Magical realism in Latin America

Do you believe in magic?  I do.  I believe that if you have a country mired deep in a deflationary depression, you can spur a recovery simply by debasing its currency.  That’s right folks; to make a country richer you take the public’s money and make it worth less.  (Not worthless.)  If that doesn’t count as magic I don’t know what does.

Arnold Kling does not believe in magic:

Scott Sumner writes,

If the Spanish and Greek governments shrank enough to balance their budgets, they’d still have 24% unemployment, if not more. Their economies are hopelessly uncompetitive at the current exchange rate.

And if those countries had a huge currency devaluation, what would the unemployment rates look like? My guess: still more than 20 percent.

I believe that you could take a country with a Latin culture, and lots of statist policies, and a population about halfway between Greece and Spain, that was mired in a deflationary depression with more than 20% unemployment due to an ill-advised and rigid monetary regime (currency board) with no flexibility, and magically create a rapid recovery by simply debasing its currency.  And I believe you could still do that even if every other policy adopted by the government during the recovery was a horrible statist boondoggle that would, ceteris paribus, reduce RGDP.  That’s powerful magic; even Julio Cortazar could never dream up something so unlikely.


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58 Responses to “Magical realism in Latin America”

  1. Gravatar of Nick Rowe Nick Rowe
    26. July 2012 at 05:49

    Argentina?

  2. Gravatar of Rien Huizer Rien Huizer
    26. July 2012 at 05:53

    Scott,

    The record is mixed. Some countries did well and others not, after a devaluation. It may not be necessary and is probably not always sufficient.

    Anyway, Feldstein is behind the facts: the EUR has been becoming cheaper on a trade-weighted basis for a while now and what do we see? continued economic weakness, no export surge, no rapid import-led rise in inflation (forgetting primary products). There are two places where exchange rates are used as a policy tool with commensurate effects: Singapore and the RoK. The use as a policy tool is tricky because of diplomatic consequences and most countries practising it would deny doing so. Within Europe, Sweden was a spectacular (and maybe successful if someone can do a proper analysis) case of monetary policy with a predictable effect on the exchange rate. But that is close to inappropriate behaviour within the EU members committed (as Sweden is, except for the small detail of popular rejection) to EU membership. Anyway, Sweden has quickly mended its ways and is now basically back where it was before the GFC (and suffering unwelcome buoyancy).

    Hence, this if far less straightforward than it looks. But a primary channel for NDGP targeting in a smallish open economy, of course. Not to be confused with currency manipulation for the benefit of boosting competitiveness of one’s own exporting private sector, as the Japanese are accusing the Koreans of.

  3. Gravatar of ChacoKevy ChacoKevy
    26. July 2012 at 06:06

    Juilo Cortazar! Wow! I know you used him as he was Argentine, but kudos to you anyway for passing up the obvious Gabriel Garcia Marquez reference in a post discussing magical realism.

  4. Gravatar of Alex Godofsky Alex Godofsky
    26. July 2012 at 06:25

    Maybe Argentina just had better patterns of sustainable specialization and trade, or something!

  5. Gravatar of Major_Freedom Major_Freedom
    26. July 2012 at 06:57

    Magic? Sarcasm or not, admission is the first step towards recovery.

    I believe that you could take a country with a Latin culture, and lots of statist policies, and a population about halfway between Greece and Spain, that was mired in a deflationary depression with more than 20% unemployment due to an ill-advised and rigid monetary regime (currency board) with no flexibility, and magically create a rapid recovery by simply debasing its currency.

    I believe that you could take a country with a Latin culture, and lots of statist policies, and a population about halfway between Greece and Spain, that was mired in a deflationary depression with more than 20% unemployment due to an ill-advised and rigid fiscal regime (treasury board) with no flexibility, and magically create a rapid recovery by simply spending more money.

    I believe that you could take a country with a Latin culture, and lots of statist policies, and a population about halfway between Greece and Spain, that was mired in a deflationary depression with more than 20% unemployment due to an ill-advised and rigid driving regime (transportation board) with no flexibility, and magically create a rapid recovery by simply driving on more roads.

    I believe that you could take a country with a Latin culture, and lots of statist policies, and a population about halfway between Greece and Spain, that was mired in a deflationary depression with more than 20% unemployment due to an ill-advised and rigid goat farming regime (goat board) with no flexibility, and magically create a rapid recovery by simply farming more goats.

    I believe that you could take a country with a Latin culture, and lots of statist policies, and a population about halfway between Greece and Spain, that was mired in a deflationary depression with more than 20% unemployment due to an ill-advised and rigid flibbertygibbet regime (flibbertygibbet board) with no flexibility, and magically create a rapid recovery by simply flibbertying more gibbets.

    When you a priori view the world’s problems as a lack of enough [money printing / government spending / driving / goat farming / flibbertygibbets], the world’s solutions always seem to point back to more [money printing / government spending / driving / goat farming / flibbertygibbets]. Who would have thought?

    ——————

    Do you believe in magic? I do. I believe that if you have a country mired deep in a deflationary depression, you can spur a recovery simply by debasing its currency. That’s right folks; to make a country richer you take the public’s money and make it worth less. (Not worthless.) If that doesn’t count as magic I don’t know what does.

    Do you believe in magic? I do. I believe that if you have a firm mired deep in a black magic set of words, you can spur a recovery simply by debasing its currency. That’s right folks; to make a firm richer you give it more money and make other people’s money worth less. (Not worthless.) If that doesn’t count as magic I don’t know what does.

    Do you believe in magic? I do. I believe that if you have an individual mired deep in a black magic set of words, you can spur a recovery simply by debasing his currency. That’s right folks; to make an individual richer you give him more money and make other people’s money worth less. (Not worthless.) If that doesn’t count as magic I don’t know what does.

    ——————

    I don’t think anyone doubts that a central bank can prolong economic corrections, excuse me, I mean reduce unemployment, by printing money. The question market monetarists are not seriously addressing is “at what cost?”. If I bad bad investment choices, for example a $1 billion investment in a fake dog poop making factory with 1000 employees, that later incurred losses, there is little doubt that my investment could become nominally profitable if only money printers created so much new money that the marginal utility of another piece of dog poop outweighs the marginal utility of alternatives at their current prices.

    If many investors across the economy made bad investment choices, because they were all duped by the same artificially low interest rates and the same artificially high credit inflation, then it is absurd to believe that the solution is even lower interest rates and even more credit inflation. Depressions look like the problem is not enough spending, because reduction in spending is exactly what happens when the problem is structural! Structural corrections don’t consist of the same nominal spending with changes on the real side.

    If a home builder, in the process of his construction, realized he made an error in judgment (e.g. he thought he had 50,000 bricks when he really only had 40,000 bricks), after which he then corrected his errors by either redesigning the floor plan, or waiting for more bricks to be produced, or tearing it down and starting again, whatever his correction process, it is absurd to believe that in the process of his corrections, he’ll spend in the same way as before, that is, paying the same amount for labor, the same amount for bricks, the same amount for gasoline, the same amount for renting tools, and so on. OF COURSE he will reduce his spending from what it was prior. He was spending TOO MUCH prior! The prices he was paying were the wrong prices! They were contingent upon his belief that he had 50,000 bricks. Who in their right mind would insist that his problems be rectified alongside the same money spending as before, when he was acting incorrectly vis a vis his goal? Yet this is exactly what the structuralist deniers believe should happen.

    If this home builder does reduce his money spending, while he makes corrections, how in the world can anyone believe that his problems can be solved by there being more green pieces of paper in the economy? The solution isn’t more green pieces of paper, it’s that he engaged in a project that requires more capital than exists. The solution is either to wait for enough capital to be produced (10,000 more bricks), or start a new project (a project that can be completed with the remaining half built house and remaining bricks).

  6. Gravatar of Becky Hargrove Becky Hargrove
    26. July 2012 at 07:48

    A little monetary riddle: Imagine a village where the money ‘locked away in a chest’ is actually units of human skill. In this village there is a doctor who holds many units of human skill. Now, there are some other people who hold corresponding (valuable) units of skill by which they can pay the doctor, and in the aggregate there is a reasonable amount of exchange. However, there could be more exchange overall if devaluation were to occur (more skills printing), that is, more people might therefore participate, and provide greater economic activity in the aggregate. But that ‘appears’ to debase the skills currency of the doctor and his better skilled counterparts…or does that actually have to be so?

