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Source link: http://archive.mises.org/6285/the-fateful-wish-for-price-stability/

The Fateful Wish for Price Stability

February 21, 2007 by

The Austrians’ great concern is that a government-dominated money-supply regime would ultimately lead to economic and therefore political disaster; the objective of price stability would not alter such a dismal prediction. Even if a central bank succeeds in stabilizing a targeted price index, it would — by an ideologically motivated increase in credit and money supply — generously increase credit and money supply. It thereby distorts the economy’s price mechanism, promotes malinvestment and initiates subsequent economic downturns. And it is actually the latter with which the trouble really starts. FULL ARTICLE

{ 17 comments }

RogerM February 21, 2007 at 10:14 am

Excellent article! Thanks.

It seems to me that the article implies an Austrian preference for floating exchange rates and, potentially, for a dollar not fixed to a specific amount of gold. When the value of the dollar floats against the value of gold, then government manipulation of the paper currency becomes obvious to all and entrepreneurs can adjust their plans accordingly.

Also, the price indexes show that fractional reserve banking is the chief evil, for even during the gold standard days, prices fluctuated wildly. The main difference between then and today was that under gold money, prices fell as often as they rose. But the rise in prices was probably caused by fractional reserve credit expansion; the price declines by the resulting bust and collapse of ex nihilo credit expansion.

We love to bash the Fed, but Huerta de Soto writes that a central bank is the natural outcome of fractional reserve banking, because the rapid succession of booms and busts cause people to demand stability through government intervention. Without fractional reserve banking, the Fed would have no purpose. It seems to me that if we could end fractional reserve banking, we could use sea shells for money and it wouldn’t matter.

Adam Knott February 21, 2007 at 1:13 pm

Yes, Great article.

What about the idea of free banking along the lines of what Lawrence White argues for?

It seems to me the point isn’t to argue for this or that specific institution or the abolishment of one or the other. What is necessary is for entrepreneurs to be free to offer alternatives to currently existing holdings. That way, any manipulation of any currency whatsoever brings opportunities for “honest” or better currency products to emerge.

Abolishing one bad institution won’t solve the problem when other laws prevent the emergence of good alternatives.

It seems then we get caught up in arguing for a specific banking arrangement, rather than arguing for complete economic freedom in banking/currency products.

adi February 21, 2007 at 1:22 pm

Good article from Mr Polleit.

There has been some discussion amongst economists concerning neutrality of money. Sometimes it’s said that economy dichotomices when nominal variables (like money supply) dont affect real variables (like real output) and sometimes it’s said that neutrality means just that in the long run increase of money supply cannot affect permanently real output. In a (hypothetic) economy where this dichotomy is true money could be said to be a “veil” which just hides workings of real economy.

Interesting thing is that one can infer from those graphs given by Mr Polleit that variances of changes of price indices have been quite large during gold standard and might have some serial dependences (ARCH/GARCH type of processes). These monetary shocks might have been caused by the large increases of money supplies, after new findings of gold deposits have been made.

Now my thought experiment: Suppose one wants to make selection between two monetary regimes. One regime is gold standard and another is government managed monetary regime. Then one says that selection is based on the variance of change of CPI/WPI and that regime is selected which has minimum variance. Based on those previous graphs one could very well say that gold standard doesnt give any advantage over government managed monetary regime.

Even if the fiat regime produces positive annual change in the CPI, it’s thought to be more stable regime since variance is smaller.

Any comments?

DISCLAIMER: Previous analysis doesnt necessarily reflect my own opinion about monetary regimes.

RogerM February 21, 2007 at 1:37 pm

Adi: “Even if the fiat regime produces positive annual change in the CPI, it’s thought to be more stable regime since variance is smaller.”

You’re right. I noticed that about the graphs, too. The variance with fiat money is smaller, though always positive. That’s due to the Fed reducing the frequency of bank crises and always inflating. As Huerta de Soto writes, people will always demand a central bank if fractional reserve banking is allowed in order to reduce the volatility. Given the choice, people will always vote for inflation over volatility.

Adam: “What is necessary is for entrepreneurs to be free to offer alternatives to currently existing holdings.”

Fraud is an issue with fractional reserve banking. Liberty doesn’t mean the lack of law and order. Fraud should always be punished, even in a total anarcho-capitalist society. Huerta de Soto recommends allowing capitalists who go broke because of a period of ex nihilo credit expansion be allowed to sue banks in court for fraud. I guess is the courts allowed that, then fractional banking would be fine, except I don’t think it would last under that kind of law.

The second issue is the theft of wealth caused by fractional reserve banking (FRB). FRB transfers wealth from entrepreneurs and consumers to themselves without penalty.

