Posts
From: patrickbarron@msn.com
To: wsj.ltrs@wsj.com
Subject: Russia Bans Grain Exports
Date: Fri, 6 Aug 2010 08:05:33 -0400
Re: Russia Bans Grain Exports
Dear Sirs:
Russia is suffering from excessive heat and wildfires. So President Putin has banned the export of grain and has set up an emergency relief fund of $1.2 billion for farmers. These measures usually meet with approval by those unfamiliar with economics. But President Putin's arbitrary decisions overrule the wishes of millions of Russians. If Russians want more grain, they can divert their spending from less important choices. But they will have less money with which to do so, because President Putin also has confiscated it for handouts to farmers. The market is far superior in reacting to natural disasters than arbitrary government edits. Yet politicians must grandstand, so they wave their hands and pass laws to convince the public that they can make it all better. We saw this farce in spades five years ago when Hurricane Katrina hit New Orleans and the Gulf coast.
Patrick Barron
Friday, August 6, 2010
My Letter to the Financial Times re: France Preventing Outsourcing by State Industries
From: patrickbarron@msn.com
To: letters.editor@ft.com
Subject: Re: France to reign in state-backed groups
Date: Thu, 5 Aug 2010 19:09:25 -0400
Re: France to rein in state-backed groups
Dear Sir:
By prohibiting state-backed companies from seeking the lowest cost and/or best quality factors of production, the French economy will revert, by just that much, to a lower production possibility frontier. This process will create an economic cancer in the French economy, because these industries will require higher and higher levels of subsidies, robbing other, more entrepreneurial businesses of life-giving capital. This is just another obstacle placed on the French economy by its Mercantilist-style governmental policies.
Patrick Barron
To: letters.editor@ft.com
Subject: Re: France to reign in state-backed groups
Date: Thu, 5 Aug 2010 19:09:25 -0400
Re: France to rein in state-backed groups
Dear Sir:
By prohibiting state-backed companies from seeking the lowest cost and/or best quality factors of production, the French economy will revert, by just that much, to a lower production possibility frontier. This process will create an economic cancer in the French economy, because these industries will require higher and higher levels of subsidies, robbing other, more entrepreneurial businesses of life-giving capital. This is just another obstacle placed on the French economy by its Mercantilist-style governmental policies.
Patrick Barron
Thursday, August 5, 2010
My Letter to the WSJ re: Geithner Pushes Tax Boost for the Wealthy
From: patrickbarron@msn.com
To: wsj.ltrs@wsj.com
Subject: Geithner Pushes Tax Boost for the Wealthy
Date: Thu, 5 Aug 2010 08:20:00 -0400
Re: Geithner Pushes Tax Boost for the Wealthy
Dear Sirs:
By defending increasing taxes on the wealthy, Treasury Secretary Geithner honestly reveals three things about this administration that the American people should know. One, that this administration wants more of the peoples' money; two, that the administration knows that the only place to get it is by taking more of the money from the nation's most productive people (that's why they are paid more); and, three, that the administration believes that savings is bad for the economy. Seldom has a high administrative official been so revealing about the vast chasm that exists between those who must work for a living and those who live as parasites off the fruits of others' labor.
Patrick Barron
To: wsj.ltrs@wsj.com
Subject: Geithner Pushes Tax Boost for the Wealthy
Date: Thu, 5 Aug 2010 08:20:00 -0400
Re: Geithner Pushes Tax Boost for the Wealthy
Dear Sirs:
By defending increasing taxes on the wealthy, Treasury Secretary Geithner honestly reveals three things about this administration that the American people should know. One, that this administration wants more of the peoples' money; two, that the administration knows that the only place to get it is by taking more of the money from the nation's most productive people (that's why they are paid more); and, three, that the administration believes that savings is bad for the economy. Seldom has a high administrative official been so revealing about the vast chasm that exists between those who must work for a living and those who live as parasites off the fruits of others' labor.