  7. Gravatar of J.V. Dubois J.V. Dubois
    26. July 2012 at 07:48

    Rien: “Anyway, Feldstein is behind the facts: the EUR has been becoming cheaper on a trade-weighted basis for a while now and what do we see? continued economic weakness, no export surge, no rapid import-led rise in inflation (forgetting primary products)”

    It may have something to do with the fact, that ECB tightens the monetary policy whenever it sees increased price of imports such as oil of food – either explicitly as under Trichet in Spring-Summer 2011 or implicitly as with the latest refusal of ECB to loosen the monetary policy because “Upside risks pertain to further increases in indirect taxes, owing to the need for fiscal consolidation, and higher than expected energy prices over the medium term”

  8. Gravatar of Josiah Josiah
    26. July 2012 at 07:49

    It would appear that Major Freedom doesn’t get the joke.

  9. Gravatar of Jon Jon
    26. July 2012 at 07:55

    AD stabilization is a necessary but not sufficient condition for stable real growth. After you strip out money demand as an issue you’re still left with a problematic AS curve.

    We’re seeing this is Britian right now. There are people generically questioning austerity, and it is quite wrong that they don’t divide their concerns into AS and AD components…

    One of the basic traps is that cutting back efficient government services is an AS shock., but boosting AD is not a solution–I.e. you want to avoid increasing transfer payments. Instead the strongest road to austerity is to cut transfer payments and preserve government output while taking other measures to enhance efficiency in private markets.

    In Greece, the troika needs to realize they have limited political capital and they should be spending it on AS reforms and guarantees that a future Greek government won’t turn into a robber baron–probably by ceding sovereign control with free enterprise zones and a reiteration that private contracts in euros will be enforced and cannot be repudiated even if a parallel currency is introduced.

    As an investor, I’d like to see a commitment by the EU to defend those free enterprise zones by force if need be.

  10. Gravatar of ssumner ssumner
    26. July 2012 at 07:59

    Nick, Yes.

    Rien. I never claimed devaluations help countries (never reason from a price change.)

    Devaluations help when countries are mired in deflationary depressions.

    Thanks ChacoKevy.

    Alex. That’s “not necessarily foolish.”

    Becky, Do you have sticky prices?

    Josiah, What a surprise.

  11. Gravatar of Becky Hargrove Becky Hargrove
    26. July 2012 at 10:38

    Scott, it seems there could be sticky prices because of a ‘first mover’ issue: first movers would do so with no protection and also create further asymmetry in the process. Consequently, people with high skill align with people who develop capital, as the same problem exists for both in terms of revaluations or redefinitions of markets. The first mover problem (in the face of complexity) is why I like the idea of creating small potential examples for voluntary economic relationships.

  12. Gravatar of Javier Touceda Javier Touceda
    26. July 2012 at 11:13

    The problem is the latin culture?
    Greece is a latin country? And Ireland?

  13. Gravatar of StatsGuy StatsGuy
    26. July 2012 at 11:25

    So, do I know understand that you have stopped defending and admiring Kling’s politically self-serving policy views?

  14. Gravatar of Major_Freedom Major_Freedom
    26. July 2012 at 11:32

    Josiah:

    I don’t think you get the seriousness in Sumner’s post that lies behind the “magic” joke exterior.

    I get the joke, I was addressing the serious component of this post.

  15. Gravatar of Federico S Federico S
    26. July 2012 at 11:53

    I protest, magical realism should always refer to Colombia.

  16. Gravatar of Major_Freedom Major_Freedom
    26. July 2012 at 11:55

    ssumner:

    Josiah, What a surprise.

    It’s clear at this point that you’re just agreeing with anyone who says anything non-supportive, or corrective, or otherwise the exact opposite of how Benjamin Cole prefaces each one of his posts with “Excellent blogging!”, to what I write.

    It’s also clear that you continue to be not at all concerned with ideas, but teams and popularity and appearances. Us versus them. Never agree with MF, because if you give him an inch, the entire market monetarist worldview collapses. I’ve seen this happen with those relatively less educated libertarians who won’t even address Marxist writings nor accept ANYTHING he said, even the most trivial, for fear of opening up a can of worms and refuting their entire worldview.

    I have found that it tends to be a product of not believing in one’s own convictions. Of suspecting some crucial flaw that must be ignored and covered up at all costs.

    ——————

    Jon:

    AD stabilization is a necessary but not sufficient condition for stable real growth.

    Only free market determined AD is a necessary but not sufficient condition for stable real growth. Central bank AD stabilization leads to unsustainable real growth which requires an accelerating growth in the money supply which of course is not sustainable in the long run.

    No individual has any what money and spending should be, given individual preferences, unless we respect individuals choosing to produce and use whatever money they want. Central planning can’t even mimic this, let alone improve upon this, because there is no private property subject to profit and loss signalling with central bank fiat money. They have to operate according to arbitrary, non-economically grounded “rules” like the combination of begging the question and status quo fallacy: “5% NGDP because that’s what it has historically been with central banks.” Begging the question because the argument for central bank 5% NGDP contains a premise of central bank 5% NGDP, and it is status quo because that’s what central banks have historically done.

    None of this is economics. It’s going with the flow. It is trying to copy historical data. It is justifying such copying on the premise that it is a copying.

    If central planners can not only mimic the free market, but improve upon it, then why not centralize goods that are far more important than money, such as food, water, medicine, and shelter? Without these, no amount of money can prevent extinction of the human race.

    So what is the exact argument for why food production should not be monopolized by the state, but money production should be, even though food is far more important than money?

    If the state monopolized food production, would you all turn into “market” agriculturalists and say that the state should focus on a 5% increase in every food item? Or 5% more potatoes but unchanged salt production? How will you know what is more highly valued and what is less highly valued, given that you are working in scarcity and have to make choices that make all other possible choices impossible at the time?

    Who among you will advocate for privatization of food production, and who will be opportunitists and advise the monopolists on what food they should produce and how often and where?

  17. Gravatar of david david
    26. July 2012 at 12:49

    Indonesia bounced from recession to recession by devaluing the rupiah over and over again. It was ever more of a basketcase than Argentina.

    In a move than I’m sure that would warm the cockles of M_F’s heart, whilst the repeated devaluations worked for over three decades to boost export-led growth, in 1997 it suddenly forced huge domestic inflation instead (~70%) and the downfall of the ruling regime.

  18. Gravatar of david david
    26. July 2012 at 12:49

    Still, it worked for three decades. That’s a lot of recessions spared.

  19. Gravatar of Major_Freedom Major_Freedom
    26. July 2012 at 13:17

    david:

    In a move than I’m sure that would warm the cockles of M_F’s heart, whilst the repeated devaluations worked for over three decades to boost export-led growth, in 1997 it suddenly forced huge domestic inflation instead (~70%) and the downfall of the ruling regime.

    David, I do not feel at all warmed or heartened by unnecessary agony that innocent people have to go through because of state transgressions in the sphere of money production and interest rates. I don’t feel good at all when monetary orders collapse. Innocent people are victimized.

    I really do wish that we could print our way to prosperity and not have to incur the costs of past mistakes, and did not transfer the costs onto the general population which makes empirical comparisons of free markets versus socialism impossible, and thus only a few who have the imagination to know what could have otherwise occurred but cannot convince those who only look at empirical data and make temporal-based arguments rather than the necessary counter-factual arguments.

    If I gained X, but the costs were incurred on 300 million other people, it will LOOK like a gain without a cost has occurred. Here’s me with a new yacht, mansion, a sports car, and being owner of a professional baseball team, and there’s 300 million people with $1 less in purchasing power than they otherwise would have had.

    When the costs of inflation are transferred into everyone, it is impossible to OBSERVE what otherwise would have taken place with “the economy.” This is why inflation is so insidious. It leads dimwitted political strategists to believing that inflation is like magic, and can create net gains subject to certain conditions which themselves are always caused by past inflation but are not interpreted as such by the believers who want to believe a free lunch is possible.

