Keynesianism?

by Don Boudreaux on December 20, 2008

in Myths and Fallacies

In this entertaining video, Dan Mitchell of the Cato Institute intelligently challenges Keynesianism.

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Andrew Garland December 21, 2008 at 12:01 am

My attack on Keynesianism is at

The Myth of the Economic Multiplier

… The appearance of 6 rolls at the table is new value appearing in the dinner table economy. The wave of spending and re-spending sends value around the table. The Economic Value approach sees 6 rolls of spending, followed by a wave of 5+4+3+2+1 of re-spending, for a total of 21 rolls of Economic Value, and a 3.5 Economic Multiplier (3.5 x 6 = 21). But there are only 6 rolls. The re-spending distributes the rolls; it doesn't create more rolls. The real value of 6 rolls is overcounted by looking at the roll-passing transactions.

Gil December 21, 2008 at 12:34 am

Aw come on, admit it, Keynesianism is akin the Great Auto Bailout – declaring the economy is made up of circular institutions and it would forbid people from leaving that economy. Yes people would save/hoard in a way there was no counterbalancing lending/investment because such believed all the potential investments were bad. It would be like a town going the way of a ghost town because it offered no real reason to stay (e.g. a mining town with a depleted mine). People want to take their savings and leave. Keynesianism means people are forced to stay and prop the local ghost town economy.

Anonymous December 21, 2008 at 2:03 am

Saw this posted at the Heritage Foundation's blog, The Foundry. Really is an excellent video. We need more videos like these to educate the rising generation. With people like Paul Krugman getting a bigger soapbox, and more and more younger people reading the absolute nonsense at the HuffPo/DailyKos/et al., we have a lot of work to do.

Kudos to the Center for Freedom and Prosperity Foundation, and other firms like The Heritage Foundation.

Jacob Oost December 21, 2008 at 2:07 am

Excellent video. I've seen this guy's video on the Laffer curve and it was great.

Share and enjoy!

Although his best guess as to why Keynesianism is still popular doesn't really go very far towards explaining it. I think there are many factors for many people. I honestly think that for a lot of academics, like Krugman, they simply don't want to admit that their long-dominant school of thought was shown to be intellectually bankrupt. "Yeah, we were wrong about some stuff, but we're still right about most stuff!" seems to be the attitude I see in macro textbooks.

And, of course, politicians like to be seen as "doing something" when the economy sputters.

And the elephant in the room, something people actually get mad at if you bring it up, is that Keynesianism, like environmentalism, has become a haven for crypto-socialists who realize that socialism is an unsellable product, and needs some new packaging.

TrUmPiT December 21, 2008 at 4:30 am

I don't believe in Keynesian theory either. The government is in massive debt already. Let's arrange to pay that off first. Let's kindly ask Bill Gates, Warren Buffett, & the Walton family to turn over all their loot to salvage a government and country in dire economic staits. It really is obnoxious that Gates and Buffet want to spend millions in Africa when there is so much need right here in America where they made their billions. Charity begins at home. What if in the unlikely event they refuse to do their patriot duty to their country? They should gently be parted from their money, so no one gets hurt. Once upon a time my sister had her bank account emptied by the IRS without her explicit consent because they said she owed them back taxes. She was outraged and appalled, but wasn't imprisioned or physically harmed. Life goes on. It Gates and Buffett are such talented and smart people as most people think, they'll have little trouble making another billion in no time. Let see if they can do it. More power to them if they can. Keynsianism seems like a risky proposition to me and of questionable morality because posterity will likely be saddled with even more debt. Relieving billionaires of their billions is quite moral because they should never have been allowed to accumulate such ridiculous wealth in the first place. If the rich don't want to play Santa Claus for Xmas, then it is up to the people to play Robbin Hood.

Martin Brock December 21, 2008 at 9:51 am

Dan's first fallacy is itself fallacious. He says, "… government puts money into the economy's right pocket. But where does the government get that money [to produce a 'Keynesian' stimulus]? It borrows it, which means that it comes out of the economy's left pocket."

This assertion clearly assumes a zero sum game, and Dan himself would surely dismiss the assumption if someone else used it in a different context.

First, "money" is not a scarce, valuable resource that can only be moved from pocket to another. Money is an accounting device, accounting for value added by real resources.

Second, employing idle resources by extending credit need not affect other resources already employed.

Third, a monetary authority may "borrow" from itself (create money from nothing to extend credit), as when the Congress "borrows" from the Fed to spend. As long as the expenditure adds real value, by employing idle resources to produce goods of real value exceeding the nominal value of credit extended, this creation of money to extend credit can propel economic growth.

Private employers organizing resources profitably behave this way themselves routinely. Ideally, a private employer employees a resource only as long as it generates revenue exceeding the cost of its employment. In a very meaningful sense, my private employer is my creditor, and my wage is credit he extends to me, and my marginal contribution to business revenue repays the credit extended.

When resources are idle, creating new money to employ them profitably is completely reasonable and involves no moving of resources from Dan's hypothetical "right pocket" to any "left pocket", because the idle resources are in neither pocket. They aren't in the "right pocket" of "private" creditors, and they aren't in the "left pocket" of the more central authorities either.

