Carpe Diem

Happy 102nd birthday, Milton Friedman

miltonMilton Friedman was born on this day, July 31, in 1912, and he would have been 102 years old today. Unfortunately, Milton died on November 16, 2006 when he was 94 years old. In an editorial in the Wall Street Journal following Friedman’s death, they reported his loss with the same tribute Milton used when Ronald Reagan died, saying “few people in human history have contributed more to the achievement of human freedom.” In honor of his legacy and birthday, here are some of my favorite Milton Friedman quotes:

1. There is nothing as permanent as a temporary government program.

2. Inflation is always and everywhere a monetary phenomenon.

3. Inflation is caused by too much money chasing after too few goods.

4. Sloppy writing reflects sloppy thinking.

5. All learning is ultimately self-learning.

6. I’m in favor of legalizing drugs. According to my values system, if people want to kill themselves, they have every right to do so. Most of the harm that comes from drugs is because they are illegal.

7. Nobody spends somebody else’s money as carefully as he spends his own. Nobody uses somebody else’s resources as carefully as he uses his own. So if you want efficiency and effectiveness, if you want knowledge to be properly utilized, you have to do it through the means of private property.

8. The government solution to a problem is usually as bad as the problem.

9. The Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than by any inherent instability of the private economy.

10. The high rate of unemployment among teenagers, and especially black teenagers, is both a scandal and a serious source of social unrest. Yet it is largely a result of minimum wage laws. We regard the minimum wage law as one of the most, if not the most, anti-black laws on the statute books.

11. Industrial progress, mechanical improvement, all of the great wonders of the modern era have meant relatively little to the wealthy. The rich in Ancient Greece would have benefited hardly at all from modern plumbing: running servants replaced running water. Television and radio? The patricians of Rome could enjoy the leading musicians and actors in their home, could have the leading actors as domestic retainers. Ready-to-wear clothing, supermarkets — all these and many other modern developments would have added little to their life. The great achievements of Western capitalism have redounded primarily to the benefit of the ordinary person. These achievements have made available to the masses conveniences and amenities that were previously the exclusive prerogative of the rich and powerful.

12. President Kennedy said, “Ask not what your country can do for you — ask what you can do for your country.”… Neither half of that statement expresses a relation between the citizen and his government that is worthy of the ideals of free men in a free society. “What your country can do for you” implies that the government is the patron, the citizen the ward. “What you can do for your country” assumes that the government is the master, the citizen the servant.

13. On the difference between public vs. private education: “Try talking French with someone who studied it in public school. Then with a Berlitz graduate.”

14. Fair’ is in the eye of the beholder; ‘free’ is the verdict of the market. The word ‘free’ is used three times in the Declaration of Independence and once in the First Amendment to the Constitution, along with ‘freedom.’ The word ‘fair’ is not used in either of our founding documents.

15. What most people really object to when they object to a free market is that it is so hard for them to shape it to their own will. The market gives people what the people want instead of what other people think they ought to want. At the bottom of many criticisms of the market economy is really lack of belief in freedom itself.

16. The great achievements of civilization have not come from government bureaus. Einstein didn’t construct his theory under order from a bureaucrat. Henry Ford didn’t revolutionize the automobile industry that way. In the only cases in which the masses have escaped from grinding poverty, the only cases in recorded history are where they’ve had capitalism and largely free trade. If you want to know where the masses are worst off, it’s exactly in the kinds of societies that depart from that, so that the record of history is absolutely crystal clear: that there is no alternative way so far discovered of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system.”

17. The problem of social organization is how to set up an arrangement under which greed will do the least harm; capitalism is that kind of a system.

18. With some notable exceptions, businessmen favor free enterprise in general but are opposed to it when it comes to themselves.

19. The case for prohibiting drugs is exactly as strong and as weak as the case for prohibiting people from overeating.

20. The government has no more right to tell me what goes into my mouth [including illegal drugs] than it has to tell me what comes out of my mouth.

For more Milton Friedman quotes, see this list here at “The Collected Works of Milton Friedman” project at Stanford University’s Hoover Institution.

74 thoughts on “Happy 102nd birthday, Milton Friedman

  1. #11 is one of my favorites. In a very short paragraph, he deftly explains why a market-based economy so quickly leads to wealth for all people.

    If you look at the richest people in America (or, for that matter, the world), the vast majority of them made their money providing goods and services to the masses: Zuckerberg, Walton, Gates, Koch…you all know the names. They made their fortunes improving the lives of the masses, not catering to the rich and famous.

    And that is how you make money in a market society. By providing value.

    • Paul

      #21) “It’s just obvious you can’t have free immigration and a welfare state.”

      Yes. Here’s his complete comment on the subject.

      Notice that he says: “Look, for example, at the obvious, immediate, practical example of illegal Mexican immigration. Now, that Mexican immigration, over the border, is a good thing. It’s a good thing for the illegal immigrants. It’s a good thing for the United States. It’s a good thing for the citizens of the country. But, it’s only good so long as it’s illegal.”

      He favored open immigration. but points out the obvious limits imposed by a welfare state.

      • Ron,
        but points out the obvious limits imposed by a welfare state.

        Obvious limits? Well, that’s a good start. :)

        I obviously don’t agree with Friedman that illegal immigration, “so long as it’s illegal,” is a good thing for the United States.

        • Paul

          I obviously don’t agree with Friedman that illegal immigration, “so long as it’s illegal,” is a good thing for the United States.

          Watch the video, if you haven’t done so. As long as illegal immigrants aren’t entitled to most of the welfare benefits to which legal residents are entitled, the immigrant benefits, employers benefit, we all benefit. If they were legal they would be entitled to full freebies, they would have fewer incentives to work, and the cost of failing would be minimized.

          As I’m sure you remember, I’m opposed completely to any form of state welfare.

          • As long as illegal immigrants aren’t entitled to most of the welfare benefits to which legal residents are entitled..

            Given the fact of anchor babies, multiple previous amnesties, and the upcoming administrative(and quite possible legislative) amnesty, we know how that movie ends.

            the immigrant benefits, employers benefit, we all benefit.

            The first two, agreed. Not the last. Unskilled Americans are negatively affected overall by unskilled immigration. For example, let’s consider Friedman’s statement in #10, “The high rate of unemployment among teenagers, and especially black teenagers, is both a scandal and a serious source of social unrest.” Well, according to Civil Rights Commissioner Peter Kirsanow, “In 2008, the Commission held a briefing regarding the impact of illegal
            immigration on the wages and employment opportunities of African-Americans.The testimony at the briefing indicated that illegal immigration disproportionately impacts the wages and employment opportunities of African-American men. In 2008, the Commission held a briefing regarding the impact of illegal immigration on the wages and employment opportunities of African-Americans. The testimony at the briefing indicated that illegal immigration disproportionately impacts the
            wages and employment opportunities of African-American men. The briefing witnesses, well-regarded scholars from leading universities and independent groups, were ideologically diverse. All the witnesses acknowledged that
            illegal immigration has a negative impact on black employment, both in terms of employment opportunities and wages. The witnesses differed on the extent of that impact, but every witness agreed that illegal immigration has a discernible negative effect on black employment. For example, Professor Gordon Hanson’s research showed that “Immigration . . . accounts for about 40 percent of the 18 percentage point decline [from 1960-2000] in black employment rates.”
            Professor Vernon Briggs writes that illegal immigrants and blacks (who are disproportionately likely to be low-skilled) often find themselves in competition for the same jobs, and the huge number of illegal immigrants ensures that there is a continual surplus of low-skilled labor, thus preventing wages from rising.
            Professor Gerald Jaynes’s research found that illegal immigrants had displaced U.S. citizens in industries that had traditionally employed large numbers of African-Americans, such as meatpacking.”

            If you read the rest of the article, you see how black displacement by immigrants in the workplace inflames the disintegration of the black family and also incarceration rates.

          • Ron,
            As I’m sure you remember, I’m opposed completely to any form of state welfare.”

            “While most open-border libertarians proclaim a desire to dismantle both borders and the welfare state, in practice what they offer is open borders today and a vague (and almost certainly illusory) promise to end the welfare state in the indefinite future. As Milton Friedman understood, open-border enthusiasts have the sequence wrong: Opening borders with the redistributionist state still intact will result in a larger and more confiscatory government. In response to libertarians who propose to open borders and dismantle the welfare state, practical conservatives should answer: “Go ahead. Dismantle the welfare state. As soon as you’ve got that finished, let us know, and then we’ll talk about open borders.”

            ~Robert Rector

          • paul-

            as we have discussed a number of times in the past, i see no reason that both goals cannot be achieved simultaneously though a well designed guest worker program.

            while i would love to see the welfare system dismantled in the us, i think we both know that such an undertaking is going to be very, very hard if not flat out impossible until it actually collapses under an inability to meet promises.

            so, saying “we have dismantle welfare first” is a bit like saying “when hell freezes over”.

            but, if we were to admit guest workers who would pay taxes but, based on their status, NOT have access to welfare etc and be required to demonstrate visible means of support else have to go home, then we get a bigger tax base, more labor, can keep those who do grad school here, etc etc.

            this seems like a win/win (except to those who want to salt the electorate with low income newcomers, and frankly, that’s likely a good thing too).

            the notion that it has to be all or nothing seem like it takes a very workable solution out of play here.

            what amazes me, is that damn near no one in DC will even discuss this.

            immigration policy seems to be about grandstanding and finding wedge issues to rile up voters. it seems both sides have more vested in continual crisis than in finding a solution.

            the politics around this are just sickening.

          • Morg,

            The guest worker program sounds ok(or better than what we have now) on paper, but, given the reality of organized political interests on the left, I don’t believe it would work out as anything other than an eventual path to citizenship.

            but, if we were to admit guest workers who would pay taxes but, based on their status, NOT have access to welfare etc and be required to demonstrate visible means of support else have to go home, then we get a bigger tax base, more labor, can keep those who do grad school here, etc etc.

            Problem is we already have those requirements now with legal immigration and I can tell you the whole “can’t be a public charge” thing is a joke. For example: an immigrant acquaintance of my wife’s, who made it clear she didn’t care for us gringos, waited until she had legalized status to have a kid. She promptly signed up for government aid. She actually offered my wife some extra WIC coupons because she had more than she needed. Not a hint of shame.

            For another example, the USDA has been advertising for years in Mexico to promote food stamps. In a flyer given to the Mexican embassy by the USDA, it highlights that “You need not divulge information regarding your immigration status in seeking this benefit for your children.”

            http://foxnewsinsider.com/2013/04/29/judge-napolitano-government-advertising-food-stamps-ilegals

            So there’s just not a chance the guest-worker “no welfare” rule would survive first contact with reality. The left wants these people as voters, and they are going to do anything they can to make sure they are registered and dependent on government.

          • paul-

            i’m not convinced it cannot work.

            i definitely hear your concerns about rubber meeting the road, but lots of other countries have made such things work, many who have welafare states well in excess of our own.

            canada, austria, the scandanavian countries, denmark, the dutch, and the swiss are making it work.

            i have no issue with it being a path to citizenship. if you can live here, gainfully employed, not commit a crime, take care of yourself and pay taxes for 5 or 7 years, why would we not want you as a citizen?

            such policies would, by their very nature, weed out those who seek welfare as 5 years with no assistance and a job tends to prove that and weed out the lazy.

            the one fly in this ointment is the 14th amendment.

            that truly does need to be modified. anchor babies are very serious issue and honestly, THAT is where the real welfare state issue mostly arise.

            it amazes me, given how popular such a thing would be, that no politician has taken up that cause.

          • Morg,

            if you can live here, gainfully employed, not commit a crime, take care of yourself and pay taxes for 5 or 7 years, why would we not want you as a citizen?

