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Source link: http://archive.mises.org/12724/selgin-contra-horwitz-and-white-on-misess-view-of-fiduciary-media/

Selgin Contra Horwitz and White on Mises’s View of Fiduciary Media

May 16, 2010 by

Recently Steve Horwitz has adamantly defended Larry White’s interpretation of Mises’s attitude toward fiduciary media, an interpretation which I have criticized. Steve is surprisingly uncompromising and has even gone as far as to stake Mises’s reputation as a historian of economic thought and monetary theorist on the correctness of White’s interpretation. Writes Steve:

To read Mises as a 100% reserves supporter is to disrespect him as a historian of economic thought and a great monetary theorist. The guy knew his shit and he understood monetary theory better than just about anyone who claims his mantle on any side today. To think he rejected the basics of monetary theory that inform the ME/FB [i.e. Monetary Equilibrium/FreeBanking] argument is to say that he didn’t understand some pretty fundamental economics.

In other words, Mises is a monetary equilibrium theorist who favors the creation of fiduciary media, dang it, and if he is not, well then so much the worse for Mises’s reputation as an economist. Now I suggest that before venturing out on a limb with such an irrevocable statement, it would have been wise for Steve to have consulted the book by his mentor George Selgin on The Theory of Free Banking (pp. 61-62). There Selgin explicitly denied that Mises either was a monetary equilibrium theorist or ever maintained that the issue of fiduciary media in any quantity would not generate a business cycle. As Selgin put it, correctly in my view,

A contrasting view of bank credit appears in the writings of several of the Austrian economists, especially Ludwig von Mises. . . . According to these writers any credit expansion or increase in the supply of fiduciary media–inside money [i.e., bank notes and deposits]not backed 100 percent by reserves of commodity or base money–is unwarranted. . . . In other words, all net expansion of fiduciary credit is a cause of loan market disequilibrium. It causes bank rates of interest to fall below their ‘natural’ levels, leading to forced savings and other trade-cycle phenomena. This contrasts with the view defended here, which holds that no ill consequences result from the issue of fiduciary media in response to a greater demand for balances of inside money. . . . However one intreprets it, Mises’s view of commodity [i.e., non-created] credit as the only sort of credit consistent with loan market equilibrium causes him to be critical of fractional reserve banking. . . . Indeed Mises’s support for free banking is based in part on his agreement with Cernuschi who. . . believed that freedom of note issue would automatically lead to 100 percent reserve banking.

I await with great interest Horwitz’s response to Selgin, given that Selgin expressed precisely the same view that Murray Rothbard held.

{ 216 comments }

Current May 16, 2010 at 6:18 pm

The problem with this debate is that there are so many sides to it. There is the banking question – can banks safely issue fiduciary media. There is the inflation/deflation question – should inflation and deflation account for demand for money. And, there is the business cycle question – is ABCT caused by issue of fiduciary media per se, or by fiduciary media beyond the demand to hold it.

Rothbards view on the banking question was that bank’s can’t safely issue fiduciary media. His view on the inflation/deflation question I’m not sure about. On the business cycle question he was sure that issue of fiduciary media per se caused ABCT.

Mises view is different. His view of the banking question was that bank “normally do fairly well” with the issue of fiduciary media. His view on the inflation/deflation question was that consideration of these problems should include the demand for money. I think there is a good argument though that after his early work Mises’ view on the business cycle question is that issue of fiduciary media per se cause ABCT.

I think Mises was wrong about this latter point, but I don’t want to argue that he held the MET view.

The difficulty in the debate is that people link together things according to their own theories and don’t understand why the other side doesn’t link things in the same way.

newson May 16, 2010 at 7:36 pm

just a curiosity – have you read hülsmann’s “error cycles”?
http://mises.org/journals/qjae/pdf/qjae1_4_1.pdf

DD5 May 16, 2010 at 9:31 pm

Why don’t you read Rothbard before you propose to tell us all what he thought. Rothbard’s view on free banking is almost identical to Mises.

Read Ch 8 (free banking) at: http://mises.org/books/mysteryofbanking.pdf

I think it’s the least you can do before you teach us all about what Rothbard said.

Current May 16, 2010 at 10:00 pm

I have read Rothbard. What specifically do you think I’m getting wrong in my post?

DD5 May 16, 2010 at 10:14 pm

“Rothbards view on the banking question was that bank’s can’t safely issue fiduciary media.”

Totally false! 180 degrees backwards, inverted, reversed, and whatever.

But I give you the solution to the problem … and what do you do? Ignore it of course, and come right back here and decide you’re going to call my bluff or something, as if we were playing poker.

newson May 16, 2010 at 10:59 pm

rothbard’s attitude toward free banking also undergoes transformation (as does mises’ from tmc to ha and later). in “mystery” he seems aligned with mises about free-banking being acceptable, whereas in “the case for a 100% gold dollar”, p. 22 he has a different view (which seems more consistent with the later rothbard):

“And yet if “free trade in banking is free trade in swindling,” then surely the soundest course would be to take the swindling out of banking altogether. Mises’ sole argument against 100 percent gold banking is that this would admit the unfortunate precedent of government control of the banking system. But if fractional-reserve banking is fraudulent, then it could be outlawed not as a form of administrative government intervention in the monetary system, but rather as part of the general legal prohibition of force and fraud.Within this general prohibition of fraud, my proposed banking reform would leave
the private banks entirely free.”

DD5 May 16, 2010 at 11:12 pm

Shame on you!

The above quote is totally out of context. The “free trade in banking is free trade in swindling” is totally out of context. Rothbard flat out rejects this famous quote, yet you just posted it is such an out of context manner that one is surely to get the opposite impression.

Either you don’t understand what you read or you took this quote from some other source who has done what you just did.

newson May 17, 2010 at 1:56 am

read the book for yourself. it’s in plain english, and you’ll find no conflict with the context. but if you’re still blinkered about rothbard’s change of heart, read this

“And like Mises a half-century later (and like most American currency men at the time), Modeste realized that demand deposits, like bank notes beyond 100 percent reserves, are illicit, fraudulent, and inflationary as well as being generators of the business cycle. Demand deposits, like bank notes, constitute “false money.” But Modeste’s policy conclusion was different. His answer was to point out that “false” demand liabilities that pretend to be but cannot be converted into gold are in reality tantamount to fraud and embezzlement. Modeste concludes that false titles and values, such as false claims to gold under fractional-reserve banking, are at all times

equivalent to theft; that theft in all its forms everywhere deserves its penalties
. . ., that every bank administrator . . . must be warned that to pass as
value where there is no value . . . to subscribe to an engagement that cannot
be accomplished . . . are criminal acts which should be relieved under the
criminal law.

The answer to fraud, then, is not administrative regulation, but prohibition
of tort and fraud under general law.

rothbard, “the myth of free banking in scotland”
http://mises.org/journals/rae/pdf/RAE2_1_15.pdf

newson May 17, 2010 at 2:21 am

“A gold-coin standard, coupled with instant liquidation for any bank that fails to meet its contractual obligations, would bring about a free banking system so “hard” and sound, that any problem of inflationary credit or counterfeiting would be minimal. It is perhaps a “second-best” solution to the ideal of treating fractional-reserve bankers as embezzlers, but it would suffice at least as an excellent solution for the time
being, that is, until people are ready to press on to full 100 percent banking.

rothbard, “the case against the fed” p. 150 and 51

need i go on?

newson May 17, 2010 at 2:29 am

http://mises.org/journals/aen/aen10_2_1.pdf
rothbard:

“The Chilean experience highlights an important point: that central banking and free-banking are not the only possible monetary alternatives. A third route is freedom of banking within a firm matrix of 100 percent specie reserves, any fractional reserve issue being considered a violation of the general laws against fraud and theft.”

enough?

Peter Surda May 17, 2010 at 7:15 am

Dear newson,

let’s start with theory. In my humble opinion, fraud is defined as entering into a contract without the intention of fulfilling it. The parties are then defrauder (criminal) and defraudee (victim). You cannot defraud a third party, their opinion is irrelevant. Also, all contracts bear a non-zero risk of non-fulfillment, this is an unavoidable consequence of real life.

Let’s assume absence of legal tender laws. If fractional reserves were fraud, logically, bank would be the criminal and (some of) their customers victims. For simplification, there are only two types of bank customers: those with deposit accounts (creditors), and those borrowing money (debtors). So, which ones are the victims and why?

The only logical reason I can find is if the bank misrepresents the contract risk default to the creditors, which is in my opinion a dubious reason. Everyone knows that banks can go bankrupt. Since noone is forcing you to enter into a contract with a bank, I don’t see why it should be fraud.

I also don’t see how debtors can be victims. They are either given cash (non-fraud), or the money they borrowed is transferred to another bank account, and then the holders of these accounts would be creditors (see previous paragraph). So, where is the fraud?

I don’t actually know whether the FRB-fraud is your own opinion or you are just quoting Rothbard to refute DD5, but you seem to be interested in the topic so maybe you can answer this.

mpolzkill May 17, 2010 at 7:46 am

I don’t know either, just asking here. That’s the thing, isn’t it, Newson and Peter? Get rid of legal tender laws and it isn’t fraud.

antiip May 17, 2010 at 12:01 pm

@Peter:

FRB could be fraud if creditors were told that they could at any time retract their money from the bank and that at any time the bank holds as much values as the deposits are worth.

newson May 17, 2010 at 8:01 pm

to peter surda:
i didn’t specifically use the word “fraud”, but i do believe that banks have delighted and taken advantage of the ambiguities of the “deposit” contract, and that many punters are oblivious to the difference between the legal and the economic nature of the bargain. huerta de soto goes into this at great length in “money, bank credit and economic cycles” (see literature section).

i don’t believe one can compare the third-party effects of frb to that of ordinary competition. for example, if i cut a deal with a tailor to undercut his competition, i put tailors’ margins under pressure. what tailors lose in opportunity profits, the rest of the community gains in more competitive suit prices. i don’t see any similar benefits for the general community in frb; all those outside the borrower/lender pay higher prices, i see no competitive benefits whatsoever.

Current May 17, 2010 at 7:17 am

DD5,

What I mean is, in “The Case Against the Fed” Rothbard argues that banks cannot estimate the turnover of their deposits well. His argument is that fractional reserve banks are always insolvent and vulnerable to runs because of that. See p.45-50 of “Case Against the Fed”.

newson May 17, 2010 at 10:15 am

to peter surda:
i’m actually just quoting rothbard to dd5 because i believe he’s not shown rothbard in a fully comprehensive way.

whilst i share rothbard’s predilection for fully-reserved banks, i find the hülsmann/hoppe/herbener camp to be more convincing advocates, and bagus also shows rothbard’s inconsistency (ditto for mises) on deflation. i’m not aware of any of the freebankers addressing the hülsmann paper i cited earlier, despite the fact that it shows the flaws in both rothbard and mises’ abct formulation.

my gripe with frb, even absent central banking is that the actual deposit account is not what the language implies – it’s a loan and not a deposit. term depositors are aware that they’re loaning and lose control over their money for a given period, current account holders often are not aware of this. this is a structural feature of frb, not a business risk.

if you subscribe to the austrian view of money, and assume that the freebankers’ notes enjoy circulation amongst the general public, then the first to get their hands on that newly created money (bank borrowers) enjoy a higher purchasing power that the second person to get that money. so there is a third party effect. likewise, if you buy the thesis that the frb mechanism is behind the boom/bust cycle, and that this cycle creates harm not strictly limited to the banker and his customer, then whilst it’s not two parties conspiring against a third, there is collateral damage.

Peter Surda May 17, 2010 at 10:34 am

I agree with the last paragraph. But merely because there is negative externality, there does not need to be fraud. One does not have a right to the value of his possessions, only to the physical integrity thereof.

I also tend to agree that a current account is nowadays to be seen more like a loan. In my opinion therefore, it would be more likely that absent legal tender, banks would diversify their products more strictly, e.g. current accounts (100% backing) and term deposits (FRB).

I am not familiar wit the papers you refer to, once I find time I’ll read them.

antiip May 17, 2010 at 12:05 pm

@newson

There is no fraud necessarily involved when your property “loses value”.

Just think about being the only seller of oranges in a market: What if another seller entered the market and therefore your oranges “lost value”?

The same goes for “intellectual property values”…

Jay Lakner May 17, 2010 at 12:37 pm

FRB is not fraud as long as the customers are aware that they are placing their money in a FR bank. Absent a government, I do not see how FRB could exist for extended periods of time. Banks that have extended too many loans can be sent bankrupt by their more cautious competitors. After some period of trial and error (and a few big bankruptcies), I imagine all banks would be 100% reserve banks or close to it in a truly free market.

If people insist on the existence of legal tender laws, then it stands to reason that we should enforce 100% reserves. It is ridiculous to force citizens to use one particular currency and then allow others to devalue that currency to the citizens’ detriment.
Yes, no fraud is being committed, but legal tender laws have created a nasty side effect in that FRB directly and unavoidbaly harms third parties.

It’s the same story as usual:
The State enacts (unnecessary) law A.
Law A leads to nasty side effect X.
The State enacts law B to address problem X.
Law B leads to nasty side effect Y.
The State enacts law C to address problem Y.
Law C leads to nasty side effect Z.
etc etc etc etc etc

Before you know it, you have 100000 laws. All completely unnecessary if we remove the initial stupid law, in this case legal tender laws. But they can’t do that because they need legal tender laws in order to drain taxes from it’s citizens. And without taxes the State can’t survive.

Current May 17, 2010 at 10:36 pm

Jay Lakner,

In a free market banks would put option clauses on their note to prevent rivals from trying to bankrupt them.

I see no good evidence that free markets would lead to 100% reserves or anything close. The Scottish free banks got away with <4% reserves.

I agree though that legal tender laws and other government interference allow central banks and commercial banks to offer inferior money.

The main interference isn't legal tender laws though, it's tax. We all have to pay income tax in our native currency so it's hard not to have major dealing in it.

Jay Lakner May 17, 2010 at 10:44 pm

Current,
Please explain how these “option clauses” would work exactly.

Stephen Grossman June 18, 2010 at 10:44 am

>The problem with this debate is that there are so many sides to it. There is the banking question – can banks safely issue fiduciary media. There is the inflation/deflation question – should inflation and deflation account for demand for money. And, there is the business cycle question – is ABCT caused by issue of fiduciary media per se, or by fiduciary media beyond the demand to hold it.

These are integrated. The original, FR fraud necessarily causes the rest of it (altho I dont clearly understand “should inflation and deflation account for demand for money”). FR buys production without ones own production. Theft, however abstract, lessens production.

Current June 18, 2010 at 11:13 am

As I said earlier, I don’t believe that FR is either necessarily either fraud or theft.

You write:
> FR buys production without ones own production. Theft, however abstract,
> lessens production.

An FR banks money-substitutes are it’s liability. It has to have corresponding assets. This is what many Rothbardians forget. A bank can’t have 10% reserves and nothing else on the asset side of it’s balance sheet. It must have reserves and assets that correspond to more than 100% of it’s total liabilities.

What we are discussing here is what I call the “banking issues”. Which are about how banking works. But, there are also the inflation/deflation issues and the ABCT issue.

I don’t think that FR creates ABCT and I think that it protects against wide swings in money prices. That’s part of why I think it’s far superior to 100% reserve banking. But, these issues are somewhat separate to the banking ones.

george t morgan June 19, 2010 at 2:05 am

do you think anything else creates ABCT??

george t morgan June 19, 2010 at 2:10 am

if the bank just issued FM and nobody spent it how would that lead to anything??

if the abct that is claimed occurs at mises sites is true..i dont know that it is, wouldnt it have to be accepted by many in order to create any type of cycle or so called malinvestements?

Bala May 16, 2010 at 6:21 pm

I am no qualified economist. I have just read some of Mises’ and Rothbard’s most important works (just about completing Human Action). What I find seriously problematic in these engagements with the Free Bankers is that you people (“followers” of Mises and Rothbard) are letting the Free Bankers get away with gross misuse of the concept “money”. I see innumerable places in their articles and their responses in the comment sections where they use the term “money” to denote what is not “money”.

For instance, I found this

” Fiduciary media is bank issued money used to fund loans. ”

out here

http://monetaryfreedom-billwoolsey.blogspot.com/2010/05/was-mises-wrong.html

It does not surprise me that they are shameless enough to try to confound the discussion by referring to money substitutes as money. What surprises me is why their opponents in the debate (Salerno and others out here) are letting them get away with this intellectual “crime”. Just thought a little focus will help. Thanks.

Current May 16, 2010 at 6:27 pm

Fiduciary media is “money in the broader sense” as Mises defines it, it circulates like money as a money substitute. It is necessary for some purposes to differentiate between it an “money in the narrower sense”. Both the 100% commodity supporters and the Free bankers make this differentiation when it’s needed.

Bill Woolsey doesn’t agree with the Free-banker’s position anyway. Bill Woolsey’s ideas are inbetween several different schools of economics, he takes some idea from Austrian Economics, some from monetarism and some from Keynesianism.

