Volatility in the news

by Kurt Schuler January 26th, 2012 12:14 am

Larry Summers had op-eds in the Financial Times and the Washington Post this week with essentially the same message. (Well played, Larry: apparently the Post’s editors do not read the Financial Times. It would not hurt them to start.) In both, he used the line, “Government has no higher responsibility than ensuring that economies have an adequate level of demand.” So, that stuff about securing life, liberty, and the pursuit of happiness is all secondary to ensuring an adequate level of demand?

That brings me to another recent column, also in the Washington Post, by Robert Samuelson. Though not an economist by training, Samuelson’s curiosity, willingness to listen to different views, and frank admission of how much he (and we) do not know make him consistently interesting to read.  By combining those characteristics with diligence, he has become a better economist than most professional economists. He writes:

"There’s a paradox to economic policy. The more it succeeds at prolonging short-term prosperity, the more it inspires long-run destabilizing behavior by businesses, banks, consumers, investors and government. If they think basic stability is assured, they will assume greater risks — loosen credit standards, borrow more, engage in more speculation, relax wage and price behavior — that ultimately make the economy less stable. Long booms threaten deep busts."

Samuelson expresses a view that the Austrian school of economics is somewhat comfortable with but that most other schools are not. Cross Ludwig von Mises on the drawbacks of interventionism and Joseph Schumpeter on the “creative destruction” of capitalism, and you get the conclusion that an unhindered market economy may in fact seem quite unstable in some ways, but that it is in fact less so than an economy that government is continuously trying to stabilize. It’s a “pay me now or pay me later” view that a market economy contains an irreducible minimum volatility. If you want to stabilize it permanently you have to suppress its dynamism.

I said the Austrians are somewhat comfortable with this view because it is in partial conflict with the idea that absent government intervention, many problems of scarcity would be greatly reduced, improving and even saving lives. I think the key is to understand that, as one of my economics professors, the late Don Lavoie, used to stress, we must ask “Compared to what?” That is, what is the workable alternative to an economy that experiences a shallow bust now and then: an economy that experiences no busts, or an economy that experiences deep busts? This is a topic that requires further development by Austrian economists.

Finally, I note a poll of 40 economists in which they unanimously disagreed that a gold standard would result in better price stability and employment outcomes for the average American. The poll taker remarks that “The panel members are all senior faculty at the most elite research universities in the United States.” That must account for the deadening uniformity of opinion; normally it’s hard to get 40 economists even to agree that the sky is blue. The economists who offer short answers for their votes say something along the lines of “the price of gold would be too volatile.” Compared, for instance, to the dollar, which was $35 per troy ounce about 40 years ago and is now around $1700? What would it take to pry open a few minds among these elite economists? First, evidently, a calamity; the near-calamity of 2008-09 was not enough. Second, they would have to know to distinguish among different types of gold standard, a topic I have discussed before and which I will soon return because it is still not sufficiently appreciated.

ADDENDUM: If the Austrians are somewhat comfortable with the idea of minimum volatility, some economists who work on "real business cycle" theory are completely comfortable. I thought when I wrote the post that after waiting awhile I might have something to say about them later, but I don't. They seem content to stick to their classrooms and their academic papers, and haven't made as much noise in newspapers or in blogs as other tendencies of thought.


Financial Stability: FSOC, Continued Secrecy, Fannie and Freddie

by Vern McKinley January 22nd, 2012 8:01 pm

I address this range of issues in an editorial this week published in the Washington Times.


Missing from the debate on multipliers

by Kurt Schuler January 19th, 2012 11:43 pm

Scott Sumner and Paul Krugman have been going back and forth about fiscal multipliers, in a debate with many other participants. (Here are the first post and the latest post by Sumner on the issue.) For those of you who have not followed the debate, the fiscal multiplier is the change in output resulting from an additional dollar of government spending. If the multiplier is greater than one, $1 of additional government spending results in more than $1 of output.

What has been missing from the debate is the concept of the structure of production. Resources, including human abilities, are not just a homogeneous lump. They have a structure: some are less scarce than others, some are easier to switch to new purposes than others, some require less know-how to work with than others. The idea of a fiscal multiplier from spending makes me uneasy because it is basically a supposed case of something for nothing: the government, which almost everywhere in the world cannot even deliver the mail at a profit, steps in to fix a situation that the private sector cannot. How does it happen? The answer has to be that somehow the government is able to put resources to a higher-valued use than the private sector can. Given the specificity of resources and the knowledge that must be applied to use them efficiently, it is hard to imagine how such a thing can happen unless resources are so abundant that is little risk from wasting them.

