Friday, August 24, 2012

Goldstein and Gold

I had no idea that Ayn Rand and John Gault ruled the Republican Party and Congress, but Paul Krugman claims that is so, and who can doubt what he says, given Krugman is always right about everything. So, today he claims that Paul Ryan is a devoted follower of Ayn Rand and that he is going to try to impose a gold coin standard upon us and destroy the economy.

Given that we have had Republicans talking about gold for decades, including Ronald Reagan and his Gold Commission, and it was a Republican, Richard Nixon, who destroyed the remnants of the American gold standard, somehow I don't think a guy who has read Atlas Shrugged a few times is going to end the paper money standard we have had for a while. However, all of us know that Goldstein is capable of anything, and no one depends more upon Goldstein that Krugman.

Yes, Krugman goes over the Usual Stuff on how Republicans always are going to completely end the Welfare State, even though Republicans in power never have done that. Well, Ryan did read some works by Ayn Rand, didn't he? What other proof do you need? Krugman writes:
Well, it’s right there in that 2005 speech to the Atlas Society, in which he declared that he always goes back to “Francisco d’Anconia’s speech on money” when thinking about monetary policy. Who? Never mind. That speech (which clocks in at a mere 23 paragraphs) is a case of hard-money obsession gone ballistic. Not only does the character in question, a Galt sidekick, call for a return to the gold standard, he denounces the notion of paper money and demands a return to gold coins.

But then Krugman gets into the meat of this column: Ryan will impose a gold standard, and the economy will collapse. This falls into the "Yeah, Right" Category. First, Krugman has been claiming that inflation will lead us into recovery, and he also has claimed that inflation is a wonderful way to transfer money from the wealthy to the poor. (Please tell that to the poor and lower-income people who have been spending more and more money at the gas pump and the grocery store that inflation is their savior.)

Second, Krugman claims that the inflation rate is so low that we really don't need to worry about money, anyway. So, what is it? Is inflation bad or good? If the rate is low, why doesn't he come out and claim that we need much more monetary debasement?

63 comments:

Mike M said...

Who is John Galt?

:-)

John Goodman said...

Inflation increases prices but wages are labour prices.

Krugman supports higher, but single digit inflation. The calamitous effects of hyperinflation do not apply to single digit inflation - so do not worry.

Deflation unambiguously helps the wealthy at the expense of the poor, by increasing the value of debt. So better to have single digit inflation than deflation.

Are your questions answered?

M bjoerkheim said...

Prof. Anderson,

Krugmann has repeatedly argued for higher inflation(~4%), both in the current situation and in normal times. It surprises me you don't seem to know this.

M. Bjoerkheim - jmu undergrad

Joseph Fetz said...

John Goodman,

So, you're readily admitting that the entire purpose of tinkering with the money supply to induce price inflation is to transfer wealth from one party/group to another? And you can reason to yourself that this is somehow okay and not completely fucked?

Rick T. said...

John Goodman: "Inflation increases prices but wages are labour prices." How about periods like the last few years, when energy and food prices went up, but wage rates were stagnant at best? And what about all those on fixed income, such as retirees, whose cost of living keeps rising but don't get any wages, let alone higher ones?

"Krugman supports higher, but single digit inflation. The calamitous effects of hyperinflation do not apply to single digit inflation - so do not worry."

What a coincidence. The German central bank during Weimar times, and the Zimbabwe central bank a few years ago also supported higher, but single digit inflation. That must mean they didn't end up with hyperinflation anyway.

"Deflation unambiguously helps the wealthy at the expense of the poor, by increasing the value of debt. So better to have single digit inflation than deflation."

You have it backwards. Central bank money printing could manifest itself in increases in the prices of goods and services (conventionally called "inflation") or those prices could be quiet, but asset prices zoom, which is what has been the case in the US for the last dozen years. Since the late 1990s we've had successive booms in stock prices, housing, stocks again, and especially bonds. Asset inflation helps the already rich, who own the assets, not the poor, who don't. Deflation of any kind would reduce the wealth of the rich without directly hurting the poor, and anything that brings down the price of food and energy (the two are related, because food production and distribution is very energy intensive) would help wage earners and those on fixed incomes.

Who benefits should not determine the correct policy. What we need is an honest, unmanipulated money supply that allows prices to go where they want to go, based upon supply and demand.

Mike M said...

Rick T
I concur with your comments in response to John Goodman. He has it backwards.

If I may extend them a bit:
Inflation can benefit the rich who own assets that benefit from the inflation and reduce the real burden of any debt they hold used to acquire those assets. Thus they can benefit both ways. The rich generally use debt strategically with the ability to repay or replace at will and therefore not exposed to credit squeezes by lenders like the non-rich. (Assuming they are not overleveraged in which case they get bailed out)

The non-rich on the other hand would benefit greatly from mild natural deflation. Their cost of living burden would reduce and their ability to buy selected assets would not climb out of reach. HOWEVER, this is only true for them if they are not overly indebted. Deflation raises the real cost of servicing debt and the non-rich have no flexibility in this area. Given the over indebted status of the average American, deflation at this stage is a bad thing for them absent bankruptcy.

Given the above, as well as other factors, one can see why the stage is set for continued currency debasement.

Zachriel said...

Rick T: You have it backwards.

Pricing instability is generally bad, but it doesn't affect everyone equally.

With deflation, those who have cash generally benefit, as their dollars can now buy more. Deflation is bad for debtors, as money is paid back in dearer dollars. Deflation also tends to cause unemployment as wages are sticky.

Overall, as the poor tend to have little available cash, have higher debt per asset ratio, and rely much more upon employment for sustenance, they are most impacted by deflation.

Rick T. said...

Zachriel: You have to dig a little deeper to understand things, try to be a chess player who is able to think more than one ply at a time. Of course then you'll have to give up Keynesianism, but you'll be a better person for having done so.

You said "Overall, as the poor tend ... to have higher debt per asset ratio, and...they are most impacted by deflation."

