Social Democracy for the 21st Century: A Post Keynesian Perspective

The Rise of State Capitalism

2012-01-27T11:56:00.000-08:00

A quick post. The Economist has an interesting article here on the rise of state capitalism in the developing world, particularly China:

Neil Webb, “The Visible Hand,” Economist.com, January 21st, 2012.

Well worth a read.

What Hoover Should have Done in 1931

2012-01-26T08:06:00.000-08:00

The tired and idiotic meme that Hoover tried a properly designed Keynesian stimulus in 1931 and 1932, and that this allegedly should have stopped the Great Depression continues to permeate the minds of various Austrians.

Robert P. Murphy quotes from his book The Politically Incorrect Guide to the Great Depression and the New Deal (2009) in a recent blog post:

“As with the evaluation of Hoover’s high-wages policy, his high-federal-budget policy can be usefully contrasted with the depression occurring at the end of Woodrow Wilson’s watch. With the conclusion of World War I, the U.S. government slashed its budget from $18.5 billion in FY 1919 down to $6.4 billion one year later. As the U.S. economy entered a depression at the turn of the decade, receipts fell. The Wilson Administration responded by cutting spending even more, down to $5.0 billion in FY 1921 and then following with a single-year slash of 34 percent, down to $3.3 billion in FY 1922. (Because of the fiscal/calendar year mismatch, it is debatable whether Wilson or Harding should be associated with the FY 1922 budget.)

So how do the two strategies stack up? We already know that Hoover faced 20+ percent unemployment after the second full year of his Keynesian stimulus policies. Wilson/Harding, on the other hand, was Krugman’s worst nightmare, taking the axe to federal spending in a way that would have given even Ron Paul the willies, and during a depression to boot! Yet as we already know, unemployment peaked at 11.7 percent in 1921, then began falling sharply. The depression was over for Harding, at the corresponding point when a desperate Hoover had decided to (try to) rein in his massive budget deficits” (Murphy 2009: 49).

Some basic facts should be stated first:

(1) In fiscal year 1930, Hoover actually ran a federal budget surplus, not a deficit. Federal policy was contractionary in this fiscal year.

(2) The Federal Reserve raised the discount rate in 1931.

(3) In fiscal year 1933, total federal spending was cut in relation to fiscal year 1932. Hoover introduced the Revenue Act of 1932 (June 6) which increased taxes across the board and applied to fiscal year 1932 and subsequent years. These were contractionary measures, and these two policies are the very antithesis of Keynesianism stimulus.

Murphy declares that Hoover engaged in “Keynesian stimulus policies.” If by this he means that the effect of federal government fiscal policy was weakly expansionary in 1931 and 1932 relative to the collapse of GNP, this is true enough. In 1931, for example, it is well known that fiscal policy was expansionary: one of the stimulative measures (passed over Hoover’s objections, however) included the Veterans’ Bonus Bill. The budget may have expanded demand by 2% of GNP in 1931 more than the 1929 budget, but this was not large relative to the collapse of GNP, which is the key (Temin 1989: 27–28). In 1931, GNP collapsed by 16.11% relative to its level in 1930, from $91.2 billion to $76.5 billion.

If by these words he means that Hoover engaged in the type of proper stimulative Keynesian fiscal expansion designed to halt the depression to restore growth, he is wrong, and contemptibly wrong.

In fiscal years 1931 and 1932, Hoover did indeed raise federal spending (especially in 1932), but it was woefully inadequate. In no sense do these miserable increases compared to the scale of the GDP collapse contradict Keynesian economics. Once you factor in state and local austerity and surpluses total federal spending increases was reduced.

In order to stimulate an economy back to its growth path and potential GDP, one has to do the following:

(1) calculate potential GDP and estimate how severely GDP is likely to collapse by,
(2) estimate the Keynesian multiplier and
(3) then design fiscal policy to expand demand by tax cuts and/or appropriate level of discretionary spending increases to hit potential GDP via the multiplier.

In 1931, US GDP collapsed by $14.7 billion dollars, in a debt deflationary spiral with bank failures and a collapse in consumption, employment and investment. If we assume a multiplier of 4 (which is very high), then Hoover’s federal spending increase of $257 million dollars in fiscal year 1931 might have generated at most $1.028 billion of GDP in fiscal year 1931 (the effect of state and local fiscal policy reduced this, however).

But GDP fell by $14.7 billion dollars, and it is the height of idiocy to seriously argue that Hoover’s increase in spending in fiscal year 1931 could have prevented the depression, to offset such a catastrophic fall in GDP. It could never have done any such thing.

To stop the downturn, Hoover needed to do the following:

(1) spend an additional $3.675 billion in fiscal year 1931 in stimulus;

(2) Hoover needed to at least stop fiscal contraction by states and local government, so some bailout of them was necessary to make (1) work.

He did no such thing. Not even close. $257 million dollars is not $3.675 billion. Hoover’s federal fiscal expansion was 6.9% of the sum required.

Of course, if Hoover had quickly stabilised the banking system in 1931, the GNP collapse would have been significantly reduced as well, and the scale of the needed stimulus would have been reduced too.

There is an easy empirical way to demonstrate that a Keynesian stimulus failed and that, moreover, something is wrong with Keynesian theory:

(1) in an economy experiencing a recession, calculate potential GDP, estimate the Keynesian multiplier and
(2) design fiscal policy to expand demand by tax cuts and/or appropriate level of discretionary spending increases to hit potential GDP via the multiplier, and if
(3) the stimulus is implemented and
(4) GNP continues to collapse, then you have empirical evidence that your stimulus failed, and that there are problems with your theory.

If in 1931, Hoover had designed a fiscal policy that stimulated the economy by an additional $3.675 billion, and US GNP had simply continued to collapse, then this would have been a failed stimulus. It would provide strong empirical evidence against Keynesian theory.

However, no such thing was ever done. Keynesianism did not fail, because Hoover never tried a proper Keynesian stimulus. Hoover’s fiscal policy in 1931 and 1932 was weak and feeble fiscal expansion, woefully inadequate.

BIBLIOGRAPHY

Murphy, Robert. P. 2009. The Politically Incorrect Guide to the Great Depression and the New Deal, Regnery Publishing, Inc. Washington, DC.

Temin, P. 1989. Lessons from the Great Depression, MIT Press, Cambridge, Mass.

The Definition of a Depression

2012-01-26T04:59:00.000-08:00

What is a depression? What is the proper definition?

In the 19th century, people tended to use the term loosely to refer to contractions in real output often accompanied by deflation. In the Oxford English Dictionary, we get a general definition:

“5. a. A lowering in quality, vigour, or amount; the state of being lowered or reduced in force, activity, intensity, etc. In mod. use esp. of trade; spec. the Depression, the financial and industrial ‘slump’ of 1929 and subsequent years.”

(Oxford English Dictionary [2nd edn. 1989], s.v. “depression,” 5.a.).

The earliest use of the word in this sense cited in the Oxford English Dictionary is from an 1827 publication, where we read that the “commencement of the present year was marked by a continuance of that depression in manufactures and commerce, which had prevailed at the close of the preceding [year]” (The Annual Register: Or a View of the History, Politics, and Literature, of the Year 1826, 1827, p. 1).

In the 19th century, when people referred to output contractions (normally with price deflation), they spoke of a “slump in trade,” “depression of commerce” or “depression of trade and industry”, and so on. Sometimes writers spoke of a “depression” in certain particular sectors as well.

The 1870s and 1890s were widely spoken of as decades marked by depression in the 19th century, and the whole 1873–1896 period was also sometimes misleadingly referred to as a depression by contemporaries, because of the persistent price deflation in these years (even though real output growth went through several cycles).

But the sheer scale and length of the early 1930s contraction in many countries led to the expression the “Great Depression” to refer to this historically unprecedented slump.

However, today we would tend to refer to most contractions of output or downturns in the business cycle as “recessions.” A recession is often defined as two or more consecutive quarters of negative real GNP/GDP growth, accompanied by rising unemployment (Oxford English Dictionary [2nd edn. 1989], s.v. “recession,” 5.b: the earliest use in the quotations is from 1905).

The word “depression” has come mostly to refer to severe recessions. While there is no universal, formal and strictly-used definition, there is in fact a definition widely employed by economists:

“There is no formal definition of a depression, though an old joke says that a recession is when your neighbor loses his or her job, a depression is when you lose your job. An informal definition is an economic contraction in which output falls by more than 10 percent.” (Knoop 2010: 14).

“Another proposed definition of depression includes two general rules: (1) a decline in real GDP exceeding 10%, or (2) a recession lasting 2 or more years.”
http://en.wikipedia.org/wiki/Depression_%28economics%29

“Some economists say that if gross domestic product were to decline at a 10 percent or greater annualized rate for some unspecified period of time, that would be a depression.” (Posner 2010: 218).

This definition is also used by some astute popular writers, commentators and journalists in the popular press.

I contend that the definition of a depression as an real output contraction of 10% or more is a very useful one and ought to be employed in formal economic analysis.

Recessions are those periods where output contacts by less than 10%. A mild recession would be a real GDP contraction of up to 3.33%, a moderate recession from 3.33–6.33% and a very severe recession from 6.33–9.99%. By this definition, there was no “depression” in 1920–1921 by recent, revised GNP estimates: there was a moderate recession (either a 3.47% or 5.58% fall in real output).

Whatever definition of “depression” economists, bloggers or commentators on economics use, above all they ought to be consistent in their use and see where consistent use of the definition leads.

Let us take a very loose and, I charge, unsound definition of depression: simply using it to refer to the aftermath of a real output contraction where there is positive GNP/GDP growth but high unemployment.

While the “Great Depression” normally includes (1) the years after 1933 when the US economy suffered high unemployment along with (2) the actual period of contraction from 1929–1933, this is a special and often popular historical usage, and it is potential misleading: for the US had positive GNP growth after 1933 and falling unemployment until 1938 (when fiscal contraction again plunged the economy into recession).

Some Austrians claim that the US in 2010 and 2011 was, or is now (January 2012), in depression. Yet the US has positive GDP growth now and did so last year (and has had positive GDP growth since 2009). There has not been in a period of actual GDP contraction since 2009. By adopting such a loose definition of depression and applying it consistently, what does this lead to? By using the same definition, I could now claim that the US was in depression for virtually the whole 1890s after 1893 because of high unemployment. I could also claim it was in depression for most of the late 1870s. Only it wasn’t really by the other important metric we have: real GNP growth. There appears to have been positive GNP growth in 1895 and 1897–1900, and after 1874 in the US. What happened was a severe shock to the economy and real GNP fell well below its potential in these years. The economy was not generating enough growth to create high employment. Thus high unemployment persisted for years. This is in fact a regular condition in capitalist economies, even though they are in periods of output expansion: full or high employment is not reached.

But this state is a different situation from an actual depression (a period of severe fall in output by 10% or more). The former is what Keynes’s (misleadingly) called an “unemployment equilibrium” (which is better called an “unemployment disequilibrium”). Keynes’s view was that real-world capitalist systems have a tendency to fluctuate around a state well below full employment:

“our actual experience … [sc. is] that we oscillate, avoiding the gravest extremes of fluctuation in employment and in prices in both directions, round an intermediate position appreciably below full employment and appreciably above the minimum employment a decline below which would endanger life.” (Keynes 2008 [1936]: 229).

But such a state (with positive GNP growth) is not a “depression”: it is better called an “unemployment disequilibrium.”

Moreover, by continuing to use the same loose definition of “depression,” I could also demonstrate that many capitalist economies outside of the 1945–1973 period were very frequently in depression, because they had high involuntary unemployment. But, by that point, I have robbed the word “depression” of useful meaning, and the same also applies to the original loose use anyway: something is wrong with this self-serving definition of “depression.” It is a rhetorical trick, unsound and ought to be discarded.

A depression can be defined with respect to severity of a real output contraction or its duration. In short, a depression is

(1) a period of actual real GNP/GDP contraction where real output falls by 10% or more, or

(2) a period of actual real GNP/GDP contraction that lasts for 2 years or more (but where real output may not fall by 10% or more).

BIBLIOGRAPHY

Keynes, J. M. 2008 [1936]. The General Theory of Employment, Interest, and Money, Atlantic Publishers, New Delhi.

Knoop, Todd A. 2010. Recessions and Depressions: Understanding Business Cycles (2nd edn.), Praeger, Santa Barbara, Calif.

Posner, Richard A. The Crisis of Capitalist Democracy, Harvard University Press, Cambridge, Mass. 2010.

The Annual Register: Or a View of the History, Politics, and Literature, of the Year 1826, J. Cuthell, et al., London.

US Unemployment, 1869–1899

2012-01-26T03:35:00.001-08:00

There are a number of estimates of US unemployment in the late 19th century. One of the widely-cited estimates is that of J. R. Vernon (1994):

Year | Unemployment Rate
1869 | 3.97%
1870 | 3.52%
1871 | 3.66%
1872 | 4.00%
1873 | 3.99%
1874 | 5.53%
1875 | 5.83%
1876 | 7.00%
1877 | 7.77%
1878 | 8.25%
1879 | 6.59%
1880 | 4.48%
1881 | 4.12%
1882 | 3.29%
1883 | 3.48%
1884 | 4.01%
1885 | 4.62%
1886 | 4.72%
1887 | 4.30%
1888 | 5.08%
1889 | 4.27%
1890 | 3.97%
1891 | 4.34%
1892 | 4.33%
1893 | 5.51%
1894 | 7.73%
1895 | 6.46%
1896 | 8.19%
1897 | 7.54%
1898 | 8.01%
1899 | 6.20%
(Vernon 1994: 710).

I have highlighted in yellow those years where unemployment was over 5% and the years where unemployment showed a tendency to rise when it was above 5%.

According to the figures of Balke and Gordon (1989: 84), the US had negative GNP growth in 1874, 1888, 1893–1894, and 1896. There is a correlation between these recessions and rising unemployment in Vernon’s estimates.

But more puzzling is the marked rise in unemployment in the 1875–1878 and 1894–1898 periods.

While the double dip recession of the 1890s would explain the rising unemployment from 1893–1896, there was stubbornly high unemployment until 1898.

According to the GNP estimates of Balke and Gordon, the US had positive GNP growth rates from 1875–1878, yet unemployment rose in this period. Earlier estimates of GNP showed that the US economy experienced a recession in these years, with the NBER data showing the longest recession in US history from October 1873 to March 1879 (a 65 month recession). At the very least, there appears to have been contraction in certain important sectors.

This confirms that something was wrong with the US economy in these years, and that revised annual GNP estimates do not necessarily give us an accurate picture of the health of the economy on their own.

BIBLIOGRAPHY

Balke, N. S., and R. J. Gordon, 1989. “The Estimation of Prewar Gross National Product: Methodology and New Evidence,” Journal of Political Economy 97.1: 38–92.

Vernon, J. R. 1994. “Unemployment Rates in Post-Bellum America: 1869–1899,” Journal of Macroeconomics 16: 701–714.

US Unemployment in the 1890s

2012-01-24T11:05:00.000-08:00

With all the talk of the recession of 1920–1921 at the moment (see here and here), there is another issue: the double dip recession of the 1890s.

Various Austrians are asserting that 1920–1921 proves that austerity can “quickly” end a recession. I have debunked that nonsense here, and the dishonest (or at least misleading) reference to a depression of 1920–1921, when there was no such thing, just a mild or moderate recession (depending on whether you use the revised data of (1) Romer or (2) Balke and Gordon).

Moreover, there was quite clearly a mild or moderate recession in the 1890s that completely contradicts the Austrians’ belief that austerity leads to rapid prosperity and high employment.

I. The GNP Data
According to the figures of Balke and Gordon, 1890s America suffered a double dip recession, with contractions in real GNP from 1893–1894 and 1896.

Balke and Gordon’s estimates for real GNP are here (the GNP growth rates are my own calculations):

Year | GNP* | Growth Rate
1890 | $183.9 | 1.43%
1891 | $189.9 | 3.26%
1892 | $198.8 | 4.68%
1893 | $198.7 | -0.05%
1894 | $192.9 | -2.91%
1895 | $215.5 | 11.7%
1896 | $210.6 | -2.27
1897 | $227.8 | 8.16%
1898 | $233.2 | 2.37%
1899 | $260.3 | 11.6%
1900 | $265.4 | 1.95%
* Billions of 1982 dollars
(Balke and Gordon 1989: 84).

As we can see, according to these figures, the US had a moderate recession from 1893–1894 in which GNP fell by 2.96%, with a recovery in 1895, but a further serious recession in 1896 with real GNP falling by 2.27%.

II. Unemployment
What were the effects of these output shocks on employment? There are three estimates that have been done:

(1) Lebergott’s estimates of the unemployment rate.
(2) Romer (1986: 31):
(3) Vernon (1994: 710).

Here are Lebergott’s estimates of the unemployment rate:

Year | Unemployment Rate
1890 | 4.0%
1891 | 5.4%
1892 | 3.0%
1893 | 11.7%
1894 | 18.4%
1895 | 13.7%
1896 | 14.5%
1897 | 14.5%
1898 | 12.4%
1899 | 6.5%
1900 | 5.0%

By these figures, the unemployment rates were a disaster in the 1890s, but Lebergott’s figures are challenged by Romer (1986).

The revised figures in Romer are as follows:

Year | Unemployment Rate
1892 | 3.72%
1893 | 8.09%
1894 | 12.33%
1895 | 11.11%
1896 | 11.965
1897 | 12.43%
1898 | 11.62%
1899 | 8.66%
1900 | 5.00%
(Romer 1986: 31).

Even using Romer’s figures, the US economy did not return to high employment for nearly a decade after 1893.

Finally, here are Vernon’s (1994) figures:

Year | Unemployment Rate
1890 | 3.97%
1891 | 4.34%
1892 | 4.33%
1893 | 5.51%
1894 | 7.73%
1895 | 6.46%
1896 | 8.19%
1897 | 7.54%
1898 | 8.01%
1899 | 6.20%
(Vernon 1994: 710).

They are lower than Romer’s, but still in the high single digits.

So it does not matter what figures you use: the double dip recession of the 1890s led to high unemployment that persisted to the end of the decade. There was a period of protracted unemployment in the 1890s comparable to the aftermath of the Great Depression (in the years from 1933–1939).

III. Conclusions
An important point is that 1890s America had no central bank, government spending was a very small percentage of GDP (it fluctuated between 2.55% and 3.62% in the 1890s), and governments tended to pursue austerity in times of recession. In fact, US federal government spending fell from 1893 to 1896 and fell from $465.1 million in 1893 to $443.1 million by 1896, which was obviously contractionary fiscal policy. Yet the culmination of the fiscal contraction in 1896 saw the economy in recession again.

Above all – and I wish to emphasise this – the fiscal contraction from 1893-1896 is correlated with rising unemployment in both the unemployment estimates of Romer and Vernon. Even by Vernon’s figures unemployment remained at nearly 8% until 1898. In Lebergott’s original estimates, unemployment soared from 1892-1894, went down in 1895, but then surged again in 1896 and stayed at 14.5% in 1897. No estimates of unemployment give any support to the view that austerity returns a shocked economy to high employment quickly. Curiously, a quick look at the data on
US federal government spending shows that spending rose from 1897 to 1899, and that this is also correlated with falling unemployment in the estimates from 1897 to 1899.

As an aside, I note how utterly absurd it is for Austrians to invoke 1920–1921 as an (alleged) vindication of their theories, when in that period America had a central bank. By any definition, 1920–1921 was even less of a laissez faire system than 1890s America, so it should be less relevant than the 1890s.

If 1920–1921 can be invoked as some kind of “proof” that austerity works, then, with even greater reason, the 1890s should show the “proof” of austerity too. But it does no such thing: although there was some high real GNP growth after the double dip in 1896, this was not sufficiently high to bring unemployment down.

Why was this? After all, real GNP growth rates of 8.16% (in 1897) and 11.6% (in 1899) seem very high by the contemporary averages of the mature US economy.

But there is a crucial issue: the US was a newly industrialising economy in the late 19th century, and in this respect was very much like China in the last three decades. With a large reserve of urban labour, coming from the countryside and from overseas in the case of the US in the late 1800s, an industrialising economy requires very high growth rates to maintain employment levels. In the case of China, a GDP growth rate of less than 7–8% leads to serious unemployment:

“‘China needs a growth rate of at least 7 per cent to avoid massive unemployment’ (www.economist.com, 10 November 2008). ‘The original estimated for China’s minimum rate of growth, which was made in the mid-1990s, was 7 per cent’ (The Economist, 15 November 2008, p. 88).

More recently somewhat higher figures for minimum GDP growth have been mentioned. ‘Most economists estimate that 8 per cent growth is needed to prevent urban unemployment from rising, which could trigger demonstrations and undermine the country’s social stability’ (www.iht.com, 20 October 2008; IHT, 21 October 2008, IHT, 21 October 2008, p. 11).

‘The government is expected to supply a fiscal stimulus to keep growth above 8 per cent’ (The Economist, 11 October 2008, p. 110). ‘China's own leaders believe they need growth of at least 8 per cent a year to avoid painful unemployment’ (The Economist, 15 November 2008, p. 14).” (Jeffries 2011: 10).

In other words, a growth rate of less than 7% in China today is the functional equivalent of a recession for workers in terms of its effects on unemployment.

I suspect a similar phenomenon was going on in 19th century America: just because there were positive growth rates (even what seem like high ones in 1897 and 1899), it does not mean that unemployment was always falling or that the economy was booming.

A research question I would propose is: what level of real GNP growth was necessary in 1890s America to mop up idle labour and reduce high unemployment? If there was a certain level of positive GNP growth required to prevent falling unemployment, a moderate recession (in technical terms) with a contraction of 2.96% in GNP may well have been a disaster for employment levels. In fact, it is possible that positive growth rates of 1%–4% may have been insufficient to maintain employment. All in all, this suggests to me that America’s actual GNP was well below its potential GNP in these years. This was not a healthy economy: it was an economy operating at well below its potential and no “proof” of the success of austerity at all. Rather, the 19th century, laissez faire policies of the US government were a disaster, above all in terms of unemployment.

It is no surprise to me that you do not see the Austrians appealing to the 1890s as an example of the wonders of the free market allegedly ending the aftermath of a recession, because on the metric of unemployment alone the 1890s completely contradict their absurd fantasies.

Appendix 1: Romer’s Figures for GNP in the 1890s

Romer’s estimates for real GNP are here (the GNP growth rates are my own calculations):

Year | GNP* | Growth Rate
1890 | $182.964 | 4.53%
1891 | $191.757 | 4.80%
1892 | $204.279 | 6.53%
1893 | $202.616 | -0.81%
1894 | $200.819 | -0.88%
1895 | $215.668 | 7.39%
1896 | $221.438 | 2.67%
1897 | $233.655 | 5.51%
1898 | $241.459 | 3.33%
1899 | $254.728 | 5.49%
1900 | $264.540 | 3.85%
* Billions of 1982 dollars
(Romer 1989: 22).

Romer’s figures show no contraction in 1896, and only a mild contraction in 1893–1894. Yet we know by all estimates unemployment soared in these years. What is going on? Romer’s estimates might be flawed. More likely, I think this supports the view that America in the late 19th century was very much like China today: just because growth rates were positive does not necessarily mean the economy was healthy, or that it was growing at its potential capacity.

Appendix 2: Were Movements in the Labour Force Pro-cyclical or Countercyclical in the 19th century?

There is the question whether movements in the labour force – especially involving women – were pro-cyclical or countercyclical in the 19th century. If it was countercyclical, this adds to unemployment, as women, young adults, and perhaps even children go out and look for employment when their husband/fathers/breadwinners lose employment (for literature, see James and Thomas 2007; Weir 1986, 1992). This is relevant for the method and accuracy of unemployment estimates in the 1890s.

BIBLIOGRAPHY

Balke, N. S., and R. J. Gordon, 1989. “The Estimation of Prewar Gross National Product: Methodology and New Evidence,” Journal of Political Economy 97.1: 38–92.

James, J. A. and M. Thomas, 2007. “Romer Revisited: Long-Term Changes in the Cyclical Sensitivity of Unemployment,” Cliometrica 1.1: 19–44.

Jeffries, I. 2011. Political Developments in Contemporary China: A Guide, Routledge, Oxon, England and New York.

Lebergott, S. 1964. Manpower in Economic Growth: The American Record since 1800, McGraw-Hill, New York.

Lebergott, S. 1964. Men Without Work: The Economics of Unemployment, Prentice-Hall, Englewood Cliffs, N.J.

Lebergott, S. 1986. “Discussion,” Journal of Economic History 46: 367-371.

Romer, C. D. 1986. “Spurious Volatility in Historical Unemployment Data,” Journal of Political Economy 94: 1–37.

Vernon, J. R. 1994. “Unemployment Rates in Post-Bellum America: 1869–1899,” Journal of Macroeconomics 16: 701–714.

Weir, D. R. 1986. “The Reliability of Historical Macroeconomic Data for Comparing Cyclical Stability,” The Journal of Economic History 46.2: 353–365.

Weir, D. R. 1992. “A Century of U.S. Unemployment, 1890–1990: Revised Estimates and Evidence for Stabilization,” Research in Economic History 14: 301–346.

David Graeber versus Robert Murphy: A Review

2012-01-24T05:56:00.001-08:00

Since I have been dealing with David Graeber’s work in the last post, I will also review the debate he had with the Austrian economist Robert P. Murphy.

Let’s review the debate:

(1) This interview with Graeber (“What is Debt? – An Interview with Economic Anthropologist David Graeber,” August 26, 2011) sparked off the debate.

(2) Robert P. Murphy’s attention was drawn to Graeber’s interview by an inaccurate summary of it by Gene Callahan. Murphy admitted he didn’t even read Graeber’s book.

(3) From the very beginning, Murphy appears to have misunderstood Graeber’s position. Graeber does not deny that money in some historical circumstances can emerge from barter between strangers, especially in long distance trade. On p. 75 of Debt: The First 5,000 Years (2011), Graber cites the cacao money of Mesoamerica and the salt money of Ethiopia as instances of money emerging through barter. It is the view that money can only ever emerge from barter spot transactions that must be rejected. Murphy in his original criticism of Graeber also appeared to charge Graeber with denying that moneyless spot trade (barter) had historical existence. That was a completely false charge.

(4) What Graeber attacks is the idea that money-less communities come to have economies dominated by barter spot trades. He also notes that in reality money-less societies tend to be dominated by debt/credit transactions, and that this can largely avoid the immediate, notorious problem of the “double coincidence of wants” that allegedly leads to money’s origin. Robert Murphy eventually made a rather important concession here:
“This is an excellent point, and Graeber is right: In the standard exposition of a barter economy, economists typically think in terms of spot transactions. But in principle, there’s no reason to restrict ourselves in this way. If we can imagine a farmer trading a pig for an axe, we can also imagine a farmer trading a pig for a promise to deliver an axe in two weeks.

Graeber is also right that the possibility of credit transactions expands the scope of a moneyless economy, and mitigates the problem of finding a double coincidence of wants.”

Robert Murphy, “Murphy Replies to David Graeber on Menger and Money,” Mises.org, September 8, 2011.
(5) Murphy cites the work of R. A. Radford (“The Economic Organization of a POW Camp,” Economica 12.48 [1945]: 189–201) that demonstrates the emergence of a cigarette money in a POW camp. But this evidence does not show what Murphy thinks it does. Situations in which barter is observed in groups of human beings in modern times where some good emerges as a medium of exchange can hardly be regarded as confirming the barter origin of money theory, because the people concerned in these cases were already perfectly familiar with money and a price system (Graeber 2011: 37; see also Ingham 2006: 264–265).

Murphy’s citation of Jeff Tucker’s account of “micro-size Three Musketeers bars” emerging as a medium of exchange amongst children bartering with Halloween candies is also invalid and does not prove anything: older and even young children are perfectly familiar with the concept of money and prices.

In any case, Graeber did not deny that money can emerge this way in the distant past: what he denies is that money can only arise this way. As Graeber remarks:
“The idea that there is a single ‘origin’ of money is rather dubious in itself – if money is simply a mathematical system whereby one can compare proportional values, then something of that sort must have emerged in innumerable different occasions in human history for different reasons. The standard version of how it emerged, however, that goes back to Adam Smith, is repeated by Jevons, Menger, etc, is one of the least likely, in fact, which is strongly counter-indicated by all existing evidence.”

Robert Murphy, “David Graeber’s Response to My Article,” Mises.org, September 8, 2011.
(6) Graeber accepts the idea of long distance or regular trade between strangers generating a money unit of account:
“If you have regular exchange between strangers, it’s because there are specific goods that each side knows they want or need. One has to bear in mind that under ancient conditions, long-distance trade was extremely dangerous. …. You show up because you know there are people who have always wanted woolens and who have always had lapis lazuli. Logically, what such a situation would lead to is a series of conventional equivalences – so many woolens for so many pieces of lapis lazuli – which are maintained despite contingencies of supply and demand, because all parties need to reduce risk or the trade would simply stop. And once again, what logic would predict is precisely what we find. Even in periods of human history where money and markets did already exist, high-risk long distance trade has often continued to be carried out through a system of conventional equivalents, administered prices, between specific commodities that merchants already know will be available, or in demand, at certain pre-established locations.

Now, could such a system generate something like money of account – that is, the use of one or two relatively desirable commodities to measure the value of other ones, once more items were added to the mix (say, you’re making several stops)? Sure. It is likely that in certain circumstances, something like this did happen – but it would have meant that money, in such cases, was created first as a means to avoid market mechanisms, and that it was not used mainly as a medium of transactions, but rather, primarily as a means of account. One could even make up an imaginary scenario whereby once you start using one divisible/portable/etc commodity as a means of establishing fixed equivalents between other ones, you could start using for minor occasional transactions, to measure negotiated prices for spot trade swaps on the side, in a more market-driven way. All that is possible and likely as not did happen here and there. However there is no reason to assume that such a system would produce a concrete medium of exchange actually used in making these transactions – in fact, given the dangers of ancient trade, insisting that some medium like silver actually be used in all transactions, rather than a credit system, would be completely irrational, since the need to carry around such a money-stuff would make one a far, far, more attractive target to potential thieves. …. The other problem is there is no reason to believe that such mechanism – which would presumably only be used by that tiny proportion of the population who engaged in long distance trade, and who tended to treat such matters as specialized knowledge to be guarded from outsiders – could possibly create a money system used in everyday transactions within a society or any evidence that it might have done so.

Robert Murphy, “David Graeber’s Response to My Article,” Mises.org, September 8, 2011.
(7) In trying to reconcile Menger’s barter view of the origin of money with the evidence from ancient Mesopotamia, Murphy contends that temples picked silver as an unit of account because silver was what was used to facilitate trades with foreigners. Yet there is a misunderstanding here: the temples used their own produced goods to obtain silver from foreigners, in long distance trade. Silver was a weight unit (Hudson 2003: 42), a high prestige object, and used in temples for objects associated with the gods. As late as the Old Babylonian period (c. 2000–1600 BC), silver was largely confined to temples and palaces (Nemet-Nejat 2002: 267). It did not circulate much as an actual medium of exchange within Mesopotamia in the third millennium BC. It is highly unlikely that silver emerged as the most saleable commodity in barter spot trades and then indirect trades within Mesopotamia to attain the status of money. Rather, a silver unit of account was developed by temples from its use as a weight unit in those temples.

RESOURCES

Graeber, David, 2009. “Debt: The First Five Thousand Years,” Eurozine.com, 20th August.
An early summary of Graeber’s work on debt.

“What is Debt? – An Interview with Economic Anthropologist David Graeber,” Nakedcapitalism.com, August 26, 2011.
The original interview with Graeber that sparked the debate.

Gene Callahan, “Fiat Currency,” Saturday, August 27, 2011.
A summary of Graeber’s interview that sparked off a debate between Gene Callahan and Robert Murphy.

Robert P. Murphy, “Have Anthropologists Overturned Menger?,” Mises Daily, September 1, 2011.
This is Robert P. Murphy’s response to Graeber’s interview at Nakedcapitalism.com.

Robert Murphy, “David Graeber’s Response to My Article,” Mises.org, September 8, 2011.
This is a summary of David Graeber’s comments on Robert P. Murphy’s article “Have Anthropologists Overturned Menger?.”

Robert Murphy, “Murphy Replies to David Graeber on Menger and Money,” Mises.org, September 8, 2011.
This is Murphy’s reply to David Graeber’s comments.

David Graeber, “On the Invention of Money – Notes on Sex, Adventure, Monomaniacal Sociopathy and the True Function of Economics. A Reply to Robert Murphy’s ‘Have Anthropologists Overturned Menger?,’” September 13, 2011.
David Graeber’s final response to Murphy, published on Nakedcapitalism.com.

BIBLIOGRAPHY

Graeber, David. 2011. Debt: The First 5,000 Years, Melville House, Brooklyn, N.Y.