An early critic of John Maynard Keynes, W.H. (William Harold) Hutt wrote a book on precisely this point in 1939, called The Theory of Idle Resources. Hutt carefully explained how many resources that seem idle to the unpracticed eye are in some kind of use — perhaps not the most active use we can imagine for them, but one that has considerable economic value. Considers cars. Most car owners use their cars for just an hour or two per day. Are the cars idle the rest of the day? True, they are parked, but they not idle in the economic sense. They are held in inventory, set aside by their owners for whatever need may arise to use them. People who don’t wish to hold a car in inventory can ride the bus or hail a taxi to get them where they want to go. (George Selgin or Steve Horwitz, both of whom have used Hutt’s ideas to help develop their own conceptions of the relationship between money and business cycles, may want to chime in with their own posts to say more about Hutt.)

If some resources are so abundant that there is little risk from wasting them, something is restraining the private sector from using them. Either millions of experienced businessmen can find no opportunities for converting something abundant into something more valuable, or government is somehow preventing the private sector from taking the initiative.

I lean to the latter explanation. Why should government, which eats profits (through taxes) rather than generating them, know how to turn resources to more profitable use than the people in the private sector who spend their whole careers trying to do just that?

As Scott Sumner has discussed on his blog, when monetary policy has gone so wrong that it is impeding trades that people would otherwise make, to their mutual benefit, there is a case for certain kinds of fiscal policy as a clumsy work-around. The simpler course, though, is to change monetary policy. And so I wind back up at free banking. Because free banking applies principles of competition that we observe at work in other markets, and that historically have worked in the issuance of money and credit as well, free banking is less likely than central banking to result in economy-wide failures to use resources efficiently. I do not think free banking would eliminate credit booms and busts, but I think they would be less severe than they are under central banking because the scale for making mistakes in monetary policy would be smaller. Then there would be even less reason to debate fiscal multipliers.


A free banking gold standard versus other gold standards

by Kurt Schuler January 7th, 2012 10:49 pm

Discussion about the gold standard often has advocates and critics talking past one another. One of the reasons is that there are members of both groups who do not know or, during the heat of argument, do not acknowledge that there have been many varieties of the gold standard. A free banking gold standard differs in important respects from other varieties of the gold standard. Here are key questions about the details of a gold standard, and the answers as they apply to its free banking form.

What is the legal foundation for payment in gold? Ordinary contract law. Government may establish a definition of a currency unit in terms of gold, but if so, under free banking the unit (say, the dollar) is merely a convenient name for the weight of gold, rather than saying that “a dollar is a dollar” no matter how much the gold content changes.

Is gold the only legal form of payment? No; payment can occur in any commodity or currency that people wish to use. This contrasts with the practice in some countries under various other forms of the gold standard, in which certain payments were only legal if made in national currency.

Who offers payment in gold? Anybody may do so. This means lenders and borrowers may agree to "gold clauses" in contracts. In many countries, governments have nullified such clauses after abandoning the gold standard or after moving to a more restrictive form of the gold standard where people have less freedom to own and pay in gold.

What forms of money and credit are payable in gold? Any that the issuers of those forms wish to offer.

Is production of any of these forms a legal monopoly? No; in particular, under a pure free banking system there is no legal monopoly of notes or coins, so they are competitive in the same way that deposits are competitive. In most historical free banking systems, issuance of notes was competitive but issuance of coins was not.

Who can demand payment in gold? Anybody who holds a liability that an issuer has made payable in gold. This contrasts with the Bretton Woods gold standard as it existed in the United States, under which Americans were prohibited from owning gold bullion.

Are there restrictions on the purposes for which people can demand payment in gold? No, there are no exchange controls or like restrictions. Again, this contrasts with the Bretton Woods gold standard, under which most countries on the standard imposed exchange controls.

What legal penalties exist for people or organizations that break their promise to pay in gold? The standard penalties applying to breach of contract. Observe that this differs from a central banking gold standard, in which the central bank cannot be sued for breach of contract if it devalues.