Have the poor always tended to be net debtors? Actually, no. For centuries the poor had no money, but were rarely in debt because no one would lend them any money, since they had no assets for security and not enough income to support the debt. It has only been in the last hundred years, with the demise of the gold standard and the rise of central banks with the ability to print money at will that we have seen the vast bulk of people in Western economies turn into debtors. They did/do so rationally, because the steady money printing results not just in "inflation" as it is conventionally defined, i.e., a rise in the price of goods and services, but a rise in asset prices, as people trade in their newly printed dollars, euros, pounds, or whatever, for something real that unlike fiat currencies can't be conjured out of thin air, such as real estate, stocks, bonds, art works, etc.

Poor people aren't stupid. They see those with assets benefiting from asset price inflation, and want to get into that game, so they borrow money to do so. Unfortunately for them, the government "helps" them buy houses at the top, and "helps" them with student loans that they will never make enough money to repay.

So yes, many poor people are in debt, but they are only in debt out of self defense, their way to protect their relative position in a society where the rich get richer because of rising asset values curtesy of a money printing central bank.

Deflation is bad only after the central banks have pressured the populace to borrow to try to keep up with the rich, who own assets without having to borrow. The solution isn't to continue the inflation, which continues to impoverish those without assets, but to switch to an honest, stable money system (gold is a great candidate) in which there won't be a central bank constantly blowing asset bubbles and justifying them on the grounds that goods and services aren't also going up.

Wage rates have fallen behind the increase in energy and food prices, but the worst off are those who have retired and get no wages. Retirees with savings now earn nothing, while their expenses keep rising. I would like to see Bernanke chat with some of them and explain why inflation is so great. If there were deflation, they might have some money left after paying for food, gas, and heat.

Tel said...

The argument of who suffers from inflation and deflation is old and boring. I still say that price stability is the very best that any Reserve Bank can offer.

Much more interesting is the political situation for the coming election. Krugman obviously wants Obama to win, I mean that much is surely uncontroversial. If the Romney/Ryan team is going to win, they absolutely need the Libertarian vote to achieve that. I think Ron Paul proved this in the primaries, just going on rough numbers and the back of the envelope.

The biggest threat to Romney/Ryan is that perhaps the Libertarian voters don't see Ryan as sufficiently committed to the real cause of freedom (and there are indeed valid reasons for that point of view, Ryan is no Ron Paul by any means, but he's not the worst pick either). Libertarians might choose not to vote at all, or just vote RP anyhow as a protest (a perfectly legitimate protest, but non-functional never the less).

OK, so think about this strategically. The worst thing that could happen for Ryan (and hence best thing for Obama) is that the Libertarian voters think of Ryan as some sort of RINO corporatist lackey who does the job that the establishment sends him to do.

What does Krugman do here? Well, he does his best to establish Ryan's credentials as a real tooting Ayn Rand loving, gold standard supporting Liberty freak. Obviously it's a caricature but it does sound like either Krugman is doing his level best to move the swing vote over to the Romney camp, or else I've completely misread the situation and this charade is somehow a requirement to mobilize the Democrat base.

Is Krugman really that far out of tough with what's going on? Or maybe I am?

Zachriel said...

Rick T: Have the poor always tended to be net debtors? Actually, no. For centuries the poor had no money, but were rarely in debt because no one would lend them any money, since they had no assets for security and not enough income to support the debt.

For centuries, the poor were peasants tied to the land, and what little they had they had through barter.

In any case, that wasn't the question being raised. You had claimed that the poor are generally helped by deflation. That is incorrect. In deflation, cash is king. Many rich, who might be overly leveraged, can be ruined by deflation, but if anyone has substantial cash reserves, it is the rich, not the poor. The poor rely on wage labor, and due to stickiness in the wage labor markets, they are often unemployed during periods of unemployment. In addition, during any period of instability, the poor have it worse, as their loss of income may result in serious want.

Zachriel said...

... they are often unemployed during periods of deflation.

Mike M said...

Zac
Go back and reread my 10:33 and Rick T’s 8:24. Keep rereading until it sinks in. Seriously dude, I read your stuff and I feel like my eyeballs are starting to bleed.

Zachriel said...

Mike M: Go back and reread my 10:33 and Rick T’s 8:24. Keep rereading until it sinks in.

We read your comments, then responded. You, on the other hand, did not.

In deflation, cash is king.

Mike M said...

In deflation, cash is king

No kidding, really?

It's the rest you didn't get

Mike M said...

Zac
BTW you said "WE read your comments.

Are you part of a collective? Member of the Borg?

Zachriel said...

Mike M: It's the rest you didn't get

Notably, you still didn't respond.

In deflation, cash is king. Many of the rich, who might be overly leveraged, can be ruined by deflation, but if anyone has substantial cash reserves, it is the rich, not the poor. With fixed payment assets, debtors lose and creditors win. Again, the rich are more likely to be creditors. The poor rely on wage labor, and due to stickiness in the wage labor markets, they are often unemployed during periods of deflation. In addition, during any period of instability, the poor have it worse, as their loss of income may result in serious want.

Mike M said...

Zac

My main issue with your post is for the most part all you have done is state the obvious. Yet it is the obvious of the "A" side of the record and you're stuck on it. You need to play the "B" side and listen to it. Re-read my 10:33 and Rick T’s 8:24. That has some of the "B" side.

The other issue is your argument of "stickiness." Again obvious but you state is as a conclusive element to your position. You fail to recognize that there are plenty others in society besides the "rich with cash" that benefit from mild natural deflation. If the economy suffers from 20% unemployment, you have 80% still working that benefit, non wage earners, fixed income recipients etc. Are they to be denied the benefits at the expense of another class of citizens politically favored at a given moment?

You correctly state that in the current economy the debt ridden poor would suffer most from any form of deflation. But the issue is the DEBT, not the natural deflation forces.

Listen to side "B". Look through a few windshields in front of you not just your own.

Zachriel said...

Mike M: Yet it is the obvious of the "A" side of the record and you're stuck on it.

So you have no disagreement with our position on side A. Yet, you agreed that John Goodman had it backwards when he said "Deflation unambiguously helps the wealthy at the expense of the poor, by increasing the value of debt."

But Goodman didn't have it backwards. While it is not unambiguous (even the rich can be overleveraged), it is certainly true as a general rule. So you were either wrong then, or wrong now.