Fourth, a more central authority might literally "borrow" from "private" interests (or even tax them) to employ idle resources, and this "borrowing" needn't idle other resources or diminish demand otherwise, because the private "lenders" may hold cash, or hold real assets like gold unproductively, rather than organize idle resources to add value.

For example, I may hold gold somewhere in Georgia while a resource stands idle somewhere in Washington state. I don't sell my gold to employ this idle resource, because I don't even know that it exists, and it doesn't know that I exist either. Since I have no other use for my gold, I simply hold it. Dan presume that this "cash" is "available" overall, but it isn't available to employ the idle resource in Washington in fact.

But even if no one meaningfully holds cash anywhere, extending credit to employ idle resources, by "borrowing" from a monetary authority (creating money from nothing), can still add value. Conceivable, everyone has already spent every dime they have and every dime they expect to earn for some future period while resources still stand idle. In this scenario, "aggregate demand" cannot employ the idle resources during this period.

So a true "Keynesian" stimulus does not redistribute demand but instead creates new demand by extending credit to idle resources as these resources, in turn, create new value. Classical economics (pre-Keynes) says that this stimulus is never necessary, because the price of an idle resource always falls until it clears the market, reaching a level at which it is reemployed. The whole point of Keynes' analysis is to show that this reemployment doesn't necessarily occur.

The whole premise of Dan's analysis is that "Keynesian stimulus" simply hands cash to already employed people to spend or hands it to unemployed people without expecting any productive output from them, as with the Bush "tax rebate" we all banked back in February or the earlier, incredibly unproductive expenditures that Bushniks championed post-9/11. Keynes himself never suggested such a thing. In fact, as Don's own sources suggest in an article he posted only a few weeks ago, the New Deal was never a properly "Keynesian" stimulus at all.

That said, I don't advocate central authorities "borrowing" from any source to organize resources in the current climate, because I suppose we have an Austrian-style bust following an inflationary expansion, though not only from central bank policy. If unprofitable organizations employ many resources, these organizations must dissolve or reorganize. This reorganization creates the new nominal demand, as organizational obligations to pay for nothing dissolve. Bondholders lose expected principal and interest income, employees adding too little value lose their jobs and so on. Less central authorities over credit can then reemploy resources more effectively than more central authorities.

muirgeo December 21, 2008 at 10:07 am

I love it when the vase breakers tell us how not to repair them.

Randy December 21, 2008 at 10:48 am

Martin,

"As long as the expenditure adds real value, by employing idle resources to produce goods of real value exceeding the nominal value of credit extended…"

Is there any evidence to suggest that the government's use of resources will produce goods of real value? – that is, evidence that the application will not be simply redistributive? Not propaganda – evidence.

andy December 21, 2008 at 11:25 am

Martin…
This assertion clearly assumes a zero sum game
But the government DOES work in zero-sume game mode here. The point of free market is that BOTH sides gain from transaction. This is not the case when government taxation is involved, actually a negative-sum game is very likely.

Third..borrowing from the Fed IS printing money. And you might want to explain WHY are the resources idle and why lowering price of those resources wouldn't un-idle them the same way printing money may. The only argument I heard from Keynessians is that wages/prices are inflexible downward. Do you have any other argument?

because the private "lenders" may hold cash, or hold real assets like gold unproductively, rather than organize idle resources to add value.
This was addressed in the video in the part "creative keynessians".

So a true "Keynesian" stimulus does not redistribute demand but instead creates new demand by extending credit to idle resources as these resources, in turn, create new value.

That's like saying that "true socialism" is when people live in harmony. Only to notice that whenever you try it somewhere you end up with disaster. The same way the "true Keynesian stimulus" somehow always ends up moving money from one pocket to the other… I guess the reason might be that when you borrow money from some people and give it to the others, you just move money from the left pocket to the right….

Marcus December 21, 2008 at 11:35 am

"First, "money" is not a scarce, valuable resource that can only be moved from pocket to another. Money is an accounting device, accounting for value added by real resources."
– Posted by: Martin Brock | Dec 21, 2008 9:51:44 AM

This is a non-sensical statement. It's like saying, "I use shovels to dig holes therefore shovels are not a scarce, valuable resource." It doesn't follow.

One use of money is for accounting purposes. There's nothing about that fact which alters money being a scarce and valuable resource.

Note too, that the columns of an accounting spreadsheet are required to balance out. You can't just invent money out of thin air between the columns.

You might argue that the Fed can (invent money out of thin air). But that's the Fed, not Congress or the Treasury. That the Government can effectively borrow from the Fed doesn't justify government expansion. Money borrowed from the Fed could just as readily be used to reduce the governments burden on people (ie. reduce taxes).

"Second, employing idle resources by extending credit need not affect other resources already employed."

I can't believe you, of all people who post on this blog, who actually argues that buying a treasury is nothing more than theft would argue in support of it.

That said, there is a good argument right now for deficit spending. Namely, the fact that the government can borrow right now for free.

But that doesn't justify government expansion. It can use the free money to reduce its burden on society by reducing taxes.