Hudson, M. 2003. “The Creditary/Monetarist Debate in Historical Perspective,” in S. A. Bell and E. J. Nell (eds), The State, the Market, and the Euro: Chartalism versus Metallism in the Theory of Money, Edward Elgar, Cheltenham. 39–76.

Ingham, G. 2006. “Further Reflections on the Ontology of Money: Responses to Lapavitsas and Dodd,” Economy and Society 35.2: 259–278.

Nemet-Nejat, K. R. 2002. Daily Life in Ancient Mesopotamia, Hendrickson, Peabody, Mass.

Radford, R. A. 1945. “The Economic Organization of a POW Camp,” Economica 12. 48: 189–201.

David Graeber on the Origins of Money

2012-01-23T12:03:00.000-08:00

I have just finished reading David Graeber’s Debt: The First 5,000 Years (Brooklyn, N.Y., 2011). While I will not review the whole book, a review of some of the chapters on the origins of money is worthwhile, with reference to some of the specialist literature cited by Graeber.

We won’t get very far without defining what money is, however. Money’s functions are usually divided into the following:

(1) money of account or a unit of account,
(2) a means of payment and medium of exchange and
(3) a store of value.

Graeber (2011: 21) notes that historically economists have been obsessed with the medium of exchange role, and treat the latter as the primary role.

But a crucial division can be made between (a) money conceived as what Keynes called an abstract money of account (that is, money as an abstract unit of account) and (b) things which function as an actual means of payment and medium of exchange, which act as money in an abstract or physical way.

The money of account is the unit of account in which prices and debts are measured. It is abstract. But it is clear you can have an abstract money of account without a large role for an actual physical medium of exchange. For example, in practice, many exchanges in an economy might be done by credit transactions.

Graeber notes that the mainstream view of money as emerging from barter spot trades goes back to Adam Smith (Graeber 2011: 24). The modern neoclassical economics profession is obsessed with barter because they regard money as a neutral veil and their “real” analysis of economies is essentially that of a barter system (Graeber 2011: 44–45).

It is important to note that Graeber does not deny that money in some historical circumstances can emerge from barter between strangers, especially in long distance trade. Graber cites the cacao money of Mesoamerica and the salt money of Ethiopia as instances of money emerging through barter (Graeber 2011: 75; on Ethiopian salt money, see Einzig 1949: 123–126). Graeber also cites the views of Max Weber (1978: 673–674) and Karl Bücher (1901), who argued that money emerged from barter between different societies, not within societies (Karl Polanyi may also have held a position close to this).

The points that can be made against the standard barter theory of money are as follows:

(1) the view that money can only ever emerge from barter spot transactions must be rejected.

(2) even the assumption lying behind standard neoclassical theory that money-less communities come to have economies dominated by barter spot trades is contradicted by the evidence of anthropology.

Money-less societies are frequently dominated by debt/credit transactions, or “gift exchange,” not by barter spot trades (on barter, see Chapman 1980; Heady 2005; Humphrey 1984). Even in cases where goods exchange for goods in spot trades, social relations can complicate matters considerably, and historically barter seems to have been prevalent between one community and another, or, that is to say, between people who were strangers and where relationships were implicitly or explicitly hostile (Graeber 2011: 29–30; cf. Heady 2005: 267). In small human communities, gift exchange and credit transactions in goods, services or social relations can largely overcome the immediate double coincidence of wants problem encountered in barter spot trades, and in such communities there may exist a ranked list of various things according to their value, in which certain things are also deemed roughly equivalent (Graeber 2011: 36; Graeber 2011: 395, n. 24 notes that Ralph Hawtrey was one of the few economists to consider the role of deferred payments).

Situations in which barter is observed in groups of human beings in modern times where some good emerges as a medium of exchange (as in cigarettes in POW camps, for example) can hardly be regarded as confirming the barter origin of money theory, because the people concerned in these cases were already perfectly familiar with money (Graeber 2011: 37).

In ancient Mesopotamia, money as a unit of account seems to have been the invention of temple and palace institutions. These were state institutions with large internal centrally planned economies, with complex weights and measurements for internal accounting of the products produced, received and distributed, and rent and interest owed. The units of account were (1) the shekel of silver (which was equal to the monthly grain ration) and (2) barley. One gur of barley was equal to the shekel. The shekel of silver was set by temple/palace planners to equal to the monthly grain ration (i.e., a gur of wages in barley) doled out to their workers. Thus they seem to have designed a unit of account from the major weight units: many prices were probably even set and administered in the money of account which developed from weight units (Graeber 2011: 39; Hudson 2003; 2004a; 2004b). Payment could be made in silver but in fact was probably not done so in reality very often. The economy operated on credit/debt transactions and payment could be made in real goods.

While a non-enumerated system of debts/credits or gift exchange might not give rise to money, there is clearly a role for debt in the history of money (Graeber 2011: 40), and Graeber draws attention to the work of Alfred Mitchell Innes (1864–1950), who published two important papers on money and the debt/credit origins of money (see Mitchell Innes 1913 and 1914). As a matter of interest, Alfred Mitchell Innes was influenced by the Scottish economist Henry Dunning Macleod’s (1821–1902) credit theory of money (see MacLeod 1902).

In many periods of history when coined money did exist, such as the European Middle Ages, it was actually very scarce, and societies continued to operate on debt/credit transactions: in reality the following conceptual development is wrong:

barter > money > credit.

In the real world, gift exchange and debt/credit arrangements existed long before money, and societies could develop an abstract unit of account in which debt/credit transactions were still the predominant system (Graeber 2011: 40). The use of coinage, when it was developed, could remain uneven and coins scarce. Instances when barter has become a predominate system (as after the collapse of the Soviet Union or Argentina after 2001) are usually when currency collapses (Graeber 2011: 40).

In a society where debt/credits are the major transaction, IOUs/debts can be transferable and used as a means of payment or medium of exchange. Graeber thinks of an example:

“Say, for example, that Joshua were to give his shoes to Henry, and, rather than Henry owing him a favour, Henry promises him something of equivalent value. Henry gives Joshua an IOU. Joshua could wait for Henry to have something useful, and then redeem it. In that case Henry would rip up the IOU and the story would be over. But say Joshua were to pass the IOU on to a third party—Sheila—to whom he owes something else. He could tick it off against his debt to a fourth party, Lola—now Henry will owe that amount to her. Hence money is born.” (Graeber 2011: 46).

A type of medium of exchange could emerge in theory in this way in small communities, or communities of specific people like merchants where IOUs can be verified. The empirical evidence demonstrates that this is precisely how promissory notes and bills of exchange become a medium of exchange. A kind of debt money can emerge in communities where there exist people willing to accept it or cancel the debt IOUs (Graeber 2011: 74). Graeber notes how for centuries English shops issued their own wood, lead or leather token money as debt money redeemable at the particular merchant’s store (Graeber 2011: 74). Graeber’s eclectic view on the origins of money is expressed in this way:

“Throughout most of history, even where we do find elaborate markets, we also find a complex jumble of different sorts of currency. Some of these may have originally emerged from barter between foreigners: the cacao money of Mesoamerica and the salt money of Ethiopia are frequently cited examples. Other arose from credit systems, or from arguments over what sort of goods should be acceptable to pay taxes or other debts. Such questions were often matters of endless contestation.” (Graeber 2011: 75)

Graeber, however, doubts that local or community debt/IOU money systems can “create a full-blown currency system, and there’s no evidence that they ever have” (Graeber 2011: 47). But this is where Georg Friedrich Knapp’s (1842–1926) chartalist theory of money comes in (see Knapp 1905; Knapp 1973 [1924]). When the state issues IOUs it can do so on a large scale, and then demand the same IOU tokens back as payment of taxes. Graeber notes the use of tally sticks in the Middle Ages: the British exchequer could issue them, and they would circulate as tokens of debt owed to the government (Graeber 2011: 48–49), but also circulate as a medium of exchange within England accepted for payment of taxes (Davies 2002: 146–151).

Graeber (2011: 59–62) also refers to the thesis of Grierson on how wergeld-like customs could create a system of measurement of relative values (Grierson 1978: 11; Grierson 1977).

The origins of money, then, lie in different sources, and not simply in a barter origin of money theory.

I end with a curious but important fact: Graeber notes how primitive monies – like shell money in the Americas or Papua New Guinea, cattle money in Africa, bead money, feather money, and so on – are often rarely used to buy everyday items in the societies that use them. Instead, they are employed in social relations like marriages and to settle disputes (Graeber 2011: 60). The story of money is rather more complex than neoclassical economists imagine.

BIBLIOGRAPHY

Bücher, K. 1901. Industrial Evolution (trans. S. Morley Wickett), H. Holt and Co., New York.

Chapman, A. 1980. “Barter as a Universal Mode of Exchange,” L’Homme 20.3: 33–83.

Davies, Glyn. 2002. A History of Money: From Ancient Times to the Present Day (3rd edn.), University of Wales Press, Cardiff.

Einzig, Paul. 1949. Primitive Money: In Its Ethnological, Historical, and Economic Aspects, Eyre & Spottiswoode, London.

Fayazmanesh, S. 2006. Money and Exchange: Folktales and Reality, Routledge, New York.

Graeber, David. 2011. Debt: The First 5,000 Years, Melville House, Brooklyn, N.Y.

Grierson, P. 1977. The Origin of Money, Athlone Press and University of London, London.

Grierson, P. 1978. “The Origins of Money,” Research in Economic Anthropology 1: 1–35.

Hart, K. 1986. “Heads or Tails? Two Sides of the Coin,” Man n.s. 21.4: 637-656.

Heady, P. 2005. “Barter,” in J. Carrier (ed.), A Handbook of Economic Anthropology, Edward Elgar Publishing Limited, Cheltenham. 262–274.

Hudson, M. 2003. “The Creditary/Monetarist Debate in Historical Perspective,” in S. A. Bell and E. J. Nell (eds), The State, the Market, and the Euro: Chartalism versus Metallism in the Theory of Money, Edward Elgar, Cheltenham. 39–76.

Hudson, M. 2004a. “The Archaeology of Money: Debt Versus Barter Theories of Money’s Origins,” in L. R. Wray (ed.), Credit and State Theories of Money: the Contributions of A. Mitchell Innes, Edward Elgar, Cheltenham. 99–127.

Hudson, M. 2004b. “The Development of Money-of-Account in Sumer’s Temples,” in M. Hudson and C. Wunsch (eds.), Creating Economic Order: Record-Keeping, Standardization, and the Development of Accounting in the Ancient Near East, CDL Press, Bethesda, MD. 303–329.

Humphrey, C. 1984. “Barter and Economic Disintegration,” Man 20.1: 48–72.

Knapp, G. F. 1905. Staatliche Theorie des Geldes, Duncker & Humblot, Leipzig.

Knapp, G. F. 1973 [1924]. The State Theory of Money (trans. H. M. Lucas and J. Bonar), Augustus M. Kelley, Clifton, NY.

MacLeod, H. D. 1902. Theory and Practice of Banking (6th edn), Longmans, Green, Reader, & Dyer, London.

Mitchell Innes, A. 1913. “What is Money?,” Banking Law Journal 30.5 (May): 377–408.

Mitchell Innes, A. 1914. “The Credit Theory of Money,” Banking Law Journal 31.2 (January–December): 151-168.

Weber, M. 1978. Economy and Society: An Outline of Interpretive Sociology (eds. G. Roth and C. Wittich; trans. E. Fischoff et al.), University of California Press, Berkeley and London.

Daniel Kahneman Interviews

2012-01-23T09:04:00.001-08:00

Daniel Kahneman has done a considerable amount of work on human intuition and decision making. I highly recommend his paper “A Psychological Perspective on Economics” (American Economic Review 93.2 [2003]: 162–168), and I have already discussed the “heuristic and biases” method of Tversky and Kahneman, and how this is a very useful approach to decision-making under uncertainty, which confirms and complements the Post Keynesian theory of business decision-making under uncertainty (Tversky and Kahneman 1974; and Kahneman et al. 1982; Fontana 2009: 39–41).

I post two videos below.

The first Daniel Kahneman talks about behavioural economics.

The second is an extended, more general interview with Daniel Kahneman by Harry Kreisler, in the Conversations with History (2007). It is a wide-ranging interview.

BIBLIOGRAPHY

Fontana, G. 2009. Money, Uncertainty and Time, Routledge, London and New York.

Kahneman D. 2003. “A Psychological Perspective on Economics,” American Economic Review 93.2: 162–168.

Kahneman, D., Slovic, P. and A. Tversky (eds), 1982. Judgment Under Uncertainty: Heuristics and Biases, Cambridge University Press, Cambridge.

Tversky, A. and D. Kahneman, 1974. “Judgment under Uncertainty: Heuristics and Biases,” Science (American Association for the Advancement of Science) 185 (4157): 1124–1131.

Austrian Substitutes for GDP – They are Aggregates!

2012-01-22T11:49:00.000-08:00

How often do we hear endless nonsense from Austrians that GDP is unsound because it is an aggregate value?

And yet – astonishingly – the only serious Austrian measures of real national output proposed in place of GDP, such as Rothbard’s Gross Private Product (GPP) and Mark Skousen’s Gross Domestic Output (GDO) are nothing but aggregates!

GDP is the following:

GDP = C + I + G + (X-M).

Rothbard’s Gross Private Product is little more than GDP, with G removed. That is to say, Rothbard’s Gross Private Product is merely this:

GDP = C + I + (X-M).

This is an aggregate of aggregates too: the total value of final consumer goods and total value of gross investment (new housing, replacement purchases, net additions to capital assets and investments in inventories), and exports minus imports. If Rothbard’s Gross Private Product is to be taken seriously, then it must be legitimate to aggregate the value of C, I, and (X-M).

Think of C as an example: the aggregation of the sale price of consumer goods in money terms in one year must be perfectly valid and meaningful, though such goods are heterogeneous. If you could not, for example, meaningfully aggregate the value of sales of heterogeneous goods in one year for a firm, how could a firm calculate its total income from sales?

Now gross investment is, as I have said, new housing, replacement purchases, net additions to capital assets and investments in inventories. Obviously, these goods are heterogeneous, and not all capital goods investments in one year will lead to a profit in the future, but you can still aggregate the sale price of these new capital goods bought (or value of new capital goods added into the capital stock). Rothbard’s Gross Private Product requires gross investment.

Government spending (G) is (1) final consumption expenditure by government and (2) government gross capital formation (infrastructure investment or research spending). Government expenditures that are transfers of money (social security payments, pensions, etc.) are transfer payments. Transfer payments are not included in government purchases. Rothbard’s Gross Private Product removes income originating in government and government enterprises.

Mark Skousen appeals to “Gross Output (GO)” – which is intermediate input plus GDP – as a more accurate measure of national output. In The Structure of Production (1990), Skousen attempted to create a new output statistic: Gross Domestic Output (GDO), as his “Austrian” alternative to GDP. However, he seems to regard Gross Output (GO) as an acceptable version of this, and Gross Output (GO) is nothing but an official Commerce department aggregate measure of output that aggregates GDP and the value of intermediate input (or what Skousen calls the “goods-in-process sector of the economy,” including commodity factor inputs, manufacturing, and wholesale stages of production).

Now, if GDP is not a meaningful or valid measure of output, how could Skousen’s Gross Output (GO) be meaningful or valid? The answer is: it couldn’t, and Gross Output can only be meaningful, if we also accept the meaningful nature of GDP.

Without a measure of the value or volume of real output, most attempts by any type of economist (Austrians included) to analyse an economy collapse: for how could you know whether Keynesian stimulus or Austrian liquidationism have the effects allegedly claimed for them, without looking at real output in some aggregate form? How could you even know whether the economy is in a recession or an expansionary phase?

Appendix

Robert Batemarco (1987) discusses Rothbard’s Gross Private Product, and on p. 183 gives a table of US GNP and Gross Private Product for the period 1947-1983.

BIBLIOGRAPHY

Batemarco, R. 1987. “GNP, PPR, and the Standard of Living,” Review of Austrian Economics 1: 181-186.

Skousen, Mark. 1990. The Structure of Production, New York University Press, New York and London.

Skousen, Mark, 2001. “Beyond GDP: A Breakthrough in National Income Accounting,” Mskousen.com, April 1, 2001
http://www.mskousen.com/2001/04/beyond-gdp-a-breakthrough-in-national-income-accounting/

“We Are All Austrians Now” and the Recent Debate about Austrian Economics

2012-01-21T04:52:00.000-08:00

Ron Paul hopes for the day when Republicans can say that they are all Austrians (with respect to economics, that is), as you can see in this video.

This has led to a surge of interest in Austrian economics and Austrian-inspired libertarianism in the blogosphere:

Matthew Yglesias, “What is ‘Austrian Economics’?”, Slate.com, January 6, 2012.

Sheldon Richman, “Austrian Economics Hits the Headlines: Critics ought to understand it first,” Freeman Online, January 13, 2012.

Sophie Roell, “Peter Boettke on Austrian Economics,” FiveBooks Interviews, January 12, 2012.

Matthew Yglesias’s “What is ‘Austrian Economics’?” provoked a response from Sheldon Richman (“Austrian Economics Hits the Headlines”).

Although I don’t disagree in principle with Yglesias’s critical post on Austrian economics, there are some other points to be made:

(1) A distinction should be made between (1) Mises’s economic and political version of Austrianism and (2) that of Murray Rothbard. Rothbard was an anarcho-capitalist who wanted the abolition of the state; Mises was a Classical liberal who believed in an important role for government as a minimal state. Ron Paul, although he supports a radical reduction in government, seems to be more like a Misesian Classical liberal than a Rothbardian anarcho-capitalist, as Paul accepts the idea of a minimal state.

An important point is that there is considerable diversity within the Austrian school on both political and economic issues. Important divisions can be made, as follows:
(1) The Anarcho-capitalists
E.g., Murray Rothbard, Hans-Hermann Hoppe and Jörg Guido Hülsmann;
The Anarcho-capitalists support praxeology, and usually natural rights or Hoppe’s argumentation ethic.

(2) The minimal state/classical liberal Austrians in the tradition of Mises
This variety supports praxeology too, but often utilitarianism as an ethical theory;

(3) Hayek’s economics, with a minimal state;
Hayek rejected Mises’s apriorism and strict Misesian praxeology for a more empirical Popperian method for economics.

(4) Moderate subjectivist Austrians
E.g., Israel Kirzner and Roger Garrison;

(5) Radical subjectivists like Ludwig M. Lachmann (1906-1990), and Austrians influenced by him.

See “The Different Types of Austrian Economics,” December 5, 2010.
In fact, on policy and political issues, there was also a clear split in the early Austrian school. Some were Classical liberals; others were what we would now call progressive liberals or even sympathetic to Fabian socialism, including the following:
(1) Eugen von Philippovich, a leader of Austrian social liberalism and Fabian socialist;
(2) Friedrich von Wieser, sympathetic to Fabian socialism;
(3) the early Hayek, sympathetic to Wieser's mild Fabian socialism, and
(4) Richard von Strigl, who was, according to Hayek, “if anything, a socialist” (Nobel Prize-Winning Economist: Friedrich A. von Hayek, pp. 54–56).

See “Friedrich von Wieser and Eugen von Philippovich von Philippsberg: Austrian Economists and Fabian Socialists,” October 21, 2010.

“Why are there no Austrian Socialists?,” June 3, 2011.
The connection with Fabian socialism that some of the early Austrians had is not something much discussed by their modern descendants, the worst of whom – the anarcho-capitalists – are little better than a cult.

(2) Yglesias states that “Austrians reject the idea that there is anything at all the government can do to stabilize macroeconomic fluctuations.” This is indeed the view of the most extreme Austrians, yet there were Austrians who supported government interventions in the depression: Hayek was the most notable example. Hayek allowed for monetary and fiscal stabilization during depressions, and, by the late 1930s, gave (qualified) support for government public works in a depression and monetary stabilization:
“Did Hayek Advocate Public Works in a Depression?,” September 25, 2011.
The Austrian radical subjectivist Ludwig Lachmann allowed an important role for government “interventions for stability,” and accepted that Keynesian macroeconomic expansion would have ended the Great Depression (hear Lachmann say so here):
“A Startling Admission from Ludwig Lachmann,” July 11, 2011.

“Ludwig Lachmann on Government Intervention,” July 9, 2011.
(3) Yglesias could have looked at other critiques of the Austrian business cycle theory (ABCT); in particular the damaging attack of Piero Sraffa (Sraffa 1932a and 1932b) of the Hayekian theory, and the collapse of the Hayekian version of the ABCT once it is seen to be an equilibrium theory requiring Walrasian fantasy notions of stationary equilibrium and the failure to consider uncertainty and subjective expectations:
“Hayek’s Trade Cycle Theory, Equilibrium, Knowledge and Expectations,” January 4, 2012.

“Austrian Business Cycle Theory: The Various Versions and a Critique,” June 21, 2011.
Secondly, Sraffa destroyed Hayek’s flawed concept of the unique natural rate of interest:
“Robert P. Murphy on the Sraffa-Hayek Debate,” July 19, 2011.

“Hayek’s Natural Rate on Capital Goods, Sraffa and ABCT,” December 27, 2011.

“Austrian Business Cycle Theory (ABCT) and the Natural Rate of Interest,” June 18, 2011.
Eventually even Hayek himself came to see his original ABCT was increasingly irrelevant to the modern world where credit flows to consumers were important:
“Hayek on the Flaws and Irrelevance of his Trade Cycle Theory,” June 29, 2011.
Furthermore, even prominent Austrians like Kirzner and Lachmann never thought the ABCT was a universal theory of cycles:
“Lachmann on Trade Cycle Models,” August 27, 2011.
(4) Yglesias notes that “developed countries that have done best in the recession—places like Israel and Sweden—are the ones that have pursued the least ‘Austrian’ courses of action.” That is correct.

One could add that in the 1930s those nations that pursued the course of fiscal contraction had the worst depressions. Weimar Germany engaged in a highly deflationary policy of budget cuts, as did a number of other countries. Yet such policies did not lead to recovery. By contrast, the nations in the 1930s that used large-scale monetary and, above all, fiscal expansion got out of the depression quickly:
“Keynesian Stimulus in New Zealand: 1936–1938,” September 23, 2011.

“Fiscal Stimulus in Germany 1933–1936,” September 3, 2011.

“Takahashi Korekiyo and Fiscal Stimulus in Japan in the 1930s,” August 27, 2011.

BIBLIOGRAPHY

Nobel Prize-Winning Economist: Friedrich A. von Hayek. Interviewed by Earlene Graver, Axel Leijonhufvud, Leo Rosten, Jack High, James Buchanan, Robert Bork, Thomas Hazlett, Armen A. Alchian, Robert Chitester, Regents of the University of California, 1983.

Sraffa, P. 1932a. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.

Sraffa, P. 1932b. “A Rejoinder,” Economic Journal 42 (June): 249–251.

Steve Keen on Debunking Economics

2012-01-20T11:36:00.000-08:00

I post here a video talk by Steve Keen, held as an open session of the IIEA Economists Group, 16 November 2011. I think this talk was held in Ireland (but I could be wrong).

Bibliography on the Origins of Money

2012-01-19T03:04:00.000-08:00

I will start a bibliography here on the origins of money, and I will attempt to update it.

For the standard Classical, Austrian and neoclassical accounts of the origin of money, see Smith (1811): 16–17, Jevons (1875), Menger (1892), Menger (1909): 555–610 (translation in Menger 2002 [1909]: 25–108), Mises (1998) [1949]: 402–404, Kiyotaki and Wright (1989), Kiyotaki and Wright (1991), Kiyotaki and Wright (1992), and Iwai (2001).

For heterodox theories on the origins of money in ancient Egypt, see Henry (2004). See also Bogoslovsky (1987) (cf. Holtz 1984), and for the history of Egyptian media of exchange, see Curtis (1951). For Mesopotamia, see Hudson (2004) and Hallo (1996): 18-25. For Greece, see the review of the work of Laum (1924) in Economica 14 (1925): 218–222; see also Peacock (2003–2004), Peacock (2006), Peacock (2011), and Semenova (2011).

Grierson (1977) and Grierson (1978) provide important analysis of the role of wergeld-like social customs in the origin of money, by arguing that wergeld provided societies with tariffs of compensation in which heterogeneous types of injury and damage were measured by means of abstract and concrete units of account. Peacock (2003–2004) develops the thesis of Grierson.

For a good starting point for anyone wishing for a specialist treatment of the origins of money from the heterodox economics perspective, see Semenova 2011.

BIBLIOGRAPHY

Arestis, P. and M. Sawyer (eds.), 2006. A Handbook of Alternative Monetary Economics, Edward Elgar, Cheltenham.

Ashley, W. M. 1925. “Heiliges Geld: Eine Historiche Untersuchung über den Sakralen Ursprung des Geldes by Bernhard Laum” (Review), The Economic Journal 35.138: 288–289.

B[?], A. R. 1925. “Heiliges Geld: Eine historische Untersuchung über den sakralen Ursprung des Geldes by Bernhard Laum” (Review), Economica 14: 218–222.
N.B. The surname of the author is not listed.

Bell, D. 1991. “Modes of Exchange: Gift and Commodity,” Journal of Socio-Economics 20.2: 155–167.

Bell, S. and J. F. Henry, 2001. “Hospitality versus Exchange: the Limits of Monetary Economies,” Review of Social Economy 59.2: 203–226.

Bogoslovsky, E. S. 1987. “On the Process of Appearance of Money in Ancient Egypt,” Altorientalische Forschungen 14: 227–236.

Crump, T. 1981. The Phenomenon of Money, Routledge & Kegan Paul, London.

Curtis, J. W. 1951. “Media of Exchange in Ancient Egypt,” The Numismatist 64.5: 482-491.

Davies, J. K. 2001. “Temples, Credit, and the Circulation of Money,” in A. Meadows and K. Shipton (eds.), Money and its Uses in the Ancient Greek World, Oxford University Press, Oxford. 117-128.

Dowd, K. 2001. “The Emergence of Fiat Money: A Reconsideration,” Cato Journal 20.3: 467–476.

Einzig, Paul. 1966. Primitive Money: In Its Ethnological, Historical, and Economic Aspects (2nd edn.), Pergamon Press, Oxford.

Goodhart, C. A. E. 1998. “The Two Concepts of Money: Implications for the Analysis of Optimal Currency Areas,” European Journal of Political Economy 14.3: 407–432.

Graeber, D. 2011. Debt: The First 5,000 Years, Melville House, Brooklyn, N.Y.

Grierson, P. 1977. The Origin of Money, Athlone Press and University of London, London.

Grierson, P. 1978. “The Origins of Money,” Research in Economic Anthropology 1: 1–35.

Hallo, W. W. 1996. Origins: The Ancient Near Eastern Background of Some Modern Western Institutions, Brill, New York. pp. 18-25.

Hart, K. 1986. “Heads or Tails? Two Sides of the Coin,” Man n.s. 21.4: 637-656.

Heidel, W. A. 1926. “Heiliges Geld, eine historische Untersuchung über den sakralen Ursprung des Geldes by Bernhard Laum” (Review), Classical Philology 21.2: 191–192.

Henry, J. F. 2004. “The Social Origins of Money: The Case of Egypt,” in L. R. Wray (ed.), Credit and State Theories of Money: The Contributions of A. Mitchell Innes, Edward Elgar, Cheltenham, UK. 79–98.

Holtz, J. 1984. Kritik der Geldentstehungstheorien. Carl Menger, Wilhelm Gerloff und eine Untersuchung über die Entstehung des Geldes im alten Ägypten und Mesopotamien, Dietrich Reimer Verlag, Berlin.

Hudson, M. 2004. “The Archaeology of Money: Debt Versus Barter Theories of Money’s Origins,” in L. R. Wray (ed.), Credit and State Theories of Money: the Contributions of A. Mitchell Innes, Edward Elgar, Cheltenham. 99–127.

Humphrey, C. 1984. “Barter and Economic Disintegration,” Man 20.1: 48–72.

Ingham, G. 2004. “The Emergence of Capitalist Credit Money,” in L. R. Wray (ed.), Credit and State Theories of Money: The Contributions of A. Mitchell Innes, Edward Elgar, Cheltenham. 173–222.

Ingham, G. 2006. “Further Reflections on the Ontology of Money,” Economy and Society 36.2: 264–265.

Ingham, G., 2000. “Modern Money,” in J. Smithin, J. (ed.), 2000. What is Money?, Routledge, London and New York.

Innes, A. M. 1913. “What is Money?,” Banking Law Journal May: 377–408.

Iwai, K. 2001. “The Evolution of Money,” in A. Nicita and U. Pagano (eds.), The Evolution of Economic Diversity, Routledge, London and New York. 396–431.

Jevons, W. S. 1875. Money and the Mechanism of Exchange, H.S. King & Co., London.

Jevons, W. S. 1923. Money and the Mechanism of Exchange (25th edn.), Kegan Paul, Trench, Trubner, London.

Kim, H. S. 2001. “Archaic Coinage as Evidence for the Use of Money,” in A. Meadows and K. Shipton (eds.), Money and its Uses in the Ancient Greek World, Oxford University Press, Oxford. 7-21.

Kim, H. S. 2002. “Small Change and the Moneyed Economy,” in P. Cartledge, E. E. Cohen and L. Foxhall (eds.), Money, Labour and Land. Approaches to the Economies of Ancient Greece, Routledge, London and New York. 52-66.

Kiyotaki, N. and Wright, R. 1989. “On Money as a Medium of Exchange,” Journal of Political Economy 97: 927–954.

Kiyotaki, N. and Wright, R. 1991. “A Contribution to the Pure Theory of Money,” Journal of Economic Theory 53: 215–235.

Kiyotaki, N. and Wright, R. 1992. “Acceptability, Means of Payment, and Media of Exchange,” Federal Reserve Bank of Minneapolis Quarterly Review 2–10.

Knapp, G. F. 1973 [1924]. The State Theory of Money, Augustus M. Kelley, Clifton, NY.

Kraay, C. M. 1964. “Hoards, Small Change and the Origin of Coinage,” Journal of Hellenic Studies 84: 76–91.

Laum, B. 1924. Heiliges Geld: eine historische Untersuchung über den sakralen Ursprung des Geldes, Mohr, Tübingen.

Lo Cascio, E. 2003. Credito e moneta nel mondo romano: atti degli Incontri capresi di storia dell'economia antica: Capri, 12-14 ottobre 2000, Edipuglia, Bari.

Mastromatteo, G. and L. Ventura, 2007. “The Origin of Money: A Survey of the Contemporary Literature,” International Review of Economics 54. 2: 195–224.

Mauss, Marcel. 2002. The Gift: The Form and Reason for Exchange in Archaic Societies (trans. W. D. Halls), Routledge, London.

Menger, C. 1892. “Geld,” in Handwörterbuch der Staatswissenschaften (vol. 3). 730–757.

Menger, C. 1892. “On the Origin of Money” (trans. C. A. Foley), Economic Journal 2: 238–255.

Menger, C. 1909. “Geld,” in J. Conrad et al. (eds.), Handwörterbuch der Staatswissenschaften (vol. 4; 3rd edn.), Fischer, Jena. 555–610.

Menger, C. 1923. Grundsätze der Volkswirtschaftslehre (2nd rev. edn.), Hölder-Pichler-Tempsky, Vienna.

Menger, C. 2002 [1909]. “Money” (trans. L. B. Yeager and M. Streissler), in M. Latzer and S. W. Schmitz (eds.), Carl Menger and the Evolution of Payments Systems, Edward Elgar, Cheltenham, UK. 25–108. [N.B. this is a translation of Menger 1909.]

Menger, C. 2007. Principles of Economics (trans. Grundsätze der Volkswirtschaftslehre [1st edn. 1871] by J. Dingwall and B. F. Hoselitz), Ludwig von Mises Institute, Auburn, Alabama.

Minnen, P. van. 2008. “Money and Credit in Roman Egypt,” in W. V. Harris (ed.), The Monetary Systems of the Greeks and Romans, Oxford University Press, Oxford. 226-241.

Mises, L. von. 1998 [1949]. Human Action: A Treatise on Economics. The Scholar’s Edition, Ludwig von Mises Institute, Auburn, Ala.

Mises, L. von. 2009 [1953]. The Theory of Money and Credit (trans. J. E. Batson), Mises Institute, Auburn, Ala.

Moini, M. 2001. “Toward a General Theory of Credit and Money,” Review of Austrian Economics 14.4: 267–317.

Müller-Wollermann, R. 1988–1991. “Funktionsträger von Geld im Alten Ägypten,” in S. Schoske (ed.), Akten des vierten Internationalen Ägyptologen Kongresses: München 1985 (vol. 4), Helmut Buske, Hamburg. 147–158.

