What real assets are backing the dollar? How dilluted is that backing? I don’t think that’s enough to alter the conclusion of the time-structure with respect to fiat money. In otherwords, if the backing were sufficient, the dollar would not even be considered fiat money.

They say the dollar is backed by Faith and Confidence in the U.S. Government. Fancy words, but perhaps the more accurate word is Power. One could go as far to say that the value of the dollar is proporational to the degree at which the U.S. Government exercises its power on people both foreign and domestic. Thus, the State must wage war on all sides at the risk of its own collapse. I’d even say that the State and War are essentially equivalent, or at least so closely connected that it’s hard to differentiate one from the other. Eventually the entire structure collapses on its own weight, not to be replaced with liberty, but with dictators and criminals who seek to install their own twisted version of the very thing they have replaced.

Rafael: “The interest rate is determined by the supply and demand for capital…”

You refer to the market rate of interest. The author was referring to pure interest, which is a minor component of the market rate. Think of pure interest as the interest rate in pure equilibrium.

Rafael: “There are only “present goods” involved in utility choices.”

“Future goods” is just a term that applies to the desire to save for future consumption. Literally, there is no such thing as future goods. Many economists, not just Austrians, use the term future goods because it has a nice symmetry with present goods.

Rafael: “Money is not a consumer good, and thus not what Jorg calls a “present good”. It is always a capital good.”

Accountants call money a capital good, but in economics it’s not because money isn’t used to produce anything; it’s used to purchase things that can produce, such as labor. The only reason people hold money is for making purchases or payments in the near future. If they wanted money for the distant future, they would invest that money. So money is used to purchase present goods. If you only have two catagories, present and future, where would money logically exist? In the present.

Rafael: “Increased demand for money means falling prices, which will increase the *realized* real interest rate…”

Again, you refer to the market rate of interest, not pure interest.

Rafael:”the increased ROI of money production comes at the expense of decreased ROI in other sectors.”

Not necessarily. The costs of inputs and the prices of outputs should fall equally as the demand for money increases. So the ROI for all industries but silver and gold mining should remain the same. But for mining, silver and gold are the products and increased demand has increased the price of that output. So the mines benefit from lower costs but higher prices for their output, thereby increasing the ROI of mines. However, in the next step, after mine output has increased, the demand for money falls as the supply increases and all other prices rise. So the costs of mining increase while the price of output falls.

“If the demand for money increases, therefore, the purchasing power of money tends to increase beyond the level it would otherwise have reached, which means that the general level of money prices will tend to decrease. Inversely, when the demand for money diminishes, the purchasing power of money will tend to fall below the level it would otherwise have reached, or, which is the same thing, the general level of money prices will tend to increase.”

This part, early in the article, is merely assumed, and is not argued for. The rest of an article is largely an unproductive tangent to that.

The more productive approach is to consider:
1. The demand for metallic money, rather than for all forms of money (or, alternatively, the demand for bank issued money separately from metallic money).
2. Consider the nominal market interest rate on short term money loans rather than the real interest rate.

If you take this approach you may find:
1. The supply of metallic money in a closed economy is inelastic, while the demand to hold it is of intermediate elasticity, and that the opportunity cost and price of holding metallic money is the nominal interest rate.
2. The supply of bank issued money in a closed or open economy is elastic, and that the opportunity cost of holding bank issued money is also the interest rate. The demand to hold bank issued money can be elastic in the case of a form of bank issued money that has perfect substitutes (e.g. the notes of bank A when the notes of bank B are considered just as sound and good), or of intermediate elasticity (e.g. all bank issued money, where the only alternatives are metallic money and non-money marketable securities).
3. Metallic money is a form of capital, a savings that is used to produce metallic money’s services.
4. That there is some particular allocation of the social capital stock between metallic money and other forms of capital that is best, a smaller amount or larger amount being inefficient or suboptimal.

Rafael Garcia, I like the way you are thinking, perhaps we should correspond (david.hillary@gmail.com).

So do you believe that the value of the dollar is determined purely by the supply of and demand for dollars, and not at all by the assets the Fed holds as backing for the dollar?
What does it mean for a dollar to be “backed” by an asset, anyway? If you have a ten dollar bill in your hand right now, do you know if it’s backed by a Treasury Bill, a farm, a mortgage fund, or gold? If you had a ten dollar silver certificate as opposed to a Federal Reserve Note, and the banking system was on a silver standard, then you could know it was backed by silver, and would, in effect, be using silver as money, with the certificate as a money-substitute for the silver. Allowing, of course, for a discount based upon fractional reserve banking, if it is in place.
As it stands now, nobody really knows or cares what backs our Federal Reserve Notes, which is one of the reasons that it can be considered a fiat money.
And, since money is the most commonly-traded commodity, IOU’s for less common things like farms or mortgages, if people care about backing, would be more like barter or low-level indirect exchange, than money. The paper being traded is a substitute for the actual good, but the actual good would be what is being actually traded. Although again, if you can’t tell the difference between an IOU for a farm and an IOU for silver, then you either can’t trust the money or you aren’t concerned about the backing.
Thus “backing” only matters if people know what backs the paper and realize that the paper is a money-substitute, and the “backing” asset is the actual money. As it stands now, the Federal Reserve Note is the actual money, and the “backing” is just some arcane accounting system used by the banking system.