Patrick Barron
Wednesday, August 4, 2010
Understanding the Relationship between Money and the Price Level
One of the conundrums of current economic life is why the increase in the money supply had not caused runaway price inflation. Furthermore, the federal government has run a one-trillion-dollar deficit this year, with promises of more for several more years, while at the same time interest rates have fallen to unprecedented low levels. Both of these phenomena seem to violate economic law. Shouldn’t more money drive up prices? And shouldn’t government’s massive borrowings cause interest rates to rise? Yet prices for most goods have remained stable and the interest rate is at historic lows. Has all economic law been shown to be fallacious?
In this essay I will explain the fundamental forces at work to explain the relationship between the money supply and the price level, which will, coincidentally, help to explain the low rate of interest. There is no violation of economic law. The seeming anomalies stem from the fundamental error of placing economics within the realm of the physical sciences and not in the realm of the social sciences. The view of economics as a physical science leads one to the conclusion that economics is mechanical and can be explained by formulas; whereas understanding economics as a social science leads one to understand that human volition cannot be predicted or reduced to mathematical formula with substantive and temporal exactness.
The Quantity Theory of Money
At the foundation of our understanding of money and prices resides the quantity theory of money. At this most basic level it is axiomatic that the price level is the intersection of the quantity of goods for sale on the market and the amount of money available to purchase these goods. Prices can rise for only two reasons. One, the quantity of money rises faster than the quantity of goods for sale. Two, the quantity of goods for sale drops faster than the quantity of money. Of course the reverse is true about a falling price level. Prices can fall for only two reasons. One, the quantity of money falls faster than the quantity of goods for sale. Two, the quantity of goods rises faster than the quantity of money.
Let’s use a simple example. Assume that there is only one commodity for sale in the economy. One hundred units of this commodity are produced. The money supply consists of one thousand units of currency; we’ll use dollars as our money supply unit. The only price that will clear the market of all goods offered for sale is ten dollars per unit. ($1,000 divided by 100 units) Let us suppose that there is a production improvement that allows the market to produce two hundred units of the same commodity. Then the market-clearing price will be five dollars per unit. ($1,000 divided by 200 units) Likewise, let us assume that the money supply increases to two thousand dollars while the ability of the market to produce goods remains the same at one hundred units. Then the market-clearing price will be twenty dollars per unit. ($2,000 divided by 100 units) From this simple example one can clearly see that, if we admit that the U.S. economy produced more goods today than it did twenty years ago, then the primary reason that prices have not fallen is that the money supply increased concomitantly. If the money supply had remained stable, the only way that the market could have cleared the supply of goods for sale would have been for prices to fall. Since most price statistics show that prices have not fallen and in fact have risen somewhat, then the only explanation is that the money supply increased.
(Although the quantity theory of money knows no definitive author and has been known for centuries, Professor George Reisman has written extensively on the subject. I recommend pages 505 and 506 of his magnum opus Capitalism for a brief explanation. Then the reader can continue elsewhere in this magnificent book for further and more detailed discussion of money, prices, and production.)
There Are Only Three Uses of Money
Yet my illustration above and recent experience seem to make a mockery of economic science. I had said that economics was not a physical science, and yet I used mathematics to illustrate my point. Is not mathematics a physical science? Furthermore, my illustration would predict that prices must rise when the money supply increases, and yet in recent months the money supply HAS increased and prices have not followed. Should we discard the quantity theory of money? No. The theory is at the foundation of understanding money and prices and it does explain long-term trends. (Since 1990 M2 has increased by a factor of 2.62 while nominal GNP has increased by 2.57, which leads one to the conclusion that the economy has not really grown at all in terms of real goods and services in two decades. All of the increase GNP can be attributed to higher nominal prices caused by an increase in the money supply.) But other factors operating within this foundational theory determine market prices in the short-term.
There are three and only three uses for money—to hold (hoard), spend, and invest. Of the three, only the size of the spend-and-invest components determine the price level; i.e., spending and investing are those components of the money supply that are brought to market to purchase goods available for sale. As the total quantity of spending and investing increase in relation to the quantity of goods and services brought to market, prices will increase. If either or both of these components decrease, prices will decrease. Furthermore, if the money supply increases—that is, the total of all three uses increases—and all of the increase goes into hoarding, the price level will remain the same.
(As is the case with the quantity theory of money, the concept that there are only three uses of money was not discovered by any single economist, but I refer the reader to chapter seven of Hans-Hermann Hoppe’s The Economics and Ethics of Private Property for an excellent discussion of the subject.)