Bala May 16, 2010 at 6:45 pm

My only point is that emphasising that fiduciary media are money substitutes and not money proper is important in engaging the free bankers. That they are “money in the broader sense” only means that for the study of exchange, it helps to treat them as one would treat money because the majority of people who constitute the market do so. However, that does not take from their essential nature that they are not money. It is the identification of this nature that lies at the root of ABCT. IMO, forcing (by insisting on strict definitions) the free bankers to refer to bank created money substitutes not backed by money proper as fiduciary media will limit the scope of their false arguments.

Current May 16, 2010 at 7:05 pm

Have a read of what the free bankers have written in their books. You’ll find that your criticisms are unfounded.

When discussing the details of money they differentiate between “inside” (or “base”) and “outside” money.

Stephen Grossman June 18, 2010 at 10:56 am

>emphasising that fiduciary media are money substitutes and not money proper is important in engaging the free bankers. That they are “money in the broader sense” only means that for the study of exchange, it helps to treat them as one would treat money because the majority of people who constitute the market do so. However, that does not take from their essential nature that they are not money.

Mises, in HA, distinguished commodity money, money substitutes (paper redeemable in commodity money) and fiduciary money (circulating credit) not backed by commodity money.
After my new bar buddy and I blathered and blarneyed at each other he bought me a bar token entitling me to a drink should I return to the bar. I do not believe Mises discussed the economics of this critical issue. Does anyone know of a dissertation on it?

Ivan May 17, 2010 at 3:20 am

You simply don’t know what you’re talking about.

Bala May 17, 2010 at 10:03 am

WOW!!! How very enlightening….

Stephen Grossman June 18, 2010 at 11:05 am

>You simply don’t know what you’re talking about.

Are you addressing a poster here or modern culture in general? Recall Peter Finch’s rant in “Network,” “Im mad as hell and Im not going to take it anymore!” Imagine ,if you will, people with
“You simply don’t know what you’re talking about” on signs as they stand in front of the White House. It could be intellectually devastating to the former constitutional law (ha ha) professor within.

Steve Horwitz May 16, 2010 at 7:58 pm

As passionate defenders of a position often do, Joe has presented the pieces of the story that are congenial to his view and chosen to ignore those that are not. He also plays a bit of a bait and switch with my argument. I started the blog comment Joe quotes by saying “There *are* passages in Mises where he argues against [the issuance of] ‘fiduciary media’” and then I went on to note that those have to be read in a particular context in Mises, namely the one articulated below, which is as a second-best reform given central banks. I then made the claim that reading Mises as a 100% reserve supporter is problematic, because his first-best world is free banking and that he largely, though not always, understands that argument in terms very familiar to monetary equilibrium theorists. I then made the argument that Joe quotes.

I happily admit to some over-exuberance in that argument, however if one reads my comments later in that thread as well as the discussion that took place on Coordination Problem last fall, you will see that I clarified my position thusly:

“[ADDENDUM: To be clear, I am not arguing that Mises was clearly and unambiguously a MET-fractional reserve free banker. The evidence is not that clear. What I am arguing is threefold: 1) the preponderance of the evidence is that Mises was more or less a MET-FR-FB; 2) there is very little evidence at all that Mises thought a Rothbard-style 100% reserve system was the first-best ideal monetary system; and 3) where Mises does recommend 100% reserves, it is almost always in the context of a program for monetary reform given that government is deeply entwined in the banking system.]“

That addendum originally appeared in a post of September 2009 where I offered evidence for claim 3. That whole post (found here: http://www.coordinationproblem.org/2009/09/mises-and-his-call-for-100-reserves.html ) is well worth reading for this discussion as not only do I offer textual evidence for the third point, I address several other issues as well. Bottom line: I think the preponderance of the evidence supports my reading of Mises but by no means is it unambiguous.

In fact agreeing with me on the point that Mises is ambiguous to one degree or another is none other than the same George Selgin, who Joe tries to use against me. Joe apparently didn’t read any later into the comments on that same thread or he would have found that George’s view in 2010 is not the same as his view in 1988:

“Although it is true that in my first book I did refer to and criticize a passage from Mises in which he seems to endorse the 100% percent reserve position, I agree with Richard Ebeling that Mises is simply not consistent in his claims about fractional reserves. In places he appears to suggest that 100% reserves would be desirable; in others he suggests that they are undesirable. Rothbard and his followers are wrong to suggest that Mises’ stance was one that consistently favored 100% reserves. I think it important as a matter of history of thought that we resist making the opposite error. Reasonable people can of course disagree concerning whether a preponderance of Mises’ statements point one way or the other.”

http://www.coordinationproblem.org/2010/05/mises-and-free-banking-why-is-there-a-debate.html?cid=6a00d83451eb0069e20133ed69c6d1970b#comment-6a00d83451eb0069e20133ed69c6d1970b

It was precisely to avoid “making the opposite error” (i.e., saying Mises was unambiguously a free banker) that I added that addendum both in September 2009 and again in the comment thread above. So Joe, I’m happy to join George in rejecting his view from 1988. I await your next blog post accusing George of being at odds with himself!

Joe might also wish to consult Richard Ebeling’s (and I hope we would both agree that Richard is, to say the least, a knowledgeable and fair interpreter of Mises) comments of September 2009, where he said, and I apologize for the length:

“If I may be permitted, in my article “Ludwig von Mises and the Gold Standard,” which first appeared in 1985 in “The Gold Standard: An Austrian Perspective” ed. by Lew Rockwell, and which is reprinted in my book, “Austrian Economics and the Political Economy of Freedom” (Edward Elgar, 2003) pp. 136-158, I make very clear (along the same lines as yourself [Horwitz]) that in advocating 100 percent reserves, Mises was making a proposal for a “first stage” of a program for monetary reform.

In this first stage the task is to prohibit the government from using the central bank to print up money to finance budget deficits or to generate credit expansions based on fiduciary media (i.e., any further banknote or demand deposit expansion not backed fully by new inflow of specie).

Mises is clear, as you say, that he views this as applying a more complete version of Peel’s Bank Act to prevent monetary expansion in the 20th century.

But, it is also clear that he considers this as an institutional means to control the handle of the money-creating printing press in an institutional setting in which a central bank still exists.
When, at some point, central banking has been abolished (the final stage of comprehensive monetary and banking reform in Mises’ view) the financial system would function on the basis of free, competitive private banking.

In every instance in which Mises discusses the workings of a future free banking system he never advocates 100 percent reserve requirements. He presumes that in what will be a free banking setting banks would have the liberty to operate on the basis of fractional reserve banking.

But he also explains that in such a setting the ability of depositors to withdraw their accounts from any bank or banks, and the clearing house mechanism between banks and other financial institutions would generate the self-interested incentives for those owning and managing such banks to be “conservative” in their issuance of uncovered notes and deposit accounts. (And in “Human Action” he makes clear that part of the incentives and signals on limiting any such privately issued fiduciary media would be depositors’ demand to hold money-substitutes.)”

Richard’s comment is here: http://www.coordinationproblem.org/2009/09/mises-and-his-call-for-100-reserves.html?cid=6a00d83451eb0069e20120a59df8cb970c#comment-6a00d83451eb0069e20120a59df8cb970c

Finally, folks can consult Mises in Theory of Money and Credit (438, LP edition) where he concludes his section on the problem of the freedom of the banks thusly, supporting Richard’s interpretation and my own:

“If the arguments for and against state regulation of the bank-of-issue system and of the whole system of fiduciary media are examined without the etatistic prejudice in favor of rules and prohibitions, they can lead to no other conclusion than that of one of the last defenders of banking freedom [cite to Horn]: ‘There is only one danger that is peculiar to the issue of notes; that of its being released from the common-law obligation under which everybody who enters into a commitment is strictly required to fulfill it at all times and in all places. This danger is infinitely greater and more threatening under a system of monopoly.’”

So apparently Mises thought that even “systems of fiduciary media” are fine as long as issuers of notes are required to fulfill their legal obligations to redeem. No free banker would disagree. But boy that sounds a lot different than the claim that Mises was never okay with fiduciary media or that only 100% reserves was acceptable. Mises also appears to recognize that the danger of being released from such an obligation is much greater under central banking, rendering intelligible his call for 100% reserves as a second-best proposal GIVEN the existence of a central bank. (And Mises, nowhere that I’m aware of, disavows that position in one of the later editions of TTOMAC.)

I await with great interest Salerno’s response to Ebeling, given that Ebeling expressed precisely the same view that I hold.

So where does that leave things Joe? It leaves George and I in agreement on the principle (that Mises is best read as neither an unambiguous 100% reserve advocate nor an unambiguous free banker), though we may or may not disagree where the preponderance of the evidence lies. Since you seem to agree that Selgin is a reliable interpreter of Mises, you might want to rethink the “contra” in your post’s title.

It also leaves me in agreement with Richard Ebeling on the question of Mises’s support for 100% reserves being part of a second-best vision of reform under central banking. If you are disagreeing with Richard’s reading of Mises, feel free to say so loud and clear as I’m sure Richard would find it an interesting discussion. As far as my own view goes, readers are welcome to go to the links above and decide for themselves after a full reading of my argument and the evidence I present.

(Also folks following the discussion on Joe’s earlier post on White might find this of interest: http://www.coordinationproblem.org/2010/05/is-expanding-the-money-supply-costless-for-free-banks.html )

Joseph Salerno May 17, 2010 at 3:50 pm

Steve,

Thank you for your temperate and thoughtful reply. But I think you mave missed the point of my posts. I will gladly stipulate that Mises was a “free banker” and did not want to impose 100 percent-reserve requirements or any government regulations on competitive banks. Not only will I stipulate to it, I will shout it from the rooftops and write it 100 times on the whiteboard in my classroom. I have never denied this in any of my writings and, neither, by the way, did Rothbard. It is true that in his last significant publication on money and banking matters, Part Four of The Theory of Money and Credit written in 1952, Mises proposed a legally mandated marginal 100-percent gold reserve requirement–which as you know would result in the prohibition of further creation of fiduciary media. Now there is not sufficicent evidence to ascertain whether this proposal represented a further evolution of Mises’s thought or a second-best solution to his previous ideal of free banking. However because he continued to recommend free banking in the 2nd and 3rd editions of Human Action published in the 1960s, I will stipulate to it being a second best solution. In short there is nothing in the passage you cite from Richard Ebeling that I disagree with.

But this is all beside the point. The real issue as I tried to make clear in my two posts is that from his very first work in monetary and business cycle theory to his very last discussion of the issue in Human Action Mises never deviated from two views. The first was that the creation of fiduciary media under any and all circumstances caused a downward deviation of the loan rate from the natural rate leading to the sequence of phenomena known as the business cycle. The second was that free banking was the best policy available for bringing about the goal of the Currency School and Peel’s Act which was the eradication of the of issuance of fiduciary media. In fact Mises’s primary aim was to revive Currency School approach in theory and formulate a means to effectively achieve their policy goal. Given the evidence I have adduced in my first post and that Nicholaj and others have presented, there is no longer any question that Mises unwaveringly maintained these views.

Now you open your post with the following statement: “As passionate defenders of a position often do, Joe has presented the pieces of the story that are congenial to his view and chosen to ignore those that are not.” Who cares if someone is a “passionate defender” of a position or if someone is jaded defender of a long held position that he has a reputational stake in? What I would like to read from you or anyone else are citations to statements by Mises which explicitly argue that:

1. the creation of fiduciary media does not cause a business cycle when the additional quantity matches an increase in the demand for money;

2 in the absence of the creation of fiduciary media, an increase in the demand for “inside” (bank notes and deposits) money will lead to a rise in the loan rate of interest above the natural rate of interest thus causing a depression (or conversely, a fall in the demand for money unmatched by a contraction of fiduciary media will depress the loan rate below the natural rate and precipitate a business cycle);

3. a regime of free banking will lead over time to progressively lower reserve ratios for bank notes and deposits;

4. the goal and program of the Currency School was fundamentally misconceived.Such statements would indeed mark Mises as a forerunner of the Selgin-White neo-Banking School. However I have not seen them.

We of the neo-Currency School have presented you with abundant evidence that Mises made numerous statements throughout his career that explicitly and forthrightly contravene each and every one of these propositions. It behooves you to cite the evidence that you claim makes Mises’s position on these issues so ambiguous. In the absence of such statements by Mises, I believe we should consider the debate over and move on to substantive issues in disentangling the two schools.

Ivan May 17, 2010 at 4:36 pm

What two schools are you talking about? This “neo-Currency” and “neo-Banking” school distinction is entirely laughable. Mises wasn’t part of either the currency school or the banking school, but rather drew from both schools while remedying much of their confusion. You’re creating an artificial divide; it’s entirely illusory.

DD5 May 17, 2010 at 4:53 pm

The divide is basically this:

1. Fiduciary media is always bad
2. Fiduciary media can be good

I would say that’s a pretty good distinction between the two schools. Notice the “neo” prefix! It means obviously, that the theoretical arguments put forward are not the same as those put forward by the original schools.

Ivan May 17, 2010 at 5:02 pm

First, that’s a distinction between Rothbardians on the one hand, and all other schools of thought on the other; but I guess that’s the point. Next, I don’t think the Currency school even believed in fiduciary media or understood what it was; they didn’t even know that deposits were money or that they could be inflationary.

Peter Surda May 18, 2010 at 5:17 am

Well, in my opinion, the divide is imprecise. There are two questions, not one:

- does fiduciary media cause the business cycle?
- is FRB fraud / would fiduciary media exist without government interference?

The combination of those creates four positions, not two.

Steve Horwitz May 17, 2010 at 8:33 pm
Ivan May 18, 2010 at 2:45 am

That pretty much sums it up really. Mises was too smart to ignore the effects of an elevated market rate of interest above the natural rate, which is a simple one or two-step deduction. In fact, Mises, in chapter 17 TMC, essentially says that the effects of such a condition are obvious (mainly because Wicksell dealt with it and because deflation was not the major economic problem of the time).

Again, here’s Mises:

“In fact, the development of the clearing system and fiduciary media has at least kept pace with the potential increase of the demand for money brought about by the extension of the money economy, so that the tremendous increase in the exchange value of money, which otherwise would have occurred as a consequence of the extension of the use of money, had been completely avoided, together with its undesirable consequences (pp. 333).”

DD5 May 18, 2010 at 4:08 am

The elevated market rate of interest above the natural rate refers to the reverse process of credit expansion – Credit contraction! Obviously, when fiduciary media are withdrawn from the system, the cash induced changes elevate the market rate above the natural rate just as during the expansion phase, the cash induced changes depressed the market rate below the natural rate. So again, interest rate is distorted due to fiduciary media.

Yet you have completely misunderstood this point, that you are defending fiduciary media to allegedly remedy a problem caused by fiduciary media in the first place.
The quote provided by Steven from HA proves this point and if you read it in its full context, you will see what Mises is referring to. Simply the reverse process of the Business cycle.

You have made this claim already numerous times in the past ,and every effort to steer you away from this blunder just results in insults from you. It’s a shame.

Now of course, I’m not surprised at all that Steven would yet again, provide quotes that are even more compatible with Salerno’s interpretation of Mises’ views.

Stephen Grossman June 18, 2010 at 11:18 am

>So apparently Mises thought that even “systems of fiduciary media” are fine as long as issuers of notes are required to fulfill their legal obligations to redeem.

But they cant redeem all notes at the same time. Rothbard says or cites that banks are bankrupt with the very issue of fiduciary media prior to a bankrupting redemption. And, of course, fiduciary media encourage loans that shift resources to less productive investments.

If Mises had no final, clear view of FR, Rothbard does and its the logical implication of Mises. No FR!

Current June 18, 2010 at 12:14 pm

I suggest you read “The Theory of Money and Credit”, Mises has a very carefully worked out system of fiduciary media. It’s quite different from Rothbard’s.

> But they cant redeem all notes at the same time.

Yes, but so what? Banks don’t have to redeem them all at the same time. They only have to redeem them all at the same time if customers run and they’ll only do that if they *have a reason* to run.

> Rothbard says or cites that banks are bankrupt with the very issue of fiduciary
> media prior to a bankrupting redemption.

He does say that and he’s wrong. By that definition insurance companies would be bankrupt too, and so would many other sorts of company.

Rothbard thought that the amount of redemptions a bank faces at a particular time is uncertain, it may be 0% of liabilities or it may be 100%. But, in practice it doesn’t work like that. In practice it can be predicted.

> And, of course, fiduciary media encourage loans that shift resources to less
> productive investments.

Why do you claim it does that?

Beefcake the Mighty May 16, 2010 at 10:47 pm

Prof Salerno should be forewarned, last summer when the heroic Nikolaj appealed to
Selgin’s work on the GMU blog in refuting some of Horwitz’ claims, Selgin called him a
liar and promised to provide textual evidence demonstrating this. He never did.

cret May 16, 2010 at 11:04 pm

i was told that a money substitute was different than fiduciary media. especially in a current context. money substitute was a paper receipt for specie that did not circulate…when the receipt for the specie did not circulate the specie likely would.

does fiduciary media operate differntly than a money subsitute?? does fiduciary media spend along side the the stuff that it is a claim for???

currently i am told that reserves dont even have to be paper cash and also told that fiduciary media spend along side non paper cash. and in mises video this system is the cause of all financial woes.

