Effect of Setting Fire to a Bill

Morosoph

Tue Sep 16 11:26:11 -0700 2008

manage

Re: I can set fire to a single US$100 dollar bill and it has a direct and proportional effect on all the remaining money.

Common sense doesn't apply here, for money isn't the same kind of stuff as (say) bricks. If you burn money, you don't get a shortage, but simply the manufacture of another dollar bill. The reason for this is that the supply of bills is determined by the bank rate and other relatively slowly changing factors. Just as soon as the population "feels" a slight shortage of money, then Hey presto! it's worth someone's while to borrow at the current rate, for which the supply prior to burning the note was correct.

Property is not what our evolutionarily rooted propertarian instincts lead us to think it is. The current treatment of "intellectual property" is an excellent example of how bad an intuition our "common sense" gives us. Indeed, in this latter case, plenty of studies have shown it to be completely mistaken.

Effect of Setting Fire to a Bill

Charles E Hill

Tue Sep 16 13:24:56 -0700 2008

manage

Actually, he may be correct but only in this literal example.  You'd actually have to set fire to the physical cash to make a difference.  And I don't think it would be feasable to actually lay your hands on enough to matter to anyone other than you personally.  Short of Goldfinger setting off a nuke in Fort Knox, I can't see physical destruction of money on a large enough scale to actually matter.

What happened with Lehman isn't the equivalent of setting fire to money.  It was shuffling around columns of numbers.  Especially when you consider the various national banks have been pumping "liquidity" into the market for the last could of days.

Just like a Doritos commercial "Crunch all you want.  We'll make more!" the banks will print all the paper people want.

Effect of Setting Fire to a Bill

itwerx

Tue Sep 16 13:30:12 -0700 2008

manage

Agreed!

   Guy Fawkes is missing some important pieces of foundation in economic theory (and reality) in this article. 

   Sorry Guy - you have some good articles now and then but this wasn't one of them.  (Ironically, it's the less long-winded articles that tend to be more accurate and insightful.  :)

Effect of Setting Fire to a Bill

disco

Wed Sep 17 06:08:24 -0700 2008

manage

Guy is older than you so knows more, about everything, than you. Right Guy?

Effect of Setting Fire to a Bill

Uncle Entity

Tue Sep 16 13:49:02 -0700 2008

manage

Not too sure I agree with your positive right property theory but that's a bit off topic...

The problem with 'Hey presto!', other than the obvious inflationary problems it causes, is that instead of create an incentive for people to defer consumption and invest their money into productive industries it creates a disincentive to save since you, as a saver, have to compete against the banks that have the power to counterfeit and therefore don't have to defer consumption to supply the loanable funds. The whole supply/demand thing, the more of something there is the less it 'sells' for which would be the interest rate in this case.

The 'defer consumption' point is critical contrary to what they teach in ECON101 as this is how the productive capacity is established. If the baker were to spend all his income like a good little Keynesian then he would soon find that his supply of flour and such would run out and *poof*, so does his income. But, like any good entrepreneur naturally knows, if he were to both spend part of his income on capital goods like flour to meet current demand for his products and also save a little more on top of this so he could expand his business in the future then he and his his future customers would gain from him deferring current consumption for future consumption. This is what the artificially low interest rate discourages because the main measure of the health of the economy is measured in 'current consumption' dollars when in fact the bulk of the actual spending in the economy is business-to-business producer goods changing hands—somewhere between 70 - 90% of all economic activity, too lazy to try to find the exact number—which doesn't show up in the GDP.

So, the more new money they produce the lower the 'current rate' becomes until it doesn't reflect the underlying time preferences of the people that compose the economy and you end up with projects that are undertaken at the 'current rate' but turn out to be unprofitable at the 'natural' interest rate which is itself a direct reflection of people's time preference. Which, I suppose, is the 'obvious inflationary problems'.

Where's this all lead? Right up to where we are today with there being major shifts in capital as a result of all the malinvestments that 'Hey presto!' has directly caused. This in itself isn't bad, what is bad is the central planning that has lead the economy into this state to begin with and the enabler of this cartel scheme they have enacted (with all the calculation problems that comes with) is their ability to say 'Hey presto!' when there is a 'shortage' in the money supply.