            Sure, if you actually pay taxes. But as it is, about half the American public receives more in government $ than they pay out. We don’t need to import more tax consumers, and a high school drop-out from a dysfunctional culture is statistically likely to cost taxpayers a boatload of money. According to Robert Rector, On average, low-skill immigrant families receive $30,160 per year in government benefits and services while paying $10,573 in taxes, creating a net fiscal deficit of $19,587 that has to be paid by higher-income taxpayers.”

          • paul-

            i do not know who rector is or where he is getting that info, but it sounds like it is either quite suspect or is relevant to something else.

            if you come illegally, you pay nearly no taxes. if you have kids, you get services.

            that would seem to skew the sample a great deal and would not be an issue if we tightened that up and got a guest worker program.

            i simply do not see how his numbers work for someone paying income tax.

            if you have a family of 4, 2 parents, 2 kids, and you make $40k, you pay about $1200 in income taxes and maybe $2500 in fica for a total of $3700.

            what is all the rest of this tax? even with sales and state taxes, it’s hard to get to unless you are at a number like $50k at which point, you are not using such a huge pile of services.

            i am just finding his numbers implausible for a working family.

            he must be lumping in the one who cross illegally, have a kid here, and then go on welfare or some such.

            that is precisely what we could get rid of with a guest worker program and a change to the 14th amendment (which needs changing in any event)

            i think you are using a bit of a fanciful vision of the possible on the other side to compare with a GW plan.

            there is just not way we are going to be able to close the border to illegal immigration. it’s like assuming that more laws will stop drug use. it’s not going to work like that. you cannot get rid of this level of demand. using “control the border and stop illegal immigration” as a comparative option is simply unrealistic.

            we’re just going to be in the same boat we are in now, and this is clearly not working.

            even if a guest worker program is not perfect, it seems far better than this status quo and “enforce away demand” especially with the 14th amendment in place, seems awfully implausible. it’s sure never worked before.

          • Morg,

            Robert Rector: http://www.heritage.org/about/staff/r/robert-rector

            Even if you find fault with his numbers, it’s not hard to see how unskilled immigrants from Mexico are a net fiscal drain that are changing the culture and the political landscape for the worse. I agree we can’t eliminate illegal immigration, but there’s an enormous potential to reduce it dramatically by finishing the fence to Israeli standards. We could then redeploy the border patrol more efficiently.

          • Paul

            “On average, low-skill immigrant families receive $30,160 per year in government benefits and services while paying $10,573 in taxes, creating a net fiscal deficit of $19,587 that has to be paid by higher-income taxpayers.” — Robert Rector

            $10,573 in taxes sounds high for a poor immigrant family, and $30,160 sounds very high as an average for benefits received, considering there are many not available to non-citizens. Does Rector support those numbers with actual data somewhere?

            And of course Rector is not including the value added to an employer’s business by immigrant employees in his calculations, unless you’re leaving something out.

            Here’s an interesting paper on the subject.

            If you read the rest of the article, you see how black displacement by immigrants in the workplace inflames the disintegration of the black family and also incarceration rates.

            Amazing. Nowhere in that article does Kirsanow mention the more damaging, and easier to fix barrier to low skilled black employment – the minimum wage. Makes one wonder what the real issue is, doesn’t it?

            Instead his recommendation is to limit the supply of low skilled labor available, so that consumers can pay the higher prices necessary to support the higher price for low skilled labor. Kirsanow obviously slept through any economics classes he might have taken in school.

          • Ron,

            “Amazing. Nowhere in that article does Kirsanow mention the more damaging, and easier to fix barrier to low skilled black employment – the minimum wage. Makes one wonder what the real issue is, doesn’t it?”

            Well, he doesn’t mention the damaging effects of business taxes, government regulation, welfare, or ghetto culture either. The topic was immigration.

      • Paul, Kirsanow is writing as a member of the US Commision on Civil Rights to the Chair of the Congressional Black Caucus. His stated interest, consistent with his capacity as a member of that commission, is the employment difficulties of low income blacks.

        To limit his concern to only one of many factors that affect low income blacks seems incomplete. The possibility that he is promoting a political agenda by appealing to black members of Congress using an issue in which they are interested seems more likely.

  2. Milton Friedman also advocated a progressive consumption tax to finance federal military outlays, and taxing pollution.
    And I agree—the federal government is usually the worst way to fix a “problem.” See Afghanistan, Iraq or the VA .

    • I just thought of a great drinking game: every time Joe mentions the VA you have to take a shot. Although this may be a tad dangerous….

  3. “Inflation is always and everywhere a monetary phenomenon.”

    i’m a big fan of much of friedman, but that quote has always annoyed me.

    it’s either such a definitional tautology as to be meaningless, (eg prices are in money so changes in price are monetary) or it’s just wrong.

    if all else is held constant save a drought that makes fruits and vegetables more expensive, we get inflation.

    but the cause is not monetary, it’s a supply shock.

    i really do not see the point he is trying to make.

    one could just money supply to reflect fewer goods, but that does not change wages and savings. the difference gets made up by velocity.

    • —–”if all else is held constant save a drought that makes fruits and vegetables more expensive, we get inflation.”

      You get inflation in fruits and vegetables then but deflation in something else that people buy less of because they spent more money on fruits and vegetables.

    • I believe he backed away from this claim later in his life, ie he used to think the quantity and growth of the money supply is all that mattered but came to realize it wasn’t. Velocity is the more important concept and much harder to quantify.

      The whole concept of inflation is suspect, unless one is printing money backed by nothing, hyperinflation which would happen occasionally during that time. The entire “price level” is a mishmash of billions of subjective prices. To attempt the kind of rigid mathematical relationships that simplistic economists sometimes try to draw out of that chaos is madness.

      • Sprewell

        The whole concept of inflation is suspect, unless one is printing money backed by nothing…

        Nah, there could never be money backed by nothing. How could anyone trust it?

        Oh wait…

        • —”Nah, there could never be money backed by nothing. How could anyone trust it?

          Oh wait…”

          And this was another of Milton’s favorite themes. It is that trust itself, not the thing that the people may think is backing the money, that allows it to serve as money. This is another economic fact that Milton helped to make common knowledge.

          • Greg

            And this was another of Milton’s favorite themes. It is that trust itself, not the thing that the people may think is backing the money, that allows it to serve as money. This is another economic fact that Milton helped to make common knowledge.

            Yes. It’s the belief that whatever is accepted in an exchange, whether it’s paper money, gold coins, clam shells, or anything else, will also be recognized accepted at the same value by the next person in the next exchange.

            If I wish to exchange 10 of apples for 12 oranges, I may instead accept a piece of paper, trusting that someone who actually has oranges will accept that piece of paper in exchange for 12 oranges.

        • If you’re talking about Federal Reserve Notes, ie Dollars, they are backed by purchases of treasuries. There may be some problems with this backing, but it’s not “backed by nothing.”

          • Right, a currency may be, and usually is, backed by something. And that backing may well affect the trust in the currency. But in the end, the trust matters a lot more than the backing. Backing without trust won’t make a currency. Trust without backing will.

          • Well, the backing creates trust, so saying the trust comes first is getting it backwards. Nobody would have ever trusted the dollar if it hadn’t been backed by gold at one point.

            In any case, we’re in for a bunch of digital currencies online, so we’ll see all kinds of experiments get run soon. Bitcoin already has almost a $10 billion market cap, which is only 1% of Fed Notes outstanding but impressive considering it has no backing whatsoever. :) I suspect we’ll start moving back towards backing, ie trading actual goods, and eventually to digital barter, where we get rid of the “currency” altogether.

          • Sprewell

            If you’re talking about Federal Reserve Notes, ie Dollars, they are backed by purchases of treasuries. There may be some problems with this backing, but it’s not “backed by nothing.”

            I’ll say there are problems. Treasuries are promises to pay future dollars from future tax revenue. Treasuries are denominated in dollars, and dollars are backed by treasuries. That incestuous relationship should bother you.

            The Fed buys Treasuries with a check drawn on itself, so to speak, thus creating that amount of money out of thin air. Sure, it holds the equivalent in assets, but the money didn’t exist before the purchase.

            Then, as if that weren’t bad enough, that money then enters the banking system where fractional reserve requirements allow multiples of the original amount to be loaned. A $million in treasuries becomes $10million in circulating money.

            If you call that “backed by something”, you have a looser definition than I do.

          • Sprewell

            Well, the backing creates trust, so saying the trust comes first is getting it backwards. Nobody would have ever trusted the dollar if it hadn’t been backed by gold at one point.

            And nobody would have ever trusted gold, unless they believed shiny pieces of metal could be exchanged for actual goods and services. The trust comes first.

            In any case, we’re in for a bunch of digital currencies online, so we’ll see all kinds of experiments get run soon. Bitcoin already has almost a $10 billion market cap, which is only 1% of Fed Notes outstanding but impressive considering it has no backing whatsoever. :)

            I’m excited about this trend, as it removes all government control of the money. As bitcoin and other alternative currencies gain acceptance, it will be easier to visualize its value in terms of actual goods and services.

            I suspect we’ll start moving back towards backing, ie trading actual goods, and eventually to digital barter, where we get rid of the “currency” altogether.

          • Sprewell

            I suspect we’ll start moving back towards backing, ie trading actual goods, and eventually to digital barter, where we get rid of the “currency” altogether.

            I missed this previously.

            I don’t see why that would happen. If you mean physical currency – maybe – but the whole purpose of money is to stand in as a substitute for actual goods and services when there’s no direct exchange possible, which is most of the time. The very concept of money is a mechanism to facilitate asymmetrical exchanges. Why would anyone want to go back to direct barter, even if technology somehow made it easier? There is nothing to be gained by giving up a useful and reliable medium of exchange.

            How would you exchange totally unlike goods and services without some unit of measure that could be applied to both?

          • I’ll say there are problems. Treasuries are promises to pay future dollars from future tax revenue. Treasuries are denominated in dollars, and dollars are backed by treasuries. That incestuous relationship should bother you.

            Yes, that circular definition is one of the problems I had in mind, but when you’re creating $1 trillion/year in treasury debt and only about $40 billion/year in Fed Notes, the Fed is not the real problem.

            The Fed buys Treasuries with a check drawn on itself, so to speak, thus creating that amount of money out of thin air. Sure, it holds the equivalent in assets, but the money didn’t exist before the purchase.

            This is another one I was thinking of, but I’m not sure this really matters. Suppose the Fed bought up a bunch of treasuries with their existing currency, say raised by a fee on their member banks, then issued new currency with those treasuries as backing, which would be the alternative. Would that really make a difference from just creating the currency and then buying the treasuries, as they do now? The first way, you’re going to have to buy something or loan out the money to get the new currency into the economy anyway, you’re just moving it into the economy easier the second way. Of course, the advantage of the first way is that it puts some constraint on creation of new money, whereas the second way nominally has little constraint. But the real constraint is information, ie once people know you’re just printing up a bunch of new money, they react negatively.

            Then, as if that weren’t bad enough, that money then enters the banking system where fractional reserve requirements allow multiples of the original amount to be loaned. A $million in treasuries becomes $10million in circulating money.

            No individual bank can loan “multiples of the original amount,” that’s a number that’s come up with in the aggregate from all the banks. And banks can always choose not to lend out that new currency, as they’re currently sitting on a couple trillion in reserves more than they’re legally required to hold.

            If you call that “backed by something”, you have a looser definition than I do.

            That additional amount from the fractional-reserve multiplier is also backed by the assets of the bank, which range from real estate to bonds, the assets they’ll have to liquidate if they need to. The banks actually have better backing than the Fed. :)

            And nobody would have ever trusted gold, unless they believed shiny pieces of metal could be exchanged for actual goods and services. The trust comes first.

