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Source link: http://archive.mises.org/8933/can-friedmans-money-rule-stabilize-the-economy/

Can Friedman’s Money Rule Stabilize the Economy?

November 12, 2008 by

Contrary to Friedman, the boom is not just about an increase in the rate of growth of the money supply; it is also about various nonproductive activities that spring up on the back of the expanding money-supply rate of growth. Furthermore, an economic bust is not about a fall in the rate of growth of the money supply; it is about the elimination of various nonproductive activities on account of the decline in the rate of growth of the money supply. FULL ARTICLE


fundamentalist November 12, 2008 at 8:55 pm

Mark Humphrey: “Fundamentalist thinks that an increase in the supply of gold somehow alters the structure of production leading to the cycle of boom and bust. But this would seem to be mistaken, because an increase in gold-money does not artifically depress interest rates below the natural rate established by time preference.”

Keep in mind that time preference is just one of the factors that makes up interest rates. Hayek says it determines how much people will save, but only indirectly determines interest rates.

Mark: “If time preferences remain unchanged following the increase in gold supplies, the new gold-money will be spent and saved in proportions identical to that prevailing before the gold increase.”

That can’t be the case because the money won’t be evenly spread over the entire economy. It enters at a certain point. For gold it would be through the miners and their employees. Even if that is the case, you still have more money chasing a limited amount of goods in the short run. It will drive up prices and profits in consumer goods and set in motion the ABCT.

If all of the gold is spent on consumption, the prices of consumer goods will rise, as Cantillon wrote, unless there has been a depression and idle resources are lying around. If all the gold is saved, it will depress interest rates. Most of the money invested will go to pay salaries which will increase demand for consumer goods, too. I don’t see how you can get away from an increase in gold causing consumer prices to rise relative to producer goods, and that kicks in the business cycle. Of course, the cycle will be shorter and milder than any caused by fiat money.

RichardJ: “Question is, if the government introduced 100% fiat reserves then increased the money supply by 2% a year by giving cash to every citizen i.e. not the loan market, would this mean there would be no boom-bust cycle?”

It’s hard to say. Money manipulation is the most frequent cause of boom-bust cycles and it causes them to be deeper. But drought, crop failure, and natural disasters can cause busts while war can cause a boom then a bust.

coquillion November 12, 2008 at 10:25 pm

Assuming we abandon fiat money for gold (or other tangible store of value) and eliminate fractional reserve banking, doesn’t that imply an ongoing deflationary trend? Assuming that the money supply expands through mining, won’t the use of gold as a medium of exchange create a distortion in the importance of mining gold, relative to other capital intensive activities? While people have historically accepted gold as a store of value and something to be desired, it doesn’t seem that gold has that much practical utility (besides its industrial uses.) Wouldn’t it be better to use energy as money (not necessarily directly) instead?

Mark Humphrey November 12, 2008 at 10:27 pm

Richard asks: “Question is, if the government introduced 100% fiat reserves then increased the money supply by 2% a year by giving cash to every citizen i.e. not the loan market, would this mean there would be no boom-bust cycle?”

We assume the Federal Reserve prints currency equal to 2%, and mails it to citizens. Every citizen now has an extra $100 to save or spend.

Let’s first assume that, in accordance with time preferences, 100% of the new money is spent at the mall. The profit margins of retailers expand unsustainably, and they consume all the additional 2% in revenues that flows into added profits. The firms they patronize do the same, until retail prices rise 2%. No expansion of retail production occurs in this instance, because all the new money went into consumption. Because no additional output of consumer goods occurs, the winners in the zero-sum redistribution of wealth are the consumers who get to the mall the soonest.

However, consumers are fooled by the new money into believing that they are $100 richer than before. So instead of continuing to set aside funds, as in the past, to cover depreciation and amortization of various capital assets, for the purpose of just maintaining those assets, as contrasted with saving and accumulating additional capital, consumers spend 2% more of their incomes on consumption than they would otherwise. This 2% increase in consumption is necessarily extracted from the capital base. This reduction in capital erodes real incomes and wage rates, and profits among capital goods producers–a condition identical to the recession brought on by artifically depressing the rate of interest through fractional reserve inflating. So in this example, the boom and bust cycle rides again.

Next, let’s assume that the recipients of the new money spend one half and save one half, again in accordance with their time preferences. The new money that is spent at the mall produces the effect described in the paragraph above. The money that is saved is deposited, and then loaned by banks to consumers and business. To the extent that consumers borrow the new loan money, consumer prices rise further, thereby reinforcing the process by which people are fooled into eating their seed corn. To the extent that producers borrow the new money, producer profit margins expand unsustainably, prices rise, and capital gets eroded.
Again the erosion of capital depresses business spending, profits, wage rates, and incomes. Again, the effect is similar to a recession resulting from fractional reserve inflating.

