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The Keynesians Answer Back

by George Selgin August 5th, 2011 3:29 pm

Last week's debate has naturally generated some response from defenders of Keynes who have found fault with my and Jamie Whyte's characterization of Keynes's views, or who have simply found fault with our...personalities!

Over at Tax Research UK, for instance, Richard Murphy and some of his friends observe that, besides being humorless, Jamie and I must also lack the basic human ability to "empathize" with others (which is, when you get down to brass tacks, just a tiny step away from coming right out and calling us a couple of sadists), for how could we otherwise be opposed to unbridled government spending and bailouts? Concerning the last, Mr. Murphy takes for granted that in suggesting that insolvent banks ought to have been allowed to fail I meant that they ought to have been left to collapse, leaving depositors out in the cold. Murphy's implicit view that collapse is the only alternative to bailouts is of course one that insolvent bankers themselves are happy to see promulgated. Nevertheless it is perfectly unfounded, as I indicate in my contributions to the blog in question, where I refer to what some have styled the "Swedish" alternative.

At Social Democracy a post-Keynesian blogger who styles himself "Lord Keynes" similarly misinterpreted my "liquidationist" stand, inviting what became a long exchange with me there that was interesting in part because by engaging in it I learned that trying to argue with a dreaded Post-Keynesian can after all be a lot more rewarding, as well as a lot more pleasant, than trying to argue with many Rothbardians!

Finally, at Prime another post-Keynesian, Victoria Chick (who I reckon one of my favorite "Keynesian" economists, for what it's worth) accuses Jamie Whyte and me of committing eight serious "fallacies" in our part of the debate. As I only just finished replying to her post, and my answers--one for each of the supposed "fallacies"--still await moderation, I reproduce the latter here (you must consult the original blog for the accusations themselves):

1. Hayek as “an opponent of financial excess”

The suggestion that deregulation was responsible for the sub-prime excess is unfounded. The Glass-Steagall “repeal” of 1999 merely allowed investment banks to have commercial bank subsidiaries; since it was the investment banks themselves rather than their (smallish) commercial bank subsidiaries that got in hot water, the reform made no difference except by making it easier to rescue tottering stand-alone investment banks through bank mergers. As for deregulation in the ’80s, the supposed link to the sub prime boom here is too obviously tenuous to be worthy of comment.

2. Keynesian policy as “promoting the big state”

It’s true that Keynes himself was what today would be considered a (long-run) fiscal conservative. This is a point I myself made in an excised portion of the debate. However it is also true that the Keynesian suggestion that expansionary policies are generally capable (see below) of combating non-trivial levels of unemployment has been seized upon by politicians as justifying government profligacy.

3. The inflation of the 1970s as “the fault of Keynesian policies”

I don’t recall myself blaming “Keynesianism” for the inflation of the 70s. On the contrary: in part of the debate that was edited I specifically observed that Keynes had been a consistent advocate of price-level stabilization. As for the 70s, in the U.S. inflation started creeping up in the 60s, partly because of the Vietnam war but also at the urging of prominent self-styled Keynesians who insisted that higher inflation would bring lower unemployment, as had appeared to be the case earlier in the decade. The so-called stable “Phillips Curve” is not something critics of Keynesianism invented: it was the brainchild of self-styled Keynesians themselves, and it did certainly play its part in the Vietnam-era escalation of U.S. inflation rates.

4. Keynes as “advocate of deficit spending”

and

5. Keynes as “a supporter of wasteful expenditures”

Whether he intended the consequence or not, Keynes’s “pyramid building” rhetoric licensed wasteful government spending. It’s a shame that he isn’t around to assail those who have abused his arguments so. But even a smallish dose of public-choice theory should have sufficed to predict what politicians would make out of the suggestion that any sort of spending is capable of combating depression and, indeed (if Lord Skidelsky is to be taken at his word) capable of promoting long-run economic growth!

6. Roosevelt’s New Deal as “trivial in scale and impact”

Romer wasn’t “compromised” by her earlier writings on the New Deal: she was simply embarrassed by them once she found herself leading the economic team of an administration committed to fiscal stimulus. The evidence and argument contained in her key writings on the 30s remain as solid as ever. Moreover, she is far from alone in having argued that major components of the New Deal, and the NRA especially, were either ineffective or actually counterproductive in ending the depression.