Here is an example that I use in my Austrian economics class at the University of Iowa: Suppose that the Fed printed enough paper money to give everyone in America one million dollars. Since there are 300 million Americans, the money supply would increase by 300 trillion dollars! Surely that would trigger higher prices! But let us also assume that every American took the money and placed it under his mattress. He did not spend one cent. What would happen? Well, the money supply would increase by 300 trillion dollars, but the price level would remain the same. All the new money would have gone into hoarding and would have no impact on prices.
Now we get a glimpse of what has been happening for several years. Central banks around the world have been printing money, but most of this money has been hoarded. When governments spend money without first borrowing it from the existing monetary stock or taxing it from the citizenry, the new spending eventually goes into bank reserves. Since the banks have not increased lending, the money supply has not increased. As of July 28, 2010 bank excess reserves stood at $1.012 trillion dollars. This is a form of money hoarding. Another form of money hoarding is the buying of sovereign debt. For example, the U.S. government has sold hundreds of billions of dollars of debt to our trading partners. This happens when foreigners foolishly believe that running large trade surpluses is somehow a national advantage. But Frederic Bastiat exploded this fallacy over a century and a half ago in his essay Government. By holding its currency cheap in order to export goods, a country impoverishes itself by shipping useful goods in exchange for depreciating paper money. Since these foreign governments have no use, so far, for American products, they buy U.S. Treasury debt in order to “park” the money until some future date. This, too, is a form of hoarding, because the money does not finance spending and/or investing.
The End to Hoarding
There is no way to predict the end to hoarding, but when it comes American prices will rise: the hoarded money will flow into spending and/or investing. At some point the hoarded money will burn a hole in peoples’ pockets. The first holders of large amounts of American money will be able to exchange their dollars for goods, services, and assets at today’s prices. But as this hoarded money flows into spending and investing, prices will start to rise. Other holders of hoarded U.S. dollars will realize that nothing can stop the depreciation of the dollar, as illustrated by relentless price increases. Now we will enter what Ludwig von Mises called the “danger zone”. Even if the central banks try to stop the flow of hoarded funds into spending and investing, they will be unsuccessful because market psychology has changed. No one will wish to hold depreciating dollars; they will be spent as rapidly as possible, creating the real possibility of what Mises called the “crack-up boom”. Money becomes worthless.
Just as the psychology of today’s market mitigates holding dollars, once the floodgates have been opened the psychology of the market will reverse. In The Mystery of Banking Murray N. Rothbard explained that market psychology can change very slowly, as in America for the first two decades after World War II, or very rapidly, as in Germany after World War I, where in 1923 the world witnessed the worst crack-up boom ever to appear in a modern, industrial nation. Germany recovered only when it exchanged the old mark for the new Rentenmark at one trillion old marks for each new Rentenmark and the Reichsbank pledged to hold the supply of Rentenmarks stable. When the Reichsbank kept its word gradually the people regained confidence in their currency. But the damage had been done. The resources of the middle class had been wiped out, and, more importantly, the German peoples’ confidence in social institutions had been shattered, opening the door to the demagoguery of National Socialism.
It Can’t Happen Here
Americans are no less ruled by the iron laws of economics than are other, less fortunate peoples. Never in the history of the world has so dominant a world power engaged in such massive money debasement. The trillions of dollars held around the world represent claims upon the productive sector of the U.S. economy that simply cannot be met--at least not at today’s prices. The German hyperinflation of 1923 wiped out the German government’s war reparation debt, but at the stupendous price of ushering in the fascists. Likewise, the U.S. could technically pay its national debt by so devaluing the dollar that it effectively robs dollar holders of their good faith claims upon American resources. I would remind xenophobic Americans, who may believe that robbing foreigners is of no concern, that Americans hold dollar claims, too, and would suffer just as much, if not more.
At the present time there is no better market alternative to holding American dollars. All currencies are fiat currencies, managed by the whim of politicians buying votes with more entitlements. But forces are building to end American hegemony in monetary affairs. The Chinese, the Indians, the Arabs, and the Russians are floating rumors of issuing a gold-backed currency, and the market always rewards a better product. It would be the greatest tragedy to befall this nation, if our foolish government destroyed our currency at the height of our productive capacity, making indirect, peaceful, cooperative exchange an impossibility. It can happen here!