In summary, the boom and bust feature is unavoidable, because printing new money is necessarily promotive of consumption beyond the level that is consistent with prevailing time preferences. When people reassert their old time preferences, a temporary slump occurs.

That’s my best imperfect understanding of this, for tonight, at least.

Fundamentalist, we agree that an increase in gold production that is substantially greater than the increase in the production of other goods will lead to rising prices. But we disagree beyond that point.

If mines double their gold output in a single year due to some technological breakthrough, then particular firms and individuals will be the earliest recipients of the big supply of new gold-money. Some firms will save more than the aggregate time preference that influenced spending before; some individuals will consume more than aggregate time preferences influenced aggregate spending before.

But very rapdily, the new money is exchanged for various goods and services. As it comes into new hands, they spend the money in accordance with old, presumeably unchanged time preferences. Nobody got tricked into assuming they were wealthier than they actually are, as in the case of fiat money expansion. Why? Because, in fact, they really are wealthier than before the increase in gold production. Gold is a real good that comprises real wealth. As we both know, fiat money is not a good; it is a means of embezzlement.

Finally, the business cycle that results from fractional reserve inflating is characterized, not by an initial rise in consumer goods prices, but instead by an initial rise in demand for capital goods, followed quickly by a rise in capital goods prices. This rise in capital goods demand and pricing starts the boom. When the new money finally percolates down to consumer prices, the reality of scarcity forces people to adjust back and the recession begins.

newson November 13, 2008 at 12:12 am

ktibuk says:
“I am saying take it further. Say mining is so efficient that it is almost costless to mine gold (as costless as printing paper money) and increase the money supply.
Is this a crime or not?”

there’s no crime. a service is rendered to society by the alchemist. instead of gold having mainly (but not entirely) monetary value, the plumbing industry now has the perfect anti-bacterial pipe, ointments can now use nanoparticles of gold as antifungal agents, and lenin’s urinals can now sensibly be gold-plated.

the metallurgists who perfected aluminium smelting killed it as a monetary metal, but gave us coca-cola in cans.

there would naturally be cantillon effects as the devaluation of gold worked its way through the world.

the fraud is that the paper money is masquerading as some real, tangible good. when the notes are only worth their paper value, the game is over!

Chuck November 13, 2008 at 1:25 am

All this talk of gold vs paper is missing the point. Government should not control the money supply. Few would say government needs to control the supply of socks to prevent sock shortages/surpluses. Why is money any different?

newson November 13, 2008 at 1:50 am

inquisitor says:
“…starting with a system of private property rights, asserting that multiple claims to the same good, which a bank agreed contractually to store, is pretty much fraud, in any sense you’d like to mention.”
“FRB is fine if it is made known to the bank’s clients what it is doing, and done so explicitly.”

if you concede that frb is a fraud, then how can disclosure absolve this? surely you’re not suggesting that fractional reserve banks actually include the “f” word in their disclaimer?
besides, who is going to enforce the obligation to disclose? the government?
written disclaimers are often set aside by courts, so i don’t find this argument persuasive, either on a moral plane or on a practical one.

if i buy shares in a brickworks, i expect the inventory has been checked out by both internal and external auditors. whilst the government doesn’t run the company, i can still sue the directors or auditors should it turn out that the bricks on the balance sheet don’t exist, and they knew or should have known. why shouldn’t that be the case with depository banks? what on earth makes banks unique in both company law and corporate accounting from any other corporation?

Paul November 13, 2008 at 2:34 am

Another educational article by my favorite contributor Frank Shostak, for sophomore students of the Austrian School such as myself.

ktibuk November 13, 2008 at 4:08 am

Mark Humphrey, “As I explained in my previous post, an increase of gold is an increase in real wealth, because gold is a real good. In contrast, an increase in the quantity of fiat money does not increase real wealth; it merely dilutes it per unit of fiat money”

This is the part where you are mistaken just like Shostak. Gold money is not only a good. It is part money, part good. Those are two different functions.

Increase in gold in a “gold money economy”, increases both “gold as a good” and “gold as money”. The increase of “gold as a good” increases wealth. But increase of “gold as money” dilutes the purchasing power of money. It has no positive effect. Neutral at best, but since the new money enters the economy unevenly through miners it dilutes the purchasing power of the previous money and has the same effects of fiat money increase. And since this effect also depresses interest rates, the increase of wealth through the increase of “gold as a good” can not compensate the negative effects. But we have witnessed through history that this negative effect is negligable.

It is the same thing with paper fiat money, but weight of “money” and “good” functions are a little different.

That 10 dollar bill you have in your pocket, has both money and good functions. But compared to “gold money”, good function of paper money is tiny. It is scarp paper. As a good more of the scrap paper, better it is. For other uses of course. It increases wealth. But as money the amount is irrelevant. And if the amount increases unevenly then there is a wealth transfer because it dilutes purchasing power, plus it mimics a change in time preference because it depresses the interest rate when there is no change hence causing the boom in the cycle.