Current May 17, 2010 at 7:23 am

There is a diagram of the classification system that Mises uses in Appendix B of “The Theory of Money and Credit”. Get the Mises.org PDF of that book and have a look. It’s on page 485 (using PDF pages).

Stephen Grossman June 18, 2010 at 11:31 am

>Thanks!

Anonymous May 17, 2010 at 12:40 am

“The first step must be a radical and unconditional abandonment of any further inflation. The total amount of dollar bills, whatever their name or legal characteristic may be, must not be increased by further issuance. No bank must be permitted to expand the total amount of its deposits subject to check or the balance of such deposits of any individual customer, be he a private citizen or the U.S. Treasury, otherwise than by receiving cash deposits in legal-tender banknotes from the public or by receiving a check payable by another domestic bank subject to the same limitations. This means a rigid 100 percent reserve for all future deposits” (The Theory of Money and Credit, pg. 491).

Ivan May 17, 2010 at 3:26 am

Re-posting a portion of my comment from the other thread because (a) both blog posts are essentially identical (though I don’t really understand Dr. Salerno’s point in this one), and (b) this portion of my comment was never addressed:

Mises, like Wicksell, believed that there’s an organic automatic adjustment process to the demand for money in a free banking system (though under different conditions and for different reasons). Here’s Mises:

“Of course, all of this is true only under the assumption that all banks issue fiduciary media according to uniform principles, or that there is only one bank that issues fiduciary media. A single bank carrying on its business in competition with numerous others is not in a position to enter upon an independent discount policy… Thus the banks may be seen to pay a certain amount of regard to the periodical fluctuations in the demand for money. They increase and decrease their circulation pari passu with the variations in the demand for money, so far as the lack of a uniform procedure makes it impossible for them to follow and independent interest policy. But in doing so, they help to stabilize the objective exchange value of money. To this extent, therefore, the theory of the elasticity of the circulation of fiduciary media is correct; it has rightly apprehended one of the phenomena of the market, even if it has also completely misapprehended its cause (pp. 347).”

Here’s why the Rothbardians are just plain wrong: money is both a good and a class in itself (though there are many forms of money) which exerts an influence over the money rates of interest. Therefore, interest rates can rise, or fall, depending solely on monetary conditions, independent of time preferences. When there’s an elevated demand for money, that goes unsatiated, the money rate of interest will rise above the natural rate (since time preferences, which is the ratio of demand between present and future goods, remains unchanged) and, in the face of price rigidities, will cause a decline in output and/or higher unemployment.

Bad deflation exists.

It is true that, in an imperfectly competitive banking environment, banks will inevitably expand the supply of fiduciary media beyond the demand for cash, which will suppress the market rate below the natural rate and set off the ABC, and it’s true that even if banks don’t expand the supply of money beyond the demand for cash holdings, the money may not flow directly towards those who wish to increase their cash holdings. It may, in fact, flow towards those who which to increase consumption and/or investment.

Thus, this entire debate misses the point. The Rothbardian’s attempt to eliminate the business cycle does so only by first replacing it with a condition of perpetual economic stagnation, that is, they want to replace boom-bust with perpetual bust.

newson May 17, 2010 at 4:29 am

kindly explain error cycles then.

scineram May 17, 2010 at 7:12 am

Imbalance between supply and demand for money?

Beefcake the Mighty May 17, 2010 at 8:17 am

How would that be any different from, say, a price cap or floor on any other good?
Such policies create distortions, no doubt, but they hardly create a boom-bust cycle.

Current May 17, 2010 at 7:29 am

Though I criticise the 100% reserve side myself I doubt that their proposal would lead to “permanent bust”. Certainly it would exacerbate recessions.

However prices can adjust to the stock of money available, it just takes time.

DD5 May 17, 2010 at 9:24 am

The market is being condemned here for not reacting to change instantaneously. I see. And this can be somehow remedied by money injection.

And even more curious is that this somehow is suppose to based on Misesian economic theory. According to ME theorists, Mises rejected the bulk of Monetarism simply because they got their set point wrong. Instead of setting the price level to “price stability”, ME will have the price level set to some other point that they claim represents the equilibrium point of demand for money.

Current May 17, 2010 at 11:47 am

I’m not condemning the market in any way. I’m simply pointing to the fact that money prices change slowly. All of the Austrian economists would agree with that by the way.

Really, it is the 100% reservists are rejecting the idea of a free market for money. It is through the free market for money that money supply and demand can be met without prices having to change.

Those who support a legal 100% reserve law require the market to go through the artificial contortion of deflation when money demand increases followed by inflation when in falls. This is costly, and a cost that need not be borne.

Beefcake the Mighty May 17, 2010 at 12:33 pm

It seems that much of what you say here could apply equally well to *any* good,
yet we don’t hear calls for a special institution like FRB to accelerate the price
system’s adjustment to changes in demand for, say, beer.

Current May 17, 2010 at 9:46 pm

FRB isn’t a special institution. It’s something that happens in other industries too.

I used to work for a large computer company. We kept fractional reserves of spares, and fractional reserves of service staff to fit them.

It’s quite normal in many industries that when it says “we gaurantee to do X” the business doesn’t actually commit resources to cope with every customer exercising that option.

Ivan May 17, 2010 at 4:14 pm

@DD5,

Why resort to obfuscation? Who’s condemning markets? Sorry, DD5, but you’re the only one condemning markets. Financial markets are legitimate markets that facilitate mutually beneficial and voluntary exchange and which serve a vital economic function.

“According to ME theorists, Mises rejected the bulk of Monetarism simply because they got their set point wrong. Instead of setting the price level to “price stability”, ME will have the price level set to some other point that they claim represents the equilibrium point of demand for money.”

Monetarism is wrong because (a) they believe that there’s a direct causal connection between the demand for money and monetary aggregates, that is, they take the equation of exchange literally and assume a constant or stable velocity; (b) they ignore the micro-foundations of macro phenomena, and (c) they have no capital theory. I’d say there are huge differences between the monetarist and Austrian schools, and we don’t need to support 100% reserves just to be different for the sake of being different.

DD5 May 17, 2010 at 4:40 pm

Ivan,Stop with your 100% cult nonsense. I don’t care about it.

The neo-banking school as Salerno referred to it are guilty of precisely that: (a), (b), and (c). Unlike the Monterists, the situation, however is more complicated. They are aware of (a), (b) , and (c) in theory and claim they are not making those mistakes. But careful examination of Monetary equilibrium theory suggests that they are making the exact same mistakes. I have explained above why this is so. So the rhetoric is different, no doubt. The theoretical explanations are more sophisticated. But the result is the same: A monetary theory that cannot be correct if (a), (b), and (c) are not ignored or underplayed.

You have yourself acknowledged some of the unresolved problems that you potentially see with ME/FB. I know because I saw them in your posts over at the forum. If you explore this further, you may see it all more clearly. I have shown you the sources.

Ivan May 17, 2010 at 4:46 pm

Just more empty/meaningless assertions from you. Care to explain? Or are you done?

Steve Horwitz May 17, 2010 at 4:47 pm

Sorry DD5, but I explicitly reject each of a), b), and c) in my book, with the interesting title of Microfoundations and Macroeconomics: An Austrian Perspective. Said book contains an entire chapter on capital theory and integrates it into the monetary equilibrium perspective. And I do go to great pains to explain the microfoundations of the equation of exchange. I also spend a great deal of time talking about the microeconomic effects of inflation and deflation and cycles.

Now you may think I botched the job, but to claim those are “ignored” or “underplayed” are simply false. And if you think I botched it on a), b), and c), I invite to write up a critique and send it to the Review of Austrian Economics. Or, if you’d rather, write up something shorter, that demonstrates you’ve read the book and have specific criticisms, and email it to me, I’ll happily post it at Coordination Problem so that it can be available for discussion.

DD5 May 17, 2010 at 5:17 pm

To Steve Horwitz (reply to your reply at 5/17/10 4:47pm)

You response does not respond to the point I was making. It misrepresents what I’ve said. I’ve specifically said:

“They are aware of (a), (b) , and (c) in theory and claim they are not making those mistakes.” So you’re response is off the mark.

So I didn’t claim that you don’t reject (a), (b), and (c).

I am obviously saying that ME is flawed and that its flaws can be explained by showing that it makes very similar errors to that of the Monterist school. These errors have been raised numerous times, but you have often just ignored them or given precisely that type of response: “submit it to a journal”. I would if they were originally mine but much of it has already been published by what I think is a rather satisfactory manner. For example, for a start, see de Soto. (THE THEORY OF “MONETARY EQUILIBRIUM” IN FREE BANKING RESTS ON AN EXCLUSIVELY MACROECONOMIC ANALYSIS) pp. 688.

newson May 17, 2010 at 9:55 am

not that austrians have ever had problems incorporating time into their view of market operations. i’d say that’s one of the distinguishing characteristics of the school.

if you believe that expansion/recession cycles are still possible in a fully-reserved banking system, then i guess you reject the abct, so the question then becomes how do you account for error cycles?

newson May 17, 2010 at 9:56 am

my comment is directed @ current

Jay Lakner May 17, 2010 at 8:23 am

This is not my strongest area, but it always seems to me that people completely overcomplicate it.

Firstly, I really don’t understand this “demand for money” nonsense. Money is simply a medium of exchange. Since the demand for goods and services is limitless, then the demand for money must always be infinite. Whenever anyone starts ranting on about the demand for money, I usually come to the conclusion that they are talking rubbish.
If a great number of people wish to swiftly increase their cash balances for whatever reason, then there will simply be a downward effect on prices (including wages). The only price rigidities that should exist are contracts, and even then an intelligent society would make intelligent contracts that accommodate for future problems. Bad deflation? What nonsense! There is no bad deflation, only bad currencies (like the ones we’re forced to use).

Secondly, with regard to FRB, I don’t see a problem with it as long as banks admit they are practicing it. (ie they are not commiting fraud)
Depositing your money in a FR bank is similar to investing in the stock market, going to a casino or playing the lottery. You get a return on your money but run the risk of the bank going bust.
The real issue is the existence of legal tender laws which prohibit citizens from using other forms of money. If you are forced to use one particular currency as money, then FR banks will cause an artificial boom followed by bank runs and the collapse of FR banks. The existence of a central bank simply prevents FR banks from going bankrupt to the detriment of the citizens of society (inflation is the result, which generally hurts the poorest citizens).

Legal Tender Laws + FRB = Boom/Bust Cycle

Remove the Legal Tender Laws and you effectively put an end to the boom/bust cycle. Currencies like Gold and Silver will win the day as people will ultimately learn to avoid paper money.

(That being said, just about all taxes will have to end because it is virtually impossible to enforce taxation if people can use anything they want as money)

mpolzkill May 17, 2010 at 8:37 am

Thanks for the whole thing in English, Jay. This is exactly how I see it, I guess we’re simpletons?

Slow, sure and steady growth and a world of stability would look like stagnation to Ivan, I reckon?

Steve Horwitz May 17, 2010 at 8:47 am

Firstly, I really don’t understand this “demand for money” nonsense. Money is simply a medium of exchange. Since the demand for goods and services is limitless, then the demand for money must always be infinite. Whenever anyone starts ranting on about the demand for money, I usually come to the conclusion that they are talking rubbish.

“There exists a demand for media of exchange because people want to keep a store of them. Every member of a market society wants to have a definite amount of money in his pocket or box, a cash holding or cash balance of a definite height. … Their cash holding is not merely a residuum, an unspent margin of their wealth. It is not an unintentional remainder left over after all intentional acts of buying and selling have been consummated. Its amount is determined by a deliberate demand for cash. And as with all other goods, it is the changes in the relation between demand for and supply of money that bring about changes in the exchange ratio between money and vendible goods.”

That would be the “rubbish” of one Ludwig von Mises (Human Action, p. 402 in an entire section on the demand for money and supply of money). He was the guy who invented the cash balance approach to the demand for money. But if you think he’s talking rubbish there, by all means say so.

DD5 May 17, 2010 at 9:09 am

And Mises goes on to make it clear that it is not money they are really after but the goods and services that it can buy. I’m not going to search the book for the quote unless you challenge this view, which I doubt it. So demand for money is actually demand for purchasing power.

So the point the commenter makes is not completely incorrect (although badly phrased) given that he is recognizing that prices will drop in response to this increase in demand.

Steve Horwitz May 17, 2010 at 9:29 am

Let’s be a little careful. Yes, we want to hold money because money can ultimately purchase goods and services, so in that sense we care about money for its ability to buy things. But the reasons why we hold a specific, definite quantity (and here’s where the OP was totally and utterly wrong – the demand for money is not “infinite”, he’s confusing “wealth” and “money,” which is day one in Econ 100) also have to do with our expectations of the future among other things. Money is an asset that helps us deal with uncertainty – the more uncertain we are about what we might have to spend in the future, the higher our demand for cash balances will be.

I recommend Hutt’s “The Yield on Money Held” on this subject, as well as my own piece on “A Subjectivist Approach to the Demand for Money” ( http://myslu.stlawu.edu/~shorwitz/Papers/Subjectivist%20Money%20JEEH%201990.pdf ).

I wasn’t interested in debating the “prices drop” point. My reply was driven by having heard this nonsense about the demand for money not making any sense on various fora around here over the years and finally having enough. What the OP said about the demand for money being infinite etc is utterly and completely wrong and misunderstanding that point will lead folks down the road to economic nonsense very quickly.

Putting aside the issues of the FRB/100% debate, this is just about understanding Austrian economics. Whatever side of that debate we are on, I would think we would have an interest in correctly understanding monetary economics on the points on which Austrians and pretty much everyone else agree. And this is one of them: the demand for money is a sensible concept and it is not infinite. And it was Mises who was foundational for understanding this point.

No other agenda than that here.

Jay Lakner May 17, 2010 at 10:03 am

Not that I even want to debate this point, but the demand for “excess cash holdings” is different than the “demand for money”. When Mises wrote about the “demand for money” he was refering to excess cash holdings.
We both agree that the demand for wealth is infinite.
We both agree that the demand for excess cash holdings is finite.
What we seem to disagree on is whether the demand for “money” is infinite or not. Money is such a broad term that I’m guessing this might be a definitional disagreement.

mpolzkill May 17, 2010 at 10:09 am

Isn’t this definitional confusion the camel’s nose for the sophists’ control of money?

Steve Horwitz May 17, 2010 at 10:12 am

Not that I even want to debate this point, but the demand for “excess cash holdings” is different than the “demand for money”. When Mises wrote about the “demand for money” he was refering to excess cash holdings.

No, he wasn’t. He was referring to how much purchasing power people wish to hold in their checking accounts, gold, notes, etc.. He meant the demand to hold such balances, just in the same way almost every economist talks about it today.

“The appraisement of money is to be explained in the same way as the appraisement of all other goods: by the demand on the part of those who are eager to acquire a definite quantity of it.” (HA: 403) “The demand for money is determined by the conduct of people intent upon acquiring it for their cash holding.” (404)

In fact, later on that page, Mises says: “The very notion of an unlimited demand [for money] is, however, contradictory. This popular reasoning is entirely fallacious. It confounds the demand for money for cash holding with the desire for more wealth as expressed in terms of money.”

So please, give it up Jay. You’re just wrong about the demand for money. Admitting that does not imply a commitment to any other position, especially on the FB/100% debate. Again, I’m only interested in teaching good economics here. Anyone who makes the arguments you are making is spreading economic fallacies and ones that Mises dispatched with 100 years ago. You’re here on the Mises blog, so I would think admitting that Mises was right on this wouldn’t be so hard, especially if you are serious about understanding economics correctly.

Jay Lakner May 17, 2010 at 10:22 am

From Wiki:
“Money is anything that is generally accepted as payment for goods and services and repayment of debts.”

more money = more purchasing power
more purchasing power –> more property
more property = more wealth

demand for wealth = infinity
therefore, demand for purchasing power = infinity
therefore, demand for money = infinity

Jay Lakner May 17, 2010 at 11:08 am

I’m finding it very difficult to understand how anyone can see it any other way.
People have limited resources to achieve their desired ends. I’m sure everyone would like to save up enough money to buy their own yacht, but a yacht would be low down on most peoples’ value scales. They are too busy scraping up enough money to buy the things high on their scale of values.

To say that the level of savings at any one particular moment in time is an indication of the demand for money is complete nonsense. The demand for money can never be satisfied.

There is what people demand (infinite).
And there is what people have actually accumulated (finite).

The mistaken thinking seems to be that of equating “accumulated money” with “demand for money”. I can’t understand why you would treat them to be the same thing.

Current May 17, 2010 at 9:54 pm

In economics what “demand” means is the desire for something coupled with the ability to pay for it. It doesn’t simply mean the desire alone.

That’s why in the section Steve quotes Mises wrote: “It confounds the demand for money for cash holding with the desire for more wealth as expressed in terms of money.”

To “demand” in the economic sense a person must produce something first (even if that something is only an agreement to do something in the future). Demanding isn’t just wanting.

Jay Lakner May 17, 2010 at 11:04 pm

>In economics what “demand” means is the desire for something coupled with the ability to pay for it. It doesn’t simply mean the desire alone.

That makes no sense to me. The price of any good is what someone is willing to pay for it. Everyone has the “ability to pay”, just at lower prices. This cannot be the definition of demand.