Murphy, Robert P. 2003. “The Origin of Money and Its Value,” Mises Daily, September 29, http://mises.org/daily/1333

Peacock, M. S. 2003–2004. “State, Money, Catallaxy: Underlaboring for a Chartalist Theory of Money,” Journal of Post Keynesian Economics 26.2: 205–225.

Peacock, M. S. 2006. “The Origins of Money in Ancient Greece: The Political Economy of Coinage and Exchange,” Cambridge Journal of Economics 30: 637–650.

Peacock, M. S. 2011. “The Political Economy of Homeric Society and the Origins of Money,”Contributions to Political Economy 30: 47–65.

Powell, M. 1978 “A Contribution to the History of Money in Mesopotamia Prior to the Invention of Coinage,” in B. Hruška and G. Komoróczy (eds.), Festschrift Lubor Matouš, Eötvös Loránd Tudományegyetem, Ókori Történeti Tanszekek, Budapest. 211–243.

Pryor, F. L. 1977. “The Origins of Money,” Journal of Money, Credit and Banking 9.3: 391–409.

Robert, R. 1956. “A Short History of Tallies,” in A. C. Littleton and B. S. Yamey (eds.), Studies in the History of Accounting, Richard D. Irwin, Homewood, Il. 75–85.

Roberts, K. 2011. The Origins of Business, Money, and Markets, Columbia University Press, New York.

Rothbard, M. N., 2009, The Essential von Mises, von Mises Institute, Auburn, Alabama.

Schaps, D. M. 2001. “The Conceptual Prehistory of Money and its Impact on the Greek Economy,” in M. S. Balmuth (ed.), Hacksilber to Coinage: New Insights into the Monetary History of the Near East and Greece. A Collection of Eight Papers Presented at the 99th Annual Meeting of the Archaeological Institute of America, The American Numismatic Society, New York. 93-104.

Schaps, D. M. 2004. The Invention of Coinage and the Monetization of Ancient Greece, University of Michigan Press, Ann Arbor

Schaps, D. M. 2008. “What Was Money in Ancient Greece?,” in W. V. Harris (ed.), The Monetary Systems of the Greeks and Romans, Oxford University Press, Oxford. 38-48.

Seaford, R. 2004. Money and the Early Greek Mind: Homer, Philosophy, Tragedy, Cambridge University Press, Cambridge.

Semenova, A. 2011. “Would You Barter With God? Why Holy Debts and not Profane Markets Created Money,” American Journal of Economics and Sociology 70.2: 376–400.

Semenova, A. 2011. The Origins of Money: Evaluating Chartalist and Metallist Theories in the Context of Ancient Greece and Mesopotamia, PhD dissert. University of Missouri-Kansas City, Kansas City, Missouri.
https://mospace.umsystem.edu/xmlui/bitstream/handle/10355/10843/SemenovaOriMonEva.pdf?sequence=1

Smith, A. 1811. An Inquiry into the Nature and Causes of the Wealth of Nations (11 edn; vol. 1), Oliver D. Cooke, Hartford.

Smithin, J. (ed.). 2000a. What is Money?, Routledge, London and New York.

Smithin, J. 2000b. “‘Babylonian Madness’: On the Historical and Sociological Origins of Money,” in J. Smithin, J. (ed.), 2000. What is Money?, Routledge, London and New York.

Tymoigne, É. and L. R. Wray. 2006. “Money: An Alternative Story,” in P. Arestis and M. Sawyer (eds.), A Handbook of Alternative Monetary Economics, Edward Elgar, Cheltenham. 1–16.

von Reden, S. 1997. “Money, Law and Exchange: Coinage in the Greek Polis,” Journal of Hellenic Studies 117: 154–176.

von Reden, S. 2002. “Money in the ancient economy: A survey of recent research,” Klio 84.1: 141–174.

Wittenburg, A. and B. Laum, 1995. “Bernhard Laum und der sakrale Ursprung des Geldes,” in H. Flashar (ed.), Altertumswissenschaft in den 20er Jahren. Neue Fragen und Impulse, Franz Steiner Verlag, Stuttgart. 259-274.

Wray, L. R. 1998. Understanding Modern Money: The Key to Full Employment and Price Stability, Edward Elgar, Cheltenham.

Wray, L. R. 2002. “State Money,” International Journal of Political Economy32.3: 23–40.

Wray, L. R. (ed.). 2004. Credit and State Theories of Money: The Contributions of A. Mitchell Innes, Edward Elgar, Cheltenham.

Wray, L. R. 2008. “Banking, Finance and Money,” in J. B. Davis and W. Dolfsma (eds.), The Elgar Companion to Social Economics, Edward Elgar, Cheltenham. 478–495.

Appendix: Bibliographical Resources for the Ancient Near East

The first money we know of emerged in the ancient Near East in Mesopotamia. For those interested in resources for searching the research literature on the ancient Near East, the following are useful:

(1) “Elenchus Bibliographicus Biblicus,” 1920–1967, Biblica, Rome.
Elenchus Bibliographicus Biblicus, 1968–1984, Rome.
Elenchus of Biblica, 1985–, Editrice Pontificio Istituto Biblico, Rome.

A comprehensive annual bibliography, which covers nearly all relevant journals for the ancient Near East. This work contains extensive indices. For 1920–1967, the index was published in the journal Biblica (Pontificium Institutum Biblicum, Rome). Then it became a separate publication, the latest version of which is Elenchus of Biblica (1985 onwards).

(2) “Keilschriftbibliographie,” 1932–, Orientalia (published quarterly), Pontificium institutum biblicum, Rome.

Published in the Journal Orientalia, this is an index for work on the Ancient Near East. The index has subject and name indices, and is published as the last article in one volume of Orientalia biannually. The index provides bibliographical references to publications in the previous year under ten subject areas, viz., General, Writing and Epigraphy, Language and Philology, History of the Ancient Middle East, Religion and Mythology, Law, Science and Technology, Geography, and Archaeology.

(3) Hupper, W. G., 1987–, An Index to English Periodical Literature on the Old Testament and Ancient Near Eastern Studies. Metuchen, N. J.

This index contains citations for over six hundred journals in English for Near Eastern archaeology, history, language, science, and theology from 1793 to 1970. Five volumes have appeared, and a further five are planned.

Alla Semenova on the Origins of Money

2012-01-15T05:16:00.000-08:00

Alla Semenova (who currently appears to be a Visiting Instructor in Economics at Dickinson College; see Semenova 2011: 376, n.) is the author of this very interesting PhD from the University of Missouri-Kansas City:

Semenova, Alla. 2011. The Origins of Money: Evaluating Chartalist and Metallist Theories in the Context of Ancient Greece and Mesopotamia, PhD dissert. University of Missouri-Kansas City, Kansas City, Missouri.
https://mospace.umsystem.edu/xmlui/bitstream/handle/10355/10843/SemenovaOriMonEva.pdf?sequence=1

I am currently reading this, and it is a very useful work.

This is a good starting point for anyone wishing for a specialist treatment of the origins of money from the heterodox economics perspective. The bibliography is also up-to-date and valuable.

BIBLIOGRAPHY

Semenova, A. 2011. “Would You Barter With God? Why Holy Debts and not Profane Markets Created Money,” American Journal of Economics and Sociology 70.2: 376–400.

Semenova, Alla. 2011. The Origins of Money: Evaluating Chartalist and Metallist Theories in the Context of Ancient Greece and Mesopotamia, PhD dissert. University of Missouri-Kansas City, Kansas City, Missouri.
https://mospace.umsystem.edu/xmlui/bitstream/handle/10355/10843/SemenovaOriMonEva.pdf?sequence=1

Charles Goodhart on the Future of Finance

2012-01-15T03:24:00.000-08:00

Below is the video of a talk by Charles A. E. Goodhart on financial regulation, given at The Future of Finance Conference in the Institute of Engineering and Technology in London (July, 2010).

Hayek the Ethnic Bigot and the Perils of the Ad Hominem Fallacy

2012-01-14T04:42:00.000-08:00

Hayek (1899–1992) was once asked what kind of people he disliked, and his response is not a pretty sight:

CHITESTER: …. Going back to the question I asked you about people you dislike or can’t deal with, can you make any additional comments in that regard, in terms of the characteristics of people that trouble you?

HAYEK: I don’t have many strong dislikes. I admit that as a teacher—I have no racial prejudices in general—but there were certain types, and conspicuous among them the Near Eastern populations, which I still dislike because they are fundamentally dishonest. And I must say dishonesty is a thing I intensely dislike. It was a type which, in my childhood in Austria, was described as Levantine, typical of the people of the eastern Mediterranean. But I encountered it later, and I have a profound dislike for the typical Indian students at the London School of Economics, which I admit are all one type—Bengali moneylender sons. They are to me a detestable type, I admit, but not with any racial feeling. I have found a little of the same amongst the Egyptians —basically a lack of honesty in them. (Nobel Prize-Winning Economist: Friedrich A. von Hayek, Regents of the University of California, 1983. p. 490).

So here we have Hayek asserting:

(1) Although he protested that he had no racial prejudices, Hayek admitted a dislike for a certain type of persons conspicuous among “Near Eastern populations” whom he found fundamentally dishonest, and who in the Austria of his youth could be described as “Levantine, typical of the people of the eastern Mediterranean.”

There is something shocking in these statements. Who on earth was Hayek talking about here? Some have charged that Hayek was showing latent anti-Semitism (Reder 2002: 263), and I find it difficult not to agree. Any person ranting about fundamentally “dishonest” Levantine people sounds like a cowardly anti-Semite to me. If not, who was the target? I don’t think there were many Syrians or Lebanese in the Austria of Hayek’s childhood and youth (which is the period from 1899–1918). Nor will the charge of ethnic slander and bigotry be dismissed if one chooses to deny that Hayek had in mind here human beings who happen to be of Jewish ethnicity: for now Hayek is open to the charge of even greater bigotry against Levantine people in general. Who seriously thinks that whole nations of people are all fundamentally “dishonest”? Anyone who thinks this is a bigot and an idiot.

(2) Hayek held a profound dislike for “the typical Indian students at the London School of Economics” supposedly of a particular detestable type, “Bengali moneylender sons.” Hayek showed himself guilty of a contemptible ethnic slur here, one which Anand Chandavarkar has described as Hayek’s “bizarre notion of Bengali students as sons of moneylenders, the one profession which the versatile Bengali has always scorned. The few postgraduate Indian pupils of Hayek – S. R. Sen, Said Ahmad Meenai and B. R. Shenoy – were all ‘honest’ high achievers who certainly did not answer to his image of Indian students” (Chandavarkar 2002: 224). I might add that I find it ridiculous and paradoxical that an inveterate apologist for Classical liberal, laissez faire capitalism like Hayek would have a prejudice against money-lenders’ sons. Isn’t money lending or banking a fundamentally important profession in modern capitalism?

(3) If this wasn’t enough, Hayek found time to use a similar ethnic slur of dishonesty (if not quite as pronounced) against Egyptians as well.

Now, to be fair to Hayek, I don’t see evidence of the kind of vile and shameful 19th-century racism in these opinions that holds that certain groups of human beings are inferior in terms of intelligence, morality or honesty owing to genetic or hereditary causes. But Hayek’s contemptible, irrational and disgraceful ethnic slurs and bigotry cannot be denied either.

If any apologist for Hayek contends that Hayek was kind and generous to his students and friends who happened to be Jewish or Indian, then the very same defence can be made of Keynes: just like Hayek, Keynes had Jewish friends and displayed great kindness toward them.

The lesson here is that Hayek, like Keynes, was also guilty of despicable ethnic slanders and prejudices (see Chandavarkar 2000 for Keynes’s anti-Semitism). Moreover, do these bigoted remarks provide us with any reason to reject the economic theories of Hayek?

Of course not. To do so would be to invoke the ad hominem fallacy. The shameful anti-Semitism of Keynes is irrelevant to the question of the truth of the economic theories in the General Theory and Keynes’s later work. The shameful (and arguably) latent anti-Semitism of Hayek is strictly irrelevant to the truth of Hayek’s economic theories.

Any modern Keynesian can condemn the bigotry of Keynes as an utterly disgraceful and immoral part of Keynes’s personality and character, while asserting the fundamental truth of many of the economic theories in the General Theory. The modern Austrian can condemn the bigotry of Hayek as an utterly disgraceful and immoral part of Hayek’s personality and character, while asserting the truth of the ideas in Hayek’s economics. The ad hominem fallacy and name calling abuse have no part in the debates on economic theory.

BIBLIOGRAPHY

Chandavarkar, A. 2000. “Was Keynes Anti-Semitic?,” Economic and Political Weekly 35.19 (6–12 May): 1619–1624.

Chandavarkar, A. 2002. “Did Hayek Deserve the Nobel Prize? Friedrich Hayek (A Biography) by Alan Ebenstein,” Economic and Political Weekly 37.3 (Jan. 19–25): 223–224.

Hamowy, R. 2002. “A Note on Hayek and Anti-Semitism,” History of Political Economy 34.1: 255–260.

Hamowy, R. 2005. The Political Sociology of Freedom: Adam Ferguson and F. A. Hayek, Edward Elgar, Cheltenham.

Nobel Prize-Winning Economist: Friedrich A. von Hayek. Interviewed by Earlene Graver, Axel Leijonhufvud, Leo Rosten, Jack High, James Buchanan, Robert Bork, Thomas Hazlett, Armen A. Alchian, Robert Chitester, Regents of the University of California, 1983.

Reder, M. W. 2000. “The Anti-Semitism of Some Eminent Economists,” History of Political Economy 32: 834–856.

Reder, M. W. 2002. “Reply to Hamowy’s Note on Hayek and Anti-Semitism,” History of Political Economy 34.1: 261–272.

Mises’s Regression Theorem: A Critique

2012-01-13T07:32:00.000-08:00

Ludwig von Mises held that money can only have an indirect utility: money has indirect utility by its ability to purchase goods and services. That is to say, the indirect utility of money is derived from the utility of any commodity or set of possible commodities you can purchase with it. Mises stated this in the following way:

“In the case of money, subjective use-value and subjective exchange value coincide. Both are derived from objective exchange-value, for money has no utility other than that arising from the possibility of obtaining other economic goods in exchange for it. It is impossible to conceive of any function of money, qua money, that can be separated from the fact of its objective exchange-value. As far as the use value of a commodity is concerned, it is immaterial whether the commodity also has exchange-value or not; but for money to have use-value, the existence of exchange-value is essential. This peculiarity of the value of money can also be expressed by saying that, as far as the individual is concerned, money has no use-value at all, but only subjective exchange-value.” (Mises 2009 [1953]: 97–98).

“The price of money, like other prices, is determined in the last resort by the subjective valuations of buyers and sellers. But, as has been said already, the subjective use-value of money, which coincides with its subjective exchange-value, is nothing but the anticipated use-value of the things that are to be bought with it. The subjective value of money must be measured by the marginal utility of the goods for which the money can be exchanged. It follows that a valuation of money is possible only on the assumption that the money has a certain objective exchange-value.” (Mises 2009 [1953]: 108–109).

To clarify, according to Mises, the objective exchange-value of money is “popularly called its purchasing power” (Mises 2009 [1953]: 97). The problem, then, for Mises was to account for the “origin of the objective exchange-value of money” (Mises 2009 [1953]: 123). Money is held by people in cash balances, but not to be consumed: money (supposedly) has no use in itself, but is held because of its past exchange value, so that it may be exchanged for goods (Rothbard 2011: 692). What is the cause of the immediate future purchasing power of money? Mises held that the solution is to look at the purchasing power of money in the immediate past (Mises 1998 [1949]: 405).

However, there is a problem with this: it appears that the indirect utility of money (by means of its purchasing power) depends on its utility (see Graziani 2003: 7–9; Schumpeter 1954: 1086–1091).

The Regression Theorem was intended to break this circularity (Mises 2009 [1953]: 97–123; Mises 1998 [1949]: 405–413; Rothbard 2009: 60–61; Rothbard 2011: 692–695). Mises states:

“The objective exchange-value of money which rules in the market to-day is derived from yesterday’s under the influence of the subjective valuations of the individuals frequenting the market, just as yesterday’s in its turn was derived under the influence of subjective valuations from the objective exchange-value possessed by the money the day before yesterday. If in this way we continually go farther and farther back we must eventually arrive at a point where we no longer find any component in the objective exchange-value of money that arises from valuations based on the function of money as a common medium of exchange; where the value of money is nothing other than the value of an object that is useful in some other way than as money. But this point is not merely an instrumental concept of theory; it is an actual phenomenon of economic history, making its appearance at the moment when indirect exchange begins.

Before it was usual to acquire goods in the market, not for personal consumption, but simply in order to exchange them again for the goods that were really wanted, each individual commodity was only accredited with that value given by the subjective valuations based on its direct utility. It was not until it became customary to acquire certain goods merely in order to use them as media of exchange that people began to esteem them more highly than before, on account of this possibility of using them in indirect exchange. The individual valued them in the first place because they were useful in the ordinary sense, and then additionally because they could be used as media of exchange.” (Mises 2009 [1953]: 121).

Money’s purchasing power today is derived from its purchasing power yesterday and so on back to a time when money originally had direct utility as a commodity. The Regression Theorem was also used to explain why fiduciary media or fiat money have and maintain value:

“If the objective exchange-value of money must always be linked with a pre-existing market exchange-ratio between money and other economic goods (since otherwise individuals would not be in a position to estimate the value of the money), it follows that an object cannot be used as money unless, at the moment when its use as money begins, it already possesses an objective exchange-value based on some other use. This provides both a refutation of those theories which derive the origin of money from a general agreement to impute fictitious value to things intrinsically valueless and a confirmation of Menger’s hypothesis concerning the origin of the use of money.

This link with a pre-existing exchange-value is necessary not only for commodity money, but equally for credit money and fiat money. No fiat money could ever come into existence if it did not satisfy this condition. Let us suppose that, among those ancient and modern kinds of money about which it may be doubtful whether they should be reckoned as credit money or fiat money, there have actually been representatives of pure fiat money. Such money must have come into existence in one of two ways. It may have come into existence because money-substitutes already in circulation, i.e., claims payable in money on demand, were deprived of their character as claims, and yet still used in commerce as media of exchange. In this case, the starting-point for their valuation lay in the objective exchange-value that they had at the moment when they were deprived of their character as claims. The other possible case is that in which coins that once circulated as commodity-money are transformed into fiat money by cessation of free coinage (either because there was no further minting at all, or because minting was continued only on behalf of the Treasury), no obligation of conversion being de jure or de facto assumed by anybody, and nobody having any grounds for hoping that such an obligation ever would be assumed by anybody. Here the starting-point for the valuation lies in the objective exchange-value of the coins at the time of the cessation of free coinage. Before an economic good begins to function as money it must already possess exchange-value based on some other cause than its monetary function. But money that already functions as such may remain valuable even when the original source of its exchange-value has ceased to exist. Its value then is based entirely on its function as common medium of exchange.” (Mises 2009 [1953]: 110–111).

Thus a “money thing” must emerge from its original exchange value in direct exchanges, but then it comes to be used as a medium of exchange in indirect exchanges. The process Mises imagines is as follows:

commodity with objective exchange-value traded in direct barter exchange > commodity used as a medium of exchange for indirect exchanges > emergence of money.

The essence of Mises’s theory was summed up by Sir John Hicks as the idea that “money is a ghost of gold – because, so it appeared, money as such has no marginal utility” (Hicks 1935: 2).

But there is a severe flaw underlying Mises’s whole intellectual program in producing his Regression Theorem: the truth of the assumption that money only has indirect utility.

The view that money only has utility through its exchange value is also held by neoclassicals. As the American neoclassical F. W. Taussig argued,

“[t]he phrase “marginal utility of money” must … be used with caution. Money has utility in a different way from other things. It is valued not because it serves in itself to satisfy wants, but as a medium of exchange, having purchasing power over other things. Gold jewelry is subject to the law of diminishing utility precisely as other things are. But gold coin—money—is subject to it only in the sense that an individual buys first the things he prizes most, and then other things in the order of their less utility” (Taussig 1911: 124).

This idea held by Austrians and neoclassicals should be rejected. To begin with, the neoclassical idea that money is non-neutral is false: the economy cannot be modelled as a mere barter system, as if money is only a numeraire.

Subjective value (or “economic value”) consists in the utility (satisfaction or pleasure) derived by an economic agent from a good. Fiat money may not be a good in the sense of a producible commodity, but money and even financial assets do have utility in themselves, because they have a store of value function in an uncertain world: holding or possessing them allows security against uncertainty, which gives one the ability to meet future uncertain obligations and needs.

Money can even be hoarded directly by some people for the pleasure they might derive from holding large amounts, such social prestige associated with the status of being rich. The existence of the practice of hoarding of money, particularly in times before the widespread use of fractional reserve banking, cannot be doubted either. In a world where we face pure uncertainty in the Knightian sense, cash balances have direct utility (for the history of the idea of preference for liquidity in an uncertain world, see Ritzmann 1999).

But money as the most liquid asset has greater utility than most financial assets, except perhaps the debt instruments we call fractional reserve demand deposits or transactions accounts. Possession of money gives direct satisfaction in providing protection against uncertainty, and allows one to discharge expected and unexpected future liabilities or obligations. Hence money provides a liquid balance that provides the satisfaction of protection against uncertainty. The economist Karl Schlesinger (1914) was an early proponent of this view, and he argued that money held as cash balances can have direct utility, in addition to the indirect utility money can have from its purchasing power (Graziani 2003: 10). John Hicks (1980 [1933]: 528) also appears to have come close to the same view in a 1933 paper.⁽¹⁾ (see Leijonhufvud 2000: 97–98 for an analysis of the wider issues Hicks raised relating to general equilibrium theory).

Money, then, can yield direct utility (Graziani 2003: 11). Post Keynesian economics also takes the view that money (even fiat money) has utility:

“In an uncertain world, the possession of money and other nonproducible liquid assets provides utility by protecting the holder from fear of being unable to meet future liabilities” (Davidson 2003: 236).

Where does this leave Mises’s Regression theorem? The conclusions to be drawn are as follows:

(1) The search for a solution to the alleged circularity of the indirect utility of money depends on rejecting the view that money has direct utility. But money has direct utility, and the whole problem of the alleged circularity that Mises tried to solve is an illusion. It follows that the Regression Theorem is essentially pointless and worthless.

The whole assumption underlying the Regression Theorem is flawed in that the expected future value of money or liquid financial assets can provide direct utility to the holder of money or that asset (for other critiques of Mises’s Regression Theorem, see Patinkin 1965, whose critique already raised the possibility that Mises’s assumption of only an indirect utility for money was wrong; Zazzaro 2003: 237, n. 18; Timberlake 1987).

(2) The regression theorem also commits a non sequitur in ignoring the role that money can have in discharging future obligations such as taxes, and the theoretical possibility and empirical reality that money could arise by governments imposing tax obligations on a community, by taking goods in kind, paying wages for labour, or issuing debt, and giving in return a token or money thing, and demanding that taxes be discharged in that particular money thing (e.g., a hazelwood tallystick, paper money, etc.). Money can then acquire purchasing power through people’s need to acquire it to pay taxes: the purchasing power of money would then develop as related to the value of goods that can also be used to extinguish taxes. The direct utility that money provides would be the ability to meet future tax obligations.

I suspect that real world examples of the introduction of paper money or fiat money provide empirical evidence that refutes the Regression Theorem, including the following:
(1) The introduction of paper money under some dynasties in medieval China (although it is possible that these paper monies were originally convertible into specie; see Glahn 1996 for a starting point in the research literature).

(2) Some of the fiat monies of the British North American colonies in the 18th century.

(3) The issue and use of hazelwood tally sticks by European medieval states as debt money issued to state creditors, which could be used as a medium of exchange and to discharge tax obligations.
A further investigation of these historical examples is clearly in order, though I will not do it here.

In ancient Mesopotamia, money appears to arise first as a unit of account developed from weight units of silver and barley by temple and palace institutions, which was used to calculate the value of taxes, rents and debt, in real goods. Payment could be made not just in silver or barley, but in goods through administered prices denominated in the temple/state unit of account. The use of the unit of account and the medium of exchange was then imposed on the community.

Footnotes

(1) Strictly speaking, Hicks did not appear to regard his demand for cash balances owing to future uncertainty as providing “direct” utility: “ … people always demand money as money – not because it has direct utility to them, but because it is to be used in the making of future payments. In addition to the demand for money as a commodity, there is a demand that arises directly out of ignorance of the future” (Hicks 1980 [1933]: 528).

BIBLIOGRAPHY

Anderson, B. M. 1917. The Value of Money, Macmillan, New York.

Davidson, P. 2003. “Keynes’ General Theory,” in J. E. King (ed.), Elgar Companion to Post Keynesian Economics, Edward Elgar Publishing, Cheltenham, UK and Northampton, MA. 229–237.

Ellis, H. S. 1934. German Monetary Theory, 1905–1933, Harvard University Press, Cambridge, Mass.

Glahn, R. von. 1996. Fountain of Fortune: Money and Monetary Policy in China, 1000–1700, University of California Press, Berkeley, Calif. and London.

Graziani, A. 2003. The Monetary Theory of Production, Cambridge University Press, Cambridge.

Hicks, J. R. 1933. “Gleichgewicht und Konjunktur,” Zeitschrift fur Nationalokonomie 4: 441–45.

Hicks, J. R. 1935. “A Suggestion for Simplifying the Theory of Money,” Economica n.s. 2.5: 1–19.

Hicks, J. R. 1980 [1933]. “Equilibrium and the Cycle,” Economic Inquiry 18.4: 523–534.

Hicks, J. R. 1982. Money, Interest and Wages (vol. 2), Blackwell, Oxford.

Huerta de Soto, J. 2006. Money, Bank Credit and Economic Cycles (trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala.

Innes, A. M. 1913. “What is Money?,” Banking Law Journal May: 377–408.

Leijonhufvud, Axel. 2000. Macroeconomic Instability and Coordination: Selected Essays of Axel Leijonhufvud, Edward Elgar, Cheltenham.

Mises, L. 1998 [1949]. Human Action: A Treatise on Economics, Ludwig von Mises Institute, Auburn, Ala.

Mises, L. von, 2009 [1953]. The Theory of Money and Credit (trans. J. E. Batson), Mises Institute, Auburn, Ala.

Murphy, R. P. and A. Gabriel, 2008. Study Guide to Human Action: A Guide Tutorial of Ludwig von Mises’s Classic Work, Ludwig von Mises Institute, Auburn, Ala.

Patinkin, Don. 1956. Money, Interest, and Prices: An Integration of Monetary and Value Theory, Row, Peterson, Evanston, Ill.

Patinkin, Don. 1965. Money, Interest, and Prices: An Integration of Monetary and Value Theory (2nd edn.), Harper & Row, New York.

Ritzmann, F. 1999. “Money, A Substitute for Confidence? Vaughan to Keynes and Beyond,” The American Journal of Economics and Sociology 58. 2: 167–192.

Rothbard, M. N. 1988. “Timberlake on the Austrian Theory of Money: A Comment,” Review of Austrian Economics 2: 179–187.

Rothbard, M. N. 2009. Man, Economy, and State: A Treatise on Economic Principles (2nd edn.), Ludwig von Mises Institute, Auburn, Ala.

Rothbard, M. N. 2009. The Essential von Mises, Ludwig von Mises Institute, Auburn, Alabama.

Rothbard, M. N. 2011. Economic Controversies, Ludwig von Mises Institute, Auburn, Ala.

Schlesinger, Karl. 1914. Theorie der Geld- und Kreditwirtschaft, Duncker & Humblot, Munich.

Schumpeter, J. A. 1954. History of Economic Analysis, Allen & Unwin, London and New York.

Taussig, F. W. 1911. Principles of Economics, Volume 1. Macmillan Company, New York.

Timberlake, R. H. 1987. “A Critique of Monetarist and Austrian Doctrines on the Utility and Value of Money,” Review of Austrian Economics 1: 81–96.

Zazzaro, A. 2003. “How Heterodox is the Heterodoxy of Monetary Circuit Theory? The Nature of Money and the Microeconomics of the Circuit,” in L.-P. Rochon and S. Rossi (eds), Modern Theories of Money: The Nature and Role of Money in Capitalist Economies,Edward Elgar Pub, Cheltenham. 219–245.

Mises on the Origin of Money

2012-01-12T05:36:00.001-08:00

Ludwig von Mises’s The Theory of Money and Credit (2009 [1953]) is his major treatise on money.

On pp. 30–34, Mises gives us an account of the origin of money (see also Mises 1998 [1949]: 402–404). Mises distinguishes “direct exchange” from “indirect exchange”: direct exchange involves no medium of exchange; and indirect exchange involves money used as medium of exchange.

This is described by Mises in the following way:

“Suppose that A and B exchange with each other a number of units of the commodities m and n. A acquires the commodity n because of the use-value that it has for him. He intends to consume it. The same is true of B, who acquires the commodity m for his immediate use. This is a case of direct exchange.” (Mises 2009 [1953]: 30).

It is clear that Mises – like other Classical and neoclassical economists – imagines barter spot transactions (or direct and immediate exchange of goods for goods) in his account of the origin of money. This is evident in Mises’s words “for his immediate use”: if two people have exchanged present goods for immediate use, then no exchange of present for future goods (a credit/debt exchange) is imagined here. The barter spot trade is the foundation of Mises’s account of the origin of money.

Mises then asserts that the most marketable goods will become the common media of exchange, and eventually the number of such media will probably be reduced, and in theory to one (Mises 2009 [1953]: 32). Mises recognised two such fundamental media at the time The Theory of Money and Credit was originally written (1912): gold and silver (Mises 2009 [1953]: 33).

Mises’s account of the origin of money is subject to the same criticisms as that of Menger and others I have outlined here:

“Menger on the Origin of Money,” January 5, 2012.

“The Origins of Money,” January 8, 2012.

In short, the gapping hole in the imagined origin of money by Adam Smith, Carl Menger, Ludwig von Mises and many modern neoclassical economists is the assumption that money-less, primitive human societies come to have economies dominated by barter spot transactions (that is, by barter through spot trades).

Anthropology, however, shows us that many money-less societies do not need to be based fundamentally on barter, and that they are capable of often evading the immediate double coincidence of wants problem by engaging in credit/debt transactions. In many societies, this takes the form of the gift exchange economy. In primitive human societies, the mutual giving of “gifts,” a type of debt/credit relation (Mauss 2002: 46), appears to be very important, and this incorporates social relations as well as commodities (the gift exchange economy bears some similarity to Peter Kropotkin’s notion of “mutual aid”).

While there appear to be instances where a medium of exchange has emerged from long distance trade, such as the cacao money of Mesoamerica and the salt money of Ethiopia (Graeber 2011: 75), money can arise in other ways:

(1) a unit of account can be developed by temple and palace complexes from weight units (as in ancient Egypt and Mesopotamia), and

(2) money might emerge from wergild-like social practices (e.g., some Medieval societies).

“Money” in the sense of a money of account (as a measure of value of commodities) can emerge before the medium of exchange role.

Mises’s Austrian approach to money is flawed by focussing on money’s medium of exchange role, and the belief that this must always come first. It is also flawed by its inability to account for money having arisen by ways other than barter spot trades.

BIBLIOGRAPHY

Bell, D. 1991. “Modes of Exchange: Gift and Commodity,” Journal of Socio-Economics 20.2: 155–167.

Graeber, David. 2011. Debt: The First 5,000 Years, Melville House, Brooklyn, N.Y.

Mauss, Marcel. 2002. The Gift: The Form and Reason for Exchange in Archaic Societies (trans. W. D. Halls), Routledge, London.

Mises, L. von. 1998 [1949]. Human Action: A Treatise on Economics. The Scholar’s Edition, Ludwig von Mises Institute, Auburn, Ala.

Mises, L. von. 2009 [1953]. The Theory of Money and Credit (trans. J. E. Batson), Mises Institute, Auburn, Ala.

Pavalina Tcherneva on MMT

2012-01-10T02:32:00.000-08:00

Another interesting video here: Pavalina Tcherneva (Assistant Professor of Economics, Franklin and Marshall College) is interviewed on “At Issue with Ben Merens” on economic issues and MMT.

Pavlina Tcherneva on an MMT Employment Program

2012-01-09T06:38:00.000-08:00

Pavlina Tcherneva speaks in this interview about an MMT solution to unemployment: a direct employment program. Some good remarks on the inadequacy of the old IS-LM models and neoclassical synthesis Keynesianism.

The Origins of Money

2012-01-08T10:07:00.000-08:00

Adam Smith wrote an influential account of the origin of money, as follows:

“When the division of labour has been once thoroughly established, it is but a very small part of a man’s wants, which the produce of his own labour can supply. He supplies the far greater part of them by exchanging that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men’s labour as he has occasion for. Every man thus lives by exchanging, or becomes in some measure a merchant, and the society itself grows to be what is properly a commercial society.