But back to you Martin, if you're going to be consistent with yourself, you must oppose government borrowing. After all, people buying treasuries are simplying hiring the government to protect their money through the use of force.

Marcus December 21, 2008 at 11:51 am

"But back to you Martin, if you're going to be consistent with yourself, you must oppose government borrowing. After all, people buying treasuries are simplying hiring the government to protect their money through the use of force."

I forgot about your last paragraph Martin. Please ignore the above paragraph.

Anonymous December 21, 2008 at 12:15 pm

Yeah, I agree with you all. Martin doesn't know what he's talking about.

And to muirgeo, how is Dan Mitchell or Center for Freedom and Prosperity Foundation the vase breaker?

Talk about nonsensical.

Martin Brock December 21, 2008 at 12:27 pm

Is there any evidence to suggest that the government's use of resources will produce goods of real value?

The best evidence is a free consumer's decision to exchange the value of his labor for the value of other labor in a free market. I don't have this evidence of the value of the interstate highway system; however, I use the system frequently myself, so I must attribute some value to it. I attribute far less value to the automatic weapons imposing "order" on Baghdad.

I don't have this evidence for the value of a vast assortment of expenditures, including countless expenditures by nominally "private" interests in our nominally "free" market, so I don't have the luxury of much libertarian idealism when evaluating state policies.

Again, I prefer "stimulus" in the form of credit extended by less central authorities. If authorities extend credit poorly, they lose their authority, and other creditors replace them. Ideally, a central bank is only a policeman requiring less central bankers to follow these rules and entitling new bankers to replace failed bankers continuously.

Bankruptcy and the resulting losses are essential to this process. Statesmen substituting taxpayer obligations for the promissory notes of failed bankers is precisely what I don't want. In any economic system I could enthusiastically support, banks and other organizations would fail routinely and their depositors and other creditors would routinely lose money, but sufficient credit to employ idle resources would always exist.

Sam Grove December 21, 2008 at 12:41 pm

Note too, that the columns of an accounting spreadsheet are required to balance out. You can't just invent money out of thin air between the columns.

Not legally, unless you are the government.

As long as the expenditure adds real value, by employing idle resources to produce goods of real value exceeding the nominal value of credit extended, this creation of money to extend credit can propel economic growth.

But as you know, the government isn't responding to market demand, but rather to political pressure.

andy December 21, 2008 at 12:47 pm

but sufficient credit to employ idle resources would always exist.

That's almost by definition when prices are flexible, isn't it? Because then the opportunity price of using such resource is zero and enterpreneurs would want to use these resources instead of those they are using now, thus bidding down their prices as well….which surprisingly leads to growing real aggregate demand.

Martin Brock December 21, 2008 at 12:57 pm

This is a non-sensical statement. It's like saying, "I use shovels to dig holes therefore shovels are not a scarce, valuable resource." It doesn't follow.

My statement is not remotely like yours. My statement is like saying, "I use numbers to count shovels digging holes, but numbers are not the scarce resource they count."

One use of money is for accounting purposes. There's nothing about that fact which alters money being a scarce and valuable resource.

Money is not a scarce, valuable resource subject to some sort of conservation law, requiring that money appearing in one pocket must have disappeared from another pocket. That's what I say very clearly.

Note too, that the columns of an accounting spreadsheet are required to balance out. You can't just invent money out of thin air between the columns.

Of course, you can. Dollars you hold in your pocket right now were created this way. Dollars you receive in your paycheck typically account for value that you've not yet added. This value doesn't exist until goods to which you contribute find a buyer in the marketplace, and these goods may never find a buyer. If your organization's goods never find a buyer, the organization eventually dissolves, and its investors lose money, but the "investors" may have created the dollars invested from nothing.

Even in a free banking system, under a gold standard, with no central bank, money appears and disappears continuously this way. I like the idea of free banking in principle, though I don't like the idea of a gold standard (a price of gold fixed by statute) so much. Fixing the price of some index of commodities (an average of commodity prices) might be more stable, and including less durable commodities in the index seems necessary.

You might argue that the Fed can (invent money out of thin air). But that's the Fed, not Congress or the Treasury.

Distinction without a difference.

Money borrowed from the Fed could just as readily be used to reduce the governments burden on people (ie. reduce taxes).

Bush claims to have cut taxes this way, but as a matter of standard accounting, the Fed buys Treasury securities in open market operations to create money, as well as lending through the discount window. This newly created money passes through a few "private" interests on its way from the Fed to the Treasury, interests like Henry Paulson before he became Treasury Secretary. As long as the Fed holds the securities it buys, its "borrowing" is not meaningfully different from Congress creating money to spend it. The Fed is a creation of the Congress after all.

I don't like this way of doing business at all, but it's the way things work in reality for the moment. My biggest beef with Don's rhetoric is that he seems to think it naughty to question the incredible incomes of people playing this game.

After all, why shouldn't Paulson's successor receive a ten million dollar bonus after arranging the sale of preferred stock in Goldman Sachs to Paulson's Treasury Department for ten billion dollars after Paulson sells ten billion dollars in taxpayer obligations to Ben Bernanke as Bernanke creates the ten billion dollars from nothing? Isn't the bonus right, just, proper and noble? Am I not immature to dispute its propriety? Shouldn't I just stick my tongue up the ass of every wealthy lord as far as it'll reach?