>That’s why in the section Steve quotes Mises wrote: “It confounds the demand for money for cash holding with the desire for more wealth as expressed in terms of money.”

I’m not talking about the demand for “cash holding”, I’m talking about the demand for “money”.

>To “demand” in the economic sense a person must produce something first (even if that something is only an agreement to do something in the future). Demanding isn’t just wanting.

You’re saying that “demand” requires a “supply”?
Everything that is supplied will be sold. The market always clears. Basically you’re telling me that “demand” and “supply” have the exact same definition.
If you are right, then what exactly is the purpose of the word “demand”?

Jay Lakner May 17, 2010 at 11:21 pm

I’d also like to point out that your definition does not clear up the absurdity of the concept the “demand for money”. If demand = supply, then there is no point talking about insufficient supply of money because the demand is perfectly met. To say that the demand has not been met makes no sense if demand requires a supply.

Mikeikon May 18, 2010 at 11:41 am

Your demand for a good is how much of it you’ll buy at its current price

…Not how much of it you’d want if you could get it for free.

Money is not free (you have to pay for it with other goods & services), therefor it has a limited demand.

This is really basic stuff.

Jay Lakner May 18, 2010 at 2:56 pm

> Your demand for a good is how much of it you’ll buy at its current price

This causes the same problem I’ve mentioned already. If you increase the supply of a good, you decrease it’s price. So by your definition, supply = demand.

> Money is not free (you have to pay for it with other goods & services), therefor it has a limited demand.

Money is a means of exchange. It is not the end you desire but instead is a means to achieve that end. Money is purchasing power. The demand for purchasing power is unlimited. Therefore the demand for money is unlimited.

It seems that a large number of people have all made the same error in thinking that supply and demand are the same thing. They are not.

newson May 17, 2010 at 9:43 am

i’d hazard a guess that depositors don’t think of their frb current accounts as a betting account. it’s definitely not analogous to a stock market investment. in company insolvency, equity is distributed in a way that follows a known legal procedure. in a bank run, it’s completely unknowable which depositors will be successful in saving their capital. prior to deposit insurance, and central banking, depositors had no way of knowing how much a gamble they were taking (how could they, when the banks’ managers didn’t know themselves, otherwise they’d have shrunk their loan books prior to the onset of the crisis?).

the only honest way to describe frb is a gamble, and nothing in the history of banking shows the industry being in any way candid with respect to this point.

Peter Surda May 17, 2010 at 10:48 am

There are lot of companies that cannot provide 100% service if all of their customers requested it at the same time, although they might have the contractual right to it. Should it happen, they would not get it evenly distributed either. Electricity, phones (landline or mobile), internet providers all practice “fractional reserve services”. Airlines overbook. And let’s not even get started with insurance businesses. Is it fraud? Hardly.

Does that mean it is a gamble? In a way, all business is a gamble. But how many consumers are going to request 100% reserves for the above services?

newson May 17, 2010 at 8:31 pm

if you leave (deposit) your car at the airport car park, can you rightfully expect to find it there on return, or do you just hope the managers do their best? the deposit contract is purely one of safekeeping of your good. the other example you’ve offered are null; you do not own any part of the airline, telco, etc that you can demand safekeeping of your property.

Current May 17, 2010 at 10:49 pm

All that demonstrates is that “deposit” is a poor word to describe the service banks provide.

Peter Surda May 18, 2010 at 6:36 am

Indeed, as it also has aspects of a loan, investment and service contract, calling it deposit is, in my opinion, of historical relevance rather than a reflection of current practices. Pure “deposit” is not what banks do and it’s also not what their customers want from them. I don’t know if people put the majority of their savings into current accounts but I kind of doubt it.

newson May 18, 2010 at 8:10 pm

yep. call me cynical, but with billions of dollars spent each year on drafting banking covenants, contracts etc, i find it hard to imagine that the ambiguity allowed by this term isn’t completely deliberate.

bill woolsey May 18, 2010 at 9:11 am

Checking accounts are like buying bonds.

There are any number of scenarios where there borrower won’t be able to pay off and will default.

The risk of the bonds depends on the likelihood of those scenarios.

Banking is the same.

There are various scenarios where banks won’t be able to pay off. The risk of a deposit depends on the likelihood of those scenarios.

Mikeikon May 18, 2010 at 11:53 am

Depositors don’t think of FRB accounts as risky because they aren’t anymore. The FDIC insures them.

Beefcake the Mighty May 18, 2010 at 12:04 pm

LOL! Oh, wait, this is a serious statement….

Stephen Grossman June 18, 2010 at 11:45 am

>Depositing your money in a FR bank is similar to investing in the stock market, going to a casino or playing the lottery.

So I can ask the convenience store clerk who sold a lottery ticket to me for a withdrawal? Or after I lost my shirt at roulette I can ask for a refund! Wow! This makes Keynes look like a hoarder.

Beefcake the Mighty May 17, 2010 at 8:32 am

Horwitz is really cranking them out lately:

http://www.coordinationproblem.org/2010/05/ebeling-and-selgin-contra-salerno-on-mises-and-100-reserves.html#comments

This statement is truly rich:

“As passionate defenders of a position often do, Salerno has presented the pieces of the story that are congenial to his view and chosen to ignore those that are not.”

Pot, meet kettle. Talk about chutzpah.

newson May 17, 2010 at 10:43 am

i’ve always found it amusing that mises’, a minarchist, preferred to allow interbank competition to limit fiduciary media emission rather than trusting the state to regulate a fully reserved system. it’s amusing that one who distrusted the state on monetary probity was open to the usefulness of state schooling, and pro-state defense and law and order.

bob May 17, 2010 at 10:46 am

Demand for money CANNOT push the interest rate above its natural rate. If money demand increased, all prices would fall. Thus, entrepreneurs would have to borrow less to secure the same amount of resources. Thus, loan demand falls, at the same time as loan supply falls. Thus, the natural interest rate is unaltered.

I think free bankers often miss this point entirely. Also, they believe that redemption demand is a perfect proxy for time preference. It isn’t. In fact, using it as a proxy will lead to a business cycle, because time preference is generally higher than redemption demand would indicate (at least before the bust phase).

I think we should all agree, however, that free banking is our best choice of action, as long as such banks cannot capture government and nullify their contracts when they cannot meet them. It seems we need anarchy.

Mises always thought about the issue inside a state paradigm, which is why it becomes confusing. Does he advocate his view as a result of state control or a result of the market. if the government acts, is it limiting choice because the actions are fraudulent and unjust, or to promote economy. Or is it simply acting in its own self-interest?

Current May 17, 2010 at 10:29 pm

> Demand for money CANNOT push the interest rate above its
> natural rate. If money demand increased, all prices would
> fall. Thus, entrepreneurs would have to borrow less to secure
> the same amount of resources. Thus, loan demand falls, at the
> same time as loan supply falls. Thus, the natural interest rate
> is unaltered.

This presumes that prices fall quickly, in practice they cannot, they fall slowly. Once prices have fallen what you say is quite correct.

Think about what you have said in the opposite direction with inflation as the subject instead of deflation. If the consumer price level rose as soon as the central bank created large amounts of new money then the real rate of interest would stay unchanged. Entrepreneurs would have to borrow a larger nominal amount to finance their projects. This doesn’t happen though because the price inflation doesn’t occur immediately after the money inflation. That’s why real interest rates remain artificially low for a period.

Stephen Grossman June 18, 2010 at 11:51 am

>It seems we need anarchy.

I just recognized the meaning of the book title, _Eyeless In Gaza_. What happens when alleged market anarchists confront Marxist anarchists? An equilibrating process of bullets and bombs?

Nikolaj May 17, 2010 at 10:49 am

Steve,the only problem with your (and Ebeling’s) theory is that it flies directly in the face of the direct textual evidence from Mises. For from being an advocate of 100% reserve only for central banking regime, Mises directly and specifically stated on many places that elimination or at least suppression of further issuance of fiduciary media was the only way of eliminating any HUMAN influence on the business cycle;Mises: “But the two shortcomings of the Currency School vitiated this famous act. On one hand, the system of government interference with banking was preserved. On the other hand, limits were placed only on the issuance of banknotes not covered by specie. The fiduciary media were suppressed only in the shape of banknotes. They could thrive as deposit currency.”As you can see, Mises here talks about the preservation of the government influence on banking and the retaining of the fiduciary media, as TWO INDEPENDENT mistakes committed by the Currency School. In other words, even if they advocated the abolishing of central bank, retaining the ability of private banks to create the credit out of thin air even in free banking still would be mistake. That directly invalidates your and Ebeling’s claim that Msies favored 100% system only within the central banking regime.In Human Action he says additionally: “”The notion of “normal” credit expansion is absurd. Issuance of additional fiduciary media, no matter what its quantity may be, always sets in motion those changes in the price structure the description of which is the task of the theory of the trade cycle. Of course, if the additional amount issued is not large, neither are the inevitable effects of the expansion.”Your thesis is that emission of fiduciary media, if matched by an appropriate increase in demand for money, would not create the same “inevitable effects” Mises is taking about here. On the contrary, you think that credit inflation allows for better intertemporal management of the money supply (in a wider sense). You believe in a positive function of fiduciary media in alleviating the business fluctuations. Mises believed it created the business fluctuations.As prof Salerno demonstrated in the previous post, the real problem here is whether fiduciary media creates or alleviates the business cycle? As simple as that. I would really like to see any evidence that Mises ever thought the banking inflation, ie fiduciary media emission could dampen the business cycle. The personal impressions of you and Richard Ebeling, without any factual evidence, and contrary to all available evidence we have, are not enough, I am afraid.

Beefcake the Mighty May 17, 2010 at 10:54 am

Nikolaj, fantastic to have you here. I’ve always loved your comments over at the
GMU blog (and I’m amazed they haven’t banned you yet).

Nikolaj May 17, 2010 at 10:57 am

Steve,

the only problem with your (and Ebeling’s) theory is that it flies directly in the face of the direct textual evidence from Mises. For from being an advocate of 100% reserve only for central banking regime, Mises directly and specifically stated on many places that elimination or at least suppression of further issuance of fiduciary media was the only way of eliminating any HUMAN influence on the business cycle, irrespective of whether that influence is carried out via central bank or free private commercial banks;

Mises: “But the two shortcomings of the Currency School vitiated this famous act. On one hand, the system of government interference with banking was preserved. On the other hand, limits were placed only on the issuance of banknotes not covered by specie. The fiduciary media were suppressed only in the shape of banknotes. They could thrive as deposit currency.”

As you can see, Mises here talks about the preservation of the government influence on banking and the retaining of the fiduciary media, as TWO INDEPENDENT mistakes committed by the Currency School. In other words, even if they advocated the abolishing of central bank, retaining the ability of private banks to create the credit out of thin air even in free banking still would be mistake. That directly invalidates your and Ebeling’s claim that Msies favored 100% system only within the central banking regime.

In Human Action he says additionally: “”The notion of “normal” credit expansion is absurd. Issuance of additional fiduciary media, no matter what its quantity may be, always sets in motion those changes in the price structure the description of which is the task of the theory of the trade cycle. Of course, if the additional amount issued is not large, neither are the inevitable effects of the expansion.”

Your thesis is that emission of fiduciary media, if matched by an appropriate increase in demand for money, would not create the same “inevitable effects” Mises is taking about here. On the contrary, you think that credit inflation allows for better intertemporal management of the money supply (in a wider sense). You believe in a positive function of fiduciary media in alleviating the business fluctuations. Mises believed it created the business fluctuations.As prof Salerno demonstrated in the previous post, the real problem here is whether fiduciary media creates or alleviates the business cycle? As simple as that. I would really like to see any evidence that Mises ever thought the banking inflation, ie fiduciary media emission could dampen the business cycle. The personal impressions of you and Richard Ebeling, without any factual evidence, and contrary to all available evidence we have, are not enough, I am afraid.

Steve Horwitz May 17, 2010 at 11:26 am

I’m glad that Nikolaj had the honesty to say that his understanding of Mises is superior to that of Richard Ebeling. Talk about chutzpah.

And let’s be clear about one thing: I do believe that “fiduciary media” are what create the business cycle. Not fiduciary media per se, but an excess supply of them yes.

Let’s also be clear that you are begging the question by defining the existence of any fiduciary media as “inflation.” You say that I believe that “credit inflation” or “banking inflation” has a positive effect. I do not. You only think that because you are accepting the Rothbardian definition of inflation, which I deny. You might be right, I might be right, but calling it inflation begs the question.

The argument of MET (and I’ve offered textual evidence from Mises to show he agrees) is that inflation is rightly defined as an excess supply of money (in the broad sense to use Mises’ s terms). My argument is not that inflation is good but that sometimes increases in the money supply are warranted and are not inflationary.

I would submit that no contemporary Austrian has written more on the problems with inflation than I have. So at the very least do me the courtesy of not begging the question and describing what I believe in the terms that I would use to do so. It’s the least one can do if one wants to have a serious discussion of these issues, rather than a question-begging shouting match.

After all, I think we all agree here that little is more damaging to an economy than inflation and that at this very moment we are sitting on an inflationary timebomb that all of us can agree would be disastrous and needs our critique.

newson May 17, 2010 at 9:41 pm

i think hülsmann’s point needs addressing, ie. that it’s not growth in money supply per se that generates the business cycle, but how inflation occurs. money supply growth in specie regimes (able to be predicted) not generating the business cycle, which can occur only in frb and fiat money regimes.

Beefcake the Mighty May 17, 2010 at 9:51 pm

Right, as Huelsmann notes, if entrepreneurs correctly identify a credit inflation
*as such*, then they can correctly anticipate price spreads as they would for any
other perceived change in conditions on the market, and there will not be a boom-
bust cycle set in motion. But, it is the nature of FRB that market actors *believe*
that a (unilateral) increase in loanable funds by the bankers constitutes a real increase
in capital funds, which is of course an illusion, an illusion that must eventually be
shattered in the subsequent bust.

Good luck getting Steve or any other GMUer to address Huelsmann’s work, be it
monetary theory, the calculation debate, etc.

newson May 18, 2010 at 8:25 pm

i can’t understand why the festschrift article by hülsmann doesn’t get any airplay either. nor does the “theory of interest rates”, especially since time preference (mises-vbb version) is cited in almost all material on this site.

Current May 19, 2010 at 9:43 pm

Beefcake,

Free bankers agree about a all that stuff you write above, it’s ordinary Austrian Theory.

But, we don’t think that free banks can set in motion an increase in circulating fiduciary media. So, we don’t think that they can cause the illusion of more loanable funds than real capital.

Beefcake the Mighty May 19, 2010 at 9:52 pm

No, I disagree, Current, Huelsmann explicitly criticizes the conventional ABCT
expounded by both Mises and Rothbard. (Very roughly speaking, he would
agree with the Rational Expectations critiques of the theory.) The article is
very much worth reading.

Ivan May 17, 2010 at 5:37 pm

@Nikolaj

Here’s Mises:

“In fact, the development of the clearing system and fiduciary media has at least kept pace with the potential increase of the demand for money brought about by the extension of the money economy, so that the tremendous increase in the exchange value of money, which otherwise would have occurred as a consequence of the extension of the use of money, had been completely avoided, together with its undesirable consequences (TMC, pp. 333).”

You then say:

“In Human Action he says additionally: “”The notion of “normal” credit expansion is absurd. Issuance of additional fiduciary media, no matter what its quantity may be, always sets in motion those changes in the price structure the description of which is the task of the theory of the trade cycle. Of course, if the additional amount issued is not large, neither are the inevitable effects of the expansion.”

This is just wrong. Hayek explains that (a) expanding the supply of money, in the broader sense, facilitates the further division of labor (as long as it meets, and does not exceed the additional business demand for money), and (b) expanding the money supply has no affect on the structure of production insofar as it does not exceed the demand for cash holdings.

Here’s Hayek (Prices and Production):

“In such a situation, therefore, the transition to more or less capitalistic methods of production may also require a change in the quantity of money, not because the physical magnitude of the goods-stream has changed, but because money has been transferred from a sphere where the coefficient of money transactions has been higher to one where it is lower or vice versa.”

“No doubt that the statement as it stands only provides another, and probably clearer, formulation of the old distinction between the demand for additional money as money which is justifiable, and the demand for additional money as capital which is not justifiable (pp. 297).”

Hayek explicitly says that inter-temporal disequilibrium is solely caused by expanding the supply of money beyond the demand for cash holdings, which alters the ratio of demand between present and future goods, and therefore altering the structure of production away from its natural condition. Of course, all of this assumes that the new fiduciary media flows towards those who wish to increase their cash holdings. Hayek says that this assumption is not far-fetched; I’m not sure that I entirely agree.

newson May 18, 2010 at 8:29 pm

what’s hayek got to do with this?

Adam Knott May 17, 2010 at 12:13 pm

The Rothbardian Interpretation of Mises on Free Banking

Writing in his 1992 essay “The Present State of Austrian Economics,” Rothbard argues against free banking:

“If counterfeiting per se is deplorable and to be outlawed, then the same standards must be applied to its surrogate, fractional reserve banking, which is currently legal and which would run rampant in the “free-banking” heaven of our non-Misesian pseudo-Austrians.”