But when the division of labour first began to take place, this power of exchanging must frequently have been very much clogged and embarrassed in its operations. One man, we shall suppose, has more of a certain commodity than he himself has occasion for, while another has less. The former consequently would be glad to dispose of, and the latter to purchase, a part of this superfluity. But if this latter should chance to have nothing that the former stands in need of, no exchange can be made between them. The butcher has more meat in his shop than he himself can consume, and the brewer and the baker would each of them be willing to purchase a part of it. But they have nothing to offer in exchange, except the different productions of their respective trades, and the butcher is already provided with all the bread and beer which he has immediate occasion for. No exchange can, in this case, be made between them. He cannot be their merchant, nor they his customers; and they are all of them thus mutually less serviceable to one another. In order to avoid the inconveniency of such situations, very prudent man in every period of society, after the first establishment of the division of labour, must naturally have endeavoured to manage his affairs in such a manner, as to have at all times by him, besides the peculiar produce of his own industry, a certain quantity of some one commodity or other, such as he imagined few people would be likely to refuse in exchange for the produce of their industry.

Many different commodities, it is probable, were successively both thought of and employed for this purpose. In the rude ages of society, cattle are said to have been the common instrument of commerce; and though they must have been a most inconvenient one, yet in old times we find things were frequently valued according to the number of cattle which had been given in exchange for them. The armour of [Diomedes] ..., says Homer, cost only nine oxen; but that of Glaucus, cost an hundred oxen. Salt is said to be the common instrument of commerce and exchanges in Abyssinia; a species of shells in some parts of the coast of India; dried cod at Newfoundland; tobacco in Virginia; sugar in some of our West India colonies; hides or dressed leather in some other countries; and there is at this day a village in Scotland where it is not uncommon, I am told, for a workman to carry nails instead of money to the baker’s shop or the ale-house.

In all countries, however, men seem at last to have been determined by irresistible reasons to give the preference, for this employment, to metals above every other commodity. Metals can not only be kept with as little loss as any other commodity, scarce any thing being less perishable than they are; but they can likewise, without any loss, be divided into any number of parts, as by fusion those parts can easily be re-united again; a quality which no other equally durable commodities possess, and which more than any other quality renders them fit to be the instruments of commerce and circulation. The man who wanted to buy salt, for example, and had nothing but cattle to give in exchange for it, must have been obliged to buy salt to the value of a whole ox, or a whole sheep, at a time. He could seldom buy less than this, because what he was to give for it could seldom be divided without loss; and if he had a mind to buy more, he must, for the same reasons, have been obliged to buy double or triple the quantity, the value, to wit, of two or three oxen, or of two or three sheep. If, on the contrary, instead of sheep or oxen, he had metals to give in exchange for it, he could easily proportion the quantity of the metal to the precise quantity of the commodity which he had immediate occasion for.” (Smith 1811: 16–17).

This thesis – that money emerged as a commodity from barter spot transactions – was taken up and developed by many Classical and Neoclassical economists.

Carl Menger (1892) developed a similar theory in the late 19th century (Menger 1892 and 2002 [1909]; cf. Goodhart 2004), which I have criticised here. Money emerges as a medium of exchange from the most saleable commodity in direct barter trades: usually (though not always) it must have the properties of being portable, homogeneous, easily divisible, and not subject to depreciation.

In the most extreme forms, it holds that money can only ever emerge from barter spot transactions as the most saleable commodity becomes the common medium of exchange. It has been known for a long time that there are severe problems with this latter view of the origin of money.

From the 16th century onwards, Europeans came into contact with numerous communities in various parts of the world. The empirical evidence from serious, scholarly study of money-less communities, especially since the 18th century onwards, demonstrates that the economies of communities which are (1) money-less or (2) have a marginal role for money take many forms, and the pure barter economy imagined by economists is a myth (Humphrey 1984: 48). More alarming still is that surveys show that societies where barter was a predominant form of transaction in certain sectors of the economy are astonishingly small: just three “primitive” economies where barter was predominant have been found (Crump 1981: 34, who mentions pre-Colonial Mexico, the Congo basin, and the northern coast of New Guinea and its adjacent islands, but in all of these barter was essentially an activity in long distance trade transactions). Barter does exist frequently of course, but often as a marginal activity or “in a corner of the economy,” and is often despised by people as being somewhat disreputable (Humphrey 1984: 49). It is often confined to foreigners or long distance trade. The notion that human beings have some natural propensity to “truck” or “barter” is itself questionable (Humphrey 1984: 50).

The gapping hole in the imagined origin of money by Adam Smith, Carl Menger, Ludwig von Mises and many modern neoclassical economists is that barter spot transactions can be mostly unnecessary in a money-less human society.

The sequence of historical development imagined by most economists is as follows:

barter > money > credit.

In reality, other sequences are more plausible:

Debt/credit relations (gift economies) > minimal/peripheral barter > moneyless society with debt/credit transactions and minimal barter.

Debt/credit relations (gift economies) > minimal/peripheral barter > wergild social practices > emergence of a unit of account through reckoning of relative values for compensation by legal codes > money.

Debt/credit relations (gift economies) > minimal/peripheral barter > emergence of a unit of account through reckoning of relative values in planning by influential socio-economic agents in society (e.g., priests, temples, kings) > money.

If an economy is dominated by debt/credit relations, where the debts are vague and non-enumerated, then there is no significant double coincidence of wants dilemma: and no need to invent money. There were presumably numerous human societies that never invented what we would call money, because they never needed to.

Economists have ignored the unit of account function of money. Grierson (1978: 11) emphasised how in many societies an abstract or concrete unit of account can be a measure of value, while payment is made in goods. If money is conceived as an abstract thing which is used to measure the value of one thing against another, an abstract unit of account can emerge before some commodity becomes a physical medium of exchange: it can be created by conscious design by deriving an abstract unit of account from weights or from high-prestige commodities. Alternatively, societies can develop wergild-like social practices in which a kind of “price system” is developed by legal experts to reckon the values of compensation and damage payments, but where the payments system must have a common unit of account to calculate what kinds of payment in kind are equivalent for damages paid.

We do in fact observe historical instances where money has emerged in just the ways described: in Mesopotamia (one of the earliest literate civilisations), Egypt and medieval tribal societies. In ancient Egypt, money appears as the most important unit of account called the deben (or uten), which was a unit of weight, originally equated to 92 (or 91) grams (Henry 2004: 92; there was also the unit called the khar for measuring wheat or barley, and 1 khar was equivalent to 2 deben of bronze). This unit of account appears to have been developed by complex palace, government and temple institutions for internal accounting. While goods came to be denominated in terms of deben, there were no physical deben changing hands, there were administered price lists for some goods, and coins were unknown in Egypt until the Ptolemaic era (323–31 BC; Henry 2004: 92). That is to say, the deben did not function as a physical means of payment, and did not emerge by barter spot transactions as the most saleable medium of exchange. Even though goods and services were measured in a deben unit of account, payment was made in goods.

An important element in this process was the institution (or institutions) where surplus products were stored from taxation, tribute and gifts. These institutions dealt with complex flows, in and out, of goods: they were palace and temple complexes. Accounting systems, weight measures and writing are connected with just such institutions, and, importantly, some abstract unit of account arose by which to measure relative values of goods. Since loans were also no doubt made from surplus products stored, repayment of loans in kind was facilitated by a unit of account. The preceding account applies to both ancient Egypt and Mesopotamia.

In ancient Greece, the Homeric epics the Iliad and the Odyssey were written c. 750–700 BC, and reflect social practices in the late Dark/Geometric Age (c. 1200–800 BC) and early Archaic period (800–480 BC). In Homer’s epics, cattle or oxen are the unit of account, but the means of payment are variable goods, not just cattle (Peacock 2011: 49–54).

The emergence of money in Greece appears to be related to religion and cult offerings. The ox was an important sacrificial animal and offering to the gods. The Greeks appear to have developed a cattle or ox unit of account derived from the value these animals had in sacrifice (Seaford 2004: 61). Priests needed to be paid in cattle for religious services, but it was also necessary to calculate the ox-value of other commodities offered for payment to temples or for sacrifice in lieu of oxen (Semenova 2011: 385): hence people came to develop “prices” of other goods in terms of oxen, and an ox unit of account emerged (Schaps 2004: 9–10; Heidel 1926; I cite the English review of Heidel in Economica 14 [1925]: 218–222; Heidel’s thesis is modified by Peacock 2011: 54–63; Peacock 2003–2004). But oxen were not generally used as a medium of exchange. Instead, other goods like metals or items associated with sacrifice of oxen like tripods, cauldrons, double-axes, and spits (Schaps 2004: 10) were used as a means of payment and medium of exchange, whose value was measured in a cattle unit of account. Some fines appear to have been payable in tripods and cauldrons, for example. Coins were introduced by states from 600–500 BC (Peacock 2011: 54–63). With the emergence of iron spits (oboloi), the beginnings of precious metal money can be seen, although gold and silver had been previously used as a means of payment as measured in the cattle unit of account. The first electrum coins appear at Ephesus in late 7th century (700–600 BC), and spread to mainland Greece from 575–550 BC (von Reden 2002: 152, n. 30).

In the Indo-European and, above all, medieval Germanic societies, we have the institution of wergild: a system of fines and compensations payments for killing a human being and also for a wide range of other injuries, infractions or insults, and for theft of objects and commodities (Grierson 1978: 11; Grierson 1977). Compensation payments are made in various goods, such as cattle, bondmaids, and precious metal, but it is likely a common unit of account was developed to simplify calculation of payments, which later spread to the wider community in economic transactions.

By using induction, we can postulate that it is likely that these various phenomena and social processes may well have occurred in pre-historic societies too, and that money, if and when it was invented in some forms in pre-literate, primitive societies, emerged just as often by the ways described above, as by barter.

BIBLIOGRAPHY

Angell, N. 1929. The Story of Money, Frederick A. Stokes Company, New York.

Ashley, W. M. 1925. “Heiliges Geld: Eine Historiche Untersuchung über den Sakralen Ursprung des Geldes by Bernhard Laum” (Review), The Economic Journal 35.138: 288–289.

Crump, T. 1981. The Phenomenon of Money, Routledge & Kegan Paul, London.

Desmonde, W. H. 1962. Magic, Myth, and Money: The Origin of Money in Religious Ritual, Free Press of Glencoe, Inc. New York.

Goodhart, C. A. E. 1998. “The Two Concepts of Money: Implications for the Analysis of Optimal Currency Areas,” European Journal of Political Economy 14.3: 407–432.

Goodhart, C. A. E. 2004. “Carl Menger and the Evolution of Payments Systems: From Barter to Electronic Money (Review),” History of Political Economy 36.1: 210-212.

Grierson, P. 1977. The Origin of Money, Athlone Press and University of London, London.

Grierson, P. 1978. “The Origins of Money,” Research in Economic Anthropology 1: 1–35.

Graeber, D. 2011. Debt: The First 5,000 Years, Melville House, Brooklyn, N.Y.

Heidel, W. A. 1926. “Heiliges Geld, eine historische Untersuchung über den sakralen Ursprung des Geldes by Bernhard Laum” (Review), Classical Philology 21.2: 191–192.

Henry, J. F. 2004. “The Social Origins of Money: The Case of Egypt,” in L. R. Wray (ed.), Credit and State Theories of Money: The Contributions of A. Mitchell Innes, Edward Elgar, Cheltenham, UK. 79–98.

Humphrey, C. 1984. “Barter and Economic Disintegration,” Man 20.1: 48–72.

Ingham, G. 2006. “Further Reflections on the Ontology of Money,” Economy and Society 36.2: 264–265.

Janssen, Jac. J. 1975a. “Prolegomena to the Study of Egypt’s Economic History during the New Kingdom,” Studien zur Altägyptischen Kultur 3: 127-185.

Janssen, Jac. J. 1975b. Commodity Prices from the Ramessid Period: An Economic Study of the Village of Necropolis Workmen at Thebes, Brill, Leiden.

Laum, B. 1924. Heiliges Geld: eine historische Untersuchung über den sakralen Ursprung des Geldes, Mohr, Tübingen.

Menger, C. 1892. “On the Origin of Money,” Economic Journal 2: 238–255.

Menger, C. 1909. “Geld,” in J. Conrad et al. (eds.), Handwörterbuch der Staatswissenschaften (vol. 4; 3rd edn.), Fischer, Jena. 555–610.

Menger, C. 2002 [1909]. “Money” (trans. L. B. Yeager and M. Streissler), in M. Latzer and S. W. Schmitz (eds.), Carl Menger and the Evolution of Payments Systems, Edward Elgar, Cheltenham, UK. 25–108. [N.B. this is a translation of Menger 1909.]

Peacock, M. S. 2003–2004. “State, Money, Catallaxy: Underlaboring for a Chartalist Theory of Money,” Journal of Post Keynesian Economics 26.2: 205–225.

Peacock, M. S. 2006. “The Origins of Money in Ancient Greece: The Political Economy of Coinage and Exchange,” Cambridge Journal of Economics 30: 637–650.

Peacock, M. S. 2011. “The Political Economy of Homeric Society and the Origins of Money,”Contributions to Political Economy 30: 47–65.

Schaps, D. M. 2004. The Invention of Coinage and the Monetization of Ancient Greece, University of Michigan Press, Ann Arbor

Seaford, R. 2004. Money and the Early Greek Mind: Homer, Philosophy, Tragedy, Cambridge University Press, Cambridge.

Semenova, A. 2011. “Would You Barter With God? Why Holy Debts and not Profane Markets Created Money,” American Journal of Economics and Sociology 70.2: 376-400.

Smith, A. 1811. An Inquiry into the Nature and Causes of the Wealth of Nations (11 edn; vol. 1), Oliver D. Cooke, Hartford.

Smithin, J. 2000. “‘Babylonian Madness’: On the Historical and Sociological Origins of Money,” in J. Smithin, J. (ed.), 2000. What is Money?, Routledge, London and New York.

von Reden, S. 1997. “Money, Law and Exchange: Coinage in the Greek Polis,” Journal of Hellenic Studies 117: 154–176.

von Reden, S. 2002. “Money in the ancient economy: A survey of recent research,” Klio 84.1: 141–174.

Wray, L. R. 2002. “State Money,” International Journal of Political Economy 32.3: 23-40

James K. Galbraith Interview

2012-01-07T23:41:00.000-08:00

An enjoyable interview here with James K. Galbraith, about quite a few topics, inlcuding the great financial crisis, inequality, John Kenneth Galbraith, history and economics.

Menger on the Origin of Money

2012-01-05T06:37:00.000-08:00

Carl Menger (1840-1921), the founder of Austrian economics, wrote this classic paper:

Menger, C. 1892. “On the Origin of Money,” Economic Journal 2: 238–255.

Menger imagines a world without money. In this world, people exchange goods for goods in spot transactions (barter). What happens when person A wants a good from person B, but the latter does not want the goods the former has to trade? This is the famous problem of the double coincidence of wants.

Menger notes that commodities have “different degrees of saleableness,” and that money has a virtually unlimited saleableness (Menger 1892: 242–243). Yet the differences of degrees of saleableness apply to many other commodities. Many goods once bought cannot be sold again except at a loss (Menger 1892: 244).

What do you do with your excess goods once you have obtained what you immediately want in a barter exchange? What do you do if you are unable to obtain what you want through a direct barter spot transaction? It makes sense for you to obtain goods with a high degree of saleableness, and then exchange these in the wider community at present or in the future. By this process, the most saleable good (or goods) becomes the medium of exchange (Menger 1892: 249).

I find it curious that even Menger makes this concession at the beginning of the following important paragraph:

“It is not impossible for media of exchange, serving as they do the commonweal in the most emphatic sense of the word, to be instituted also by way of legislation, like other social institutions. But this is neither the only, nor the primary mode in which money has taken its origin. This is much more to be traced in the process depicted above, notwithstanding the nature of that process would be but very incompletely explained if we were to call it ‘organic,’ or denote money as something ‘primordial,’ of ‘primaeval growth,’ and so forth. Putting aside assumptions which are historically unsound, we can only come fully to understand the origin of money by learning to view the establishment of the social procedure, with which we are dealing, as the spontaneous outcome, the unpremeditated resultant, of particular, individual efforts of the members of a society, who have little by little worked their way to a discrimination of the different degrees of saleableness in commodities.” (Menger 1892: 250).

Menger concludes that precious metals have arisen as a medium of exchange among many peoples because “their saleableness is far and away superior to that of all other commodities” (Menger 1892: 252). Yet Menger also recognises the “important functions of state administration” in creating coinage and creating public confidence in the “genuineness, weight, and fineness” of coined money (Menger 1892: 255). Another important point is that Menger held that the government reduces the uncertainty associated with “several commodities serving as currency” by legal recognition of some commodities as money, or where more than one commodity money exists by fixing a definite exchange ratio between them (Menger 1892: 255). In this way, governments have perfected precious metals in their function as money (Menger 1892: 255).

There are a number of problems with Menger’s paper, as follows:

(1) The flawed assumption running through the paper is that a money-less human society would be one where goods are obtained to a significant extent by barter spot transactions. This is clear in the hypothetical scenario Menger (1892: 241–243) envisages early in his paper.

It is perfectly possible that money might have arisen this way, but it is quite another thing to say that it can only ever have arisen in this way, and in no other way. The Austrians have a militant position on the origin of money that appears to me to go well beyond what Menger said in this 1892 article. For modern Austrians,
“[sc. Mises’s] Regression Theorem also shows that money, in any society, can only become established by a market process emerging from barter. Money cannot be established by a social contract, by government imposition, or by artificial schemes proposed by economists.” (Rothbard 2009: 61).
Yet it appears to me that Menger explicitly rejects this idea here:
“It is not impossible for media of exchange, serving as they do the commonweal in the most emphatic sense of the word, to be instituted also by way of legislation, like other social institutions. But this is neither the only, nor the primary mode in which money has taken its origin.” (Menger 1892: 250).
That seems to leave some room in Menger’s view for government law to establish money.

It is obvious that the historical origin of money cannot be traced to one moment of invention in the past: for there have undoubtedly been multiple independent instances in history where things have emerged as a unit of account and medium of exchange in different societies in different times. It is far more likely that the origins of money are complex. Here history and anthropology matter: the idea that you can sit in an armchair and use deduction to obtain apodictic certainty about how some complex social practice arose in the past is nonsensical. Empirical evidence and inductive reasoning are clearly important.

The obsession with barter spot transactions seen in Menger ignores another fundamental relation: the existence of debt/credit transactions (which might even be construed as reciprocal gift giving). As David Graeber argues,
“[the] great flaw of the economic model is that it assumed spot transactions. I have arrowheads, you have beaver pelts, if you don’t need arrowheads right now, no deal. But even if we presume that neighbors in a small community are exchanging items in some way, why on earth would they limit themselves to spot transactions? If your neighbor doesn’t need your arrowheads right now, he probably will at some point in the future, and even if he won’t, you’re his neighbor—you will undoubtedly have something he wants, or be able to do some sort of favor for him, eventually. But without assuming the spot trade, there’s no double coincidence of wants problem, and therefore, no need to invent money.

... What anthropologists have in fact observed where money is not used is not a system of explicit lending and borrowing, but a very broad system of non-enumerated credits and debts. In most such societies, if a neighbor wants some possession of yours, it usually suffices simply to praise it (‘what a magnificent pig!’); the response is to immediately hand it over, accompanied by much insistence that this is a gift and the donor certainly would never want anything in return. In fact, the recipient now owes him a favor. Now, he might well just sit on the favor, since it’s nice to have others beholden to you, or he might demand something of an explicitly non-material kind (‘you know, my son is in love with your daughter...’) He might ask for another pig, or something he considers roughly equivalent in kind. But it’s almost impossible to see how any of this would lead to a system whereby it’s possible to measure proportional values.”
David Graeber, “On the Invention of Money – Notes on Sex, Adventure, Monomaniacal Sociopathy and the True Function of Economics. A Reply to Robert Murphy’s ‘Have Anthropologists Overturned Menger?,’” September 13, 2011.
In theory, one could even transfer debts/IOUs and obtain commodities in this way.

Most probably, money has emerged in complex ways:
(1) from debt/credit transactions and transfers of IOUs;

(2) from wergild-like social practices (e.g., some Medieval societies),

(3) from government-based designation of a unit of account and the demand for taxes measured in that unit of account (e.g., ancient Mesopotamia; see below), and

(4) barter between strangers and in international trade. The cacao money of Mesoamerica and the salt money of Ethiopia may well be instances of money emerging through barter (Graeber 2011: 75). However, in long distance trade, barter transactions might have led to the origin of money in the sense of a money of account (to measure the value of other commodities), but even here may not have widely functioned as a medium of exchange.
As Graeber notes, money in the sense of a money of account (as a measure of value of commodities) can very probably emerge before the medium of exchange role.

And in actual human societies (whether small hunter gatherer or agricultural communities, or larger tribe/group communities with more complex economic organisation with greater division of labour), the way goods are obtained and distributed may be by open-ended sharing, centralized allocation (e.g., Iroquoi allocation of goods by women’s councils), “gift exchange,” where a present good is exchanged for the social obligation of a future “gift,” even though there does not need to be exact value equivalence. Social relations complicate even this “gift exchange” economy: some people may not even bother to call in the gifts owed to them, they might accept something of lesser value in the end. Such money-less societies can persist for centuries, with barter spot transactions remaining insignificant or confined to external transactions with strangers.

The emergence of money from such arrangements appears to have much to do with the legal or social systems of penalties and fines for crimes, injuries or slights. It was here that things – prized things – were used to measure value, in the sense of compensation for injury.

The origin of money in ancient Mesopotamia appears to be in the development of an abstract money of account in the temple and palace institutions: these temples and palaces represented state institutions with large internal centrally planned economies, with complex weights and measurements for internal accounting of the products produced, received and distributed, and rent and interest owed. Many prices were set and administered in the money of account which developed from weight units. The two units of account were (1) the shekel of silver (which was equal to the monthly grain ration) and (2) barley. In the private economy, exchange involved a high degree of credit/debt transactions or “gift exchange,” not simply barter in spot transactions (Hudson 2004: 102). Silver money of account spread to the private economy mostly notably as a means of paying debts to temples and palaces (Hudson 2004: 115). But many ordinary people could pay in commodities, and the administered pricing system in terms of silver/grain developed in the temples was to assist in calculation of payments in kind.

(2) Menger holds that precious metals emerged as the medium of exchange for their “special saleableness.” He thinks that no “accident, nor the consequence of state compulsion, nor voluntary convention of traders effected this” (Menger 1892: 254). This seems to contradict his statement on p. 250 (cited above).

In fact, Menger’s view is highly questionable, since metals were not especially divisible or used in uniform divisible units until the invention of coinage. Most bullion and metal would have been of too high a value for ordinary transactions. The historical origin of coinage in Western civilization lies with the state:
“the state’s role in the development of coinage is undisputed … Coinage was not an endogenous development of the economic sphere, as Menger held, nor was it created merely in order to facilitate trade which had existed thousands of years before money and was in no need of facilitation” (Peacock 2006: 642).
To be fair to Menger, he did not assert that coinage “was an endogenous development of the economic sphere.” What Menger believed is that precious metal as commodity money (not necessarily coined) emerged because of its “special saleableness.” But this is not necessarily true, because precious metal was unlikely to have been used in daily, ordinary transactions by common people before small unit coins. Coins were the creation of the state, and even the early coins were minted in denominations far too high for small transactions (Kraay 1964). The reason that coinage eventually became a widely-accepted medium of exchange and unit of account was that the state demanded its issued coin back for payment of taxes and other payments to the state, such as harbour dues and fines. This process is what monetized the economy and encouraged the use of coinage as a medium of exchange. This is essentially the Chartalist explanation of monetised economies.

We can end by noting that, in contrast to the cultish, dogmatic assertions of Rothbard (2009: 61), Menger recognised that the state improved the effectiveness of money through issuing coinage, and in fixing exchange ratios between commodity money. He also allowed that a medium of exchange might be instituted by way of government legislation (Menger 1892: 250).

UPDATE
I will also look at Menger’s Principles of Economics (1st edn. 1871) in the section on money, but I think most of the criticisms above will also apply to it.

DAVID GRAEBER LINKS

Graeber, David, 2009. “Debt: The First Five Thousand Years,” Eurozine.com, 20th August.

“What is Debt? – An Interview with Economic Anthropologist David Graeber,” August 26, 2011.

Robert Murphy, “Murphy Replies to David Graeber on Menger and Money,” Mises.org, September 8, 2011.

David Graeber, “On the Invention of Money – Notes on Sex, Adventure, Monomaniacal Sociopathy and the True Function of Economics. A Reply to Robert Murphy’s ‘Have Anthropologists Overturned Menger?,’” September 13, 2011.

BIBLIOGRAPHY

Graeber, David. 2011. Debt: The First 5,000 Years, Melville House, Brooklyn, N.Y.

Hudson, M. 2004. “The Archaeology of Money: Debt Versus Barter Theories of Money’s Origins,” in L. R. Wray (ed.), Credit and State Theories of Money: the Contributions of A. Mitchell Innes, Edward Elgar, Cheltenham. 99–127.

Kraay, C. M. 1964. “Hoards, Small Change and the Origin of Coinage,” Journal of Hellenic Studies 84: 76–91.

Menger, Carl, 2007. Principles of Economics (trans. Grundsätze der Volkwirthschaftslehre [1st edn. 1871] by J. Dingwall and B. F. Hoselitz), Ludwig von Mises Institute, Auburn, Alabama.

Menger, C. 1892. “On the Origin of Money,” Economic Journal 2: 238–255.

Murphy, Robert P. 2003. “The Origin of Money and Its Value,” Mises Daily, September 29, 2003
http://mises.org/daily/1333

Peacock, M. S. 2006. “The Origins of Money in Ancient Greece: The Political Economy of Coinage and Exchange,” Cambridge Journal of Economics 30: 637–650.

Rothbard, M. N., 2009, The Essential von Mises, Ludwig von Mises Institute, Auburn, Alabama.

Robert Skidelsky on Lessons from the Crisis

2012-01-04T21:08:00.000-08:00

This is an OECD interview with Robert Skidelsky, about a year old, but still relevant, and Skidelsky is right.

Hayek’s Trade Cycle Theory, Equilibrium, Knowledge and Expectations

2012-01-04T08:38:00.001-08:00

It is well known that Hayek abandoned general equilibrium theory after the 1940s for the concept of a “spontaneously emerging market order.” But Hayek’s views on equilibrium also evolved over time, and some scholars feel it is necessary to divide Hayek’s career into three phases in his views on equilibrium (Gloria-Palermo 1999: 75). In the first phase down to 1937, Hayek thought that “all legitimate economic explanations should be based upon an analysis of equilibrium” (Gloria-Palermo 1999: 75; McCloughry 1984: viii). The second phase from 1937 to the 1940s involved Hayek’s attempt to redefine equilibrium as plan co-ordination, which occurred in his important paper “Economics and Knowledge” (Hayek 1937; Gloria-Palermo 1999: 75). From the 1940s, there was a third phase where Hayek broke with equilibrium analysis and created a new concept of “spontaneous order” as a method for studying coordination processes in market economies.

While Hayek developed an intertemporal equilibrium theory in 1928 in his paper “Intertemporal Price Equilibrium and Movement in the Value of Money” (Hayek 1984 [1928]), he did not use this in Prices and Production (1931). Instead, “he reverted to the stationary equilibrium approach, by adopting the simple stationary-equilibrium model put forward by Wicksell in Interest and Money as the starting point for his analysis” [my emphasis] (Donzelli 1993: 57). In Prices and Production, an initial stationary state moves to disequilibrium and then moves via boom and bust into a new stationary state. This might be viewed as an application of Hayek’s intertemporal equilibrium theory of 1928 where perfect foresight is needed as an assumption (Foss 1995: 353). Hayek’s definition of monetary stability is a state where voluntary savings equal voluntary investment. The unique natural rate of interest is taken over from Wicksell via Mises.

An equilibrium state is the starting point of a real world economy allegedly subject to Hayek’s Austrian trade cycle (Loasby 1997: 54: “Hayek began ... with a monetary expansion ... impinging on a perfectly co-ordinated economy”). Hayek explicitly stated that he had assumed full employment equilibrium in Prices and Production (1931):

“As it is sometimes alleged that the ‘Austrians’ were unaware of the fact that the effect of an expansion of credit will be different according as there are unemployed resources available or not, the following passage from Professor Mises’ Geldwertstabilisierung und Konjunkturpolitik (1928, p. 49) perhaps deserves to be quoted: ‘Even on an unimpeded market there will be at times certain quantities of unsold commodities which exceed the stocks that would be held under static conditions, of unused productive plant, and of unused workmen. The increased activity will at first bring about a mobilisation of these reserves. Once they have been absorbed the increase of the means of circulation must, however, cause disturbances of a peculiar kind.’ In Prices and Production, where I started explicitly from an assumed equilibrium position, I had, of course, no occasion to deal with these problems. (Hayek 1975 [1939]: 42, n. 1).

U. Witt has identified the severe problem running through Hayek’s reliance on general equilibrium for his trade cycle theory:

“It is an irony that the perfectionist endeavour turned out to run into troubles which, it is claimed here, developed into a crisis of the whole program. In Mises’s understanding (general) equilibrium is a fictitious, imaginary construction useful as a logical basis of comparative statics … Though often arguing similarly in this respect, Hayek takes a different position. While Mises’s apodictic apriorism did not require Mises to derive empirical hypotheses, it is quite clear, e.g., from Hayek (1933) that he aimed at empirically meaningful propositions about the business cycle. For this reason, he was forced to identify general equilibrium in some way or other with an empirical state of the economy, and his theory indeed seems to suggest the state of the markets in the pre-upswing stage of the business cycle. However, in an empirical economic theory it is difficult to determine the conditions under which general equilibrium should be observable. It is even more obscure to see how individual imaginations of, and plans for, future events come to be coordinated so that prices can converge to their equilibrium values. The latter question is crucial in an individualistic approach where subjective expectations are supposed to play a key role.” (Witt 1997: 49).

In other words, Hayek came to see that perfect information and foresight were necessary to explain the convergence back to an equilibrium state as the upswing turned to a bust. The existence of subjective expectations in the real world and the non-existence of equilibrium states are severe stumbling blocks to Hayek’s theory.

Hayek’s assumptions go much further than the idea of a starting equilibrium state. They also assume:

(1) The flexibility of prices and perfect or near perfect adjustments in prices in response to demand and supply;

(2) frictionless markets, and perfect price information on the part of agents (Witt 1997: 47).

None of these assumptions can be taken seriously: prices are not perfectly flexible, and in reality agents ex ante expectations can be severely disappointed ex post, and Knightian uncertainty causes subjective expectations.

Karl Gunnar Myrdal (1898–1987) had already levelled this criticism against Hayek in a paper in 1933 (Myrdal 1933: 385; Foss 1995: 354), and Hayek’s famous paper “Economics and Knowledge” (1937) can be seen as the beginning of his attempt to answer these criticisms (Witt 1997: 49).

The problematic role of expectations for Hayek’s trade cycle theory was already being raised within the Austrian school in the 1930s, as Ludwig Lachmann related in an Austrian Economics Newsletter (AEN) interview:

“AEN: You have talked a number of times about the importance of expectations in business cycle theory. What first drew your interest to expectations as far as the business cycle question was concerned.

Lachmann: Talking to Paul Rosenstein-Rodan, who was then a lecturer at University College, London – not technically in the London School of Economics – but he gave a course on the history of economic thought to which all of us who were research students then went. It was Rosenstein-Rodan who in discussing Austrian trade cycle theory with me said, ‘Ah yes, but whatever happens in the business cycle is in the first place determined by expectations.’ And then he told me of the work that had been done in Sweden.”
Ludwig Lachmann, “An Interview with Ludwig Lachmann,” The Austrian Economics Newsletter, Volume 1, Number 3 (Fall 1978), Mises.org.

Lachmann heard of the work of the Stockholm school from Paul Rosenstein-Rodan: the Stockholm school at this time was being influenced by Gunnar Myrdal’s incorporation of Knightian uncertainty into economic theory (and Lachmann himself later came to examine the role of expectations, see Lachmann 1943 and 1945).

In fact, Hayek delivered a lecture called “Price Expectations, Monetary Disturbances and Malinvestments” on December 7, 1933 in Copenhagen (first published in German in 1935; English trans. Hayek 1939) where he responded to Myrdal’s criticisms. Here he began to modify his ideas on the equilibrium interest rate and the concept of equilibrium itself, which was more fully developed in his paper “Economics and Knowledge” (Hayek 1937). Hayek needed to free himself from the stationary equilibrium approach and construct a dynamic approach suitable for his trade cycle theory (Donzelli 1993: 59; others like Myrdal, Ohlin, Lindahl, and Hicks also freed themselves from the stationary equilibrium approach in the 1930s, and rediscovered the Walrasian instantaneous equilibrium approach; see Donzelli 1993: 60). In his 1933 paper in Copenhagen, Hayek had revived his “intertemporal equilibrium” idea, even though this was really “a temporary equilibrium notion with perfect foresight” (Donzelli 1993: 60). The meshing of plans with correct foresight defined as equilibrium in “Economics and Knowledge” (Hayek 1937) is also a reflection of this.