Patrick Barron December 21, 2008 at 1:00 pm

My only disagreement with the video is with an early statement that our government is not printing money. The Fed is debasing the money supply with massive injections of fiat money. So far, these injections have gone into the banking system as reserves but have not shown up as increases in the money supply because bank lending is depressed. It is bank lending that causes the money supply to expand by multiples (approximately a factor of ten) of the new reserves. Bank lending is depressed because the economy is in recession; that is, borrowers are wisely trying to strengthen their balance sheets by reducing debt. But we can expect higher prices (the public calls this "inflation", but the inflation occurred when the Fed injected the reserves) when banks finally start lending again. It is frustrating for Austrian economists to watch one arm of the government (the politicized Council of Economic Advisors, for example) calling for more bank lending while another arm (the bank regulators) is telling banks to stop lending. This is the insanity that ensues from combining Keynesian economics with central bank fiat money. At the end of this video the moderator asks the rhetorical question why government would keep pursuing Keynesianism when it fails the test of both theory and practice. His answer is right on the mark–politicians love to spend other people's money. I would add that they love to exercise power, too. It gives them an opportunity to punish their enemies, usually the maligned "wealthiest five percent", and reward their friends, who just happen to be big shot bankers and Wall Street investment houses. Also, they expect all those voters who got stimulus checks to remember them fondly at the next election.

Marcus December 21, 2008 at 1:02 pm

"Not legally, unless you are the government."

No, the government cannot and that's the point.

The Fed can. The distinction is relevant because it shows that monetary expansion and fiscal expansion are not one and the same thing.

Fiscal expansion always comes out of the market.

Marcus December 21, 2008 at 1:06 pm

If money is not a scarce resource, then there is no purpose for the Fed. You can't have it both ways.

Martin Brock December 21, 2008 at 1:22 pm

That's almost by definition when prices are flexible, isn't it?

That's precisely the definitive proposition that Keynes disputes in his General Theory. Suppose you and I are the only two factors in an economy. I produce widgets, and you produce gidgets. Whatever profit I earn on my produce buys gidgets, while your profit buy widgets.

Ultimately, we decide to commit ourselves to spending all of our earnings on one another's produce, so I essentially obligate myself to spend all of my future profit on your gidgets while you obligate yourself to spend all of your future profits on my widgets. We're content this way.

In this scenario, Don and Russ appear looking for work. Who employs them? I can't, because I don't have a spare dime, as all of my income either meets my own productive expenses or buys your gidgets. You can't either. Even if Russ and Don will work for a penny an hour, we can't still can't employ them. We'll employ them for nothing, but that's little help. Maybe they'll work for widgets and gidgets, but the two of us consume all that we produce by assumption.

One solution to this problem has Russ and Don producing widgets and gidgets for one another, just as you and I do. They needn't interact with us at all. Specifically, the monetary financing for their productive organization cannot come from us, because neither of us has a spare dime to lend.

Because then the opportunity price of using such resource is zero and enterpreneurs would want to use these resources instead of those they are using now, thus bidding down their prices as well….which surprisingly leads to growing real aggregate demand.

If all prices fall together, bidding down prices needn't create any new demand. It is possible for you and I to be fully employed producing solely for our own consumption. If all existing money flows solely between the two of us, how are Don and Russ ever to get any? They don't need this money to buy anything from us. They only need it to buy things from one another, as we do.

So the real problem here is not money. Money only accounts for our exchanges, and we may always account for any exchange we choose. A more likely impediment to Russ and Don's productive organization is some monopoly right impeding Russ and Don from producing for one another what you and I already produce for each other.

Martin Brock December 21, 2008 at 1:25 pm

If money is not a scarce resource, then there is no purpose for the Fed. You can't have it both ways.

You simply ignore half of my statement. Money is an accounting device. It accounts for resources that are scarce and valuable, but it is not one of these resources itself. Most money these days is literally accounting entries in electronic memories. If we doubled every one of these entries, the nominal "money supply" would immediately double, but nothing materially would change.

Marcus December 21, 2008 at 1:36 pm

The same could have been said when money was just gold. If we doubled the quantity of gold everyone had, nothing materially would change (other than the gold of course).

It's a non argument.

Of course, we can't just double all the numbers. New money, even the electronic kind, has to be introduced by the Fed.

Anybody else creating new money, even the electronic kind, will be arrested and jailed for counterfeiting.

Anonymous December 21, 2008 at 1:42 pm

But as you know, the government isn't responding to market demand, but rather to political pressure.

I agree. The line between political pressure and market demand is also very blurry.

Martin Brock December 21, 2008 at 2:00 pm

The same could have been said when money was just gold.

Money was never just gold. This understanding of a gold standard is incredible. Bank notes under a gold standard do not account for banked gold. They account for countless valuable goods all of which can be exchanged for gold and thus have a variable market price relative to the price of gold, gold having a standard fixed price rather than a market price. It's a "gold standard", because gold has a standard price and its value is thus the standard against which all other values are measured.