    I just know economics, and so I do not take my magical wishes and pretend that they are somehow brilliant intuitions that need economic explanations which are ex post rationalizations of wanting to turn my magical wishes into reality.

    ———-

    I challenge your choice of words. You said it “worked” for 3 decades. But the economist’s job, as Hayek repeatedly noted, is to direct people’s attention to the long term outcomes, even if they are 40 years out, and not try to be politicians looking to serve the immediate moment.

    You also said “that’s a lot of recessions spared.” You say this as if the inflation throughout that period was not itself a cause for the recessions. You seem to only see inflation as a cure, and not a disease, as if periodic recessions are a part of an unhampered market.

    ———-

    Political collapses are dangerous, especially when the cause is high inflation. I’d rather collapse nonconsensual, i.e. violent, ruling regimes, by education, since I hold that such ruling regimes can only continue to exist if enough people implicitly accept it and support it, without which it could not continue.

    If you want to know my Utopian vision, it is the entire American productive side of the population engaging in a permanent peaceful voluntary resistance to aggression, that only turns violent when violence is initiated by those in the state and those in the civilian population who benefited from past initiations of violence, until those in the ruling regime and their civilian friends are compelled to start producing for themselves through voluntary exchange. That is my dream. I don’t care if I go to my grave fighting for it. I am “possessed” by the thought of peace and goodwill towards men, and I don’t care if that means I acquire less real wealth all else equal. If I felt that benefiting myself at other people’s expense, through aggression, was justified, I’d just as soon cease all pretensions to rationality, logic, debates, and every other self-imposed “rule” based behavior, and I’d join the state and become a murderer and thief by trade myself, and lie about how my actions benefit those who object.

  20. Gravatar of ssumner ssumner
    26. July 2012 at 13:22

    Jon, You said;

    “AD stabilization is a necessary but not sufficient condition for stable real growth.”

    Exactly.

    Javier, You said;

    “The problem is the latin culture?”

    Of course not, it’s an overvalued exchange rate. I thought I made that clear.

  21. Gravatar of Evan Soltas Evan Soltas
    26. July 2012 at 13:37

    Scott, you’re not saying that these countries would be made better off in the long run by devaluing, right? Just in the short run? Perhaps I would acknowledge that sticky prices mean that there is a small tradeoff at the ZLB between real and nominal variables in the long run. But money is basically neutral in the long run.

  22. Gravatar of John John
    26. July 2012 at 13:37

    Some of the stuff by market monetarism supporters in this thread is pretty funny. Keep in mind guys that you’re arguing for developed countries in Europe and possibly us here in the U.S. to follow the economic policies of the poorest countries in the world.

    Indonesia was quite an economic tiger for those 30 years huh? Do you really think the Greeks want to trade places with Venezuela? Your arguments are like saying that it’s better to be poor because then you have to work harder.

  23. Gravatar of John John
    26. July 2012 at 13:38

    I’m gonna try one last time to convince the people on this site that higher inflation is not the answer. None other than Warren Buffet said that inflation is the worst tax imaginable. For someone living off of fixed income investments earning a 5% return, it doesn’t make any difference whether the tax on interest income is 0% and inflation is 5% or the tax on interest income is 100% and inflation is 0%. Inflation is the best known way to consume the capital that the economy needs to make any type of progress at all.

  24. Gravatar of Mike Sax Mike Sax
    26. July 2012 at 13:42

    “For someone living off of fixed income investments earning a 5% return, it doesn’t make any difference whether the tax on interest income is 0% and inflation is 5% or the tax on interest income is 100% and inflation is 0%. Inflation is the best known way to consume the capital that the economy needs to make any type of progress at all.”

    John, I’d be interested in a quote for Buffett saying this. A 100% tax with no inflation is the same as as 0% tax and 5% inflation?

    Simple math says that’s wrong.

  25. Gravatar of Major_Freedom Major_Freedom
    26. July 2012 at 14:06

    Mike Sax:

    Simple math says that’s wrong.

    Simple minded math, maybe.

    John was speaking in terms of purchasing power, of REAL return, and his math checks out.

    You buy a bond for $100, and the interest rate is 5%, then you will gross $105 in nominal return.

    If inflation is 5% and tax is 0%, then you net a real return of zero. You invested $100 and you get $105 that is worth what $100 used to buy.

    If inflation is 0% and tax on interest is 100%, then you net a real return of zero also. You invested $100 and you get $100 that is worth what $100 used to buy.

  26. Gravatar of Major_Freedom Major_Freedom
    26. July 2012 at 14:16

    John:

    I’m gonna try one last time to convince the people on this site that higher inflation is not the answer.

    You don’t have to convince me, since I already agree.

    Fixed incomes is only a partial explanation for why inflation doesn’t work. Even if incomes were flexible, there is still the Cantillon Effect of some people receiving the new money before others, which cannot raise everyone’s nominal incomes equally, since the very mechanics of inflation is that only some people get the new money first. Inflation isn’t a system where everyone’s incomes and cash balance increases at the same rate at the same time.

    Inflation is actually a micro-economic phenomena. It is incorrectly treated as a macro-economic phenomena solely because it is mathematically possible to add up total incomes or prices at any given time and divide by the number of income earners or number of goods, to get an average single statistic, and economically illiterate nincompoops believe that being able to add quantities together somehow means one is creating a new reified concept that has a causal life of its own.

    EVERY economic phenomena is “micro-economic” in nature. You tell me “unemployment is 8%”, then I can in principle show you exactly which individuals are claiming to want to find a job but haven’t yet found one. If you tell me “CPI inflation is 3%”, then I can in principle show you exactly which particular class of goods rose at which particular rate in price.

    Macroeconomics is voodoo. Always has been, always will be. Macroeconomics was specifically designed to justify exploitative micro-economic behavior between individuals, typically between those in the state and those not in the state.

    The Fed prints money for its banker friends, and we’re supposed to believe this is helping the “macro-economy”, despite there being identifiable reductions in particular individual’s real incomes. This is when economic science is abandoned and “utilitarian” nonsense is introduced of “We’d all die in a fire if the Fed didn’t print money for its banker friends.”

    It’s because we’re too stupid to manage our own finances and setting our own interest rates, you see.

  27. Gravatar of ssumner ssumner
    26. July 2012 at 14:22

    Statsguy, you said;

    “So, do I know understand that you have stopped defending and admiring Kling’s politically self-serving policy views?”

    It would be hard to find a less self-serving blogger on the internet. I’ve always loved his non-monetary stuff, and disliked his monetary stuff. Nothing’s changed.

    David, Most devaluations don’t help.

  28. Gravatar of ssumner ssumner
    26. July 2012 at 14:31

    Evan, Absolutely, it’s just a short run boost when they are depressed due to falling NGDP and sticky wages.

    John You said;

    “Indonesia was quite an economic tiger for those 30 years huh? Do you really think the Greeks want to trade places with Venezuela? Your arguments are like saying that it’s better to be poor because then you have to work harder.”

    It actually makes me feel better about market monetarism when I see the quality of my critics. Let me say once again, devaluation is rarely a good idea.

    Keep this up John and I’ll start lumping you in with MF. If critics can’t even bother to read the post, then what’s the point of responding?

  29. Gravatar of Mike Sax Mike Sax
    26. July 2012 at 15:09

    “You buy a bond for $100, and the interest rate is 5%, then you will gross $105 in nominal return”

    “If inflation is 5% and tax is 0%, then you net a real return of zero. You invested $100 and you get $105 that is worth what $100 used to buy.”

    “If inflation is 0% and tax on interest is 100%, then you net a real return of zero also. You invested $100 and you get $100 that is worth what $100 used to buy.”

    Ok if you meant simply this coupon clipper gets no return fine. Still there are others who benefit from an increase in inflation. Why should I prefer this person with their fixed investment over other economic agents who may well be poorer?

    Any policy you mention there will be winners and losers. You’re only looking at it from this coupon clipper’s perspective.

  30. Gravatar of Matt Waters Matt Waters
    26. July 2012 at 15:30

    Is there a good source for NGDP of countries in their local currency? Everything I’ve looked for in Argentina’s case has been in dollars.