In this essay I will explain the fundamental forces at work to explain the relationship between the money supply and the price level, which will, coincidentally, help to explain the low rate of interest. There is no violation of economic law. The seeming anomalies stem from the fundamental error of placing economics within the realm of the physical sciences and not in the realm of the social sciences. The view of economics as a physical science leads one to the conclusion that economics is mechanical and can be explained by formulas; whereas understanding economics as a social science leads one to understand that human volition cannot be predicted or reduced to mathematical formula with substantive and temporal exactness.
The Quantity Theory of Money
At the foundation of our understanding of money and prices resides the quantity theory of money. At this most basic level it is axiomatic that the price level is the intersection of the quantity of goods for sale on the market and the amount of money available to purchase these goods. Prices can rise for only two reasons. One, the quantity of money rises faster than the quantity of goods for sale. Two, the quantity of goods for sale drops faster than the quantity of money. Of course the reverse is true about a falling price level. Prices can fall for only two reasons. One, the quantity of money falls faster than the quantity of goods for sale. Two, the quantity of goods rises faster than the quantity of money.
Let’s use a simple example. Assume that there is only one commodity for sale in the economy. One hundred units of this commodity are produced. The money supply consists of one thousand units of currency; we’ll use dollars as our money supply unit. The only price that will clear the market of all goods offered for sale is ten dollars per unit. ($1,000 divided by 100 units) Let us suppose that there is a production improvement that allows the market to produce two hundred units of the same commodity. Then the market-clearing price will be five dollars per unit. ($1,000 divided by 200 units) Likewise, let us assume that the money supply increases to two thousand dollars while the ability of the market to produce goods remains the same at one hundred units. Then the market-clearing price will be twenty dollars per unit. ($2,000 divided by 100 units) From this simple example one can clearly see that, if we admit that the U.S. economy produced more goods today than it did twenty years ago, then the primary reason that prices have not fallen is that the money supply increased concomitantly. If the money supply had remained stable, the only way that the market could have cleared the supply of goods for sale would have been for prices to fall. Since most price statistics show that prices have not fallen and in fact have risen somewhat, then the only explanation is that the money supply increased.
(Although the quantity theory of money knows no definitive author and has been known for centuries, Professor George Reisman has written extensively on the subject. I recommend pages 505 and 506 of his magnum opus Capitalism for a brief explanation. Then the reader can continue elsewhere in this magnificent book for further and more detailed discussion of money, prices, and production.)
There Are Only Three Uses of Money
Yet my illustration above and recent experience seem to make a mockery of economic science. I had said that economics was not a physical science, and yet I used mathematics to illustrate my point. Is not mathematics a physical science? Furthermore, my illustration would predict that prices must rise when the money supply increases, and yet in recent months the money supply HAS increased and prices have not followed. Should we discard the quantity theory of money? No. The theory is at the foundation of understanding money and prices and it does explain long-term trends. (Since 1990 M2 has increased by a factor of 2.62 while nominal GNP has increased by 2.57, which leads one to the conclusion that the economy has not really grown at all in terms of real goods and services in two decades. All of the increase GNP can be attributed to higher nominal prices caused by an increase in the money supply.) But other factors operating within this foundational theory determine market prices in the short-term.
There are three and only three uses for money—to hold (hoard), spend, and invest. Of the three, only the size of the spend-and-invest components determine the price level; i.e., spending and investing are those components of the money supply that are brought to market to purchase goods available for sale. As the total quantity of spending and investing increase in relation to the quantity of goods and services brought to market, prices will increase. If either or both of these components decrease, prices will decrease. Furthermore, if the money supply increases—that is, the total of all three uses increases—and all of the increase goes into hoarding, the price level will remain the same.
(As is the case with the quantity theory of money, the concept that there are only three uses of money was not discovered by any single economist, but I refer the reader to chapter seven of Hans-Hermann Hoppe’s The Economics and Ethics of Private Property for an excellent discussion of the subject.)