Indeed, Keynes himself believed that the NRA would impede rather than hasten recovery, and said so in a letter to Roosevelt written after the act’s passage. The letter reads in part,

“I am not clear, looking back over the last nine months, that the order of
urgency between measures of Recovery and measures of Reform has been duly
observed, or that the latter has not sometimes been mistaken for the former. In
particular, I cannot detect any material aid to recovery in N.I.R.A., though its
social gains have been large. The driving force which has been put behind the
vast administrative task set by this Act has seemed to represent a wrong choice
in the order of urgencies. The Act is on the Statute Book; a considerable amount
has been done towards implementing it; but it might be better for the present to
allow experience to accumulate before trying to force through all its details. That
is my first reflection–that N.I.R.A., which is essentially Reform and probably
impedes Recovery, has been put across too hastily, in the false guise of being
part of the technique of Recovery.”

(Interested readers can read the whole letter here.)

7. The 2008-9 financial rescue as “‘Keynesian”

Well, here is Keynesian support for bank bailouts. Q.E.D.

By the way, it has been suggested by some (not here) that in opposing such I in effect favored simply letting banks collapse. But the suggestion that collapse is the only alternative to bailouts ignores what some term the “Swedish approach”, which was the alternative I had in mind.

8. The failure of stimulus as “a failure of Keynesian policy”

Sorry, but it’s back to pyramids again: the Keynesian argument is that the problem is solely one of inadequate demand, so that, much as public works and such might be preferred, any sort of fiscal [stimulus] should help; and it was on such grounds that U.S. proponents of fiscal stimulus didn’t trouble themselves over just where stimulus money would go in arriving at their (ultimately very wrong) estimates of the “multiplier” effects we could all look forward to. If more orthodox Keynesians think that all this was a mistake, I am glad to hear it. But they still need to explain how to reconcile their ideal stimulus with the workings of real world (democratic) governments.

Addendum: Soon after this posting Mr. Murphy shut-down comments on his blog entry. Perhaps I'm being too uncharitable in supposing that this had anything to do with the accumulation of negative feedback he was receiving, much of which was evidently from sympathetic, regular readers. Mr. Murphy, in any event, allowed himself the following last words:

"Trouble is – I’ve never known an empathic person who can find a cent of sympathy for Hayek and Hayekians."

Meaning, I surmise, either (1) that he couldn't hear all those people shouting "Yo Hayek" in the BBC podcast or (2) that he maintains that every one of them was incapable of empathy.

Methinks the man doth protest too much.

18 Responses to “The Keynesians Answer Back”

  1. avatar Jamie Whyte says:

    I left a comment on Richard Murphy's blog which appears to have failed the hi moral standards he clearly applies to his moderating. I repeat it below (the text inside quotation marks is what he said in his post: i.e. these quotation marks appear in my comment).

    “Duncan Weldon and Robert Skidelsky gave good, and amusing account of themselves for keynes. The Hayekians showed themselves in their usual light; as charmless people with no sense of empathy for the human race. As someone put it to me, chess players have more feeling for their pieces than these people seem to have for the people of the world.”

    “I, and others of empathic disposition, realise that …”

    This moral self-congratulaton may pass for charm in your circles, but it makes me feel queasy. Especially because it is always those who seek a license to push other people around, like pieces on a chess board, who make such a fuss about their own moral superiority.

  2. avatar Martin says:

    I am not entirely sure, but why are the bank bailouts Keynesian? Didn't they essentially buy bank debt that was later (supposed to be?) repaid? I don't exactly see how that boosts G as a substitute for C. If anything, it's saving (S). Not all saving is repaid at par, but I believe the TARP did make a profit?

    Personally I don't see much of a difference between stabilizing MV and a fiscal stimulus, both raise NGDP => PY. Stabilizing MV itself is though preferable than to do it through PY, but it is supposed to have the same effect. Isn't the former also what Hayek proposed? Or am I looking at Hayek with Neoclassical glasses?

    Loved the debate, video would have been better and the end of the broadcast cuts you guys off mid-answer.

  3. avatar Andrew_M_Garland says:

    === ===
    During a 1934 dinner in the U.S., one economist carefully removed a washroom towel from a stack to dry his hands. Mr. Keynes swept the whole pile of towels on the floor and crumpled them up. He explained that his way of using towels did more to stimulate employment among restaurant workers.
    === ===

    Keynes, Digger of Holes

    - -
    All governments are Keynesian, and just as wrong as Keynes was. Amazingly, the US and China (among most other governments) use the following logic:
    (1) When it rains, many people use umbrellas.
    (2) If we make people use umbrellas, then it will rain.

    Don't believe me? Here is the exact logic of the US and China (among others):
    (1) We have measured GDP (Gross Domestic Product) at different times.
    (2) During times of prosperity, GDP is high. (This makes general sense; people are producing more stuff.)
    (3) We can raise GDP (by accounting definition) by building more stuff of any kind, by borrowing and collecting high taxes. In the US, it was the stimulus package, building millions of houses, and ongoing bloat in the federal and state governments. In China they are building cities in new places. This increases GDP by definition.
    (4) Wait a bit, prosperity is sure to come.