Or, in other words, there is nothing special about money...it is a good like any other which has the ability to find a market clearing price without having to engineer the supply to meet demand...and do a whole lot of wealth redistribution in the process.

Effect of Setting Fire to a Bill

mcrbids

Wed Sep 17 18:47:02 -0700 2008

manage

WTF?

This post sounds something like the explanation given by the architect when Neo finally reaches him in Matrix 3.

It sounds like you are saying that high inflation creates a disincentive to create real wealth, and I would agree. Of course, a foundational problem is the "Federal Reserve" system itself, to which Congress has abrogated its constitutional right/duty to "coin money and regulate the value thereof".

All solutions have problems. A free market (by definition) creates inequality. Insurance equalizes things, but only by negating the value of the free market. 

Ever see a hospital bill? Think about how many sponges you could buy at the local grocery store for the cost of a single sponge bought in an emergency room! The reason that hospitals get away with their $50 sponges is because the insurance companies don't care, they just raise premiums. It's not their money. And the customers don't care, because insurance covers the $50 sponge. It's not "their" money, either.

The free market is negated, and you, the insured, pay ever higher premiums.

In this case, FDIC insurance equalizes your bank, providing assurance that if the bank goes belly up, you (the customer) don't lose your assets. But this then creates incentive for banks to screw you, because they have nothing to lose! They are insured!

So we keep our bank accounts "secure", and our mortgages won't get pulled out from under our feet, but we all pay, in higher taxes, reduced monetary value, and economic instability elsewhere. 

No solution exists that doesn't itself cause other problems. Once you understand that, you can try to build a balanced approach rather than "solve" it with over-simplistic solutions that cause more problems than they solve.

Effect of Setting Fire to a Bill

Morosoph

Sun Sep 21 06:39:05 -0700 2008

manage

I'm sure that we'll discuss my positive right property theory another time :o)

The point of another note coming available is that it isn't two notes. That is assuming that the bank rate is correct. Whether central banks are trustworthy is another issue entirely, and one in which you're likely to find me agreeing with you voraciously.

However, assuming competence and goodwill, the argument goes roughly as follows:

Cash doesn't obey normal rules of supply and demand. Why not? Primarily because it can be reused. The velocity of money can change without that of goods changing, so that a fixed supply of cash (M0) can under different circumstances be inflationary or deflationary. For example, in times of relative poverty, there can be a greater demand for cash since people operate more from "hand to mouth", so that the scarcity of goods faces a faster-moving flow of cash.

I am certainly not advocating an infinite tap of cash, but rather a system that keeps the right degree of tension in the money supply. This need not be engineered by a central bank, but could be engineered by mints that are trusted because they promise to redeem their notes against a known and trusted benchmark. In that case, surpluses are mopped up (as with the case I've run through above), and the currency gains trust in the long term.

The major disadvantage with such a plan is that any mint has a supply of free money, and therefore the motivation to choose a compromise between sustaining the value of their cash piles, and monetising them. This is not unlike the behaviour of governments.

However, my point remains, and that is that there are policies that are more stabilising than a fixed supply of cash, but I certainly agree with you that an open tap is most definitely not one of them.

Effect of Setting Fire to a Bill

Uncle Entity

Sun Sep 21 17:21:36 -0700 2008

manage

Ah, yes, the old velocity of money fallacy...

Don't really have time to demonstrate how your argument disproves the velocity theory because I'm off to trade my past labor for present beer with dollars being the enabler of this transaction.

Some may say I'm going to measure the velocity of beer.

Effect of Setting Fire to a Bill

Morosoph

Sun Sep 21 23:09:52 -0700 2008

manage

Of course, the ratio of bread to potatoes will stay constant, but that is to (falsely) assert that inflation and deflation are unimportant, not that it doesn't occur.

