patrick.net

"If gold is your currency it will appreciate in a deflationary environment."

You mean like USD is doing right now?

"V = nQ / M nQ ~= GDP, M = money supply"

You remind me of this guy Randy (on this blog from a while back) who said we would/could never experience deflation here in the US. All he did was point to formulas from his college economic books based on a discredited and obsolete theory of economics.

Read about the Austrian theory of economics to understand why your analysis is ass-backwards.

TOB, I believe the issue at hand is the current administration's actions and letting the economy correct itself with minimal interference. So far they've done nothing but try to stall this process (mostly to no avail and to the taxpayer's detriment).

frank, I happen to think that Randy H. is a pretty smart guy. Perhaps you would care to provide some actual rebuttal of why you think Austrian theory is so far superior to Keynesian theory? I would recommend starting with why you believe that hard money does not result in deflation during periods of real growth (via productivity increases or improved labor supply).

I find it hard to believe that Randy said we couldn't experience deflation. Do you have a link? His own blog at Capitalism 2.0 has a very detailed explanation of why velocity of money and deleveraging must result in short-term deflation. Randy has repeatedly said that no credible military power has ever experienced hyperinflation, simply because it is easier to tell your creditors to take a hike, but I don't recall him ever commenting that we couldn't see deflation.

Frank, you said: "I believe the issue at hand is the current administration’s actions and letting the economy correct itself with minimal interference."

Minimal interference??? What rock have you been under? We are currently experiencing the biggest government intervention into the economy in history!

Fiat has a bias toward inflation, and deflation is very unlikely. However, if velocity slows sufficiently we can have deflation. But deflation is not likely to last long with fiat currency because the government can just print it's way out of a deflationary environment.

Frank said: "Oh man, Brand, Kewp and Zephr, sorry but your analysis and understanding of monetary theory and practice are so woefully wrong that I don’t even know where to begin."

Really? You can't think of anything? You offer no argument.
You just insult us - and don't bother with any facts.

You have no idea what we know or how experienced we might be in these matters.

And you have offered no information or arguments on the topic.
Do you have anything to offer? You have shown nothing so far.

Frank, You say that fiat currencies do not and cannot work. History proves you wrong.

Fiat currencies can work, and have worked very well for the US and most of the industrialized world.

In fact, since we detached our currency from gold the world has experienced unprecedented and prolonged economic growth, with fewer and less severe declines and panics. Not perfection, but better than when we were chained to gold. Clearly fiat does work.

Certainly, there remains the inflation risk of government printing excessive quantities of money. And gold as money is reasonably held out as a means to prevent this risk.

However, gold as currency also exposes the economy to wide fluctuations between inflation and deflation caused by market swings (and it exacerbates declines). The damage routinely caused by such fluctuations is greater than the occasional damage caused by ongoing fiat inflation.

Properly managed fiat is far superior to gold as currency. With fiat the risk is in the management. With gold the risk is inherent. Gold is only superior to severely mismanaged fiat.

Fiat currency is imperfect. But gold is also imperfect.

LOL. You can take that up with his wife. I thought it was a somewhat high-and-mighty title for a blog, but Silicon Valley techies are fond of hyperbole. It is a memorable name, I suppose. Grand title aside, the content is high-quality with lots of supporting links and explanation.

Brand, we need to start with some definitions.

I’ve seen many people in the media, on this blog and elsewhere refer to deflation as “a decrease of prices” and inflation as “an increase in prices”, however this is not only incorrect but obscure because there are many definitions of “price” and many measurements for it (e.g. consumer vs. producers prices and the many variations of CPI and PPI).

The truth is that deflation and inflation can only be correctly defined in terms of money supply. Affects on prices are only consequences of these monetary phenomenon.

Moreover, the term “money supply” must also be properly defined. For this I’d like to refer you to "The Mystery of the Money Supply Definition" by Frank Shostak (http://www.mises.org/journals/qjae/pdf/qjae3_4_3.pdf).

frank.

A quote from RandyH:

http://capitalism2.org/

Presently there is an increasingly raucous debate brewing between those who believe there will be long-run inflation, and those who see an extended period of deflation. I have elaborated my position here and elsewhere, which is basically that we're currently at the head-end of a deflationary period which risks collapsing into a broader deflation cycle.

RandyH is a stand out among the many gifted writers on this blog. If you are going to stuff words in his mouth, be sure that readers who are truly familiar with his posts are going to call you on it. Besides, I am an ardent believer in upcoming defaltion (although OO has some sobering points) and I notice who puts out arguments to the contrary.

The proper definition of inflation and deflation must be expressed in terms of a precise definition of money supply that distinguishes between money and credit. The link above should provide you with a good understanding of such, but to summarize:

Inflation is a net expansion of money supply and credit and deflation is the opposite, a net contraction.

HeadSet, Randy and I have had long and heated debates on this very blog for several months back in 2005 when he said that the then current economic conditions would not result in a deflationary outcome. Obviously he has changed is tone in light of the fact that we have been in a deflationary mode for over a year now.