    Unless you have a very severe supply shock, NGDP growth in and of itself stops helping RGDP at 5% or so. A 5% or so growth ensures the average company sees 5% more revenue and the government sees 5% nominal tax revenue increases. That gives room for companies to make the math work (expenses < revenues) without having either headcount cuts or nominal wage cuts.

    I'm guessing that in the case of Indonesia and many other unsuccessful devaluations, NGDP growth was already well into the double-digits. Market monetarists would then have wanted far tighter policy and their high unemployment would have to be dealt with through structural reforms.

    I guess in the minds of MF and other anti-monetarists, we always think more inflation is better. Actually, an NGDP target would have dramatically reduced inflation in the 70's and, certainly in most third world devaluations, an NGDP target would have said not to devalue.

    In some cases though, currency devaluation is the quickest way to stopping an NGDP shock. Two cases where this happened, Argentina and Iceland, are also the two cases where unemployment went down.

  31. Gravatar of Major_Freedom Major_Freedom
    26. July 2012 at 15:41

    Mike Sax:

    Still there are others who benefit from an increase in inflation. Why should I prefer this person with their fixed investment over other economic agents who may well be poorer?

    Poor people also tend to be on relatively fixed incomes, such as welfare and wages.

    And even if they weren’t on relatively fixed incomes, there is still the Cantillon Effect that benefits some at the expense of others, regardless of whether or not their incomes are fixed, because the money actually has to filter through the economy before it can increase the incomes of people down the line.

    Any policy you mention there will be winners and losers. You’re only looking at it from this coupon clipper’s perspective.

    Actually no. It is from the perspective of ANYONE who happens to be last in line to the money flow after it is created.

    It wouldn’t be wrong, IMO, if people weren’t compelled by force into accepting the inflating currency for tax purposes.

  32. Gravatar of Major_Freedom Major_Freedom
    26. July 2012 at 15:42

    ssumner:

    Keep this up John and I’ll start lumping you in with MF. If critics can’t even bother to read the post, then what’s the point of responding?

    Yeah I think that’s just a dishonest claim at this point. If all you have left is “you aren’t reading what I am writing!” then I think you should be upfront and concede you have no counter-argument, i.e. you are defeated.

  33. Gravatar of Doug M Doug M
    26. July 2012 at 15:50

    David,

    “Still, it worked for three decades. That’s a lot of recessions spared.”

    30 years without a recession, but ending in catastrophe is not stability. Suppressing short-term turbulence is generally a bad policy.

    Mike Sax,

    “Ok if you meant simply this coupon clipper gets no return fine. Still there are others who benefit from an increase in inflation. Why should I prefer this person with their fixed investment over other economic agents who may well be poorer?”

    A spike in inflation is most devastating to the elderly. People on a pension, and those approaching retirement. They have saved a moderate nest egg and depend on the income to live.

    The working class gets hit next. They will receive a reduction in their real wage. However they will probably have a chance to see their incomes adjust upward in time.

    Those who have lots of real assets — “the rich” — are hurt only a little bit. The value of their real assets will appreciate while the value of their financial assets fall.

    The poor are not affected one way or another. They were poor to begin with they are still poor. If they receive government assistance it will be adjusted upward.

    The unemployed may benefit as the falling real wage may make it easier to find work.

    The beneficiaries of an unanticipated spike in inflation are the debtors. However, chronic debtors will at some point have to refinance in a higher interest rate environment.

    So, on the top of the heap are those with debts, and real assets, and the wherewithal to pay off their debts. Donald Trump may be the biggest beneficiary from an inflation spike.

  34. Gravatar of Mike Sax Mike Sax
    26. July 2012 at 15:53

    “Poor people also tend to be on relatively fixed incomes, such as welfare and wages.”

    Well it can also reduce all the debt they owe. You might see that as theft but many of these loans were basically theft-ususry and fraud.

    The student loans have an ironclad guarantee even. They are the one kind of loan there is no remedy of bankruptcy for.

    How can the young people of today even have a chance? They get out of college and the jobs they went to college for aren’t there and even if they do find a decent paying job they got to spend their whole lifetime paying back the student leners.

  35. Gravatar of Mike Sax Mike Sax
    26. July 2012 at 15:59

    Doug:

    “A spike in inflation is most devastating to the elderly. People on a pension, and those approaching retirement. They have saved a moderate nest egg and depend on the income to live”

    The elderly are mostly fairly affluent today. To be honest I’m pretty unimpressed with that generation. They were the ones that benefitted from Social Security and Medicare.

    Now they are rabidly Republican and love the Ryan plan. Why? Cause Ryan was smart and made his block grant scheme only apply to those under 55.

    “The working class gets hit next. They will receive a reduction in their real wage. However they will probably have a chance to see their incomes adjust upward in time”

    Plus they will get some needed relief from debt.

    “Those who have lots of real assets “” “the rich” “” are hurt only a little bit. The value of their real assets will appreciate while the value of their financial assets fall”

    The Wall Street Journal editorial page doesn’t agree.

    “So, on the top of the heap are those with debts, and real assets, and the wherewithal to pay off their debts. Donald Trump may be the biggest beneficiary from an inflation spike.”

    Maybe but he doesn’t think so. He’s running around making a fuss out of the idea that the dollar is about to tank.

    What we see Doug is that there are some benefits and some disbenefits.

    Overall, however, the macroeconomy may benefit

  36. Gravatar of Matt Waters Matt Waters
    26. July 2012 at 16:20

    A real interest rate of zero or negative is not set by the Fed. The Fed’s traditional inflation/employment targets came from NGDP growth, and NGDP is a mix of investment and consumption.

    Theoretically, nobody would invest at a negative real interest rate. At a negative real rate, spending the money now gives you more real stuff than spending the money later. But the Global Savings Glut, income inequality, principal-agent problems in finance or whatever has changed that math. Real interest rates have been very low for awhile because people have really, really wanted to save.

    If markets set real interest rates based on propensity to save, then the long-term inflation rate of 0% or 5% makes little difference to investors. The choice is not between 0% inflation with 5% rates and 5% inflation with 5% rates, it’s between 0% inflation with 0% rates and 5% inflation with 5% rates.

    Inflation/deflation can make a difference for creditors and debtors in two cases however:

    1. If interest rates are fixed, then changes in expected inflation levels transfer some real wealth to either creditor or debtor. For example, we paid 18% interest for decades after Volker pushed inflation far below that level. Conversely, creditors such as S&L’s were hurt badly as inflation increases in the late-70’s unexpectedly devalued their fixed interest loans. In this case, the expected 5% inflation would not have devalued their loans. That inflation level was built in. Unexpected 10% inflation was what devalued their loans.

    2. Banks built variable rate instruments to protect themselves from such rapid changes in expected inflation/interest rates, as well as interest rate swaps to insulate their fixed rate portfolio from interest rates. However, deflation is always a boon to creditors as long as the debtor does not default. Even with variable rate instruments, the rates cannot go below zero and so deflation greatly increases the real interest rate from the real rate at the time the contract was agreed to. Real interest rates did in fact soar in late-2008 for this very reason.

    Also, once the loans have either matured or defaulted, most of creditors’ money would likely sit in vaults instead of being lent out like before. In late-2008, a lot of people were very angry at the banks for not lending out more money, but the real issue was loan demand. Based on future NGDP and price expectations at that point, people would have been crazy to borrow money at such high real interest rates and relatively few people did. Real investment dropped dramatically.

    So, since the Fed can magically make real rates 10% through 10% deflation, when markets would have cleared otherwise at real rates of 0%, should it do it to benefit savers? From an unemployment and economic efficiency perspective, it is absolutely disastrous. We saw the result of 50% deflation from 1929 to 1933. But is it worth economic catastrophe for the creditors to get 10% real interest from the debtors when they would have gotten 0% real interest?

    Maybe it is worth a Great Depression to you guys to see Treasury-holders and conservative investors get higher-than-market real interest rates, but in my opinion at least, the Fed isn’t in the business of picking winners or losers. A low, relatively constant rate of inflation is ideal as it will involve no surprises in nominal debt contracts. Debtor and creditor agree on the real time value of money and they actually pay that value of money. Through supporting deflation (which is what we have, even today, since the CPI levels are below their expected levels), you are supporting a government transfer from debtors to creditors.