Money is not a good and it is not wealth. It is a function. And many different things can have this function to a degree. That is why it is impossible to calculate and control the money supply. That is where monetarism is wrong.

There is also no inherent difference between money and money substitutes as money functions. That is the reason why money substitute can function as money. The only difference is in commodity money increase of the supply is dispursed among different miners and increase happens relatively slowly because of natural reasons. But in a fiat money economy there is one that produces money and production is fast so money supply increases relatively more quickly.

ktibuk November 13, 2008 at 4:21 am

Newson, “the fraud is that the paper money is masquerading as some real, tangible good.”

Yes I agree. This happened in history but as of now when the FED floods the economy with dollars they are not doing this. Today nobody thinks the dollars they hold represent some other real, tangible good.

It is like there is one miner, one very efficient miner and he is pumping gold into the economy. And since no one thinks that gold is backed by something else there is no fraud.

This may seem a minor point but I think it is important to understand what money is.

Ireland November 13, 2008 at 7:26 am

ktibuk: Today nobody thinks the dollars they hold represent some other real, tangible good.

Control question: Why on earth would then anyone accept USD as salary, for settling trade, savings etc?

The statement in italics is fully true for continentals and other already failed fiat money. While current USD is accelerating the same way, we’re not there yet.

Campbell November 13, 2008 at 7:35 am

ktibuk – Thanks for your reply. The thing is, the central bank/government has the power to devalue currency whether it’s made of paper or paper-representing-a-commodity. For a case study, see US monetary policy 1913-1971.

The only way out I can see is to use the commodity itself, directly, as currency. Legislate against government interference with money in any way. I suppose gold or platinum coins would work well with vending machines, but I’d seriously have to re-tool my wallet.

Capitalism is a fantastic engine for improving the lot of society. The big problem is, it has no steering wheel.

joebhed November 13, 2008 at 7:59 am

Thanks to greg for making very simple and rational observations.
As to mark h’s proof offering using the 2 percent increase in money BY THE GOVERNMENT, it falls apart based on Friedman’s plan.
The only reason for the 2 percent increase in fiat money is because there is a 2 percent increase in economic production
Were there a 0 percent increase in production, it would call for a 0 percent increase in the money supply.
Ladies and gentlemen.
It is time to forget about the gold standard as the solution.
It is time to forget about the government getting out of its constitutional power to control the money system of the country.
THAT will never happen.
What we want is an honest and fair money system and we can get most of that from Friedman’s platform of eradicating the fractional reserve system, and a productivity-based (however YOU want to define that) increase in the money supply on an ongoing, sustainable basis.
By the government(Treasury) and not the bankers.
Pillory away.

newson November 13, 2008 at 8:04 am

to ktibuk:
the alchemist has rendered a precious metal so common that a myriad industrial uses now are possible for the devalued gold. if its monetary utility is diminished as a result of its abundance, it means that people now value its industrial utility more.

the fed ruins good paper by dyeing it. blank paper at least has commodity value.

as regards the fraud of paper masquerading as a good, i had frb in mind, not irredeemable dollars.

newson November 13, 2008 at 8:16 am

to ktibuk:
let me twist your analogy a little. if i somehow figure out a way to increase wheat yields ten thousand fold, i may well bankrupt many corn, rice, sorghum producers, as well as my conventional wheat-farming competitors. but i produce a gain to all the actual and potentially-new wheat consumers, so i’m not sucking the lymph of society at large.

counterfeiting produces no net gain to society, merely redistribution.

Michael A. Clem November 13, 2008 at 8:32 am

It enters at a certain point. For gold it would be through the miners and their employees. Even if that is the case, you still have more money chasing a limited amount of goods in the short run. It will drive up prices and profits in consumer goods and set in motion the ABCT.
Fundamentalist, I would agree that an increase in gold is inflationary and would drive up prices, but I don’t think that it starts ABCT, because, yes, the new gold will divert the allocation of resources, but since new wealth in the form of gold has entered the system, it is not unsustainable. Unlike the fiat system, they are not getting something for nothing.

fundamentalist November 13, 2008 at 8:38 am

Mark Humphrey: “Finally, the business cycle that results from fractional reserve inflating is characterized, not by an initial rise in consumer goods prices, but instead by an initial rise in demand for capital goods, followed quickly by a rise in capital goods prices. This rise in capital goods demand and pricing starts the boom.”

I think if you look again at Hayek’s “Prices and Production” you’ll find that consumer prices always rise faster than capital goods prices. Hayek takes a lot of space to make that clear in several of his works. Yes, the boom starts when businesses borrow to invest and purchase capital goods. But those capital goods won’t produce any new consumer goods for a long time. Meanwhile, the new workers in the capital goods industries are spending their wages on consumer goods, demanding more.