Mike M: Inflation can benefit the rich who own assets that benefit from the inflation and reduce the real burden of any debt they hold used to acquire those assets.

Inflationary increases in asset value doesn't mean anything as any profits are spent on higher priced commodities; that is, unless the asset is paying a fixed return, in which case inflation hurts and deflation helps.

Mike M: The non-rich on the other hand would benefit greatly from mild natural deflation.

No, for the reasons already given.

Mike M: Their cost of living burden would reduce and their ability to buy selected assets would not climb out of reach.

No. Because there is downward pressure on wages, so they have less money to buy the lower priced goods. It's a wash, except that the poor are more likely to have debt, which becomes a burden, more likely to lose their jobs during deflationary periods, leaving them destitute, and being poor, having few reserves on which to subsist.

Mike M: If the economy suffers from 20% unemployment, you have 80% still working that benefit, non wage earners, fixed income recipients etc. Are they to be denied the benefits at the expense of another class of citizens politically favored at a given moment?

That's a moral question, which you have just answered.

Zachriel said...

Mike M: If the economy suffers from 20% unemployment, you have 80% still working that benefit, non wage earners, fixed income recipients etc. Are they to be denied the benefits at the expense of another class of citizens politically favored at a given moment?

MM: If the 99% of the people have to suffer, are the 1% to be denied the benefit?

MM: If you could torture one innocent child and provide endless plenty for everyone else ...

Dennis said...

An economy only grows when entrepreneurs develop new techniques that create more production per unit of capital and labor. In other words, economic growth is a result of increasing the division of labor. Since multiplying the medium of exchange cannot possibly have any impact on the division of labor, inflation cannot make an economy "grow" any more than chanting nursery rhymes could create a rainstorm.

Mike M said...

Zac,

You’re pathetic. I made a point to illustrate that there is more than one side to the argument about who benefits and is disadvantaged from inflation/deflation environments. You have completely distorted the point by playing the “1%” game and implying torture of children for some alleged greater good.

You’re either intellectually deficient in ability to engage in critical thinking about abstract matters or you’re intellectually dishonest.

Either way, I don’t care.

Go home and get your shine box. You’re in over your head here.

Zachriel said...

Mike M: I made a point to illustrate that there is more than one side to the argument about who benefits and is disadvantaged from inflation/deflation environments.

Sure, but you incorrectly said Goodman had it backwards. While he didn't allow for exceptions, he was largely correct.

Mike M: Either way, I don’t care.

You had said "If the economy suffers from 20% unemployment, you have 80% still working that benefit, non wage earners, fixed income recipients etc. Are they to be denied the benefits at the expense of another class of citizens politically favored at a given moment?" Most people think that everyone should productively contribute and be included in the modern economy rather than some benefiting from the economic misery of others.

Zachriel said...

Dennis: An economy only grows when entrepreneurs develop new techniques that create more production per unit of capital and labor.

Or when idle resources are put to work.

Mike M said...

Zac,
I revise my criticism of Goodman’s post. He is neither right nor wrong, just woefully incomplete in his analysis. Sometimes an inherent element of a Blog response forum.

“Most people think that everyone should productively contribute and be included in the modern economy rather than some benefiting from the economic misery of others.’
Nice platitude. Hard to disagree with superficially. The problem is in the detail of method. The vast majority of economic misery suffered by people has its roots in tyranny in one form or another. You continue to ignore the fact there are groups of people that would benefit from natural deflation elements in the economic system and they have every legitimate right to those benefits.

“Or when idle resources are put to work”

If private assets are idle, there is a reason. Its private property. It’s the owner’s decision based on all the inputs in the marketplace. Sometimes the decisions are correct, sometimes not. More importantly, who are you or any other central planning busybody to artificially manipulate behavior as if you know better?

Zachriel said...

Mike M: Nice platitude. Hard to disagree with superficially.

Good. That's called common ground. The reason for the previous exchange wasn't because you would agree the extreme positions, but because you would disagree.

Mike M: The vast majority of economic misery suffered by people has its roots in tyranny in one form or another.

Nice platitude. We agree.

Mike M: You continue to ignore the fact there are groups of people that would benefit from natural deflation elements in the economic system and they have every legitimate right to those benefits.

While some would certainly benefit from deflation (e.g. people with cash, or assets with fixed payouts), why would they have a 'legitimate right' to the additional benefits due to deflation?

Mike M: If private assets are idle, there is a reason.

Perhaps, but that doesn't change the answer to Dennis' comment. Economies can grow not only through greater efficiency, but by putting idle resources to work.

Mike M said...

Zac,

"The reason for the previous exchange wasn't because you would agree the extreme positions, but because you would disagree'

Silly game. Not constructive.


“…why would they have a 'legitimate right' to the additional benefits due to deflation?”

Because it’s an inherent property interest in their asset (ie increased purchasing power of cash or income). Because it would naturally occur absent government monetary interference.

As a corollary, would you deny the inherent adjustment upward in an individual’s asset value due to currency debasement? That would be unjust. It would be stealing just as stripping away an individual’s increased purchasing power from deflation is stealing.

Actually the since we (USA) do not index capital gains tax for inflation does in fact steal some of the compensation purchasing power loss by taxing phantom gains.

Dennis said...

Why should the simple act of multiplying the medium of exchange (inflation) necessarily put any idle resources (the unemployed?) to work? No causal connection between these two events is being demonstrated here.

The stagflation period of the 1970's, which was characterized by both high inflation and high unemployment, should put to rest the notion that inflation somehow helps the unemployed.

Wage reductions eventually help an economy recover from a recession by restoring business confidence and thus profitability. You don't need inflation to achieve this, however. Rescinding government controls over the labor market will do the same thing without the economic distortions that inflation creates.

Zachriel said...

Mike M: Because it’s an inherent property interest in their asset (ie increased purchasing power of cash or income). Because it would naturally occur absent government monetary interference.

Not sure your point. The underlying value of assets doesn't depend on deflation. Indeed, in the simplified case, it makes no difference the denomination, as all assets will deflate equally and have the same relative value (excepting those denominated in fixed dollar returns during the term of their payout).