I am astounded how the article that you link fails to counter a mathematical truism, relying instead upon an appeal to moral sense. Mises here fails to grok that supply and demand of money flow holds in order to pontificate:

"In analyzing the equation of exchange one assumes that one of its elements--total supply of money, volume of trade, velocity of circulation--changes, without asking how such changes occur. It is not recognized that changes in these magnitudes do not emerge in the Volkswirtschaft [political economy, or more loosely `economy'] as such, but in the individual actors' conditions, and that it is the interplay of the reactions of these actors that results in alterations of the price structure. The mathematical economists refuse to start from the various individuals' demand for and supply of money. They introduce instead the spurious notion of velocity of circulation fashioned according to the patterns of mechanics." (Human Action, p. 399)

This isn't an argument; "fashioned according to the patterns of mechanics" is a barbed insult against those who dare challenge the way the problem "should" be analysed, and further denies a fundamental truism of economics: that supply and demand (in this case of flow and counterflow rather than constant physical objects) is more potent than individual will in setting prices.

Still, the human mind being what it is, I doubt that I will succeed in getting my point across without an analogy. So here we go. Let us say (for the sake of argument) that grain is produced yearly in fields, and that corn can be harvested twice a year. New crop are seeded from old crop, and wages are small compared to land rent. If it is found that corn can be harvested three times a year instead of two, it is clear that the rate of exchange of grain to corn will adjust accordingly.

Similarly, is the velocity of money is 3 instead of 2, a clear parallel can be drawn between every act of exchange with its corresponding labour, and the reseeding and harvesting of the land. It isn't hard to see that a general shortage of necessities so that people spend their income more rapidly instead of banking it can have exactly this kind of effect.

Please note that this analogy is not my argument, but is rather an attempt to explain the mathematics. If you're going to refuse mathematics as being "mechanical", I might as well be talking with a Marxist, since logic cannot be refuted with moral assertion in the manner that Mises is attempting to achieve above.

Money supply economists rely upon long run effects to counter the argument based upon money supply, asserting in effect that the velocity of money averages out. I am simply saying that it isn't hard to construct a scenario where this isn't the case, and in fact, such a scenario (such as a drought or other general shortage of necessities) yields inflation when it is most harmful.

Ps. I hope that you enjoy your beer! :P

Effect of Setting Fire to a Bill

Uncle Entity

Mon Sep 22 03:30:43 -0700 2008

manage

It is always safe to assume that any single paragraph quoted from Mises isn't the whole argument. You are also trying to equate the effects of price inflation to monetary inflation where they are two completely different things.

...and further denies a fundamental truism of economics: that supply and demand (in this case of flow and counterflow rather than constant physical objects) is more potent than individual will in setting prices.

Supply and demand is somehow disconnected from the actual people who engage in the buying and selling of the goods and services in question? Mindless automatons I suppose...

Similarly, is the velocity of money is 3 instead of 2, a clear parallel can be drawn between every act of exchange with its corresponding labour, and the reseeding and harvesting of the land.

Yeah, that's the whole argument. You aren't measuring some monetary velocity independent of the underlying exchanges between the landowner, laborer and whoever else is included in the mix. You are measuring the exchanges.

If that makes any sense.

Here's another article (with quote from Mises) that sums it up much better than I can. Just so no one suggests that the Austrian theory 'fails to counter a mathematical truism' that doesn't exist.

Effect of Setting Fire to a Bill

Morosoph

Mon Sep 22 06:03:35 -0700 2008

manage

I think that I see where our misunderstanding arises, but luckily the linked article clears things up somewhat.

I am not arguing for something as hard and fast as the Fisherine equation, naively applied; rather, I am arguing that the relevant factor in the sustainable value of money isn't money supply per se, but rather the correct "tightness" of supply. In fact, because the Fisherine equation is tautological, that means that the proportionality of money supply and price is not, and Henry Hazlitt's observation about how inflation occurs underscores this fact.

Of course, something can fail to be tautological, and nonetheless be true in practice, and in particular, when times are hard, people could spend more slowly in perfect inverse proportion, so that the lower flow of goods meets a slower-moving flow of cash.

However, if people know that there are shortages, it is human nature to bid for those items that are in shortage so that their price goes up, given that they have (in aggregate) the same amount of cash in their pocket. Accordingly, the scenario painted in the previous paragraph appears to be unlikely, to say the least.