  37. Gravatar of Matt Waters Matt Waters
    26. July 2012 at 16:53

    “30 years without a recession, but ending in catastrophe is not stability. Suppressing short-term turbulence is generally a bad policy.”

    It depends on the short-term turbulence that you are talking about. If the Fed’s goal is to prop up the stock market and keep it stable, then I agree that’s bad. I have even been pretty disgusted with how the Fed has conflated the banks’ health with the economy’s health. The Fed and the US government has caused significant real harm by backstopping TBTF banks. We all pay more for deposits through the FDIC bailing out small banks and FDIC fees going up.

    But that’s not what Scott argues for. He argues for the Fed to focus on what it is, by law, supposed to focus on: inflation and unemployment. When the Fed prints money to buy a Treasury bond, it does not directly affect anyone’s wealth. Somebody who was worth $100 million and had $10 million in Treasuries is still worth $100 million after the Fed purchases their Treasuries. The only difference is that they now have $10 million in cash instead of $10 million in Treasuries.

    Notice that the basic asset swap does not magically make bad investments pay off. It does not target a certain market or asset. In theory, it could change absolutely nothing. In practice, some of the receivers of new QE money don’t sit on it. They spend some of it in the real economy.

    In other words, broad-based monetary policy merely moves the needle up or down on private spending. The bucket of good that private spending is spent on is up to private actors. It does not necessarily favor stock markets, banks, or any other asset

    Now, in the 90’s and 00’s, the new spending partly went to some very stupid things. .com IPO’s, McMansions in Las Vegas, Greek debt, etc. But what is the chain of causality in the Fed exchanging money with Treasuries to the Fed supporting those markets? There isn’t one; the private market did that all by itself (with some help by the Treasury, but not the Fed).

    In my opinion, the various bubbles brought to light some issues with the EMH’s application to all markets, including markets with very serious principal-agent problems. As Greenspan essentially targeted NGDP in the 00’s, the money that went into investment in these dumb things should have went to consumption. But picking which dollars go to which investment or which piece of consumption is not what the Fed does. That’s a pure regulatory issue.

  38. Gravatar of Rien Huizer Rien Huizer
    26. July 2012 at 19:54

    JV Dubois

    “It may have something to do with the fact, that ECB tightens the monetary policy whenever it sees increased price of imports such as oil of food – either explicitly as under Trichet in Spring-Summer 2011 or implicitly as with the latest refusal of ECB to loosen the monetary policy because “Upside risks pertain to further increases in indirect taxes, owing to the need for fiscal consolidation, and higher than expected energy prices over the medium term”

    Absolutely, the ECB (could be changing, membership) is making Germanic noises and occasionally acts the part> expectations. Bad for domestic inflation. But that should not have affected the net exports performance. It is much more complex. You have a weakening currency with low inflationary expectations plus expectations that the adjustment processes will be without political painkillers (ie anticyclical policy – even severely procyclical). But maybe the price elasticity of European trade plays a big role. Exports mainly branded and upmarket; imports via domestic price-setters (except primary products). Lots of sources of stickyness.

    But consider the counterfactual: imagine the EUR would behave like the JPY.I am grateful for the German politicians creating so much uncertainty around the EUR that it refuses to appreciate…

  39. Gravatar of John John
    27. July 2012 at 00:57

    Mike Sax,

    The quote by Warren Buffet is on Wikipedia. I saw it yesterday,

    You didn’t look at the whole thing I was saying. The hypothetical person in this example draws a 5% interest income. 5% inflation entirely destroys the value of that interest income in the same way as a 100% tax. She has gained 0 purchasing power whether the money is taxed away or inflated away or some combination of both.

  40. Gravatar of John John
    27. July 2012 at 01:03

    Mike Sax,

    You should be concerned about inflation’s redistributing effects, which benefits some at the expense of others as you point out, because inflation makes idiots out of people who save money and almost impossible for people who want to save money without assuming the additional risks of playing the stock market (which ends up fleecing most people with expenses anyway). By severely damaging the ability to save, inflation will make it impossible for further investments that will improve production and raise living standards.

  41. Gravatar of Mike Sax Mike Sax
    27. July 2012 at 01:07

    John, there’s too much saving now-or hoarding so to speak. I want them to stop saving and start spending.

  42. Gravatar of John John
    27. July 2012 at 01:10

    Mike Sax,

    Your disregard for the “coupon clipper” was so off-base that I figured I’d actually dig up the quote for you. Hopefully can see what Buffet is getting at and not just have to take my word for it that inflation attacks savings and that is a bad thing.

    “The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital. It makes no difference to a widow with her savings in a 5 percent passbook account whether she pays 100 percent income tax on her interest income during a period of zero inflation, or pays no income taxes during years of 5 percent inflation.”
    “”Buffett, Fortune (1977)

    This lady isn’t just a “coupon clipper.” The money that has been put away is being productively used either funding a bond issuer (less productively used if that bond issuer is the government) or being lent out by her bank to fund other productive projects in the community. It should raise some concern when the value of these savings that we depend on for the process of capital accumulation called economic development face continual erosion.

  43. Gravatar of John John
    27. July 2012 at 01:15

    Mike,

    There could never be too much saving. People save money in order to invest it. It’s more worthwhile to look at why corporations feel the need to hold such large cash reserves. It isn’t a lack of demand since profits have been strong and corporate America is the envy of the world right now. There are two plausible reasons: uncertainty about the future (taxes. Europe, etc) and perverse incentives created by executive compensation based on stock prices (investment lowers earnings per share while stock buybacks and cash accumulation enhance it.)

  44. Gravatar of Major_Freedom Major_Freedom
    27. July 2012 at 03:42

    John:

    There could never be too much saving.

    Thank you for being sane.

    The desire for additional wealth is always practically infinite. It may seem counter-intuitive at first blush, but even the entire world’s savings could not even come close to running out of outlets in a single city.

    —————–

    Mike Sax:

    John, there’s too much saving now-or hoarding so to speak. I want them to stop saving and start spending.

    Existing spending is more than enough to “sustain”, i.e. clear, the entire market, if only the state would allow prices to fall, especially for labor. There is no need for more “spending.”

    Saving is not hoarding. Saving is not consuming. Investment is saving.

  45. Gravatar of Major_Freedom Major_Freedom
    27. July 2012 at 03:53

    Mike Sax:

    “Poor people also tend to be on relatively fixed incomes, such as welfare and wages.”

    Well it can also reduce all the debt they owe. You might see that as theft but many of these loans were basically theft-ususry and fraud.

    Wrong on both counts. Inflation cannot reduce the debt they owe. Their cash obligations are contractually fixed. They have to pay back the promised principle and interest payments. It doesn’t matter if the lender receives back depreciated currency. The borrower is not paying back fewer dollars, and we stipulated that the borrowers are on relatively fixed incomes.

    So in actual fact, the borrowers AND the lenders will be worse off with inflation. For not only do the borrowers have to pay back a contracted principle as well as interest payments, but they have to pay higher prices for the goods they buy. You could not be more wrong. You are misunderstanding the whole “inflation benefits the borrowers and hurts the lenders” ism. It is a special case, applicable only when the borrower’s nominal income goes up because of inflation. If their nominal income does not go up, then they are harmed.

    You say many of the loans were theft. How can lending money to voluntary borrowers be theft? Theft is when you take someone’s property against their will. What property is being taken from the borrowers when lenders lend to them?

    The student loans have an ironclad guarantee even. They are the one kind of loan there is no remedy of bankruptcy for.

    Yah, too bad student loan borrowers can’t be deadbeats. But that still doesn’t make it theft. They didn’t have to hand over any of their property by force with those loans. The students are being robbed through taxation however.

    How can the young people of today even have a chance?

    Well, with statist like you running around, who distorted the education market to such a degree with federally guaranteed loans and credit expansion that the demand for education far outweighed the increase in supply that tuition prices have skyrocketed, young people have a more difficult chance.