I woud say that we are all, in fact, hacks.
But in my hackiness I can say this:
Obama has hired a crew of people 100% comitted to stopping deflation. And they are going to spend big to do it. For th first time, ever, the Fed is using Quantitative Easing. They are targeting something like 3% inflation and the Fed is totally willing to buy any asset to achieve that end.
The natural force of defltation will take time to arrest. Off-sheet leveraging in the old banks, legal levering in the former IBs, international leverage with the aid of CDS, long-time leveraging of Hedge funds, etc are all winding down. When that all ends, we need the political will to stop the new, New Deal.
When. Have we. Ever. Shown. Political Will.
The ONLY thinkg that will stop inflation on the other end of deleveraging is when inflation gets so bad you simply, once again, cannot sell an asset since the cost of funds will be crazy high.
As far as Randy's view of WWII. Umm, with the world having lost its manufacturing base due to bombing and much of the equipment made during the war was 'used' (destroyed) in the war, I would say that re-supplying the planet can explain how we avoided inflation.

Here's one interesting alternative...

"A Free-Market Monetary System" by Hayek

http://mises.org/story/3204

By the way, why do we ever have the gold as money debate? Gold was absolutely and effectively put to rest in the 1970s. In fact, any hard currency suffers from the same problem s gold: to increase the monetary base you have to go dig up more stuff, some areas have more stuff than others, blah blah blah.
There are certainly things we can do to make fiat currency more accurate, and I suspect we will be doing them in the near future.

Randy and I have had long and heated debates on this very blog for several months back in 2005 when he said that the then current economic conditions would not result in a deflationary outcome

Then I stand corrected. Apparently I have only read RandyH's posts since his change of view, possibly a change infuenced by you.

frank says
Inflation is a net expansion of money supply and credit and deflation is the opposite, a net contraction.

Sounds like MISH:

http://globaleconomicanalysis.blogspot.com/2008/06/is-inflation-scare-over-yet.html

Of course, this all starts with a proper definition of inflation. In Austrian economic terms, inflation is an expansion of money and credit.

This isn't new here. Haven't RandyH, Brand, Zepher, Duke, and others made reference to the Austrian school?

Keynesian, Monetarist, Austrian – all these views have worthy and useful points. And they each have their own bias and imperfections.

It is like the three blind men describing the elephant by each holding one part – one the trunk, one the leg, and one the tail. Each is certain of his description (a snake, a tree, a rope), but none is very accurate of the entire animal. Understanding the entire picture takes more than any single bias can tell us.

My own bias is a blend of the schools. However, the blend varies. On fiscal issues my bias is mostly Keynesian, on monetary issues my bias is very Monetarist, and on cycles my bias is the Austrian view.

http://mises.org/story/3226

As for defining inflation I prefer the more traditional view that inflation is a rise in the general price level.

Of course, it is usually caused by expansion of money (&credit). But expansion of money will not cause inflation if the supply of goods and services expands at the same or faster rate.

One could also cause inflation by reducing the supply of goods and services without changing the supply of money and credit.

Inflation and deflation are all about the relationship between the effective supply of money vs. the effective supply of what can be purchased with it.

Hey Patrick.

How about a thread on the possible future bankruptcies of municipalities?

"...to increase the monetary base you have to go dig up more stuff"

Well, your Keynesian bias is certainly evident.

The whole idea behind a gold standard is such that the monetary base cannot be easily increased. Indeed, there is rarely a case to do so given that innovation and efficient production naturally lowers prices.

Lietaer and "script currencies", oh yes. I believe, Wörgl, Austria in the early 1930s experimented with such an idea. Unsound money by any other name, is just another Keynesian scam, imo.

The idea behind Lietaer's local currency is that there's a hoarding fee (in Worgl, Austria it was 1%/month) which in effective is like negative interest that in effective guarantees inflation. It destroys savings by transferring wealth from savers to the town's treasury so they can run soup kitchens.

Our system already has a much better investment motivation, it's called interest. It's better because it's rate is determined by the market (that is ignoring the Fed) and the rates adjust to ensure that investment meets demand.

As for defining inflation I prefer the more traditional view that inflation is a rise in the general price level.

That is a somewhat ironic as that is the contemporary definition. Historically inflation simply referred to and expansion of the money supply.

Then I guess what was once old is now new. It was the textbook definition several decades ago.

I am not sure the Euro will fare too well given the disparate interests of its member nations, but that's a different discussion.

Can't find much on the web regarding Lietaer's ideas. What makes his ideas different than other local currency schemes and more importantly how does it solve the problems inherent in fiat currencies?

I believe the nonsensical definition of inflation that you refer to was introduced has part of a political campaign intended to mislead the public into thinking that rising prices resulted in an increase in money supply rather than the other way around. Many people now realize the fallacy, but nevertheless they still refer to inflation as an increase in prices.

Can't imagine how that might work, if they are referring to Ithaca Hours on that link then I don't think his idea holds too much promise. From the Ithaca Hours home page:

"It’s also fun to get and use something other than dollars (remember how much you enjoyed or still enjoy using monopoly money)..."

I think that says it all.

Excessive expansion of the money supply is the most typical cause of inflation. Many confuse the most common cause of inflation as being inflation itself. Easy to understand making that mistake given the very high correlation of the two.

