From last evening in the Wall Street Journal, a very good piece. Nothing new for readers of Mises.org but still very encouraging.
The Man Who Predicted the Depression
Ludwig von Mises explained how government-induced credit expansions led to imbalances in the economy.By MARK SPITZNAGEL
Ludwig von Mises was snubbed by economists world-wide as he warned of a credit crisis in the 1920s. We ignore the great Austrian at our peril today.
Mises’s ideas on business cycles were spelled out in his 1912 tome “Theorie des Geldes und der Umlaufsmittel” (“The Theory of Money and Credit”). Not surprisingly few people noticed, as it was published only in German and wasn’t exactly a beach read at that.
Taking his cue from David Hume and David Ricardo, Mises explained how the banking system was endowed with the singular ability to expand credit and with it the money supply, and how this was magnified by government intervention. Left alone, interest rates would adjust such that only the amount of credit would be used as is voluntarily supplied and demanded. But when credit is force-fed beyond that (call it a credit gavage), grotesque things start to happen.
Government-imposed expansion of bank credit distorts our “time preferences,” or our desire for saving versus consumption. Government-imposed interest rates artificially below rates demanded by savers leads to increased borrowing and capital investment beyond what savers will provide. This causes temporarily higher employment, wages and consumption.
Ordinarily, any random spikes in credit would be quickly absorbed by the system–the pricing errors corrected, the half-baked investments liquidated, like a supple tree yielding to the wind and then returning. But when the government holds rates artificially low in order to feed ever higher capital investment in otherwise unsound, unsustainable businesses, it creates the conditions for a crash. Everyone looks smart for a while, but eventually the whole monstrosity collapses under its own weight through a credit contraction or, worse, a banking collapse….
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This wasn’t in print was it?
Still online is a step in the right direction though.
I don’t know if it appeared in print or not.
I can recall a time when something like this would have led to a year-long celebratory amazement. Now it will be forgotten by Monday. Times have changed remarkably.
Boudreaux has written an excellent letter yet again.
http://cafehayek.com/2009/11/keynes-on-mises-and-on-himself.html
This was in print today. I am trying to better understand Austrian economy theory and was wondering if anyone out there could help explain something to me, or direct me to a good article explaining it:
How should interest rates be set?
I understand that part of the problem, according to Austrian theory, is that interest rates were artificially low, thus encouraging too much borrowing and malinvestment of that borrowed money. I also understand that it is generally seen as the Fed who sets this rate artificially low through the discount rate.
My question is: how should that rate be set? I read a lot that it should be set “by the market,” but what does that mean? Is there some better calculation the Fed should use to set the discount rate (and is that really allowing “the market” to set it)?
I’m just confused as to how interest rates would get set by market forces since at some point, some individual (or agency) actually has to set the discount rate.
“My question is: how should that rate be set? I read a lot that it should be set “by the market,” but what does that mean?”
It means that individuals should act toward ends of their choosing using means of their choosing without institutionalized coercion. A natural rate of interest would develop from the net result of their transactions.
“I’m just confused as to how interest rates would get set by market forces since at some point, some individual (or agency) actually has to set the discount rate.”
We could have competing currencies. And the federal reserve – which, along with fdic, props up the fractional-reserve banking system – doesn’t *have* to exist.
Jack: “how should that rate be set? ”
Do you mean how should the Fed set rates, or how should rates be determined in a free market?
In a free market, there would be no Federal Reserve. With free banking, banks would compete for loans and deposits and the market would set rates. Interbank loans would also be set by competition.
A good book on the subject is Huerta de Soto’s on money and banking.
As for the current Fed, they need to target a combination of asset prices and commodity prices. Often, the Feds think their interest rates are high enough because cpi increases are low. In reality, they are pumping a lot of money and it’s going into assets, like the current stock market, or housing instead of consumer purchases that drive the cpi. So they need to watch both assets and cpi. Commodities are more sensitive than the cpi index to monetary pumping.
Worth noting that the author of the article is a long time business partner of Nassim Taleb, author of The Black Swan, who might be known to people here. Taleb has talked in positive terms of austrian economics for some time, while bashing the mathematical models of neoclassicals. The Black Swan is well worth reading (he is much better in print than on TV).
Jack, how is the price of orange juice set? What about that computer you’re typing your comment from?
The price of money(*) would be determined by the supply of loanable funds vs the demand for such loans, same as orange juice.
(*) really, it’s the price of time, but who’s counting?
“how should that rate be set?”
they shouldn’t
Anyone have any idea what the interest rate (say the savings rate at a reputable bank) would be in a free market system?
You name your price(of your capital) and I will name the price I wanna pay for your capital(the interest rate is the rent). If we agree, the transaction will take place and the rate has been set if we don’t agree then transaction will not take place.
Steven: “Anyone have any idea what the interest rate (say the savings rate at a reputable bank) would be in a free market system?”
That’s hard to tell because of past distortions caused by the Feds. In the current downturn caused by previous Fed distortions, the rate would be not much higher than it is, but it would be higher. The rapidly rising stock market is an indicator that interest rates are too low. Also, gold hitting record levels is another indicator that interes rates are too low.
Under the gold standard, in times of peace, long term rates tended to be around 3% for long periods of time. But as Hayek often wrote, rates can be high in a wealthy country with plenty of capital if entrepreneurs see a lot of opportunities. Or they can be low in a poor country with little capital and few opportunities.
http://online.wsj.com/article/SB10001424052748703298004574459001609215112.html
I loved seeing this in the MSM.
@Jack
I’ll try another attempt to simplify the answer.
In a free market, the amount of credit available would basically equal the amount of money that has been saved. The more money people save, the more banks would have to loan out.
More savings = more loanable funds = lower interest rates
Less savings = less loanable funds = higher interest rates.
If the Fed actually wanted the market to set interest rates, it could do two things:
1. Stop creating any more credit/money out of thin air, leaving the money supply fixed.
2. Require 100% reserves for demand deposits. This eliminates the power of private banks to create credit out of thin air using fractional-reserve banking.
You could achieve the same result (free-market interest rates) by either abolishing the Fed or repealing the legal tender laws that give the Fed a monopoly on the creation of money.
The interest rate would be close to the return on capital. If it was lower, then why lend money? Just invest in whatever the borrower’s business plan would have been without lending the money. If it was higher, then why borrow money?
@JL Bryan
That makes no sense. The same amount of money is saved no matter who controls it. Spending money just means someone else is saving it.
The availability of credit isn’t determined by the amount of money that’s saved (otherwise you could just print money to increase credit, which is what the Non-Federal Non-Reserve does). The availability of credit is determined by the amount of goods and services that are saved!
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