Here is an example that I use in my Austrian economics class at the University of Iowa: Suppose that the Fed printed enough paper money to give everyone in America one million dollars. Since there are 300 million Americans, the money supply would increase by 300 trillion dollars! Surely that would trigger higher prices! But let us also assume that every American took the money and placed it under his mattress. He did not spend one cent. What would happen? Well, the money supply would increase by 300 trillion dollars, but the price level would remain the same. All the new money would have gone into hoarding and would have no impact on prices.
Now we get a glimpse of what has been happening for several years. Central banks around the world have been printing money, but most of this money has been hoarded. When governments spend money without first borrowing it from the existing monetary stock or taxing it from the citizenry, the new spending eventually goes into bank reserves. Since the banks have not increased lending, the money supply has not increased. As of July 28, 2010 bank excess reserves stood at $1.012 trillion dollars. This is a form of money hoarding. Another form of money hoarding is the buying of sovereign debt. For example, the U.S. government has sold hundreds of billions of dollars of debt to our trading partners. This happens when foreigners foolishly believe that running large trade surpluses is somehow a national advantage. But Frederic Bastiat exploded this fallacy over a century and a half ago in his essay Government. By holding its currency cheap in order to export goods, a country impoverishes itself by shipping useful goods in exchange for depreciating paper money. Since these foreign governments have no use, so far, for American products, they buy U.S. Treasury debt in order to “park” the money until some future date. This, too, is a form of hoarding, because the money does not finance spending and/or investing.
The End to Hoarding
There is no way to predict the end to hoarding, but when it comes American prices will rise: the hoarded money will flow into spending and/or investing. At some point the hoarded money will burn a hole in peoples’ pockets. The first holders of large amounts of American money will be able to exchange their dollars for goods, services, and assets at today’s prices. But as this hoarded money flows into spending and investing, prices will start to rise. Other holders of hoarded U.S. dollars will realize that nothing can stop the depreciation of the dollar, as illustrated by relentless price increases. Now we will enter what Ludwig von Mises called the “danger zone”. Even if the central banks try to stop the flow of hoarded funds into spending and investing, they will be unsuccessful because market psychology has changed. No one will wish to hold depreciating dollars; they will be spent as rapidly as possible, creating the real possibility of what Mises called the “crack-up boom”. Money becomes worthless.
Just as the psychology of today’s market mitigates holding dollars, once the floodgates have been opened the psychology of the market will reverse. In The Mystery of Banking Murray N. Rothbard explained that market psychology can change very slowly, as in America for the first two decades after World War II, or very rapidly, as in Germany after World War I, where in 1923 the world witnessed the worst crack-up boom ever to appear in a modern, industrial nation. Germany recovered only when it exchanged the old mark for the new Rentenmark at one trillion old marks for each new Rentenmark and the Reichsbank pledged to hold the supply of Rentenmarks stable. When the Reichsbank kept its word gradually the people regained confidence in their currency. But the damage had been done. The resources of the middle class had been wiped out, and, more importantly, the German peoples’ confidence in social institutions had been shattered, opening the door to the demagoguery of National Socialism.
It Can’t Happen Here
Americans are no less ruled by the iron laws of economics than are other, less fortunate peoples. Never in the history of the world has so dominant a world power engaged in such massive money debasement. The trillions of dollars held around the world represent claims upon the productive sector of the U.S. economy that simply cannot be met--at least not at today’s prices. The German hyperinflation of 1923 wiped out the German government’s war reparation debt, but at the stupendous price of ushering in the fascists. Likewise, the U.S. could technically pay its national debt by so devaluing the dollar that it effectively robs dollar holders of their good faith claims upon American resources. I would remind xenophobic Americans, who may believe that robbing foreigners is of no concern, that Americans hold dollar claims, too, and would suffer just as much, if not more.
At the present time there is no better market alternative to holding American dollars. All currencies are fiat currencies, managed by the whim of politicians buying votes with more entitlements. But forces are building to end American hegemony in monetary affairs. The Chinese, the Indians, the Arabs, and the Russians are floating rumors of issuing a gold-backed currency, and the market always rewards a better product. It would be the greatest tragedy to befall this nation, if our foolish government destroyed our currency at the height of our productive capacity, making indirect, peaceful, cooperative exchange an impossibility. It can happen here!
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