If consumer goods prices didn’t rise faster than capital goods prices, then profits in consumer goods industries wouldn’t be higher and there would be no shift in investment from capital to consumer goods production. Also, the Ricardo Effect, which Hayek places a great deal of emphasis on, requires that wages in the consumer goods industries fall relative to the price of output. That happens when consumer prices rise relative to wages. The relatively lower wages cause businesses to use more labor and less capital, which is one of the things that brings about the bust in the capital goods industries.

The prices of capital goods do rise, but only after consumer prices rise. The order of the rise in prices is very important to Hayek’s understanding of the business cycle. Yes, consumers do reassert their time preferences, but only after the new workers are hired in the capital goods industries and start spending.

These effect happen because the new money injected into the economy did not come from savings. Had they come from savings, then consumers would reduce their consumption so that more consumer goods would be available to new hires in the capital goods industries. An injection of gold money into the economy will have the same effect as an injection of fiat money. However, the benefit of gold is that fluctuations in the gold supply are much smaller.

Ktibuk: “Increase in gold in a “gold money economy”, increases both “gold as a good” and “gold as money”. The increase of “gold as a good” increases wealth. But increase of “gold as money” dilutes the purchasing power of money.”

This is a very good point! Bastiat makes the same point in many of his writings. He writes that money is not wealth at a time (1800′s) when gold was the only money:

“I cry out against money, just because everybody confounds it, as you did just now, with
riches, and that this confusion is the cause of errors and calamities without number. I cry out against it because its function in society is not understood, and very difficult to explain.” (Bastiat “What is Money?”)

Cantillon pointed out the harmful effects of a sudden increase in the supply of gold in a country with gold mines:

“In his first example, he showed that increased money via domestic gold and silver mining would lead to increased consumption by people in the mining industry and that
would drive the prices of the goods they purchased higher (e.g., meat and luxury goods). Entrepreneurs would adjust their production and farmers would plant their fields to meet this new pattern of demand so that the structure of production would be changed. People not associated with the mining industry would face higher prices and fewer goods to consume so there would also be a change in the distribution of income. As prices continued to rise, gold would be exported in exchange for imported goods and people from the nonmining population might even migrate to areas of higher real wages. Cantillon demonstrated here that the Mercantilists were wrong; more money could hurt
the economy and cause distortions in the pattern of production and wages, as in the cases of Spain and Portugal.” (CANTILLON ON THE CAUSE OF THE BUSINESS CYCLE by

Campbell November 13, 2008 at 8:57 am

joebhed – I agree with you that the government is not going to give up its power over the monetary system. But by the same token, neither is it going to stop exercising that power when it believes it appropriate.

For example, given our Friedman critique, any nominal growth rate is basically arbitrary, and differences between the market reality and this arbitrary number will build up over time, eventually precipitating a crash. So let’s take your scenario of a 2% currency growth rate, and a “hands off” policy by the Fed chairman. Can you imagine a major market crash, where government had the legislative power to currency-manipulate and they refused to do it? They would have to resist tremendous pressure from every lobby, and from their voters… it would not happen.

Where and how do you draw the line between what you’re willing to try and make the government do, and what you give up on them doing? If we’re going to be able to get our government “of the people” to make a major shift in monetary policy of any kind, I say go for the gusto. We may as well try and make them change the whole thing to a real free system if we think we can make them change at all.

Mark Humphrey November 13, 2008 at 9:28 am

Fundamentalist, thanks for your interesting reply to my critcism of the idea that an increase in gold money causes the business cycle.

I’m still not convinced that this is true, but I know less about this than I thought I did. I don’t have more time to spend. But you’ve convinced me that I ought to read my Hayek.

fundamentalist November 13, 2008 at 9:39 am

Mark, It’s hard to find, but I thought Hayek’s “Profits, Interest and Investment” to be the more presentation of his cycle theory. I had to get a copy through interlibrary loan. “Monetary theory and the trade Cycle” is good, too. “Prices and Production” is the most detailed and most difficult to follow.

Deefburger November 13, 2008 at 9:54 am

“A major problem with the Friedman rule is that we are still going to have an expansion in the money supply out of thin air. (Remember, Friedman advocates the expansion of money at a constant percentage.) This in turn means that various nonproductive activities will be generated.”

I saw an example of non-productive activity with the mortgage. Every month a new bank would send a letter stating that they were the new holder of the loan. Every time it changed hands, a percentage of the equity was drained off and into the coffers of non-productive banks. As a consumer, I had no need for the switch, or any say on who owned my mortgage.

I realized that if this continued for months, and not just for me, then there was billions of dollars in equity being siphoned off the capital during the inflation period of the real estate market. Had the loans remained with the original bank, there would have been breathing room when the down-turn came.

Instead, there was no room at all. The banks had been playing “hot potato” with ALL the loans! So the big banks that bought large lots of these second, third, fourth, umpteenth hand loans bought them knowing that they would have to keep them moving in an inflationary market or they would own duck spit when the market turned. Then the market turned, and there they were, stuck with duck spit.