            And why did they trust gold? Because they started off trading chickens and found over time that gold had scarcity and value and could be traded well. Nobody just “trusted” gold, trust had to be built up slowly through trade in goods and services, slowly replacing barter or earlier material “currencies.”

            I’m excited about this trend, as it removes all government control of the money. As bitcoin and other alternative currencies gain acceptance, it will be easier to visualize its value in terms of actual goods and services.

            I’m not sure they ever had much control, considering how much power private banks have in a fractional-reserve system, but yes, what little they had is about to disappear. I don’t see why bitcoin will be any easier to “visualize its value in terms of actual goods and services.” It’s yet another fiat currency, which is why I don’t think it can ever really be the final word in online currency.

            I don’t see why that would happen. If you mean physical currency – maybe – but the whole purpose of money is to stand in as a substitute for actual goods and services when there’s no direct exchange possible, which is most of the time. The very concept of money is a mechanism to facilitate asymmetrical exchanges. Why would anyone want to go back to direct barter, even if technology somehow made it easier? There is nothing to be gained by giving up a useful and reliable medium of exchange.

            No, I’m talking the death of any currency, ie electronic dollars, egold, or bitcoin. Physical currency is already dead for all intents and purposes, I’ve handled almost no cash for more than a decade. The reason to go to digital barter is because it’s not “direct barter,” ie you won’t need to have gasoline to trade to the teenager at the ice cream shop. :) You’ll simply walk in and say how much you want and your smartphone will do all the digital barter for you.

            The reason to get rid of a medium of exchange is that it always was an artificial substitution, one made for convenience. Well, the new tech of the computer and the internet can now enable barter in an even more convenient way, one that has new benefits drop out, that I’ve discussed before.

            How would you exchange totally unlike goods and services without some unit of measure that could be applied to both?

            If you buy 3 apples for $1.50 and I buy 5 plums for the same price and we trade the fruit with each other, they’re still worth whatever we traded to each other regardless of the dollars used to buy them. In other words, dollars are merely a marker to communicate value, one that’s relatively recent and can be replaced. Rather than giant computer databases containing dollar prices of every good, as one sees when you visit amazon.com, there would be large computer databases containing real-time subjective valuations of each good in terms of others, which is all the dollar was ever a stand-in for. The dollar made the math easier, particularly for consumers, but now nobody has to do that math in their head! It’ll all be programmed into computers and they’ll do all the increased calculation necessary.

            Of course, note my use of the word “subjective,” as prices depend on what people are willing to pay or accept in return for their goods. I’ve mentioned before the concept of a personal CPI, that would tell you how much any particular purchase would cost in terms of your particular basket of goods. There are many ways to represent the “price” in highly customized ways on your smarphone, that’s what’s coming. :D

          • Sprewell

            For some reason I can’t seem to post my lengthy response to your last comment. If I ever get it to post, it will be a new thread at the bottom.

    • if all else is held constant save a drought that makes fruits and vegetables more expensive, we get inflation.

      but the cause is not monetary, it’s a supply shock.

      i really do not see the point he is trying to make.”

      I think the wording “always and everywhere” is unfortunate. I don’t believe Friedman is referring to an increase in some prices as in the supply shock you described, but in general price increases in which the dollar has lost value with respect to most actual goods and services.

      A general increase in prices over time, including the price of labor, can only occur when the money supply is increased at a greater rate than the demand for money.

      • Ron,

        That’s right. Obviously, Friedman was well aware of the law of supply and demand. Friedman assumed his audience was smart enough to know that by “a monetary phenomenon” he meant “a phenomenon having to do with the relationship between the supply of money and the demand for money.”

        A little context helps. It’s easy to forget how much worse the general understanding of inflation was when Friedman made that statement. Back then people were much more likely to believe that an increase in oil prices, for example, could cause the price of everything to go up even in the absence of an increase in the effective money supply or an increase in velocity. Far fewer people believe that now thanks to Milton and thanks to that memorable quote.

        Sprewell is right that Friedman under appreciated the effects of velocity. Even worse, he just about totally missed the giant increase in the money supply caused by credit creation in the shadow banking system during the housing bubble. He died right before that all blew up and he died thinking that the management of the money supply at that time had been done really well.

        That is an embarrassing failure for the guy who was supposed to have the best understanding of the money supply but he was a very great economist despite that mistake.

        • Greg

          It’s easy to forget how much worse the general understanding of inflation was when Friedman made that statement. Back then people were much more likely to believe that an increase in oil prices, for example, could cause the price of everything to go up even in the absence of an increase in the effective money supply or an increase in velocity.

          I’m not sure the “general understanding” is any better now. If you get away from econ blogs and financial web sites you will find a sea of ignorance. Even here you will find people advocating for a higher minimum wage without explaining where the extra money will come from.

          As for velocity, it seems to be a pretty worthless concept unless you are dealing with physical money. How can you track the activity of any particular dollar in an electronic world? Basically, outside of direct barter, every transaction involves the exchange of a good or service for some number of dollars. Money moves from owner to owner just as goods and services do. The velocity of money makes no more sense than the velocity of goods and services. You can’t change velocity without changing the number or size of transactions.

          Yes, you can divide Transactions x Price (GDP) by the money supply to get a number you can call velocity, but it has no useful meaning.

          He died right before that all blew up and he died thinking that the management of the money supply at that time had been done really well.

          Yes, Friedman’s one failing was to believe that the money supply could be actively managed by really smart people to produce desired outcomes.

          • Ron

            It is certainly true that velocity is impossible to measure with a lot of accuracy but it is a mistake to think that only concepts that can be measured accurately are worthwhile.

            It was Friedman who convinced policy makers the Fed should have prevented the money supply from shrinking during the Great Depression. Since that time we have not had another depression. Before that time depressions were a regular occurrence.

            Call that a failing if you like. I call it a success. And this is precisely the issue that has caused Austrian economics to lose so much influence. When your economic beliefs are based on a priori reasoning instead of empirical evidence, it won’t go well for you when empirical evidence moves against you.

          • Greg

            Wait a minute, are you defending the idea that concepts are important even when they can’t be measured empirically and then condemning concepts that don’t include empirical evidence? Maybe you should try to get your narrative straight.

            If you think the notion of “velocity” is somehow important, please explain it in your own words, including what use you can make of a number derived from 3 other variables. This should be good.

            As for depressions, yes, there have been depressions as long as there has been government interference in the markets and in the money supply. Any depressions in the US prior to the Great one, while deep, were short-lived, due to the markets ability to quickly correct mal-investments and reallocate resources to more productive uses. With massive government intervention, the Great depression ground on for either 11 or15 years, depending on whether you count a command and control wartime economy as part of it. think about it. the Fed was created, supposedly, to smooth out the business cycle of boom and bust, and after having 17 years to sharpen its arsenal of weapons, it fell flat on its ass when called on to do something important. That’s not much of a recommendation, and I wouldn’t brag about it if I were you.

            It was Friedman who convinced policy makers the Fed should have prevented the money supply from shrinking during the Great Depression.

            Yes, he placed the blame for the Great depression squarely on the Fed, and called repeatedly for a reduction of the power of the Fed, or even its elimination.

          • Ron,

            Concepts and empirical evidence are both crucial. I don’t really understand why you think we should have to choose one or the other. You can’t interpret empirical evidence without concepts but if you think all knowledge is deductive you will interpret all possible results as supporting your narrative. Such a theory is, as the physicists say, “not even wrong.” It is just a faith based system that never produces any new knowledge even in the face of new evidence.

            Velocity is a concept that tells us that a dollar that changed hands ten times in a year has an entirely different effect on the effective money supply than a dollar that stays under your mattress for a year. I trust you can tell which of those two has the effect of increasing the money supply and which has the effect of decreasing it.

            I wasn’t bragging about the Fed’s performance during the depression and I am baffled as to why you think I was. I agree that was terrible. I was bragging about its performance since then.

            Friedman did indeed blame the depression on the Fed. He blamed them for doing far TOO LITTLE, not far too much, to keep the money supply from shrinking. We learned something from that (thanks to Friedman) and haven’t made the same mistake again.

          • Greg

            Velocity is a concept that tells us that a dollar that changed hands ten times in a year has an entirely different effect on the effective money supply than a dollar that stays under your mattress for a year. I trust you can tell which of those two has the effect of increasing the money supply and which has the effect of decreasing it.

            Just as I suspected – you are confused about money. We aren’t concerned with physical currency, but in the “money” that underlies it. The amount of paper in circulation is of little importance, and effectively only indicates a preference for cash in your pocket instead of in your checking account.

            Yes, you have the first part right. Keeping cash under the mattress decreases the money supply, not because it’s not being spent, but because it reduces the amount of money in the banking system by the amount of the reserve ratio. At a 10% reserve requirement, taking $100 out of your bank account and stashing it, reduces the available money supply by $1000. Lots of people doing that can have serious effects.

            Then we have the “velocity” question. Tell me, what possible use can you make of the fact that a particular dollar has changed hands 10 times in a year? Every time it changes hands, it represents a good or service changing hands on the other side of an exchange.

            Higher velocity equals more economic transactions. So what? The number of transactions is easy to measure, and with price information gives you GDP. That is useful information, the velocity number isn’t.

            Perhaps this will help.

          • Ron

            I was not suggesting that the holding of physical cash is as consequential as credit creation in the banking system. Of course bank credit is the main driver of the money supply. Cash under the mattress is insignificant. I was merely using, as an example, the effect of what happens to a single dollar of cash money because I thought you guys liked your examples the more micro the better.

            In your comment you assumed that banks will lend as much as they can of their deposits. Sometimes they do this and sometimes they don’t. Right now, mostly they don’t. Whether or not banks are expanding or contracting their loan portfolios has a huge effect on the money supply. And the velocity with which money is circulating in the economy has a great deal to do with the willingness of banks to lend.

            Where was it I said something that made you think I claimed to have a useful velocity measurement? I wasn’t claiming it was a useful measurement, I was claiming it is a useful concept in understanding the process.

          • Greg

            In your comment you assumed that banks will lend as much as they can of their deposits. Sometimes they do this and sometimes they don’t.

            Yes. I assume they will do as much of the business they are in as possible, as that is how they make money.

            Right now, mostly they don’t. Whether or not banks are expanding or contracting their loan portfolios has a huge effect on the money supply.

            Yes it does, and right now they are not lending at full throttle for two reasons. One is that the Fed is paying interest on reserves, effectively paying member banks to NOT lend and take risks.

            The other reason is that monstrosity called “An Act to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end “too big to fail”, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.”

            Otherwise known as the “Dodd-Frank Wall Street Reform and Consumer Protection act of 2010″, and for merciful brevity known simply as “Dodd-Frank”.

            This ridiculous impediment to banking requires lenders to account for every cent that moves anywhere within their reach, and for borrowers it requires that details of their financial life that couldn’t possibly matter, be explained. For example “Where did you get that $100 cash you used to open a new checking account with us?”

            I can’t imagine anyone with less than perfect credit, rock solid income, and multiples of required collateral qualifying for a loan, and I can’t imagine many who DO qualify, tolerating the long, detail plagued process, with its numerous delays.

            And the velocity with which money is circulating in the economy has a great deal to do with the willingness of banks to lend.

            Do you mean to tell me that meaningless number is important to lenders? Please explain how.

            Where was it I said something that made you think I claimed to have a useful velocity measurement? I wasn’t claiming it was a useful measurement, I was claiming it is a useful concept in understanding the process.

            You claimed that the concept of velocity and it’s value were somehow important, and I questioned that notion. You still haven’t provided an explanation of *why* it’s important or what important use can be made of it.

            Velocity is, in fact, very easy to measure, it’s GDP/ money supply. The problem seems to be making some use of the resulting number. Try again if you wish, but first, please read the reference I gave you if you haven’t already done so.

          • Ron

            OK. I did read that Hazlitt piece and it helped a lot in understanding why we are talking past each other so much on this. The first time I had trouble loading the page your link was on and so commented first.

