Posted on 03/10/2008 6:15:48 PM PDT by shrinkermd
If you own debts of entities that were sound before and still are after, then the value will not increase, because you deliberately contracted away such upsides to your counterparty when you agreed on the debt form.
If, on the other hand, as a side effect of the new money creation a business that was going bankrupt does not, and you hold its debts, even debts can increase in value as a result of new credit issuance.
If, a more common case, you own real equity and haven't signed away the upside you will generally see an increase in value - whether it is greater or less than others get will depend on the composition of demand and which sectors you hold etc.
And if you merely own real property or commodities, then timing issues about changes in their price will largely determine whether you gain or lose and how much. If the prices have already moved before you purchased you may gain nothing. If after, you may gain a lot, including in real terms. This arises in all the cases above too, but becomes the dominant factor in this asset type because their prices are typically the most volatile, the least driven by secular non-monetary trends etc.
And it does not matter whether it is the Fed issuing new credit, in any of the above. If I run up credit card debt, the causes and possible effects are exactly the same, just smaller in magnitude for an individual. If business entities increase their acceptance of payables and receivables from each other, the same will occur.
Again, your mistake is in assuming you have any prior right to a given valuation of the capital assets you own. Do what you will, capital is at hazard, and its value will fluctuate with every free economic action by every other economic entity.
"But I choose to hold the most secure forms of debt, and I want those to increase in real value continually, relative to all other commodities and services". Tough toenails, your wants are not your rights, least of all when you demand to pick the asset as well as its future price trajectory. "But I make no such demand!" Sure you do, as soon as you demand that no new fiduciary media shall issue without full commodity cover, because it has that effect.
You can instead as a policy matter, not a means to personal wealth, desire monetary policy to be so conducted, that prices remain broadly stable over the long term. But that is not the previous. One, because it takes continual new issuance of fiduciary media for that to happen - no new issuance would instead lead to a progressive fall in average money prices - and two, because broad price stability is perfectly compatible with violent chances in the shorter term, and most definitely with real gains and losses to you as an owner of capital assets in any form, from monetary causes.
The demand that the value of any of your capital not change as a result of monetary policies, is then a demand that cannot be met, in the nature of the case, and seeking it will entail destroying one economic freedom after another, for other people. Including my credit freedoms, which I am not willing to surrender.
You are the guy who doesn't even know that when the Fed prints (creates, get it) money beyond any expansion of the economy they just picked your pocket. Wake up, grow up and act like an adult.
Palmer has made an excellent point. You must be in some line of business that is dependent upon failing credit of some form and hopes to have it propped up at everyone else’s expense. That is the only reason I can see for your obtuseness.
Try, however, to write in the English language so that the rest of us can understand your arguments.
It does matter. The Fed created its 200B in credit from nothing, whereas your credit card credit came from a bank's capital. I never said my capital was guaranteed to go up or to do anything, all I said is my capital is worth less when credit is created from nothing. Further those of us who aren't in denial know that debts will eventually be monetized, or inflation of the money supply not just new credit.
my credit freedoms
You are free to borrow as much of my capital as you want (at 5%), just not from the Fed at 2%.
This is the Austrian position exactly. It is very simple to understand, it is sound Friedmanian economics, and JasonC is just being obtuse. The really interesting speculation is why he is being obtuse. Which of his oxen are being gored though mal-investment based on believing all of Greenspan's flimflammery.
I'm not a genius, but not an idiot either. This is an unsustainable credit bubble that has created all the symptoms I listed, there is no other explanation. Either the bubble will shrink with recessionary consequences (even a minor writoff of 0.5T of 47T has caused market upheaval), or the Fed will pump the credit higher and inevitably monetize it and destroy the currency. There are no other choices, Mises was right.
I pointed out how sneaky your choice of endpoints are for your definition of a bull market. I don't deny the percentage move, but I'm saying your choice of endpoints is flawed.
I pity you because defending W's economic performance is nearly impossible, which is why you resort to repetition and insults.
Expansion of credit does not pick my pocket. One, because expansion of credit does not always issue in inflation - it can and does, but need not, and other causes also need to operate for it to do so - and two, because inflation does not pick my pocket. I have no prior right to all prices remaining unchanged henceforth forever.
But to see it in its capitalist purest form, if a shopkeeper puts a $1 higher price on an item you wanted yesterday but did not buy, and you walk in the next day and buy it at the higher price, has the shopkeeper picked your pocket? No monetary anything, he just sought a higher profit for himself or wishes to pay his shoegirl more etc.