If we doubled the quantity of gold everyone had, nothing materially would change (other than the gold of course).

Suddenly doubling the quantity of gold everyone has is physically impossible, because gold, unlike money, does obey a conservation law. Doubling the number of "dollars" denominating the value of everyone's gold is not impossible, as we all know.

Anybody else creating new money, even the electronic kind, will be arrested and jailed for counterfeiting.

That's not as true as you might think. Suppose you hold title to a house. I can't obtain a mortgage to buy your house, because the Fed has a adopted a very restrictive monetary policy.

You're selling the house, because your kids are grown, and you're ready to retire, and you don't need such a large house to retire. After selling the house, you plan to buy bonds to secure a retirement income, but the money supply is so restrictive that you can't sell the house for the price you want.

Under the circumstances, I persuade you that my income is secure enough, so you agree to lend me the cost of the house yourself. You don't have the cash, but that's not a problem, because you hold title to the house, and I only want the money to buy the house from you.

You create a hundred thousand dollars in cash, lend this money to me and then accept the same in payment for the house, whereupon you destroy the money you previously created. Thereafter, I hold title to the house, and I make mortgage payments to you, the same money you would have received from the bonds you intended to buy anyway.

If you create and then destroy this money quickly enough, no one will notice, and you haven't actually broken any law.

Of course, this transaction doesn't often happen in practice, because the Fed is never so restrictive.

Marcus December 21, 2008 at 2:14 pm

Martin, you have an incredible talent for camouflaging your fallacies inside of a lot of irrelevant rhetoric.

Unfortunately, all it results in is a lot of tedious hair splitting.

Electronic money cannot be doubled any more than gold (or gold receipts) can. Period. That you can imagine it is irrelevant.

To every single individual out there, money is a scarce resource.

Sam Grove December 21, 2008 at 2:28 pm

No, the government cannot and that's the point.

Excuse me, the government PRINTS money out of PAPER via the Dept. of Treasury.

Marcus December 21, 2008 at 2:49 pm

"Excuse me, the government PRINTS money out of PAPER via the Dept. of Treasury."

No, they print bonds. Which they sell on the market. Banks buy up a lot of those bonds to hold as capital. They turn around and sell some of them to the Fed when the Fed has an expansive monetary policy. But the Fed is hardly the only buyer of U.S. bonds. There's an entire world market for them.

In fact, right now, the demand of U.S. treasuries is so high that that demand (and not the Fed) has driven treasury yields right down to zero.

Marcus December 21, 2008 at 3:09 pm

"Martin, you have an incredible talent for camouflaging your fallacies inside of a lot of irrelevant rhetoric."

Maybe 'fallacies' is too strong of a word. I apologize.

I think we largely agree and most of our disagreement is with semantics largely resulting from two different points of view on the same subject.

andy December 21, 2008 at 3:10 pm

Suppose you and I are the only two factors in an economy.

In this scenario, Don and Russ appear looking for work. Who employs them?

In this scenario there is no Don and no Russ, because you supposed that I and you are the only productive factors :) Anyway, what you suppose is that I exchange all my production with you. We don't need any money for that.

Even if Russ and Don will work for a penny an hour, we can't still can't employ them.

Unless I decide that I don't want to buy from you and start buying from Russ. Why shouldn't I? Did we fix the price?

If all prices fall together, bidding down prices needn't create any new demand.

Other things equal that's nonsense. If you have constant amount of money in the economy and all prices fall together it means, that the total amount of money held will buy MORE which obviously leads to higher aggregate demand.

In your example, if I used $10 to exchange the widgets with you, if we lowered the price at half, I would need only $5 to transact with you and I could easily use the remaining $5 to buy something from Russ and Don.

They only need it to buy things from one another, as we do.

We don't need the money either – and because their prices in your example are irrelevant to "our" prices, they can freely set the price of their widgets to 0.001 of price of widget I am asking you to pay and everything will work OK.

A more likely impediment to Russ and Don's productive organization is some monopoly right impeding Russ and Don from producing for one another what you and I already produce for each other.

What exactly impedes them?

flexible prices…That's precisely the definitive proposition that Keynes disputes in his General Theory.

I thought that the whole Keynessianism was BASED upon the idea that wages/prices are not flexibile downwards? Can you explain why sufficiently low prices wouldn't cure the problem?

Randy December 21, 2008 at 3:44 pm

Martin,

"The best evidence [of value] is a free consumer's decision to exchange the value of his labor for the value of other labor in a free market."

Actually, that's the only possible evidence of value. As the state cannot produce such evidence, it has no evidence. It has only propaganda. Keynesianism is just part of the propaganda.

Sam Grove December 21, 2008 at 4:30 pm

Who prints Federal Reserve Notes that are commonly known as money?

Marcus December 21, 2008 at 6:36 pm

Who prints Federal Reserve Notes that are commonly known as money?

The Treasury.

Now, I have a question for you.

What percent of the money supply is Federal Reserve Notes?

Sam Grove December 21, 2008 at 6:56 pm

I have no idea, but i was thinking of FRNs and not other types of money.