            For the most part, this issue about how to think about velocity is one of those many cases where you guys insist on using a language to talk about economics that does not conform to the prevalent language conventions in economics. Of course, you are, and should be free to do this, but that doesn’t help you to communicate effectively.

            Ironically, the language conventions that you object to here are formed (like all language conventions) by that process you claim to love so much – bottom up emergence as the result of countless voluntary individual choices.

            Of course it is true that as money circulates around the economy it causes goods and services to circulate around the economy. That is another way of describing the same thing. NO ONE is unaware that the goods and services circulate! Talking about this in terms of money velocity is JUST A CONVENTION not a failure to understand that the goods and services are also circulating as a result of the money circulating.

            On one hand Hazlitt says “Strictly speaking, money does not circulate; it is exchanged for goods.” (That is what the rest of the world MEANS by money circulating.) Then he points out that excess money easily flows into financial speculation that simply bids up the price of existing investments. Of course this is true. Austrian economics did make a very valuable contribution in showing how excess credit creation can fuel financial bubbles and business cycles. In my opinion Minsky improved on this a lot but he certainly owed a debt to the Austrians on it.

            Hazlitt insists that “velocity is not a cause but a result.” This is silly. In a complex economy, everything affects everything else; there are feedback loops all over the place and velocity is both a cause and an effect. If velocity is just the rate of exchange of goods and services it should be obvious that a change in the rate of the exchange of goods and services CAUSES other things to happen – it doesn’t just float free in space.

            At bottom this is just that old Austrian hangup about hating all types of macro analysis and wanting everything to be micro. Which is another battle you guys lost thanks to Friedman more than anyone else.

          • Ron,

            You are confused on a number of points regarding what is happening now with bank lending. I have been an outside director at a small community bank for the last 15 years so I can shed a little light on this.

            Yes, the Fed is paying interest on reserves and yes that has a very small effect towards reducing lending. Specifically, it adds 25bp to whatever spread you need to justify making a loan. This has some effect but it is a very small part of the net interest margin on a loan. No rational banker wants to turn down a profitable loan because making 25 bp is more appealing. Loans are actually being made on smaller interest margins than they used to be.

            Now some banks will turn down loans because they are worried about interest rate risk rather than credit risk but that is always a concern at any time whether or not 25bp is on offer for reserves.

            The main problem is just that there aren’t many qualified borrowers looking for funds compared to the funds on reserve. It used to be that our biggest and most innovative firms were big borrowers. Today they are lenders with huge stores of cash. And consumers don’t have the ability to borrow a lot more because they are already carrying a lot of debt.

            There is an excessive amount of new regulatory oversight that has fallen disproportionately on small banks. This is expensive but it is there whether or not you lend. It does not make it rational to turn down a credit worthy borrower unless you are afraid of interest rate risk which, as I said, is always a concern. It does however have the unintended effect of increasing the market share of TBTF firms.

            The main thing that fueled the housing bubble was a huge amount of credit creation in the shadow banking system. The explosion of the use of innovations like repo, securitization, CDO’s, CDS etc. produced an astonishing amount of credit creation that no one fully appreciated at the time. It would have been even more surprising to someone like Hazlitt writing in 1968.

            The vast amounts of money that the Fed has pumped into the system mostly just replaced money that disappeared when the shadow banking system froze up. And of course, the main reason the shadow banking system arose was that it was an effective way to avoid a lot of regulation.

          • Greg

            For the most part, this issue about how to think about velocity is one of those many cases where you guys insist on using a language to talk about economics that does not conform to the prevalent language conventions in economics. Of course, you are, and should be free to do this, but that doesn’t help you to communicate effectively.

            Oh I don’t know, I find Hazlett to be one of the clearest, and easiest to understand writers I’ve ever read. he doesn’t resort to calling it “complex” like you and Keynesians do to explain why something is hard to understand when it really isn’t.

            Ironically, the language conventions that you object to here are formed (like all language conventions) by that process you claim to love so much – bottom up emergence as the result of countless voluntary individual choices.

            Oh yes, I love emergent order. It is the opposite of central planning, and actually works, where central planning doesn’t. However, the concept of “velocity” isn’t so much an an emergence of anything, as it is an old idea made popular by Irving Fisher.

            I too use the word “circulate, so as to communicate with others who use the term, but I understand that money changes hands in individual steps, just as goods and services do, and doesn’t “flow” through the economy like a fluid., and doesn’t simply whirl around us like a tornado, with velocity describing the wind speed. I think a lot of confusion arises from that kind of visualization.

            If you are willing to say that goods and services “circulate””, then I will agree to say that money “circulates. And an increase in the rate of “circulation” of goods and services produces an increase in the “velocity” of goods and services.

            Of course it is true that as money circulates around the economy it causes goods and services to circulate around the economy. That is another way of describing the same thing. NO ONE is unaware that the goods and services circulate! Talking about this in terms of money velocity is JUST A CONVENTION not a failure to understand that the goods and services are also circulating as a result of the money circulating.”

            Don’t be so sure that the convention is well understood.

            On one hand Hazlitt says “Strictly speaking, money does not circulate; it is exchanged for goods.” (That is what the rest of the world MEANS by money circulating.) Then he points out that excess money easily flows into financial speculation that simply bids up the price of existing investments. Of course this is true. Austrian economics did make a very valuable contribution in showing how excess credit creation can fuel financial bubbles and business cycles.

            If you understand that, then why did you previously object to my claim that Austrians could and did predict what would happen with interest rates held artificially low for an extended period of time?

            A bubble was created in equities in the ’90s, then when it popped the Feds blew a housing bubble to ease the pain of a necessary correction, and now they are blowing a government debt bubble, in addition to another bubble in the stock market, and delaying the necessary correction. There is no where to go from here, and I don’t think it will end well at all.

            Hazlitt insists that “velocity is not a cause but a result.” This is silly. In a complex economy, everything affects everything else; there are feedback loops all over the place and velocity is both a cause and an effect.

            And there we have it: “it’s complicated”.

            Look, Hazlitt is absolutely correct. Velocity MUST always be a result of things that have real meaning, like T, P, and M. V CANNOT be a cause of anything, because a change in velocity can’t occur by itself to change prices, transactions, or money supply. A change in V is ALWAYS a result of a change in one of the other 3 factors.

            I’m not sure why this is so difficult for you guys. Please provide a clear example of velocity alone changing, and causing something else to change.

            If velocity is just the rate of exchange of goods and services it should be obvious that a change in the rate of the exchange of goods and services CAUSES other things to happen – it doesn’t just float free in space.

            Yes, a change in *only* the rate of exchange of goods and services, causes velocity to change, since it is the only way to balance the equation. So what? It still has no independent meaning, but can only describe relationships of the other factors.

            At bottom this is just that old Austrian hangup about hating all types of macro analysis and wanting everything to be micro. Which is another battle you guys lost thanks to Friedman more than anyone else.

            Nonsense.

          • Ron, agree and disagree with some things you’ve been saying, but strongly disagree with this:

            “Look, Hazlitt is absolutely correct. Velocity MUST always be a result of things that have real meaning, like T, P, and M. V CANNOT be a cause of anything, because a change in velocity can’t occur by itself to change prices, transactions, or money supply. A change in V is ALWAYS a result of a change in one of the other 3 factors.

            I’m not sure why this is so difficult for you guys. Please provide a clear example of velocity alone changing, and causing something else to change.”

            Why do you presume that velocity itself can’t change and affect the other factors? Simply because it is difficult to measure? There have been instances where the increase in the money supply was negligible but an increase in velocity led to inflation, the late ’90s boom is probably best described that way. Now I know what you’ll say, that every one of those high-velocity episodes was caused by an increase in the money supply, despite what the statistics say. But there are times when people’s expectations rise and the money supply doesn’t, which leads to an increase in velocity.

          • Greg

            You are confused on a number of points regarding what is happening now with bank lending. I have been an outside director at a small community bank for the last 15 years so I can shed a little light on this.

            Yes, the Fed is paying interest… [...]…Now some banks will turn down loans because they are worried about interest rate risk rather than credit risk but that is always a concern at any time whether or not 25bp is on offer for reserves.

            In other words, you have no idea why banks aren’t lending.

            There is an excessive amount of new regulatory oversight that has fallen disproportionately on small banks. This is expensive but it is there whether or not you lend. It does not make it rational to turn down a credit worthy borrower unless you are afraid of interest rate risk which, as I said, is always a concern. It does however have the unintended effect of increasing the market share of TBTF firms.

            I can tell you that Dodd-Frank affects all banks, large and small. This monster creates a level of government micromanagement of lenders, through requirements for dotting of ‘i’s and crossing of ‘t’s through ambiguous and even contradictory language , that may cause lenders to be unnecessarily cautious.

            The vast amounts of money that the Fed has pumped into the system mostly just replaced money that disappeared when the shadow banking system froze up. And of course, the main reason the shadow banking system arose was that it was an effective way to avoid a lot of regulation.

            Incentives matter, eh?

            Failure to allow the needed correction of mis-allocated resources has allowed the current recession to drag on needlessly for far too long. When incentives are misaligned, and bubbles form due to an excess of money and credit, the cure for the predictable crash is not to artificially create MORE money and credit, but to allow the misalignment of production and consumption to return to equilibrium.

  4. Sprewell

    Yes, that circular definition is one of the problems I had in mind, but when you’re creating $1 trillion/year in treasury debt and only about $40 billion/year in Fed Notes, the Fed is not the real problem.

    We’re not just talking physical paper currency, since 2008 the Fed has created 3 Trillion Dollars out of thin air. QE at $85 Billion per month is how much?

    This is another one I was thinking of, but I’m not sure this really matters. Suppose the Fed bought up a bunch of treasuries with their existing currency, say raised by a fee on their member banks, then issued new currency with those treasuries as backing, which would be the alternative.

    That makes a world of difference, Sprewell. Fees from member banks is money that already exists. It isn’t made up out of thin air.

    Would that really make a difference from just creating the currency and then buying the treasuries, as they do now?

    Yes.

    The first way, you’re going to have to buy something or loan out the money to get the new currency into the economy anyway, you’re just moving it into the economy easier the second way. Of course, the advantage of the first way is that it puts some constraint on creation of new money,

    There would be no new money if existing money came from fees from member banks. That’s just taking it with one hand and putting it back with the other. There’s no increase in the money supply.

    No individual bank can loan “multiples of the original amount,” that’s a number that’s come up with in the aggregate from all the banks.

    Whether there is one bank or a million banks, a 10% fractional reserve requiirement means a banking entity can loan 90% of the money in its demand deposit accounts, and must keep only 10% on hand to cover withdrawals.

    For example if ten people each deposit $100 in their checking accounts, the bank has $1000 on deposit. They need only keep $100 on hand to cover checks, assuming (more or less correctly) that all 10 people won’t write checks for their total balance on the same day. It is a juggling act. There is $900 loaned out and not available to cover withdrawals.

    Now, when that $900 is loaned out, it is first deposited in a checking account at the borrower’s bank, which now has increased reserves of $900, of which $810 (90%) can be loaned out. When you run this sequence of events all the way out, $10,000 total has been loaned out on deposits of $1000.

    That is $9000 with NO backing, which is being juggled in the air.

    And banks can always choose not to lend out that new currency, as they’re currently sitting on a couple trillion in reserves more than they’re legally required to hold.

    Yes they can, and that means banks are setting their own MARKET reserve rate, which is a lower ratio than the Fed requires. Of course it helps that the Fed is currently paying interest on excess reserves, so why risk loaning money when you have a rock solid guarantee from the Fed? Banks are being paid not to loan money, while at the same time being demonized for not doing so.