Have you been robbed? Did you have a right to the lower price yesterday? Should the government come and arrest the shopkeeper for stealing from you? Fix his prices? Outlaw price changes to stamp out such robbery in the future?
You agreed to the price you paid later. You therefore showed to a demonstration that the item was worth more to you all along, than the dollars you parted with to have it. Clearly the shopkeeper prefers the dollars, or he wouldn't let you walk out with his property. You are both therefore more pleased after the voluntary transaction than you were before it, or it doesn't occur.
Do you have a prior right to the extra $1, as well? You do not. There are undoubtedly a whole range of prices at which you would be willing to buy the item. Likewise a whole range of them at which he would sell. Between them, you have a deal, and the haggling between them is not a matter of right to either of you, nor is it a deal breaker, either way, and there is no robbery of any kind involved in a lick of it. You are just dickering over who gets what portion of the *gain* from your trade. You are both gaining our you'd walk, or he'd keep his item.
The freedom to set prices is therefore not a form of robbery. Unless you are clear on that, you won't get any of the rest of it. This principle, socialists deny. And that denial is in the end imcompatible with economic freedom.
None of which is specific to money effects or credit issuance effects.
Prices for some goods will rise naturally in response to changes in the composition of demand. This isn't a form of robbery, it is how the system signals the importance of one item compared to another, and all supporters of economic liberty recognize this. The economy as a whole is solving an *allocation* problem, and it cannot do so with flexibly deploying incentives, to encourage the relief of shortages where they bind the most or to supply first the most urgent requests.
The whole price level can also move, instead of its internal composition changing. This is in principle no different from the previous, and would arise under any monetary system whatever. Because the allocation problem the economy needs to solve, is not a *static* allocation problem, at one snapshot it time. It is a dynamic allocation problem, an intertemporal allocation problem. Some goods now can be traded for other goods later.
The same fluctuations in the composition of demand that can mean more expensive cars and less expensive shoes or the reverse, can mean more expensive items today and less expensive items tomorrow, or the reverse - because their composition at the different times is different, and because intertemporal trades exist. Intertemporal trades are credit and capital transactions.
There is then no a priori reason to expect the price level to remain literally unchanged, if men are free. Without any pockets being picked, and regardless of the monetary system. Nobody has a prior right to an unchanged future price level, and if one tried to enforce such a demand as a supposed requirement of justice by outlawing anything that could disturb it, then no meaningful economic freedom to engage in any credit or capital transactions would survive the procedure. Because every one of them, not just monetary policy actions, changes present and future price levels.
Next we get to gratuitious credit proper. This means the issuance of any debt accepted as full payment for something, without prior commodity cover of the debt issued. When the issuer is a bank this creates money, but that merely reflects the special status market participants afford to bank debts compared to other debts, that they universally accept them. They do so because they are the most liquid asset, everyone being willing to hold a fair portion of them and no one refusing them, in practice.
This bare acceptance implies that the benefit from using money exceeds any costs associated with it, and in that respect shows, already, that claims of robbery in the matter are hyperbole. Bankers don't put guns to your heads demanding that you accept their debts, from them or anyone else. Robbers, in case everyone forgot, do, except for the part about leaving you with anything useful, a debt or anything else.
But the point about credit equivalence is important, because any attempt to outlaw as supposedly unjust, money issuance, because it effects prices in ways some group or other claims are against its interest, could also be directed with the same logic against any other gratuitous credit transaction. They all have the same economic effects. I am not willing to sign over my freedom to engage in such transactions, I deny that my engaging in them picks anyone's pocket, and I consider it slander to say otherwise.
Move on to money issuance specifically. Does it always raise prices? No. One, prices would fall continually in the absence of new money issuance. This would represent a continuing transfer of real wealth to holders of nominal debts. Money issuance up to some level consistent with price stability, would be required to prevent that from happening. In every transfer there are two sides, so if the transfer itself is robbery and illegitimate, then the direction does not matter, only that it occurs at all. Therefore, this position is committed to demanding net new issuance of money, not to forbidding it.
The advocates involved are unclear on the point themselves. Sometimes they pretend that any money creation without commodity cover is ruinous economically, or unfair as a transfer of real value. But technically and practically, it takes some of what they condemn as economically ruinous, to prevent what they condemn as unfair as a transfer.
Lets pass by that and restrict ourselves further, to money issuance sufficient to raise the average price level. First question, how much is that? Can anybody know beforehand? Is there any mechanical relationship between the scale of new money creation and the change in future prices, that could be calculated beforehand and relied upon, to keep the level of prices steady? Answer, no, there is no such mechanical relation. And the level of new money creation required to keep the price level broadly stable, can only be found empirically, by trial and error, by issuing this much or that much and watching what happens to prices, then issuing more or less in response to their signal.