“Lets call it a calamity! Help! It’s not our fault the market turned!” Stupidity & Greed Laurel and Hardy in disguise.

joebhed November 13, 2008 at 10:08 am


In responding to why not go for free banking when we might have the fractional reserve system over a barrel, perhaps my answer is incrementalism.
There is an opportunity arising for a monetary revolution, in case you haven’t noticed it.
Most people perceptibly charge the free-marketeers on bank street with the run-up to the conflagration that is about to happen.
I am both among those, and among those who do not believe that free banking is the answer.
There is no way to free banking and unregulated money power from where we are.
People are demanding government solutions – as dreadful as they are.
I like to believe that most of the Mises posters actually do believe that 100 percent reserve bank lending and a resort to more rational money supply growth are measures that can begin to move us in the direction that monetary policy ought to take.
Thus, a revolutionary change from the present and an incremental change to where the Mises people think we need to go.
As to where to draw the line between the possible and the need for revolution, well I say you get waht you can, and then you move the line forward.
I know that as the central government planner among the posters I am in the minority in believing that by GETTING control of the money system, we the people can define where that control will take us.
But, that is what I believe.
The money power is in control of the government, and not the other way around.
When I visited Frank Shostak’s website, his firm is in the business of marketing the insane, non-productive financial market gimme’s that are driving the debt and money creation engine that is driving this inflationary game that we all claim to abhor.
I’ll take the government’s hand on the tiller any day rather than the fat cats of finance who have driven us to the present approach of the abyss in front of us today.

James November 13, 2008 at 11:56 am

Fiat money ( water marked paper) and money represented by electronic digits are essentially only a convenient medium of exchange. Unlike Gold, or any other productive wealth, they have no intrinsic value in and of themselves. They have efficacy only in so far as they are backed up bysomething of intrinsic value; the real productive wealth of a nation.
Financial bailouts compromise the integity of a nation’s money supply and undermine the soverignty of that nation. It encourages excess printing of currency that is, in effect, worthless paper. This paper not being backed up by intrinsic value increases the money supply to where it does not accuratly represent the real wealth and productivity of a nation.
Because the law of supply and demand cannot be conned, inflation is the result. If one wishes to make more lemonade, one should increase the water content only in proportion to the extent that one increases the other ingredients, otherwise, increasing the water content alone waters it down, it loses its efficacy and people shun it because it becomes tasteless,
The U.S. Federal reserve is printing counterfit money.It is avoiding skylla only to be gobbled up by caribdis.Classical inflation is the result( too many dollars chasing too few goods). Productivity is the measure of real wealth in a nation. In America’s case real dollars are backed up by productivity but the productivity is in China and other countries.they are afraid if America defaults they will lose their best customer.
A solution would be to restructure the Breton Woods Agreement into a truly international aggreement. Since world trade is conducted in the exchange of goods and services, those nations who do not reciprocate enjoy trade surpluses that increase holdings in their foreign reserves. As I said, the law of supply and demand cannot be conned for in doing so they increase their holdings in inflated dollars and both sides become losers. The world Bank should have the authority to write of Balance of payments deficits by recalling surplus balance of trade U. S. dollars out of world circulation, strenthening the integrity of the money supply and restoring eqilibrium in the balance of payments.


Michael A. Clem November 13, 2008 at 2:37 pm

I’ll take the government’s hand on the tiller any day rather than the fat cats of finance who have driven us to the present approach of the abyss in front of us today.
Which misses the point: the “fat cats of finance” couldn’t have gotten fat without the hand of the government. Incrementalism may be the practical way of making change, but it only happens because we agitate for more radical change.

james November 13, 2008 at 3:32 pm

Government has given too much control to the Financial system. Government should not have to borrow from the very people to whom they give a license to print money in the first place.
An investment in infrastructure and green renewablle energy would stimulate real wealth creation as result of the multiplier effect. This is what is needed in the nidst of a liquidity trap like the present.
The government should not have to borrow this money, it should be able to print the money it needs. It would not be inflationary because the money would be backed up by
something of intrinsic value, the capital stock of the nation.
When the nation borrows this money it not only increases debt because of interest charges that compound after several years, the borrower becomes servant to the lender. It makes one wonder, who really runs the country? obviously it is the banks. This needs to change.
James MacInnis

joebhed November 13, 2008 at 3:55 pm

“”the “fat cats of finance” couldn’t have gotten fat without the hand of the government.”"
Again, this is where we totally agree.
I do fault the government.
Thus, we demand that the government regain for the people the right of money-creation.
The FRS, with its ability to enslave the masses through fractional-reserve debt-money creation, was created by a pen, and can destroyed by a pen.
Let’s do THAT!
Let’s build the green infrastructure for tomorrrow’s progress and pay for it only once, and not thrice.

“Incrementalism may be the practical way of making change, but it only happens because we agitate for more radical change.”

