Good Deflation

Where is Martin when we need clarification.?

Discussion of the activity of money distracts us from the underlying reality of allocation of resources.

When people "save" they are foregoing consumption.

If they save by hoarding, they are still foregoing consumption.

Money may be thought of a way of creating and transferring obligations.

IAC, it is the foregone consumption that make investment, and economic growth possible.

Deflation as Robert Mundell describes it is a change in the value of the unit of account to which prices then adjust. Deflation is not a price reduction due to advancements in manufacturing technologies afforded by the addition of capital. Speaking of price increases and decreases as inflation and deflation muddies the waters.

Can you have deflation with a currency that continues to weaken? An inflation perhaps but a deflation certainly not!

There certainly _is_ "something wrong with deflation caused by saving. In a properly organized monetary system, increased savings should shift demand from savers to borrowers, without reducing overall or aggregate demand, and hence without putting downward pressure on prices.

I suppose that Mr. Lesvic might be consistent enough to really imagine he wouldn't mind living in a world were a substantial increase in saving via intermediaries was for some reason unmatched by any additional granting of new loans by those intermediaries (and corresponding growth in the money stock, in so far as measures of it include some of the intermediaries' liabilities). But I dare say that most persons having to cope with the resulting contraction of nominal income and earnings would not share his complacency--or his notion of sound economic reasoning.

On the other hand, it is not hard to appreciate the appeal of the ultra-Rothbardian view that any and all deflation is "good." Popular dogmas often have the virtue of simplicity; and, as Mencken once very correctly observed, thinking makes most people's brains hurt.

What is a "properly organized" monetary system?

Despite what Mr. Lesvic states, in my own view a "properly organized" system is emphatically _not_ a discretionary fiat system--as should be evident given the notorious failure of such to deliver the sort of stability of spending I've regarded as essential to a well-working economy. A better alternative is free banking, either on a gold standard or with a permanently frozen stock of fiat money. My pamphlet explains how the latter alternative works.

As I've been a consistent critic of discretionary central banks since before my graduate school days, and I've put my views on the matter in print in dozens of articles and books, Lesvic's attempt to create the opposite impression on this list ought to earn him the unending contempt of all those participants who are here to try and improve their understanding of markets, in the true spirit of Hayek.

Indeed, the Austrian School, with which I've had a very long an fruitful connection, has suffered a great deal from those like him who imagine that being a good "Austrian economist" is simply a matter of denouncing anyone whose views you disagree with as an "interventionist" or a "socialist" or a "Keynesian." True, the great von Mises himself had a habit of resorting to such denunciations. But he also did plenty of real economics.

Thanks for your thoughtful response.

You might moderate your reaction to Lesvic. It should be sufficient to state your case and let readers decide.

Everyone earns their own allocation in the estimations of others.

Sam,

That sort of thing is standard practise for him.

His classrooms must be a joy.

Dear Mr. Lesvic,

George is a scholar's scholar. I would have loved to be a student in one --or, better, more than one -- of his classes.

Don

I wouldn't send my children to any classrooms in the Austrian School today except yours and Russ's.

Apologies to Larry White, Peter Boettke, and the other great scholars and gentlemen in the field. I went too far. But there is still a big problem. But, nothing new about that. Human nature has always been that way.

And from what I've seen on the Internet, especially at the other blogs, his ilk is more the rule than the exception. The Austrian School is in very bad hands today. Which is all the more reason to appreciate the men running this site, far and away the greatest in economics today, the best writers and truest scholars and gentlemen.

Their colleagues must hate their guts, but their students love them.

Prof. Selgin referred to "the sort of stability of spending I've regarded as essential to a well-working economy."

Mises, another ignoramus, no doubt, explained why there could be no stability of any kind.

"With the real universe of action and unceasing change...neither neutrality of money nor stability of purchasing power are compatible. A world of the kind which the necessary requirements of neutral and stable money presuppose would be a world without action...in the frame of...a changing world money is neither neutral nor stable in purchasing power. All plans to render money neutral and stable are contradictory. Money is an element of action and consequently of change."

While Prof. Selgin referred to stability of spending, and Mises to stability of purchasing power, the principle was the same. No stability. Period.

He defines his "properly organized monetary system" as "free banking, either on a gold standard or with a permanently frozen stock of fiat money."

I'm glad to know that he's on our side, but from his choice of words, "properly organized," you can hardly blame me for having thought otherwise.

He says that my misinterpretation of his words ought to earn me unending contempt. But why was it my responsibility to interpret his ambiguous words correctly rather than his to have written unambiguously in the first place, and my fault for having drawn the most logical inference from his words?

It may be true, as he said, that some of us have been too quick to label as socialist and such those with whom we disagreed. But we must still label their errors for what they are.

He is trying to disconnect what I do with my money when I deposit it in a bank and what the bank does with it when it lends it out. The disconnect is only in my mind. I think I am saving my money but the bank knows that it is investing it. The reality is not what I think is being done with it but what is actually being done with it. It is not being saved. It is being lent out and either consumed or invested.

But, regardless, suppose that, rather than "saving" my money in a bank, I saved it in my mattress. What would be wrong with that?

Slight clarification:

A dollar cannot be both saved and spent at the same time. It is either being saved or spent, whether on consumption or investment.

Further clarification:

I assume that Prof Selgin doesn't wish to eliminate saving altogether, but merely keep its ratio to spending as constant as possible.