Why FRNs? Because they are the legal tender most people are familiar with.

I understand there are a vast array of credit instruments, we even create personal instruments by writing checks.

To my claim that government prints money, you said "No". Now you admit that government prints money in the form of FRNs. So the argument has shifted from the absolute to a percentage.

Who may issue legal tender?

Marcus December 21, 2008 at 7:10 pm

To my claim that government prints money, you said "No". Now you admit that government prints money in the form of FRNs. So the argument has shifted from the absolute to a percentage.

Well perhaps we misunderstood one another. The discussion in this thread is Keynesianism. When Keynes talks about deficit spending he isn't talking about cranking the printing press and pumping out more physical dollar bills (though it is often referred to figuratively as 'cranking the press').

When Obama comes out with his trillion dollar 'fiscal stimulus', it'll be funded through bonds.

If we misunderstood one another than for my part in that I apologize.

Jacob Oost December 21, 2008 at 7:35 pm

We're getting away from what was discussed in the video. Namely, when the government decides to just spend on infrastructure and other stuff to "stimulate the economy," then it will invariably pay more than it ought to on some things, spend less than it ought to on others, buy stuff it doesn't need, and not buy stuff it badly needs.

They're not spending their own money, so there's no incentive to spend wisely with it. More to the point, they simply have no way of knowing which kind of spending will be most effective. Will the economy be better if it buys steel from Pennsylvania or from Kentucky? Or from abroad? Should it buy more concrete and less steel? Which option most "stimulates" economic growth?

They simply *can't* know, which is why government spending with the sole purpose of stimulating the economy (or scratching their campaign donors' backs) won't work. ALL GOVERNMENT SPENDING SHOULD BE ON A NEED-TO-BUY BASIS. Not for stimulatory purposes.

vidyohs December 21, 2008 at 7:56 pm

Folks, check this out. Is the same Ford Motor Company that is crying for a bailout?

http://info.detnews.com/video/index.cfm?id=1189

You will find it interesting.

Martin Brock December 21, 2008 at 8:43 pm

Martin, you have an incredible talent for camouflaging your fallacies inside of a lot of irrelevant rhetoric.

Says nothing.

Electronic money cannot be doubled any more than gold (or gold receipts) can. Period.

Ignores an obvious, physically as well as economically meaningful distinction between a good and a number symbolizing the demand for a good relative to other goods.

brotio December 21, 2008 at 9:28 pm

Vidyohs,

Thanks for the link. Interesting, indeed.

The article states that the UAW is averse to such efficiency in the US. Instead, they're after such innovations as Card Check (so that they'll know whose knees to break after the election), which Mierduck defends as necessary for prosperity.

Martin Brock December 21, 2008 at 9:32 pm

Anyway, what you suppose is that I exchange all my production with you. We don't need any money for that.

A million people don't need money to exchange produce either, but we are discussing monetized exchange here, and the principle is the same if three or more of us exchange.

Unless I decide that I don't want to buy from you and start buying from Russ. Why shouldn't I? Did we fix the price?

Here you simply ignore the hypothesis. We fixed everything about our transactions. I'm contractually obliged to pay you every dime of profit on my production of widgets for whatever gidgets you produce and vice versa. We're a contractually closed, proprietarian system.

Other things equal that's nonsense. If you have constant amount of money in the economy and all prices fall together it means, that the total amount of money held will buy MORE which obviously leads to higher aggregate demand.

No. The total amount of money doesn't buy more if all accounting entries fall, because your bank account is an accounting entry. Your bank account is a bond you've sold to a bank's borrowers. When all prices fall, the price of your bond falls.

In your example, if I used $10 to exchange the widgets with you, if we lowered the price at half, I would need only $5 to transact with you and I could easily use the remaining $5 to buy something from Russ and Don.

All prices fall, so after the fall, you no longer own anything valued at $10. You own something valued at $5 and may exchange it for something worth $5, i.e. your real buying power is precisely the same. You want to imagine that your "money" has a fixed buying power as prices fall, but that's not what happens when all prices fall simultaneously. Your wage falls. The value of your bonds falls. The value of your gold falls. Even the value of your FRNs can fall. We just substitute new notes, FRN2s, for your old FRNs, and your $10 FRN is worth $5 in FRN2s.

We don't need the money either – …

Here again, you simply ignore the point. Keynes' point is that lowering the price of Russ and Don's labor needn't automatically generate demand for their labor if "demand" is defined in monetary terms, because everyone entitled to spend money may not have enough entitlement to spare, even if Don and Russ will work for subsistence.

In this scenario, Don and Russ want to produce for one another, thus becoming entitled to spend money on one another's produce. For this purpose, Don and Russ require monetary credit that others entitled to spend money cannot extend to them, because the others have exhausted their entitlement to spend and extend credit on one another.

… and because their prices in your example are irrelevant to "our" prices, they can freely set the price of their widgets to 0.001 of price of widget I am asking you to pay and everything will work OK.

No. They aren't so free. You simply ignore the hypothesis here. It's not true as a matter of fact that people may simply set the price of their produce at any level they choose. They must profit.