Is fractional reserve banking permitted? Yes; so is 100% gold reserve banking, but as George Selgin commented in a post some time ago, there have been no historical cases in which 100% gold reserve banking has dominated in competition with fractional reserve banking. I would expect there to be some 100% gold reserve banks, appealing to people who did not trust regular banks and were willing to forego interest, but I would expect such banks to hold less than 1 percent of all banking assets. 

Are taxes only payable in gold? Perhaps. It should not make much of a difference if a free market in foreign exchange exists.

Is accounting in units other than gold permissible? Yes, but perhaps everything has to be converted into gold units for tax purposes. This is an area where I think more work is needed to explore whether there are important implications for monetary freedom.


Hyperinflation, alive and well

by Vern McKinley January 1st, 2012 11:19 pm

In my initial post last May I mentioned I would discuss some of the economic environments that I have worked in as part of my consulting work. I have some very clear memories about inflation in the US from the late 1970s and early 1980s. I worked in a grocery store from 1979 to 1980 in suburban Chicago and one of my duties was to change prices on the full range of grocery products. This was before the time of electronic bar codes that allowed price changes to happen essentially automatically. Back then you had to either scrape the price tags off cans and put the new price tag on, or for products in boxes the old price tags had to be covered up with the new, higher price tag. Also as a business student in the early 1980s I remember that we took up quite a bit of time on inflation accounting, learning how to detail financial statement footnotes regarding the underlying cost basis. I don’t recall ever using that concept in practice once I started working full-time in the mid-1980s.

In one of my trips late last year, I spent some time working in Belarus in November.  One interesting characteristic that I found about the Belarusian economy is that inflation is currently hovering around 100 percent. The currency experienced two major devaluations during 2011. Last spring the USD/BYR exchange rate stood at about 3,000:1. One devaluation occurred in May that sent the rate to about 5,000:1 and another devaluation in September and October sent the rate to just under 9,000:1 which is about where it stood when I was there. It has recently drifted back to about 8,300:1. Usually when I travel to a country I immediately exchange a few hundred dollars into the local currency. I didn’t do that in Belarus. I exchanged about $40 of spending money every two or three days and I got a few thousand BYR more each time I went to exchange currency. Some cite loose credit in the form of “issuing cheap loans to cover state firms' budget gaps and propping up the ruble at what eventually became more than double its actual worth” as the cause of the problems with the economy. Most of the lending in Belarus is undertaken by large state-owned banks.

One final anecdote will close out my post. I have been to three countries where I have seen Lenin statues previously—Tajikistan, Ukraine and now Belarus. In Tajikistan and Ukraine, the statues were tucked away in parks. In Belarus, the statue is in front of the Government.



Good deflation and good inflation

by Kurt Schuler January 1st, 2012 12:16 am

A couple of weeks ago, Scott Sumner pointed out that many conservative-leaning economists think that certain types of deflation can be good. The same economists, though, are typically reluctant to acknowledge that by a similar argument, certain types of inflation can be good.

As Sumner points out, there are economists who understand that the argument is symmetrical. He mentions George Selgin. Selgin’s 1997 monograph Less Than Zero: The Case for a Falling Price Level in a Growing Economy implies in its title that in a shrinking economy there may be a case for a rising price level. Selgin in fact discusses the case for such "good inflation" on page 39 of the monograph, although his main focus is on "good deflation" because at the time he wrote, it was a more unusual idea. Selgin, and fellow blogger on this site Steve Horwitz, make remarks in Sumner’s comment section.

Selgin stated his arguments in a way to give them textbook simplicity for ease of understanding. In an actual free banking system, the details of the system might add some wrinkles that would require changes to the  form is arguments while preserving their spirit. Expectations about the supply of the monetary base and thus the path of prices over time might differ considerably depending on whether the monetary standard was gold, silver, a frozen fiat monetary base, a commodity basket, or something else. Under some standards, inflation and deflation might be relative to average expectations for the price level rather than absolute. It remains an open question to me whether a standard in which the monetary base was shrinking and expected to continue shrinking (as was the case in some earlier eras with the supplies of gold, silver, and copper) would be compatible with the monetary system attaining the "full information" ideal of not being a disturbing factor to trade.