Dennis: Why should the simple act of multiplying the medium of exchange (inflation) necessarily put any idle resources (the unemployed?) to work?

First things first. What you said was "An economy only grows when entrepreneurs develop new techniques that create more production per unit of capital and labor." But that's not correct, is it?

Rick T. said...

Zachriel: I think the main reason for your, and other Keynesians', confused thinking is that you believe that "deflation" (as it is conventionally defined, a fall in prices) is just one very bad thing, whereas it is actually a number of possible different things, most of which have positive effects on the economy and living standards.

If we don't consume all our output, but rather save and invest, we can increase productivity. Higher productivity should cause a constant decrease in prices. After all, higher productivity is defined as getting more output from the same input, meaning cost per unit drops, which means prices will drop. When prices drop, customers can buy more for the same money (that is good) or they can buy the same amount for less money and use what they didn't spend to to buy other stuff as well (also good) or save and invest and, if the central bank hasn't manipulated interest rates to 0%, have even more to spend in the future (also good.) Constant deflation is the normal state of a healthy economy and creates growing demand and savings as people find themselves with more money to spend or save, since they can buy the same things for less.

Keynesian hatred of deflation is based on the mistaken idea that people will not buy something if they think the price will be lower in the future. I certainly wouldn't buy a stock if I thought it was going to go down, but as far as consumption items go, most people don't care what they will sell for in the future. I presume you own a computer, or you wouldn't be posting here outside of library hours. Are you aware that every year since they have been introduced, computers keep going down in price for what you get? Has that stopped you from buying many of them over the years?

Any chance you could go to anyone, with a job or without a job, and ask them this: Would you like what you pay for food and gasoline to keep going up a lot all the time, or down a lot? Let us know whether you find anyone at all who agrees with Keynesians that deflation is bad.

Deflation of asset values, when those assets have been purchased with a lot of debt and the assets don't throw off enough cash to support the debt, is a problem for the owner of the assets and the economy in general. But that problem is caused by a combination of bubble blowing by monetary authorities that makes debt based speculative malinvestment so profitable, and fractional reserve banking that amplifies the downside when the cycle turns. The asset deflation is consequence of bad government policy and laws, not anything wrong in of itself. If you don't want a deflationary depression, don't create an inflationary bubble first. It is that simple.

To circle back to my previous comment on deflation being the natural, unmanipulated course of an economy, the fact that we had stable or slightly rising prices in the fifteen years before the peak of the real estate bubble, despite some extra deflationary pressures from the emergence of China as a new low cost supplier, shows that monetary policy was way too easy during that period and a major cause of that bubble. If monetary policy had been truly neutral (or better yet, there was no central bank or monetary policy at all, letting the market just do its job) prices would have been steadily dropping all that time.

Anonymous said...

I think you guys are getting off subject, twenty years ago Milton Friedman wrote a article on Why Paper is Better Than Gold. He did it with no ad hominem attacks. The point he made is that inflation is a tax on holders of currency while it is a subsidy to holder of debt. (Holders of real assets sorta break even) But of more interest is the fact that paper is flexible in that if the population has an increase of productivity of 3% and is willing to pay a tax on currency (inflation) of 3% then you can increase the money supply by 6% a year. The question Friedman was asking is “Who should get this free money?” As we know right now the banksters of the Federal Reserve and the Goldman Sachs get it. And I would not complain (very much) if they were running the system efficiently and effectively, but they are not. They are screwing us over while living high on the hog. If it weren’t for the bailouts, half of Wall Street would be wearing orange jumpsuits and leg shackles and the other half would be providing full employment to the trial lawyers. (Think George Bush and Enron). Would I go back to the inefficiency of the gold standard to keep these crooks and criminals from screwing me? I would in a minute.

Zachriel said...

Rick T: Higher productivity should cause a constant decrease in prices.

If there are more goods and the same quantity of money, then overall prices drop. And if people need more of everything, that's great. But it can also lead to overproduction and unemployment.

Rick T: If we don't consume all our output, but rather save and invest, we can increase productivity. Higher productivity should cause a constant decrease in prices.

Yes, that's the classical view, which applies much of the time. Deferred consumption is available for investment, lowering prices, and spurring consumption; a governor effect, which helps keep the economy on an even keel.

However, a problem occurs with deflation, where it can be more profitable to hoard cash than to invest it.

Rick T: Constant deflation is the normal state of a healthy economy and creates growing demand and savings as people find themselves with more money to spend or save, since they can buy the same things for less.

Why are you ignoring the downward pressure on wages? And because wages are sticky, the attendant unemployment.

Rick T: I certainly wouldn't buy a stock if I thought it was going to go down, ...

That's right. People simply withdraw their money from long term investments. That causes prices to drop further, spurring more people to withdraw from long term investments.

Rick T. said...

Zachriel: "If there are more goods and the same quantity of money, then overall prices drop. And if people need more of everything, that's great. But it can also lead to overproduction and unemployment."

Regardless of the quantity of money, improved productivity in the making of a product is really the same thing as saying the cost of production drops. The first producer who figures out how to get that productivity gains extra gross margin if he keep the price the same, or increased market share if he keeps his margin the same but cuts prices. Either way he comes out ahead until others figure out how to also improve productivity, and the excess profits are competed away. This would be true regardless of the quantity of money. If we didn't even use money, when widget makers learn how to be more productive, the cost of widgets in other commodities will go down. But that is good - it makes society richer, since those not in the widget business can buy them cheaper in terms of whatever it is they trade for widgets, leaving them more to use for other things. None of this causes overproduction or unemployment.

Z: "Why are you ignoring the downward pressure on wages? And because wages are sticky, the attendant unemployment."

I don't see the mechanism by which higher productivity makes wages go down. Quite the contrary, the highest wages are paid in high productivity industries and countries, and the lowest wages in low productivity and countries. That makes sense because lower costs from productivity results in lower prices, and lower prices gives consumers more money to either spend on something else or invest.

Z: "However, a problem occurs with deflation, where it can be more profitable to hoard cash than to invest it. ... People simply withdraw their money from long term investments. That causes prices to drop further, spurring more people to withdraw from long term investments."