    We know that "location, location, location" are the top three criteria for valuable real estate. China has now built thousands of buildings in the wrong locations. The US has built thousands of sidewalks in the wrong locations (a small part of the stimulus).

    According to government accountants, this has all added to GDP. We are all waiting now for the prosperity that is sure to come. And the rain.

  4. avatar lwaaks says:

    I recall a comment by Murray Rothbard that "Keynesianism is the intellectual armor of the welfare/warfare state." There might be soemthing to this. Putting aside the merits of the Keynesian argument, the social-democrats like Richard Murphy certainly do get to have their cake and eat it too. They can beat free-market economists like George Selgin with the compassion stick for failing to endorse measures to help the unemployed, win elections with massive vote buying (e.g. FDR in the 1930s) under the umbrella of stimulus and, lest their moral arguments for the welfare state fail, they can argue for virtually any social program as a form of spending.

  5. avatar Scott Burns says:

    Lord Keynes is a very respectable Keynesian. I greatly enjoy his post. That said, I'd love to meet another Keynesian who denounces wasteful and profligate spending BEFORE the government does it rather than looking back and admitting, "That might not have been the best use of public resources." As I've argued, Keynesianism (although not necessarily Keynes himself) is a slippery slope into endless statist interventions. By leaving open the question of what government should and shouldn't spend on/regulate, they open the floodgates for regime uncertainty and the very policies that give rise to booms/bust.

  6. avatar Paul Marks says:

    If someone accused me of "lack of empathy" or not being "pleasant" I would take such statements as (unintentional) complements (the real meaning of which being "you are not corrupt"). However, George Selgin appears (like Robert Nozick before him) to be sensitive about (rather than pleased) to attract such remarks from the left - so I will leave the matter alone.

    On Keynes, this post reads almost like a whitewash of Keynes - which is a weird thing for an arch critric of Keynes to have written. Although I remember Mrs Thatcher digging up all the pro free market words of Keynes himself and using them in debates with statist Keynesians (at the time I though Mrs T. was crazy to do that - but the intent may have been to force the left to either say their hero changed his position every other day, or that he lied a lot).

    Keynes was the man who wrote articles for the New York Times back in the 1930s (at the time when Henry Hazlitt was writing the opposite sort of article) praising (not opposing) the various demented government spending plans and most (although, yes, not all) the government regulations.

    Of course the private Keynes was even worse - I suggest that people read Hunter Lewis' "Where Keynes Went Wrong". The only problem with this work is the title - which implies that Keynes was once O.K. and then went bad. In reality the man's philosophy and his grasp of basic economic theory were always terrible - terrible in practical terms (because he was ignorant of the subject, economics, by which he made his name) and terrible in moral terms (and I am not talking about his homosexuality - I am talking about his whole contempt for such moral principles as honesty).

    In economics Keynes (as should be well known from the work on him by Henry Hazlitt, W.H. Hutt and many others) wanted a world were investment could occur with real saving, where progress and prosperity required no real effort or self denial. Basically a sort of "Star Trek: New Generation" view of the future. Just because Keynes sometimes made pro free market statements (when he thought it might suit his purposes to trick people by making such statements) does not mean that the real man and his agenda should be forgotten.

    The bank collapses:

    Oddly enough the opponents George Selgin mentions say some thing that are close to the truth.

    Of course if there had not been vast bailouts many (although, most likely, not all) banks would have collapsed. It is folly to deny this point.

    There are no costless policy options (just as their no costless investments - if you want to invest in something you have to consume less, in order to have the money to make the investment).

    If the banks had not been bailed out then YES many of them would have collapsed (as they may well do anyway - eventually).

    In the United States this would have meant that those people who had over one hundred thousand Dollars in any single account would have lost some of the extra money (how much they would have lost would have depended on what could have been saved from the bankrupt bank). Indeed even the 100,000 Dollars would have only been safe because of a government pledge to "depositors" (a long standing one) to bail them out (as individuals) for money up to this limit.

    The alternative policy was tried by Iceland - where "depositors" (mostly overseas) in the bankrupt banks based in Iceland were not bailed out by the government of Iceland. Instead these people went to their own governments (mostly the British and Dutch governments) to bail them out.

    The British and Dutch governments demanded payment from Iceland - but the people of Iceland (I think correctly - for there was no legal provision to bailout "depositors" in Icelanic law, at least not these "depositors") said no - actually twice said no (the government did not like the reply of the people the first time - but got the same reply the second time, American taxpayers were, of course, never asked for their opinion).