Mike Sproul, your conclusion is unwarranted. The assets are simply a mechanism for adjusting the money supply, an arcane accounting system known to few. Tell me who, or how many people, know what assets the Fed has, or cares what those assets are? It’s not like people are watching the financial news and saying, “Oh no, the Fed’s assets declined in value–I guess I’ll have to cut back on the budget again this month.” And if they’re not carefully watching the Fed’s assets, then how do they know what the value of their money is? By how much goods and services it will buy. Prices are determined by what? Supply and demand, including the supply and demand of money for making those purchases.
You don’t go to the store and buy a loaf of bread with a certificate that’s worth a quarter share of a Treasury Bill or a fractional part of a mortgage fund, but with a Federal Reserve note that’s worth whatever supply and demand has determined it to be worth. If the assets themselves are not the actual money, while the currency is simply a money substitute, then the currency is the actual money, and the assets are largely irrelevant.

It seems to me that Hulsmann is jumping through a lot of hoops here to demonstrate something that is true almost by definition: An increased demand for money is the same thing as an increased time preference. He even alludes to this in the section of his article titled “Misleading Distinction between Money and Present Goods”.

It’s also not clear what he means by PRI under a fiat money regime. My understanding is that the PRI is simply a measure of time preference. If that is true, then it would have to be affected by an increased demand for fiat money. If he means to say that this change in time preference would not be reflected in nominal interest rates, that is one thing. But to say the PRI is unaffected does not make sense to me.

I think two minor corrections are needed.
In the paragraph preceding the title “Misleading Distinction between Money and Present Goods” we should read: “Moreover, in the case of temporary increases of the demand for money, their tendency to DEcrease the price level can be offset”…

First paragraph under section V, we should read: “These results of our analysis seem to imply that COMMODITY money, despite its manifold known shortcomings, conveys definite advantages over FIAT money, in particular, in facilitating economic growth”.
Great article!

There are some definition problems in the Austrian theory of money and interest and this article mentions some of them.

Firstly, money is not a good,

“Money” is a function, just like “good” is a function.

Money function facilitates, the role of medium of exchange, and good function facilitates direct or indirect satisfaction derived from a commodity. Supply is very irrelevant for money function, any supply of money would do. But for good function supply is important. The more there is, better.

A silver coin contains both good function and money function. As a good the more silver there is, better for the whole economy because goods represent wealth.

(This is also true for paper bank notes. Paper is a useful commodity. The more there is, better. But money function of paper banknote is a different story. Its amount is neutral. The problem with paper money is paper is a very cheap commodity thus in a paper banknote, good function is very very small as opposed to money function thus can be produced almost infinitely.)

But as money, its supply is irrelevant. It doesn’t matter if there are 1,000 ounces of silver money or 1,000,000 ounces in an economy.

Regarding interest rate. Pure interest rate is the price of time in money terms.

People save time, not literally but by other means, and lend it to each other.

When a person produces a good, which takes time, and decides not to consume all and save some, he is actually saving the time that takes to produce the extra saved good. And when he lends the saved goods to someone else he is actually lending his saved time to someone else. And since time is scarce, it always has a price.

And time can be saved and lent out three ways.

One is by developing technology, and know how. You spend time to learn a technology and if the tech you reach can save time on some other venture, this means you have saved the time spent on developing that techonology.

The other is by saving real goods and lending them. If a farmer saves 1 bushel of wheat and directly lends the bushel then this means he has saved time to produced the wheat and lend this time to someone else so that he doesnt spend time growing a bushel of wheat.

And the third is a more developed way to save time and lend it, and that is using money. If nobody ever saved there would still be a use for money but the use of money helps savers save time in money and lend it in money prices.

There is a market for time because everyones productivity (ability to save time using different means) is very different A farmer uses less time to grow wheat then a shoe maker, and shoemaker spends less time to make a shoe then a farmer.

Also regarding inflation of the money supply, the inflations real menace which also causes the business cycle is, the inflated part of the money supply mimics “saved time” because saved time exchanges hand as money, in money prices.

If there is no increase in the supply of money the money price of time reflects the supply of time and the demand of time. But when there is an increase in money supply, this suppresses the money price of time, interest rates. This gives a false signal that there is more saved time then there actually is. But when the actual saved time can not facilitate the production of different goods, there comes the bust

Since money is a “medium of intermediate exchange” in can be present, future, consumer and capital goods. Even fiat paper money is money, as long as it is accepted. So if the money is selected in the market and this is probably a commodity-based (i.e. goods) type of money, the market will adapt to changes in demand and supply (i.e. productive structure).

If refrigerators would considered as money and people want hold more of that money the market would adapt to this by altering the productive structure of the economy and the interest rate.