But, in the wake of capital consumption, relatively more saving is exactly what is needed. With rainier days ahead, that is exactly what is needed. In the face of an oncoming avalanche, getting capital out of the way of it is exactly what is needed, saving it not just for the rainier days but for recovery where the opportunity for it appears.

Lesvic: "I may think I'm saving my money when I deposit it in a bank, but, if the bank lends it out to someone else who proceeds to spend it, whether on consumption or investment, it is no longer saved, but has been spent."

Nope. Lesvic is still saving; and the person to whom his funds have been lent is borrowing his savings, just as if Lesvic had purchased that person's bond. The fact that the borrower himself isn't saving doesn't mean that Lesvic has stopped doing so!

Lesvic asks what it is that I think he ought to know that he doesn't seem to know. Here is a very elementary example of what I mean. To claim expertise on monetary economics while getting this sort of thing all wrong takes real chutzpah!

What if you save and the bank does not lend the money out in fear that there are few credit worthy people. Does the aggregate demand then drop? How are we explaining the drop in demand of goods and services?

Yes, that would cause demand to decline: banks would then raise their reserve ratios instead of making loans, and this would cause a decline in overall spending.

Perhaps you could try to read the article first?

An interventionist, fiat money system.

Prof Selgin says that "In a properly organized monetary system, increased savings should shift demand from savers to borrowers."

But, ultimately, then there is no saving. I may think I'm saving my money when I deposit it in a bank, but, if the bank lends it out to someone else who proceeds to spend it, whether on consumption or investment, it is no longer saved, but has been spent, and may or may not come back to the pool of saving and be available for me when I want it.

Suppose that, to make sure it was available when I wanted it, I safeguarded it myself, or, suppose the bank itself hung on to it.

What's wrong with free market actors saving?

Why would anyone but a socialist dictator tell them that they shouldn't do so, that he knows better than they what they should do with their own money?

It seems that we're not just "all Keynesians now," we're all socialist dictators, Big Brothers who know best.

Phooey!








without reducing overall or aggregate demand, and hence without putting downward pressure on prices.

Mr. Lesvic appears to be under the impression that one cannot save other than by accumulating real property. That the vast part of savings involves the accumulation of _financial_ assets, designed to allow savings to be lent, appears to have escaped his attention. Well, I said that his grasp of economics wasn't very good, didn't I?

Of course this doesn't keep him from befouling otherwise sanitary blogs with his mental droppings. Still I hope it may at least encourage readers to tread carefully around his contributions.

Methinkers,

You said investing and spending are not the same. But investing is a form of spending. I think you meant to say that investing and consumption are not the same. Conumption is also a form of spending. So, investing and consumption are two different kinds of spending.

Prof. Selgin,

I agree that one can save monetary or financial claims on real property as well as real property itself. And I never said anything different.

But what does it mean that "financial assets" are "designed to allow savings to be lent?" Who in a free market is not allowing them to be lent? If you want to lend them out, go ahead. I certainly wouldn't stop you.

Now, again, please, what is it I don't know that I should know?

DG,

Maybe it's my narrow focus on finance, but investing and spending are not the same. If the borrower spends the money you lend him, he can't pay you back. If he invests it in an income producing asset, there's a probability that you will receive not only the money but a portion of the return. Only you (or the bank on your behalf) will be able to decide if the risk is worth the expected return.

Methinks:
"If the borrower spends the money you lend him, he can't pay you back. If he invests it in an income producing asset, there's a probability that you will receive not only the money but a portion of the return."

That's why lenders demand collateral. If you want to borrow $10,000 from me to spend on a cruise to the Bahamas, I'll lend it to you as long as you give me a lien on your house, assuming your house is worth significantly more than $10,000. The money created by that loan is backed by the house, and nobody but the borrower and the lender has any reason to care about the terms of the loan.

yes, I agree.

Some excellent books in a similar vein have also lately become available:

Deflation and Liberty: http://mises.org/books/deflationandliberty.pdf

The Ethics of Money Production: http://mises.org/books/moneyproduction.pdf

For my own taste, which is for medieval history and moral philosophy as well as economics, the Ethics of Money Production is one of the most interesting books I have ever read on these subjects.

I've started Selgin's book, but haven't had a chance to finish it yet.

Thanks for the recommend. Now if only B&N will get around to sending me my damn Nook, I'll be able to read them faster!

Certainly - I don't think there is a large contingency that thinks this describes the current deflation, though.

Depends on your point of view. Do you think the readjustment of artificially inflated asset prices (housing) is a good thing or bad thing?
Isn't that a large chunk of this crisis, falling housing prices that exposed how under capitalized the financial institution were? Sure it caused short and thanks to the Dems, long term pain, but better now then later when the pain would only be much worse.
That said, we haven't even had enough deflation in housing prices, they are still being artificially inflated, thanks to ever increasing government subsidies. When they go back down again, and they will, FHA will go under and the taxpayer will be on the line again.Only this time for even more money. Now I admit that it isn't a "good thing" only because the inflation of asset prices wasn't a good thing either, but better to take me two licks now than 20 licks down the road.

Why limit the "celebration" to deflation caused by productivity increases? Is there anything wrong with deflation caused by savings?

Are we all Keynesians now, even Prof. Boudreaux?

While I'm with you for the most part, calling Don a Keynesian isn't the way to go. Don't Keynesians think that all deflation leads to deflationary death spirals so they argue for more and more inflation.

Justin,

I always hate to say anything critical of Don, who is the greatest man in economics today. But I do think that in this matter he has fallen into the Keynesian trap.