    That additional amount from the fractional-reserve multiplier is also backed by the assets of the bank, which range from real estate to bonds, the assets they’ll have to liquidate if they need to.

    No it isn’t. Non-liquid assets are not available to redeem withdrawals from demand deposit accounts, only cash reserves. If you write a $100 check against your $150 balance would you expect to be told that it will be honored when the bank has sold some real estate or called in some loans early?

    And why did they trust gold? Because they started off trading chickens and found over time that gold had scarcity and value and could be traded well.

    You are assuming your premise. How did people find that gold had value?

    *continued

  5. *continued

    Well, I won’t keep you in suspense, I’ll tell you: gold has all the characteristics of good money, except perhaps #1. Historically gold had few practical uses except for ornamentation – pretty bling. And eventually, of course, as an outstanding roofing material. We needn’t consider very recent uses in electronics.

    1. Utility and value.
    2. Portability.
    3. Indestructibility.
    4. Homogeneity.
    5. Divisibility.
    6. Stability of value.
    7. Cognizability.

    While chickens might have worked to some degree they lacked numbers 3, 4, and 5, and to some degree #2.

    I’m not sure they ever had much control, considering how much power private banks have in a fractional-reserve system, but yes, what little they had is about to disappear.

    What? Banks are the most government regulated businesses around. Government controls the value of the dollar, the amount available, required reserve ratios, interest rates, and through fiscal policy, how much of our own money we can spend on our own choices. At every turn government makes us explain our economic transactions, the source of our money, and why we think we should get to keep some of the fruits of our labor. With Bitcoin, we have none of that.

    I don’t see why bitcoin will be any easier to “visualize its value in terms of actual goods and services.” It’s yet another fiat currency, which is why I don’t think it can ever really be the final word in online currency.

    I didn’t mean easier to visualize than dollars, I mean easier to visualize than it is now. I have no idea what the price of anything is in Bitcoins, but I usually have a general idea how many dollars I must exchange for a good or service. That allows me to measure a new car, for example, in terms of the opportunity costs. How many ice cream cones do I have to give up to buy a new car?

    No, I’m talking the death of any currency, ie electronic dollars, egold, or bitcoin. Physical currency is already dead for all intents and purposes, I’ve handled almost no cash for more than a decade.

    More and more lately I’ve been using cash to avoid the prying eyes of anybody and everybody who wants to have a look, or so it seems.

    The reason to go to digital barter is because it’s not “direct barter,” ie you won’t need to have gasoline to trade to the teenager at the ice cream shop. :) You’ll simply walk in and say how much you want and your smartphone will do all the digital barter for you.

    I don’t see an advantage, and I don’t think it would work. All values are subjective, and every transaction is almost unique. Why go to all that trouble to avoid a common measuring tape that has served so well for most of human history. You might as well suggest abandoning any system of weights and measures, as you can always measure your commute to work in terms of trips to the bathroom, or Sprewell lengths, if you prefer. Why keep using using those old fashioned feet and miles when we have all this computer power att our disposal?

    The reason to get rid of a medium of exchange is that it always was an artificial substitution, one made for convenience.

    Heh! As far as I can see, convenience a good reason to keep it. Why create a completely new equivilence with each new transaction?

    Well, the new tech of the computer and the internet can now enable barter in an even more convenient way, one that has new benefits drop out, that I’ve discussed before.

    Sprewell, Using a medium of exchange replaced barter because it is so much easier and more convenient. That doesn’t change just because you have enormous computer power. Barter will ALWAYS be more difficult than using money, no matter how you process it. Why use it for a cumbersome system that was replaced by something much better millennia ago?

    If you buy 3 apples for $1.50 and I buy 5 plums for the same price and we trade the fruit with each other, they’re still worth whatever we traded to each other regardless of the dollars used to buy them.

    You have just used dollars to compare the value of apples to plums, and that’s the whole point! We each know how to value apples to plums, a completely subjective and individual valuation, because we both know our own values for those things expressed in dollars.

    In other words, dollars are merely a marker to communicate value…

    And a very good one at that.

  6. Well, I won’t keep you in suspense, I’ll tell you: gold has all the characteristics of good money, except perhaps #1. Historically gold had few practical uses except for ornamentation – pretty bling. And eventually, of course, as an outstanding roofing material. We needn’t consider very recent uses in electronics.

    1. Utility and value.
    2. Portability.
    3. Indestructibility.
    4. Homogeneity.
    5. Divisibility.
    6. Stability of value.
    7. Cognizability.

    While chickens might have worked to some degree they lacked numbers 3, 4, and 5, and to some degree #2.

    I’m not sure they ever had much control, considering how much power private banks have in a fractional-reserve system, but yes, what little they had is about to disappear.

    What? Banks are the most government regulated businesses around. Government controls the value of the dollar, the amount available, required reserve ratios, interest rates, and through fiscal policy, how much of our own money we can spend on our own choices. At every turn government makes us explain our economic transactions, the source of our money, and why we think we should get to keep some of the fruits of our labor. With Bitcoin, we have none of that.

    I don’t see why bitcoin will be any easier to “visualize its value in terms of actual goods and services.” It’s yet another fiat currency, which is why I don’t think it can ever really be the final word in online currency.

    I didn’t mean easier to visualize than dollars, I mean easier to visualize than it is now. I have no idea what the price of anything is in Bitcoins, but I usually have a general idea how many dollars I must exchange for a good or service. That allows me to measure a new car, for example, in terms of the opportunity costs. How many ice cream cones do I have to give up to buy a new car?

    No, I’m talking the death of any currency, ie electronic dollars, egold, or bitcoin. Physical currency is already dead for all intents and purposes, I’ve handled almost no cash for more than a decade.

    More and more lately I’ve been using cash to avoid the prying eyes of anybody and everybody who wants to have a look, or so it seems.

    The reason to go to digital barter is because it’s not “direct barter,” ie you won’t need to have gasoline to trade to the teenager at the ice cream shop. :) You’ll simply walk in and say how much you want and your smartphone will do all the digital barter for you.

    I don’t see an advantage, and I don’t think it would work. All values are subjective, and every transaction is almost unique. Why go to all that trouble to avoid a common measuring tape that has served so well for most of human history. You might as well suggest abandoning any system of weights and measures, as you can always measure your commute to work in terms of trips to the bathroom, or Sprewell lengths, if you prefer. Why keep using using those old fashioned feet and miles when we have all this computer power att our disposal?

    The reason to get rid of a medium of exchange is that it always was an artificial substitution, one made for convenience.

    Heh! As far as I can see, convenience a good reason to keep it. Why create a completely new equivilence with each new transaction?

    Well, the new tech of the computer and the internet can now enable barter in an even more convenient way, one that has new benefits drop out, that I’ve discussed before.

    Sprewell, Using a medium of exchange replaced barter because it is so much easier and more convenient. That doesn’t change just because you have enormous computer power. Barter will ALWAYS be more difficult than using money, no matter how you process it. Why use it for a cumbersome system that was replaced by something much better millennia ago?

    If you buy 3 apples for $1.50 and I buy 5 plums for the same price and we trade the fruit with each other, they’re still worth whatever we traded to each other regardless of the dollars used to buy them.

    You have just used dollars to compare the value of apples to plums, and that’s the whole point! We each know how to value apples to plums, a completely subjective and individual valuation, because we both know our own values for those things expressed in dollars.

    In other words, dollars are merely a marker to communicate value…

    And a very good one at that.

    • —-”Using a medium of exchange replaced barter because it is so much easier and more convenient.”

      That is true as far as it goes, but it’s worth adding that the thing that really caused people to discover that and switch to a money economy was when governments started coining money to pay their armies. Markets then quickly sprang up around these armies. Governments then discovered that coining money was a good source of income and the practice spread further.

      There is absolutely no historical or anthropological evidence for the Austrian fable that the advantages of coining money were figured out by some brilliant proto-Austrian entrepreneurs in advance of money coinage by governments.

      • Greg

        That is true as far as it goes, but it’s worth adding that the thing that really caused people to discover that and switch to a money economy was when governments started coining money to pay their armies. Markets then quickly sprang up around these armies. Governments then discovered that coining money was a good source of income and the practice spread further.

        That sounds reasonable, it’s always in the interest of those in power to control the money, and dictate currencies, especially when they want to wage war, as they can debase the currency – effectively stealing from the people – to finance their expensive escapades. Do you have a reference?

        Of course coining money and using indirect exchange aren’t the same thing, and it’s not likely that some idiot in government discovered the whole concept of money without having experienced it. It’s More likely someone realized that they could proclaim a token equal to money and force soldiers to accept it, thus giving such coins wide exposure.

        Nothing much has changed since then.

        There is absolutely no historical or anthropological evidence for the Austrian fable that the advantages of coining money were figured out by some brilliant proto-Austrian entrepreneurs in advance of money coinage by governments.

        That’s a new one. Can you provide a reference for that Austrian fable?

  7. Ron,

    “Yes, that circular definition is one of the problems I had in mind, but when you’re creating $1 trillion/year in treasury debt and only about $40 billion/year in Fed Notes, the Fed is not the real problem.”

    We’re not just talking physical paper currency, since 2008 the Fed has created 3 Trillion Dollars out of thin air. QE at $85 Billion per month is how much?

    A balance sheet transaction, initially used to buy up a bunch of mortgage-backed securities mostly. It is a risky move, but not one that will spur inflation unless that money is actually allowed to enter the economy, which they’re not dumb enough to do.

    That makes a world of difference, Sprewell. Fees from member banks is money that already exists. It isn’t made up out of thin air.

    There would be no new money if existing money came from fees from member banks. That’s just taking it with one hand and putting it back with the other. There’s no increase in the money supply.

    You’re not following. Say they set aside $50 billion in existing currency from their member banks, then they use it to buy the equivalent in treasuries. That $50 billion is out in the economy now. Finally, they keep those treasuries on the books and issue $50 billion in new Fed Notes to the same member banks who paid in the fees, to be loaned out or whatever. You’ve now created $50 billion in new currency, as the original $50 billion is gone. The alternative is to just create the new currency and go out and buy treasuries with it, which is what they do now. I’m not sure it makes a difference which way they do it.

    “No individual bank can loan “multiples of the original amount,” that’s a number that’s come up with in the aggregate from all the banks.”

    Whether there is one bank or a million banks, a 10% fractional reserve requiirement means a banking entity can loan 90% of the money in its demand deposit accounts, and must keep only 10% on hand to cover withdrawals.

    For example if ten people each deposit $100 in their checking accounts, the bank has $1000 on deposit… That is $9000 with NO backing, which is being juggled in the air.

    Yes, I’m well aware of how fractional reserve works, the specific numerical example was unnecessary. First of all, in your hypothetical example, for the full multiplier to take effect, all the cash has to end up in reserves eventually. This does not happen: fully half of all Fed Notes in existence are held abroad. Most of the rest is held in people’s wallets or private vaults. Until late 2008, the Fed only held about $10 billion in ongoing reserves on average during the prior decade. I’ll also note that the 10% requirement only applies if the bank has short-term deposits of more than $90 million, which many small banks won’t have.

    The part you’re missing is that when a bank loans out that deposit money or buys real estate or bonds, it is better to think of that new money as being backed by those loans/real estate/bonds. The new multiplier money is not backed by nothing, there are real assets held by the bank. The problems occur in a speculative bubble, when many of those assets are overpriced, but they’re certainly not nothing.

    Yes they can, and that means banks are setting their own MARKET reserve rate, which is a lower ratio than the Fed requires. Of course it helps that the Fed is currently paying interest on excess reserves, so why risk loaning money when you have a rock solid guarantee from the Fed? Banks are being paid not to loan money, while at the same time being demonized for not doing so.