    Then they have it worse because of minimum wage laws making their labor rates illegal.

    Young people have it rough because of all the decades of “help” you statists have given them.

    They get out of college and the jobs they went to college for aren’t there and even if they do find a decent paying job they got to spend their whole lifetime paying back the student leners.

    Yay more government intervention! It ought to work this time!

    You know how Einstein defined insanity?

  46. Gravatar of Benny Lava Benny Lava
    27. July 2012 at 04:12

    Scott, that’s funny. When I got married I rifled through my wife’s books (I call them her dowry) and found 100 years of Solitude. Only to discover it was in the original Spanish. Guess I will have to add that to my summer reading list (sorry it isn’t Cortazar, baby steps).

  47. Gravatar of Sarkis Sarkis
    27. July 2012 at 12:32

    “I don’t think anyone doubts that a central bank can prolong economic corrections, excuse me, I mean reduce unemployment, by printing money. The question market monetarists are not seriously addressing is “at what cost?”. If I bad bad investment choices, for example a $1 billion investment in a fake dog poop making factory with 1000 employees, that later incurred losses, there is little doubt that my investment could become nominally profitable if only money printers…”

    @Major Freedom
    You need to consider this: In an economy with the current system (fiat money) at any point in time there is an optimal amount of money (money supply/stock) which needs to be determined by monetary policy. In my mind market monetarists propose a “new” way of dealing with this issue and one of their arguments is that in a (structural) recession restricting the money supply can exacerbate real shocks via an unnecessarily large nominal shock. If too many idiots invested in dog poo policymakers (the fed) probably need to intervene because an economywide vicious cycle of falling nominal incomes affecting real incomes is definitely a possibility.

    So basically monetary policy can make things worse, real things. If you agree then you have to agree with the following statement too: We must find the best monetary policy otherwise we could make things worse. What sort of monetary instrument should we use? How much money do we actually need? Do we need a bit of extra money in recessions? At the very least we shouldn’t restrict the amount of money in a recession.

    I think that as your posts do not propose solutions to the above problems they tend to be irrelevant (though still enjoy reading them). You argue against senseless printing of money but is this what market monetarists propose? Your logic seems to imply that the fed is useless, we can just print a fixed quantity of money and then shut down the fed and let real forces do the rest. Looks flawed unless I am missing something.

  48. Gravatar of ssumner ssumner
    28. July 2012 at 09:42

    Matt Waters, Another example is the US in 1933.

    I think the World Bank has NGDP data, but am not sure.

  49. Gravatar of Saturos Saturos
    28. July 2012 at 10:25

    MF, John, you don’t think there’s any such thing as excessive saving? So a 99% savings rate might maximize intertemporal consumption? You should probably write in to those textbook authors. And then collect your Nobel Prize. In algebra.

  50. Gravatar of Jim Glass Jim Glass
    28. July 2012 at 13:53

    There could never be too much saving. People save money in order to invest it.

    This is objectively false. People save to defer consumption.

    When people believe themselves to be at risk (of losing their jobs, natural calamity, the enemy’s army coming over the border, whatever) they consume less now to be able to consume more later when that consumption ability may be of more value to them.

    (Even when not feeling particularly at risk, this is true. People defer consumption during their working years by contributing to 401(k) plans in order to be able to consume more in their later years when they will lack labor income to fund consumption.)

    You are making an *assumption* that these savings will be mediated into investment that continues to drive GDP growth.

    But it is no trick to find real world examples when this has not been true. When the desire to defer consumption in the *safest way possible* causes money to be shipped out over the border, currency to be stashed in mattresses and safes (see the boom in the Japanese safe-building industry) etc., there’s no such mediation.

    What exists here is very simply a rise in *demand for money* relative to demand for everything else — which is deflationary. Deflation itself further increases demand for money as there is no safer way to defer consumption than by holding currency that appreciates in value.

    Such a real return on currency — +10% during the Great Depression — of course itensifies savings held in cash, as it is an “investment” return that *no* business investment can match on risk-adjusted basis.

    And when such drop in current consumption causes factory production lines to close down and loss-making unused production capacity to explode … while the real interest rates businesses have to pay goes *up* (+10% during the Great Depression) … why would firms want to invest rather than cut capacity? After all, by cutting unused capacity to increase cash holdings they move from taking losses to getting that unbeatable return on cash themselves. (See USA 1929-32).

    So how does action to defer consumption automatically create an increase in investment that continues to drive further growth in GDP?

    When a sudden general desire to safely increase deferred consumption starts in a world of significantly above >0 interest rates, then reductions in rates may counter the above process.

    But once actual deflation hits and rate reductions cannot so act (USA 1929-32, Japan post-’89, USA deflation in the last half of 2008 as banks and the economy collapsed) — with real interest rates on businesses surging (+13% in the USA during the 4th Q 2008, as Lehman went down and markets seized up) while real return on money holdings rise just as much — again, what causes increased money holdings to automatically increase investment in such a way as to continue GDP growth? From the historical record, evidently nothing.

    In the Depression stock values — the value of American businesses — fell 90%. There was no imaginable “malinvestment” during 1920-29 that could have caused a collapse of total business value on that scale. (And if there were one, it would be as big and obvious as a Brontosaurus on a putting green.)

    But suddenly and unexpectedly increase the real rate of interest paid by businesses by 10%, and push up the return on currency up by more than 10%, and *then* you retroactively create a whole host of “calculation problems” the businesses got wrong. Now you retroactively create “malinvestment” en masse. That will do it — and did.

    How to prevent retroactively creating malinvestment en masse, due to a surge in the desire to defer consumption increasing the demand for money which increases the price of money by a double-digit amount — 10% annual during the Depression, 13% annual rate during Q4 2008?

    Increase the supply of money by the amount needed to keep its price stable — as the Fed didn’t do 1930-32, but did do during late 2008 with QE1.

    “It’s more worthwhile to look at why corporations feel the need to hold such large cash reserves.”

    Well, gee. When the relative return of holding cash rises — deflation has increased its value outright again during the last two months — while costly unused capacity remains well [above trend](http://research.stlouisfed.org/fred2/graph/?chart_type=line&s%5B1%5D [id]=TCU&s[1][range]=10yrs), what else would you expect corporations to do?

  51. Gravatar of Curious Bystander Curious Bystander
    28. July 2012 at 15:16

    Jon – «There could never be too much saving. People save money in order to invest it.»

    Jim Glass – «This is objectively false. People save to defer consumption.»

    I do not think it really matters. People may save in order to invest, or to defer consumption. What matters is that it is saving is what makes investment feasible.

    Let’s take the example of an economy where bricks are both an investment and consumption good. (I’ll have a hard time when asked how bricks can be an consumption good, but under pressure I’ll manage somehow)

    The more people restrict (save on) their consumption of bricks, the more bricks are available for investment purposes. That much is obvious.

    A more interesting tidbit is that people may

    a) first buy their usual share of bricks and then bring it to investors for a share in future profits.
    b) do not buy the bricks they do not intend to consume on the spot.

    In the first case this is plain investment, nothing to see here. The second case is more interesting. A drop in demand for bricks will lead to drop in the price of bricks which means that the investors, using the same amount of money can use more bricks for investment purposes.

    But in both cases it is a increase in saving that enables an increase in investment.

    P.S. Seeing what will happen if consumers do not save more bricks but investors are suddenly given more money for investment purposes is left as an exercise for the reader.

  52. Gravatar of Jim Glass Jim Glass
    28. July 2012 at 20:49

    Jim Glass – «This is objectively false. People save to defer consumption.»

    I do not think it really matters. People may save in order to invest, or to defer consumption. What matters is that it is saving is what makes investment feasible.

    It matters because when people save to invest it makes investment feasible.

    When people increase their cash holdings for liquidity-safety purposes — putting it in a box so it will be available Friday if the bank fails on Thursday (see 1929-32, 2008) — the demand for money increases, velocity falls, deflationary price movements result across the economy, businesses that were sound and had calculated ahead accurately given a stable trend price-of-money now have suddenly retroactively “malinvested” en masse, as demand for their products falls creating overcapacity at the same time as real interest rates rise … obviously *not* a formula for making investment more feasible, rather the reverse (see 1929-38, or 2012 with domestic private investment still near 15% below the level of 2006.)

