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Research on Rand's Economic Theories

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Matthew

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Yes it is, I am objecting to your definition.

But the more fundamental disagreement is about fractional reserves.

You're focusing on consequences of actions, while I am going directly to the actions themselves and making a number of crucial distinctions among them.

There is nothing wrong with defining a concept for both an action and its consequence. But what you want to call inflation is not a clear-cut action, but a rather messy and haphazard (in my opinion) collection of different kinds of actions: engaging in fractional reserve banking, instituting fiat money, robbery, ... I still don't quite see what essential characteristic is supposed to unite those actions.

I look at fractional reserve banking the way I look at the use of intoxicating substances

Ah, I remember you from the intoxication thread, you're Pepsi Guy! Well, if we can't even agree on the definition of "good drink," no wonder we diverge on inflation! :o

In particular re customers being told what's going on, the use of the word 'deposit' should be kept strictly to what it means, that there is an actual deposit put in and physically kept safe by the bank.

The bank has a right to use whatever terminology it pleases as long as it is clear to customers what the bank means. If my wife and I agree that, when used between us, the phrase "I'm going to kill you" shall mean what is ordinarily expressed using the words "I love you so much," then there is nothing criminal about my uttering that phrase to her, even if a certain Australian customer of PepsiCo believes that the use of the word "kill" ought to be kept strictly to what it means. The important thing is that the customers be aware of the risks they are taking, not how they are made aware of them.

And BTW, we can add "deposit" to the list so far consisting of "good drink" and "inflation." :P

No, there is no need for fractional reserve banking for that. The use of low-value money substitutes can proceed quite happily, serving the purposes you note, without ever resorting to fractional reserves.

What is a paper dollar bill going to denote, if not a bank's obligation to pay the bearer a certain fixed sum in gold, independent of who presents it and when? A profit-oriented bank will not issue bills unless it can make money from doing so, which means that it either has to charge for the storage of gold an amount proportional to (or otherwise dependent on) the time of storage--or earn interest by lending out a carefully chosen portion of the gold. If the bank could not earn interest, a bill issued for depositing a $1 coin today would be worth $.95 next year, $.90 in two years, $.85 in three years--and $.72291666666... in 5 years, 6 months, and 15 days. If you had ten dollar bills in your wallet, you would have to look at the date on each of them, compute the number of days since then, then look at the bill to see what the bank charges for keeping, multiply the number of days with the charge, and substract it from the nominal value of the bill--all this just to find out how much money you have on you. But in exchange, you can be 100% sure that the bank will be able to give you nice and shiny gold coins if for some strange reason you suddenly develop an urge to have them--instead of the 99.9999% assurance you would have with fractional-reserve banking. That a good deal?

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But the more fundamental disagreement is about fractional reserves.

I disagree, but I have nothing more to add to what I've already written. Yeh, it looks haphazard as it is, and a big clean-up is in order, but here is not the place. My own work besides my thoughts is just a set of notes and observations rather than a fully-written chapter for another's reading. I'll get around to that eventually.

There is nothing wrong with defining a concept for both an action and its consequence

There is if the aim is to keep in mind the natures of different causes with similar consequences for the immediate future but which causes lead to different paths of consequences as time passes. Calling different causes by the same one used-daily term obscures this crucial difference.

I still don't quite see what essential characteristic is supposed to unite those actions.

The one thing that unites them (fiat paper, deliberate FRB, incidental FRB, and so on) is the injection of something valueless into the money supply. The immediate consequence is a fall in the purchasing power of a unit - but this is because the value of the existing units is being diluted by the addition of the new units. The man doing the injection is thereby gaining a value without producing a value. It is right that this injection, dilution and value-shift be identified with a term whose application is consistent with its original meaning, consistent with its opposite term, and which non-virtuous actions are validly labeled with a pejorative too.

In contrast, an increase in the gold (or silver or whatever) in circulation is objectively differentiable from all the variants of the above because it is the addition of what really is valuable into the money supply. The immediate consequence is also a fall in the purchasing power of a unit - but this is because of the operation of the Law of Diminishing Marginal Value taking place because of the fungibility of the existing units with the new units. The man doing the addition is gaining a value by producing both a value and an earned profit to boot. It is wrong that this addition and profit-generation be identified with a term whose application is in contradiction with its original meaning, in contradiction with its opposite term, and which virtuous actions are unjustly labeled with a pejorative.