People invest where they believe they can make a fair return relative to risk. (Human nature is such that what many people believe about the future turns out to be wrong. At least in capitalism, risking one's own money focuses the mind, since gains or losses accrue to one's own wealth, whereas government employees spending other people's money have little incentive to spend wisely.)

My not investing in something doesn't mean that no one will ever invest in that thing ever again, as you imply. If the price of a widget factory drops enough due to many people feeling that one can't buy it at that price and get a good return, and some point the price gets low enough where someone will take the chance.

At one level, all profits or losses are nothing more than a message to the economy of where supply is too low (and therefore profits are high and more investment in capacity is needed) or too high (creating losses because there is an excess of supply over demand and we just don't need any more widget factories right then.)

If there are big price drops in some or many industries not connected to improved productivity, then companies in those businesses will start losing money, which makes sense - when there is too much capacity relative to demand, the market should not be signaling entrepreneurs to build more widget plants. Creating additional capacity when there is already excess does no one any good.

We may wish that were not the case, but that is an honest message. To invest more anyway is to destroy wealth and lower living standards. But a downturn isn't forever. As always with capitalism, there is a good working governor. When there are few good investments, interest rates will drop, sending the message that one should consume more, since one isn't getting paid to save and invest. That increased current consumption will improve the supply demand balance, restoring profits to industries and making investment more attractive.

Zachriel said...

Rick T: Regardless of the quantity of money, improved productivity in the making of a product is really the same thing as saying the cost of production drops.

We're talking about denominating it in money.

Rick T: If we didn't even use money, when widget makers learn how to be more productive, the cost of widgets in other commodities will go down.

Yes, but we're not talking about a reduction of price in a single commodity, but a general decrease in prices across the economy.

Anonymous said...

Does Zimbabwe have low unemployment? Has their inflation brought about the economic prosperity inflationists claim it does? Has it helped the poor?

Anonymous said...

Rick wins this argument against Zach. The mark of a bad economist in the 19th century is what Zach espouses here, thanks to dolts enamored with Keynes, a guy who even doubted his own 'theory' at the end of his life. For people who tout empirical-ism they sure like to ignore empirical data. Stagflation? Well, that doesn't count against us because, um, we forgot to carry the 2 in our equations but we've corrected it. Japan's lost decade and a half? Not our fault because, um, they didn't get in enough debt. Yeah, that's it. They forgot to carry the two in their equations, otherwise they would have boomed!

Funny how they never bother to check their starting assumptions, like slumps are caused by lack of demand. They will never learn.

Rick T. said...

Zachriel: Regardless of how we denominate the value of a product - dollars, yen, ounces of gold, wampum, whatever - increased productivity in making a given product will reduce its cost initially and then its price. This will make everyone in society richer, because they will have to give up less money to buy it, or barter fewer goods if there were no money, and can then use what is left for other things. There is nothing about being more efficient that will lower anyone's wages.

A general decrease in prices across the economy is what you want to happen. It makes many more people richer than if it were only one or two goods. It discourages a temporary excess of production to create extra goods for people to hoard, which is what happens when there is a general increase in prices throughout the economy.

If the general decrease in prices across the economy is occurring for a different reason, i.e., not productivity gains, but rather a simultaneous excess of supply over demand in nearly all things at once, then that is a sure sign of a collapse of debt fueled overinvestment and malinvestment bubble, caused by bad government policies (such as huge incentives to invest in housing) and bad central bank policies in the form of excessively easy money. These are not characteristic of capitalism, but are rather the consequence of government and central bank interference with the market and the money we use, combined with fractional reserve banking, which magnifies the intensity of all down cycles.

To prevent it from happening again, you have to get the government out of the economy as much as possible, and have a sound money that can't be printed at will by the central bank and given to the government, which in turn gives it to the politically favored - almost always the banks.

I don't think it is necessary to abolish fractional reserve banking, but the damage done by creating excessive credit and consequent bank runs when depositors see those loans going bad is great. Our existing system of banks being corporations with limited liability, and the existence of the FDIC which makes sure depositors have no reason to care what their bank is doing with their money, is a really stupid one. It lets bank officers enrich themselves making large numbers of bad loans, and then get to keep all that money when the bank fails and taxpayers have to pay the loss. Clawbacks or forcing banks to be partnerships with the general partners liable for losses would force them to be much more prudent in their loans in the up part of the cycle.

I mention all this because Keynesianism exists to solve a supposed problem in capitalism, depressions, that are actually caused by government policy, its agents in the central bank, and government rules on how banks are organized. Deflations that occur during depressions are a symptom of previous government induced overinvestment, not the cause of anything bad.

Mike M said...

Zac

The more I study your posts the more I am convinced you are missing a solid foundation in the subject matter of this Blog. If your foundational understanding of economics as it applies to the real world was obtained in a typical college,(like mine originally was) scrap it and start over again. Once I did that all sorts of light bulbs came on and I began to see a better harmony with the world around me.

Rick T has done a great job. My compliments to him as he provides additional ways to explain concepts. But replies in a Blog post cannot substitute for real study of a subject matter.

Please continue to contribute here but also pursue a path of further study. Nobody masters any subject and retaining intellectual curiosity and engaging in life long learning is a sign of a healthy and mature mind.

Professor Anderson, perhaps you could provide a list of books for suggested reading that should be in everyone's library.

Cheers

Mike M said...

Anonomous

Re your 12:04
The question Friedman was asking is “Who should get this free money?”

Answer: No one

Zachriel said...

Rick T: Regardless of how we denominate the value of a product - dollars, yen, ounces of gold, wampum, whatever - increased productivity in making a given product will reduce its cost initially and then its price.

Yes.

Rick T: This will make everyone in society richer, because they will have to give up less money to buy it, or barter fewer goods if there were no money, and can then use what is left for other things.

Not everyone, but perhaps generally.

Rick T: There is nothing about being more efficient that will lower anyone's wages.

People only want so many widgets. If you can saturate the market with widgets using fewer workers, then workers will be laid off. They may find other jobs, but that takes time and money; one of many sources of friction. And unemployed people cut spending, so demand drops, and you have deflation beyond what is expected due solely to productivity gains.