    Sadly it is not "needless to say" that private deposit insurance is simply not practical. It is possible to insure against fire, or flood, or earthquake, or even acts of man such as theft. But insure against bad business judgement? Insure against the bank making loans to people who do not pay them back?

    The above means that someone who gives money to a bank to lend out (in the FALSE modern language a "depositor" - false language because the money is not "deposited", it is lent out) should be very careful what bank he or she gives the money to - for fear of losing the money.

    However, in the world of government backing "deposites" (or people believing they are government backed - as with Iceland, where the people who had given banks in Iceland their money seemed astonished to find they government of Iceland was not going to bail them out) people just put money in the bank that offers the highest interest rates (or some such reason).

    People do not bother their little heads about how the bank is run. After all, why should they bother thinking? The government will bail them out if anything goes wrong. Under such conditions adult human beings revert to being children (and rather greedy and stupid children at that).

    An obvious recent example of the foolisness of this form of thinking is Ireland.

    In the opposite of the example of Iceland, the Irish government declared (when the banks first started showing signs of being in trouble) that it would back any amount of money (put in by anyone) in an Irish bank.

    The results were easy to predict - and were predicted by many people.

    Money flooded into the Irish banks, but they continued to be a hopeless mess (O.K. perhaps the Bank of Ireland was not quite as bad as Anglo Irish and the rest of them), so the scale of the problme just went up and up, and so Ireland de facto went bankrupt.

    The liablities the Irish state took upon itself were vastly greater than the Irish people could possibly bear - and so Ireland became a ward of the European Union, with the independence of a once proud nation being betrayed.

    "Do not be so melodramatic Paul - we are economists, at least the Irish government was made to cut government spending".

    But was it?

    There is endless talk of "cuts" - but the gap between private wages and government wages has never been higher in Ireland ("public sector" wages and benefits are 44% higher than private wages) indeed government wages have gone UP since the financial crises started.

    And in all the talk of "cuts" there is the matter of the bank bailouts themselves - once you include those costs into govenment spending figures a different picture emerges....

    The real picture - the picture of Irish government spending having reached levels it had never been at in history before. So much for "cuts".

    However, I repeat - there are no costless policy alternatives.

    It is possible (that in bankruptcy) people who put their money into the Bank of Ireland might have got a lot of it (if not all of it) back.

    But people who put their savings into Anglo Irish (and the rest)? Not a chance - they would have lost (and lost hard).

    The United States?

    George Selgin may know more about the state of the finances of J.P. Morgan Chase, Bank of America, Citigroup (and so on). However, I suspect there would have been surprises in a bankruptcy process - and these would not have been nice surprises (indeed I suspect that some major banks make Enron look like saints - in regard to their books).

    That does NOT mean that these banks should have been bailed out (I agree with George Selgin that they should not have been), but (yet again) there are no costless policy options.

    Do not bailout them out and it can not be just bank shareholders who lose money - "depositors" (people who put their savings in the bank) must lose some money also.

    Otherwise this is not a free market - it is just a weird "crony capitalist" game, where if people win they get to keep their profits (such as the interest on savings), but if they lose the government bails them out (they do not lose their "deposites").

    And, yes (of course), a load of bankrupt banks would have dragged down the business enterprises connected to them - who would (in turn) have dragged down the business enterprises connected to them.

    There is no way that most (if not all) of the major banks going bankrupt can not lead to a major economic crash - with the terrible rises in unemployment (although, if labour markets are flexible, only temporary rises in unemployment and falls in wages and conditions).

    One must be honest with people.

    When the left say "if the banks are not bailed out there will be crash and you will likely lose your job" one must have the courage to say the following....

    "Yes that is going to happen - and yes you are likely to lose your job. But that is going to happen anyway (spending money we have not got is only going to make things worse in the end). If you have to clean toilets to feed your children (and you used to have a good position) well get cleaning the toilets. And yes you may end up living in a trailer (when you used to have a big house) - that is all you can afford, so learn to make the best of it. You are going to have to work your way up from the bottom again - and YES you may never make it back to where you were (only your children may achieve that)".

    To those who claim that people would not accept the above - that they would riot (and so on), as the left want, if we told them the truth.

    I see, and people will love us when they find out we have been lying - and they do lose their job and home?

    Tell the truth - help people prepare for what is comming (what is still comming), do the best you can. It is odd thing - but no matter how poor someone is (and I have been poor most of my life) you can always find some way to help someone else. There is always something that can be done - some help that can be offered.