This does not happen with fiat paper money, because its creation is not connected to the productive structure. So changing demand in fiat paper money does not lead to an adaption of the productive structure. Since these structure does not represent the time preference of the people / market it has defects that might lead to malinvestment and overconsumption.

I think this is the message of the essay of Mr. Hülsmann. One might argue about the correct meaning of various defintions, but since value is subjective this also applys to words.

Okay, one last post.

Bob Rooney: “One might argue about the correct meaning of various defintions, but since value is subjective this also applys to words.”

Economic value is subjective. Truth is not.

fundamentalist: “Money is neither capital nor consumer. But in terms of present and future goods, it can only be present goods.”

We disagree on money. But even granting your definition, increased demand for money means increased demand for a particular production process (gold mining). If this process is costlier than the previous marginal cost of capital (interest rate) under equilibrium, then the increased demand for gold will raise the marginal cost of capital and thus the interest rate. Conversely, if gold mining costs less than the equilibrium interest rate, then increased demand for gold will lower the marginal cost of capital and thus the interest rate. Jorg’s conclusion that hoarding must increase the interest rate is based on the erroneous view of hoarding as a form of consumption. In fact, hoarding is simply increased demand for a particular produced good (cash). Depending on how this increased demand affects the total cost of production, the interest rate can increase or decrease.

fundamentalist: “In equilibrium, ROI and pure interest are the same thing and interchangeable.”

In equilibrium, ROI equals the market rate of interest. This market rate of interest is not based purely on time preference, as I have tried to show. It is, instead, the marginal cost of capital. An increased demand for cash is funded by decreased demand for all other goods. If these goods are more costly to produce than cash, society has gained utility from increased demand for a cheaper good, and thus ROI increases by definition. If these goods are cheaper to produce, then increased demand for cash over other goods requires a costlier production structure, and the marginal ROI will decrease.

Thanks for engaging with me so meticulously, fundamentalist. I appreciate the back-and-forth. My complaints about orthodox Austrianism aren’t fully worked out yet, and they certainly don’t mean I have any fondness for other schools of economics. I just think I see better avenues to develop some of these definitions than previous writers have come up with.

Other comments I have circle around the question of whether or not the demand for commodity money is or is not time-neutral.

“The Demand for Commodity Money is Not Time-Neutral

“Rothbard is correct in pointing out that changes in the demand for money do not have any systematic direct implications for the relative spending on consumers’ goods and on the corresponding producers’ goods. But as he admits, they do have implications for the return on investment (ROI) of money production, at any rate in the case of commodity monies such as silver or gold. An increased demand for silver will increase the ROI of silver production, because the factors of production needed to produce a given amount of silver now tend to become available at lower silver prices. This in turn will modify the spending on all other goods. In particular, capital will move from other industries…”

From other industries not providing goods complimentary to the silver industry.

“… into the silver industry, prompting the ROI of silver production to fall and the ROI of all other industries to rise, until the ROI of all lines of business is equal. Thus there will be a new PRI that is higher than the PRI that prevailed before the increase of the demand for money was priced into the market.”

This argument appeals to me, however it induces me to ask if this analysis cannot be applied to the demand, ROI, production changes and resulting arbitrage activity in connection with any particular good – from the consumption good to the most specialized of production goods. For instance, if the demand for a particular consumption good, say apple pies increases, does this not imply the very same results. But pies are a consumption good, so perhaps this is to be expected.

What if the demand for a specialized piece of machinery increases, and we apply the same analysis we applied to precious metal production, or precious metal coin production. Would we not conclude that such an increase in demand for a production good also implies an increase in the interest rate, due again to the raising of profits across the economy due to the very same arbitrage activity?

Yet this conclusion is not intuitively right to me, and I don’t think Professor Hulsmann is driving toward that particular conclusion. And i think somehow this puts the above thesis in doubt.

“In other words, there is a positive causal relationship between the demand for commodity money and the PRI. The demand for commodity money is not time-neutral. Increases of the demand for commodity money tend to increase the PRI. Decreases of the demand for commodity money tend to decrease it.[15]

“This relationship holds not only during a period of adjustment, during which more silver is being produced according to the higher demand. It also holds in final equilibrium, because the wear and tear increases along with the greater silver supply. The silver production will be increased permanently, and thus the PRI will also permanently be higher than it otherwise would have been.
The time structure of production will tend to be modified accordingly. A higher demand for money creates incentives to shorten the structure and to make it thicker than it otherwise would have been. And a lower demand for money will tend to lengthen the structure and make it thinner than otherwise. In short, the demand for money does affect the time structure of production.

“The same effects hold in the case of temporary increases of the demand for money, as it is often the case at the onset and in the middle of the deflationary bust phase of the business cycle, when market participants seek to sell their non-monetary assets at a discount (thus the increase of the PRI), but a discount that is lower than the one they expect for the near future. In such cases the increase of the demand for money lasts only until the price structure has been adjusted to its new (lower) final equilibrium level.[16]“