Rick T: A general decrease in prices across the economy is what you want to happen.

Assuming nothing else changes, but other things often do change. The problem with a general deflation, even if strictly due to productivity gains, is that people will tend to horde cash rather than spend or invest. Why should they risk their money, when their wealth increases simply by putting cash in a mattress. This lowers the velocity of money, and creates additional deflationary pressure. Asset prices will drop to compensate, but if this creates an expectation of more deflation, people will hold onto their cash even more.

Meanwhile, debtors are in a situation where their effective debt is increasing, so they cut spending, creating more deflation.

Your model only works in an abstract world. In the real economy, there are many more forces at work.

Rick T. said...

Zachriel: "The problem with a general deflation, even if strictly due to productivity gains, is that people will tend to horde cash rather than spend or invest. Why should they risk their money, when their wealth increases simply by putting cash in a mattress."

Not true. Please look at the process, step by step, product by product: 1) Company X within the Widget Industry figures out a more efficient way to make Widgets. Its costs therefore drop and profits rise. Unlike its competitors, its lower costs let it cut prices and still maintain good profits. 2) Other companies in the industry learn or figure out how X did it, and they do it too. They cut prices and profits return to their previous level. So prices charged for Widgets are now lower than they were, but the industry is still profitable. What would keep people from continuing to invest in the industry, despite the lower prices? The profits are still there.

To say that in a general deflation one's wealth increases by keeping cash in the mattress is not the case in the real world. If you are hungry today, and you see from looking at futures prices that food will be cheaper next month, do you feel you are getting richer by not eating? We've known for decades now that every year computers get more powerful and cheaper, so does everyone sit around not buying them because their wealth will increase as their dollars will be worth more? Obviously no to both examples.

Consumption items that you want now are always more valuable now than not having them because you expect them to be 1% cheaper a year from now. Most people figure, hey, they might not even be alive in a year. And since, with improving productivity and lower costs a business can lower its prices and not hurt profits, the idea that entrepreneurs will leave their investment dollars in the mattress, turning down profitable investments because the industry in question has falling prices, makes no sense. Haven't computer and software companies invested billions over the years in an industry where falling prices are endemic? Despite Keynesian orthodoxy, deflation is good for the economy and society, not bad.

"Your model only works in an abstract world. In the real economy, there are many more forces at work."

I am trying to simplify things to explain them, but adding complexity favors my side, not yours, since markets handle complex interactions better than governments do. See the USSR economy, and the Chinese economy before its turn away from statism and toward capitalism 20 years ago, for some recent examples in the real world.

Zachriel said...

Rick T: What would keep people from continuing to invest in the industry, despite the lower prices?

Because innovation is never a sure thing. There was that guy who invested in mechanical typesetters, a great idea, no doubt. He poured all his money into it, and went bankrupt. They'll probably make it work one day. Who knows. And that lady who put money into electric car lights. Sounds like the next great thing. But they couldn't make the batteries last long enough compared to old fashioned acetylene lamps. Poor thing, ended up impoverished. That's innovation for you! There's risk.

Where did you get the idea that risking your money in innovation was a sure thing?

Rick T: To say that in a general deflation one's wealth increases by keeping cash in the mattress is not the case in the real world.

Um, because that is the case in the real world when you have deflation.

Rick T: If you are hungry today, and you see from looking at futures prices that food will be cheaper next month, do you feel you are getting richer by not eating?

That's irrelevant as that money isn't available for investment.

Rick T: We've known for decades now that every year computers get more powerful and cheaper, so does everyone sit around not buying them because their wealth will increase as their dollars will be worth more?

No, because the modern economy is usually inflationary. So the money is wasting away if sitting in a mattress. You have to take some risks in order for your wealth to grow, or even to break even.

Rick T: I am trying to simplify things to explain them, but adding complexity favors my side, not yours, since markets handle complex interactions better than governments do.

So now you change the subject. We're quite aware that markets act as a great distributed intelligence.

Rick T. said...

Zachriel: "Where did you get the idea that risking your money in innovation was a sure thing? "

Hey, I know that better than you - investing in new things has been my business for more than 40 years. You were arguing that declining prices cause investors not to invest, regardless of whether or not the declining prices are associated with an increase, or at least no diminishment, in profitability, due to lower costs from rising productivity. You are wrong.

Only if the drop in prices came from overcapacity in the industry and the cause of losses would investment diminish, and rightly so. Losses are the way the market tells people we have enough capacity, please do not waste our limited capital be creating more of it. Statist systems lack that information flow, or they ignore it because, say, investing in solar energy sounds sexy.

In any event, uncertainty and risk exist in every investment at all times, and has nothing to do with inflation or deflation.

Your other comments also don't really make much sense as responses to what you are quoting from me. For example, I asked whether steadily declining prices of computers stopped you from buying them, as you claim is how people behave in deflations, and you responded that one has to take risks in an inflationary economy. I am glad to argue our various issues, but this time you aren't giving me anything sensible to respond to.

Zachriel said...

Rick T: You were arguing that declining prices cause investors not to invest, regardless of whether or not the declining prices are associated with an increase, or at least no diminishment, in profitability, due to lower costs from rising productivity.

No. It doesn't preclude investment, it just discourages it. This was your question.

Rick T: What would keep people from continuing to invest in the industry, despite the lower prices?

The answer is risk balanced against the safety of money in a mattress.

Rick T: In any event, uncertainty and risk exist in every investment at all times, and has nothing to do with inflation or deflation.

Of course it does, for the reasons given above. But we'll repeat it again. In a deflationary economy, money in a mattress gains value with little or no risk. In an inflationary economy, money in a mattress loses value, so it encourages people to invest the money before it loses its value.

Rick T: For example, I asked whether steadily declining prices of computers stopped you from buying them, as you claim is how people behave in deflations, and you responded that one has to take risks in an inflationary economy.

If you're talking about a home computer, that's consumption. People buy home computers because they want them now. If you are talking about an investment, which is the topic, then people buy them now because they need to invest in order to grow their wealth. In a deflating economy, they can delay the investment indefinitely and still increase their wealth with little or no risk.