Rothbard is arguing for legal restrictions on banking, and claiming that those who argue for free banking are pseudo-Austrians. In support of his position, Rothbard cites a phrase that he says was one of Mises’ favorites:

“One of Mises’ favorite quotes on money and banking was from Thomas Tooke: “free trade in banking is tantamount to free trade in swindling.” Tooke and Mises, of course, were referring to fractional-reserve banking, in which banks pledge to redeem on demand receipts to non-existent money in their vaults. These bank notes or deposits are just as much counterfeit as warehouse receipts to grain, which were loaned out by grain elevators until recent decades—until, that is, the practice of fractional-reserve issues of receipts in grain, was outlawed and cracked down on.”

Thus, Rothbard implies Mises is in agreement with both himself (Rothbard) and Tooke, in holding that “free trade in banking is tantamount to free trade in swindling.” What Rothbard is saying is that one of Mises’ favorite quotes was “free trade in banking is tantamount to free trade in swindling,” and that Mises would often use this phrase to express his opposition to free banking.
The following are two instances where Mises uses this phrase in his lectures and written works:

“Propagandists who wanted to make the government pre-eminent in the issuance of money substitutes have publicized many stories about private money substitutes. These tales were condensed by an anonymous American who is credited with the dictum “Free trade in banking is free trade in swindling.” Economists, however, think differently; they consider free trade in banking as the only protection against the government’s issuance of bad banknotes.” (The Free Market and its Enemies, p.63)

and

“People often refer to the dictum of an anonymous American quoted by Tooke: “Free trade in banking is free trade in swindling.” However, freedom in the issuance of banknotes would have narrowed down the use of banknotes considerably if it had not entirely suppressed it. It was this idea which Cernuschi advanced in the hearings of the French Banking Inquiry on October 24, 1865: “I believe that what is called freedom of banking would result in a total suppression of banknotes in France. I want to give everybody the right to issue banknotes so that nobody should take any banknotes any longer.” (Human Action, 3rd Rev. ed. p. 446)

In both instances in which Mises refers to the quote attributed to Tooke, Mises clearly takes issue with the quote, and immediately counters this quote by saying that economists consider free banking as the best means to limit the issuance of banknotes generally, and the best means to protect people against the government’s bad banknotes.

The dictum “free trade in banking is free trade in swindling” is meant to convey that free trade in banking is the cause of harm and therefore should be prevented. In both cases where Mises addresses this quote directly, his answer is to argue the opposite: that free trade in banking is the best means to prevent harm and therefore should be promoted. Mises is arguing that free trade in banking is the best means to diminish both private and public issuance of value-losing currency notes.

Rothbard is implying that Mises believed free banking is a bad idea, and that Mises agreed that “free trade in banking is free trade in swindling.” Contrary to this though, Mises himself took issue with this very quote, and argues that free banking is the best means to protect people from value-losing notes.

Anonymous May 17, 2010 at 2:17 pm

“The first step must be a radical and unconditional abandonment of any further inflation… THIS MEANS A RIGID 100 PERCENT RESERVE FOR ALL FUTURE DEPOSITS” (The Theory of Money and Credit, pg. 491).

Steve Horwitz May 17, 2010 at 2:31 pm

If you read before and after that quote, you’ll see that the “first step” refers to a reform proposal GIVEN the existence of the Fed and the rest of the existing state apparatus. Your quote only provides proof for my claim (and Ebeling’s) that when Mises DID support 100% reserves it was in the context of a second-best proposal for monetary reform, not his first-best ideal. See the evidence here: http://www.coordinationproblem.org/2009/09/mises-and-his-call-for-100-reserves.html

Beefcake the Mighty May 17, 2010 at 2:44 pm

I have to note an observation made by Nikolaj here and myself on the other
thread in this debate: despite his protestations, Steve seems more concerned
with proving that Mises’ view is compatible with his own view rather than getting
at the truth. And the GMUers call Rothbardians cultists?

Mikeikon May 18, 2010 at 11:59 am

I’ve noticed that you guys are more interested in what Mises and/or Rothbard thought than what is true.

Beefcake the Mighty May 18, 2010 at 12:02 pm

You must be blind if you don’t see this as being far worse over on the GMU side.

Anonymous May 17, 2010 at 2:57 pm

True, this quote does refer to financial reform. But Mises does not suggest in the following pages that the reform should eventually entail a change from a 100% reserve to a free banking system.

Tell me where Mises says this initial 100% reserve should be eventually transformed into a free banking system?

Recall, this section of “The Theory of Money and Credit” was written in 1952.

Nikolaj May 17, 2010 at 1:10 pm

Steve: “I’m glad that Nikolaj had the honesty to say that his understanding of Mises is superior to that of Richard Ebeling. Talk about chutzpah.

“Steve, that’s not my interpretation, but the one that, I would say, represents a consensus interpretation across the 100%-free banking line of divide; not only that almost all Rothbardians accept that interpretation, but also some high profile critics of both Mises and Rothbard, such as here quoted Selgin (at least the “early” Selgin from his published works, not the new, revisionist Selgin from your blog). I don’t see any obvious reason why accepting Salerno’s, De Soto’s or Selgin’s interpretation of Mises would be necessarily more arrogant than accepting Ebeling’s position?

As for inflation, Mises repeteadly described the teachings of Banking School that you accept as “inflationist”. However, it is irrelevant whether you are going to call the emission of the fiduciary media a “credit inflation”, or not. The fact is that Mises, and Rothbard and Rothbardians in his footsteps understood the creation of credit supply above the gold reserves a cause of the business cycle. That’s the main issue here. I think that you are the one who begs the real question – how MET assumption that free banking provides a better management of fiduciary media could be reconciled with Mises belief that free banking is better than CB only because it creates a less fiduciary media? And that any amount of fiduciary media would create the same “inevitable consequences” of credit cycle? In your last response you directly deny this proposition, still you want to call yourself a Misesian on this point.

As you said, you can be right, Mises (and Rothbardians) can be right, but it is puzzling to me why do you still try to claim the Misesian mantle for an obviously anti-Misesian position on free banking and fiduciary media? You can simply say, just Selgin did in his book, that Mises was wrong on this, and offer the arguments why your theory is better.

It is a bit ironical that you, who often lambast Rothbardians for “Mises cultism”, deny the very possibility that Mises was entirely wrong on some issue, and cut the corners mercilessly only to prove that he was at least somewhat in agreement with you.

Ivan May 17, 2010 at 5:48 pm

I think it’s important to note that Mises’ definition of inflation (though he hated that term) was an increase in the supply of money beyond the demand for cash holdings, as opposed to Rothbard’s definition of inflation as an increase in the supply of money beyond the supply of gold. It seems like the Rothbardians are reading Mises while applying Rothbard’s definition of inflation. This is causing much confusion.

newson May 18, 2010 at 2:59 am

…and yet mises seemed to back rothbard’s analysis in “america’s great depression”.

Nikolaj May 17, 2010 at 6:16 pm

Ivan,
how one would define “inflation” is a red herring. The critical issue is – whether issuance of fiduciary media creates the credit cycle in whatever system it is carried out, as Mises and Rothbard say, or it can actually improve the monetary system if it is carried out in the free banking system, as neo-Banking school asserts. If you want to find some consolation in calling “inflation” only an increase in the quantity of banknotes, (while denying that issuance of fiduciary media is a “credit inflation”), so be it. I only don’t see any obvious implication of that rhetorical hair splitting for the central problem analyzed here.

Further, the whole neo-Banking MET is based on the notion that increased cash holdings in the economic contraction indicate increase in the demand for money that has to be offset by increasing the money supply for an equal amount. If you read Horwitz or Selgin you will find all standard Keynesian theorems, idle money, insufficient effective demand etc as a part of the theoretical explanation why larger cash holdings mean increased demand for money, which means larger pool of real savings, which means a green light for the credit creation (Machlup).

Not so, not so, says Mises:
“It is unsound to distinguish between circulating and idle money. It is no less faulty to distinguish between circulating money and hoarded money. What is called hoarding is a height of cash holding which—according to the personal opinion of an observer— exceeds what is deemed normal and adequate. However, hoarding is cash holding. Hoarded money is still money and it serves in the hoards the same purposes which it serves in cash holdings called normal. He who hoards money believes that some special conditions make it expedient to accumulate a cash holding which exceeds the amount he himself would keep under different conditions, or other people keep, or an economist censuring his action considers appropriate.”

Ivan May 17, 2010 at 6:56 pm

@Nikolaj,

“how one would define “inflation” is a red herring. The critical issue is – whether issuance of fiduciary media creates the credit cycle in whatever system it is carried out, as Mises and Rothbard say, or it can actually improve the monetary system if it is carried out in the free banking system, as neo-Banking school asserts.”

No, you’re presupposing the validity of your conclusions right off the bat. The Austrian framework is comprised of Bohm-Bawerkian capital theory, and Wicksell’s (monetary equilibrium theorist) monetary theory, with money rates of interest and the natural rate (from Bohm-Bawerk’s “natural interest”).

Mises’ TMC was merely an extension to Wicksell’s “Interest and Prices,” where Mises showed that the organic automatic adjustment of the supply of money to the demand for money was indeed correct, though under different conditions and for different reasons. Furthermore, he showed that Wicksell’s “theoretical construct,” namely the entire banking system consolidated into a single bank was not a theoretical construct at all, but rather explained real world conditions.

Again, here’s Mises:

“Thus the banks may be seen to pay a certain amount of regard to the periodical fluctuations in the demand for money. They increase and decrease their circulation pari passu with the variations in the demand for money, so far as the lack of a uniform procedure makes it impossible for them to follow and independent interest policy. But in doing so, they help to stabilize the objective exchange value of money. To this extent, therefore, the theory of the elasticity of the circulation of fiduciary media is correct; it has rightly apprehended one of the phenomena of the market, even if it has also completely misapprehended its cause (pp. 347).”

and,

“In fact, the development of the clearing system and fiduciary media has at least kept pace with the potential increase of the demand for money brought about by the extension of the money economy, so that the tremendous increase in the exchange value of money, which otherwise would have occurred as a consequence of the extension of the use of money, had been completely avoided, together with its undesirable consequences (TMC, pp. 333).”

Finally, Hayek expanded upon Bohm-Bawerks overly simplistic framework by adding additional dimensions and variables in order to better elucidate real world phenomena (Lachmann took it even further), while abandoning the “average period of production.” Hayek explicitly says that expanding the supply of money facilitates the further division of labor, and that you can expand the supply of money as money, but not as capital.

Here’s Hayek:

“No doubt that the statement as it stands only provides another, and probably clearer, formulation of the old distinction between the demand for additional money as money which is justifiable, and the demand for additional money as capital which is not justifiable (pp. 297).”

The Austrian monetary tradition is rooted in monetary equilibrium theory, and Rothbard was the major break (not the other way around). You then say,

“Further, the whole neo-Banking MET is based on the notion that increased cash holdings in the economic contraction indicate increase in the demand for money that has to be offset by increasing the money supply for an equal amount. If you read Horwitz or Selgin you will find all standard Keynesian theorems, idle money, insufficient effective demand etc as a part of the theoretical explanation why larger cash holdings mean increased demand for money, which means larger pool of real savings, which means a green light for the credit creation (Machlup).”

I haven’t read the works of the modern-day free-bankers so I can’t respond. But portions of the monetarist and Keynesian frameworks are not entirely incompatible with Austrian theory. In fact, Keynes was using the Wicksellian framework, though without an adequate capital theory.
You have the boom bust cycle, on the one hand, which causes inter-temporal disequilibrium, and where the malformed capital structure needs to be liquidated, and on the other hand, you have excess demand for cash which elevates the market rate of interest above the natural rate causing recessions (due to price rigidities). But this is not “Keynesian theory.” It’s entirely compatible with Mises’ three-fold distinction of goods (consumer, producer, and media of exchange) and Wicksell’s notion of natural and money rates of interest, as well as Hayek’s capital theory. Nowhere do Austrian MET say that savings is self-defeating, or that there’s a causal relationship between employment and inflation, or that the acceleration principle is correct, ect (I can go on for days).

Bad deflation exists; the money rate can be pushed below AND above the natural rate of interest. Essentially the Rothbardian dismissal of MET seems to be a knee-jerk reaction against anything which remotely resembles anything Keynesian, and an ideological tie to Rothbardian ethics. I’ve yet to hear a single coherent economic argument, on this blog post or the previous one, against MET (contra-Mises/Wicksell/Hayek).

PS: I did once hear Selgin say that money was a financial asset. That sounds absurd to me, and is in fact a Keynesian argument. Money is a good.

Nikolaj May 18, 2010 at 8:57 am

Ivan,

the central issue here (maybe not in the Austrian economics as such, but in this post) is whether fiduciary media creates or alleviates the business cycle. I fail to see what your lengthy lesson about who influenced whom in the Austrian school and how, has to do with this problem. Your lesson is as far as I can tell mostly correct but irrelevant for the problem at hand.

On the other hand, there is no something called an “excessed demand for cash” anywhere in Mises. That a pure Keynesian construct. I quoted the passage from HA in my previous comment that showed exactly that Mises argued there was not an “excessive” demand, but only demand, lower or higher. The notion of “excessive demand” is just a rhetorical devise for the advocacy of credit inflation, either in the standard Banking school’s form of “needs of trade” doctrine, or in the form of the Keynesian theory that whatever purchasing power is created by the banks corresponds to the genuine savings, or the neo-Banking theory where monetary “equilibration” is achieved by the means of the additional credit creation. Those are just the different ways of saying the same thing. Therefore, as far as the alleged “differences” between MET and Keynesianism are concerned, you are pointing to the irrelevant ones. We are not talking about their understanding of the aggregate demand, but about their common misunderstanding of saving, time-preference and the role of fiduciary media, where they are in complete agreement. George Selgin directly says in his book that Keynesians could accept the MET.

Let me quote once again Mises rejection of the notion of an excessive demand for money:”It is unsound to distinguish between circulating and idle money. It is no less faulty to distinguish between circulating money and hoarded money. What is called hoarding is a height of cash holding which—according to the personal opinion of an observer— exceeds what is deemed normal and adequate. However, hoarding is cash holding. Hoarded money is still money and it serves in the hoards the same purposes which it serves in cash holdings called normal. He who hoards money believes that some special conditions make it expedient to accumulate a cash holding which exceeds the amount he himself would keep under different conditions, or other people keep, or an economist censuring his action considers appropriate”.

So, if we accept this, the whole basis for treating the “excessive demand” for cash as a green light for additional credit creation crumbles.

Current May 18, 2010 at 10:40 am

MET proponents aren’t arguing that hoards of money are not being used. As you say all money is being used all the time. We don’t disagree with this.

Ivan May 18, 2010 at 5:34 pm

@Nikolaj

Well some historical context is useful here. The fact that Mises did not spend a lot of time talking about the effects of deflation (an elevated market rate above the natural rate) does not mean that he was unaware of such a phenomenon. Mises, in Austrian circles, is sometimes referred to or considered to be the alpha and the omega, but he had influences (Wicksell).

And yes, the term “excessive demand for cash” is indeed meaningless. Economics is a value free science, and the preferences of individuals are not to be judged, they are to be taken as given. There is either a higher demand for cash holdings, or a lower demand for cash holdings. And of course, inflation does not increase savings, nor can it permanently increase the capital stock. I don’t think this is controversial.

But the point is that MET and the free-banking position does not, in anyway, deviate from the works of Mises, Wicksell, Bohm-Bawerk, Menger, Hayek, et al. (1) goods are broken down into three distinct classes, namely producer goods, consumer goods, and media of exchange; (2) time preferences are expressed by the ratio of demand between consumer (present) goods and producer (future) goods (the demand for money does not influence time preferences); (3) the money/market rates of interest are determined by the banking system and monetary conditions; and (4) the structure of production reflects true time preferences only when the market rate of interest is at the natural rate.

From this, one can simply deduce the effects of both a suppressed and/or elevated market rate either above or below the natural rate. I haven’t read any modern-day free-banking literature, but the Austrian framework clearly does not oppose fiduciary media on all accounts. I’m not going to quote Mises or Hayek again, as I’ve done so about 10 times now.

I’d also like to add that Keynes was just a terrible and confused Austrian economist who lacked a capital theory (his Marshallian influences didn’t help either). Both Keynes and the Austrians used the Wicksellian framework, but only one party actually understood it.

Beefcake the Mighty May 18, 2010 at 5:59 pm

(1) is false.

Ivan May 19, 2010 at 1:38 am

I’m sorry but that doesn’t make any sense. Money is never consumed and it can be saved. Mises, in TMC, says that money clearly isn’t a present good, and then he goes onto explain why it’s not a future good (refuting Bohm-Bawerk). But I can see why the Rothbardian’s take issue with Mises’ typology.

Beefcake the Mighty May 19, 2010 at 1:45 pm

The point is, like any other present good, money does not require any
subsequent transformation to yield the services it is intended to provide.
And, under a commodity money system, the effect of increased monetary
demand is a shortening of the structure of production (due to the lowered
prices of factors of production used for extraction of the monetary
commodity), as it would be for a shift of preferences towards present-
orientedness.