Finally, as I wrote above, the volatility caused by FRB creates an outcry for a central bank and increased government control of money and banking.

adi February 21, 2007 at 1:59 pm

RogerM, your are right about the FRB part since inflation-deflation cycles could be much more violent during less than honest gold standard. But mainly I was thinking that also with 100% gold standard similar fluctuations in the change of CPI could be seen since appreciation of value of gold would give an powerfull incentive to go out and prospect new gold. This incentive is there as long costs of finding and mining gold would be smaller than price of gold.

I just remembered that in my home country similar mechanism worked with respect of exchange rates. Finland used to escape many recessions through devaluation of our Mark (FIM) and this gave competitive advantage for Finnish forest industry. Their earnings were in USD and most expenses fixed in FIM. After export bonanza was underway industry’s expenses also increased since forest owners, unionized workers of plants and so on got their own share of profits. After inflation increased in Finland most export businesses lost their competitive advantage and new devaluation was demanded from our monetary authorities. Forest industry was often succesfull in this…

Finnish economist Sixten Korkman gave this phenomenon a new name: Devaluation Cycle.

RogerM February 21, 2007 at 2:29 pm

Adi: “This incentive is there as long costs of finding and mining gold would be smaller than price of gold.”

It’s only theoretical, since we haven’t had an economy without FRB in 800 years, but Reisman writes that gold production would increase 2-3% a year, and thus raise the money supply by that amount. If production increased 2%-3% per year, prices wouldn’t change. I suspect that the volatility of prices in the 1800′s was due to credit expansion by FRB.

Your example if the Finnish forest industry is interesting. I suspect that another cause of the devaluations was the inflation of the US$. Especially in the 1960′s and 1970′s, but the 1990′s also saw huge amounts of inflation of the US money supply, except that the CPI didn’t increase as much as earlier periods due to higher productivity in the 1990′s. As the US$ loses value due to inflation, the FIM would automatically become overvalued if it were pegged to the US$. That’s why I like floating exchange rates: the re-valuation of currencies takes place daily and central banks can’t hide their fraud.

David White February 21, 2007 at 2:30 pm

As George Reisman begins his brilliant essay “The Goal of Monetary Reform”:

“The essential reason that a 100-percent-reserve gold standard should be the ultimate goal of monetary reform is that it would secure the economic system against the evils both of inflation and of deflation–depression. In addition, it would be consistent with the fundamental moral–political principle of the absence of the initiation of physical force and thus the positive presence of individual freedom. Indeed, by virtue of the safeguards it imposes against inflation and deflation–depression, it would secure the individual’s freedom against the state better than any other monetary system.”

I highly recommend it:

http://mises.org/journals/qjae/pdf/qjae3_3_1.pdf

Pepe February 21, 2007 at 4:00 pm

Adam Knoll said: “It seems then we get caught up in arguing for a specific banking arrangement, rather than arguing for complete economic freedom in banking/currency products.”

Hear, hear! I believe this is the reason why the ideas of such rigorous yet iconoclastic thinkers such as Antal Fekete are hardly ever given an airing in otherwise excellent forums such as LRC or mises.org. For example, Fekete’s theory of interest or his advocation of the Real Bills Doctrine, which actually build upon Misesian foundations are considered anathema.

RogerM February 21, 2007 at 4:36 pm

David, Yes, Reisman’s article is great! But I wonder, with 100% reserve banking, if we still need gold. Just a thought, because there’s nothing to go on but speculation. But with 100% reserves, there’s no business cycle, no banking crises, and therefore no need for a central bank. Without a central bank to create credit out of nothing, even with paper dollars, how would the government expand the money supply? I guess it could print currency, but as long as the dollar can float against gold, that would become obvious very quickly. Citizens could hedge with gold options.

David White February 21, 2007 at 4:40 pm

Pepe, have you read Robert Blumen on the subject of the RBD?

http://mises.org/daily/1833

http://blog.mises.org/archives/004196.asp

Michael February 21, 2007 at 4:58 pm

There is a spurious dollar sign (“19$20s”) in the paragraph immediately preceding the heading “Increasing Money Supply Leads to Inflation.”

David White February 21, 2007 at 5:19 pm

RogerM, you still need gold because you still need commodity-based money (which needn’t be limited to gold), as it’s the only way to reign in government, precisely as Sir Alan, back when he was a lowly but principled commoner, well knew:

http://www.usagold.com/gildedopinion/Greenspan.html

Which is to say that government as we know it depends on the corruption of money. Hence budget deficits, trade deficits, and the unsustainability thereof. Or to quote Ayn Rand again: “We can evade reality, but we cannot evade the consequences of evading reality.”

Pepe February 22, 2007 at 3:46 am

David,

Yes, I have been following that particular debate very closely. I have read Blumen, Corrigan, as well as Hultberg and Fekete on the subject.