Already this means that any demand, whether of justice or of just practical expediency, that money issuance be regulated to keep future prices broadly stable, requires ongoing continual money issuance by some authority with discretion to change the rate at which new money is added. Denounce any such authority as unjust or as pickpockets, and you much abandon any pretence that monetary policy will be so regulated as to keep future prices stable, since it takes new issuance and adaptive discretion to even try.
No one has a prior right to the results of an elaborate learned art, which doesn't exist in the world at all, natively. Especially not to a perfectionist version of those results. Even if everyone agreed on that goal of policy and everyone conscientiously acted seeking it, it would be but indifferently achieved. No claim in justice would run against the attempters for being human and missing occasionally. But that is an aside - the reality is men also disagree about the goals etc.
Restrict further, now we consider new money issuance sufficient to increase future prices and deliberately sought to do so, and successful in the sense that future prices do rise. Has my pocket been picked, or yours? No. All that has happened is the exchange value of one good, money, has changed compared to the exchange value of all other goods.
Did I have to hold that asset, as the price changed? I did not. If I contracted in that asset as a measurement device, do I have to ignore likely future changes in its price when deciding the terms? No. If e.g. I expect to be paid back in a year for some loan, but expect the value of dollars used to denominate it to fall in the meantime, does this pick my pocket because it runs against me as lender and in favor of the borrower? No.
If I expect 4% changes and require 3% real interest, then I just demand 7% dollar interest from the counterparty. If he agrees with the price change forecast and to the real rate, he will agree. If he does not, it is because we disagree about how much the terms will transfer. If we want the amount to be contingent on price changes, we can stipulate 3% plus reported CPI or whatever other measure we prefer. Or we can denominate the loan in silver, or any other commodity we like, instead of dollars.
Nobody's pocket has been picked.
As a matter of expediency, it might be a good policy to aim at long run price stability in money policy. That isn't the subject being debated. The subject being debated concerns economic rights of private parties and whether they are being violated, not the usefulness of this or that goal for a policy thought of as free to range between alternatives. The claim the other side is advancing is that only one outcome in such matters is just, and that claim is false (as well as largely unachievable in practice, and very dangerous to economic liberties to seek).
Now to the real economic effects of credit issuance. When new loans are deployed economically, they raise the wealth of the society. New capital *value* is actually created. Notice that new physical capital is not required to create new capital values, since rearrangements of use of existing physical capital is perfectly capable of doing so.
Notice also that prior net savings out of income are not required for new capital value to be created. That is one way new capital values can arise certainly, but they can also arise from better use or arrangement causing capital gains to the value of existing resources. Notice further that new savings ill deployed, will evaporate as a capital value, even if new physical capital is created (build an empty building where no one wants it e.g.).
The principle is - when the use of resources brought about by the new command issued by wealth being risked to arrange things in manner X, has greater value than the use of those resources in the old manner Y, then new capital value is created and is quite entirely real. When on the other hand the value of arrangement Y was greater than the value of arrangement X, then capital value is lost. We say, capital was misallocated, the understanding being, that men deploy their capital seeking to increase its value. Strictly, this isn't always a "mis" allocation, because men have a perfect right to consume the value of their capital if they choose to do so - but presumably do not intend mere allocation losses that destroy that value without benefit to themselves.
Then the question is, does net new issuance of credit (or bank credit to restrict it to money) always or automatically result in misallocation and capital loss? And the answer is, emphatically not. It can, because men are free to err in their capital allocation attempts. But if new credit it prudently used, it can and routinely does raise the capital value of the entire society, by producing capital gains fully equal to the new debt creation. The new debts are then paid when due, they are sound, they work.
Nobody is having their pocket picked when that happens - someone is just earning a gain somewhere by efficient allocation of resources, and the debt issued was a mere means of gaining command over those resources and risking them in that specific use.
But the reverse can also happen and it also frequently does. The new use of resources commanded by the entities the new loans went to, may instead fail to support the capital value of those loans. When that happens, those loans go sour, they fail, they are not repaid - or, to cover them, some other capital value is sacrificed by the entities involved.
Notice, if every scrap of the new use were funded by *equity* instead of debt, *exactly* the same thing can happen. If lots of people save out of income and transfer the real resources involved to an internet start up and it goes utterly bust, wasting and losing all their invested capital, the effect is quite exactly the same, as if a bank lent to that start up and the loan went bad.
Capital misallocation is what causes such capital losses, not the form under which the allocation is financed, or how the entities involved bid for the resources.