This is laid out in the Huelsmann article I keep recommending, “The Demand
for Money and the Time-Structure of Production,” in the Hoppe Festschrift
(it can be downloaded from this site).

Beefcake the Mighty May 19, 2010 at 1:47 pm

To follow up, Huelsmann takes issue with Rothbard on this point.

Beefcake the Mighty May 18, 2010 at 6:55 pm

(2)-(4) also have aspects that are not quite correct, as some of the claims
depend on the nature of the underlying monetary system; again, see the
Huelsmann article.

Beefcake the Mighty May 18, 2010 at 4:07 pm

Money is a present good. The three-way categorization that Mises and sometimes
Rothbard appealed to is spurious. Again see Huelsmann’s essay in the Hoppe festschrift.

Current May 18, 2010 at 12:17 pm

As I said over at Coordination problem when reading Mises you have to take his definition of deflation and inflation seriously. In the present time we are used to considering “inflation” to be either price inflation or the creation of money. In Mises time it really wasn’t that clear, that’s why Mises gave his own definitions in “The Theory of Money and Credit” which are MET in nature.

Larry White and Steve Horwitz aren’t stretching things to say that when Mises refers to inflation and deflation later he is referring to his own definitions of them. It may feel natural to us now to when reading a quote of Mises to read “inflation” as meaning “price level rise” or “money creation”, but that’s just because we’ve read later books. What we should do though is to read whatever quote it is in the context of the definitions given in the book it’s from.

Adam Knott May 17, 2010 at 6:30 pm

As further background information for this debate, I would like to post the important passages from Lew Rockwell’s article of last year “Money and Our Future.” http://mises.org/daily/3318

In this article, Mr. Rockwell argues for what he terms “a fully laissez-faire system” concerning banking and currency. I would interpret this to mean complete freedom of banking, subject to standard contract law.

Mr. Rockwell credits Hayek, Hulsmann, and Ron Paul with this idea. The Daily Bell asked Mr. Rockwell about what they perceived as a shift in the Institute’s position on the subject of free banking:

Daily Bell: We have noted what we think is a softening of an institutional position regarding the gold standard – and the possibility that free-banking would be a considered option as well. Is this a correct observation of your organizations’ stance?

Rockwell: I wouldn’t say that we have an official position. There are many ways to move to free-market money and non-inflationary banking. I would never want to close off any viable path. One problem with the Misesian plan for a gold standard is that it relies on the idea that the people in charge will do the right thing. This is a charming, old-world idea, but I don’t think it holds true in our times. We need to be open to the possibility that reform will never come from the top. (end quote)

Mr. Rockwell didn’t directly address the anti-free banking aspect of the question. But I believe that in calling for “a fully laissez-faire system” in an article entitled “Money and Our Future,” Mr. Rockwell is calling for what many of us consider to be free banking.

Here are the important passages:

In an essay written at the end of his career, and recently brought back to life by the Mises Institute, F.A. Hayek discusses the only serious means of reform that is open to us. We must completely abolish the central bank. Money itself must be wholly untied from the state. It must be restored as a private good, privately produced for private markets. Government must have no role at all in monetary affairs. Money should be produced by private enterprise alone. Banks must exist only as free-enterprise institutions, with no privileges from the state. This plan has also been advanced by Ron Paul.

What strikes me is how this accords precisely with what Hülsmann writes. His book on the Ethics of Money Production ends with a call for an end to all intervention in monetary affairs. Coinage must be private. Banking must receive no privileges. There should be no legal-tender laws, no guarantees, no restrictions on currency use — a fully laissez-faire system.

What is further striking about the Hayek, Hülsmann, and Paul idea here is that they offer no plan for restoring a gold dollar. It’s not that they would disagree with the idea, but they have fully confronted the reality that the idea of converting the existing currency from fiat money to sound money is essentially a 19th-century ideal that presupposes an enlightened class of political managers. This condition is not met today.

But what is the means? It is the same as we propose in every other area of national life: get the government out. Let the people be free to manage their own affairs. Stop interfering with commercial acts between consenting adults. Stop using violence to interfere with economic affairs. Let the people pursue mutually beneficial exchange based on their own self-assessment of the advantages. Let property owners accept the risk and reward for their own decisions.

It is the same with monetary policy and banking policy too. Let failing banks die. Let profitable banks live. Let the people choose to use any form of money. Let the people choose any means of payment. Let entrepreneurs create any form of financial instrument. Law applies only the way it applies to all other human affairs: punishing force and fraud. Otherwise, the law should have nothing to do with it.

What would be the results? We cannot know for sure. But history can be a guide in our speculations. Throughout all time and in all places, precious metals have emerged as the foundation of the monetary system. I think we can have every expectation that the same would be true today. Evidence comes from how people turn to gold in difficult times as a store of value, a safehouse from the machinations of government. Gold, in my view, is destined to be the foundation of a new free-market monetary system.
“The idea of converting the existing currency from fiat money to sound money is essentially a 19th-century ideal that presupposes an enlightened class of political managers.”

To this extent, and with this expectation, all believers in liberty can consider themselves advocates of the gold standard. But we must also be careful with this phrase. It is identified with a particular set of policies associated with 19th-century practice. It was a policy choice among many that some favored and some opposed.

A free-market monetary system of the future will not be a policy option in this sense. It is not something we want the government to adopt as its own. In fact, we don’t want the government to adopt any particular policy but rather abandon the policy option altogether. There should be no policy at all in the sense that this word is routinely used today.

In this way, a path forward in money and banking is no different from the path forward in agriculture, labor, health care, education, or any other sector. The right policy is no policy. The job of the government is to stop interfering altogether.

Now, I’m aware that this is a big intellectual leap these days. But you only need to consider the myriad ways in which government fails at everything it attempts, whereas the market succeeds. There is nothing about the structure of the universe that confers upon money and banking any special status that requires the government to regulate it, to serve as a lender of last resort, the marker of money, the guarantor of stability, or anything else. A free market in money would work the same as a free market in everything else.

newson May 18, 2010 at 12:04 am

the frb contract in that case would be then be accurately described as aleatory. the i’m-feeling-lucky-account would no doubt enjoy overwhelming approval by market participants.

Beefcake the Mighty May 17, 2010 at 7:51 pm

Pete Boettke is worried that the unwashed masses will be exposed to this debate (and
presumably, not get any problems coordinated instead):

http://www.coordinationproblem.org/2010/05/ebeling-and-selgin-contra-salerno-on-mises-and-100-reserves.html#comments

Jay Lakner May 17, 2010 at 10:35 pm

Since the subject came up, I’m curious…
Does anyone else here share my view that “demand for money” is a nonsensical concept?

bill woolsey May 17, 2010 at 10:42 pm

-I think an increase in the demand for money, given the quantity of money, will generally cause the market interest rate to rise above the natural interest rate. In the simplest scenario, those choosing to increase money holdings sell bonds. Bond prices fall, and their yields rise. The market interest rate is higher. There has been no change in the supply of saving or the demand for investment. The natural interest rate is unchanged. The market interest rate has risen above the natural interest rate. This creates an incentive to increase the quantity of saving supplied–that is, spend less on consumer goods. It also creates an incentive to reduce the quantity of investment demanded. Less spending on capital goods. The lower demands for all of these various goods results in lower prices. However, the demands for goods with greater interest elasticity of demand fall more than those with lower interest elasticity of demand. Still, as prices fall, the real quantity of money rises. As the real quantity of money rises, people purchase more bonds. Bond prices rise and their yields fall. The market interest rate falls back to the natural interest rate. As this occurs saving falls and investment rises, the real demands for the more interest elastic goods rise back more and those less interest elastic rise less (reversing their previous change) and the economy is back to equilibrium with but the price level is lower.

Now, read that over, and when you are inclined to say the an increase in the demand for money causes lower prices and doesn’t cause a higher interest rate.. well, how exactly? What is the process by which a higher demand for money leads to lower prices?

It is possible, of course, that people would accumulate more money by spending less on consumer goods rather than selling bonds. Less spending on consumer goods is more saving. The natural interest rate is lower. There has been no change in the market interest rate. No one is lending more or borrowing less. The market interest rate is above the natural interest rate. Saving is greater than investment.

It is possible that firms will refrain from purchasing capital goods out of cash flow and accumulate money. Investment demand has fallen. The natural interest rate is less. There has been no change in borrowing or lending. The market interest rate is unchanged. And so, again, the market interest rate is greater than the natural interest rate.

In these scenarios, as in the first, lower demands for goods (consumer goods or capital goods) results in lower prices and an increase in the real quantity of money. If the increase in real balances is spent on bonds, the market interest rate falls to match the new natural interest rate. It is conceivable, that added real balances will be spend on consumer goods or capital goods, implying a change in saving or investment (or both) so that the natural rate rises again to an unchanged market rate.

P.S. Nothing in my blog post regarding Salerno depends on the distinction between money and money substitutes. Under current conditions, transactions deposits are by far the most important part of the medium of exchange. Hand-to-hand currency is less important. And gold has nothing to do with it.

P.P.S. The demand for money is infinite? Why can’t Salerno do something useful and write a short post explaining how the great Mises introduced the supply and demand approach to monetary economics. I learned it from reading Rothbard.

Jay Lakner May 17, 2010 at 10:52 pm

Money is a medium of exchange. Therefore it is a means to achieve a desired end.
Every human has an infinite number of desired ends he wishes to achieve, and virtually all of them require the means of money. Therefore the demand for money is infinite. (ie it is nonsensical to discuss “demand for money”)
The only time “demand for money” makes even the slightest shred of sense is when the money is an end in itself. But in that case it fails to fit the definition of “money”.
If I am so completely flat out wrong, then surely someone can produce a simple airtight argument demonstrating why.

Mike Sproul May 17, 2010 at 11:30 pm

Jay Lakner:

“Does anyone else here share my view that “demand for money” is a nonsensical concept?”

Amen. Economists might notice that the demand curves drawn in microeconomics texts are for actual commodities–things that are produced subject to a production function, and which enter the utility function. Money can consist of computer blips that can be costlessly created and destroyed in an instant.

bill woolsey May 17, 2010 at 11:46 pm

The demand for money is the amount of money people want to hold now–that means, not spend it now. Presumably, they intend to spend it later. To hold money now means that other assets–like stocks or bonds–cannot be held. Or current consumption is being sacrificed. To get the money to hold, people must earn it. or else they most sell some other assets, like stocks or bonds.

The demand for money isn’t how much money people would accept as a gift. Suppose someone were to start handing you twenties. Here, I am giving you another. How about another $20? Want another? When do you say, stop. I don’t want you to give me any more money. Well, economists don’t have a term for the biggest gift of money a person would accept.

I teach economics. I cover this every semester. The demand for money isn’t how much money people want to borrow. That is the demand for credit or loanable funds. The demand for money isn’t how much money people want earn. That is the supply of labor or other productive resources. And it sure as hell isn’t how much money people would take as a gift.

It is how much money people want to hold. And that means not spend it. The demand for money is very limited because people want to spend it. But not spending the money now provides benefits–generally the ability to take care of unexpected emergencies or take advantage of unexpected opportunities.

DD5 May 18, 2010 at 2:22 am

“It is how much money people want to hold. And that means not spend it.”

Yes,

“To hold money now means that other assets–like stocks or bonds–cannot be held.”

Also correct.
Yet according to you, somehow holding bank liabilities in the form of IOUs is all of a sudden perfectly compatible with holding money.

bill woolsey May 18, 2010 at 5:42 am

Bank liabilities that serve as medium of exchange are money.

From the point of view of those holding them, they are assets.

From the point of view of the bank, they are liabilities.

Jay Lakner May 18, 2010 at 12:57 am

What you are describing is the demand for excess cash holdings. This is not the same as the demand for money. Cash holdings are a form of insurance. You could theoretically form a very detailed and complex contract with an insurance company which achieves the same result.
Money is a means to achieve an end. “Excess cash holdings” is an end in itself and no longer fits the definition of “money”.
The demand for “excess cash holdings” may be a finite amount, but the demand for “money” must at all times remain infinite.
Maybe people think I’m being pedantic, but I really get annoyed by the phrase “demand for money”. It is an attack on the very definition of the word “money”.

Furthermore, in a free society there is never any reason to create more money. If, due to some unforseen circumstance, people start accumulating more cash holdings, all prices must drop in order for the market to clear. The drop in prices increases the real value of cash holdings until the desired demand for cash holdings is met. This scenario does not reflect a “demand for money”. That is utter nonsense. The demand for money always remains infinite. There is no need for more money to be produced. The scenario reflects a need for the existing money to be redistributed and stored as excess cash holdings. The demand is for cash holdings, not for money.

bill woolsey May 18, 2010 at 5:47 am

Apparently, what you call “the demand for excess cash holdings” is what the rest of us call “the demand for money.” Why exactly should we adopt your definitions?

In a free society there is never a need for an increase in the quantity of money?

Jeez.

I am perfectly aware of the market process by which the real quantity of money adjusts to the demand to hold money. I described at least one plausible account by which the market interest rate rose above the natural interest rate, there was a decrease in the demands for various goods, and so, lower prices, and increase in the real quantity of money, and a return to equilibrium.

Ivan May 18, 2010 at 2:25 am

@Jay LaknerMoney is not wealth. A trillionaire on a desert island is not wealthy. People demand money for many reasons, but it’s mainly demanded for exchange (it’s also demanded for security). There are many people today who are extremely wealthy, that is, they own plenty of assets, and yet they don’t have much cash. The worst of all economic fallacies is the notion that wealth = money, and that the demand for money is infinite. If that were true, then hyper-inflation’s (when the demand for money collapses) could never occur.

Buy a basic economics/monetary theory textbook.

DixieFlatline May 18, 2010 at 2:32 am

Well explained Ivan.

except the condescending bit about telling him to buy a basic textbook.

Jay Lakner May 18, 2010 at 7:13 am

Ivan,

a) I never said money = wealth. I said money is a means of achieving wealth.
b) Money is a medium of exchange. If there is nobody present on the desert island with the trillionaire that will accept his dollars for goods and services, then his trillions of dollars do not fit the definition of money. ie, a trillionaire on a desert island does not have any money.
c) Hyper-inflation is NOT a collapse in the demand for money. Hyper-inflation is a rapid rise in the supply of monetary units which has the effect of decreasing the real value of each unit. If a currency goes bust and is no longer demanded, the demand for that particular currency has dropped to zero. But that does not mean that the “demand for money” has dropped to zero. It only means that a particular currency no longer fits the definition of “money”.

Buy a basic “logical thinking” textbook.

Peter Surda May 18, 2010 at 7:28 am

Lol same thinking :-)

Peter Surda May 18, 2010 at 7:26 am

Money is not wealth. A trillionaire on a desert island is not wealthy.

That is the only correct part of your statement. Nominal value of the money is not wealth, rather the exchange value of money is.

You are confusing the demand for the exchange value of money with the demand for the nominal value of money. Unless the increase of supply of the latter goes to you in excess of the inflation rate, this will actually cause a decrease in the exchange value you have.

As the supply of money units extends to infinity, the exchange value per unit moves towards zero.

Rather than Jay buing an econ book, it is you Ivan who should buy a math book and look at how division works. Check out what the graph of f(x) = 1/x looks like.

frank May 18, 2010 at 7:10 am

“If I am so completely flat out wrong, then surely someone can produce a simple airtight argument demonstrating why.”

We should also consider the possibility that the problem is ill-defined or incompletely defined as stated in which case a simple rebuttal will not be possible.

Forget money. What is my “demand” for oranges? I might want more oranges than I have – but I think “desire” a better word for this. “demand” I would say should be measurable – that is, you should be able to look at someone’s actions and determine what their “demand” for oranges is (ie. it is a function of real-world measurable properties). So, if I have money to spend but spend it on apples while there are oranges right next to them, we can say my “demand” for oranges is 0 (even though i’d like more of them if I could click my fingers and have them, I can’t do this – I can only obtain them using the limited scarce resources at my disposal and choose not to).

What do you say to this Jay?

Jay Lakner May 18, 2010 at 7:48 am

By this logic, it makes no sense to talk about an “unsatisfied demand”. The market always clears, so everything that is supplied is also demanded. Those oranges will be bought by someone and you would use that to measure their demand. Demand, the way you put it, must always be equal to supply. What exactly is the purpose of the concept of demand in this case?
(I should note here that perishable items might not clear in time – so your use of “demand” in this sense might be applicable to them. But it certainly cannot apply to non-perishable things, like money).
If the world runs out of oranges completely, I would say there is now an unmet demand for oranges. It seems you would say “no there isn’t” and explain to me that there is no supply of oranges and therefore there cannot be any demand for oranges. (There is now nothing to measure.)

I’m sorry Frank. It still makes no sense to me. Try again :)

bill woolsey May 18, 2010 at 9:04 am

Lanker,

Coming up with your own lingo for economics doesn’t really help anything.

By your definition, the demand for oranges is the amount of oranges that people would accept as gifts. That is the amount where the marginal utility of oranges is zero. It is how many they would take at a price of zero.

That is how you are defining the demand for money. It is the amount of money people would accept as a gift. You claim it must be infinite. I have no desire to dispute that claim at this point.