Please understand that we disagree on the nature of the more radical change that is coming.
But, we need to be at a place where we can argue point for point each of the remaining changes that we all think are necessary or possible.
IN THE MEANTIME, if we can get to the bridge of 100 percent reserve banking and price-stable money growth, we will be in a better position to determine the “next best thing” to pursue.

newson November 13, 2008 at 5:08 pm

to fundamentalist:
“Cantillon demonstrated here that the Mercantilists were wrong; more money could hurt
the economy and cause distortions in the pattern of production and wages, as in the cases of Spain and Portugal.”

i think thornton is right about “distortions”, wrong about “hurt”. i don’t see anything particularly unnatural about changes in consumption behaviour. although there is inflation, without frb, there is no business cycle, and these businessmen will service a need until the gold flow stops, when they will have to change business model.

Ireland November 13, 2008 at 5:27 pm

Well, I don’t know. It’s different when things change from one state to another, and stay there – a change for better via innovation, or for worse due to natural disaster – people adjust all right.

But if there’s change in gold supply, and the fact that the increase is only temporary is obfuscated, or people simply believe hard that it’s the “new prosperity, which will last forever”, then once things go back and reality kicks in – Well I’d bet that forced change of business model will be called a bust and business cycle.

Control question: was Tulip mania a business cycle? What was used for money?

gene berman November 14, 2008 at 8:19 am

William Rader:

You’ve got it exactly backwards. As the market price of gold rises, so does the total value of all the gold in the “reserves” of differing concentrations. But the actual concentration of those reserves, as it affects the mining and milling processes, decrees that some
ores are more expensive to mine, i.e., they cannot be exploited profitably until the price of gold on the market has increased sufficiently to justify such extraction.

In practice, things are rarely quite so simple, so, for most mines, it would still be a matter of extracting ores of differing grades, with the range of ore values shifting downward with price increases and upward with declines.

My guess is that you probably knew that and just wrote it backwards.

gene berman November 14, 2008 at 8:45 am

William Rader:

In practice, a mine with ores of substantially differing concentrations (or a mining company with properties exhibiting similar variations) is guided by futures markets for the out-turn; they can plan just which ores they will work on and when in order to make more secure a certain margin of profit; they also can (and many do) sell a certain amount of their production forward to achieve the same effect.

A ‘wild card” for which they have less information and control is the prospect for changes in costs of production: labor, energy and fuel, water, etc. Big enough changes in one or more of these can play havoc with profitability projections based just on market prices and ore values. Another is the risk of loss due to unanticipated production failure, whether due to a “wildcat” strike, to equipment failure, flood, or fire. The actual damage may be compensated by insurance that will restore a mine’s equipment, etc. but the time required may play havoc with prior planning. You can satisfy your futures contracts by delivering the gold you’ve mined to assure your profit but, if you haven’t mined the gold, the “nut” has got to come out of your pocket.

newson November 14, 2008 at 9:27 pm

to ireland:
have a read of the blog comments that follow doug french’s article on tulipmania
i am not totally convinced by french’s arguments, and nor are many of the bloggers, one of whom points out that the bank of amsterdam really breached its charter and became a fractional reserve bank not long after its creation.

constantly changing business models is part of progress, and doesn’t imply a business cycle. horse and cart turned into lorry and car without provoking boom or bust.

the abct swings on the presumption that the “natural” rate of interest is not allowed to prevail by dint of interference by government or bankers, ie fiat money or frb. in a free market of specie money, the natural rate is determined by people’s time preferences.

rothbard and mises, from memory, define inflation as growth in money supply over and above the growth of specie. this strikes me as problematic, given that there have been historical periods where specie supply has experienced dramatic increases.

newson November 14, 2008 at 9:45 pm

besides, in a totally specie-money economy (no fiat, no frb), the only way for deflation to occur is for the industrial use of specie to consume more than the current mine production. with a specie money only, it’s hard to imagine anything but disinflation occurring, when the mining flows fall off.

gene berman November 15, 2008 at 9:16 am


“rothbard and mises, from memory” etc.

Dunno about Rothbard but, insofar as von Mises is concerned, your memory ain’t much good. As a matter of fact, my memory is that Mises insists that “inflation” is a term without economic definition or even use; it’s a common-language designator of the public experience of a rising price level and especially favored by those with political axes to grind.

Nor, of course, were either (M or R) unfamiliar with the economic effects (particularly on Europe) that came about as the result of great new gold discoveries, first of the New World and, later, in the American West.

The main thing to bear in mind is that there are no constant relationships, including that of the annual addition to the above-ground amount of gold as the result of mining OR in the relationship of the money-function to the industrial usages of gold. Not onlt are these thing undergoing perpetual change but so are both the population and the uses to which money may be put, the latter subsuming not only productivity changes (especially due to the advance of technologic methods and their spread) but also the emergence of entirely new consumer desires.