The classic economics textbook definition of inflation is a rise in the general level of prices. Has been such for many decades.

Well, things get dicey when your monetary system is based on debt.

Short term credit/debit inflation (and associated price inflation) will ultimately lead to monetary and price deflation. Debt can only be defaulted on paid back; both of which reduce and individuals purchasing power.

In reality, the interest on debt amounts to a tax on consumption. This can only cause deflation in the long-term.

Ultimately the problem does not lie with the currency but with the issuer of the currency, whether the currency is backed by gold or fiat, local or global. Can we trust the issuer to give us a money that preserves our savings and at the same time provides for productive and meaningful investment?

I like Hayek's idea of a free market issuer. That the free market should provide its own currency by methods subject to the same laws that govern it seems like a promising alternative.

If the government is to remain the issuer, then the gold standard is the only method we known to force discipline.

On monopolies, seems to me that the government interference in the form of favoritism (i.e. anti-free market) is what creates unwanted monopolies. As for monopolies in general, I don't view them as necessarily evil for several reasons:

1) if there is one company that provides the best product at the best price bar none, well then all the more power to them.

2) the existence of such a company does not bar any others from nibbling away at it's profits if there is a profit to be made by providing a better and/or less expensive product.

3) while such a company can conceivably use its market dominance to crush competition in ways not complementary with its service to the public (e.g. not improving the product and/or cost of manufacture), it can only do this at a cost and therefore cannot do this forever. And indeed it would need to be able to do this forever for as long as there is a profit to be made, the barrage of new competitors would never cease.

4) It's only via government favoritism or other non-free market mechanisms that unfavorable monopolies can maintain their dominance in a cost effective manner.

"While Im not an expert in Hayek’s views on ‘free market currencies’, its seems as though he is in accord with Lietaer."

If Lietaer is proposing competing currencies that do not implicitly or explicitly have the backing of any body of governance, then I believe the proposals are very much the same.

TOB says: One weakness I find with the libertarian cosmology is that they refuse to admit the problem of monopolization. As if the ‘market’ will correct it.

I arrive at the same headache reading mises.org. Most of the libertarian economists also ignore that we do not have a clean initial state. Without strict laws, the existing "haves" in the system can easily collude to remove competition in the new system. Their present resources are a huge sledgehammer with which they could create artificial barriers to entry. Any truly "free" market must also be accompanied by massive political reform, particularly on campaign donations and corruption. And lastly, it seems that many Austrian theorists restrict their analysis to simplistic models involving carpenters, glassmakers and cobblers. As we have just seen in the present financial crisis, the goals of the CEO are not necessarily aligned with those of the shareholders, which means that there is no reason to believe capital would truly be allocated efficiently. It seems naive to assume that corporations would behave in society's best interests without meaningful oversight.

frank says: 3) while such a company can conceivably use its market dominance to crush competition in ways not complementary with its service to the public (e.g. not improving the product and/or cost of manufacture), it can only do this at a cost and therefore cannot do this forever.

frank, a fundamental problem here is that:

0

Grh. Open/close braces.

0 is less than my lifetime, is less than forever. Summary: it might take 100 years for a monopoly to correct itself naturally, and the societal damage it causes might far outweigh the eventual benefit of its demise. Most of these theories appear to idealize the relationship between industry and society... in reality, industry must always be subordinate to society, so that the general good can be served by the efficient allocation of labor and capital. Man cannot serve his own machine.

"It seems naive to assume that corporations would behave in society’s best interests without meaningful oversight."

According to Austrian economics, corporations do NOT behave in society's best interests per se, but in the interests of making a profit. Only as far as those interests are aligned with those of society does society benefit.

You totally miss the boat when it comes to understanding this very basic premise.

I suggest you read mises.org before presuming anything else, like that they only deal with carpenters, glassmakers and cobblers.

You're also wrong to assume the theory places any reliance on what the CEO's true goals are. It's naive to believe that any oversight could possibly be a substitute for a free market, especially in light of the recent failures in oversight by the SEC, the FED, the sanctioned rating agencies, the FDIC and the GSEs (just to name a few) in our current crisis. Sheesh, what more could it possibly take to convince anyone of this fallacy?

Austrian economics does not preclude strict laws, this should be obvious if you read anything about it, and certainly does not condone corruption through campaign donations. They are against government intervention in the free market, which would make this all the more difficult.

I agree that there must be reform. We should start by eliminating the Fed, fractional reserve lending. the SEC, the FDIC and the GSEs.

"it might take 100 years for a monopoly to correct itself naturally,"

Based on what? That's ridiculous. Name a monopoly that existed any time in history that operated in a free market manner and didn't provide the best product or at the best price that existed for any appreciable length of time as such.

"in reality, industry must always be subordinate to society, so that the general good can be served by the efficient allocation of labor and capital."

If you mean that society, through free market actions, is efficient at allocation of labor and capital, then you'll have no argument from me or any libertarian.

I would go further and say the the free market is by definition the only truly efficient such allocator of capital and that a governing body can only guess and often guesses incorrectly.