But economists use the term “demand for money” to mean something other than how much money people would accept as a gift. We don’t use the “demand for oranges” to mean how many oranges people would accept as a gift.

Now, the demand for money is a demand for a stock, and the demand for oranges is a demand for a flow, but ignoring that for a minute, just like the quantity demanded for oranges is the amount of oranges people want to buy at a particular price, the quantity of money demanded would be the amount of money people want to hold given that they must pay for it. To get money, you must earn income and save or else sell some asset you own. To hold it now you have the opportunity cost of not spending on consumer goods or some kind of real or financial asset. The demand for money is about how much money people want to hold given those constraints. It isn’t how much money people would take because they could spend it on different things and so it amounts to the total amount of all good and services they would possibly have any use for. That isn’t what demand for money means.

Now, the amount of oranges people would take as a gift, the amount they would have any use for, what they would “buy” if the price is zero, that is, if oranges are just given away, is a little easier to deal with. But that is only the quantity demanded of oranges at a price of zero. The demand for oranges doesn’t mean the quantity demanded at a price of zero. It doesn’t mean the satiation point for oranges.

Personally, I think demand is a relationship. That is the standard view. It is all of the price and desired purchase combinations. Similarly, the quantity of money demanded is how much money people want to hold given the prices of goods, resources, and yields on financial assets. And the demand for money is the relationship between how much money people want to hold and different purchasing powers of money.

To complicate things, it is usual to speak of the real demand for money, and that is how much purchasing people want to hold given the fact that to hold it there is an opportunity cost of consumer goods forgone, or financial or real assets that can be held. But people have to get the money to. They pay for it. But since we are interested in how much they hold, it is the opportunity costs that are more relevant.

In truth, I am less careful about this distinction between demand and quantity demanded when discussing the demand for money than with the demand for oranges. But regardless, neither the demand for money nor the demand for oranges means how much people have any use for. How much would have to exist so that it isn’t scarce.

You are just imagining that the words “demand for money” must mean “how much money I wish I had if someone would just give it to me.” It is obvious that such a use is inconsistent with “demand for oranges” or “demand for Ford stock” or “demand for IMB 2008 8% AA bonds.” None of that means how much people would take if it was just a gift.

Logic just tells me that the word must mean something? Sorry, but logic doesn’t tell you what words must mean.

We really don’t have a short word defining the amount of some good people would use if it were free. The concept is well understood for consumer goods. But we don’t have a special word for it. It is the point where the good is no longer are scarce. It is the quantity necessary for them to be free.

And the idea of how much money people would take if it was given away has no special word. And it really isn’t all that well defined. It is inconsistent with the idea of scarcity. I don’t think it is exactly impossible, but not worth worrying about.

Jay Lakner May 18, 2010 at 2:11 pm

Products that are consistently high on peoples’ value scales are high in demand.
Products that are consistently low on peoples’ value scales are low in demand.

I agree that demand is a relationship. The total demand for any one product depends on its availability and its average place on the scale of values of individuals relative to all other products. Prices can reflect this demand. And a supply is needed in order to be able to even make judgements about this demand.

Money is not an end product but instead is a means of exchange. “Money” itself is not on an individual’s scale of values. Money is a means to satisfy the ends on value scales. That is all. Therefore, the “demand for money” is a completely nonsensical concept.

I am not the one using inconsistent definitions. First I define money, then I define demand, then I conclude that demand for money is nonsensical. You define money and demand but then your definition of “demand for money” is inconsistent with these definitions. I have tried to point out that you and many others are confusing “demand for money” with “demand for cash holdings”.
It is irrelevant what the standard conventional definition for “demand for money” is. This meaning is inconsistent with the very definition of “money”. I’m also guessing that it’s this misguided lack of understanding of the difference between “demand for money” and “demand for cash holdings” that has lead people to make completely illogical proposals, such as increasing the supply of money.

frank May 18, 2010 at 10:27 am

“Demand, the way you put it, must always be equal to supply.”

Why? I can go to the market with the products of my labour and intend to buy oranges and not apples. If the oranges aren’t there, I tell the grocer I wanted oranges and not apples – this puts my “demand” into concrete information in the real world. More realistically, I go to the next door that does have oranges and this store therefore makes more money than the other one, again registering my “demand” in the real world. Or maybe the first guy has oranges but they are too expensive – my “demand” at this price is not there, I find somewhere cheaper. Again, “demand” at one price but not another is established in the market.

How does me wanting 5000 oranges for 1 dollar register itself in the market place? How is this information encoded so as to enter the price system?

Jay Lakner May 18, 2010 at 2:33 pm

Frank,

I have no issues with what you have just said. The statement I took issue with was:

> if I have money to spend but spend it on apples while there are oranges right next to them, we can say my “demand” for oranges is 0

To say your demand for oranges is 0 is simply not correct. Oranges are simply lower down on your value scales than apples. You still have a demand for oranges but simply did not have the resources available to you to purchase them. The price of the oranges are a reflection of the net effect of every person in society acting. If the supply of oranges were to increase, then you would be able to purchase them. Hence you are saying that a supply must exist for a demand to exist.

A supply of oranges must exist for us to have more accurate information about the demand for oranges. But if that supply is taken away, the demand for oranges still exists but we have less information of what this demand is.

frank May 18, 2010 at 4:15 pm

“To say your demand for oranges is 0 is simply not correct.”

I’m trying to define desire and demand so they are useful and logically consistent – according to how I defined it, this is correct (by definition). But of course you need not agree on my definition.

But you are ignoring the distinction between the two and as such the word “demand” as you use it is useless, it doesn;t allow us to express anything interesting. Your definition has “demand” for oranges whether you buy them, there are none, they are too expensive or you have them coming out of your ears or whatever, there is just always this demand. This contains no information – it is always constant and high. This just isn;t a very useful definition.

So I would adjust your comment above, for example, to ‘You still have a DESIRE for oranges but simply did not have the resources available to you to purchase them. So, there is no DEMAND at the current price’.

you have no desire for grapes laced with cyanide. no matter what the price, you won’t buy them. You do have desire for normal grapes though. But so long as they are below apples and oranges on the value scale, this “desire” will remain out of reach of the market place until such time as, say, a grocer gambles that people have a desire but no demand for grapes and so invests to produce more at a lower price and therefore your desire turns into a demand.

You are basically saying that “there are other market conditions in which i would buy oranges so, even though i’m not buying them now, i have a DEMAND for them”. But there are always other market conditions in which most goods would be purchased – Rolls Royce manufacturers do not factor me into their sales projections, even though if they were 1 dollar I would put them above apples on my value scale and buy one. Are you saying then that i have a demand for a Rolls Royce?

If you don’t agree with my distinction, try another one. Or explain why there is no distinction between desire and demand.

Ivan May 18, 2010 at 3:42 pm

@Jay Lakner,

A person with an infinite demand for money would die of starvation; he/she would sell all his/her assets in order to hoard cash. When the demand for money is high, the demand for goods and services are low, and vice versa. Money is not a means of achieving wealth; wealth is the end result of production. Thus, the means of achieving wealth are land, labor, capital, capital combination’s, technological discovery, ect. You (a) produce, (b) exchange your productions for money, and then (c) exchange your money for the productions of others. Again, money is merely a medium of exchange, and no one has an infinite demand for exchange.

Why is this so hard for you to understand? Can we move on now? Oh, and just to be clear, hyper-inflation’s are indeed caused by a collapsed money demand. See Mises’ “Theory of Money and Credit.”

bill woolsey May 17, 2010 at 11:35 pm

The notion that an increase in the quantity of money that matches an increase in the demand to hold money causes malinvestment is confused. I think the source of the confusion is a false comparison. The expansion of bank loans will impact the demands for particular things. There are injection effects. But, compared to what?

The proper comparison is with other market changes. For example, suppose a household spends less on restaurant meals and uses income to purchase newly issued corporate bonds. The household saves. The issuer of the bond uses the money received to purchase a drill press machine. The firm invests. Now, if we just focus on the new spending on the drill press machine, the firms selling the machines earn more profit. Maybe they hire more workers. The added profit or wages result in more consumption here or there. And, of course, the restaurant owner earns less. Maybe he lays off workers. They spend less on consumer goods.

Now, suppose instead that the household spends less on consumer goods but rather than buy corporate bonds simply holds more money. The demand for money rises. Now, suppose the bank supplies more money. The bank lends money to a corporation that purchases drill press machines. The manufacturers make more profit. Maybe they hire more people. They consume more of particular things. The “new” money impact the economy in ever widening circles. But this is exactly what would have happened if the household had purchased a corporate bond. And, of course, the impact on the restaurant owner, and workers, and the firms they patronize are the same.

Is the money injected by the banks “neutral?” No. But neither is any other method of saving and investment.

As is so often in these discussions, I have described a scenario where the increase in the demand for money was an increase in saving. A household spends less on restaurant meals and purchases corporate bonds or holds more money. The firm issuing the bonds or else obtaining the bank loans spend more money on capital goods. There is less demand for consumer goods and more demand for capital goods.

But suppose instead that a household (or firm) demands more money and sells bonds to obtain the money. (Or reduces purchases of bonds out of current income and doesn’t spend ion anything else–accumulates more money.) Of course this will have some effect on the pattern of expenditure, but it is like any other change in how savings are allocated among different assets.

Suppose a household purchases fewer bonds issued by construction firms and more railroad bonds. Construction firms will have more difficulty obtaining finance. They spend less. Those they would have bought from earn less, and they spend less. Meanwhile, the railroads have more funding. They can spend more. Those they purchase from spend more.. in ever widening circles…

Now, suppose the household purchases fewer bonds issued by construction firms and instead hold more money. The banks increase the quantity of money by making loans to the railroads. The construction firms have less funding. Those they would have purchased from sell less. They spend less, and so on. The railroads can obtain more funding. Those they purchase from sell more. They spend more. Etc.

In this situation, there has been no change in saving. The demand for present and future goods are the same. There is instead a change in the financing of future goods. Of course there is an effect. Just like a change in what kind of bonds people choose to hold will have an effect. If they switch from bonds to money, and the banks lend to someone other than whomever would have sold the bonds, of course different projects will be funded.

The notion that somehow the newly created money should get into the hands of the restaurant owner, his workers, or those they purchase from is odd. The notion that the banks must lend to the construction firms who can no longer sell bonds is odd. Why?

And to treat the flow of new spending on the drill press machines or by the railroads as disruptive malinvestments because the money is “new” fails to appreciate how other forms of saving or shifts in financing have exactly the same kind of impacts.

Now, if the quantity of money rises and the demand for money hasn’t increased, then there is a difference. There is no decrease in demand for other things to offset the expanded expenditure from the new money. An excess supply of money is the source of the problem.

DD5 May 18, 2010 at 2:06 am

“An excess supply of money is the source of the problem.”

So now ABCT is reduced to simply monetary policy not following the correct rule.

A complete misunderstanding of capital theory and ABCT on your part. Or excuse me, perhaps not a misunderstanding but a rejection of it.

bill woolsey May 18, 2010 at 5:49 am

I didn’t say anything about monetary policy.

I said that malinvestment can only be a problem when there is an excess supply of money. This says nothing about monetary institutions and whether or not they will generate an excess supply of money.

bill woolsey May 18, 2010 at 5:51 am

I find capital theory quite difficult.

What part do I misunderstand?

cret May 18, 2010 at 3:10 am

Now, if the quantity of money rises and the demand for money hasn’t increased, then there is a difference.

does this ever happen??

bill woolsey May 18, 2010 at 5:49 am

Does an excess supply of money ever happen?

I think the answer is yes. Quite often.

Current May 18, 2010 at 9:19 am

Yes. Central banks often cause it by issuing more money than is demanded. When it happens people spend their excess causing prices to rise. The price rise begins slowly and perculates through the economy.

Graeme Bird May 20, 2010 at 11:27 pm

“Yes. Central banks often cause it by issuing more money than is demanded.”

Dude how can you say that? For starters, in the modern era money supply growth is private-bank led. Secondly …… Its a fact of economics that supply and demand equate. So what is this jive about central banks releasing more money than what is demanded? For starters central banks release cash. Private Banks pyramid on this cash, and the result is what we call MONEY, or if you like “The money supply.”

So central banks don’t release money. Private banks create money, central banks release monetary base, and otherwise engage in various subsidies to the private banks, at the expense of the general public. .

There is no such thing as releasing more supply, than what is demanded, in a market built-to-clear.

What you must be saying is that you have some fetish for an invariant price level. Thats what I’m getting anyhow.

DixieFlatline May 18, 2010 at 2:23 am

Prof. Salerno, thanks for the very insightful blog post.

I also liked Larry White’s response on the Division of Labor blog.

Crank Watch May 18, 2010 at 6:08 am

“Good luck getting Steve or any other GMUer to address Huelsmann’s work, be it monetary theory, the calculation debate, etc.Read more: Selgin Contra Horwitz and White on Mises’s View of Fiduciary Media — Mises Economics Blog http://blog.mises.org/12724/selgin-contra-horwitz-and-white-on-misess-view-of-fiduciary-media/comment-page-1/#comment-688842#ixzz0oHHsAHHm“OH MAN! HUELSMANN! Hahahaha! Seriously, Huelsmann has a negative citation count.

But hey, at least the Huelsmann recommendation explains a few things, like the idea of infinite demand for money (even Rothbard knew better than that!)

Beefcake the Mighty May 18, 2010 at 8:11 am

Hey ass-hat, where did I (or Huelsmann) say there was an infinite demand for money?

newson May 20, 2010 at 9:27 pm
Beefcake the Mighty May 20, 2010 at 10:03 pm

newson,

Yes, in fact it is sitting in a pile in my office but I admit I have simply not made time
to read it yet. What is your opinion?

Graeme Bird May 20, 2010 at 11:21 pm

You don’t have an office champ. You are too stupid to be employed.

newson May 21, 2010 at 8:09 pm

worthwhile.

George Selgin May 18, 2010 at 9:40 am

Because I’ve been traveling abroad, I haven’t had time until now to read or reply to Joe’s post concerning my interpretation of Mises. In fact, Steve’s comment is entirely accurate. To be clear: in my _Theory of Free Banking_ I referred critically to a passage in Mises’ work. In _that_ passage Mises seemed to favor 100% reserves. I did not claim then and do not believe now that Mises was consistent on the matter. Larry White’s article showing how in many places Mises argues the advantages of fractional reserves should have put to rest any attempt to portray him as a consistent 100-percent reserve proponent.

Clean and Jerk May 18, 2010 at 11:42 am

It’s worthwhile pointing out that Huelsmann hasn’t responded either yet. Like Selgin he has legitimate reasons. Every time he tries to post a comment he gets an R&R. Things are certainly looking up for him! At least this time it got sent to the referees.

Beefcake the Mighty May 18, 2010 at 12:09 pm

You’re that wad “Fourier” from back in November, right?

Clean and Jerk May 18, 2010 at 1:04 pm

Fourier died quite a while ago! Silly Austrians don’t know their math(ematicians). My name is Esther Duflo.

Nikolaj May 18, 2010 at 5:19 pm

This comment of Larry White’s response is posted here, because it is impossible to comment on Division of Labour:

White: “Mises’ plan for a 100-percent reserve requirement on new currency and checking deposits appears in his 1952 epilogue on “Monetary Reconstruction” added to The Theory of Money and Credit. My reading of that piece is that it is Mises’ second-best proposal for restricting credit expansion under central banking, assuming that we are stuck with central banking and that free banking reforms are out of the question.”

This is incorrect interpretation. In the text in question Mises says explicitly that the creation of fiduciary media, quite irrespective of the type of the monetary system in which it occurrs leads to the qualitatively same consequences vis a vis the credit cycle. He adds:

“Fiduciary media are scarcely different in nature from money; a supply of them affects the market in the same way as a supply of money proper; variations in their quantity influence the objective exchange value of money in just the same way as do variations in the quantity of money proper. Hence, they should logically be subjected to the same principles that have been established with regard to money proper; the same attempts should be made in their case as well to eliminate as far as possible human influence on the exchange ratio between money and other economic goods.”.

And concludes: The possibility of causing temporary fluctuations in the exchange ratios between goods of higher and of lower orders by the issue of fiduciary media, and the pernicious consequences connected with a divergence between the natural and money rates of interest, are circumstances leading to the same conclusion. Now it is obvious that the only way of eliminating human influence on the credit system is to suppress all further issue of fiduciary media. The basic conception of Peel’s Act ought to be restated and more completely implemented than it was in the England of his time by including the issue of credit in the form of bank balances within the legislative prohibition.”

So, he is talking about the elimination of fiduciary media as the only way to eliminate ANY HUMAN influence on the credit system, not only the influence of the central banking. Further, the notion that Mises required the 100% reserve system only for central banking is illogical because he explicitly rejected that diea – the Chicago school approach of 100% reserve in central banking, accusing Simons and Fisher for devising the scheme how easier to control the money supply by the government. How on the earth Mises in the same time should be interpreted as supporting the same scheme he explicitly denounced as “untenable”?