It's absurd to think that a hundred million Mexicans could cross the U.S. border and immediately be employed entirely from extensions of credit by U.S. citizens lending the value of their own resources. U.S. citizens don't possess sufficient resources for this purpose. The Mexicans would bring most of the valuable resources to be financed with them, i.e. they would bring their own labor, as your ancestors and mine did.

What exactly impedes them?

The monopoly right I mentioned impedes them. Armed men threaten to shoot them. For example, you and I own all of the arable land. We're content to eat only what we grow between us, leaving the rest of the land in its natural state, and we shoot trespassers. We might also hold patents on the production of particular goods and be content to produce these goods only for one another.

I thought that the whole Keynessianism was BASED upon the idea that wages/prices are not flexibile downwards?

No. Keynes doesn't assume that prices cannot fall, but he argues that falling price alone is not sufficient to employ idle resources. "Price" suggests a value measured in the bits of entitlement called "money". Naturally, Don and Russ (and any number of other people) may produce for one another's consumption through barter, if they have sufficient access to natural resources, but Keynes doesn't address barter in a natural state.

Can you explain why sufficiently low prices wouldn't cure the problem?

I did that, but you simply ignored the explanation with pointless nitpicking like "two people exchanging only with one another don't need money."

Martin Brock December 21, 2008 at 9:41 pm

Your bank account is a bond you've sold to a bank's borrowers.

Correction: Your bank account is a bond you've bought from a bank's borrowers.

Martin Brock December 21, 2008 at 9:46 pm

Maybe 'fallacies' is too strong of a word. I apologize.

Accepted.

Sam Grove December 21, 2008 at 11:49 pm

Another problem with government doing this:

In the private sector, experiments in business often fail and that is necessary to the proper functioning of the market.
When the government is involved, it goes to great lengths to avoid failure, the appearance of failure, or admission of failure.

andy December 22, 2008 at 4:08 am

Martin…
Here you simply ignore the hypothesis. We fixed everything about our transactions. I'm contractually obliged to pay you every dime of profit on my production of widgets for whatever gidgets you produce and vice versa. We're a contractually closed, proprietarian system.

Keynes doesn't assume that prices cannot fall, but he argues that falling price alone is not sufficient to employ idle resources.

You may not assume price fixing, but you assume some weird "product fixing"…. That's actually not that much different…. First, that is even more stringent than simple price-fixing, second do you think such arrangement exists in the real world? Could you show me real world example?

No. The total amount of money doesn't buy more if all accounting entries fall, because your bank account is an accounting entry.

Sure, the bank account is accounting entry FOR THE MONEY. Therefore if prices of other things fail, the accounting entry for the money does not change, therefore I have more money, therefore higher aggregate demand. Should you argue otherwise, please, post a countreexample with full double-entry accounting entries with bank balances.

The value of your bonds falls. The value of your gold falls. Even the value of your FRNs can fall. We just substitute new notes, FRN2s, for your old FRNs, and your $10 FRN is worth $5 in FRN2s.

That's some hypothetical Harry Potter's world, isn't it? Yes, my wage falls. However you DID NOT substitute my $10 FRN for $5, it is still $10 FRN!! And precisely because all prices in the economy fell, I can buy twice as much compared to situation if they did not fell. Therefore the aggregate demand DID go up.

For this purpose, Don and Russ require monetary credit that others entitled to spend money cannot extend to them, because the others have exhausted their entitlement to spend and extend credit on one another.

Again, you assume that everyone else (except Don and Russ) is contractually obliged to everyone else (except Don and Russ) to exchange all their production with them. Why would they do that?

For example, you and I own all of the arable land.
That's great. Therefore I can hire Don, I will be able to grow more crops and I can pay him in specie. Where's the problem? I can even pay Don in money instead of you and HE will buy something from you. I don't see a problem?

"Price" suggests a value measured in the bits of entitlement called "money".

Money is NOT entitlement. If you claim otherwise, please show me what money entitles me to.

I did that, but you simply ignored the explanation with pointless nitpicking like "two people exchanging only with one another don't need money."

Your example show some weird situation of a group of people that somehow closed a contract that they will exchange all their production with themselves. Therefore, by definition, they will not be able to exchange anything with anybody outside of the group. If the Keynes theory relies on this assumption, I have to conclude that it does not work in the real world because this assumption is true in the real world. I am the counterexample to your claim – I am not contractually obliged to spend any of my profit to anybody else in any group.

andy December 22, 2008 at 4:11 am

I have to conclude that it does not work in the real world because this assumption is true in the real world.

… is not true…

Tom December 22, 2008 at 5:36 am

Isn't his criticism weakened by the ability for Government to borrow funds externally (from other countries)?

Also, in response to the money multiplier criticisms above: if I put my savings in my bank account – I still make my consumption decisions based on my total wealth. The banks loan the money and the person who borrows the money spends the money as if it were theirs… Hence my money has been used in consumption decisions more than once… Isn't that a multiplier?