What I believe Mises would have us appreciate is that the structure of prices on “the market” at every moment (and continuously) conveys to every last participant the best, most accurate information available with which to plan his own economic actions, whether aimed at the satisfaction of the immediate moment or the more remote future. Though not “perfect” in any absolute sense, the market signals are the “best possible” and, furthermore, every attempt to interfere with either the mechanism or the various signals of the market, most especially by authoritarian interference, will, through causal relationships, produce “not much” of whatever was intended by such interference and much more of unwanted and unwelcome unintended consequences.

If you don’t screw with it, things may not make everyone ecstatically happy but most will be as happy as possible. If you do screw with it, you can, at the most, make a portion happier than they would have been, albeit temporarily, and most, if not all, will, before very long, be both poorer and unhappier than if you hadn’t screwed with it in the first place.

newson November 15, 2008 at 11:24 pm

to gene berman:
“Inflation, as the term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check.”(Economic Freedom and Intervention: An Anthology of Articles and Essays by Ludwig von Mises, 1990, p 99.)

i read this to mean that mises does concur with rothbard that inflation is money supply growth over and above growth in specie money. i know mises was hesitant to define inflation in earlier works, feeling the meaning had been corrupted.

newson November 16, 2008 at 12:11 am

“Gold Changes and the Cycle
On one important point of business cycle theory this writer is reluctantly forced to part company with Mises. In his Human Action, Mises first investigated the laws of a free-market economy and then analyzed various forms of coercive intervention in the free market. He admits that he had considered relegating trade-cycle theory to the section on intervention, but then retained the discussion in the free market part of the volume. He did so because he believed that a boom–bust cycle could also be generated by an increase in gold money, provided that the gold entered the loan market before all its price-raising effects had been completed. The potential range of such cyclical effects in practice, of course, is severely limited: the gold supply is limited by the fortunes of gold mining, and only a fraction of new gold enters the loan market before influencing prices and wage rates. Still, an important theoretical problem remains: can a boom–depression cycle of any degree be generated in a 100 percent gold economy? Can a purely free market suffer from business cycles, however limited in extent? One crucial distinction between a credit expansion and entry of new gold onto the loan market is that bank credit expansion distorts the market’s reflection of the pattern of voluntary time preferences; the gold inflow embodies changes in the structure of voluntary time preferences. Setting aside any permanent shifts in income distribution caused by gold changes, time preferences may temporarily fall during the transition period before the effect of increased gold on the price system is completed. (On the other hand, time preferences may temporarily rise.) The fall will cause a temporary increase in saved funds, an increase that will disappear once the effects of the new money on prices are completed. This is the case noted by Mises.

Here is an instance in which savings may be expected to increase first and then decline. There may certainly be other cases in which time preferences will change suddenly on the free market, first falling, then increasing. The latter change will undoubtedly cause a “crisis” and temporary readjustment to malinvestments, but these would be better termed irregular fluctuations than regular processes of the business cycle. Furthermore, entrepreneurs are trained to estimate changes and avoid error. They can handle irregular fluctuations, and certainly they should be able to cope with the results of an inflow of gold, results which are roughly predictable. They could not forecast the results of a credit expansion, because the credit expansion tampered with all their moorings, distorted interest rates and calculations of capital. No such tampering takes place when gold flows into the economy, and the normal forecasting ability of entrepreneurs is allowed full sway. We must, therefore, conclude that we cannot apply the “business cycle” label to any processes of the free market. Irregular fluctuations, in response to changing consumer tastes, resources, etc. will certainly occur, and sometimes there will be aggregate losses as a result. But the regular, systematic distortion that invariably ends in a cluster of business errors and depression—characteristic phenomena of the “business cycle”—can only flow from intervention of the banking system in the market. ”

rothbard takes a different view to mises as to whether increasing specie money precipitates the business cycle. “america’s great depression”, p 34.

Paul Marks November 16, 2008 at 12:32 pm

If people found an easy and inexpensive way of flooding the market with gold then people would tend to use other things (such as silver – or something else) as money, they would make future contracts in some other material.

What matters about gold-as-money is not that gold is a nice yellow metal (although that is not a problem) – it is that it takes power away from the government and the credit bubble fractional reserve banks that the government supports (by the way such banks are “frauds” because they lend out more money than there is real savings – and for borrowing to be greater than real savings fraud must be involved, no matter how “legal” the government and its courts say the whole scam is).

This is the problem with the word “standard” in the term “gold standard” – the word “standard” implies that the gold is NOT the money, that gold simply “backs” the money.

This lays people open to such massive frauds as the late 1920′s when under the “gold STANDARD” credit money increased vastly.

Either gold is the money or it is not – and if the gold is the money there is no need for the word “standard”.

Ditto with silver or any other material people choose to use as money.

James November 18, 2008 at 12:24 pm

There are two types of inflation! Cost push inflation, caused by increases in prices or wages as a result of monopoly by Trade unions or oligopolies.
If productivity increases at an annual rate of 2% and I recieve a raise in wages of 8%, that increase has to come from someone elses disposable income. If companys raise their prices for no reason other then the fact they have the privilage of doing so, this impacts on disposable income as well causing a demand for higer wages and the wage price spiral begins.