Further, the quotation from pp 447-8 does not support Whites’ contention bellow it whatsoever. Mises is talking about the illegitimacy of government meddling into banking business, and that the only legitimate government intervention would be to abolish the previous interventions. White portrays that as supporting free banking over 100% reserve system!
The misinterpretation of the quotation from the page 443 is even more blatant: Mises is saying there, among other things :

“What is needed to prevent any further credit expansion is to place the banking business under the general rules of commercial and civil laws compelling every individual and firm to fulfill all obligations in full compliance with the terms of the contract”.

Notice the phrase “to prevent any further credit expansion”. Whatever reason Mises really had to support free banking he obviously thought that free banking will prevent ANY further credit expansion, i.e. fiduciary media emission. On the other hand, White interprets this passage as a support for the fractional reserve banking!

White subscribes to the notion “that the creation of fiduciary media by banks is not only benign, but a necessary prerequisite to prevent the market economy from plunging into depression in circumstances where households and businesses increase their demand to hold fiduciary media, effectively reducing total spending in the economy”. Hmm, that does not seem really “Misesian”, since Mises thought that ANY amount of fiduciary media created the business cycle and had the same detrimental consequences. Probably aware of this , White then tries to create the ground for the agreement with Mises:
“Salerno correctly notes that “Mises supported a free banking regime precisely because it would eventually result in ‘extreme restraint in the issue of fiduciary media.’” So do I.” Now, all of the sudden, White rejects the idea of the indispensable function of fiduciary media, and agrees with Mises that the real merit of free banking will be in minimizing the amount of fiduciary credit!
But, in the very next sentence, White forgets this agreement, and return to his old position in favour of fiduciary media, criticizing Mises for “ahistorical suggestions (where he cites the French economist Cernuschi, Human Action p. 447) that under free banking the acceptance of fiduciary media would be narrow and reserve ratios would be high.”

Now, how one can agree (if one is not a postmodernist, that is ) with the proposition that free banking would result in the “extreme restraint in the issuance of the fiduciary media” and in the same time to reject the proposition that “the acceptance of fiduciary media would be narrow and reserve ratios would be high”?

That is the same question Steve Horwitz never answered to me: do you support free banking because it would effectively minimize or even eliminate fiduciary media (as Mises did), or because free banking would provide a better intertemproal management of fiduciary media? Is fiduciary media a necessary evil that always creates the malinvestment and causes recessions, or an indispensable tool of preventing recessions? It cannot be both.

Graeme Bird May 20, 2010 at 10:26 pm

Current? You asked a question in an unclear fashion. And then you lament that you are unsure on the “inflation-deflation question.”Finding answers is ofen quite a simple matter. If you don’t know the answer to something, go ahead and ask the appropriate question.

But the idea, is that you have to formulate-the-question, as clearly as you can.

As a counter-example to this recommendation, lets look at a question you asked:

“There is the inflation/deflation question – should inflation and deflation account for demand for money?”

What on earth do you mean by this question? Formulate the question with more clarity, and I can almost guarantee, that your answer, will be quickly forthcoming.

Beefcake the Mighty May 20, 2010 at 10:42 pm

I think you really need to smoke a big, fat J.

Graeme Bird May 20, 2010 at 11:18 pm

You are just not real real bright are you fella? You are in fact a dim bulb. You are going to have to wake up to yourself. No use stooging yourself. Running on a source of wealth that is illusory.

Plus I don’t have a big fat J around, and the girl would take a dim view of such proceedings.

Beefcake the Mighty May 21, 2010 at 6:11 am

What girl? You strike me as the type who likes boys.

Graeme Bird May 20, 2010 at 10:41 pm

“Current May 16, 2010 at 7:05 pm
Have a read of what the free bankers have written in their books. You’ll find that your criticisms are unfounded.”

Hiding. Actually I don’t think he will find this. Free banking advocates are often impressive, so long as they are not spruiking their fractional reserve religious beliefs. You ought try and make your argument in your own words. You ought not be setting homework for people.

Graeme Bird May 20, 2010 at 10:46 pm

“Those who support a legal 100% reserve law require the market to go through the artificial contortion of deflation when money demand increases followed by inflation when in falls. This is costly, and a cost that need not be borne.”

Thats the total opposite of the truth. Do you not know how banks operate? Do you have no idea about the circumstances upon which the demand for money for holding reasserts itself? About how the banking system reacts to an increase in the demand for cash balances?

This statement is just bizarre. If someone as smart, impressive, and likable as Selgin, sold you on this daft idea, then it almost proves that fractional reserve advocacy is a substitute religion.

Graeme Bird May 20, 2010 at 11:07 pm

“let’s start with theory. In my humble opinion, fraud is defined as entering into a contract without the intention of fulfilling it…..”

No good Peter. Because its not just two parties we are talking about here. Its the community entire. The money is passed from hand to hand. Its not like a second-hand car-salesman that sells you a lemon. Money is a hot potato. Soon as you debase it, and pass it hand to hand, you’ve undermined the entire community.

Further to that bank-cash-pyramiding debauches price information immediately. Its not simply about whether the banker will get away with it or not. Soon as the pyramiding begins, in secret or otherwise, the distorted price signals flow through the market. No amount of transparency can overcome the debauch to price information. Because “price information” isn’t just information. Prices send with them real resources. The price information comes with revenues, real resources and enhanced abilities to get things done. Since bank-cash-pyramiding changes price information it also alters the flow of real resources and thus undermines economic freedom at its root.

Peter Surda May 25, 2010 at 3:13 am

Dear Graeme,

you miss the point of the argument. The argument is not that fractional reserve banking doesn’t have negative effects (I am quite convinced it does), but that these negative effects are neither a violation of property rights nor a violation of contracts, and are therefore legitimate. You cannot defraud someone who is not a party to a contract, and you do not have a right to a value or effect of your property. Merely because you do not like the outcome of an action does not mean that the action is illegitimate.

Stephen Grossman June 19, 2010 at 1:05 pm

>Since bank-cash-pyramiding changes price information it also alters the flow of real resources and thus undermines economic freedom at its root.

Good essentializing.

Graeme Bird May 20, 2010 at 11:11 pm

“FRB could be fraud if creditors were told that they could at any time retract their money from the bank and that at any time the bank holds as much VALUES as the deposits are worth.

“VALUES?

You mean alternate assets right? Such a scheme cannot work. Since the value of the alternate assets will crash when the ponzi-money collapses. But this is besides the point. Do not forget the attack on the price system, throughout the structure of production, that bank-cash-pyramiding, represents.

Plus a free market is where everyone is equal before the law. If you are mandating the holding of alternative unspecified assets to cover the difference, then already what we have is a set of cartelisation-regulations in the making.

This is precisely how things work now. The banking regulations, in effect ask HOW RICH ARE YOU? If you are already a bigshot bank you are apportioned more of the loot, within the outstanding den-of-thieves.Only the reserve requirement represents a true level playing field. Only the 100% reserve requirement clarifies all property rights, and eliminates conflict of interest in this situation.

Luís Marques June 14, 2010 at 9:40 am

People are used to the presence of government, as its supposed purpose is generally obvious due to large amounts of pro-government propaganda. It is only after careful consideration that the disadvantages and immoralities of government become obvious.

If we accept this, then it makes sense that an economist like Mises would more readily see the benefits of the lack of government intervention in his study area than in areas he was less familiar with.

Stephen Grossman June 18, 2010 at 1:42 pm

>People are used to the presence of government, as its supposed purpose is generally obvious due to large amounts of pro-government propaganda. It is only after careful consideration that the disadvantages and immoralities of government become obvious.

Its obvious that you are wrong. I am an anti-evidence libertarian. I’m free from the shackles of evidence. I’m obviously right, with no evidence to chain me to the oppression of logic. I wonder what’s obvious to Afghanistanis, Somalis and Gazans. Or to mental patients.

scineram June 18, 2010 at 1:56 pm

We already saw that from your previous posts.

Current June 18, 2010 at 2:08 pm

Well, that explains a lot.

Matt C. June 14, 2010 at 4:49 pm

There are two positions that you can have on this subject. Either you’re for protecting property rights, or you’re not. The free market presupposes that property rights are protected and that contracts are honored. To bury this in academic jargon is a sign that we don’t take the issue very seriously.

http://mises.org/books/desoto.pdf

Peter Surda June 15, 2010 at 7:26 am

I respectfully disagree (at least with respect to the “is it fraud” aspect of the problem). It is not whether one supports property rights and contract enforcement, but what is the definition of property and contracts. Both sides, from their point of view, support property rights and contract enforcement, but differ in the interpretation thereof. I maintain that my opponents have not shown a consistent definition of contracts and private property that allows them to conclude that FRB is fraud. I maintain that a third party’s opinion about a contract has no effect on the validity thereof, and absent a contract there is no right to abstract concepts like the market price or the meaning of said property.

Hopefully we can all agree at least that legal tender laws have no place in a free market system and should be abolished.

george t morgan June 19, 2010 at 3:53 am

would it even be called legal tender in a free market???

if there benefit when a govt decrees legal tender to be a money that was a free market money rather than complete govt management???

Peter Surda June 19, 2010 at 4:14 am

I find it doubtful. The term “legal tender” is of no use if it is not defined by the government.

george t morgan June 19, 2010 at 2:18 am

“……….on this subject”….

is that what occurs with the banking system now??? or is the current banking operation and system not part of this subject???

Stephen Grossman June 18, 2010 at 9:13 am

>Peter Surda:fraud is defined as entering into a contract without the intention of fulfilling it.

Whether one intends fraud upon entering or later is irrelevant to the fraud itself. One may intend to pay a debt but later refuse. And intentions w/o actions are legally and morally irrelevant.

scineram June 18, 2010 at 1:57 pm

No, that’s not fraud. The end.

Stephen Grossman June 18, 2010 at 2:58 pm

Claims w/o evidence are intellectually dishonest. Man’s mind needs respect, not indifference.

scineram June 19, 2010 at 7:03 am

We have centuries of case law. What do you have?

Stephen Grossman June 19, 2010 at 9:49 am

This is the (alleged) evidence that you should have initially provided instead of your arbitrary claim. Further, law is based on views of human nature, morality, etc. Thus fraud must be applied, in the law, as examples of those wider views. Law is not wrapped up in itself. Knowledge is hierarchical. Law itself must be judged.

george t morgan June 19, 2010 at 2:13 am

are they?? if i plan to fulfill a contract but die and have no money to pay it….

if i say i will pay somethnig accordign to contract but never intend to..isnt there a difference??

george t morgan June 19, 2010 at 2:14 am

doesnt fraud require intent???

Stephen Grossman June 19, 2010 at 2:05 pm

Caution. Intent can only be legally recognized in action. Law, rational law, bans
certain actions ,not states of consciousness. Jimmy Carter cannot be divorced for
lust in his heart (tho his wife may be sensitive to his emotions and put him in the
doghouse).

james e fraser June 22, 2010 at 3:34 am

Caution. Intent can only be recognized in action.

you brought up the word fraud. dont need caution. if i signed a contract and die and cant fulfill it – contract unfulfilled.

is i sign a contract and intend never to fulfull it and dont , contract unfulfilled.

which is fraud and which is not??

if i see you fall off a skate board you could have lost your balance of fell intentioanlly.

Peter Surda June 19, 2010 at 5:26 am

If you intend to pay the debt but later refuse, that is not fraud but merely a non-fulfilment of a contract. Fraud requires intent. Erring is not intent.

Stephen Grossman June 19, 2010 at 10:03 am

>Peter Surda : If you intend to pay the debt but later refuse, that is not fraud but merely a non-fulfilment of a contract. Fraud requires intent. Erring is not intent

One intends to refuse, thus fraud. Unless, of course, youre positing an unintentional refusal. Agreed that erring is not intent but refusal is not erring. Ie, intention to defraud is not time-dependent. I may honestly promise now but later refuse to honor it. Its fraud.

Peter Surda June 19, 2010 at 11:13 am

You cannot honestly promise now and later change your mind. That is not honest. You are trying to fabricate a situation that has two contradictory requirements.

Stephen Grossman June 19, 2010 at 8:25 pm

Its honest at the time of the promise but dishonest later. One can now intend to be honest in the future and, in the future, reject that intention. Ie, the dishonesty is later. Most people in history randomly careen between honesty and dishonesty. Im not claiming its human nature since man has free will. Its two situations, each consistent w/itself. Further, man-made situations can be contradictory. Eg, govt attacks on markets. Inflation causes a boom which is then contradicted by a bust.

See “Honesty” in Tara Smith’s _Virtuous Egoist_.

Peter Surda June 21, 2010 at 7:39 am

I have a problem with this definition, because it makes the legal status of an action dependent on the changes of one’s state of mind for the duration of the contract’s validity (thus making it subjective and undeterminable). We can objectively say only
- what the content of the contract at the time of agreement was
- whether the performance occurred or didn’t
Why should any change that occurs during these two points in time (agreement and performance) be relevant? The only reason for relevance is if such a change is covered in the contents of the contract. Not only that, but if such a change occurs in the thought processes of one of the involved parties, how can one determine whether this change qualifies as honest or not? You can’t. You can only determine whether the performance occurred or not.

On the reasons of subjectivity and lack of relevance, I have to reject your definition.

The Kid Salami June 21, 2010 at 8:18 am

“Fraud requires intent. Erring is not intent.”

The important point is that it could be impossible to distinguish (via actions) between:

- someone who says they’re honest, signs a contract and then does what they always intended and DOES NOT fulfill the contract, and
- someone who says they’re honest, signs a contract and then does what they always intended and DOES fulfill the contract

The actions of two such people could well be completely indistinguishable. So the “intent” has nothing to do with the state of mind of the person, this is strictly irrelevant. There has to be some objective criteria by which a third party can determine intent and this is a practical questions, not a logical one.

Peter Surda June 21, 2010 at 9:22 am

Dear Kid Salami,

that makes sense. I guess I got distracted. I would thus go back to my original theories and reformulate that fraud is misrepresenting to the other party the contents of the contract. The question then is obviously if there is a contract at all if both parties disagree on the contents thereof.

james e fraser June 22, 2010 at 3:39 am

Whether one intends fraud upon entering or later is irrelevant to the fraud itself.

how do you commit fraud without intending it???

wouldnt it be called something else???

george t morgan June 19, 2010 at 2:25 am

with the banking system as it is now does the bank create a dollar that isnt paper or coinage to spend???
when i write a check it says dollars and my debit card an bank statement says dollars as well.

if they do, are the banks (via contract and i guess some govt legislation) creating a dollar in a different state than the paper and coin dollar??

is the bank created dollar (that actually circulates?) a claim on expected future paper/coin dollars as well as additional dollar claims??

james e fraser June 22, 2010 at 3:46 am

when a rothbard call the fractional reserve banking systems, the govt kind, is it saying that it is a faud that is forced upon citizens???

i was told that earlier, the govt made notes that granted a specific weight of gold to a bearer on demand but that there never was enough gold to meet all of the notes if gold was demanded by bearers??? is that true??????….and would that be fraud forced on citizens????

we know we cant fulful the bearer part but you cant do anything about it becasue of govt violence saying so???

james e fraser June 22, 2010 at 3:50 am

i have read that some of historical unbacked notes circulated at par with gold and silver in places??
would circulating at par be at par if 10 people did that or 20?? would that be differnt that 20, 000 people having unbacekd notes at par with gold and silver coinage???

if this was done without any govt heavy handedness how did that work contractually??

did an unbacked note say pay to bearere on demand??? would the momeont that one person got one of those notes who didnt sign anythng with a bank and believe teh gold or silver to be sitting in a bank be defrauded in some way???

is that what actually occurred???

tungsten watches July 23, 2010 at 6:29 am

I also want to say FRB could be fraud if creditors were told that they could at any time retract their money from the bank and that at any time the bank holds as much values as the deposits are worth.

Jimmie December 20, 2010 at 12:29 am

Forgive me if I’m clueless here as I’m very new to the Austrian school, but from what I gather so far everything around here is based on free market. So based on a gold standard, why can’t there be banks of both types(free/100%reserve)? Wouldn’t the market eventually decide which would stay and which would go or there could be a niche for both correct?

james b. longacre December 20, 2010 at 2:07 am

in a free market there could.

however being new to the austrian school is being new to a lie.

if you knew a note might not be redeemable for gold or whatever you wouldnt have to accept it from the the note holder trying to buy goods with it who contracted with a bank to only keep a fraction of the reserves of gold necessary to redeem all its notes.

now with a govt around and it not going anywhere anytime soon i guess the govt would tax you in someting. maybe you could contract with govt to take your possibly redeemable notes or the govt may just take your property… ie, beaver skins, acrerage, etc as tax payment in a money/curency that it pays its employees in and buys goods with.

i was told that earlier in us history currency paper was to be redeemable in gold but apparently there were far more notes than there was corresponding gold.

David Bholat January 7, 2011 at 9:22 am

This is a fascinating thread, and I am happy that a lively debate around fractional reserve banking is taking place somewhere, post financial crisis. I would be most appreciative if the major combatants in this discussion would give the key works that have influenced their thinking on this subject, so that those of us who are still making up our minds might have more resources to draw upon. Obviously, Mises Theory of Money and Credit is fundamental and Rothbard’s Mystery of Banking and I have just recently purchased De Soto’s work. I would be particularly keen to have folks recommend books that link capital theory to this issue.Cheers,David Bholat

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