Gil December 22, 2008 at 6:54 am

I think I get what M. Brock means – I believe he is trying to say money isn't supposed to be a commodity unto itself rather it's supposed to be a measure as to what various good & services are worth so people can make informed trades. Most monetary conservative types prefer that money be gold coinage & weights because the amount of gold is deemed on a relative par with the amount of goods & services in circulation (Gold mining would create inflation but makes the return on gold mining less worthwhile (thus avoiding hyperinflation) and deflation makes gold more valuable restarting the gold mining process).

andy December 22, 2008 at 6:58 am

Tom, I always thought about the idea, if there is some positive effect in the fact, that the government can guarantee the debt by making assurance that it can coerce at least somebody in the economy vs. private sector where you cannot do it (i.e. the debtor can default). This argument might work when government debt levels are low (not current situation), however the negative counter-effect is moral hazard. In order to achive similar result without moral hazard a law can be changed to allow debt-slavery – this would have the same effect.

As of the "credit multiplicator", I am not quite sure how does it relate to Keynessianism. Can you explain it further?

Martin Brock December 22, 2008 at 7:38 am

Most monetary conservative types prefer that money be gold coinage & weights because the amount of gold is deemed on a relative par with the amount of goods & services in circulation …

This conception of a gold standard completely misconstrues the idea. There was never a time when gold itself was money, and the quantity of gold is not presumed proportionate to the quantity of other goods under a gold standard. Rather, the demand for gold relative to demand for other goods must be stable for this monetary system to be stable, because the price of gold is fixed. Demand is not simply a matter of quantity. Scarcity alone does not imply value. My shit is scarce, but I don't expect to make my fortune packaging Martin's Shit. Maybe if a could package Elvis' Shit …

Banknotes under a gold standard do not represent gold. They represent all sorts of assets, particularly land and houses. The notes may promise redemption in gold, because these other assets have a value relative to the value of gold and may be exchanged for gold. A dollar "bill" is this sort of promissory note, not a warehouse receipt for banked gold. Selgin discusses free banking under a gold standard in a recent econtalk.

(Gold mining would create inflation but makes the return on gold mining less worthwhile (thus avoiding hyperinflation) and deflation makes gold more valuable restarting the gold mining process).

Gold mining is not the primary force behind inflation under a gold standard. Excessive extension of credit is the problem, with or without a gold standard. Creditors promise more gold than assets are really worth in the final analysis. These assets are not simply the bank notes that creditors circulate. They're the land and houses and other assets securing the banks' extensions of credit.

If I'm a banker and you're a depositor of gold in my bank, I'm not bankrupt when you present banknotes for gold and I don't have sufficient gold on hand. I'm insolvent in this scenario but not necessarily bankrupt, because I can call a loan and sell its collateral to raise the gold for you, or I can sell a performing loan with sound collateral to another bank and raise the gold for you this way. I'm bankrupt only when all of the assets securing all of my banknotes aren't worth the face value, in gold, of the notes.

Gold works for this purpose, not because it's so much in demand but because it's not so much in demand. Most people have little need for gold as a practical matter. In fact, gold is more practically useful today than it was when it was a standard of value. Bank runs occur when demand for gold surges. This surge drives down the price of goods securing banknotes, because these prices vary relative to the price of gold while the price of gold is fixed. Increasing demand for gold cannot raise the price of gold, so it must drive down the price of everything else.

Marcus December 22, 2008 at 9:34 am

"If I'm a banker and you're a depositor of gold in my bank, I'm not bankrupt when you present banknotes for gold and I don't have sufficient gold on hand. I'm insolvent in this scenario but not necessarily bankrupt…"

You have it backwards. You are bankrupt but you are not necessarily insolvent.

You are bankrupt because your cash flows cannot meet you current obligations.

You may still be solvent if your assets exceed your liabilities.

Your problem is one of liquidity. Your assets are illiquid. You have to pay the depositor now but it takes time to sell a loan to another bank to raise the cash to pay the depositor with.

andy December 22, 2008 at 9:59 am

There was never a time when gold itself was money,

Actually there was. There probably was not time when ONLY gold was money, but I would argue that this depends on the definition of money. It seems to me that old Greece used mostly only silver as money.

Rather, the demand for gold relative to demand for other goods must be stable for this monetary system to be stable, because the price of gold is fixed.
I love it when calling '33.1g of gold' '1 ounce' is called price fixing :-) )

Banknotes under a gold standard do not represent gold.

A dollar "bill" is this sort of promissory note, not a warehouse receipt for banked gold.

Actually banknote under gold standard is ENTITLEMENT on the gold. The bank is legally obliged to exchange the banknote for gold upon request. And it is non-sequitur – from the notion that it is a promissory note does NOT follow that it is not represent gold.

This surge drives down the price of goods securing banknotes, because these prices vary relative to the price of gold while the price of gold is fixed.
I mostly agree with your conclusions, but not with your arguments. The term "price" denotes "exchange ratio". Thus the price of 1 shoe can be 0.5 ounce of gold, 15g of gold, 2 ounces of silver, 1kg of oranges etc. Or, the price of gold can be explained as 2 shoes, 4 ounces of silver, 2kg of oranges etc.

Can you explain which price, i.e. exchange ratio, is "fixed"?

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