Anonymous said...

But we'll repeat it again. In a deflationary economy, money in a mattress gains value with little or no risk.

You know, people don't just eternally store money under the mattress, specially because a load of money will have no value for you if you don't use it eventually.

In a deflating economy, they can delay the investment indefinitely and still increase their wealth with little or no risk.

The more money people save, the more money available for enterpreneurs which would certainly give people incentives so they would invest their saved money. Specially because having a lot of money is not useful if you don't have anything to buy.

BTW: people don't just wait eternally before they buy an iPhone. Even if they know the next iPhone will be cheaper.

Zachriel said...

Anonymous: You know, people don't just eternally store money under the mattress, specially because a load of money will have no value for you if you don't use it eventually.

Eventually, most people will spend their money when they want something, but the question is what to do with excess cash until that time.

Anonymous: The more money people save, the more money available for enterpreneurs which would certainly give people incentives so they would invest their saved money.

We're talking about money saved in a mattress. In a modern economy, with deflation, people tend to move money out of risk with preference to liquidity.

Rick T. said...

Zachriel: "If you're talking about a home computer, that's consumption. People buy home computers because they want them now. If you are talking about an investment, which is the topic, then people buy them now because they need to invest in order to grow their wealth. In a deflating economy, they can delay the investment indefinitely and still increase their wealth with little or no risk."

Consumption varies by country by time, but to look at the US in the current day, it amounts to about 70% of GDP, if I recall. When there is a general deflation, anyone with a job or fixed income becomes wealthier, in that they can buy more things, or pay down debt, with the money they are saving through lower prices. One cause of the strong economy in the Clinton years came from the new availability of goods from China which were much lower priced than the US manufactured goods they replaced, giving people more money to spend on other things. Wal-Mart selling Chinese goods cheap created jobs all over the economy, since its customers now had more money to spend on other things. As Bastiat pointed out, you have to look at "that which is unseen."

So you now appear to agree with me that deflation is good for consumers, and that the outlook for lower prices doesn't cause a consumer to keep money in the mattress because they want the computer or the food now, not a year from now. And you will probably concede now that with consumption ~70% of GDP, deflation in some things would boost demand for other things and help the economy that way. Good.

But you still insist that a mattress is a compelling alternative to investors when there is deflation, even if they believe that an investment in some business would bring a higher return. But consider the magnitudes involved. As you have said, prices tend to be sticky on the downside. So what is the biggest deflation anyone is likely to expect, or we have ever had? 1%/year? 2%? Has it ever been more than 5% except for a very short interval? I don't have time to look it up, but these are very trivial returns.

People who invest in a business believe, rightly or wrongly, that the investment will bring 15% or 25% or 50%, an order of magnitude something like that. You think they are going to trade in that potential because deflation might reduce it by 1%? I am not saying that people always achieve their goals, but they wouldn't be investing in a risky business (and usually adding a lot of sweat labor) to earn 1% more than they would make in a bank CD or in their mattress because there is a tiny amount of deflation.

The only thing in which one can fairly say investment is higher during inflationary times is inventory. A car maker will buy extra steel if it thinks the price of steel is going to go up. But building inventories provides a very limited and temporary help to the economy, and hurts the economy as soon as price increases moderate and the car maker works off excess inventories so it can pay down debt. This creates extra volatility and layoffs at the steel maker. Who needs that?

If the best you can say for inflation is that it hurts consumption, it doesn't affect investment much, but it ties up capital needlessly in extra inventory and thereby makes the economy more volatile, then I'll stick to the idea that we should be trying to encourage deflation, not inflation.

Mike M said...

Zac said "but the question is what to do with excess cash until that time. "

What is "excess" cash? At what point does savings become excess? What is the proper format of savings? What is the proper time frame to hold cash or savings?

Who defines these terms? You or the holder of the asset?

Who are you or any other central planning elite to dictate to me, either via edict or policy manipulation, what to do with my property? If I make a bad decision, I am responsible for my action. If you as a central planner make a bad decision, you are responsible. In which case whom do I petition for redress? Or are central planner infallible?

You see, when you decide you want to play master of the universe, you raise more questions than you answer.

Zachriel said...

Rick T: When there is a general deflation, anyone with a job or fixed income becomes wealthier, in that they can buy more things, or pay down debt, with the money they are saving through lower prices.

When there is general deflation, there is also downward pressure on wages.

Rick T: One cause of the strong economy in the Clinton years came from the new availability of goods from China which were much lower priced than the US manufactured goods they replaced, giving people more money to spend on other things.

It wasn't a general deflation. And it displaced American workers. However, the economy was rapidly expanding, so it absorbed those workers. Notably, there was ~2½% annual inflation from 1993 to 2001.

Rick T: So you now appear to agree with me that deflation is good for consumers, and that the outlook for lower prices doesn't cause a consumer to keep money in the mattress because they want the computer or the food now, not a year from now.

People may delay some purchases due to deflation, but if they have excess money, they will spend it at some point.

Rick T: But you still insist that a mattress is a compelling alternative to investors when there is deflation, even if they believe that an investment in some business would bring a higher return.

Risk.

Rick T: People who invest in a business believe, rightly or wrongly, that the investment will bring 15% or 25% or 50%, an order of magnitude something like that.

Keep selling it.

Zachriel said...

Mike M: What is "excess" cash? At what point does savings become excess?

Savings are the excess beyond what is used for consumption.

Mike M: What is the proper format of savings? What is the proper time frame to hold cash or savings? Who defines these terms? You or the holder of the asset?

Each investor makes their own determination based on their understanding of market conditions. Generally, if the economy is deflating, people move their assets to increase their liquidity. They do this because they can realize a real return, and they can avoid risks. As people do this, it reduces the velocity of money, which increases the natural deflation mentioned above. That causes more people to pull their assets. And so on.

Mike M said...

Zac said

"When there is general deflation, there is also downward pressure on wages"

So what. So long as my purchasing power of those wages remains the same. Ahhhh but wait ... You will say that harms those wage earners with debt as the debt burden will increase. The problem is staring at you smack in the face. The problem is the debt not the naturally occurring deflation.

"Each investor makes their own determination based on their understanding of market conditions."

