%20Hayek/Pure%20Theory%20of%20Capital.pdf

[jmherbener]

Historical analysis, whether of past events or events yet to occur, requires making judgments about the relevance of the different causal factors at work that bring about the effects we wish to analyze.

The same causal factors can be at work in different historical instances but with different intensities peculiar to each instance. If so, the effects can be different.

According to Hans Sennholz, an important causal factor in the German hyperinflation was the delusion held by policy makers that rapidly increasing the nominal money supply was not inflationary because the real money supply was stable or even shrinking. I don’t think that factor is present in any significant strength in America today. Here is Sennholz on the German hyperinflation.

http://mises.org/daily/2347

Also, hyperinflation requires runaway inflationary expectations. These, in turn, must be caused by an actual significant and accelerating price inflation, which in turn, must be set in motion by monetary inflation. We don’t seem to be on such a path today and there are plenty of possibilities of avoiding it. (As I’ve suggested in earlier posts, the Fed does have ways of containing the inflationary potential of its build-up of bank reserves. The most obvious being to simply turn the excess reserves into required reserves with a rule change requiring 100% reserve checking accounts.) Here is an interesting article by David Laider on German economists writing during the German hyperinflation explaining the role of inflationary expectations.

http://www.jstor.org/discover/10.2307/2601130?uid=3739864&uid=2&uid=4&uid=3739256&sid=21101171442211

Of course, there are several causal factors at work in America today tending toward hyperinflation. But making a prediction of how our history will occur requires more than just pointing this out. It requires making plausible judgments of the likelihood of the strength of those causal factors relative to others that would generate a different set of effects. There are other alternatives policy makers could take instead of direct monetizing of the Federal debt. For example, debt repudiation. It seems to me at least as likely that the Federal government would repudiate on its debt, especially given that a large portion of it is held by foreigners and the Fed itself, instead of nationalizing banks.

In any case, Woods and North aren’t denying the existence of causal factors tending toward hyperinflation or the possibility of hyperinflation, they’re arguing that it isn’t the most likely outcome because other factors not tending toward hyperinflation will turn out to be more significant.

[jmherbener]

In normal times, you’re correct. Banks hold only required reserves and invest any excess reserves (or turn excess reserves into required reserves by issuing fiduciary media through credit creation).

In the last few years, the Fed has been paying interest to banks on reserves they hold as account balances at the Fed. Given the climate of investment in the economy, banks have decided to invest in excess reserves themselves. The quote reflects this situation and not the normal one.

But your point is still well taken. Several Austrians made a similar point after the Fed built excess reserves up from almost nothing to $1.6 trillion dollars. If banks return to normal operations by converting their current excess reserves into required reserves by issuing fiduciary media through credit creation, the money supply will increase by $25 trillion dollars. Currently M1 is $2.3 trillion and M2 is $10 trillion.

If the Fed had increased excess reserves to $50 trillion, then the monetary inflationary potential could increase the money supply by $800 trillion, If, instead, the Fed printed the $50 trillion and buried it in the ground, they wouldn’t face the problem of unwinding that amount of excess reserves without serious price inflation. As it is, the Fed has to worry about unwinding an inflationary potential of only 10 times M1 and 2.5 times M2.

[jmherbener]

Two breakdowns of world reserve currencies have occurred in the twentieth century. The pound in the interwar period and the dollar after the collapse of Bretton-Woods. Neither resulted in a hyperinflation.

Inflationary repercussion of the repatriation of dollars is possible in the wake of another collapse of the dollar as a world reserve currency. But, it’s not a foregone conclusion. The Fed could manage the problem. For example, it could require banks to hold increasing amounts of currency as reserve and exchange account balances that banks hold at the Fed for currency as the repatriation proceeds.

Of course, the possibility of hyperinflation or deflation remains since the Fed may prove to be unwilling or unable to manage the problems that its monetary inflation and credit expansion create.

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