    Why do you think the Fed is paying interest on excess reserves? Could it be that Bernanke didn’t want that money to enter the economy? I suggest you look at the assets he bought with those excess reserves, that’s where he made his moves. The reserves themselves are not important as long as they don’t enter the economy, which he didn’t allow.

    “That additional amount from the fractional-reserve multiplier is also backed by the assets of the bank, which range from real estate to bonds, the assets they’ll have to liquidate if they need to.”

    No it isn’t. Non-liquid assets are not available to redeem withdrawals from demand deposit accounts, only cash reserves. If you write a $100 check against your $150 balance would you expect to be told that it will be honored when the bank has sold some real estate or called in some loans early?

    It is easy for the bank to borrow cash from other banks short-term while they liquidate some assets. It is true that if every depositor tried to pull out their deposits as cash at once, it would not be possible to pay them all out, but that never happens. The point is that just as the Fed creates the initial $1000 in your example above by backing it with $1000 in treasuries that they buy, the banks create the multiplied amount, whether $4k or $9k, by backing it in the various assets they buy and put on their books.

    “And why did they trust gold? Because they started off trading chickens and found over time that gold had scarcity and value and could be traded well.”

    You are assuming your premise. How did people find that gold had value?

    You’re using that phrase wrong, just like morg. :)

    Well, I won’t keep you in suspense, I’ll tell you: gold has all the characteristics of good money, except perhaps #1. Historically gold had few practical uses except for ornamentation – pretty bling. And eventually, of course, as an outstanding roofing material. We needn’t consider very recent uses in electronics.

    Nothing here contradicts what I said, which is that gold had some good qualities that allowed it to earn trust over time. If you think people sat down and enumerated these qualities in a list and simply decided to all trust gold because of your list, I’d like to have what you’re smoking. ;)

    But lets look at your list:

    1. Utility and value.

    This is actually crucial, because it means that if everybody else decides not to use your currency anymore, you can still use it for something yourself. This is one of the main reasons digital barter will take off.

    2. Portability.

    Gold actually isn’t that portable and with electronic options nowadays, all physical currency is outmoded. But yeah, gold was better than chickens! :)

    3. Indestructibility.

    Not sure this is that relevant nowadays, it’s not like paper notes are that robust.

    4. Homogeneity.

    This has actually always been a big problem for gold, adulteration, but not really a problem for new electronic methods.

    5. Divisibility.

    How do you divide a gold coin? Bitcoin and other electronic options are divisible into minute amounts.

    6. Stability of value.

    Probably one of the key benefits of gold, because it was tough to dig up some more. Of course there would always be a new find somewhere eventually and then a bunch of new gold would rush into the market.

    7. Cognizability.

    Bite it? ;) Easily solved by new electronic methods.

    While chickens might have worked to some degree they lacked numbers 3, 4, and 5, and to some degree #2.

    While gold has some of the qualities in your list, it’s not as good as new electronic options, whether bitcoin or digital barter.

    “I’m not sure they ever had much control, considering how much power private banks have in a fractional-reserve system, but yes, what little they had is about to disappear.”

    What? Banks are the most government regulated businesses around. Government controls the value of the dollar, the amount available, required reserve ratios, interest rates, and through fiscal policy, how much of our own money we can spend on our own choices. At every turn government makes us explain our economic transactions, the source of our money, and why we think we should get to keep some of the fruits of our labor. With Bitcoin, we have none of that.

    The Fed, not the govt, tries to influence the value of the dollar and has some control on the other monetary factors you list, big difference. As for fiscal policy, c’mon, that’s not control of the currency, but we agree that that is the much greater concern than any of these monetary issues, as I noted with the much larger federal deficit and debt. I don’t see how Bitcoin gets the govt off your back of filling out tax returns. Trust me, they will come after that online currency too.

    I didn’t mean easier to visualize than dollars, I mean easier to visualize than it is now. I have no idea what the price of anything is in Bitcoins, but I usually have a general idea how many dollars I must exchange for a good or service. That allows me to measure a new car, for example, in terms of the opportunity costs. How many ice cream cones do I have to give up to buy a new car?

    Oh, I thought you meant Bitcoin would somehow be better than dollars. As for opportunity costs, which is probably how most people make actual decisions, ie by translating to cones or hours worked, see below.

    I don’t see an advantage, and I don’t think it would work. All values are subjective, and every transaction is almost unique. Why go to all that trouble to avoid a common measuring tape that has served so well for most of human history.

    Wait, everything is subjective and unique, but it’s possible to have “a common measuring tape… for most of human history?” Seems contradictory. :)

    You might as well suggest abandoning any system of weights and measures, as you can always measure your commute to work in terms of trips to the bathroom, or Sprewell lengths, if you prefer. Why keep using using those old fashioned feet and miles when we have all this computer power att our disposal?

    Yep, exactly my point. :) I’ll note that you can even take new currencies or digital barter out of the picture and this is what’s going to happen anyway. Everybody is going to have prices presented to them in the way they prefer. For example, if you get paid a flat $10 hourly wage, you will be able to have all prices show up on your smartphone or amazon in hours of work, ie that $30 set of speakers will show up as 3 hours of work on the screen. :) Others might choose Big Macs or ice cream cones or whatever unit of measure makes the most sense to them.

    This is how people actually calculate value in their head, not by using dollars, even today. Such customization of how “prices” are shown to the customer, by doing the calculation for them, is the future regardless of what underlying currency is used to complete the transaction, but this change will also enable swapping out the dollar with Bitcoin or digital barter. Whether people will do the same with their bathroom scales and odometers is yet to be seen. ;)

    Heh! As far as I can see, convenience a good reason to keep it. Why create a completely new equivilence with each new transaction?

    I went over a bunch of reasons in the linked comment above.

    Sprewell, Using a medium of exchange replaced barter because it is so much easier and more convenient. That doesn’t change just because you have enormous computer power. Barter will ALWAYS be more difficult than using money, no matter how you process it. Why use it for a cumbersome system that was replaced by something much better millennia ago?

    Because any system online is going to be much more convenient than what came before, and digital barter has a bunch more benefits which are now feasible, because of computer power and more importantly because of the widespread availability of the internet anywhere you go. Barter was only more cumbersome because we didn’t have this tech back then, but now it’s actually better. :)

    “If you buy 3 apples for $1.50 and I buy 5 plums for the same price and we trade the fruit with each other, they’re still worth whatever we traded to each other regardless of the dollars used to buy them.”

    You have just used dollars to compare the value of apples to plums, and that’s the whole point! We each know how to value apples to plums, a completely subjective and individual valuation, because we both know our own values for those things expressed in dollars.

    No, I mentioned the dollars in the example only to point out that they’re irrelevant. I didn’t say how many apples and plums we traded with each other: maybe we traded one apple for one plum, as that’s what they were worth to us at that moment. My point is that the relative value of an apple to a plum is not determined by the dollar amounts, the dollar amounts are merely a way of communicating that relative amount, one that is unnecessary when we’re straight up trading fruit. We have much better ways of calculating and communicating all those relative valuations, now that we have the power of the internet and computers at our fingertips everywhere we go.

    “In other words, dollars are merely a marker to communicate value…”

    And a very good one at that.

    We’ve been over all this before, when we talked about this last summer. Historically, paper currency or credit cards were superior to the alternatives. They aren’t anymore.

  8. Sprewell

    Why do you presume that velocity itself can’t change and affect the other factors? Simply because it is difficult to measure?

    Velocity isn’t at all difficult to measure, it’s difficult to describe as something meaningful.

    The ‘quantity theory of money’ is a mechanical explanation for the relationship of transactions, price, and the money supply popularized by Irving fisher in the early 20th century. It has no practical application in the real world, but is ,merely a fun way to transpose several economic factors.

    The equation MV=PT is a common expression of those relationships.

    All transactions – T times prices – P divided by the money supply – M e1uals velocity – V.

    In other words PT = GDP. So GDP divided by the money supply = V.

    So what? V is derived from the other 3 factors, and has no life of its own. Can you define V in any meaningful way other than to say “it’s the number of times a unit of money must be used in a period of time to produce PT.

    When a dollar changes hands, it always moves one step in the opposite direction of some good or service in an exchange. The velocity of money can’t increase unless the number of transactions increases.

    If you missed it in my comment to Greg, here’s the best explanation I’ve ever read.

    • Since you linked that piece yet again, I finally read it. Some worthwhile stuff, a bit that’s confused.

      As I noted in my original comment in this thread, I think the Fisher equation is too simplistic, and precisely for the reason Hazlitt gave in his essay. Velocity was obviously devised as a fudge factor and as he notes, used in exactly that way historically, to explain away times when an increase in the money supply didn’t lead to inflation. However, rather than say it’s a worthless concept, I’d say it’s useful as an indicator of something like “the changed valuation by individuals of either goods or money or both,” the phenomenon that he thinks is worthwhile. He does raise a good point that increased velocity can also lead to a speculative fall in prices, which those using the equation don’t account for. The biggest problem with the equation is that it’s vague, with the terms not precisely defined or thought through.

      The main part I didn’t like is his last paragraph, particularly this line, “When people value money less in relation to goods, they offer more money for goods; when they value it more in relation to goods, they offer less money for goods.” First, if one used his own standards in the essay, obviously “people” don’t value money less or there wouldn’t be any sellers willing to take the money. But leaving aside that logical twit, nobody actually “values” money, they value whether it can buy them more goods later or now. Inflationary periods can best be thought of as a bidding war, when many people really value buying certain or many goods right away. Good examples would be the recent housing bubble or the following commodities bubble that pushed oil prices sky high. In a hyperinflation, it is often because they are awash with more and more printed money, but I don’t think the money supply is usually or necessarily the main factor otherwise.

      It’d be more accurate to say that the buyers value the work they’ve done in the past, and in today’s world awash in debt, the work they’ll do in the future less than whatever goods and services they’re bidding for at that moment. Money is merely the marker and an arbitrary one at that, as it’s somewhat meaningless whether a burger costs $5 or $50 in dollars. It’s all about relative valuation to every other good and service.

      Good think digital barter will get rid of these worthless markers altogether. ;)

    • Sprewell

      You are right, the Fisherine equation is too simplistic. there is no direct mechanical link among the factors.

      My point is that velocity can’t be used independently of the other variables and have any independent meaning. It is a derivative.

      I’d say it’s useful as an indicator of something like “the changed valuation by individuals of either goods or money or both,” the phenomenon that he thinks is worthwhile.

      The indicator of valuation of goods in terms of other goods, or goods in terms of money, or money in terms of goods is called the ‘price’.

      He does raise a good point that increased velocity can also lead to a speculative fall in prices, which those using the equation don’t account for.

      I don’t see how increased velocity can lead to lower prices, as increased velocity can only occur with an increased number of transactions, which is generally a RESULT of lower prices due to changes in supply and/or demand.

      The biggest problem with the equation is that it’s vague, with the terms not precisely defined or thought through.

      I think the biggest problem with the equation is that it produces no useful results in the real world. It’s easy to define M, P, and T, and therefore V. What useful thing can I do with this equation?

      The main part I didn’t like is his last paragraph, particularly this line, “When people value money less in relation to goods, they offer more money for goods; when they value it more in relation to goods, they offer less money for goods.” First, if one used his own standards in the essay, obviously “people” don’t value money less or there wouldn’t be any sellers willing to take the money.

      I find it helpful to think of money as just one more commodity that can be used as an indirect trade good, just like wheat, oil, gold, or chickens.

      With that view I could say:

      ““When people value money (chickens or oil or gold or wheat) less in relation to other goods, they offer more money (chickens or oil or gold or wheat) for other goods; when they value (those things) more in relation to other goods, they offer less/fewer money of (those things) for other goods.”

      Money is just one side of an exchange. You could say you are buying money with chickens, depending on which side of the exchange you’re on.

      But leaving aside that logical twit, nobody actually “values” money, they value whether it can buy them more goods later or now.”