And yet you advocate interventionist policies that interfere with natural market conditions pushing an investor to do things they otherwise would not do.

Do you not see the intellectual inconsistency in your positions.

Zachriel said...

Mike M: So what. So long as my purchasing power of those wages remains the same.

So you disagree with Rick, who claimed that people become wealthier. People with money become wealthier. Become poorer. And because of people's reaction to deflation, there are secondary effects.

Mike M: And yet you advocate interventionist policies that interfere with natural market conditions pushing an investor to do things they otherwise would not do.

At this point, we've just been discussing the economic effects of deflation. However, any time the government issues currency, they are intervening in the economy, something which has been occurring for about four thousand years.

Zachriel said...

Debtors become poorer.

Mike M said...

Zac

You're having trouble discriminating differences and critically thinking through the matter.

No I don't disagree with Rick. Investors and savors making proper decisions can become wealthier. Non investors and nominal savors that are wage earners have their cost of living reduced with and downward wage issues. I think Rick would agree but can't speak for him.

Debtors do become poorer IF they used the debt for consumption or non productive asset purchases. Do you not get its the debt that's the problem. Apparently so.

Your understanding of "four thousand years" of currency history is inaccurate and incomplete. In addition you fail to consider other government actions that artificially push people to non natural decision.

Please refer back to my earlier post encouraging you to conduct additional study. Unless of course you think you have it all figured out.

Zachriel said...

Mike M: Investors and savors making proper decisions can become wealthier.

"Proper decisions"? People making good decisions can still lose money. That's what is meant by risk.

Mike M: Non investors and nominal savors that are wage earners have their cost of living reduced with and downward wage issues.

Deflation without secondary effects would leave people without any change, as costs reduce with wages. It's the secondary effects that cause the dislocations associated with deflation.

Mike M: Debtors do become poorer IF they used the debt for consumption or non productive asset purchases.

If you mean a house, for instance, then yes.

Rick T. said...

Zach:

"Mike M: Debtors do become poorer IF they used the debt for consumption or non productive asset purchases.

If you mean a house, for instance, then yes."

I agree with you Zachriel, in this sense: Even though we like to think otherwise, a house is a consumption item, not an investment.

Yes, if you were living in the woods under a tree, moving into a house (whether you bought it or rented it) would be an investment, in that you would get a good return on your extra expense to rent or pay the mortgage, in the form of better health, a longer life with less chance of dying from an animal bite, or whatever else bad might happen to you under the trees. When you already have a decent house, going deeply into debt to have granite counters and luxury carpets is a consumption item, plain and simple. Nothing about that move that will bring in more income, but you have increased your outgo.

An investment is intended to bring in enough income to discharge any debt needed to acquire the asset. Consumption is spending money in a way that, however pleasurable, does not bring in any extra income as a result. Since we have escaped the woods (or more accurately, barely heated shacks) housing has turned from investment to consumption.

Why did so many get so far into debt to buy houses in the late real estate bubble? Because a combination of easy money from the Fed (and other central banks) and decade of pro-housing policies created the bubble, and there were powerful incentives to participate. After all the wealthy and middle class owned houses, rather than withdraw the bad policies, the government and banks figured out ways to let less wealthy into the ponzi scheme right at the top. Thank you, Barney Frank and others, for all that help!

This is another example of how every severe deflation is a consequence of a previous government and central bank induced inflationary bubble.

If you don't want a deflationary collapse, stop inducing inflationary bubbles. This is the fault of easy money and bad government policies, not anything that the free market would have cooked up on its own without the government created bubble.

Zachriel said...

Rick T: Even though we like to think otherwise, a house is a consumption item, not an investment.

In many respects, yes. So deflation hurts the average homeowner with a mortgage. Above, you seemed to be suggesting otherwise.

burkll13 said...

"People making good decisions can still lose money."

if people are losing money because of prior decisions, what makes those decisions "good"?

Zachriel said...

burkll13: if people are losing money because of prior decisions, what makes those decisions "good"?

People necessarily have only limited knowledge. If they lack prudence, for instance, ignore bad information, or fail to do reasonable due diligence, then it can be considered a bad decision. If they make the best possible decision based on the information available to them, then it can be considered a good decision.

The race is not {always} to the swift, nor the battle to the strong, neither yet bread to the wise, nor yet riches to men of understanding, nor yet favour to men of skill; but time and chance happeneth to them all.

burkll13 said...

so as long as a person intends to make a good decision, its inherently good?

no, if a person allocates resources that are out of line with consumer preference, it is in no way "good". they lose money and society is worse off.

burkll13 said...

"People necessarily have only limited knowledge."

BTW, you also need to apply this statement to the economic overlords you support. they are only people after all.

Zachriel said...

burkll13: so as long as a person intends to make a good decision, its inherently good?

Nope, that's not what we said.

burkll13: no, if a person allocates resources that are out of line with consumer preference, it is in no way "good". they lose money and society is worse off.

But everyone deals with limited information, and no one is omniscience.

burkll13: BTW, you also need to apply this statement to the economic overlords ...

That's right, which is why markets are generally much more efficient at distributing goods and innovating new products. Knowledge is distributed and communicated across the largest number of people.

Nevertheless, the race is not always to the swift.

burkll13 said...

"Nope, that's not what we said. "

no, i believe it is. a person who intends to make a good decision utilizes as much information as they deem relevant.

"But everyone deals with limited information, and no one is omniscience. "

while what you said is very true, it is irrelevant to whether the end result of decisions were good for society or bad for society. you might think that distinction is nit picky, but i think its important (in economics) to understand the differences from the different perspectives.

in this abstract situation, nothing about the end result was good; only the original motivation to act.

Zachriel said...

burkll13: a person who intends to make a good decision utilizes as much information as they deem relevant.

But we don't judge something a good decision based on intention, but whether the person does, in fact, use all the available, relevant information.

burkll13: while what you said is very true, it is irrelevant to whether the end result of decisions were good for society or bad for society.

It should have been obvious we were using the term "good" as efficacious, not in the sense of morally beneficial.

Zachriel: People making good decisions {the best choices based on the available information} can still lose money.