By the time of the The Pure Theory of Capital, Hayek asserts it is necessary to “abandon every pretence that [sc. equilibrium] … possesses reality, in the sense that we can state the conditions under which a particular state of equilibrium would come about” (Hayek 1976 [1941]: 28). In abandoning equilibrium, Hayek was in effect abandoning his early trade cycle work, and it is no surprise that he never returned to it:

“Hayek’s changing assessment of the importance of equilibrium theory has some consequences for our story. The most telling of these concerns Hayek’s trade cycle theory, a paradigmatic example of equilibrium theory, one that Witt (1997, 48) describes as ‘an impressive example of allied price theoretical reasoning that may even delight a Chicago equilibrium economist.’ But, as Witt goes on to observe, if one rejects the usefulness of equilibrium analysis, then Hayek’s step-by-set story of how the cycle unfolds, one in which ‘each single stage necessarily had to be followed by the next one’ (46), can no longer be maintained. Witt concludes that Hayek’s cycle theory may well be incompatible with his later theory of spontaneous orders, a concern that others have voiced” (Caldwell 2004: 228).

Witt is correct.

But I would go further than Witt: Hayek’s intellectual journey in repudiating equilibrium theory requires that his business cycle theory is essentially worthless as a real world explanation of cycles.

Appendix: Hayek’s Exposition of ABCT

It is useful to list the various works where Hayek developed his trade cycle theory:

(1) Hayek’s paper on intertemporal equilibrium:

F. A. Hayek, 1984 [1928]. “Intertemporal Price Equilibrium and Movement in the Value of Money,” in R. McCloughry (ed.), Money, Capital and Fluctuations. Early Essays, Routledge & Kegan Paul, London.

(2) The essay Monetary Theory and the Trade Cycle (1929) [English trans. 1933 by N. Kaldor and H.M. Croome] in Hayek 2008: 1–130).

(3) Hayek’s first version of ABCT from his LSE lectures in Prices and Production (London, 1931).

(4) Hayek’s 2nd edition of Prices and Production in 1935:

F. A. Hayek, von, 1935. Prices and Production (2nd edn), Routledge and Kegan Paul.

(5) Hayek’s further version of his trade cycle theory with significant changes in 1939:

F. A. von Hayek, Profits, Interest and Investment (London, 1939).

(6) F. A. Hayek, 1942. “The Ricardo Effect,” Economica 9: 127–152.

BIBLIOGRAPHY

Butos, W. N. 1985. “Hayek and General Equilibrium Analysis,” Southern Economic Journal 52.2: 332–343.

Caldwell, B. J. 2002. “Wieser, Hayek and Equilibrium Theory,” Journal des Economistes et des Etudes Humaines 12.1: 47–66.

Caldwell, B. 2004. Hayek’s Challenge: An Intellectual Biography of F.A. Hayek, University of Chicago Press, Chicago and London.

Donzelli, F. 1993. “The Influence of the Socialist Calculation Debate on Hayek’s view of General Equilibrium Theory,” Revue européenne des sciences sociales 31.96.3: 47–83.

Ebenstein, A. 2001. Friedrich Hayek: A Biography, Palgrave, New York.

Ellis, H. S. 1934. German Monetary Theory, 1905–1933, Harvard University Press, Cambridge.

Foss, N. J. 1995. “More on ‘Hayek’s Transformation’,” History of Political Economy 27: 345– 364.

Gloria-Palermo, S. 1999. The Evolution of Austrian Economics: From Menger to Lachmann, Routledge, London and New York.

Hayek, F. A. von. 1937. “Economics and Knowledge,” Economica n.s. 4.13: 33–54.

Hayek, F. A. von. 1939. “Price Expectations, Monetary Disturbances and Malinvestments,” in F.A. Hayek, Profits, Interest and Investment, Routledge, London.

Hayek, F. A. von. 1942. “The Ricardo Effect,” Economica 9: 127–152.

Hayek, F. A. von. 1945. “The Use of Knowledge in Society,” American Economic Review 35.4: 519–530.

Hayek, F. A. von. 1975 [1939]. Profits, Interest and Investment, Augustus M. Kelley Publishers, Clifton, NJ.

Hayek, F. A. von. 1976 [1941]. The Pure Theory of Capital, Routledge and Kegan Paul, London.

Hayek, F. A. von. 1984 [1928]. “Intertemporal Price Equilibrium and Movement in the Value of Money,” in R. McCloughry (ed.), Money, Capital and Fluctuations. Early Essays, Routledge & Kegan Paul, London.

Hayek, F. A. von, 2008. Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard, Ludwig von Mises Institute, Auburn, Ala.

Lachmann, L. M. 1943. “The Role of Expectations in Economics as a Social Science,” Economica n.s. 10.37: 12–23.

Lachmann, L. M. 1945. “A Note on the Elasticity of Expectations,” Economica n.s. 12.48: 248–253.

Loasby, B. J. 1997. “Co-ordination Failure in Economic Theory: Economists in the 1930s,” in A. Jolink and P. Fontaine (eds.), Historical Perspectives on Macroeconomics: 60 Years After the General Theory. Routledge, London. 53–64.

McCloughry, R. 1984. “Editor’s Introduction,” in F. A. von Hayek, Money, Capital & Fluctuations: Early Essays (ed. by R. McCloughry), Routledge & Kegan Paul, London. vii–x.

Moss, L. S. and Vaughn, K. I. 1986. “Hayek’s Ricardo effect: A Second Look,” History of Political Economy 18: 545–565.

Myrdal, G. 1933. “Der Gleichgewichtsbegriff als Instrument der geld-theoretischen Analyse,” in F. A. Hayek (ed.), Beitrage zur Geldtheorie, Vienna. 361–487.

Myrdal, G. 1939. Monetary Equilibrium, William Hodge, London.

Salerno, J. T. 2002. “Friedrich von Wieser and Friedrich A. Hayek: The General Equilibrium Tradition in Austrian Economics,” Journal des Economistes et des Etudes Humaines 12.2: 357–377.

Shackle, G. L. S. 1939. “Review of Contemporary Monetary Theory by R. J. Saulnier,” Economic Journal 47: 501–502.

Witt, U. 1997. “The Hayekian Puzzle: Spontaneous Order and the Business Cycle,” Scottish Journal of Political Economy 44: 44–58.

The History of Modern Monetary Theory

2012-01-03T04:36:00.000-08:00

My last post got a bit hijacked by my attempt to write a digression on the origin of Modern Monetary Theory (MMT), which has also been called Chartalism, neo-Chartalism, the Kansas City approach, and soft currency economics. It strikes me that the subject deserves a post in its own right, so I will attempt one here (bear in mind there is some repetition).

Chartalism in the historical sense should be distinguished from Modern Monetary Theory. Chartalism was a theory of money developed by Georg Friedrich Knapp (1905; English translation 1924), which he called the “state theory of money.” This was taken up by Keynes in his Treatise on Money (1930). It appears to me that economists in the late 20th century associated with Post Keynesianism revived Chartalism as a theory, with the work of Alfred Mitchell-Innes (1913 and 1914) on credit money, including Charles A. E. Goodhart (although, strictly speaking, Goodhart does not regard himself as a Post Keynesian; see Goodhart 2005: 817).

Chartalism has been one source of MMT, and an early proponent L. Randall Wray appears to have used the term to describe the macrotheory he was developing. Randall Wray states:

“... somehow [sc. Chartalism] ... got the name Modern Money Theory. We think the first time those exact words were used might have been in a comment to Bill’s blog in 2007; if anyone can find that comment or a previous use, please send it along. It also looks like Bill used the term “modern monetary theory” in an academic paper in 2008.”
L. Randall Wray, “MMP Blog #30: What is Modern Money Theory?,” January 1, 2012.

The broader sources of Modern Monetary Theory are as follows:

(1) G. Frederick Knapp’s work (1905; 1973 [1924]);
(2) Mitchell Innes’s work (1913; 1914).
(3) Keynes;
(4) Abba Lerner’s functional finance model (1943; see also Lerner 1944; 1947; 1951);
(5) Post Keynesianism (with influence from both Keynes and Michał Kalecki), and
(6) Hyman Minsky’s work (e.g., the employer of last resort idea and the financial instability hypothesis).

Economists who stand out as inventors of Modern Monetary Theory include L. Randall Wray (1998), William F. “Bill” Mitchell, and Warren Mosler.

L. Randall Wray explains the origin of MMT:

“[sc. the origin of MMT] ... goes back to PKT (Post Keynesian Thought) in the early 1990s—the first internet discussion group I ever heard of. It started off with all the stars of heterodox economics—Paul Davidson, Herb Gintis, Michael Perelman, Ed Nell; even Hyman Minsky contributed a post or two. And then there was ... Bill Mitchell ... He had little tolerance for Keynes but otherwise I found myself agreeing with him more often than with anyone else. On Kalecki, on Marx, on fiscal policy, and especially against the Austrians that were slowly but surely killing PKT.

And one other guy stood out—a hedge fund manager named Warren Mosler who was continually pushing two things. First there was something he called soft currency economics. It sounded to me like good old Keynesian economics from the Treatise on Money, which followed Knapp’s state theory of money. ....

What Warren also added was a much deeper understanding of bank reserves and treasury bonds. I came at this from the PK endogenous money, horizontal reserves view of Basil Moore. There’s nothing seriously wrong with that, but it never understood why a sovereign government would sell bonds. Warren explained bond sales as a reserve drain, and lightbulbs went off. Exactly right: government sells bonds to hit the overnight interest rate target. I think it was Mat Forstater who brought the final piece of the puzzle: Lerner’s functional finance approach.”

Wray, L. R. 2011. “MMT: A Doubly Retrospective Analysis,” December 11.

By 1995, Warren Mosler called his theory “soft currency economics.” I quote Warren Mosler:

“The origin of MMT is ‘Soft Currency Economics’ .... I had never read or even heard of Lerner, Knapp, [Innes], Chartalism, and only knew Keynes by reading his quotes published by others. I ‘created’ what became know as ‘MMT’ entirely independently of prior economic thought. It came from my direct experience in actual monetary operations ... .”
http://mmtwiki.org/wiki/History_of_MMT

Mosler, as I understand it, has a connection with Paul Davidson (see also this interview for Mosler’s passing remarks about Charles Goodhart and the LSE). One of Mosler’s early publications was published in the Journal of Post Keynesian Economics (Mosler 1997-1998: 167-182).

Chartalism clearly was an important influence on other Modern Monetary Theory economists, but MMT, as it now exists, goes well beyond the original theories of Knapp or Mitchell-Innes.

The leading proponents of MMT hold that it is now an independent macroeconomic theory (by contrast, the Cambridge Post Keynesian Mark Hayes regards MMT as a sub-branch of Post Keynesianism). At the very least, Post Keynesianism can be regarded as the important macro-theory that stands behind MMT as one of its intellectual fathers, so to speak.

Perhaps it is even possible to think of MMT economists as a new generation of Post Keynesians—that is, as a younger generation that has developed Post Keynesian theory in new ways.

Appendix
I will end this post with a list of advocates and supporters of MMT (mainly academics):

Warren Mosler
Charles Goodhart
Basil Moore? (I could be wrong here)
Jan Kregel
Randall Wray
Bill Mitchell
Pavlina Tcherneva
Stephanie A. Kelton (formerly Stephanie Bell)
Mat Forstater
Ed Nell
Scott Fullwiler
Mike Norman

BIBLIOGRAPHY

Bell, S. 2000. “Do Taxes and Bonds Finance Government Spending?,” Journal of Economic Issues 34.3: 603-620.

Goodhart, C. A. E. 2005. “What is the Essence of Money?” (Reviewing: Geoffrey Ingham, The Nature of Money, Polity, Cambridge, 2004), Cambridge Journal of Economics 29: 817–825.

Keynes, J. M. 1930. A Treatise on Money, Macmillan, London.

Knapp, G. F. 1905. Staatliche Theorie des Geldes, Duncker & Humblot, Leipzig.

Knapp, G. F. 1918. Staatliche Theorie des Geldes (2nd edn.), Duncker & Humblot, Munich and Leipzig.

Knapp, G. F. 1921. Staatliche Theorie des Geldes (3rd edn.), Duncker & Humblot, Munich and Leipzig.

Knapp, G. F. 1973 [1924]. The State Theory of Money (trans. H. M. Lucas and J. Bonar), Augustus M. Kelley, Clifton, NY.

Lerner, A. P. 1943. “Functional Finance and the Federal Debt,” Social Research 10: 38–51.

Lerner, A. P. 1944. The Economics of Control, New York, Macmillan.

Lerner, A. P. 1947. “Money as a Creature of the State,” American Economic Review 37.2: 312–317.

Lerner, A. P. 1951. The Economics of Employment, New York, McGraw Hill.

Mitchell, Bill, 2011. “MMT is Biased Towards Anti-Crony,” December 28.
http://bilbo.economicoutlook.net/blog/?p=17528#more-17528

Mitchell, W. and J. Muysken. 2008. Full Employment Abandoned: Shifting Sands and Policy Failures, Edward Elgar, Cheltenham.

Mitchell-Innes, A. 1913. “What is Money?,” Banking Law Journal 30.5 (May): 377–408.

Mitchell-Innes, A. 1914. “The Credit Theory of Money,” Banking Law Journal 31.2 (January–December): 151-168.

Mosler, W. 1995. “Soft Currency Economics,”
http://www.mosler.org/docs/docs/soft0004.htm

Mosler, W. 1997-1998. “Full Employment and Price Stability,” Journal of Post Keynesian Economics 20.2: 167-182.

Mosler, W. 2010. The Seven Deadly Innocent Frauds of Economic Policy, Valance Co., St Croix, U.S.V.I.
http://moslereconomics.com/wp-content/powerpoints/7DIF.pdf

Wray, L. R. 1998. Understanding Modern Money: The Key to Full Employment and Price Stability, Edward Elgar, Cheltenham.

Wray, L. R. 2011. “MMT: A Doubly Retrospective Analysis,” December 11.
http://neweconomicperspectives.blogspot.com/2011/12/mmt-doubly-retrospective-analysis.html

David Graeber Videos

2012-01-02T21:17:00.000-08:00

I’ve been reading David Graeber’s Debt: The First 5,000 Years (Brooklyn, N.Y., 2011), and hope to review some of the chapters soon. I do recommend this book.

In the meantime, here are interesting videos where David Graeber talks about his work in the book on money and debt, and, above all, the debt origin of money.

Graeber’s anthropological work on the debt origin of money is a very interesting confirmation of the modern Chartalist view on this subject: that money is essentially an IOU, that debt has played a major role in the historical origin of money, and that the neoclassical pure barter origin of money is a myth (or, at least, requires substantial revision). Money’s role as an abstract unit of account/money of account (often arising from weight units, wergild-like social practices, and even planning and design as in ancient Mesopotamia) has been neglected in modern scholarship. For the opposing Austrian and neoclassical view on the origin of money from barter spot transactions, see Menger (1892) and Kiyotaki and Wright (1989; 1991; 1992).

I will end with a brief digression here on Chartalism, since Graeber mentions this theory. Chartalism as a theory of money was developed by Georg Friedrich Knapp (1905; English translation 1924), was taken up by Keynes in his Treatise on Money (1930), and was revived by economists in the late 20th century associated with Post Keynesianism, like L. Randall Wray (1998) and mavericks like Charles A. E. Goodhart (the work of Alfred Mitchell-Innes 1913 and 1914 on credit money is also highly relevant).

The macroeconomics we call Modern Monetary Theory (MMT)* appears to have been independently developed by Bill Mitchell and Warren Mosler (who called his theory “soft currency economics”), and chartalist ideas were mixed in as MMT subsequent developed. I quote Warren Mosler:

“The origin of MMT is 'Soft Currency Economics' .... I had never read or even heard of Lerner, Knapp, [Innes], Chartalism, and only knew Keynes by reading his quotes published by others. I 'created' what became know as 'MMT' entirely independently of prior economic thought. It came from my direct experience in actual monetary operations, much of which is also described in the book.”
http://mmtwiki.org/wiki/History_of_MMT

But Chartalism clearly was a later important influence on Modern Monetary Theory (MMT), and the latter goes well beyond the original theories of Knapp or Mitchell-Innes. Some leading proponents of MMT hold that it is now an independent macroeconomic theory (others like Mark Hayes regard MMT as a sub-branch of Post Keynesianism). At the very least, Post Keynesianism can be regarded as the important macro-theory that stands behind MMT as one of its intellectual fathers, so to speak.

Footnote
* L. Randall Wray states:

“... somehow [sc. Chartalism] ... got the name Modern Money Theory. We think the first time those exact words were used might have been in a comment to Bill’s blog in 2007; if anyone can find that comment or a previous use, please send it along. It also looks like Bill used the term “modern monetary theory” in an academic paper in 2008.”
L. Randall Wray, “MMP Blog #30: What is Modern Money Theory?,” January 1, 2012.

____________________

“Debt: The First 5,000 Years,” C-span Interview (by Doug Henwood), August 23, 2011.

BIBLIOGRAPHY

Kiyotaki, N. and Wright, R. 1989. “On Money as a Medium of Exchange,” Journal of Political Economy 97: 927–954.

Kiyotaki, N. and Wright, R. 1991. “A Contribution to the Pure Theory of Money,” Journal of Economic Theory 53: 215–235.

Kiyotaki, N. and Wright, R. 1992. “Acceptability, Means of Payment, and Media of Exchange,” Federal Reserve Bank of Minneapolis Quarterly Review 2–10.

Knapp, G. F. 1905. Staatliche Theorie des Geldes, Duncker & Humblot, Leipzig.

Knapp, G. F. 1918. Staatliche Theorie des Geldes (2nd edn.), Duncker & Humblot, Munich and Leipzig.

Knapp, G. F. 1921. Staatliche Theorie des Geldes (3rd edn.), Duncker & Humblot, Munich and Leipzig.

Knapp, G. F. 1973 [1924]. The State Theory of Money (trans. H. M. Lucas and J. Bonar), Augustus M. Kelley, Clifton, NY.

Menger, C. 1892. “On the Origin of Money,” Economic Journal 2: 238–255.

Mitchell-Innes, A. 1913. “What is Money?,” Banking Law Journal 30.5 (May): 377–408.

Mitchell-Innes, A. 1914. “The Credit Theory of Money,” Banking Law Journal 31.2 (January–December): 151-168.
N.B. There seems to be some confusion about whether Alfred Mitchell-Innes had a double-barrelled surname or not.

Mosler, W. 1995.“Soft Currency Economics,”
http://www.mosler.org/docs/docs/soft0004.htm

Mosler, W. 2010. The Seven Deadly Innocent Frauds of Economic Policy, Valance Co., St Croix, U.S.V.I.
http://moslereconomics.com/wp-content/powerpoints/7DIF.pdf

Wray, L. R. 1998. Understanding Modern Money: The Key to Full Employment and Price Stability, Edward Elgar, Cheltenham.

Richard Koo in Balance Sheet Recession Debate

2012-01-02T05:00:00.000-08:00

A BBC debate with Gillian Tett, Richard Koo and Francis Fukuyama about balance sheet recessions. One can also read Koo’s paper “The World in Balance Sheet Recession: Causes, Cure, and Politics,” Real-World Economics Review 58: 19-37.

Government is Not Inherently Evil

2012-01-01T23:32:00.000-08:00

That is, according to Ludwig von Mises. The issue of what Mises thought is raised here.

This is Mises’s view:

“The intellectual and moral faculties of man can thrive only where people associate with one another peacefully. Peace is the origin of all human things, not—as the ancient Greek philosopher Heraclitus said—war. But as human nature is, peace can be established and preserved only by a power fit and ready to crush all peacebreakers.

Government or state is the social apparatus of coercion and compulsion. Its purpose is to make the world safe for peaceful human cooperation by protecting society against attacks on the part of foreign aggressors or domestic gangsters. The characteristic mark of a government is that it has, within a definite part of the earth’s surface, the exclusive power and right to resort to violence.

Within the orbit of Western civilization the power and the functions of government are limited. Many hundreds, even thousands of years of bitter conflicts resulted in a state of affairs that granted to the individual citizens effective rights and freedom, not mere freedoms. In the market economy the individuals are free from government intervention as long as they do not offend against the duly promulgated laws of the land. The government interferes only to protect decent law-abiding people against violent or fraudulent attacks.

There are people who call government an evil, although a necessary evil. However, what is needed in order to attain a definite end must not be called an evil in the moral connotation of the term. It is a means, but not an evil. Government may even be called the most beneficial of all earthly institutions as without it no peaceful human cooperation, no civilization, and no moral life would be possible. In this sense the apostle declared that ‘the powers that be are ordained of God.’” (Mises 2007: 57).

Mises’s utililitarian ethics is very clear here, although, in a rhetorical flourish, he even quotes St Paul (Romans 13.1–7) at the end (“for there is no authority except from God, and those authorities that exist have been instituted by God. Therefore whoever resists authority resists what God has appointed, and those who resist will incur judgement”).

We can see how far even Mises was from anarcho-capitalism, and if there is any doubt let Mises speak for himself:

“There is a school of thought which teaches that social cooperation of men could be achieved without compulsion or coercion. Anarchism believes that a social order could be established in which all men would recognize the advantages to be derived from cooperation and be prepared to do voluntarily everything which the maintenance of society requires and to renounce voluntarily all actions detrimental to society. But the anarchists overlook two facts. There are people whose mental abilities are so limited that they cannot grasp the full benefits that society brings to them. And there are people whose flesh is so weak that they cannot resist the temptation of striving for selfish advantage through actions detrimental to society. An anarchistic society would be exposed to the mercy of every individual. We may grant that every sane adult is endowed with the faculty of realizing the good of social coöperation and of acting accordingly. However, it is beyond doubt that there are infants, the aged, and the insane. We may agree that he who acts antisocially should be considered mentally sick and in need of cure. But as long as not all are cured, and as long as there are infants and the senile, some provision must be taken lest they destroy society.

Liberalism differs radically from anarchism. It has nothing in common with the absurd illusions of the anarchists. We must emphasize this point because etatists sometimes try to discover a similarity. Liberalism is not so foolish as to aim at the abolition of the state. Liberals fully recognize that no social coöperation and no civilization could exist without some amount of compulsion and coercion. It is the task of government to protect the social system against the attacks of those who plan actions detrimental to its maintenance and operation. (Mises 2010 [1944]: 48).

In all fairness, Mises is very probably thinking of left-wing anarchism here, but that does not really matter: his view of the “illusions of the anarchists” is clear.

BIBLIOGRAPHY

Mises, L. von. 2007. Economic Freedom and Interventionism: An Anthology of Articles and Essays (ed. B. B. Greaves), Liberty Fund, Indianapolis, Ind.

Mises, L. von. 2010 [1944]. Omnipotent Government: The Rise of the Total State and Total War, Yale University Press, New Haven.

Thomas Palley on the Structural Problems of Neoliberalism and the Eurozone

2012-01-01T22:31:00.000-08:00

Thomas I. Palley is a well published, but underrated, Post Keynesian economist. He is the author of Post Keynesian Economics: Debt, Distribution, and the Macro Economy (New York, 1996), which is a useful textbook for Post Keynesian economics.

There are two videos below. In the first interview, Thomas Palley talks about the structural problems of neoliberalism: how the stagnation of real wages has been a severe underlying cause of neoliberal bubble economics, where people are driven into private debt. We need a fundamental reform of macroeconomic policy, not merely effective financial regulation (although the latter is, of course, important).

In the second video, Thomas Palley talks about the problems of the Eurozone - the flawed design of the euro system (introduced in 1999), which robs Eurozone countries of their monetary and fiscal indepedence. The Eurozone is a grave threat to social democracy. The role of central banks in the neoliberal Eurozone (where they have become “detached,” as Palley says) is even worse than the old neoliberal idea of central bank “independence.”

Keynes’s Marginal Efficiency of Capital: A Mistake?

2012-01-01T20:06:00.001-08:00

It is very interesting to note what Joan Robinson thought of Keynes’s notion of the marginal efficiency of capital:

“[sc. Keynes] made a fatal mistake in offering a quasi-long-period definition of the inducement to invest as the ‘marginal efficiency of capital’, that is, the profit that will be realised on the increment to the stock of capital that results from current investment and, still worse, identified the profitability of capital with its social utility. This was an element in the old doctrine from which he failed to escape. He had an alternative concept of the inducement to invest as the expected future return on sums of finance to be devoted to investment. Minsky (1976) points out that he did not seem to recognise the difference between the two formulations. If he had stuck to his short-period brief, he would have used only the second.” (Robinson 1979: 179–180).

I have seen other criticisms of the marginal efficiency of capital idea, on the grounds that Keynes, in developing it, failed to free himself from the neoclassical marginal productivity of capital (King 2002: 209). Keynes was also influenced by Sraffa’s own rates of interest concept (Barens and Caspari 1997: 294). In fact, Knut Wicksell’s natural interest rate concept, by one of his definitions, appears rather similar to the marginal efficiency of capital:

“The rate of interest at which the demand for loan capital and the supply of savings exactly agree, and which more or less corresponds to the expected yields on the newly created real capital, will then be the normal or natural rate. It is essentially variable. If the prospects of employment of capital become more promising, demand will increase and will at first exceed supply; interest rates will then rise as the demand from entrepreneurs contracts until a new equilibrium is reached at a slightly higher rate of interest. At the same time equilibrium must ipso facto obtain—broadly speaking, and if it is not disturbed by other causes—in the market for goods and services, so that wages and prices remain unchanged” (Wicksell 1934: 193).

The natural rate or “the expected yields on the newly created real capital” is the analogue of the marginal efficiency of capital (Uhr 1994: 94). But Keynes’s marginal efficiency of capital is arguably not a “real” concept: the marginal efficiency of capital is a rate expressed in terms of money.

BIBLIOGRAPHY

Barens, I. and V. Caspari, 1997. “Own-Rates of Interest and Their Relevance for the Existence of Underemployment Equilibrium Positions,” in G. C. Harcourt and P. A. Riach (eds.), A “Second Edition” of The General Theory (Vol. 1), Routledge, London. 283–303.

Harcourt, G. C. and P. A. Riach. 1997. A “Second Edition” of The General Theory (Vol. 1), Routledge, London.

King, J. E. 2002. A History of Post Keynesian Economics since 1936, Edward Elgar Publishing, Cheltenham, UK and Northampton, MA.

Lawlow, M. S. 1994. “The Own-Rates Framework as an Interpretation of the General Theory: A Suggestion for Complication the Keynesian Theory of Money,” in J. B. Davis (ed.). The State of Interpretation of Keynes, Kluwer Academic, Boston and London. 39–90.

Robinson, J. 1979. “Garegnani on Effective Demand,” Cambridge Journal of Economics 3: 179–180.

Uhr, C. G. 1994. “Knut Wicksell – A Centennial Evaluation,” in J. Cunningham (ed.), Knut Wicksell: Critical Assessments (vol. 3), Routledge, London. 72–103.

Wicksell, K. 1934. Lectures on Political Economy (trans. E. Classen), Routledge & Kegan Paul, London.

Hayek the Evil Socialist

2012-01-01T18:51:00.001-08:00

He can be seen through a reading of his book Law, Legislation and Liberty: A New Statement of the Liberal Principles of Justice and Political Economy (vol. 3) (London, 1979), pp. 41–64.

In particular, this striking passage could have been written by a Keynesian:

“On the other hand, it is merely common sense that government, as the biggest spender and investor whose activities cannot be guided wholly by profitability, and which for finance is in a great measure independent of the state of the capital market, should so far as practicable distribute its expenditure over time in such a manner that it will step in when private investment flags, and thereby employ resources for public investment at the least cost and with the greatest benefit to society.” (Hayek 1979: 59).

Hayek even goes on to give us a guide to fiscal rules for government spending (Hayek 1979: 59–60). In an earlier passage, we have Hayek’s defence of public goods, such as many of the amenities of modern life, such as most roads, government protection against violence, epidemics, and natural disasters such as floods or avalanches (Hayek 1979: 44), and the admission of negative externalities (Hayek 1979: 43–44) that can arise from private goods.

Passages like these in Hayek’s later writings lead anarcho-capitalists like Hans-Hermann Hoppe to complain that Hayek was really a social democrat: Mises was, he says, quite different.

But, frankly, the fundamental differences between Mises and Hayek are exaggerated. Mises was also a supporter of a limited state, with a monopoly on violence and coercion – just like Hayek.

Mises supported utilitarianism and allowed for (if not always approved of) restrictions on output by a democratic process using utilitarian arguments:

“Economics neither approves nor disapproves of government measures restricting production and output. It merely considers it its duty to clarify the consequences of such measures. The choice of policies to be adopted devolves upon the people. But in choosing they must not disregard the teachings of economics if they want to attain the ends sought. There are certainly cases in which people may consider definite restrictive measures as justified. Regulations concerning fire prevention are restrictive and raise the cost of production. But the curtailment of total output they bring about is the price to be paid for avoidance of greater disaster. The decision about each restrictive measure is to be made on the ground of a meticulous weighing of the costs to be incurred and the prize to be obtained. No reasonable man could possibly question this rule” (Mises 1998 [1949]: 741).

Now this type of utilitarian reasoning by Mises leads directly to many of Hayek’s “social democratic” positions.

Both Mises and Hayek are radically different from the anarcho-capitalist Rothbard. In fact, the private organisation that calls itself the “Ludwig von Mises Institute” is a gross misnomer, in many ways. How many libertarian supporters of a limited state who adhere to utilitarian ethics do you find at Mises.org? Not many.

In fact, to the average anarcho-capitalist cultist, everyone is a wicked, evil socialist, except for their fellow cult members.

BIBLIOGRAPHY

Hayek, F. A. von. 1979. Law, Legislation and Liberty: A New Statement of the Liberal Principles of Justice and Political Economy (vol. 3), Routledge and Kegan Paul, London.

Hoppe, Hans-Hermann. “Why Mises (and not Hayek)?,” Mises Daily, October 10, 2011.

Mises, L. 1998 [1949]. Human Action: A Treatise on Economics, Ludwig von Mises Institute, Auburn, Ala.

When Did Hayek Renounce Liquidationism?

2012-01-01T04:48:00.001-08:00

The short answer is: at some point after 1933. Certainly by the time of his 1937 essay “The Gold Problem” (“Das Goldproblem”; see Hayek 1999: 169–185, and 184), Hayek is found endorsing public works as a response to depression:

“Even though there are many concerns about organizing public works ad hoc during a depression, everything speaks in favour of having public agencies perform during a depression whatever investment activities need to be carried out in any case and can possibly be postposed until then. It is the timing of these expenses that presents a problem, since funds are often extremely hard to raise in the midst of a severe depression and the accumulation of reserves in good times generally faces the objections mentioned above. There is little question that in times of general unemployment the state must intervene to mitigate genuine hardship either by disbursing unemployment compensation or, as in earlier times, by legislation to help the poor. (Hayek 1999 [1937]: 184; see also Hayek 1978: 210–212).

I am assuming here that Hayek is thinking of deficit-financed public works in this passage.

Ludwig Lachmann in an Austrian Economics Newsletter (AEN) interview explains the change in Hayek’s thinking:

“AEN: In the early 30’s there had been great interest among the profession in the ‘Austrian’ or Hayekian theory of the trade cycle. Yet as the 1930’s progressed even those who had been adherents seemed to have given up their belief in its correctness. What reasons do you think were behind this?

Lachmann: Well, you presumably know about the two different letters to the London Times that appeared in October, 1932. This, of course, was before I came to London. In one of them, Keynes and some Cambridge economists who were not, in general, his friends, like Pigou and Dennis Robertson, demanded that the government should take steps against unemployment. And three days later, Hayek, Robbins and Arnold Plant sent another letter saying that anything the government did by way of public works or similar methods would only make things worse and would not have the affect that Keynes claimed it would have.

That is to say, the ‘Austrians’ seemed to be committed to a policy of continuous deflation whatever happened. Yes, I’m quite sure that the apparent insistence of the ‘Austrians’ that the depression must run its course in the sense that both prices and wages in general must fall seemed to make it increasingly difficult for most other economists to support it, because it was by then obvious that wages didn’t fall, not in the Britain of the 1930’s anyway. That is to say, there was an obvious difference between the point of view expressed by Hayek, Robbins and their letter of October, 1932, and their willingness to admit the following year that a secondary depression was possible.”
Ludwig Lachmann, “An Interview with Ludwig Lachmann,” The Austrian Economics Newsletter, Volume 1, Number 3 (Fall 1978), Mises.org.