    If people still choose to riot for their "rights" to goods and services (as Europeans - including people in Britain, not so many miles from me) do. Well then blank (not the first word in my mind) them - someone who reactes to poverty by looting, burning, and killing is not a man and should not be treated as if he was.

    No apology if the above is not "pleasant" and is not full of "empathy" (and other such stuff).

  7. avatar Andrew_M_Garland says:

    To Paul Marks,

    Great comment. Because the government guarantees the depositors, the bank is essentially a government department. The deposited money is only an indirect way of granting government resources (the guarantees) to the bank. Bank management has the strong, rational incentive to "bet the ranch".

    If risky loans succeed, they get bonuses. If risky loans fail, bank management moves on to other banks, without the stigma of "having lost the depositors money". No one cares, because the next bank is also guaranteed by the government.

    • avatar RickDiMare says:

      Andrew, I think you're discussing the root of the problem. Banking corporations, because of their intimate association with gov't money-creation powers on the one hand, and because the greatly affect money's power to hold personal property rights (essential to personal liberty) on the other, SHOULD NOT BE ALLOWED LIMITED LIABILITY BY GOV'T (sorry for the shouting)..... From what I've read on the success of Scottish free banking, up until around 1865 I think, the fact that the bank's shareholders were personally liable was a key feature of bank stability. I don't know why this feature is not a primary discussion point here in this blog. Banks are not in the same category as limited-liability private corporations that supply the marketplace with ordinary goods and services. I think it's pure folly for free bankers to think that fiat money should be allowed to freely compete as though it were a tangible marketable commodity.

  8. avatar Paul Marks says:

    Of course George Selgin could (quite rightly) reply that he is totally opposed to government "deposit insurance" and that fractional reserve banking need not have it - and it need not.

    But then it never seems to stay "just" factional reserve banking. For example, (as I and many others have said so often before) there is no increase in the money supply if, in a nation that has gold (or some other commodity) as its money, the following happens.

    Lots of people put X amount of gold (or some other commodity money) in banks. These banks lend out (say) 90% of this gold - by physically lending it to borrowers. A bank might (or might not) go bankrupt - but there would be no credit bubble, and no boom/bust mess.

    But fractional reserve banking never seems to stop there - it goes on to the banks trying to "expand credit" by lending out money that does not physically exist (so they may lend out more than has actually been saved). This is done by lending out financial instruments (rather than physcial money) and accepting the financial instruments of other insitutions as deposites (again with the modern misuse of language - for nothing is actually being "deposited" at all).

    So the whole boom/bust thing starts. A process that discredits free enterprise ("capitalism") in the eyes of the public.

    Of course it is unstable and the bankers actually know it is unstable - that is why they always end up asking for government interventionism (if the system could work without it - why do bankers spend so much time and effort getting the government involved?).

    Not all bankers - but the majority will ally with just about anyone who promises to keep the farce running for just a bit more time.

    Even Comrade Barack Obama himself (the old "pitchfolks" man and ACORN lawyer)- they have been backrolling him since 2004 (see "Bought and Paid For") and will not stop doing so.

    Not out of sincere Marxism (people at J.P. Morgan Chase or Goldman Sachs would not recognise a principle if they fell over one - any more than the top man at S&P would, no surprise that he was out yesterday actually opposing such things as a balanced budget Constitutional Amendement and saying all would have been well if there had been no dissent and delay on agreeing to borrow even more money).

    They do it because they make a jugdement that X politician will keep the gravy train running. And they do not bother their heads about what the man's background is, or what his longer term agenda might be.

    They just pile out the money (and the interviews of support in the msm), thinking no longer term than their end of year bonus.

    As a certain Russian nobleman said "they will sell us the rope with which we will hang them".

    He might have added "and they will lend us the money to pay for it".

  9. avatar George Selgin says:

    "For example, (as I and many others have said so often before) there is no increase in the money supply if, in a nation that has gold (or some other commodity) as its money, the following happens...Lots of people put X amount of gold (or some other commodity money) in banks. These banks lend out (say) 90% of this gold - by physically lending it to borrowers. A bank might (or might not) go bankrupt - but there would be no credit bubble, and no boom/bust mess."

    I'm sorry, Paul, but your argument betrays misunderstanding of elementary monetary theory. The system you describe here is in fact one in which, with a 10% equilibrium reserve ratio (as you assume), and allowing that this is the reserve for bank IOU's deemed to count as money, the equilibrium value of the total stock of such IOUs must be 10x the stock of gold reserves.

    In fact, in any fractional reserve system, no single competitivee bank lends out "more" than the reserves it receives. The belief to the contrary is based on misunderstanding of how money multiplication works in fractional reserve systems.