It is interesting to read of some of the history of monetary theory, and I certainly wouldn't be an advocate of adjusting the money supply in perfect inverse proportion to the velocity on the assumption that the supply of goods was steady, but if you look at my example, that is not the theory that I am using. It is the curse of those who think on their feet to be mistaken for thinkers of one school or another.

The Fisherine equation is a truism, or else Benjamin Anderson wouldn't have written that Although some true propositions can be had from the quantity theory, not every conclusion derived from it is true, but rather have trashed the theory comprehensively.

I do not require an entire theory of banking from the equation, but simply to establish that (money supply proportional to price) does not necessarily hold. Combined with plausible scenarios where one sees inflation or deflation with a constant money supply, it becomes clear that money supply isn't the most fundamental quantity if one wishes to keep price inflation in check; rather it is something like the elasticity of money that should be constant, so that there is some change in money supply, but not the one that one would get by misapplying the Fisherine equation and making too many assumptions.

It is of course entirely possible that no entity can be trusted to do this, and so that a fixed money supply is the best practicable scenario attainable.

Effect of Setting Fire to a Bill

Uncle Entity

Mon Sep 22 06:59:09 -0700 2008

manage

I like the quote right above that one because it applies to many other areas in the economic arena;

Anderson further holds that whatever true propositions the quantity theory offers can as well be deduced from a correct theory of value and that many true theories of modern economics (such as the laws of demand and supply, the theory of capitalization, and Gresham’s law) are inconsistent with it.

Plus the whole counterfeiting and fraud issue from the 'production' of money by any means other than mixing (economic) land with labor such as artificial credit expansion or simply running the printing presses. Oh, and the 'fiat' and monopoly thing.

That's the fundamental problem I have with all this.

Effect of Setting Fire to a Bill

Morosoph

Mon Sep 22 09:47:58 -0700 2008

manage

I suppose that that is a problem with so much theory. Who exactly is this "we" who control the money supply, and in who's interest do "we" wield it?

Maybe there is an "ideal policy", but is it actually likely to happen?

Fat chance.

Mints

Morosoph

Mon Sep 22 01:08:37 -0700 2008

manage

I wish to add that the suckiness of mints is not in itself proof that a constant money supply is ideal; it only means that the problem of optimum money supply is unfixable.

Money, money, money

disco

Tue Sep 16 11:44:02 -0700 2008

manage

> In the case of Leaman you have something where this particular basket of eggs was valued at 100 bucks a pop, and a short time later that same basket of eggs is valued at 10 cents a pop.

To start with, you not knowing how to spell Lehman, a group that was up until yesterday in the top ten of globally known financial firms, says a little something about your financial knowledge, but let's move on. What Lehman owned was never worth 100 bucks a pop. They thought it was, and others may have also, but they were all wrong. Just because I say my ass is worth a fortune doesn't make it so.

If 10,000 eggs are discovered rotten and you own 100 good ones then your eggs all of a sudden become more valuable. Economics 101 bubba.

You say this "deflation" is a problem, but then you talk about your father's pension evaporation, which was an "inflation" issue. You don't seem to know the difference.

It is certainly interesting times, but for none of the reasons you mention.

Money, money, money

stephen

Tue Sep 16 13:08:10 -0700 2008

manage

s/money/wealth/g ?

"Trust Us" Money

Charles E Hill

Tue Sep 16 13:16:39 -0700 2008

manage

To use your egg analogy, Lehman didn't have 10,000 eggs that went down to 100.  They had an indeterminate number of eggs that they claimed could satisfy any egg demand.  Because they were trusted (a good credit rating), they only had to show possession of a few eggs and everyone believed they either had or could acquire enough eggs on demand if needed.

As things unfolded, and people got nervous about Lehman's main source of eggs -- the secondary mortgage market -- they demanded to see more and more eggs as proof of ability to deliver.

Lehman was heavily leveraged, meaning they depended more not on their own egg supply but on the ability of their suppliers to meet demand.

In the end, no one believed Lehman could produce a baker's dozen and down they went.

AIG is going thru this right now.  Their credit rating got cut two levels today, which means about 20 million more eggs they have to pony up right now to keep people's trust.

You gotta love fractional reserves.  It is all one big game of "trust me (and everybody I trust)".