Lachmann was at the London School of Economics (LSE) as research assistant to Hayek in the 1930s, and he was in a position to know, as he conducted work for Hayek on secondary depressions. Hayek’s recantation was, as Lachmann says, related to his admission of the existence of “secondary depressions” or what he later called “secondary deflations.”

Curiously, the letter which Hayek signed with Lionel Robbins and others, printed in the Times (October 19, 1932) and which can be read here, although it rejects government spending, has this qualification:

“(1) On the first issue – whether to use one’s money or whether to hoard it – there is no important difference between us. It is agreed that hoarding money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation is in itself desirable.”

One can see how there was a fundamental contradiction between (1) the recognition that deflation in itself was not desirable and (2) the policy proposal of doing nothing of any substance (apart from capital account liberalisation and the absurd idea of more free trade, as if export-led growth would have cured the depression) in an economy hit by deflationary forces in 1932.

There is also a second issue: this was a letter signed by a number of other economists, and reflects the group’s view that they wished to see expressed in public. Hayek’s personal views might have been different. In fact, Hayek tells us explicitly that he did see deflation as desirable, not for its own sake, but for the sake of breaking the downward rigidity of wages:

“… a ‘secondary depression’ caused by an induced deflation should of course be prevented by appropriate monetary counter-measures. Though I am sometimes accused of having represented the deflationary cause of the business cycles as part of the curative process, I do not think that was ever what I argued. What I did believe at one time was that a deflation might be necessary to break the developing downward rigidity of all particular wages which has of course become one of the main causes of inflation. I no longer think this is a politically possible method and we shall have to find other means to restore the flexibility of the wage structure than the present method of raising all wages except those which must fall relatively to all others. Nor did I ever doubt that in most situations employment could be temporarily increased by increasing money expenditure.” (Hayek 1978: 210–211).

Hayek also indicated that he held a different view on the role of deflation during the depression from his later years:

“Although I do not regard deflation as the original cause of a decline in business activity, such a reaction has unquestionably the tendency to induce a process of deflation – to cause what more than 40 years ago I called a ‘secondary deflation’ – the effect of which may be worse, and in the 1930s certainly was worse, than what the original cause of the reaction made necessary, and which has no steering function to perform. I must confess that forty years ago I argued differently. I have since altered my opinion – not about the theoretical explanation of the events, but about the practical possibility of removing the obstacles to the functioning of the system in a particular way” (Hayek 1978: 206).

A third point is that one might object that the Times letter above doesn’t really show Hayek as an explicit liquidationist, but, in my opinion, Hayek’s reputation for liquidationism was the result of his lectures at the LSE and his writings in Prices and Production (1st edn.; London, 1931), which must reflect his lectures. In particular, from passages like this:

“If the foregoing analysis is correct, it should be fairly clear that the granting of credit to consumers, which has recently been so strongly advocated as a cure for depression, would in fact have quite the contrary effect; a relative increase of the demand for consumers’ goods could only make matters worse. Matters are not quite so simple so far as the effects of credits granted for productive purposes are concerned. In theory it is at least possible that, during the acute stage of the crisis when the capitalistic structure of production tends to shrink more than will ultimately prove necessary, an expansion of producers’ credits might have a wholesome effect. But this could only be the case if the quantity were so regulated as exactly to compensate for the initial, excessive rise of the relative prices of consumers’ goods, and if arrangements could be made to withdraw the additional credits as these prices fall and the proportion between the supply of consumers’ goods and the supply of intermediate products adapts itself to the proportion between the demand for these goods. And even these credits would do more harm than good if they made roundabout processes seem profitable which, even after the acute crisis had subsided, could not be kept up without the help of additional credits. Frankly, I do not see how the banks can ever be in a position to keep credit within these limits.

And, if we pass from the moment of actual crisis to the situation in the following depression, it is still more difficult to see what lasting good effects can come from credit expansion. The thing which is needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production to the proportion between the demand for consumers’ goods and the demand for producers’ goods as determined by voluntary saving and spending. If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand, it must mean that part of the available resources is again led into a wrong direction and a definite and lasting adjustment is again postponed. And, even if the absorption of the unemployed resources were to be quickened in this way, it would only mean that the seed would already be sown for new disturbances and new crises. The only way permanently to “mobilize” all available resources is, therefore, not to use artificial stimulants—whether during a crisis or thereafter—but to leave it to time to effect a permanent cure by the slow process of adapting the structure of production to the means available for capital purposes.

(10) And so, at the end of our analysis, we arrive at results which only confirm the old truth that we may perhaps prevent a crisis by checking expansion in time, but that we can do nothing to get out of it before its natural end, once it has come.” (Hayek 2008: 274–275).

Now I have quoted the second edition of Prices and Production here, but I’ve not seen any evidence that this passage was absent from the first edition.

There is an important issue open for debate: where are these alleged passages in the first edition of Prices and Production (1931) that supposedly show Hayek wanting to stabilize MV during depressions by monetary policy?

BIBLIOGRAPHY

Hayek, F. A. von, 1931. Prices and Production, G. Routledge & Sons, Ltd, London.

Hayek, F. A. von. 1978. New Studies in Philosophy, Politics, Economics, and the History of Ideas, Routledge & Kegan Paul, London.

Hayek, F. A. von. 1999. “The Gold Problem” (trans. G. Heinz), in S. Kresge (ed.), The Collected Works of F. A. Hayek. Volume 5. Good Money, Part 1. The New World, Routledge, London. 169–185.

Hayek, F. A. von, 2008. Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard, Ludwig von Mises Institute, Auburn, Ala.

Ludwig Lachmann: Bibliography and Resources

2011-12-31T22:16:00.000-08:00

I generally enjoy reading the work of Ludwig M. Lachmann (1906–1990), even if I am in no sense an Austrian. However, if there is one Austrian that Post Keynesians should be familiar with, it is Lachmann.

That being so, I’ll start a bibliography for Lachmann’s work below. Some interesting trivia:

(1) Lachmann received a PhD in 1930 under Werner Sombart at the University of Berlin.

(2) Lachmann was at the London School of Economics (LSE) as research assistant to Hayek, and observed the epic debates between Keynes and Hayek. Lachmann was a friend of George L. S. Shackle.

(3) Lachmann went to South Africa in 1948.

(4) His radical subjectivism played a major role in the revival of Austrian economics in the 1970s, when in 1975 he became a Visiting Professor of Economics at New York University (for modern Austrians talking about Lachmann’s influence, see here and here).

Lachmann’s work came to emphasise subjective expectations and the volatility of asset markets (see Lachmann 1988) and their effects on investment – ideas he shared with Keynes (Garrison 1987). Lachmann analysed the emerging Post Keynesian school at Cambridge (including Sraffa’s work) in Lachmann (1973; see also Mongiovi 1994).

MY POSTS ON LACHMANN

“Audio Lecture by Ludwig M. Lachmann,” December 21, 2011.

“A Startling Admission from Ludwig Lachmann,” July 11, 2011.

“Ludwig Lachmann on Government Intervention,” July 9, 2011.

“Lachmann on Trade Cycle Models,” August 27, 2011.

BIOGRAPHICAL, REVIEWS AND FESTSCHRIFT WORKS ABOUT LACHMANN

Peter Lewin, “Biography of Ludwig Lachmann (1906–1990): Life and Work,” Mises.org.

Koppl, R. and G. Mongiovi, 1998. Subjectivism and Economic Analysis: Essays in Memory of Ludwig M. Lachmann, Routledge, London.

Kirzner, I. M. 1986. Subjectivism, Intelligibility, and Economic Understanding: Essays in Honor of the Eightieth Birthday of Ludwig M. Lachmann, New York University Press, New York.

Torr, C. S. W., Bohm, S. and K. H. M. Mittermaier. 1992. “L.M. Lachmann: A Bibliography (1930-1990),” South African Journal of Economics 60.1: 78–81.

Mittermaier, K. 1992. “Ludwig Lachmann (1906-1990): A Biographical Sketch,” South African Journal of Economics 60.1: 4–12.
N.B. the South African Journal of Economics, March 1992 (60.1) issue has a number of articles relating to Lachmann.

Garrison, R. W. 1987. “The Kaleidic World of Ludwig Lachmann” (review article of The Market as an Economic Process), Critical Review 1.3: 77–89.
http://www.auburn.edu/~garriro/r8lachmann.htm

Boettke, P. J. 1994. “Ludwig Lachmann and His Contributions to Economic Science,” Advances in Austrian Economics (vol. 1).
http://econfaculty.gmu.edu/pboettke/pubs/ludwig_lachmann.pdf

Mongiovi, G. 1994. “Capital, Expectations and Economic Equilibrium: Some Notes on Lachmann and the So-Called Cambridge School,” in P. Boettke and M. Rizzo (eds.), Advances in Austrian Economics (vol. 1), JAI Press, London. 257–277.

INTERVIEWS

Ludwig Lachmann, “An Interview with Ludwig Lachmann,” The Austrian Economics Newsletter, Volume 1, Number 3 (Fall 1978), Mises.org.

ARTICLES

Lachmann, L. M. 1935. “Commodity Stocks and Equilibrium,” Review of Economic Studies 3: 230–234.

Lachmann, L. M. 1937. “Uncertainty and Liquidity-Preference.” Economica n.s. 4.15: 295–308.

Lachmann, L. M. 1938. “Commodity Stocks in the Trade Cycle,” Economica 5: 435–454

Lachmann, L. M. 1938. “Investment and Costs of Production,” American Economic Review 28.3: 469–448.

Lachmann, L. M. 1939. “Expectations, Investment and Income by G. L. S. Shackle” (review), Economica n.s. 6.21: 103-105.

Lachmann, L. M. 1939. “On Crisis and Adjustment,” Review of Economics and Statistics 21: 62-68

Lachmann, L. M. 1940. “A Reconsideration of the Austrian Theory of Industrial Fluctuations,” Economica n.s. 7.26: 179–196.

Lachmann, L. M. 1941. “On the Measurement of Capital,” Economica 8.32: 361–377.

Lachmann, L. M. 1943. “The Role of Expectations in Economics as a Social Science,” Economica n.s. 10.37: 12–23.

Lachmann, L. M. 1944. “Finance Capitalism?,” Economica n.s. 11.42: 64–73.

Lachmann, L. M. 1945. “A Note on the Elasticity of Expectations,” Economica n.s. 12.48: 248–253.

Lachmann, L. M. 1947. “Complementarity and Substitution in the Theory of Capital,” Economica n.s. 14.54: 108–119.

Lachmann, L. M. 1948. “Investment Repercussions,” Quarterly Journal of Economics 62.5: 698–713.

Lachmann, L. M. 1949. “Investment Repercussions: Reply,” Quarterly Journal of Economics 63.3: 432–434.

Lachmann, L. M. 1951. “The Science of Human Action,” Economica n.s. 18.72: 412–427.

Lachmann, L. M. 1954. “Some Notes on Economic Thought, 1933–1953,” South African Journal of Economics 22: 22–31.

Lachmann, L. M. 1956. “The Velocity of Circulation as a Predictor,” South African Journal of Economics 24: 17–24.

Lachmann, L. M. 1958. “Mrs. Robinson on the Accumulation of Capital,” South African Journal of Economics 26:87–100.

Lachmann, L. M. 1959. “Professor Shackle on the Economic Significance of Time,” Metroeconomica 11: 64–73.

Lachmann, L. M. 1962. “Cost Inflation and Economic Institutions,” South African Journal of Economics 30: 177–89.

Lachmann, L. M. 1963. “Cultivated Growth and the Market Economy,” South African Journal of Economics 31: 165–174.

Lachmann, L. M. 1966. “Sir John Hicks on Capital and Growth,” South African Journal of Economics 34: 113–123.

Lachmann, L. M. 1967. “Causes and Consequences of the Inflation of Our Time,” South African Journal of Economics 35: 281–291.

Lachmann, L. M. 1976. “From Mises to Shackle: An Essay on Austrian Economics and the Kaleidic Society,” Journal of Economic Literature 14.1: 54-62.

Lachmann, L. M. 1973. “Sir John Hicks as a Neo-Austrian,” South African Journal of Economics 41: 195–207.

Lachmann, L. M. 1977. “The Significance of the Austrian School of Economics in the History of Ideas,” in W. E. Grinder (ed.), Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy, Sheed Andrews and McMeel, Kansas City. 55–62.

Lachmann, L. M. 1988. “The Huttian Philosophy,” Managerial and Decision Economics (1986-1998): 13-15.

Lachmann, L. M. 1988. “Speculative Markets and Economic Complexity,” Economic Affairs 8.2: 7–10.

BOOKS

Lachmann, L. M. 1951. Economics as a Social Science. Inaugural Lecture, University of the Witwatersrand, Johannesburg.

Lachmann, L. M. 1970. The Legacy of Max Weber: Three Essays, Heinemann, London.

Lachmann, L. M. 1973. Macro-economic Thinking and the Market Economy: An Essay on the Neglect of the Micro-foundations and its Consequences, Institute of Economic Affairs, London.

Lachmann, L. M. 1977. Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy (ed. by W. E. Grinder), Sheed Andrews and McMeel, Kansas City.

Lachmann, L. M. 1978. Capital and its Structure, S. Andrews and McMeel, Kansas City.

Lachmann, L. M. 1986. The Market as an Economic Process, B. Blackwell, Oxford, UK and New York.

Lachmann, L. M. 1994. Expectations and the Meaning of Institutions: Essays in Economics (ed. by D. Lavoie), Routledge, London.

AUDIO

NOTE: The Ludwig von Mises Institute has given permission under the Creative Commons license that this audio presentation of Lachmann can be publicly reposted as long as credit is given to the Mises Institute and other guidelines are followed. More info at: http://creativecommons.org/licenses/by/3.0/us/

My blog Social Democracy for the 21st Century: A Post Keynesian Perspective is in no way endorsed by or affiliated with the Ludwig von Mises Institute, any of its lecturers or staff members.

Irish Fiscal Policy in 2009

2011-12-31T03:07:00.001-08:00

The usual suspects have questioned whether Ireland really pursued austerity. Others seized on the fact that the Irish government increased government spending in 2009: wasn’t this a stimulus?

The answer is: not likely. First, a government deficit per se does not tell you whether fiscal policy is expansionary. Nor does simply looking at total government spending by itself. There are other factors to be considered:

(1) what was the effect of local and (if relevant) state government budgets?

(2) were taxes raised? If so, by how much?

Here are the figures for Ireland’s annual government spending (the Irish fiscal year is the calendar year):

Irish Government Spending
Year | Budget*
2007 | €50.9
2008 | €55.7
2009 | €60.0
2010 | €55.0
2011 | €51.9
* Billions of euros

Now it is unclear to me whether this is total government spending at all levels (e.g., thirty-four local governments exist in Ireland called county or city councils, as well as regional authorities, although I don’t think the latter have much fiscal effect).

What is clear from the data is that, from 2009 to 2011, there was been a 13.5% cut to total national government spending. That is very sharp fiscal contraction, with the tax increases that Ireland has imposed.

What of 2009? The answer follows:

(1) There was a €4.3 billion increase in spending in 2009, over 2008.

(2) Taxes were raised in 2009. This will have offset the €4.3 billion increase in spending. Ireland passed a supplementary budget in April 2009 (the first was announced in late 2008), which involved expenditure cuts of €1.5 billion and a rise in taxes of €1.8 billion. The total fiscal corrective measures in 2009 were €8 billion (see here). Although I have not found the exact figures for tax increases in this €8 billion sum (can anyone find it?), apparently the tax increases were designed to increase the government’s tax revenue by €6 billion in one year (see “Fine Gael’s Budget for Jobs: Explanatory Memo,” p. 1), with income tax, social security and consumption tax increases. It is obvious that the tax increases alone must have wiped out all or most of any expansionary effect from the €4.3 billion increase in spending in 2009, and it is likely that these tax hikes by themselves caused a contractionary fiscal effect.

(3) I have yet to find accurate figures, but if we have to factor in local government cuts, we probably have a highly contractionary budget even in 2009.

(4) I doubt whether the net effect of fiscal policy in 2009 was stimulative, but even if the net effect was mildly stimulative (like some of Hoover’s deficits), this would have been far too small to do anything about the €13.7 billion dollar collapse of GDP in 2009, as Ireland was hit hard by the worst effects of the global recession in that year.

Butos and Koppl on Varieties of Subjectivism: Keynes and Hayek

2011-12-30T05:00:00.000-08:00

I have just finished reading this paper:

Butos, W. N. and R. Koppl, 1997. “The Varieties of Subjectivism: Keynes and Hayek on Expectations,” History of Political Economy 29.2: 327–359.

There appear to be other downloadable versions of it on the web.

This is an excellent paper, and is thought-provoking, enjoyable and intelligent. I will summarise the paper, with comments on some points.

Keynes and Hayek, Butos and Koppl note, held a subjectivist approach to economics and Keynes’s early work on the business cycle shared Wicksellian foundations with that of Hayek (Butos and Koppl 1997: 327). Keynes’s epistemology is seen as “a form of foundationalism or justificationalism” (Butos and Koppl 1997: 330–331, quoting O’Donnell 1989: 93), which is a “constructivist” or “Cartesian” rationalism (Butos and Koppl 1997: 331). Some remarks on Keynes’s view of ethics follow (Butos and Koppl 1997: 331–333). I know that Keynes was influenced by Moore’s Principia Ethica. Keynes said that he rejected the consequentialist portions of that treatise, though this statement is perhaps questionable when looking at Keynes’s practical moral reasoning (see Braithwaite 2005 [1975]: 243-244). My own view is that the virtue ethics that Keynes said he adhered to is merely a subspecies of teleological/consequentialist ethics: virtue ethics and utilitarianism all come under the same general category.

To return to Butos and Koppl, Hayek, they argue, repudiated rationalism for an “evolutionary epistemology” (Butos and Koppl 1997: 333) and Hayek came to identify himself with Popper’s Critical Rationalism (Butos and Koppl 1997: 334). Hayek held that human thought and even rational thought were “a patterned behavioral response to environmental stimuli” (Butos and Koppl 1997: 336; 334–336). On reading this, I immediately thought that Hayek’s view of human thought seems to verge on a crude form of behaviourism. Yet, according to Butos and Koppl, that is not so (Butos and Koppl 1997: 336).

Butos and Koppl make a crucial point about Hayek’s view of how we have reliable knowledge of the future:

“Hayek .. equated knowledge with practice. This matters for our argument because social practice is largely the product of blind evolution. From a Hayekian perspective, we shall argue, the reliability of our knowledge of the future, of our long-term expectations, does not depend so much on the rationality of our projections as on the properties of the economy’s selection processes. If Hayek’s view holds water, it undercuts the sort of general epistemic critique attempted by Keynes, Shackle, and Lachmann. Alternatively, if Keynes’s views on knowledge are substantially correct, then Hayek's faith in the efficacy of social evolution was misplaced.” (Butos and Koppl 1997: 337).

I think there is a great deal of merit in the remark highlighted in yellow, but not without qualification. Strangely, Butos and Koppl never develop it and overlook its importance. This is arguably the best insight of the whole paper, and I will devote attention to it in what follows.

Now Hayek’s view is that cultural evolution is group selection (Butos and Koppl 1997: 340). I would argue that human societies have certain social practices and institutions which have indeed developed to reduce uncertainty associated with the future, and economic uncertainty. Institutions influence modern capitalism (such as law courts that enforce contracts, buffer stocks, and even central banks) and have been developed precisely to deal with uncertainty. We can conceive them as external entities capable of reducing uncertainty by interventions designed to influence the state of the economic system. If I lend money, what happens if the debtor refused to pay? Law and order and contract law are basic human institutions without which commerce would be impossible. I would call in the law to demand repayment. The threat of force, or its actual use, by an entity with a monopoly on force is how it has been historically done (we call it government).

Other social conventions or institutions that reduce uncertainty (for example, forward/future markets for commodities, and even money) are so deeply ingrained that we think of them now as a fundamental part of capitalism. To the extent that such social practices and institutions exist, they do indeed help to reduce uncertainty about the future. For example, central banks developed in the 19th and 20th centuries precisely because business and financial interests wanted a system that would reduce the uncertainty caused by liquidity crises and financial panics in unregulated financial markets and banking systems.

But what happens when there remain economic phenomena that are still affected by fundamental uncertainty? The level of investment is just such a phenomenon. There is a massive hole here in Hayek’s view of the “properties of the economy’s selection processes.” Before macroeconomic interventions designed to stabilise the business cycle, there were no mechanisms to reliably end recessions and depressions. The crucial Keynesian insight is that the postulated neoclassical equilibrating mechanisms to restore full employment do not work, do not even exist, or are simply unreliable (e.g., wage and price flexibility, an alleged market-clearing equilibrium interest rate for the capital market, belief in the gross substitution axiom, etc.).

I also take issue with the idea that the “social practices” that reduce uncertainty (including institutions which underlie the market or that we now think of as a fundamental part of it) are merely the product of blind evolution. If “blind” is supposed to mean unconscious, undirected or unplanned, I think this is patently false. Human design is highly relevant. Law and order systems (such as contract law and its enforcement) have been designed and directed, and developed; they are not products of blind evolution.

Butos and Koppl discuss Keynes’s distinction between short-term and long-term expectation (Butos and Koppl 1997: 340). Events in the future relevant for long term expectation – and essentially investment decisions – are subject to fundamental uncertainty. A discussion of Keynes’s views on probability follows (Butos and Koppl 1997: 342–347). There is a statement early in Chapter 12 of Keynes’s The General Theory of Employment, Interest, and Money that supports this:

“It would be foolish, in forming our expectations, to attach great weight to matters which are very uncertain.¹ It is reasonable, therefore, to be guided to a considerable degree by the facts about which we feel somewhat confident, even though they may be less decisively relevant to the issue than other facts about which our knowledge is vague and scanty. For this reason the facts of the existing situation enter, in a sense disproportionately, into the formation of our long-term expectations; our usual practice being to take the existing situation and to project it into the future, modified only to the extent that we have more or less definite reasons for expecting a change.

The state of long-term expectation, upon which our decisions are based, does not solely depend, therefore, on the most probable forecast we can make. It also depends on the confidence with which we make this forecast-on how highly we rate the likelihood of our best forecast turning out quite wrong. If we expect large changes but are very uncertain as to what precise form these changes will take, then our confidence will be weak.

The state of confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention. …

[footnote]
1. By ‘very uncertain’ I do not mean the same thing as ‘very improbable’…” (Keynes 1936: 148).

The footnote can only refer to radical uncertainty, and it is obvious that this concept is crucial to Keynes’s theory of long-term expectation.

Butos and Koppl refer to “animal spirits” in Keynes’s thought (Butos and Koppl 1997: 349), but I think that concept, as Keynes understood it, is largely irrelevant to the theory of subjective expectations, and certainly in the modern Post Keynesian theory of subjective expectations, which can draw on modern psychology and behavioural literature.

From p. 349, Butos and Koppl try to identify Hayek’s theory of expectations. They note that Hayek’s famous 1937 paper “Economics and Knowledge” (1937: 33–54) does not, in the end, provide any such theory. Hayek’s view of knowledge is “that the evolutionary conditions of the economic environment influence the reliability of economic expectations” (Butos and Koppl 1997: 350–351). But here is precisely the problem: modern capitalist economies lacked an “evolutionary condition of the economic environment” to provide macroeconomic stability and stabilise the level of investment until the Keynesian revolution. In other words, if Hayek’s view is that economic expectations of the future influencing investment will be made reliable by some social convention or institution produced by social evolution, then they were unreliable exactly because until the 1930s there are no such effective social conventions or institutions. Keynesianism provided the solution.

Hayek argues that

“‘the process of selection that shaped customs and morality could take account of more factual circumstances than individuals could perceive, and in consequence tradition is in some respects superior to, or “wiser” than, human reason’ … . Hayek’s position suggests something similar for the market place. The homegrown traditions bred by market competition are shaped by more factual circumstances than market participants can perceive, and in consequence tried and true business practices may sometimes embody greater wisdom than rational calculation can achieve. In short, … Hayek advances a ‘rational theory of tradition.’” (Butos and Koppl 1997: 351),

This eventually leads to Kirzner’s view of the entrepreneur in capitalism, I have little doubt.

But I don’t see how this at all overcomes Keynes’s views on subjective expectation in the investment decision, and long term expectations in particular. In fact, one can conclude that Hayek’s view of expectations is a serious flaw in his whole thinking, and inferior to Keynes’s.

All in all, this is an excellent paper, raising many issues that deserve further treatment. I think, however, that Austrians would do better to engage directly with the modern Post Keynesian theory of subjective expectations, rather than simply look at Keynes.

BIBLIOGRAPHY

Braithwaite, R. B. 2005 [1975]. “Keynes as a Philosopher,” in M. Keynes (ed.), Essays on John Maynard Keynes, Cambridge University Press, Cambridge.

Hayek, F. A. 1937. “Economics and Knowledge,” Economica n.s. 4.13: 33–54.

Keynes, J. M. 1936. The General Theory of Employment, Interest, and Money, Macmillan, London.

O’Donnell, R. M. 1989. Keynes: Philosophy, Economics and Politics, St. Martin’s Press, New York.

Why isn't Ireland’s Unemployment Higher?

2011-12-30T04:10:00.000-08:00

The answer is: a mass exodus from a country devastated by neoliberal austerity. Ireland’s unemployment rate is currently 14.5%, and it would be much worse without this outflow of the labour force.

Is this supposed to be what the West’s economies can look forward to under neoclassical economics? Depopulation and a generation lost to emigration.

Hayek and the Stock Market Crash of 1929: So Much for His Predictive Powers

2011-12-28T02:21:00.000-08:00

In 1927, the Österreichische Konjunkturforschungsinstitut (Austrian Institute for Business Cycle Research) was opened and Friedrich August von Hayek was appointed as the first director (Hayek 1991: 125, n. 1; Steele 2001: 8–9; for the foundation of the Institute by Mises, see Hülsmann 2007: 575-576). Hayek wrote nearly all the monthly reports (“Monatsberichte” in German) of the institute for four years, and only obtained the assistance of Oskar Morgenstern as his collaborator in 1929 (Hayek 1991: 125, n. 1; Ebenstein 2003: 44; cf. Hülsmann 2007: 576: “Hayek himself wrote the first, very lengthy report [sc. of the “Monatsberichte”] ... Over the years, [sc. Hayek] ... relied more and more on contributions from others”).

You can find PDFs of the Monatsberichte here:

Monatsberichte, Historisches Volltextarchiv ab 1927.

Now it is said that in a report from November 1928 Hayek predicted a great economic crisis (“großen Wirtschaftskrise”) in America. Let’s turn to the relevant passage, with my translation of the German following:

“Harvard Economic Service meint, daß, wenn nicht unerwartete, jetzt nicht erkennbare Faktoren zu einer Liquidation am Effektenmarkt führen sollten, die ersten Monate 1929 eine neue Anspannung am Kapitalsmarkt bringen dürften. Die Kreditsituation sei als heikel und schwierig, nicht aber als gefährlich zu bezeichnen. Doch wenn die Krediterweiterung weiter fortgesetzt wird, wird man in einem Jahr einer noch viel schwierigeren und heikleren Situation gegenüberstehen. Die Position der Federal Reserve-Banken ist allerdings stark genug, um noch längere Zeit Kreditexpansion betreiben zu können und die Zeit der großen Wirtschaftskrise dürfte noch recht weit entfernt sein, wenn dies auch vorübergehende kleinere Liquidationsperioden nicht ausschließt.”

“[The] Harvard Economic Service thinks that factors not now apparent/recognizable, if not unexpected/unforeseen, should lead to a liquidation effect on the market, [and] the first months of 1929 may be expected to bring a new strain in the capital market. The credit situation is to be described as awkward and difficult, but not as dangerous. But, if the credit expansion is continued, we will face in a year an even more difficult and awkward situation. The position of the Federal Reserve banks, however, is strong enough to be able to conduct credit expansion for quite some time, and a time of great economic crisis is likely to be still quite far away, even if this does not exclude periods of temporary smaller liquidation.”
Monatsberichte des österreichischen Institutes für Konjunkturforschung, 2. Jahrgang, Nr. 11. (26 November, 1928). p. 174.

The first thing that sticks out like a sore thumb is the opening clause:

“Harvard Economic Service meint, daß, …” or “[the] Harvard Economic service thinks that … .”

Hayek is quoting from “The Harvard Economic Service,” a publication of the Harvard University Committee on Economic Research: this committee published a quarterly journal on economic statistics, and from 1922 began to provide business forecasting through a weekly newsletter with economic data and analysis.

Apparently, it was a forecast by the American Harvard Economic Service that Hayek is quoting in predicting that some problems would emerge on the US capital market in the first months of 1929. Indeed, Hayek himself on a trip to the US in 1923 had been impressed with empirical business cycle research at Columbia University, and this may have inspired the founding of the Austrian Institute for Business Cycle Research later in 1927 (Overtveldt 2007: 341; Hayek 1994: 6-8, 59; Ebenstein 2003: 43).

So are Hayek’s subsequent statements also derived from information he read in the Harvard Economic Service? If so, Hayek has no great predictive power here: he was relying on American research.

Here is the crucial statement:

“The position of the Federal Reserve banks, however, is strong enough for the credit expansion to be conducted for some time, and a time of great economic crisis is likely to be still quite far away, even if this does not exclude periods of temporary smaller liquidation.”

Was this Hayek’s own prediction? Until we look at the weekly (or perhaps quarterly) issues of the Harvard Economic Service, we can’t know. What is clear is that American forecasters were predicting some kind of crisis in 1929. Hayek picked up on that, and perhaps made this inference. Let’s assume that it was Hayek’s own prediction: in November, 1928 – about a year from the most devastating economic collapse seen in the US and the world – Hayek thought that a “great economic crisis is likely to be still quite far away” (“großen Wirtschaftskrise dürfte noch recht weit entfernt sein”). “Still quite far away” (“noch recht weit entfernt”) sounds like a number of years to me, not one year. This is yet another problem for the view that Hayek was some kind of prescient oracle.

Now Hayek is said to have predicted an economic crisis in the US in a February 1929 report (Steele 2001: 9; Huerta de Soto 2006: 429, n. 28 speaks of a 1929 prediction in the Monatsberichte, but gives no month). However, I cannot as yet find any such prediction. The report is here:

Monatsberichte des österreichischen Institutes für Konjunkturforschung, 3. Jahrgang, Nr. 2. (26 February 1929).

Let’s turn to the second relevant passage. This can be read in the 26 October 1929 issue of the Monatsberichte (my translation follows):

“Jedoch besteht derzeit kein Grund, einen plötzlichen Zusammenbruch der New Yorker Börse zu erwarten. Allerdings ist es nicht ausgeschlossen, daß nunmehr das Ende der geradezu phantastischen Kurssteigerungen gekommen ist und das Niveau langsam abbröckeln dürfte.

Die Kredit Möglichkeiten sind jedenfalls augenblicklich noch sehr große und es erscheint daher die Gewähr gegeben, daß eine ausgesprochen krisenhafte Zerstörung des jetzigen hohen Niveaus nicht befürchtet werden müßte. Zur Zeit werden europäische Gelder bereits in großen Beträgen abgezogen, so daß der Dollarkurs gedrückt ist.”

“However, at present there is no reason to expect a sudden crash of the New York stock exchange. However, it is not impossible that the end of the absolutely amazing price increases has arrived, and [that] the [price] level should slowly crumble. The credit possibilities/conditions are, at any rate, currently very great, and therefore it appears assured that an outright crisis-like destruction of the present high [sc. price] level should not be feared. At the moment, European funds are already being withdrawn in large amounts, so that the value of the [US] dollar is down.” Monatsberichte des österreichischen Institutes für Konjunkturforschung, 3. Jahrgang, Nr. 10 (26 October, 1929), p. 182.

There is a strong likelihood that Hayek wrote this, or possibly as a co-author with Oskar Morgenstern (it is clear from p. 186 of the issue that Hayek is listed as the editor: “Verantwortlicher Schriftleiter: Dr. Friedrich A. Hayek”).

So here a few days before the historic stock market crash of October 28, 1929 (Black Monday) and October 29 (Black Tuesday), a crash that continued until November 13, 1929, we have Hayek predicting

(1) no “sudden crash of the New York stock exchange”;
(2) the possibility of a slow fall in stock market prices, and
(3) an “outright crisis-like destruction of the present high [sc. price] level should not be feared.”

All utterly wrong.

All in all, I don’t see any great miracles of prediction here. There also remains the possibility that Hayek’s November 1928 prediction of a “great economic crisis … likely to be still quite far away” (“großen Wirtschaftskrise dürfte noch recht weit entfernt”) was something he read in the Harvard Economic Service, or that he inferred this from their own prediction of some kind of market liquidation in 1929.