    A credit "bubble" must in any case be a function, not of a system's reserve ratio, but of the growth rate of its money stock, which is generally a magnitude perfectly independent of that ratio. Thus if, of two monetary systems involving similar behavior--let us say constant--real money demand, if in each the gold reserve stock grows at a rate of 10% annually, and one is a 100% system while the other is a 10% system, the rate of M growth in each will be exactly...10%. Those who think that a lower reserve ratio implies more rapid monetary expansion make another elementary error.

  10. avatar Paul Marks says:

    I am sorry George, but you simply have not corectly read what I wrote.

    I stated that the above is what could happen - not what does happen. In fact I clearly stated that it did NOT happen.

    In reality a fractional reserve bank does not take (say) one pound (WEIGHT) of gold (from a saver or savers) and physically lend out nine tenths of a pound of gold (to a borrower or borrowers) what happens is far more complex - and is the root of the boom/bust problem that so discredits free enterprise ("capitalism") in the eyes of the public.

    I repeat that if fractional reserve banks only physically accepted the commodity money (whatever commodity it was) as "deposites" (accepting nothing else as a "deposit") and physically lent out 90% of it (indeed even 100% of it) lending out nothing else other than the physical commodity itself..... then no boom/bust problem could occur (as total lending would never be greater than total real savings).

    But, of course, this is NOT what happens.

  11. avatar Paul Marks says:

    In case there is still misunderstanding....

    What matters (in terms of whether there is going to be a boom/bust) is not what percentage of real savings banks keep in their vaults (whether the local money is gold, silver - or whatever) and what percentage they lend out.

    I repeat banks could lend out 100% of real savings (have no gold, or whatever commodity people choose to use as money in their contracts, in their vaults at all) without creating a boom/bust (although that would be a very silly way for a bank to operate).

    The root of the problem is "credit expansion" i.e. the various complex efforts to violate one of the most basic principles of political economy - i.e. that total lending must not be greater than total real savings (real savings being money that people have earned, but chosen not to spend - to make available to be lent out instead). For example, treating as a "deposit" something that is (in fact) just a financial instrument (debt paper).

  12. avatar George Selgin says:

    I don't believe I've misunderstood you, Paul. If the "deposits" in your example are what you mean by the stock of money, then the example of banks lending 90% of all gold deposited with them is in fact one in which the money stock must eventually equal 10x the stock of deposited gold. Loans, likewise, will be larger than banks' gold holdings. That's indeed a description of the typical FR case.

    I'm not myself criticizing fractional reserve lending here. I actually agree that your example is one in which the savings that banks intermediate may be genuine, as well as with your larger point that FR banking needn't be inconsistent with the absence of bubbles. But the original statement about M not expanding isn't correct according to te usual definitions.

    Your argument resembles on Von Mises made in which he distinguishes between "circulation credit" and "commodity credit." You will find my criticism of Mises' own version in The Theory of Free Banking.

  13. avatar Paul Marks says:

    On limited liability.

    Well a couple of (the smaller) Swiss banks still avoid it - although the last British banks (or near banks) to not be limited liability companies changed over (and the owners sold a lot of their ownership stake - which shows they did not think much of the long term prospects of the enterprise) some time ago.

    Actually I am not a foe of limited liablity - as long as people all know in advance.

    After all (contrary to what people think) it is not an invention of 19th century statutes. Even in the Middle Ages (in many countries) the idea of limited liability was well developed (starting in Church law - developed from Roman law).

    If (for example) a relgious guild can not pay its debts does this mean that everyone who is a member of the guild (most of whom will have no say in how it is run - and not even much knowledge of what is going on) lose their shirts?

    Well YES if they agreed to that in advance - and NO if they did not agree to that (and everyone knew they did not agree). That is why it is vital that everyone knows what sort of enterrpise they are dealing with (in the "old days" limited liability enterprises in the United States were always talked of as..... "Inc" and in Britain as ......."Ltd", I think it was a very bad development when that stopped being the case).

    It is like the old idea of the "trading pot".

    People get together to form a "company" (a merchant company - or whatever) and they put their stake in the trading pot (to finance the venture). If the enterprise failed - they lost their stake, but they did not lose everything else as well.

    Of course, if limited liability, were banned tomorrow other ways of doing business would emerge - for example a return to the "names" system that Lloyds insurance synidcates were (and, to some extent, still are) based upon. With the "names" pledging everything they have (down to their underwear) to the enterprise.