There is also classical inflation,a result of increase in the money supply, too much paper chasing too few goods. Classical inflation can be controlled by guaranteeing that bank loans are backed up by something of intrinsic value, things such as a house or car or capital stock. Bank loans to individuals to fund margin calls, loans that have no wealth backing them up as well as Bank bailouts inflat the money supply, creating counterfit money. Since Fiat money is chiefly a medium of exchange, The counterfit money compromises the integrity of the money supply. As a result, inflation in the money supply in relation to the real tangible wealth in a nation impacts wages and prices also.


The laws of economics are immutable and fixed. They cannot be tampered with without producing negative effects. In particular, the law of supply and demand cannot be conned. The public catches on when there are too many dollars chasing too few goods. I believe it was Keynes who said [ the surest way to destroy a civilization is to destroy its money supply].


newson November 18, 2008 at 4:22 pm

“cost-push inflation” doesn’t exist. friedman was right: inflation is always a monetary phenomenon. unfortunately the word has come to mean a whole range of the manifestations of the phenomenon. see this, and numerous other refutations on this site:

keynes, supposedly quoting lenin (“the economic consequences of the peace”):

“Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.
Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become “profiteers,” who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.
Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

peter helbich November 18, 2008 at 6:25 pm

this is vienna austria where it all bagan.
mozart,menger,mises,hayek etc.

send this theorem to all your friends and spread it in th internet

it proofs mathematically that the austria school of econimc is right

regards peter helbich

James November 21, 2008 at 4:07 pm


If, the rate of productivity increases 4% and one area of a unionized labor force asks for and recieves a wage increase of 8 % the 4% above the productivity rate has to come from somewhere for it is not backed up by productivity.
This begins the wage price spirel because Increased prices will reflect this increase and reduce the disposable income of those who consume these products or services. Therefore, those consumers are justified in demanding a similar increase in wages. This is cost push inflation.
During the nineties the teachers union in Ontario,Canada asked for and recieved an 8% wage increase, an amount not heard of in previous negotiations. The office workers and the janitors soon followed suit. These increases were not caused by the money supply, it was greed.
In addition, the high increase in oil prices due to the oil embargo by Opec nations during the seventies was not caused by the money supply. It was caused by the oil producing nations who used Western dependancy on oil to not only punish the west for its pro Israel policies but to increase profits as well.
If these policys were not inflationary what would you call them? Gas prices evidently accelerated, increasing costs to industry and consumers. Other energy sectors soon followed suit as Hydro and natural gas prices increased.
Monetarism, restricting the money supply forced the west into a long deep recession and

businesses who wished to expand and create wealth could only do so by borrowing at high interest rates. Monetarism forced the genie of inflation back into the bottle but it came at the cost of a long deep recession in which businesses closed their doors and people were thrown out of work, losing their homes and savings.
Most of the debt accumulated due to high interest rates that when compounded over several years foisted an onerous debt on the people.An incomes policy restricting wage increases to the rate of productivity and restraint on prices would have served more effeciently.

newson November 21, 2008 at 5:14 pm

to james:
cost-push inflation is a chimera. you’re confusing the symptoms of money supply growth with the cause.
maybe you want to read hazlitt’s “what you need to know about inflation” (pdf) available in the literature section.

“The 1973 OPEC oil hike is often cited as a graphic example of cost-push inflation and the cause of the Western world’s inflationary woes of the 1970s. If this explanation was correct, then the biggest oil importers would have the highest inflation rates. They did not. Germany is wholly dependent on imported oil, as is Japan, yet after the oil hike its inflation rate was 7 per cent while the Japanese rate was 25 per cent; Australia’s inflation rate was 17 per cent, even though it was 75 per cent self-sufficient in oil; America, which imported about 50 per cent of its oil, had a 12 per cent inflation rate; Britain, which had become an oil exporter, laboured under an inflation rate of 25 per cent; Saudi Arabia, the world’s largest oil exporter, had a 35 per cent inflation rate.”


scott December 23, 2008 at 8:56 am

As someone above pointed out, I do not think Milton Friedman thought his rule was the end-all. It was simply the best he could come up with in the Federal Reserve system. The main issues with the reserve system is that in the end, it is people who are choosing how much money to print, and therefore, they may print an amount unequal to the actual wealth being produced.

However, the Gold Standard certainly has its limitations as well, for example, since the gold standard is based on a specific natural resource, there is an upper limit to the total amount which can be produced.

However, more importantly, I do not think it really addresses the issue of a “bubble” in the economy. Bubbles are created because people incorrectly value commodities OTHER than the currency – such as Credit Default Swaps or Mortgage Backed Securities. Switching to a gold standard does not mean that some people will not be duped into paying too much gold for an over-valued asset.

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