BIBLIOGRAPHY

Ebenstein, A. O. 2003. Friedrich Hayek: A Biography, University of Chicago Press, Chicago and London.

Hayek, F. A. von. 1991. The Collected Works of F. A. Hayek. Volume 3. The Trend of Economic Thinking: Essays on Political Economists and Economic History (ed. W. W. Bartley and S. Kresge), Routledge, London.

Hayek, F. A. von. 1994. Hayek on Hayek: An Autobiographical Dialogue (eds. S. Kresge and L. Wenar), Routledge, London.

Huerta de Soto, J. 2006. Money, Bank Credit and Economic Cycles (trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala.

Hülsmann, J. G. 2007. Mises: The Last Knight of Liberalism, Ludwig von Mises Institute, Auburn, Ala.

Overtveldt, J. van. 2007. The Chicago School: How the University of Chicago Assembled the Thinkers who Revolutionized Economics and Business, Agate, Chicago.

Steele, G. R. 2001. Keynes and Hayek: The Money Economy, Routledge, London and New York.

Hayek’s Natural Rate on Capital Goods, Sraffa and ABCT

2011-12-27T15:15:00.000-08:00

Consider this passage from Hayek’s Prices and Production (2nd edn.; 1935):

“Put concisely, Wicksell’s theory is as follows: If it were not for monetary disturbances, the rate of interest would be determined so as to equalize the demand for and the supply of savings. This equilibrium rate, as I prefer to call it, he christens the natural rate of interest. In a money economy, the actual or money rate of interest (“Geldzins”) may differ from the equilibrium or natural rate, because the demand for and the supply of capital do not meet in their natural form but in the form of money, the quantity of which available for capital purposes may be arbitrarily changed by the banks.

Now, so long as the money rate of interest coincides with the equilibrium rate, the rate of interest remains “neutral” in its effects on the prices of goods, tending neither to raise nor to lower them. When the banks, however, lower the money rate of interest below the equilibrium rate, which they can do by lending more than has been entrusted to them, i.e., by adding to the circulation, this must tend to raise prices; …” (Hayek 2008 [1935]: 215).

This passage illustrates a fundamental reason why Sraffa’s critique of Hayek was so important. In Sraffa’s analysis of Hayek’s theory, we see that

(1) the relevant market for the “demand for and the supply of capital” is the market for capital goods. Depending on how one defines “saving” (see Pollin 2003: 304–308) and “investment,” the demand for capital that is met results in investment (if savings is defined simply as “income not spent,” savings can exceed investment when money or even goods are held without lending for capital goods investment).

(2) By the words
“because the demand for and the supply of capital do not meet in their natural form but in the form of money,”
Hayek is referring to the idea of loans being made in natura (in real commodities), as opposed to in money terms.

(3) A state where loans are made in in natura is a barter state (or, more correctly, a credit/debt transaction where real goods are lent out and repayed with interest with some other goods later). What would a rate of interest be when loans are made in goods? The rate of interest would be the rate on loans of a physical commodity or commodities (Sraffa 1932: 49–51). In a world of heterogeneous goods as factor inputs (including capital goods) which is out of equilibrium, there could be as many natural rates on each commodity considered as a factor input (or capital good) as there as such commodities (Barens and Caspari 1997: 288).

(4) Which one of these rates would in fact be the “natural rate”? There is no unique natural rate, but multiple rates. Any monetary rate could be both above and below a number of multiple natural rates, or, as Lachmann stated, “it is evidently possible for the money rate of interest to be lower than some [sc. multitude of commodity rates] but higher than others” (Lachmann 1994: 154). In short, one should agree with Robert P. Murphy, who concludes that “canonical ABCT does need to be updated, in light of a crippling objection raised early on by Piero Sraffa (1932a, 1932b) [my emphasis]” (see “Multiple Interest Rates and Austrian Business Cycle Theory,” p. 1).

(5) It therefore makes no sense to speak of a monetary rate of interest diverging from the unique Wicksellian natural rate of interest (or what Hayek calls the equilibrium rate), because there is no such rate outside of an imaginary equilibrium position.

(6) If some average of multiple natural rates were constructed, would this get Hayek out of his conundrum? No. As Sraffa argued,
“I pointed out that only under conditions of equilibrium would there be a single rate; and that when saving was in progress there would at any one moment be many ‘natural’ rates, possibly as many as there are commodities; so that it would be not merely difficult in practice, but altogether inconceivable, that the money rate should be equal to ‘the’ natural rate. And whilst Wicksell might fall back, for the criterion of his ‘money’ rate, upon an average of the ‘natural’ rates weighted in the same way as the index number of prices which he chose to stabilise, this way of escape was not open to Dr. Hayek, for he had emphatically repudiated the use of averages. Dr. Hayek now acknowledges the multiplicity of the ‘natural’ rates, but he has nothing more to say on this specific point than that they ‘all would be equilibrium rates.’ The only meaning (if it be a meaning) I can attach to this is that his maxim of policy now requires that the money rate should be equal to all these divergent natural rates.” (Sraffa 1932b: 251).
Lachmann also noted that Wicksell’s natural rate could be interpreted as an average of actual own-rates in a barter economy (Lachmann 1978: 76–77), and later tried to defend the natural rate idea.

For Lachmann’s attempts to salvage the notion of a natural rate, see Lachmann (1978: 75–77) and Lachmann (1986: 225–242). See Robert P. Murphy (2003) and Murphy’s paper “Multiple Interest Rates and Austrian Business Cycle Theory” for why Lachmann’s solution does not work.

BIBLIOGRAPHY

Barens, I. and V. Caspari, 1997. “Own-Rates of Interest and Their Relevance for the Existence of Underemployment Equilibrium Positions,” in G. C. Harcourt and P. A. Riach (eds.), A “Second Edition” of The General Theory (Vol. 1), Routledge, London. 283–303.

Hayek, F. A. von, 1932. “Money and Capital: A Reply,” Economic Journal 42 (June): 237–249.

Hayek, F. A. von, 2008. Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard, Ludwig von Mises Institute, Auburn, Ala.

Lachmann, L. M. 1978. Capital and its Structure, S. Andrews and McMeel, Kansas City. pp. 75–77.

Lachmann, L. M. 1986. “Austrian Economics under Fire: The Hayek-Sraffa Duel in Retrospect,” in W. Grassl and B. Smith (eds.), Austrian Economics: Historical and Philosophical Background, Croom Helm, London. 225–242. [reprinted in Lachmann 1994: 141–158.]

Lachmann, L. M. 1994. Expectations and the Meaning of Institutions: Essays in Economics (ed. by D. Lavoie), Routledge, London. 141–158.

Murphy, Robert P. 2003. Unanticipated Intertemporal Change in Theories of Interest, PhD dissert., Department of Economics, New York University.

Murphy, Robert P. “Multiple Interest Rates and Austrian Business Cycle Theory.”

Pollin, R. 2003. “Saving,” in J. E. King (ed.), The Elgar Companion to Post Keynesian Economics, Edward Elgar, Cheltenham, UK and Northhampton, MA, USA. 304–308.

Sraffa, P. 1932a. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.

Sraffa, P. 1932b. “A Rejoinder,” Economic Journal 42 (June): 249–251.

UPDATED BIBLIOGRAPHY ON THE HAYEK–SRAFFA DEBATE

Barens, I. and V. Caspari, 1997. “Own-Rates of Interest and Their Relevance for the Existence of Underemployment Equilibrium Positions,” in G. C. Harcourt and P. A. Riach (eds.), A “Second Edition” of The General Theory (Vol. 1), Routledge, London. 283–303.

Bellofiore, R. 1998. “Between Wicksell and Hayek: Mises’ Theory of Money and Credit Revisited,” American Journal of Economics and Sociology 57.4: 531–578.

Burger, P. 2003. Sustainable Fiscal Policy and Economic Stability: Theory and Practice, Edward Elgar, Cheltenham, UK.

Caldwell, B. 2004. Hayek’s Challenge: An Intellectual Biography of F.A. Hayek, University of Chicago Press, Chicago and London.

Cottrell, A. 1993. “Hayek’s Early Cycle Theory Re-examined,” Cambridge Journal of Economics 18: 197–212.

Harcourt, G. C. and P. A. Riach. 1997. A “Second Edition” of The General Theory (Vol. 1), Routledge, London.

Hayek, F. A. von, 1931. Prices and Production, G. Routledge & Sons, Ltd, London.

Hayek, F. A. von, 1932. “Money and Capital: A Reply,” Economic Journal 42 (June): 237–249.

Hayek, F. A. von, 1935. Prices and Production (2nd edn), Routledge and Kegan Paul.

Hicks, J. R. and J. C. Gilbert. 1934. Review of Beiträge zur Geldtheorie by F. A. von Hayek, Economica n.s. 1.4: 479–486.

Kurz, H. D. 2000. “Hayek-Keynes-Sraffa Controversy Reconsidered,” in H. D. Kurz (ed.), Critical Essays on Piero Sraffa’s Legacy in Economics, Cambridge University Press, Cambridge. 257-302.

Kyun, K. 1988. Equilibrium Business Cycle Theory in Historical Perspective Cambridge University Press, Cambridge. p. 36ff.

Lachmann, L. M. 1978. Capital and its Structure, S. Andrews and McMeel, Kansas City. pp. 75–77.

Lachmann, L. M. 1986. “Austrian Economics under Fire: The Hayek-Sraffa Duel in Retrospect,” in W. Grassl and B. Smith (eds.), Austrian Economics: Historical and Philosophical Background, Croom Helm, London. 225–242. [reprinted in Lachmann 1994: 141–158.]

Lachmann, L. M. 1994. Expectations and the Meaning of Institutions: Essays in Economics (ed. by D. Lavoie), Routledge, London. 141–158.

Lawlor, M. S. and Horn, B. 1992. “Notes on the Hayek–Sraffa Exchange,” Review of Political Economy 4: 317–340.

Lawlor, M. S. 1994. “The Own-Rates Framework as an Interpretation of the General Theory: A Suggestion for Complicating the Keynesian Theory of Money,” in J. B. Davis (ed.), The State of Interpretation of Keynes, Kluwer Academic, Boston and London. 39–90.

Milgate, M. 1979. “On the Origin of the Notion of ‘Intertemporal Equilibrium,’” Economica n.s. 46.181: 1–10.

Murphy, Robert P. 2003. Unanticipated Intertemporal Change in Theories of Interest, PhD dissert., Department of Economics, New York University.

Murphy, Robert P. “Multiple Interest Rates and Austrian Business Cycle Theory.”

Myrdal, G. 1965 [1939]. Monetary Equilibrium, Augustus M. Kelly, New York.

Sraffa, P. 1932a. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.

Sraffa, P. 1932b. “A Rejoinder,” Economic Journal 42 (June): 249–251.

Vaughn, K. I. 1994. Austrian Economics in America: The Migration of a Tradition, Cambridge University Press, Cambridge and New York.

Money as Debt

2011-12-26T11:20:00.001-08:00

It strikes me that debt is a major aspect of the nature of money (or at least things which function as a means of payment/medium of exchange). We have a descending list of things that are, or could be, used as money, in the sense of a means of payment/medium of exchange or store of value, from the most acceptable and final means of payment to the least acceptable. By the time we get to the bottom of the list, it is rare for the thing in question to be used as money (especially if it is not negotiable). E.g., in a commodity money world, we have the following:

Base commodity money: gold or silver, or banknotes of the central bank
so-called money certificates
demand deposits/fractional reserve current accounts
savings accounts
shares/deposits in other financial institutions (e.g., S&Ls)
promissory notes (private bank notes, other notes payable)
bills of exchange (this sometimes includes the cheque)
cheques (particularly negotiable cheques)
certain term/time CDs (e.g., negotiable CDs)
securities (bonds).

Now I have included bonds in the list because there are historical examples of bonds being used as a means of payment or medium of exchange, although ordinarily they do not function as money in this sense.

Since even in the 19th century gold fell to a small percentage of actual broad money, most central bank banknotes in the 19th century were essentially obligations (debts) of the central banks, where these central banks existed. Triffin (1985: 152) estimates that in 1800 bank money or credit money probably constituted less than 33% of the money supply in the developed world. By 1913, paper currency and bank deposits accounted for 90% of overall currency circulation in the world, and actual gold itself for not much more than 10%.

Behind all of these “money things” listed above is a crucial concept: the abstract money of account (or the abstract unit of money) by which we measure the value of things. Two concepts essential to the definition of money are therefore important:

(1) the abstract money of account or unit of account (which is not physical or concrete), and

(2) the “money things” that function as money which are denominated in the abstract money of account. This refers to things which might be physical (gold, cash, promissory note) or mere accounting records (e.g., reserves at the central bank, bank money or demand deposits recorded in a bank’s balance sheet or transferable debts recorded in written or electronic form) (Wray 2003: 261).

An important additional conceptual division is

(1) the final means of payment (which can be regarded as high powered money), the ultimate “money thing” which can clear all debts or discharge any obligation denominated in the unit of account, and

(2) other debt forms of money which are finally discharged by using (1).

Final clearing of debts of course occurs with the final means of payment: commodity money or banknotes of the central bank. When we withdraw money from our bank, we in fact demand the repayment of the debt instrument that is the fractional reserve account (or demand deposit) in the final means of payment (cash or reserves). Also, when banks settle their accounts with one another, they use the final means of payment.

Furthermore, the property of being able to demand repayment of a debt instrument on demand is by no means confined to fractional reserve demand deposits: it can also be a property of promissory notes and bills of exchange.

If we consider a modern fiat money economy, the following hierarchy is needed:

High Powered Money: cash and base money of the central bank
demand deposits/fractional reserve current accounts
savings accounts
shares/deposits in other financial institutions (e.g., S&Ls)
promissory notes (private notes payable)
bills of exchange (sometimes includes the cheque)
cheques (particularly negotiable cheques)
certain term/time CDs (e.g., negotiable CDs)
securities (bonds).

It is possible to think of high-powered money as the obligations of the central bank, though it is a special type of obligation: it is only convertible into itself (or another currency), not to any commodity. For example, a $10 note is an obligation to convert that bill into another $10 note, or two $5 notes (or some other combination of cash adding up to $10), or $10 of reserves that are merely accounting records.

In a modern economy, high-powered money (or the monetary base, base money, or US M0) is currency in circulation and bank reserves (both required and excess reserves).

M1 is the following:

(1) currency in circulation outside bank vaults (and also excluding bank reserves),
(2) checking/transactions accounts (or demand deposits) and other checkable accounts, and
(3) travellers checks.

Note that M1 excludes vault cash and bank reserves at the central bank, but includes cash held by the non-bank public and the debt forms of money we know as bank money.

BIBLIOGRAPHY

Triffin, R. 1985. “Myth and Realities of the Gold Standard,” in B. Eichengreen and M. Flandreau (eds), The Gold Standard in Theory and History, Routledge, London and New York. 140–161.

Wray, L. R. 2003. “Money,” in J. E. King (ed.), The Elgar Companion to Post Keynesian Economics, Edward Elgar, Cheltenham, UK and Northhampton, MA, USA. 261–265.

The Scale of Obama’s 2009 Stimulus

2011-12-24T22:07:00.001-08:00

What was the actual size of the American Recovery and Reinvestment Act (ARRA, Public Law 111-5), enacted on February 17, 2009? This is a subject causing some confusion. We must remember that this was the second stimulus enacted after the $168 billion Bush stimulus in 2008 (about 1% of GDP).

Here are the facts:

(1) The original estimate in early 2009 by the Congressional Budget Office (CBO) was $787 billion over 10 years.

(2) There have been subsequent revisions of the size.

(3) In January 2010, the CBO revised its estimate to $862 billion, partly because unemployment benefits were costing more than estimated.

(4) By August 2010, the January figure was revised downward to $814 billion over 10 years.

(5) In February 2011, the figure was revised to $821 billion over 10 years.

So currently it is $821 billion over 10 years, and about 70% had been spent by the end of September 2010. That is roughly $300 billion in 2009 and $300 billion in 2010. This was in a roughly $14 trillion US economy (or $14.25 trillion [2009 est.] and $14.66 trillion [2010 est.]), so that overall size of the stimulus in each year is roughly 2% of GDP .

Meanwhile, one sees hordes of ignoramuses who bandy the figure of $800 billion about as if it was all spent in one year. That is false.

And, as always, we have the question of to what extent the stimulus was offset by

(1) state and local austerity, and
(2) deleveraging (for example, many people got a tax cut: did they mostly use this to pay down debt or spend it on consumer goods?).

This will have to be taken into account.

The effect of the stimulus was that the US emerged from recession in Q3 2009, and has not had a negative quarter of growth since:

http://www.tradingeconomics.com/united-states/gdp-growth

It was widely said in early 2009 that the stimulus was not enough to close the output gap, and this is entirely correct. The US was in many ways one of the hardest hit by the financial crisis and demand shocks, so the high level of unemployment that has resulted is not surprising.

In my opinion, the New Keynesians have badly underestimated the potential GDP/GNP of the United States: the US is the largest economy on earth and has a vast unemployment problem. By U-6 (a better measure), unemployment soared to 18% in 2009. This, with massive unused resources and idle capacity (not to mention other nations ready and willing to sell goods to the US), makes for a huge aggregate demand deficiency.

By contrast, other nations have also used Keynesian stimulus, and have managed to keep unemployment levels relatively low with positive GDP growth: e.g., South Korea, China, Singapore, Australia, Germany, Sweden, Norway, and Belgium, to name a few. In fact, if there was any honesty to right wing, conservative or libertarian analysis of economic conditions over the past 3 years, they would be talking about the astonishing success of global Keynesianism. US libertarians and Austrian commentators in particular are contemptibly and laughably ignorant of what goes on outside the United States, where a vast number of other countries have used Keynesian stimulus with success.

There is no doubt whatsoever that global monetary and fiscal interventions have prevented a new Great Depression, which can be seen in the global data compiled by Barry Eichengreen and Kevin O’Rourke (comparing various relevant world statistics from 2008-2011 with 1929-1933). From 2008-2009, world industrial production, world trade, and the value of equity markets were falling off a cliff at a rate as bad as 1929-1932 (and in some cases at a rate even worse than 1929-1930). From 2009 onwards, there has been a remarkable recovery in world industrial production and world trade: the reason is that today we had governments that acted to stop financial systems from collapsing and to stimulate aggregate demand. In the 1930s, governments did not do this, and a global depression resulted.

Today, very few countries have had a depression in the proper sense of a contraction in real GDP/GNP of 10% or more. The only nations where this has happened are countries like Ireland, Greece, Latvia, Lithuania, and Estonia, in which savage austerity has been pursued and Keynesianism rejected.

LINKS

Dean Baker, “Keynes and the Current Crisis,” 7 December 2011.
http://www.cepr.net/index.php/blogs/cepr-blog/keynes-and-the-current-crisis

Paul Krugman, “On the Inadequacy of the Stimulus,” September 5, 2011
http://krugman.blogs.nytimes.com/2011/09/05/on-the-inadequacy-of-the-stimulus/

Economists Who Make the Third Stimulus Honor Roll
http://www.cepr.net/index.php/press-releases/interactive-press-releases/economists-who-make-the-third-stimulus-honor-roll/

Steve Keen on the Keiser Report

2011-12-23T21:22:00.000-08:00

An interview here with Steve Keen on the Keiser Report. Skip forward to 14.00 to get the actual interview.

Audio Lecture by Ludwig M. Lachmann

2011-12-21T19:54:00.000-08:00

I have just found this talk by Ludwig M. Lachmann, delivered at the Department of Economics at the University of Colorado in the 1970s. Some biographical trivia:

(1) Lachmann obtained a PhD from the University of Berlin, where from 1924 to 1933 he was a graduate student.

(2) Lachmann went to England in 1933, and was at the London School of Economics (LSE) as research assistant to Hayek.

(3) Lachmann went to South Africa in 1948.

Here are some comments:

(1) Lachmann ascribes the Austrian view of time to George L. S. Shackle, which I find interesting.

(2) From 8.31 onwards Lachmann gives what he calls the Austrian view of macroeconomic entities: he says Austrians don’t deny the existence of macroeconomic entities (consumption, investment, etc.). Lachmann objects to the idea that these entities have mechanical effects on each other.

(3) Lachmann (27.44 onwards) notes that Schumpeter was early on affiliated with the Austrian school, but became a Walrasian.

(4) From 43.14 Lachmann describes the victory of Keynesianism at the LSE: by 1939 he and Hayek, he says (perhaps with some exaggeration), were the only Austrians left!

(5) From 44.55, Lachmann refers to the early writings of George L. S. Shackle, and includes these writings as making a contribution to his own work on time.

(6) From 55.38, in response to a question about policies for the macroeconomy, Lachmann explicitly allows government intervention in a depression: he notes that Hayek retreated from his liquidationism of 1932 (“Hayek has now realised that that was wrong,” he says from 56.53). “In a situation in which nothing really is scarce” there can be government intervention to increase employment (56.57). That is very significant, and I have written about it here:
“A Startling Admission from Ludwig Lachmann,” July 11, 2011.

“Ludwig Lachmann on Government Intervention,” July 9, 2011.
Lachmann was a different Austrian from the hordes of modern Austrian anarcho-capitalists. In fact, one gets a wonderful insight into Lachmann’s thinking on this from his Austrian Economics Newsletter (AEN) interview:
“AEN: After you moved to England in 1933 you became a research assistant to Hayek. What type of topics were usually of interest in the famous Hayek-Robbins seminar.

Lachmann: In general, problems of the business cycle and of capital theory. I actually worked on secondary depressions. That is to say, what Hayek first used to call the process of secondary deflation, a word that had been coined by a German economist to denote that part of the process of depression which goes beyond any kind of primary maladjustment. That is to say, that kind of depression that would not be an adjustment process in the Hayekian sense. It was by then (1933) admitted that a depression of this kind could develop and I think everybody admitted that by 1933 the world was in a process of secondary depression.”

Ludwig Lachmann, “An Interview with Ludwig Lachmann,” The Austrian Economics Newsletter, Volume 1, Number 3 (Fall 1978), Mises.org.
When I read this I thought: it’s all falling into place! (as an aside, in the same interview, Lachmann talks of Paul Rosenstein-Rodan’s comments on the role of expectations and the Austrian trade cycle theory).

(7) From 59.14, Lachmann rejects the gold standard for the modern world.

(8) From 1.06.20 Lachmann gives his view on government. He confirms that he was a Classical liberal who supported a minimal state, like Mises, as the institutional foundation of the market. Lachmann sees modern democracy in which voters choose to re-distribute wealth as a problem.

(9) From 1.08.12 onwards, Lachmann argues that Austrian economics is consistent with Popper’s methodology. Lachmann quotes Keynes’s letter to Roy Harrod of 16 July 1938 on the proper method for the social sciences.

Other Resources on Lachmann:

Peter Lewin, “Biography of Ludwig Lachmann (1906-1990): Life and Work,” Mises.org.

Ludwig Lachmann, “An Interview with Ludwig Lachmann,” The Austrian Economics Newsletter, Volume 1, Number 3 (Fall 1978), Mises.org.

I strongly urge people to read the interview with Lachmann.

NOTE: The Ludwig von Mises Institute has given permission under the Creative Commons license that this audio presentation of Lachmann can be publicly reposted as long as credit is given to the Mises Institute and other guidelines are followed. More info at: http://creativecommons.org/licenses/by/3.0/us/

My blog Social Democracy for the 21st Century: A Post Keynesian Perspective is in no way endorsed by or affiliated with the Ludwig von Mises Institute, any of its lecturers or staff members.

Steve Keen on Capital Account (December 20th 2011)

2011-12-21T09:28:00.000-08:00

An interesting interview here with Steve Keen on Capital Account (December 20th 2011), with comments on the Eurozone and government debt. Skip forward to 3.30 to get to the interview.

A Classification of Libertarianism

2011-12-20T05:51:00.000-08:00

I have written on this subject before. But I think my earlier classification needs re-thinking. It is obvious that not all free market libertarianism is derived from neoclassical theory. The Austrians and the cult of Rand are not really based on neoclassical theory, although, paradoxically, the Hayekian version of the Austrian business cycle theory is heavily influenced by neoclassical equilibrium theory via Hayek’s use of Wicksellian monetary equilibrium analysis.

Here is an updated classification of free market libertarians:

(1) Randians

(2) Austrians
(i) the Anarcho-capitalists, like Rothbard and Hoppe;

(ii) The minimal state Austrians like Mises (with his praxeology);

(iii) Austrian supporters of Hayek’s economics, with a minimal state;

(iv) The “orthodox” Austrians who have a moderate subjectivist position (like Israel Kirzner and Roger Garrison);

(v) Austrian radical subjectivists like Ludwig Lachmann;
(3) Non-Austrian libertarians (but influenced by Austrian economics)
I suspect that it is also possible to put many of the “Free Bankers” in this category.
(4) Neoclassical libertarians (but influenced by Austrian economics and neoclassical theory)
(i) followers of Robert Nozick’s libertarianism;

(ii) followers of David D. Friedman’s anarcho-capitalism, and other non-Austrian anarcho-capitalism (e.g., Jan Narveson);

(iii) other non-Austrian, neoclassical influenced libertarians (e.g., Tom Palmer, Bryan Caplan and Tyler Cowen).

I have not included Milton Friedman’s monetarism here, because Friedman’s economics was the pretty much mainstream neoclassical macroeconomic theory. Moreover, I am not sure that all modern monetarists or new monetarists would really think of themselves as “libertarians.” Although they are supporters of free markets, I suspect many think of themselves just as mainstream economists.

UPDATE

I have taken Professor George Selgin out of category (3). Professor Selgin no longer self-identifies as an Austrian, but also notes in a comment below:

“... I am no less uncomfortable with the libertarian label than I am with the Austrian one. In fact, you will be hard-pressed to find me ever identifying with a "movement" of any sort: I dislike them all, viscerally.”
http://socialdemocracy21stcentury.blogspot.com/2011/12/classification-of-libertarianism.html?showComment=1324413251211#c4718352180192394769

Fair enough. I do like to get these classifications right.

Neoliberal Austerity in Ireland: A Disaster

2011-12-19T17:08:00.001-08:00

Professor Bill Mitchell has an excellent post here on the continuing disaster of Ireland’s austerity:

Bill Mitchell, “How’s Poor Old Ireland, and How Does She Stand?,” Billy Blog, December 19, 2011.

What’s happened in Ireland?:

(1) Real GDP has contracted 1.9% in Q3 2011, while real GNP contracted by 2.2%. If growth in Q4 is negative for 2011, Ireland will officially slip back into recession. Of the 14 quarters since Q2 2008, only 4 have seen real GDP growth (28%), and 5 have seen real GNP growth (36%).

(2) Unemployment is a disaster. It has soared to over 14% in early 2011 and remains at 14.5%

(3) The domestic sectors of the economy are stagnant or depressed. It is only exports that have provided some positive real GDP/GNP growth. However, with austerity and possible demand for Ireland’s exports falling in its trade partners, even that source of growth will falter, which will probably plunge the economy back into severe contraction. A healthy economy has balanced growth in both the export and domestic sectors. Ireland’s economy is deeply sick, and the only cure for its depressed domestic sector is government spending.

All in all, a dismal result for all that austerity. This is not success: it is miserable failure.

Jonathan Finegold Catalán’s Blog

2011-12-19T09:52:00.000-08:00

A quick post on Austrian blogs again. The Austrian Jonathan Finegold Catalán is blogging again:

Economic Thought.

One can start with this post:

“Austrian Economics and its Place,” 17 December, 2011.

A sample:

“The convergence of the political and economic debates brings to memory a similar debate which dominated during the mid-1930s, between Friedrich Hayek and John Maynard Keynes. .... Hayek and Keynes disagreed on the nature of the crisis and, consequently, on the method of recovering from it. Keynes, broadly considered, supported the use of monetary and fiscal stimuli to put to use unemployed resources, thereby aiding the recovery of aggregate demand. Hayek rejected this approach, since it ignored many of the microfoundations which define the nature of the market process, and instead suggested a means to recovery which relied on the personalized economization of resources by the individuals which constitute the market.”

In other words, Hayek favoured liquidationism. But what is left unsaid is that Hayek retreated from that stance and held views broadly the same as those of Keynes on monetary and fiscal stimulus in a depression by the late 1930s, as I have shown here:

“Did Hayek Advocate Public Works in a Depression?,” September 25, 2011. (this post is the second most read one on my blog, as a matter of interest).

Furthermore, Catalán asserts that

“Sraffa convincingly critiqued a very limited portion of Hayek’s theory of capital, and the profession threw the baby out with the bath water. When Hayek finally finished the polished version of his thoughts nobody was there to listen.”

That is not true: Nicholas Kaldor continued to attack Hayek’s business cycle theory in its later modified versions, in these articles:

Kaldor, N. 1939. “Capital Intensity and the Trade Cycle,” Economica n.s. 6.21: 40–66.

Kaldor, N. 1940. “The Trade Cycle and Capital Intensity: A Reply,” Economica n.s. 7.25: 16–22.

Kaldor, N. 1942. “Professor Hayek and the Concertina-Effect,” Economica n.s. 9.36: 359–382.

And, while I think of it, does anyone know what happened to Robert P. Murphy’s blog?

My Posts on Fractional Reserve Banking (Updated)

2011-12-19T04:13:00.001-08:00

This is an updated list of my various posts on fractional reserve banking:

“Are the Public Ignorant of the Nature of Fractional Reserve Banking?,” December 17, 2011.

“Why is the Fractional Reserve Account a Mutuum, not a Bailment?,” December 17, 2011.

“Callable Option Loans and Fractional Reserve Accounts,” December 16, 2011.

“Future Goods and Fractional Reserve Banking,” December 15, 2011.

“Rothbard on the Bill of Exchange,” December 11, 2011.

“Hoppe on Fractional Reserve Banking: A Critique,” December 11, 2011.

“The Monetary Production Economy and Fiduciary Media,” December 11, 2011

“Fractional Reserve Banking: An Evil?,” June 26, 2010.

“The Romans and Fractional Reserve Banking,” February 23, 2011.

“Gene Callahan on Fractional Reserve Banking,” February 18, 2011.

“Lawrence H. White refutes Huerta de Soto on Fractional Reserve Banking,” February 22, 2011.

“Selgin on Fractional Reserve Banking,” June 1, 2011.

“Schumpeter on Fractional Reserve Banking,” June 12, 2011.

“If Fractional Reserve Banking is Fraudulent, Why isn’t the Insurance Industry Fraud?,” September 29, 2011.

“The Mutuum Contract in Anglo-American Law,” September 30, 2011.

“Rothbard Mangles the Legal History of Fractional Reserve Banking,” October 1, 2011.

“More Historical Evidence on the Mutuum Contract,” October 1, 2011.

“What British Law Says about the Mutuum Contract,” October 2, 2011.

“If Fractional Reserve Banking is Voluntary, Where is the Fraud?,” October 3, 2011.

An Austrian Radical Subjectivist Blog

2011-12-18T12:45:00.000-08:00

A quick post. Here is an Austrian blog identifying with the radical subjectivist tradition of Ludwig Lachmann I have just seen:

The Radical Subjectivist.

It is worth a read.

I will just note that some commentator on the first post accuses Lachmann of having “sympathies towards Keynesian economics” (shock!, horror!). I, however, seriously doubt that. Lachmann placed a strong emphasis on subjective expectations and uncertainty in economics, as Post Keynesians do, and appreciated some of Keynes’s work where these ideas are expressed. That doesn’t necessarily mean Lachmann had “sympathies towards Keynesian economics” at all. Walter Block says this of Lachmann:

“I remember fondly Ludwig saying to me in his heavy accent: ‘Ve must smash zem!’ And he was talking about non Austrians. Inspirational.”

Walter Block, Comment at ThinkMarkets @November 27, 2009 at 10:21 pm
http://thinkmarkets.wordpress.com/2009/11/23/what-is-austrian-economics/#comment-3666

I.e., Lachmann was just as hostile to other economic schools as any Rothbardian.

Are the Public Ignorant of the Nature of Fractional Reserve Banking?

2011-12-17T11:21:00.001-08:00

The short answer is, of course, that there is no doubt some degree of ignorance – perhaps even a great degree of ignorance – about the nature of fractional reserve banking amongst the public, but as to what percentage of people are ignorant I would prefer to see more than one well-sampled survey before giving definitive numbers. One survey that is available from the UK that can be read here (“Public Attitudes to Banking. A Student Consultancy Project by ESCP Europe for The Cobden Centre,” June 2010) finds that 74% of people surveyed (in August 2009) thought that they were the legal owner of the money in their FR current account (p. 6). A further 16% thought that both the bank and the depositor were joint owners of the money (p. 6). Only 8% knew that the bank was the legal owner (p. 6).