    However, the practice of the "names" of pledging everything they have got to an enterprise and then taking no part in how that enterprise was run would not last. That was not how Lloyds syndicates were orginally - but somehow a situation developed where "names" just expected money to magically appear every month (as with some sort of "cargo cult") without them actually doing anything. The collapse of various syndicates (with "names" finding they had lost everything - their homes, the lot) discredted that sort of life.

    "But what about banks".

    I am no fan of the top people in Goldman Sachs (now a bank rather than a near bank), Bank of America, J.P. Morgan Chase, Citigroup and so on.

    Most of them are either corrupt - or actually "Progressives" (or both), if only "Progressives" in that they still support the half remembered collectivist doctrines they were taught at their Ivy League universities.

    But what about the ordinary shareholders?

    What about the people (via their pension plans) who would suddenly find that not only had they lost their investment (their pensions and so on), but that they were also being asked for their homes, and (indeed) the shirt off their backs.

    If they agreed to that in advance, well let it happen - but not if they did not, do not change the rules on them in midstream.

    "But for new banks Paul".

    Again why should not a limited liability enterprise be set up - AS LONG AS IT IS OPEN IN ITS DEALINGS.

    For example, why should an enterprise (a limited liability enterprise) not be set up which says the followering....

    "We will take your money and lend out 100% of it - if things go well we will pay back your money with X percent interest after a year".

    The problem is NOT the above - it is that banks say (or imply) they will "keep your money on deposit" when they mean "we will lend it out" (nothing wrong with lending it out - as long as everyone understands the money is not in the bank anymore).

    Also a (much bigger) problem is that banks lend out lots of "money" that noone has really saved (by all sorts of complex manipulations - such as treating as a "deposit" that can be lent out, something that is not even money, but is just various forms of promises and debt).

    Pyramid schems and chain letters - are not a good basis for a "financial system".

    By the way I doubt that ending limited liabilty would ever really get the top people - the people who actually do the damage.

    They would simply say the following....

    "Who me? I am not a shareholder - I am just an employee".

    As they went off in their private jet to their private island (both of which, quite legally, somehow got into their "remuneration" package decided upon by an "remuneration committee").

    Of course, sadly not "needless to say", the harm such people is magnified (magnified many times) by government backed Central Banking.

    That is why George Selgin is quite right to oppose such things.

    Even the biggest bunch of crooks (sorry "manipulators" if some lawyer objects to the word "crooks") can not destroy an entire economy - not unless government (via a Central Bank or some other means) is backing their antics.

  14. avatar Paul Marks says:

    George Selgin.

    By "deposites" I do not mean "the stock of money".

    I mean that the money a person (or many persons) puts into a bank - to be lent out (that is why the word "deposit" is somewhat misleading, as the money does not "deposited" anywhere).

    If the money is gold (and what commodity is used as money should, of course, be a matter for people to decide in civil society via private contracts) then a bank can lend out as much of the gold that it is deposited with it as it likes - 100% if it really wants to.

    So gold in the vaults would be zero (no reserve at all) and gold lent out would be 100% of what was saved (i.e. what people earn, but choose not to spend - but, rather, to be made available to be lent out).

    The problem only comes when the bank (by whatever complex means) manages to lend out more than 100% of the gold that was given to it.

    This is what is meant by "credit expansion".

    The point of credit expansion (as, you are correct, Ludwig Von Mises tried to point out) is to reduce interest rates.

    A good lending risk (i.e. someone people believe will pay back the money he or she borrows) can always get a loan - IF he or she is prepared (and able) to pay a high enough interest rate.

    This is the central point of time preference - as you know.

    But people do not like paying high interest rates and so may not go for loans at these interest rates - so people will not save money for loans to them (because they are not getting paid enough - in terms of the interest rates).

    So banks (and other financial enterprises) try and produce "money" from thin air - "money" than no one has worked for and no one has really saved (i.e. chosen not to spend - but to lend out instead).

    There are (as you know) many complex ways of increasing the amount of lending way beyond the amount of money really saved.

    I repeat it is not a matter of what percentage of real savings are lent out (rather than left to sit as bars of gold in bank vaults).

    It is a matter of "money" being lent out that is not real savings at all.

  15. avatar Paul Marks says:

    A bank is a money lender - but a money lender who (apart from the capital put up the shareholders) lends out other people's money.

    A bank may go bankrupt if it makes too many bad loans (in which case those people who have given it their money, to be lent out, lose their savings), but this does NOT in-its-self create a boom bust.

    Only if banks lend out "money" that no one really saved in the first place (or the same money to different parties, or pretend that money can be lent out and the "depositors" still have it) is a boom/bust created.