    All of which is nothing at all like what happens when bricks aren’t used currently but saved for future use.

    Because money is not like bricks and all the other such goods that are exchanged for each other *using* money. The medium of exchange is unique and different thing.

  53. Gravatar of Jim Glass Jim Glass
    28. July 2012 at 23:24

    Curious Bystander, perhaps the distinction between money on the one hand and bricks (and all such other goods) on the other can be made clearer.

    Bricks are consumed. When put into a building they are consumed and depreciate. There are then that many fewer bricks available for consumption. If not currently consumed they continue to exist for future consumption, and to the extent they increase the supply of bricks then, as you say, they reduce the cost of bricks which encourages future consumption.

    Money is not consumed (unless you use it to light a cigar). Money changes hands. When money is spent there is no less of it in circulation available to spend — it simply moves from one account to another. Money is the medium of exchange that enables bricks and labor and all the other goods of the world to be exchanged for each other. Money as the medium of exchange is also the unit of account/measure of value used in inter-temporal exchanges.

    In all these ways, bricks and money are in no way comparable.

    Income is either consumed or saved to fund deferred consumption. One might try to draw an analogy between income and bricks. Income that is not consumed today but deferred to fund future consumption might be compared to bricks.

    But money then complicates the comparison. (Income is not money, “Money Illusion” notwithstanding.)

    Imagine you are in the process of building a house out of bricks. Some bricks you will consume right away, others you will consume later in the building process. You have carefully and accurately predicted your requirement of bricks and invested in them accordingly to meet your needs.

    But in the midst of your construction process, suddenly and as a big surprise to you, the measurements of all your unconsumed bricks changes! The units and measures of all your bricks are off. They become different shapes than before! They no longer fit together. You find now that you have “malinvested” in your house in a big way. You are going to take a big real loss.

    When saving money for the liquidity-safety reason puts money in the proverbial box, demand for money increases, velocity drops, deflationary value changes occur, the measure of value changes, “the bricks of finance and business” no longer fit together as they did in your projected world of steady trend-value bricks/money — demand for business products falls while real interest rates businesses must pay rise … *reducing* investment, such as it was wiped out in the 1930s.

    Seeing what will happen if consumers do not save more bricks but investors are suddenly given more money for investment purposes is left as an exercise for the reader.

    What happens is that gross private investment/GDP becomes the lowest it’s been since the data starts in 1947.

    Again, the fault in comparing bricks to money is seen right there.

    Saving bricks may as you say reduce the price of bricks by increasing the supply. Saving money in the proverbial box to meet liquidity-safety demands *increases* the price of money.

    Reducing price and increasing price are opposites.

  54. Gravatar of Major_Freedom Major_Freedom
    29. July 2012 at 08:53

    Saturos:

    MF, John, you don’t think there’s any such thing as excessive saving?

    Never. For “excessive” implies a value judgment, which is subjective. You cannot arrogate your value judgments for how much money other people want to hold, invest with, or consume with, and replace their values for how much money they want to hold, invest with, or spend with.

    For just consider what you’re saying. If I earn $100, and I hold $20 of it, I invest $10 of it, and I consume $70 of it, then MY value judgments are THE value judgments that you must respect. You have no justification for asserting that your personal preference for money holding, investment, and consumption, is somehow “proper”, whereas my own choices are not.

    So a 99% savings rate might maximize intertemporal consumption?

    There is no one maximum. It is bounded above however. A 99% savings rate would lead to a dramatic overhaul in the structure of production. With 99% of incomes saved, the relative profitability of capital goods production, as compared to consumer goods production, would skyrocket, and there would almost certainly be a temporary decline in consumer output. But when the new investments become ready over time, when the output of capital goods begins to accelerate to some new trajectory, then at some point, the production of consumer goods would grow at a rate that exceeds the original rate (since more capital goods enables the production of more consumer goods), and at some point, the production of consumer goods will match the previous high, and it would continue to grow at a far higher rate than before. Within a few years, real output would be growing at rates never seen before in the history of mankind.

    The problem however, as always, are short term oriented political strategists, who will wax hysterically at the first sign of a fall in real output of consumer goods and (temporary) employment. They will scream “Recession!” “Depression!”, and yammer at the state to print and spend money to REVERSE the movement towards a more capital intensive economy! In fact, these idiots are so numerous that they have already succeeded in preventing the US economy from becoming as capital intensive as it could have.

    You should probably write in to those textbook authors. And then collect your Nobel Prize. In algebra.

    What I am saying in this particular respect has already been published. It’s not true that just because good ideas are published, that everyone will agree and adopt it. You have to understand that economics is the study of human action. Human action encompasses the entirety of what we consider to be relevant in the social studies. So economics is prone to political influence, ideological influence, philosophical influence, virtually everything. Economics is not like physics. Atoms don’t purposefully behave. Humans do.

    The Whig theory of history (what you are tacitly depending on when you make your case) is false. Ideas ebb and flow. Good ideas are often forgotten, and bad ideas often make a re-appearance. There is no such thing as progressive enlightenment in human knowledge and actions. I doubt anyone would think that the communist and fascist experiments of the 20th century were superior than all previous human actions throughout history simply because they occurred more recently.

    Economics is also prone to ebb and flow. Mainstream economics today, I would argue, represents an ebbing of good ideas. At root it is the field of philosophy that characterizes our age. We are living during a time when the dominant belief is that humans can be socially controlled like atoms in a laboratory. It is a gigantic philosophic contradiction that is going to persist until enough humans are sick and tired of the negative outcomes of it, that they eventually stumble upon the core contradiction that underlies their worldview, and then have the courage to innovate and accept that they were wrong all these years. This contradiction has enabled political opportunists and frauds to seize upon the hapless public in the name of promoting such a philosophical view.

    ————

    You might ask how can 99% savings rate can be sustainable, that is, how a 1% consumption spending rate can profitably cover 99% savings rate. The key to this puzzle is to recognize that capital goods production earns revenues and profits no less than consumer goods.

    Even in our society that is often fallaciously characterized by pundits and journalists as “70% consumer driven”, most spending that occurs is actually “business to business” spending, that is, most spending is financed by savings. The reason why so many people say “70% consumer driven” is because they are getting this from economists, who track such things, who ignore gross investment, and they only look at net investment.

    If you stopped think about what a “70% consumer driven” economy would actually entail, then you would see how this figure ignores most of what is going on. For if 70% of every dollar spent was spent on consumption, then that would mean that for every dollar spent, 70% would be revenues, and 30% would be spending that generates costs on income statements. Imagine what kind of profits would exist in such an economy. If $0.70 of every dollar spent is spent on consumption, and $0.30 of every dollar spent is spent on investment, then the implied economic rate of profit would average ($0.70 revenues – $0.30 costs)/($0.30 capital) = $0.40/$0.30 = 133%.

    Clearly something is wrong here, because average profit in our economy is nowhere near 133%. It’s usually around 10-20% before tax, give or take.

    This lower profit means that there is more investment spending (that leads to costs) than “70% consumer driven” is taking into account.

  55. Gravatar of Curious Bystander Curious Bystander
    29. July 2012 at 13:17

    Jim Glass – «When people increase their cash holdings for liquidity-safety purposes “” putting it in a box so it will be available Friday if the bank fails on Thursday (see 1929-32, 2008) “” the demand for money increases, velocity falls.. »

    That’s what a bank run will do. And a contraction of credit which will lead, to deflation but it has nothing to do with saving, as such. Are you really claiming the the gigantic drop in investment figures both in 29-32 and 2008 was caused by a correspoding increase in private money balances? Consumer hoarding?

    – «Money is not consumed»

    Yes, of course. But spending money == personal consumption. Both investing and hoarding money means restrictiong personal consumption, and in this way making more investment feasible.

    And saving (hoarding) money will just means that a less amount of money will chase and increased amount of investment goods. So every invested dollar should return a higher profit. Looks like a self-regulating feedback loop to me.

  56. Gravatar of Jim Glass Jim Glass
    29. July 2012 at 18:04

    Curious Bystander —

    Are you really claiming the the gigantic drop in investment figures both in 29-32 and 2008 was caused by a correspoding increase in private money balances? Consumer hoarding?