Now if I can only rework this into a good car analogy...

"Trust Us" Money

itwerx

Tue Sep 16 14:43:05 -0700 2008

manage

Now if I can only rework this into a good car analogy...

Wait, you mean I shouldn't trust that nice used car salesman...?  :)

"Trust Us" Money

disco

Tue Sep 16 17:05:18 -0700 2008

manage

> You gotta love fractional reserves.  It is all one big game of "trust me (and everybody I trust)".

Michael Jackson's nose is a fractional reserve problem too right? Lehman wasn't a bank. Their business wasn't loan origination. They didn't do any fractional reserve loaning. They bought some loans (CDOs) on the secondary market that weren't worth what they paid. Whether or not these loans were originated with or without fractional reserve banking is irrelevant to Lehman's situation. They'd have shitty loans on their books regardless. AIG isn't a bank either. Neither was Bear. The prevailing wisdom is that had any of these guys been a bank they'd be still around. Goldman will buy a bank and Morgan Stanley will get hooked up with one as well.

PS: The secondary mortgage market was not Lehman's main source of eggs. Their main business was bond trading, but they had other businesses too.

"Trust Us" Money

Charles E Hill

Tue Sep 16 19:06:40 -0700 2008

manage

Leahman was an Investment Bank, or had a rather large investment banking division, depending on how you want to look at it.  They are commonly listed as one of the Big 4 investment banks.  They were heavily into repackaging non-traditional mortgage debt and used it to move debts off their balance sheet.  In this arena, Lehman was highly leveraged.  More so than their main competitors, Goldman Sachs and Merrill Lynch.

Lehman's leveraged position, combined with their investment banking activities is what I'm referring to "fractional reserve".  It is a stretch of the definition, but they were providing finance guarantees in the way of credit default swaps, a form of insurance.  They facilitated funding using leveraged positions.  I'll grant you this, but refine it to say they overextended themselves in the way of uncollatoralized credit.  Their reserves were seriously inadequate.

Was their primary source of income mortgage debt backed securities?  I'd need to see their annual statements, and probably still couldn't say for sure.  They were very deep in using debt-backed financing, and even won several "awards" for arranging deals using this method.

Deal of the Year in The Netherlands
Postbank - Stichting Memphis 2005-I €3 billion residential mortgage-backed securitization (joint lead manager, joint arranger and joint bookrunner)

Euromoney also recognized Lehman Brothers with several other awards, including "Best Credit Derivatives House," "Best Debt House in North America," "Best Debt House in USA," "Best Debt House in Italy," "Best Equity House in Israel" and "Best Equity House in the Netherlands." 

Their heavy exposure to leveraging bad debt is what led to their downfall.

"Trust Us" Money

disco

Wed Sep 17 06:24:26 -0700 2008

manage

Your post is fine, as was your previous one, with the exception of your use of the term fractional reserve banking. An Investment Bank does not do any fractional reserve banking. Fractional reserve banking involves deposits and lending, of which Lehman does neither. A credit default swap is not lending someone some money. So if by "a stretch of the definition" you mean "wrong" then I'd agree with you ;-)

Eggs & Couches

tqft

Tue Sep 16 19:48:19 -0700 2008

manage

I want a used couch from JPMorgan - they stumped up USD138billion on short notice to Lehman (after the bankruptcy was filed so JPM would be protected).  How the hell do you find USD138billion in cash?  Like I said I want a couch from JPM to rip open and look for the change that has fallen down.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aX7mhYCHmVf8&refer=home

"Sept. 16 (Bloomberg) -- JPMorgan Chase & Co. gave $138 billion this week in Federal Reserve-backed advances to the broker dealer unit of Lehman Brothers Holdings Inc. to settle Lehman trades and keep financial markets stable amid the biggest bankruptcy in history, according to a court filing. "

 

But my eggs are insured with AIG so I will be OK now the Fed owns (79.9% of) AIG.

Eggs & Couches

itwerx

Tue Sep 16 22:11:17 -0700 2008

manage

How the hell do you find USD138billion in cash?

If you have a big enough chunk of change playing the money market, (a pretty sure thing right now), then your liquidity is going to be pretty darn good!  :)