Is capital more likely to be misallocated when long interest rates are different from their equilibrium level, especially when they are well below it? Yes, because long rates being "off" means the trade off between future goods and present ones, that actually obtains over the future, is not seen correctly by present arrangers and planners of the use of capital. An asset that delivers most of its rewards 10 to 40 years from now, will look more valuable in present terms, at a 4% interest rate than at an 8% interest rate. If lots of people systematically invest believing that future long rates will be 4 and in fact they are 8, then they can destroy a lot of value.
The last is the actual operating cause in most of the capital misallocation losses in our boom and bust cycles. Notice, it depends only on a price motivating investment being wrong. Notice, further, that "wrong" in a price just means "later moves". The only way all such losses could be avoided entirely, is if prices never moved - but that would mean an inflexible system not worth the candle etc.
Is there, finally, an interaction effect between these things, in which men use the relative ease of new credit issuance to reorder capital arrangements on a large scale, sometimes in response to erroneous, temporary price signals, and especially those coming from long rates? Are the misses in those long rates sometimes about misestimates of the likely future rate of inflation? Yes on both counts, the first independently, the second also operating sometimes. (In my 3% real example above, some trades will happen at 6% because one side thinks the real rate is 2 and the other thinks it is 4 e.g.).
The last can be and is a cause of capital losses in boom and bust cycles, and policy should aim at avoiding too much of it. But it arises simply because (1) men are free to err and (2) prices move, and system is not simple or static. The bare possibility of such losses cannot be removed without destroying economic freedom.
And they aren't anybody picking other people's pockets, deliberately or otherwise. They are men trying to arrange the world's capital productively, and sometimes failing to do so well.
Capitalism isn't a racket, it is other men's freedom, and the basis of our own liberty as well as prosperity. It does not deserve any of these brickbats being hurled at it.
You capital isn't worth less when credit is created from nothing, you have no idea what the effect on its value is. Capital in an FRB in your mattress goes down, in the SP500 who knows, in gold probably goes up, etc. You picked the asset mix, you are responsible for the resulting real return.
All credit, incidentally, is created from nothing. Capital is something else again, credit is just promises about it, which can come true or be false for any reason under the sun.
No, but American style central banking is.
Excellent post!
You clealry cannot think this through. That is true, but so what. Private credit can be described collectively as bills of exchange. I provide you a good or service and you provide me a piece of paper promising to provide a return good or service. These bills of exchange accumulte. Someone can become a banker and collect bills of exchange for various goods and services and shuffle them around so that I can buy grain from someone who does not want my buggywhip, but wants some lumber, etc.
So far, no problem. We are all trading goods and services at agreed upon values and will grant the banker who greases the whole thing some "discount" for the service of lubricating the free flow of goods and services.
But now that we are taking the bankers notes in exchange for goods and services, the banker discovers that he can print more of them, even though they don't actually represent an agreement between two parties to trade. He can use these notes to create demand on goods and services where there is no promise for an offsetting good or service.
Now, the banker could decide that he will "invest" by printing banknote to acquire lumber and labor to build a hotel at a sea-side resort. To the extent that folks then take a vacation (a valuable commodity) at this seaside resort, there has been a proper exhange of goods and services. This is still a problem, because instead of borrowing and paying interest, he has purloined the capital through his power of the printing press and acquired the income from this investment for himself, even though the rest of the economy was coopted, through the power to print money, to make the investment. So here we have reached a middle stage in a credit collapse.
Suppose instead, that the banker takes his printed money and builds himself a condo on fifth ave which he lives in in high style, buying French Wine, expensive hookers, and flying to a vacation home he built in the Virgin Islands on a private jet he purchased, all with bank notes that he printed. This is the end stage, the stage where we are now in our own business cycle.
This banker long ago ceased to provide a means of pooling capital to make long term investments for the betterment of the collective economy. Instead he is merely ripping it off, causing inflation, of which he is the beneficiary, and providing no valuable service in return.
You cannot write because you don't think. Your failure to write in the English language demonstrates that.
LOL! It isn’t even English, much less economics.
LOL! It isn’t even English, much less economics.
These two are tightly coupled. When capital can be obtained by creating credit out of thin air, there are no hard-nosed investors to say hey, wait a minute, that makes no sense. I am happy to speculate with "free" money, even if my LLC might not be able to make the interest payments if it goes south. I would not do the same with my own money where I lose my home and my next meal if it goes south.
Not only can't you think or write, you are a self-styled ego-maniac on top of it all.
You are a financial nitwit. Go read your Milton Friedman and get back to us.
Please show us how a bank with $200 billion in borrowed T Bills can loan $2 trillion.
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