Now 74% is indeed a high percentage, but what is very interesting to me is that, despite this number, 61% of people surveyed also said that they did not mind the bank lending out some of the money in their current account as loans (p. 8)! Only 15% said that they keep money in a FR current account for safekeeping (p. 5).
Furthermore, only 33% thought that the bank lending out some of the money from their current account was wrong because they did not give permission (p. 8). This strongly suggests to me that in fact if people were properly informed of the legal nature of FR banking (with the proviso that their debt/deposit is insured), they would not object to the actual practice of FR lending or its legal status. People want banking services with a return on their money. A majority do not mind that the bank lends their money, even though a majority most also think that they remain the legal owner of the money.

Now of course the objection that can be made to fractional reserve banking is that a majority (at least from this UK survey) do not understand the legal nature of the FR contract as a mutuum. In response to this:

(1) The existence of bank runs strongly suggests that historically many people have understood the basic facts behind fractional reserve banking. Bank runs were frequent during financial crises before the 1930s when modern fiat systems and deposit insurance generally became the norm. Now I cannot resist posting this video of one of the best movie bank runs I can think of, because it really does illustrate the issues involved.

Even as a fiction, it is illustrative. In order for such bank runs to have occurred, many people must have understood that the banks do not operate on a 100-percent-reserve basis. Nor am I insensitive to the suffering and negative economic effects caused by the failure of a FR bank (see point (2) below).

I suspect that before the 1930s there was probably a greater degree of public understanding of the nature of FR banking (though I would need empirical evidence to prove it), but in the modern world, as bank runs virtually disappeared, public ignorance has grown. Another crucial point is that before the 19th century, ordinary people did not normally use FR banking systems. FR banking was limited to the wealthy, the commercial and mercantile classes and businessmen, people who had a much better understanding of finance and the contracts they were entering into. There is, then, a strong case to be made here that the widespread ignorance of the legal nature of FR banking has only become a problem in the modern world, as ordinary people have come, in vast numbers, to open FR accounts with the money they earn.

Furthermore, people are surely aware that the money they “withdraw” from their FR reserve account cannot be the same money they deposit in a physical sense. The money you withdraw from an ATM is not the same money you may have physically deposited or that was credited to your account by electronic transfer from your paycheck. It would take but further reflection to see that the belief that your FR account is a mere bailment cannot be true.

(2) If you have failed to read your fractional reserve bank contract, whose fault is that? As a client, you ought to understand the contract that you sign. If, for example, I contract with you to lend you my wheat as a mutuum loan where I have signed a contract that explicitly states that I transferred ownership of the grain to you, but then I think that it is a mere bailment, then this is my misunderstanding. I would be a poor and incompetent businessman. There is no fraud involved, simply ignorance and misunderstanding on my part. This does not mean that there is no consequentialist moral argument for intervening to stop the distress and economic disaster caused by the failure of a fractional reserve system: on the contrary, I hold that there are strong consequentialist moral arguments for government intervention to stop the pro-cyclical nature of unregulated FR banking which lacks an effective lender of last resort. Without modern fiat money, a well-regulated financial system, deposit insurance and a central bank ready as the lender of last resort, fractional reserve banking can be extremely destabilizing and has led to disastrous bank collapses and recessions in the past.

(3) The solution to the problem of modern people not understanding the nature of fractional reserve banking – if we perceive it as problem – is simply legislation to make banks explicitly explain to potential customers when they sign a contract how FR banking works. Specifying to clients that the property rights to the money had passed to the bank, and in return an IOU or credit had been granted to the depositor, that the bank lends your money out, and that it will return not the same money, but other money from its reserves will solve the moral problem of clients not understanding the nature of FR banking. Under these circumstances, FR banking is not fraud. It is a free contract. There was very probably a strong moral argument for enforcing such legislation in the days before deposit insurance, so that people understood the risks involved in FR bank accounts.

In practical terms, however, modern FR systems are protected by deposit insurance and the central bank as a lender of last resort: there is no need to warn depositors that they could lose their money, because that simply does not happen these days. The issue of explaining FR banking to consumers is a far less pressing moral issue than it is made out to be by opponents of FB banking.

UPDATE
I have updated the post in light of this survey.

Why is the Fractional Reserve Account a Mutuum, not a Bailment?

2011-12-17T07:29:00.001-08:00

Certain anti-fractional reserve banking Austrians complain that fractional reserve (FR) banking is illegitimate, because FR accounts are not loans “in the economic sense.” This objection is derived from Mises’s comments on FR banking here:

“It is usual to reckon the acceptance of a deposit which can be drawn upon at any time by means of notes or cheques as a type of credit transaction and juristically this view is, of course, justified; but economically, the case is not one of a credit transaction. If credit in the economic sense means the exchange of a present good or a present service against a future good or a future service, then it is hardly possible to include the transactions in question under the conception of credit. A depositor of a sum of money who acquires in exchange for it a claim convertible into money at any time which will perform exactly the same service for him as the sum it refers to has exchanged no present good for a future good. The claim that he has acquired by his deposit is also a present good for him. The depositing of the money in no way means that he has renounced immediate disposal over the utility it commands.” (Mises 2009: 269; see also Huerta de Soto 2006: 14–15; Rothbard 2011: 733–734; cf. Rozeff 2010).

Essentially, this reduces to the question whether the FR account (or even callable loan) constitutes “the exchange of a present good or a present service against a future good or a future service.” The Austrian argument assumes that money is a good (Huerta de Soto 2006: 696), and with respect to any commodity money system that assumption can be accepted, when money proper in the sense of the commodity money base is distinguished from debt instruments used as a medium of exchange. In a fiat money system, money as the final means of payment is the fiat base money, the obligations of the central bank, and in fiat money systems one will have to say that the FR account involves the exchange of present units of account/medium of exchange for future goods (considered as banking services) and units of account/medium of exchange.

The FR reserve account is an exchange of present for future goods (or exchange of present units of account/medium of exchange for future goods and units of account/medium of exchange), for the following reasons:

(1) you give up the ownership and possession of your money (the present good) in exchange for

(2) the future goods that are (a) interest (which will be paid at a certain future date) and/or (b) banking services (e.g., the use of cheques, debit cards, electronic funds transfer, etc.), and (c) repayment of your loan as recorded in the debt instrument you receive, your FR account.

It is clear that the argument for the FR reserve account constituting an exchange of present for future goods relies on the crucial point that the FR clients do in fact give up the ownership of their money.

Now how do we know that the FR bank clients do, in actual fact, give up the ownership of their money? The reason is that we have overwhelming empirical evidence: we can look carefully at the present and historical actual actions and practices of FR clients and bankers, their free exchanges, their contracts, how both parties understand these actions and contracts, and how these practices were understood in human legal systems.

Let us review the two pieces of evidence:

(1) Real World Contracts, Exchange and Banking Practice.

First, the voluntary and free contract entered into to by two parties that we call the fractional reserve bank account was a real world banking practice, specified by written and verbal agreement.

In Roman law, there were a number of types of real contract (contracts re), as follows:
(1) mutuum (loan for consumption);
(2) commodatum (loan for use);
(3) pignus (pledge), and
(4) depositum or depositum regulare (bailment for safe keeping).
In Roman law, the mutuum contract included loans repayable on demand (loans with a call option, as it were), and the explicit evidence for this can be found in the Institutes of Gaius (161 AD):
“The agreement enforceable as mutuum could only be for the restoration of an equal sum of money or of goods equal in quantity and similar in quality to those lent, at a date named or, if no date was named, on demand.” (De Zulueta 1953: 149).
Already under Roman civil law, the mutuum loan of money involves either (1) a time deposit or (2) a demand deposit/callable loan. Because money can be regarded as representing a certain value, what is deposited is a quantity of a thing (quantitas) and not an individual thing itself (corpus). The depositor thus receives back the same quantity (tantundem) of money, not the same money itself (Zimmermann 1990: 215–216). The essence of the mutuum contract is that ownership rights to the money pass from the creditor to debtor: in the case of a FR account the bank now became the owner of the money.

Therefore the mutuum was the legal framework and concept under which fractional reserve banking was conducted in ancient Rome (Zimmermann 1990: 218). Whether the mutuum was a time deposit or a demand deposit depended on the type of contract between the two parties, and there is no reason to think that fractional reserve banking was held as either immoral or illegal (for how Roman law influenced Medieval law on banking, see Dotson 2004: 89–92). The evidence for the existence of FRB in the Roman Republic and Roman Empire is overwhelming (Harris 2006: 11; Harris 2011: 236). There is not one shred of evidence that it was regarded as immoral or prosecuted as a crime.

There was even a clear action and convention by which two parties indicated that their entering into such an mutuum exchange: in actual banking practice for over 2,000 years, since the Roman Republic, two parties have engaged in a type of callable loan called in Latin the mutuum, by which money brought to a bank was determined to be a loan if it was handed over in an unsealed box/bag/container.

In the Middle ages, these conventions continued. The practice of giving over money in an unsealed bag or box, as described above, was recognised in Talmudic law (Goldin 1913: 68), as it was from the Jewish community from which many medieval bankers came.

The convention entered European civil law, and it was still cited by American judges in the 19th century in Dawson et al vs. the Real Estate Bank before the Supreme Court of Arkansas in 1845:
“From a careful consideration of the authorities on this subject, we understand the general rule to be, that where money, not in a sealed packet, or closed box, bag or chest, is deposited with a bank or banking corporation, the law presumes it to be a general deposit [= mutuum loan – LK], until the contrary appears; because such deposit is esteemed the most advantageous to the depositary, and most consistent with the general objects, usages, and course of business of such companies or corporations. But if the deposit be made of any thing sealed or locked up or otherwise covered or secured in a package, cask, box, bag or chest, or any thing of the like kind of or belonging to the depositor, the law regards it as a pure or special deposit [= bailment – LK], and the depositary as having the custody thereof only for safe keeping, and the accommodation of the depositor.” (Pike 1845: 296–297).
The “general deposit” is a mutuum (or loan) and the “pure or special deposit” refers to a depositum (or bailment). The tradition of sealing money in a bag, chest or box to indicate that it was to be held in safekeeping as a depositum (not as a mutuum) goes right back to English banking practices that have been examined by Selgin (2011). In English law, showing the influence of Roman law through the Norman conquest, certainly from Elizabethan times, and probably from the Norman conquest, law and banking practice distinguished the bailment (depositum) deposit of money from the mutuum loan of money. The question whether the mutuum was a FR account (or callable loan) or time deposit would depend on the type of verbal or written contract or whether it was handed over in a sealed bag or not. This is how freely consenting clients and bankers understood their fractional reserve accounts/loans, in real world actions.

So the free actions and contractual understanding of agents engaged in FR mutuum loans throughout history

(2) The Evidence of Law.

In the legal systems, codes and legal treatises of European civilisation for over 2,000 years that described banking practice, the exchanges I have discussed above are clearly recognised. In the 4th edition of A New Institute of the Imperial or Civil Law (1730; 1st edn. 1704), Thomas Wood (1661–1722), the English Doctor of Civil Law (New College, Oxford), defines the mutuum contract:
“Mutuum (a Loan simply so call’d quod de meo tuum fiat [sc. “because let what is mine become yours”])

It hath no one particular name in the English Language.

is a Contract introduced by the Law of Nations, in which a Thing that consists in weight (as Bullion,) in number (as Money,) in measure (as Wine,) “is given to another upon condition that he shall return another thing of the same Quantity, Nature and Value upon demand. More than Consent is required, for the Thing, viz. Money, Wine, or Oil ought to be actually delivered, and more than what was delivered cannot be repaid; but less may be repaid by Agreement. This Contract forces men to be industrious and promotes Trade, and for this reason it may be greater charity to lend than to give. Creditum is a more general Word. In the case of Money, Silver may be repaid tor Gold, unless the Creditor is to be damnified by it; for it shall be understood to be the same kind of Money when it is of the same” (Wood 1730: 212).
First, the transfer of ownership of the money in a mutuum loan is explicitly stated by Wood above in the Latin phrase de meo tuum fiat (“let what is mine become yours”). This phrase (in the form quod de meo tuum fit) goes right back to Roman law (MacLeod 1902: 149) as a way of describing the mutuum loan, and is found as a definition of mutuum in the Digest (at 12.1.2.2) of Justinian (AD 530-533), part of that emperor’s Corpus Iuris Civilis (Body of Civil Law). Secondly, Wood’s statement here is important:
“he shall return another thing of the same Quantity, Nature and Value upon demand”.
The words “upon demand” confirm that under English law mutuum contracts allow demand deposits or what I call FR accounts (and not just time deposits).

If we turn to modern English law, we can cite the The Laws of England: Being a Complete Statement of the Whole Law of England (vol. 2; 3rd edn.; 1964):
“The contract of mutuum differs from that of commodatum, in that in the latter a bare possession of the chattel lent, as distinguished from the property in it, vests in the borrower, the general property in it still remaining in the lender; where in mutuum that property in the chattel passes from the lender to the borrower.
Mutuum is confined to such chattels as are intended to be consumed in the using and are capable of being estimated by number, weight, or measure, such as money, corn, or wine. The essence of the contract in the case of such loans is, not that the borrower should return to the lender the identical chattels lent (for such specific return would ordinarily render the loan valueless), but that upon demand or at a fixed date the lender should receive from the borrower an equivalent quantity of the chattels lent.” (Halsbury 1964: 112).
This clearly entails that in the case of a mutuum demand deposit in a fractional reserve bank:
(1) Ownership of the money passes from the client to the fractional reserve bank;

(2) The bank returns only money up to the same value (a tantundem), not the original money;

(3) By the terms of the mutuum contract, the money can be returned either at a fixed future date or on demand.
When a modern fractional reserve bank takes money for a new deposit, this is actually a personal loan to the bank. The money in the deposit becomes the property of the bank. This is clearly stated in FR contracts and in modern law. That fact underlies the conclusion that FR banking is an exchange of present for future goods.

The free actions, actual real world contracts, practices and law relating to FR accounts demonstrate that callable mutuum loans involve the transfer of ownership of the money lent.

The typical Austrian advocate of a priori praxeology is incapable of refuting the overwhelming evidence that people have in fact historically freely contracted to give up ownership of their money and enter into a debt contract in the case of FR accounts and callable loans. This how the FR current account/transactions account is properly defined today. The only solution that such Austrian cultists are driven to is the absurd denial of the relevance of the empirical evidence of the FR contract terms, actual banking practice, real world FR exchanges, and the principles defined in law. Such a denial is essentially an admission of defeat in argument.

BIBLIOGRAPHY

Dotson, John E. 2004. “Banks and Banking,” in C. Kleinhenz (ed.), Medieval Italy: An Encyclopedia. Vol. 1, A to K, Routledge, London. 89–92.

Goldin, H. E. 1913. Mishnah. A Digest of the Basic Principles of the Early Jewish Jurisprudence, Baba Meziah (Middle Gate), Order IV, Treatise II, G. P. Putnam’s Sons, New York & London.

Halsbury, H. S. G. 1964. The Laws of England: Being a Complete Statement of the Whole Law of England (vol. 2; 3rd edn.; ed. G. T. Simonds), Butterworth, London.

Harris, W. V. 2006. “A Revisionist View of Roman Money,” Journal of Roman Studies 96: 1–24.

Harris, W. V. 2011. Rome’s Imperial Economy. Twelve Essays, Oxford University Press, Oxford.

Huerta de Soto, J. 2006. Money, Bank Credit and Economic Cycles (trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala

Macleod, Henry Dunning, 1893. The Theory and Practice of Banking in Two Volumes (2nd edn.; vol. 1), Longmans, Green and Co., London.

Mises, L. von, 2009 [1953]. The Theory of Money and Credit (trans. J. E. Batson), Mises Institute, Auburn, Ala.

Rothbard, M. N. 2009. Man, Economy, and State: A Treatise on Economic Principles (2nd edn.), Ludwig von Mises Institute, Auburn, Ala.

Rozeff, M. S. 2010. “Rothbard on Fractional Reserve Banking: A Critique,” Independent Review 14.4 (Spring): 497–512.

Selgin, G. “Those Dishonest Goldsmiths,” revised January 20, 2011
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1589709

Wood, Thomas. 1730. A New Institute of the Imperial or Civil Law (4th edn.), J. and J. Knapton, London.

Zimmermann, R. 1990. The Law of Obligations: Roman Foundations of the Civilian Tradition, Juta & Co, Cape Town.

Zulueta, Francis de. 1953. The Institutes of Gaius Part 2, Clarendon Press, Oxford.

Callable Option Loans and Fractional Reserve Accounts

2011-12-16T10:34:00.001-08:00

Consider the following comment made by a commentator on a previous post:

“I am saying that, economically, … [sc. loans with a callable option] are no different from demand deposits, or putting one’s money underneath one’s pillow, or one’s wallet, or one’s backyard. Economically equivalent concepts cannot be altered just because they are named differently.

Contracts that are ‘loans with a perpetual call option,’ with no minimum time period, with no exchanging of control for a minimum time period, are, economically speaking, not loans, because at no time does the depositor forsake control or exchange control over the money.”

You can follow the link and read the whole tiresome exchange.

There is something very wrong with this analysis above, and here is why:

(1) If you were to keep your money in a chest in your house or buried in the ground on your property, then the following applies:
(i) Fundamentally, you still own and retain possession of the money as an asset.

(ii) this is merely the holding of an asset you own. It is certainly the hoarding of money as well, and the money involved would be idle, in the sense that it is not being (a) invested in capital goods production for a return, or (b) spent on consumer goods (and it is not even being used to buy a financial asset on a secondary market or second hand good).

(iii) You get nothing in return (no services or goods) in an interpersonal exchange here: and of course there is no interpersonal exchange at all. You also get the same money you dig up or remove from the chest.
(2) In a fractional reserve (FR) transactions account or loan with a callable option (which are both mutuum loans), you have
(i) relinquished ownership rights over any money you lent. The FR account is not a bailment at all, and it certainly requires that you have also lost possession of the money. In exchange for the money lent, you obtain an IOU, a debt instrument we call the FR account, which is merely a debt on the bank’s books. You are now faced with the risk of default, to varying degrees depending on the FR system involved. There is no risk of default in money hoarded in your house, as it is not even a loan.

(ii) Unlike hoarding of money you own at your house, the bank has lent out most of your money since it now has ownership rights. In fact, this is the purpose of banking: “the very essence of banking is to receive money as a [m]utuum” (MacLeod 1902: 318). Money is “sold” to the bank as a mutuum and is to be returned in genere (“in general form”) as a tantundem, which means you do not necessarily get the same money back, but just an equivalent amount with interest. The money has been lent for (a) consumer loans, (b) capital goods investment loans, or (c) purchasing of financial assets which the bank holds as assets on its balance sheet. Some of the original money is retained as reserves held by the bank as money they own, either as vault cash or reserves at the central bank.

(iii) Unlike the hoarding of money at your house (which is holding of your own property), a mutuum loan to the FR bank (either as a FR account or callable option loan) is an exchange of present for future goods, in which you give up the ownership and possession of your money (the present good) in exchange for the future goods that are

(a) interest and/or

(b) banking services (see also Rozeff 2010: 509, as a critique of Mises 2009: 269), e.g., use of cheques, a debit card (which these days allow you to purchase goods via the internet), electronic funds transfer overseas, and often foreign exchange transaction services without charge or little charge compared to other businesses. The most important service that banks offer is, of course, ease in making payments, without holding cash, by cheques or (in earlier periods) private banknotes.

(c) a debt instrument, your FR account. For many people, this frees them from actually holding and storing money in safety at home or on their person, and worrying about whether money they hold might be stolen. The FR account also allows you to call back your loan money in whole or part, if you wish to, as a future good that is the tantundem (not the same money you lent, but different money of the same quantity). This has historically freed people from the inconvenience of holding cash on their person to make payments as well, with the advantage of earning interest on the money given as a loan.
It should be noted that both banking services and interest are certainly future goods. In the case of interest payments, there is also usually a specified date when it will be paid. Thus the denial that future goods are not obtained in exchange for the money lent is absurd.

(3) the act of calling back your FR account loan (in whole or part) or callable option loan is different from merely digging up money buried in the ground: the former constitutes demand for repayment of a debt, and in certain historical FR systems there was the very real risk you might not be repaid. There is a significant difference between calling back a loan (with an element of risk) and merely holding a thing in your own possession (with the comparative security of direct holding).

(4) Finally, the idea that “‘loans with a perpetual call option,’ with no minimum time period, with no exchanging of control for a [sc. fixed] minimum time period, are, economically speaking, not loans, because at no time does the depositor forsake control or exchange control over the money,” if taken seriously, logically requires that all callable option loans must be made illegal by the private law code of any hypothetical anarcho-capitalist society. This appears to be the position of Huerta de Soto (2006), Walter Block and William Barnett (2009), and is attacked by George Selgin and Lawrence H. White here and here. I quote Selgin:
“If De Soto’s position is in fact that callable loans are ipso-facto illegitimate, then that position is even less tenable than I once supposed. For now it isn’t just a question of wishing to suppress fractionally-backed bank deposits, but of wishing to suppress all call loans, starting with brokers loans (which have long played a very important role in financing securities trades) but also including callable bonds and many other non-bank intermediated securities.

With respect to these call loans, there is no question of the ambiguous or deceitful use of the term ‘deposits.’ What’s more, the agents who deal with them include many of the most sophisticated players on the financial scene. Finally, it is well understood that while the ‘callability’ of the loans in question exposes borrowers to an additional risk, the extra risk in question is compensated by lower interest terms than would accompany corresponding time loans. In other words, the call feature is part of a mutually advantageous exchange.”
George Selgin, Comment @May 28, 2009 at 8:21 am, on Joseph Salerno, 2009. “White and Horwitz on Hoppe,” Mises.org, May 18.

But my main conclusion here is as follows: the idea that, “economically speaking,” loans with a callable option and FR demand deposits are equivalent to “putting one’s money underneath one’s pillow, or one’s wallet, or [sc. in] one’s backyard” is untenable.

BIBLIOGRAPHY

Block, W. E. and W. Barnett, 2009. “Time Deposits, Dimensions and Fraud,” Journal of Business Ethics 88.4: 711–716.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1889437

Huerta de Soto, J. 2006. Money, Bank Credit and Economic Cycles (trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala

MacLeod, H. D. 1902. Theory and Practice of Banking (6th edn), Longmans, Green, Reader, & Dyer, London.

Mises, L. von, 2009 [1953]. The Theory of Money and Credit (trans. J. E. Batson), Mises Institute, Auburn, Ala.

Rozeff, M. S. 2010. “Rothbard on Fractional Reserve Banking: A Critique,” Independent Review 14.4 (Spring): 497–512.

MMT Conference Panel: Fiscal Austerity or Stimulus?

2011-12-16T09:20:00.000-08:00

An interesting set of talks here on MMT and the current drive for austerity in some countries. This was a panel held on December 8, 2011 at the University of Newcastle (Australia) as part of the 13th Path to Full Employment Conference/18th National Unemployment Conference (December 7-8, 2011), hosted by the Centre of Full Employment and Equity (CofFEE). The speakers are:

(1) Professor William Mitchell (CofFEE, University of Newcastle)
(2) Professor L. Randall Wray (UMKC-Missouri)
(3) Professor Joan Muysken (CofFEE-Europe, University of Maastricht)
(4) Dr Bruce Philp (Nottingham Trent University).

Future Goods and Fractional Reserve Banking

2011-12-15T07:46:00.001-08:00

There is a crucial passage here in Mises’s The Theory of Money and Credit (2009 [1953]) used by other Austrians against fractional reserve banking (Huerta de Soto 2006: 14–15; Rothbard 2011: 733–734; Rothbard 1974: 20):

“It is usual to reckon the acceptance of a deposit which can be drawn upon at any time by means of notes or cheques as a type of credit transaction and juristically this view is, of course, justified; but economically, the case is not one of a credit transaction. If credit in the economic sense means the exchange of a present good or a present service against a future good or a future service, then it is hardly possible to include the transactions in question under the conception of credit. A depositor of a sum of money who acquires in exchange for it a claim convertible into money at any time which will perform exactly the same service for him as the sum it refers to has exchanged no present good for a future good. The claim that he has acquired by his deposit is also a present good for him. The depositing of the money in no way means that he has renounced immediate disposal over the utility it commands.” (Mises 2009: 269).

Let us review these arguments:

(1) Mises concedes that in legal terms (“juristically”) fractional reserve accounts are debt instruments. There are some anti-fractional reserve banking Austrians who do not even acknowledge that.

(2) Mises defines “credit” in the economic sense as the “exchange of a present good or a present service against a future good or a future service.” In the case of money lending, this (curiously) leads quite obviously to a monetary theory of the interest rate: interest is the return for giving up present money (conceived as a good) against future money. Yet there are few Austrians who hold a monetary theory of the interest rate. The only one I can think of is Robert P. Murphy, who concludes that interest is “quite simply the price of borrowing money or (what is the same thing) the exchange rate of present versus future money units” (Murphy 2003: 176).

(3) The assertion that a “depositor of a sum of money who acquires in exchange for it a claim convertible into money at any time which will perform exactly the same service for him as the sum it refers to has exchanged no present good for a future good” is false. Clients who open fractional reserve bank accounts lend money to a bank, and frequently leave large amounts of money of their account unused and do not call the money/debt back. Such clients do in fact regularly give up the present goods that could be purchased with money or (historically) the holding of commodity money proper that can be considered a good. Even in the case of fiat money, fractional reserve clients give up present goods that could be purchased with money.

(4) The future good that fractional reserve clients receive back when calling in their loan is money from the reserves of the bank, which represent idle money from which the fractional reserve clients are repaid their debts.

(5) Mises asserts that the “claim that he has acquired by his deposit is also a present good for him.” That is false, because the debt instrument that is the fractional reserve bank account requires the calling back of the money in order to obtain actual money proper (whether this is commodity money or, in a fiat money system, cash or the reserves of the bank). In a commodity money system, the use of fiduciary media such as a private banknote as a means of payment or medium of exchange is the use, not of money proper, but of debt instruments or IOUs as a means of payment. Whether agents wish to accept debt instruments as a means of payment for goods and services is a matter for voluntary exchange. If the use of debt as a means of payment – or the expansion of such IOUs or debt instruments acceptable as a means of payment – were invalid or immoral, vast numbers of free and voluntary transactions would be immoral. The assertion that debt or IOUs callable on demand into money proper (or whatever is used as the monetary base such as the obligations of the central bank in modern fiat systems) cannot function as money is plainly false, on both theoretical and empirical grounds. The use of IOUs or debts as money has a very long history, and this may even have been the origin of money, as many anthropologists and historians of money have concluded (Graeber 2011; Hudson 2004; Ingham 2000). Most recently, the credit origins of money have been emphasised by the anthropologist David Graeber. Let us quote from this interview with Graeber on the origin of money:

“Philip Pilkington: … Most economists claim that money was invented to replace the barter system. But you’ve found something quite different, am I correct?

David Graeber: Yes there’s a standard story we’re all taught, a ‘once upon a time’ — it’s a fairy tale.

It really deserves no other introduction: according to this theory all transactions were by barter. “Tell you what, I’ll give you twenty chickens for that cow.” Or three arrow-heads for that beaver pelt or what-have-you. This created inconveniences, because maybe your neighbor doesn’t need chickens right now, so you have to invent money.

The story goes back at least to Adam Smith and in its own way it’s the founding myth of economics. Now, I’m an anthropologist and we anthropologists have long known this is a myth simply because if there were places where everyday transactions took the form of: “I’ll give you twenty chickens for that cow,” we’d have found one or two by now. After all people have been looking since 1776, when the Wealth of Nations first came out. But if you think about it for just a second, it’s hardly surprising that we haven’t found anything.

Think about what they’re saying here – basically: that a bunch of Neolithic farmers in a village somewhere, or Native Americans or whatever, will be engaging in transactions only through the spot trade. So, if your neighbor doesn’t have what you want right now, no big deal. Obviously what would really happen, and this is what anthropologists observe when neighbors do engage in something like exchange with each other, if you want your neighbor’s cow, you’d say, “wow, nice cow” and he’d say “you like it? Take it!” – and now you owe him one. … So the real question is not how does barter generate some sort of medium of exchange, that then becomes money, but rather, how does that broad sense of ‘I owe you one’ turn into a precise system of measurement – that is: money as a unit of account?

By the time the curtain goes up on the historical record in ancient Mesopotamia, around 3200 BC, it’s already happened. There’s an elaborate system of money of account and complex credit systems. (Money as medium of exchange or as a standardized circulating units of gold, silver, bronze or whatever, only comes much later.)

So really, rather than the standard story – first there’s barter, then money, then finally credit comes out of that – if anything its precisely the other way around. Credit and debt comes first, then coinage emerges thousands of years later and then, when you do find “I’ll give you twenty chickens for that cow” type of barter systems, it’s usually when there used to be cash markets, but for some reason – as in Russia, for example, in 1998 – the currency collapses or disappears [see Humphrey 1984 – LK].”
“What is Debt? – An Interview with Economic Anthropologist David Graeber,” August 26, 2011.

There is clear evidence that IOUs and debts became transferable and used widely as a medium of exchange in many ancient societies. Debt has functioned as money for thousands of years. The fractional reserve banknote or account is merely a modern form of such IOU/debt money.

(6) In a term/time deposit with a callable option, the client can also call their loan back, though usually with some penalty such as the loss of the interest or some small part of the principal. But this process of calling back a loan with a callable option is in principle no different from the fractional reserve demand deposit client calling back some or all of his loan: yet many Austrians do not deny that time deposits of this type involve an exchange of present goods for future goods. What is most interesting is that the most extreme anti-fractional reserve banking Austrians like Jesus Huerta de Soto, Walter Block and William Barnett are driven to positions that do in fact require an outright ban on all callable loans (see here and here; see also Block and Barnett 2009).

(7) Mises asserts that:

“The claim that he has acquired by his deposit is also a present good for him. The depositing of the money in no way means that he has renounced immediate disposal over the utility it commands.”

The first sentence merely begs the question. And when a fractional reserve client gives over money to his bank as a loan, he has in fact renounced “immediate disposal over the utility it commands,” because in a commodity money world he must use private bank notes that are mere debt instruments (which might in fact be refused and rejected as a means of payment), and go to the trouble of converting his debt claim into money proper by withdrawal of cash or use of checks. Even in a fiat money world, your bank cheque may be refused, you must withdraw cash or use electronic transfer to call back your debt and make payment for goods: you have certainly renounced “immediate disposal over the utility” that actual money or cash in hand commands. As Rozeff argues:

“Mises’s second incorrect claim is that ‘[t]he depositing of the money in no way means that [the depositor] has renounced immediate disposal over the utility that it commands.’ Because the depositor cannot be sure of getting his money back and because he is exchanging it for a different good with different utility, which is why he makes the deposit in the first place, he obviously has renounced any utility that arises from immediately spending the deposit. He has exchanged it for utility arising from a deferred claim to funds plus whatever else in the rearrangement provides him with utility, such as checking services, storage, and interest.” (Rozeff 2010: 509).

BIBLIOGRAPHY

Block, W. E. and W. Barnett, 2009. “Time Deposits, Dimensions and Fraud,” Journal of Business Ethics 88.4: 711–716.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1889437

Graeber, David. 2011. Debt: The First 5,000 Years, Melville House, Brooklyn, N.Y.

Hudson, A. M. 2004. “The Archaeology of Money,” in L. R. Wray (ed.), Credit and State Theories of Money, Edward Elgar, Cheltenham. 99–127.

Huerta de Soto, J. 2006. Money, Bank Credit and Economic Cycles (trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala

Humphrey, C. 1984. “Barter and Economic Disintegration,” Man n.s. 20.1: 48–72.

Ingham, G. 2000. “‘Babylonian Madness’: on the Historical and Sociological Origins of Money,” in J. Smithin (ed.), What is Money? , Routledge, London and New York. 16–41.

Mises, L. von, 2009 [1953]. The Theory of Money and Credit (trans. J. E. Batson), Mises Institute, Auburn, Ala.

Murphy, Robert P. 2003. Unanticipated Intertemporal Change in Theories of Interest, PhD dissert., Department of Economics, New York University.

Rozeff, M. S. 2010. “Rothbard on Fractional Reserve Banking: A Critique,” Independent Review 14.4 (Spring): 497–512.

Rothbard, M. N. 1974. The Case for a 100 Percent Gold Dollar. Ludwig von Mises Institute, Auburn, Ala.

Rothbard, M. N. 2009. Man, Economy, and State: A Treatise on Economic Principles (2nd edn.), Ludwig von Mises Institute, Auburn, Ala.

Salerno, Joseph. 2009. “White and Horwitz on Hoppe,” Mises.org, May 18
http://blog.mises.org/9973/white-and-horwitz-on-hoppe/