      People “value” money in the same sense they “value” any other trade good. how many chickens can I exchange for a dollar (a convenient unit of measure for money), or how many dollars can I exchange for a chicken. The one I give in exchange is the one I want less than the one I get.

      The measure of people’s preference for consuming now as opposed to deferring consumption for later is generally known as the ‘interest rate’.

      Inflationary periods can best be thought of as a bidding war, when many people really value buying certain or many goods right away.

      Sort of. When peeople bid more for some goods, they musty bid less for others. ALL prices can’t rise unless there is an increase in the money supply which ultimately causes general monetary inflation.

      Think of a Big Mac, which is essentially the same today as the one you could get 20 years ago, yet it costs twice what it did 20 years ago (please don’t pick on that number, I just made it up to illustrate a point).

      If anything, we would expect the price of a Big Mac to go down due to improvements in productivity over that period. The price increase is due to an ever increasing money supply relative to the general demand for money, which has caused us to value each dollar less.

      Good examples would be the recent housing bubble or the following commodities bubble that pushed oil prices sky high.”

      The recent housing bubble was caused by a number of factors, but one of the most important was the broken signal between consumers and producers due to artificially low interest rates. The excess money created will go somewhere, and it may not be where it would be used most productively. In this case it went into the housing market, creating artificial demand and higher prices. Ultimately people can believe that prices can only go up.

      In a hyperinflation, it is often because they are awash with more and more printed money, but I don’t think the money supply is usually or necessarily the main factor otherwise.

      In a hyperinflation, people have come to distrust the currency and believe it will continue to lose value, so they do everything they can to exchange it for something of value as soon as they possibly can. It’s like a hot potato. As government continues to print ever more to cover its expenses, the currency becomes worthless.

      Money is merely the marker and an arbitrary one at that, as it’s somewhat meaningless whether a burger costs $5 or $50 in dollars. It’s all about relative valuation to every other good and service.

      That’s absolutely correct. However, a continually increasing supply of money reduces the value of each dollar, causes prices to rise, and modifies people’s expectations and behavior.

    • You are right, the Fisherine equation is too simplistic. there is no direct mechanical link among the factors.

      Turns out the concept is actually from Hume, through J.S. Mill, Fisher merely wrote it down algebraically.

      My point is that velocity can’t be used independently of the other variables and have any independent meaning. It is a derivative.

      No, that’s the way velocity may commonly be used and abused, but it does have its own meaning and use.

      The indicator of valuation of goods in terms of other goods, or goods in terms of money, or money in terms of goods is called the ‘price’.

      Price change is one possible result, it is not the only one. Here’s an example, using your favored gold-backed currency. Let’s say a private bank bought a cache of gold and then issued a bunch of currency backed by that gold to J.P. Morgan. By definition, the money supply has increased. But suppose Morgan thought the market was overpriced and sat on that money for years. As a result, prices are not affected all. How does one explain this? The money supply has gone up, but it has no effect on prices.

      Well, in the equation, velocity has gone down, by definition, as the turnover of existing currency units stayed whatever it was before but the amount of currency increased, and since you divide the former by the latter to get velocity, velocity went down. This is what happens sometimes, the money supply goes up but because there’s not much commercial activity going on, often because of a recession, it doesn’t affect prices much. Velocity refers to that independent activity of slowing or rising commerce.

      I don’t see how increased velocity can lead to lower prices, as increased velocity can only occur with an increased number of transactions, which is generally a RESULT of lower prices due to changes in supply and/or demand.

      The cause-effect goes both ways: Hazlitt uses 1929 as his historical example in your linked essay.

      I think the biggest problem with the equation is that it produces no useful results in the real world. It’s easy to define M, P, and T, and therefore V. What useful thing can I do with this equation?

      It gives us a simplified framework to think about how the money supply and increased commercial activity, ie velocity, affect prices. The problems occur when people confuse this simplified map for the terrain, ie taking the equation far too seriously.

      I find it helpful to think of money as just one more commodity that can be used as an indirect trade good, just like wheat, oil, gold, or chickens.

      With that view I could say:

      ““When people value money (chickens or oil or gold or wheat) less in relation to other goods, they offer more money (chickens or oil or gold or wheat) for other goods; when they value (those things) more in relation to other goods, they offer less/fewer money of (those things) for other goods.”

      Money is just one side of an exchange. You could say you are buying money with chickens, depending on which side of the exchange you’re on.

      That is one viewpoint, which I don’t find particularly helpful. I prefer Fischer Black:

      “I think that the price level and the rate of inflation are literally indeterminate. They are whatever people think they will be. They are determined by expectations, but expectations follow no rational rules. If people believe that certain changes in the money stock will cause changes in the rate of inflation, that may well happen, because their expectations will be built into their long term contracts.”

      Read the entire essay, it’s a classic.

      The problems occur because the relative value of one good for another, whether buying cows using chickens or dollars, is fairly arbitrary and subjective. It is even more so with currency than with chickens, and completely arbitrary with a fiat currency. Whether we all choose to pay $5 or $50 for a Big Mac is completely up to us in our heads, ie the price level in dollars is completely arbitrary as long as the relative valuations stay about the same, regardless of whether the money supply has increased or not. Therefore, there come times where we fairly arbitrarily decide to pay more or less for the same goods: we call these periods inflation and deflation. The size of the money supply is one factor in these episodes, but it is not the only or necessarily most important factor.

      People “value” money in the same sense they “value” any other trade good. how many chickens can I exchange for a dollar (a convenient unit of measure for money), or how many dollars can I exchange for a chicken. The one I give in exchange is the one I want less than the one I get.

      The problem is that chickens have actually utility and value, whereas Fed Notes don’t. Since subjective valuation is a big factor, even with chickens, this means that inflationary jumps are fairly arbitrary.

      The measure of people’s preference for consuming now as opposed to deferring consumption for later is generally known as the ‘interest rate’.

      Thanks for stating the obvious: interest rates are determined off of the baseline of current or expected inflation, which is what we were actually discussing, ie you can’t know the interest rate without determining inflation first.

      “Inflationary periods can best be thought of as a bidding war, when many people really value buying certain or many goods right away.”

      Sort of. When peeople bid more for some goods, they musty bid less for others. ALL prices can’t rise unless there is an increase in the money supply which ultimately causes general monetary inflation.

      Wrong, you can have inflation even with a decreasing money supply. You may have been right when there were no banks, but it certainly isn’t the case today.

      Think of a Big Mac, which is essentially the same today as the one you could get 20 years ago, yet it costs twice what it did 20 years ago (please don’t pick on that number, I just made it up to illustrate a point).

      If anything, we would expect the price of a Big Mac to go down due to improvements in productivity over that period. The price increase is due to an ever increasing money supply relative to the general demand for money, which has caused us to value each dollar less.

      The money supply is one factor in long-term inflation, it is not the only one.

      The recent housing bubble was caused by a number of factors, but one of the most important was the broken signal between consumers and producers due to artificially low interest rates. The excess money created will go somewhere, and it may not be where it would be used most productively. In this case it went into the housing market, creating artificial demand and higher prices. Ultimately people can believe that prices can only go up.

      The money supply was a negligible factor in the recent bubbles. The global savings glut was a much bigger factor.

      That’s absolutely correct. However, a continually increasing supply of money reduces the value of each dollar, causes prices to rise, and modifies people’s expectations and behavior.

      Not necessarily. It depends on how that money is backed.

      • Sprewell

        I am rapidly loosing interest in this discussion due to frustration with my apparent inability to communicate concepts to you in a way that you understand. I will respond to some of your last comment now, and more later – maybe.

        No, that’s the way velocity may commonly be used and abused, but it does have its own meaning and use.

        Then I challenge you to define “velocity” without using the terms “price”, ” transactions” or “money supply”. I can define any of those three without using the term “velocity”, but not the term velocity itself. It’s a derivative. It doesn’t stand alone and has no independent meaning.

        Price change is one possible result, it is not the only one

        No, not “price change”, but “price”.

        You wrote: ““ I’d say it’s useful as an indicator of something like “the changed valuation by individuals of either goods or money or both,” the phenomenon that he thinks is worthwhile.

        Referring, I assume to Velocity.

        I responded: “The indicator of valuation of goods in terms of other goods, or goods in terms of money, or money in terms of goods is called the ‘price’..”

        Meaning we have no need for another term to describe the relationships of valuation between goods, as we already have a term – price – which works really well.

        Here’s an example, using your favored gold-backed currency. Let’s say a private bank bought a cache of gold and then issued a bunch of currency backed by that gold to J.P. Morgan.”

        What did they buy it with?

        By definition, the money supply has increased.

        Only if the issuing bank created it out of thin air.

        But suppose Morgan thought the market was overpriced and sat on that money for years. As a result, prices are not affected all.

        The money supply is unchanged unless the issuing bank created the money out of thin air, but you said they bought gold to back their currency.

        Morgan *holding* the money, which is equal to the gold, which is equal to whatever the bank paid for the gold with, effectively *decreases* the available money supply, causing lower prices.

        How does one explain this? The money supply has gone up, but it has no effect on prices.

        I just explained it.

        The money must be used in exchange to affect prices. I could print up a bunch $100 bills in my basement, and keep them in a closet, and they wouldn’t affect prices at all. Only when I exchanged them for goods and services would prices rise due to the greater availability of money compares to the availability of goods and services. It is the available supply of money that matters. There is no mechanical link.

        In my chickens as money example I think it would be perfectly clear that if government controlled the supply of chickens, increasing the supply of chickens would decrease the value of each chicken in terms of other goods. Flooding the economy with chickens would mean other things would cost more chickens. It’s no different with money.

        Well, in the equation, velocity has gone down, by definition, as the turnover of existing currency units stayed whatever it was before but the amount of currency increased, and since you divide the former by the latter to get velocity, velocity went down.

        Yes, each individual dollar was used less frequently in a given time period. So what? What’s the point, Sprewell? What’s the effing point?

        This is what happens sometimes, the money supply goes up but because there’s not much commercial activity going on, often because of a recession, it doesn’t affect prices much.

        The money supply goes up when the Fed increases the supply, or changes bank reserve requirements.

        Velocity refers to that independent activity of slowing or rising commerce.

        No, that’s GDP. (=PT) A change in velocity can’t occur without a change in =PT/M. P, T, or M must change to change velocity. It is a derivative.

        I read the Fischer Black Piece, and may comment on it later.

        Meanwhile, I will return the favor and recommend some additional reading for you:

        Henry Hazlitt:
        - “Economics In One Lesson”
        - “What You Should Know About Inflation”

        Murray Rothbard:
        - “What Has Government Done To Our Money”

        All are available at Amazon, and are short, informative reads.. I didn’t use links to avoid CD spam filter.

      • I am rapidly loosing interest in this discussion due to frustration with my apparent inability to communicate concepts to you in a way that you understand. I will respond to some of your last comment now, and more later – maybe.

        Lol, I’ve had no problem understanding your concepts, as I’ve then pointed out flaws in your reasoning. You, on the other hand, keep needing to be explained the same thing over again.

        “No, that’s the way velocity may commonly be used and abused, but it does have its own meaning and use.”

        Then I challenge you to define “velocity” without using the terms “price”, ” transactions” or “money supply”. I can define any of those three without using the term “velocity”, but not the term velocity itself. It’s a derivative. It doesn’t stand alone and has no independent meaning.

        It’s in the wikipedia link above, “the average frequency with which a unit of money is spent.” :) The reason velocity is often defined in terms of the others is that, contrary to what you wrote above, it is incredibly difficult to measure. So it’s often used as a fudge factor, since it’s difficult to figure out what it actually is at any given moment, but that doesn’t mean it isn’t a worthwhile concept that has real meaning, contrary to whatever you’re reading or claiming.