My take on the hullaballoo is that the two sides have hitherto, willfully or not, failed to agree on what the basic terms of debate really mean: credit, clearing, interest, discounting, or even money itself.

Regards,

Pepe

PS. Sorry to Adam Knott, whose surname I misspelled… must get my eyes checked one of these days.

billwald February 22, 2007 at 10:34 am

Would you all require banks to stockpile sufficient gold to cover credit card balances?

Just got gold crown for a tooth, cost $800. What would it have cost if we went to 100% gold backed money?

Ike Hall February 23, 2007 at 10:29 pm

Dunno, billwald. How much gold did the dentist use? :D

Björn Lundahl February 24, 2007 at 3:02 am

The purchasing power of money, the gold standard and fiat money

If the gold supply will, on the average, increase as much as total output in a 100% gold reserve money standard or not, is not a praxeological fact but a speculation. It might be a relatively good speculation, but it still is a speculation. Technological advancements that favour increased gold supplies have, of course, been going on since the beginning of the industrial revolution.

Historically, prices have on the average fallen when economies were on a gold standard and those economies were not even based on a 100% gold reserve money standard.

Deflation defined as increases of the purchasing power of money is not, at all, harmful for the society and the economy.

Rothbard saw falling prices as a natural condition of a market economy, For a New Liberty:

“Thus, falling prices are apparently the normal functioning of a growing market economy.”

“And, indeed, if we look at the world past and present, we find that the money supply has been going up at a rapid pace. It rose in the nineteenth century, too, but at a much slower pace, far slower than the increase of goods and services; but, since World War II, the increase in the money supply—both here and abroad—has been much faster than in the supply of goods. Hence, inflation.”

http://mises.org/rothbard/newliberty9.asp

Now when another masterpiece has been added to the great family of glorious books in Austrian economics with the title “Money, Bank Credit, and Economic Cycles” written by Jesús Huerta De Soto, I am pleased to quote the author’s comment about the purchasing power of money under 100% gold reserve money standard page 776:

“Consequently one aspect we can foresee is that in the proposed model, nominal interest rates would reach historically low level. Indeed, if on average we can predict an increase in productivity of around 3 percent and growth in the world’s gold reserve of 1 percent each year, there would be slight annual “deflation” of approximately 2 percent.”

And on page 777:

“The model of slight, gradual, and continues “deflation” which would appear in a system that rests on a pure gold standard and a 100-percent reserve requirement would not only not prevent sustained, harmonious economic development, but would actively foster it.”

I quote from the book “Democracy The God That Failed”, by Hans-Hermann Hoppe, page 58:

“During the monarchical age with commodity money largely outside of government control, the “level” of prices had generally fallen and the purchasing power of money increased, except during times of war or new gold discoveries. Various prices indices for Britain, for instance, indicate that prices were substantially lower in 1760 than they had been hundred years earlier, and in 1860 they were lower than they had been in 1760. Connected by an international gold standard, the development in other countries was similar. In sharp contrast, during the democratic-republican age, with the world financial center shifted from Britain to the U.S. and the latter in the role of international monetary trend setter, a very different pattern emerged. Before World War I, the U.S. index of wholesale commodity prices had fallen from 125 shortly after the end of the War between the States, in 1868, to below 80 in 1914. It was then lower than it had been in 1800. In contrast, shortly after World War I, in 1921, the U.S. wholesale commodity price index stood at 113. After World War II, in 1948, it had risen to 185. In 1971 it was 255, by 1981 it reached 658 and in 1991 it was near 1,000. During only two decades of irredeemable fiat money, the consumer price index in the U.S. rose from 40 in 1971 to 136 in 1991, in the United Kingdom it climbed from 24 to 157, in France from 30 to 137, and in Germany from 56 to 116.

Similarly, during more than seventy years, from 1845 until the end of World War I in 1918, the British money supply had increased about six-fold. In distinct contrast, during the seventy-three years from 1918 until 1991, the U.S. money supply increased more than sixty-four-fold.”

Björn Lundahl
Göteborg, Sweden

J Thulin March 1, 2007 at 7:38 am


Indeed, great article

Ah, I always return to the haven of Austrian economy after having suffered through 100 pages of Keynesianism in my college-textbook (Macroeconomics – Mankiw).

To me it is one of the great puzzles of history why Mises theories and contribution are consistantly being neglected within mainstream economics. The Austrian theory of business-cycles is so much more logically and intuitively appealing than Keynes shaky IM/LM approach, which lacks a sound microeconomic base.

WHY oh WHY isn’t this being debated more at universities? To me, a full reading of “Human Capital” roughly equals four years of Swedish Economical Science (of which most is devoted to building mathematical models out of perverse assumption – resulting in most of the energy being wasted on how to master the science of math)

Sometimes the world just doesn’t make sense…

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