    You are a business that in 1928 takes out a mortgage on your factory at 6% interest, has leases on office and retail space, contracts, other fixed-dollar obligations, etc.

    Then suddenly and unexpectedly 25% deflation occurs, the price of money increases by 33% — $0.75 buys what $1 did in 1928, so to repay each $1 of a debt incurred in 1928 you must pay a dollar that is worth $1.33 in the 1928 dollars you borrowed.

    Now your interest, lease payment costs, all fixed-dollar obligations, have increased by 33% in real terms. And *after* paying this 33% increased rate of interest on your mortgage, you find the principal you owe on it has increased 30% in real terms! Ouch! (The size of all your bricks has changed! You’ve made a heck of a “calculation” mistake, retroactively.)

    Of course, to cover all these unexpected cost increases, your business and countless others like it slash expenditures — such as payrolls — which in turn slash consumer spending and reduce your business’s income.

    So now your business is incurring (1) seriously increased costs plus (2) seriously reduced income, and is suffering from loss-making increased-cost overcapacity.

    Do you now invest more or less?

    I think we’ll probably agree that you invest less, trying to slash your overcapacity.

    So what is driving this situation? The 33% increase in the price of money (deflation).

    And what causes an increase in the price of money? The same thing that causes an increase in the price of anything — a rise in demand for it relative to the supply of it.

    Does this answer your question?

    BTW, what happened in 2008? Deflation — the price of money increased — throughout the second half of the year, accelerating to a 13% rate in the 4th Quarter. That means real interest rates on businesses rocketed up, etc … same events as in 1930 (except the Fed increased the supply of money at year end to stop the deflation then) … and same result with investment, it plunged to the lowest since the Great Depression itself. As you saw in the chart provided.

    It is really pretty obvious that a change in the demand for money will change its price, with effects on the total price level that have systematic effects on the entire economy very *unlike* a price change in any other thing. Hume wrote about this with insight in the 1700s. Yet it seems to be a difficult concept for many people to grasp.

    spending money == personal consumption

    No. You continue to confuse “money” with “income” (which is “money illusion”, as in the name of this blog.)

    Both investing and hoarding money means restrictiong personal consumption, and in this way making more investment feasible.

    You mean: “Both investing and hoarding income means restricting personal consumption, and in this way making more investment feasible.”

    But if the demand for *money* rockets up to cause 25% deflation, what is the result on investment? Does a 33% increase in real interest rates combined with a 33% increase in outstanding loan balances and all other fixed obligations really “make investment more feasible” for businesses?

    And saving (hoarding) money…

    Saving income is **not** hoarding money. Two different things. “Income” “money”.

    I save a year’s worth of income and invest it in growth stocks. I have saved a lot, but hoarded zero money.

    Now I get scared, sell all the stocks and keep the sale proceeds in currency that I keep in my wall safe. By this act I have hoarded a lot of money but have saved nothing.

    Of course, the time when I am most likely to get scared is after the stocks have fallen — now I have increased my money hoard but have *less savings*.

    And I’m really likely to be scared most of all if I have lost my job too and have to consume my savings and so can’t afford to risk losing any of them at all, so I convert them all to money.

    Money hoard rising, savings falling!

    Hoarding money is not saving. Say that three times.

    … will just means that a less amount of money will chase and increased amount of investment goods. So every invested dollar should return a higher profit. Looks like a self-regulating feedback loop to me.

    Please explain: How do you keep the big increase in demand for money (as illustrated by all the hoarding of it) from causing a big increase in the price of money, via the law of supply-and-demand — say increase by 33%?

    If the price of money unexpectedly does go up by 33%, does the resulting unexpected, unplanned-for 33% increase in real interest rates combined with a 33% real increase in outstanding loan balances and all other fixed obligations (very possibly combined with less saving overall!) make increased investment by business more or less feasible?

  57. Gravatar of Major_Freedom Major_Freedom
    30. July 2012 at 10:11

    Jim Glass:

    Entrepreneurs invest according to price differentials, input prices and output prices. They do not invest according to aggregate demand.

    If an entrepreneur expects lower future nominal demand, then he will bid the prices of his inputs downwards. If most entrepreneurs expect falling future prices, then they will bid most input prices downward.

    If entrepreneurs don’t bid input prices down enough, then you have to remove every conceivable barrier to falling prices, most especially central bankers who promise continued price inflation, instead of their original purpose which was to bail out banks in the case of widespread bank panics.

    Funny how that original plan turned into perpetual inflation day in and day out, huh?

  58. Gravatar of Curious Bystander Curious Bystander
    30. July 2012 at 11:21

    Jim Glass – «You are a business that in 1928 takes out a mortgage on your factory at 6% interest, has leases on office and retail space, contracts, other fixed-dollar obligations, etc.

    Then suddenly and unexpectedly 25% deflation occurs… »

    Let’s stop right here. You are not answering my question. You, obviously, feel quite strongly about deflation, but you only blame increased demand for it. Why not blame supply for a change?

    Because it is exactly what happened. First an overextension of credit and then a contraction of credit and money supply.

    Of course, your argument can be that since a sudden and unexpected deflation (caused by a contraction of money supply) is so bad, should be as bad as well. Doesn’t follow.

    – «So now your business is incurring (1) seriously increased costs plus (2) seriously reduced income, and is suffering from loss-making increased-cost overcapacity.»

    and (3) seriously reduced input costs. Right? At the margin some people will go bankrupt, but the new owners can pick up the operations and go on.

    – «Do you now invest more or less?»

    If you are heavily in debt, than less of course. Otherwise you may invest more. If not in nominal than in real terms. Everything’s cheaper.

    I’ll copy here a rather big chunk from Jack London’ Burning Daylight novel just for historical perspective

    Money grew tighter. Beginning with the crash of several of the greatest Eastern banking houses, the tightness spread, until every bank in the country was calling in its credits. Daylight was caught, and caught because of the fact that for the first time he had been playing the legitimate business game. In the old days, such a panic, with the accompanying extreme shrinkage of values, would have been a golden harvest time for him. As it was, he watched the gamblers, who had ridden the wave of prosperity and made preparation for the slump, getting out from under and safely scurrying to cover or proceeding to reap a double harvest. Nothing remained for him but to stand fast and hold up.

    He saw the situation clearly. When the banks demanded that he pay his loans, he knew that the banks were in sore need of the money. But he was in sorer need. And he knew that the banks did not want his collateral which they held. It would do them no good. In such a tumbling of values was no time to sell. His collateral was good, all of it, eminently sound and worth while; yet it was worthless at such a moment, when the one unceasing cry was money, money, money. Finding him obdurate, the banks demanded more collateral, and as the money pinch tightened they asked for two and even three times as much as had been originally accepted. Sometimes Daylight yielded to these demands, but more often not, and always battling fiercely.

    He fought as with clay behind a crumbling wall. All portions of the wall were menaced, and he went around constantly strengthening the weakest parts with clay. This clay was money, and was applied, a sop here and a sop there, as fast as it was needed, but only when it was directly needed. The strength of his position lay in the Yerba Buena Ferry Company, the Consolidated Street Railways, and the United Water Company. Though people were no longer buying residence lots and factory and business sites, they were compelled to ride on his cars and ferry-boats and to consume his water. When all the financial world was clamoring for money and perishing through lack of it, the first of each month many thousands of dollars poured into his coffers from the water-rates, and each day ten thousand dollars, in dime and nickels, came in from his street railways and ferries.

    Cash was what was wanted, and had he had the use of all this steady river of cash, all would have been well with him. As it was, he had to fight continually for a portion of it. Improvement work ceased, and only absolutely essential repairs were made. His fiercest fight was with the operating expenses, and this was a fight that never ended. There was never any let-up in his turning the thumb-screws of extended credit and economy. From the big wholesale suppliers down through the salary list to office stationery and postage stamps, he kept the thumb-screws turning. When his superintendents and heads of departments performed prodigies of cutting down, he patted them on the back and demanded more. When they threw down their hands in despair, he showed them how more could be accomplished.

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