        I’ll also note that the two left-hand terms, M and V, are much easier understood and more salient concepts than the two on the right, P and T. The price level? What the hell does such a worthless aggregate mean and how the hell do you propose to measure it? T is perhaps the vaguest of all the terms and has all the problems of P.

        “Price change is one possible result, it is not the only one”

        No, not “price change”, but “price”.

        You can’t figure out “the changed valuation by individuals of either goods or money or both” through price, it takes a price change to track such a change in valuation.

        You wrote: ““ I’d say it’s useful as an indicator of something like “the changed valuation by individuals of either goods or money or both,” the phenomenon that he thinks is worthwhile.”

        Referring, I assume to Velocity.

        Of course, it’s in the previous sentence.

        I responded: “The indicator of valuation of goods in terms of other goods, or goods in terms of money, or money in terms of goods is called the ‘price’..”

        Meaning we have no need for another term to describe the relationships of valuation between goods, as we already have a term – price – which works really well.

        Sigh, I explained and gave you a specific example of when a decrease in velocity may not show up in price changes at all.

        Here’s an example, using your favored gold-backed currency. Let’s say a private bank bought a cache of gold and then issued a bunch of currency backed by that gold to J.P. Morgan.”

        What did they buy it with?

        What does it matter? It could be anything. All that matters is that they acquired a cache of gold that wasn’t backing any currency and then issued new currency backed by it.

        “By definition, the money supply has increased.”

        Only if the issuing bank created it out of thin air.

        “But suppose Morgan thought the market was overpriced and sat on that money for years. As a result, prices are not affected all.”

        The money supply is unchanged unless the issuing bank created the money out of thin air, but you said they bought gold to back their currency.

        Sigh, now you’re going to redefine gold as part of the money supply, ignoring the fact that almost nobody will accept gold as payment and nobody will do so without first translating it into its dollar value. OK, if you’re going to make such a claim, change the example to cows. The bank buys a bunch of cows and then issues dollars to Morgan backed by those cows, ie he can always trade those dollars back in for the cows when he wants. New money is created, but because Morgan doesn’t spend it, velocity goes down and prices aren’t affected.

        Morgan *holding* the money, which is equal to the gold, which is equal to whatever the bank paid for the gold with, effectively *decreases* the available money supply, causing lower prices.

        Yes, this is the point of the example, :) to show that a decrease in velocity effectively decreases the money supply, even if new money is created. That’s why the two variables can counteract each other in the equation. You’re finally getting it, Ron. :D

        “How does one explain this? The money supply has gone up, but it has no effect on prices.”

        I just explained it.

        The money must be used in exchange to affect prices. I could print up a bunch $100 bills in my basement, and keep them in a closet, and they wouldn’t affect prices at all. Only when I exchanged them for goods and services would prices rise due to the greater availability of money compares to the availability of goods and services. It is the available supply of money that matters. There is no mechanical link.

        Well, you just explained the whole point of velocity to yourself, congratulations. Unless you’re trying to say that M is only “the only available supply of money,” which you’re now weirdly redefining to not include cash held under mattresses. In which case, you’re merely playing logical games with yourself.

        Who said there was “a mechanical link?” You keep repeating that term when nobody brought it up.

        In my chickens as money example I think it would be perfectly clear that if government controlled the supply of chickens, increasing the supply of chickens would decrease the value of each chicken in terms of other goods. Flooding the economy with chickens would mean other things would cost more chickens. It’s no different with money.

        It is different because the value of chickens is determined by their actual utility for consumption, whereas money is merely used as a token for exchange. As long as the new money is backed by goods with value, creating some more need not mean the existing supply loses value at all.

        “Well, in the equation, velocity has gone down, by definition, as the turnover of existing currency units stayed whatever it was before but the amount of currency increased, and since you divide the former by the latter to get velocity, velocity went down.”

        Yes, each individual dollar was used less frequently in a given time period. So what? What’s the point, Sprewell? What’s the effing point?

        I believe you just explained it to yourself above, :) it decreased the available money supply and so prices were not affected. Funny how you have no trouble defining velocity yourself here (“each individual dollar was used less frequently in a given time period”), yet you asked me to define it for you in the beginning of this comment. :D

        “This is what happens sometimes, the money supply goes up but because there’s not much commercial activity going on, often because of a recession, it doesn’t affect prices much.”

        The money supply goes up when the Fed increases the supply, or changes bank reserve requirements.

        Thank you for stating the obvious: what does this have to do with the comment I made?

        “Velocity refers to that independent activity of slowing or rising commerce.”

        No, that’s GDP. (=PT) A change in velocity can’t occur without a change in =PT/M. P, T, or M must change to change velocity. It is a derivative.

        That’s how it’s often calculated, because it’s difficult to measure on its own. You are conflating that difficulty in measurement with V not having any independent meaning, despite having no problem with such a concept in the example I gave. Your explanation for why it is a “derivative” is algebraically idiotic. V, T, or P must change for M to change: is M therefore merely derivative?

        I read the Fischer Black Piece, and may comment on it later.

        Meanwhile, I will return the favor and recommend some additional reading for you:

        Henry Hazlitt:
        - “Economics In One Lesson”
        - “What You Should Know About Inflation”

        Murray Rothbard:
        - “What Has Government Done To Our Money”

        All are available at Amazon, and are short, informative reads.. I didn’t use links to avoid CD spam filter.

        Hazlitt and Rothbard have worthwhile things to say, but I suspect their views on inflation were limited by their time and ideology. The spur for this discussion was that Friedman himself walked back from his “always and everywhere a monetary phenomenon” statement as he aged, as he realized that expectations, velocity and other factors were perhaps more important. Perhaps Hazlitt and Rothbard didn’t live long enough to change their minds too. I suggest you actually grapple with these issues, rather than simply repeating phrases from their works.

  9. Ron

    ___”In other words, you have no idea why banks aren’t lending.”

    Apparently you missed this:

    “The main problem is just that there aren’t many qualified borrowers looking for funds compared to the funds on reserve. It used to be that our biggest and most innovative firms were big borrowers. Today they are lenders with huge stores of cash. And consumers don’t have the ability to borrow a lot more because they are already carrying a lot of debt.”

    Now you might not agree with that but you will have to explain to me why you think it is not an idea.

    You will also have to explain to me who these people are who fail to realize that goods and services circulate around the economy with the money that pays for them. WHO ARE THEY? Where do they say that? Can you name even one that you can support with a quote? If people are really saying that I will be happy to join you in calling them idiots. It’s just that I’ve never heard of a real person who actually believed that.

    Your objections to appeals to economic complexity are deeply ironic. Hayek was the best Austrian economist and his main theme was how complex the economy is and how it is comprised of such a vast array of decentralized knowledge. And how the effects of policies could not be accurately predicted. He was brilliant on the topic. I don’t think you will be able to show me where he ever thought Austrian economists could accurately predict future economic events.

    A cyclical economy will be cyclical. That’s a tautology, not a prediction. You need to specify a time frame to make a real prediction.

    Austrian economics is the chiropractics of economics. Same diagnosis and treatment for every problem.

    • Greg

      “The main problem is just that there aren’t many qualified borrowers looking for funds compared to the funds on reserve. It used to be that our biggest and most innovative firms were big borrowers. Today they are lenders with huge stores of cash. And consumers don’t have the ability to borrow a lot more because they are already carrying a lot of debt.

      No, I didn’t miss it, but it doesn’t attempt to explain WHY the biggest and most innovative firms are holding cash instead of borrowing, or WHY consumers are carrying so much debt, and it especially doesn’t explain WHY, if those things are true, the Fed has continued to pump MORE money and credit into the economy for so long, when that appears to be the very cause of the problem in the first place.

      When your dog starts eating less, your best bet might be to investigate WHY he is eating less, rather than just feeding him more to make up for it.

      You’re welcome to try again.

      Now you might not agree with that but you will have to explain to me why you think it is not an idea.

      You will also have to explain to me who these people are who fail to realize that goods and services circulate around the economy with the money that pays for them. WHO ARE THEY?

      Well, I won’t “have to” explain, but I will.

      Members of the general public, and the pundits that provide them with relatively useless information MAY not understand the concept of goods and services ‘circulating’ in lock step with the money that is exchanged for them, because in my experience, they never SAY it. It is common to hear people say that money ‘circulates’, or is ‘in circulation’, as if it were a constant flow rather than a series of discrete steps, but I NEVER, except in discussions like this one, hear or read anyone refer to goods and services “circulating’.

      Visualizing money as “flowing”, allows people to discuss the “velocity” of that flow, as if it meant something, while ignoring the equal and opposite “flow” of goods and services, and never discussing the “velocity” of those goods and services.

      It’s not that anyone believes goods and services DON’T circulate, it’s just an awkward and not very useful concept.

      I prefer that neither money, nor goods be described as circulating, but as you pointed out, we are stuck with that conventional language. I use it because I must. I don’t wish to have this entire discussion every time the subject comes up in conversation, which it does fairly regularly.

      Your objections to appeals to economic complexity are deeply ironic.

      Not at all. My objection is to those, including you, who support the notion that velocity is some important concept, and who throw out “Oh, it’s complicated” in what appears to be a cover for the fact that you don’t have a good answer.

      What is truly ironic is you using Hayek for support, when his economics is, in almost every instance, diametrically opposite to yours.

      Hayek was the best Austrian economist and his main theme was how complex the economy is and how it is comprised of such a vast array of decentralized knowledge. And how the effects of policies could not be accurately predicted. He was brilliant on the topic. I don’t think you will be able to show me where he ever thought Austrian economists could accurately predict future economic events.

      Hayek was great. Hopefully you understand that your accurate characterization of Hayek is a refutation of central planning and government involvement in the economy. Now THAT’S irony. You couldn’t have picked many less likely figures as support, except Rothbard, Mises, or Menger perhaps.

      Of course the economy is complex – everyone knows that, and that’s the whole point of why central planners and policy makers, no matter how smart or well intentioned they are, can’t possibly manage as well as individuals pursuing their own interests can.

      Velocity, however, isn’t one of those complicated things. What did Hayek tell you about “velocity”?

      A cyclical economy will be cyclical. That’s a tautology, not a prediction.

      And Hayek observed that historically, business cycle booms and busts were almost invariably caused by manipulation by government.

      You need to specify a time frame to make a real prediction.

      Some things are just so obvious as to need no explanation. Austrian theory, based as it is on the study of individual human actions, can predict pretty well what individual actors will do in various circumstances. For example people will borrow more when interest rates are low, based on their time preference. Therefore, Austrians can predict that if the Fed keeps interest rates artificially low for a long time, people will accumulate a lot of debt, and producers will be fooled into thinking that the low interest rate represents a high rate of savings, and will, therefore, over invest in means of production. Since the apparent high demand isn’t real, the excess money created will find the path of least resistance, and create a bubble in some part of the economy. In the late ’90s it was equities. In the mid ’00s it was housing.

      At some point, the mis-allocation of resources caused by broken market signals due meddling, will reach a point at which it can no longer be sustained, and there will be a crash. Any one with a reasonable understanding of basic economics, which would include all Austrians, can understand those things clearly, and could therefore predict that the good times would end with a crash and a necessary correction.

      It may bother you that no one could predict an exact date, but that’s just not possible, even for Austrians. The economy IS complicated, because there are so many individual moving parts, but the basics are pretty easy.

      If you disagree, then ask yourself why, if they are so effing smart, the Fed whose job it is to prevent these ups and downs, along with other moneterists and Keynesians, didn’t see the predictable result of their actions and change course.

      I expect the answer is “Oh, it’s complicated”. Read: “We don’t know the answer”.

      Austrians economics is the chiropractics of economics. Same diagnosis and treatment for every problem.

      Yes. Keep your meddling hands out of the economy, and it will regulate itself. Too simple for you?

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