    Of course a sane money lender (who is lending out other people's money) will keep a "reserve" on hand in case some of these people come asking for their money back (and he does not have a long term contract with them - saying they may only have it back after a certain period of time).

    But a money lender (a bank) may do without a large reserve (if it is happy with the idea of a large risk of bankruptcy) without creating a boom/bust.

    As long as it is only lending out money that really exists.

    In short - if gold is the money, then borrowing may never be greater than the physical gold that was actually saved.

    Ditto silver (or whatever).

    Violation of this rule may not be technical "fraud" (that depends on how statutes are worded) - but it is folly.

    Of course the size of a boom/bust will depend on how much the rule (the rule that borrowing must never be greater than real savings) is violated.

    Say people save 10% of their income - they earn X amount of gold and save 10% of it.

    And then say the banks lend out not this amount of gold - but this amount plus an extra 1% (that does not actually exist - no one really saved it). This is clearly a "bad thing" - but it is not going to destroy an economy.

    But let us say that people save 10% of their income (X amount of gold - or whatever) and the banks lend out ten times this (1000% of it) or a hundred times it.....

    Then the credit bubble (and the boom/bust) is going to be vastly larger - and more harmful.

  16. avatar MichaelM says:

    Paul Marks, I'm not so sure about Continental Law, but in the English Common Law you were required to incorporate to receive limited liability (because limited liability was a function of the unlimited liability of the corporation itself, with all the shareholders themselves being protected by not being direct debtors). Juries decided that unincorporated companies could not offer limited liability because the company had no legal personality separate from the shareholders, and thus couldn't take out debts in its own name. However, a kind of de facto limited liability was available to shareholders through legal anonymity. People who desired limited liability could simply refuse to announce their ownership in the company in court, and so couldn't be sought to cover the company's debts in the event of its bankruptcy. The drawback of this is you also couldn't sue the company for anything without giving up your anonymity (and, thus, your limited liability).

    The drawback acted as a kind of price to pay for limited liability. Corporate income taxes and capital gains taxes act as a substitute for this cost but, like in deposit insurance, there's no market mechanism to determine the magnitude at which this price should be set, and limited liability ends up being mis-priced, distorting the market.

    A system of economy in which we tried to use limited liability correctly would most likely involve the repeal of general incorporation laws and the limitation of the use of the corporate form to purely public benefit (as opposed to private benefit, business) uses, after which we could return to this common law doctrine of anonymous ownership limited liability.

  17. avatar Paul Marks says:

    I have never denied that there were 19th century limited liablity statutes (Of course statute law is not Common Law). Although the first major statute seems to have made things more unclear rather than less unclear.

    Before then investing in a normal business could be very dangerious - as one did not just run the risk of losing one's stake (but everything).

    Sir Walter Scott may have been left in his home (by the kindness of the creditors of the publishing house he unwisely invested in) - but he still worked himself to death trying to repay debts that he had no say in running up (as he had no say in how the publishing house was actually run, indeed he did not even know what was going on).

    "More fool him - never invest in something you do not control" that is an argueable point of view, although not mine.

    Like the Church lawyers (and, although it is not admitted much today, Common Law was vastly influenced by Cannon Law, although it later moved away from it) I hold that an enterprise (including a commercial enterprise) need not involve the destruction of all its members if it fails - IF, all creditors were told (IN ADVANCE) of the nature of the enterprise.

    I.E. That they (the creditors) could only claim the property of the corporate body - not the individual property of individual members. This is a point on which people of good will can agree to disagree. Certainly the juries you mention ruled as you say they did - rejecting the idea of a corporate body as "Roman" (in more ways than one).

    However, I am deeply worried by the term "public benefit", (as I am by such terms as the "general welfare" or "public interest").

    If a group of people put stakes in a "trading pot" to set up a trading company - I know what they are doing and why they are doing it.

    But when someone tells me he is doing something (financial) for the "public benefit" I get deeply nervious.

    On taxation:

    I believe that the main reason that corporations have grown (and owner manager companies have shrunk) in imporance is the following....

    Income tax (especially high graduate income tax). Inhertiance tax. And Capital Gains Tax.

    CGT has been the main reason why companies have become dominted by instutional shareholders (hired managers in charge of other hired managers - with no true owners in sight, not good).

    And high income tax and inheritance tax cripple family business enterprises - and help the dominance of corporations.

    It is interesting to note that in Germany (where, at least till recently, such things as inheritance tax had much less bite than they do in Britain and the United States) the family owned business still has much more weight.

    There is something deeply depressing about seeing a family busines sold to some big corporation (such as that controlled by Mr Buffett) for TAX REASONS and the next generation turned into idle "trust fund kids" (kids who never grow up).

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