Pepsi Guy!

Pepsi-MAX to be precise :o Cheers, mate!

The bank has a right to use whatever terminology it pleases as long as it is clear to customers what the bank means.

No, it does not. This is crossing over into contract law and the law's recognition of the meaning of words. In a personal context you can do as you like, but in a formal setting with strangers involved and there are legal expectations and presumptions everywhere a slide in the meaning of the words is coming perilously close to fraud. Indeed, in the early days when FRB got started it damn well was outright fraud.

It's the same principle as gays having every right to expect the government to recognise the existence of and protect the content of their contract of personal partnership but being disallowed from calling it marriage because (amongst other reasons) there are third-party legal ramifications relating to that term and related ones like husband and wife. For instance, an insurance contract may specify special deals for married couples. If the government legally recognises a shift in what 'marriage' refers to then it is engaging in the use of force to unilaterally alter valid contracts to suit a social agenda - which is exactly why the activists are out to have the government do that.

The present usage of "deposit" is only not outright fraud today because everyone has sort-of gotten use to the new arrangement, but that does not make it right. A key point in this is that the slides in the meaning of 'deposit' and of related concepts such as "I have X money in the bank" have not gone so far as to make the redemption of the term more trouble than it is worth. As well as noting the proper use of the term in "safety deposit box" and of law relating to them accordingly, have a look at what people actually think and do. Note that most people aren't in fact fully aware of what's going on but instead they only have a vague notion whose implications have not sunk in. To this day a lot of people still say "it's MY money" and are almost totally unaware of their status as creditors under the present legal situation. Notice how people get upset and immediately think of theft or other wrong-doing when banks go under? This is not simply dislike of financial institutions - notice how indignant they get when they find out that they are unsecured creditors and that as a consequence of this they are way way down on the priorities order to get funds back. As far as I can see (I'd have to do more research), nobody with any clout has taken it upon themselves to address the matter clearly even though it is often a newsworthy matter and an important talking-point in discussions of reform of banking law and practice.

For someone in a bank or the legal justice system, or theorists for both, to deliberately seek to maintain that state of affairs while knowing of its nature and importance is fraud - but I wouldn't automatically make judgements about banking and legal people's characters on this score because with the state of today's education they are likely as muddled as everyone else, too. One of the solutions to the "unsecured-creditor problem" that has been mooted is to change banking law to rearrange the order of creditor claims priorities, as had already been done in relation to tax liabilities and employees' back-pay. This is highly improper as again it is the unilateral change of valid contracts by force to suit a social agenda. The proper solution is indeed the redemption of the word "deposit" and all the practical consequences that flow from this.

(ps: it's funny that I should be re-listening to Dr Peikoff's Art of Thinking, and have not long past the part where he was stunned that Miss Rand could validly link economics and sex. Now I know how that works :P )

What is a paper dollar bill going to denote, if not a bank's obligation to pay the bearer a certain fixed sum in gold, independent of who presents it and when? A profit-oriented bank will not issue bills unless it can make money from doing so, which means that it either has to charge for the storage of gold an amount proportional to (or otherwise dependent on) the time of storage--or earn interest by lending out a carefully chosen portion of the gold.

I am not a gold bug, but for simplicity let's just say gold=money and it's $20/oz.

A bank note is when the bank holds gold that it owns, as distinct from holding gold that its customers own. FRB for for notes is when the total nominal value of those notes and coins is greater than the amount the bank actually holds (deliberate FRB is when the bank does this intentionally, while incidental FRB is when it arises because the reserves are stolen or lost). You're missing out on other ways a bank can earn revenues. A bank can make money by issuing notes even without resorting to FRB, by two methods.

The immediate source of revenue is seignorage. A customer with some gold walks into the bank with want of something easier to carry around (whether too heavy or too fiddly). There is more value in the note than the gold because of that ease, which is why the customer wants the note rather than the gold. The bank will then not exchange exactly 1 ounce for $20 but require say 1.02 ounces per $20. This is no different to that same arm of the same bank taking raw gold and minting coins with it, again for seignorage. This is also no different from the wider principle of the bid-ask spread. In the other direction, a note presented for redemption must get back exactly what it says, ie $20 -> one ounce, because the issuer is contractually bound to do so.

Certainly, a bank could issue bills of exchange drawn upon its own reserves, and today there is still some circulation of these in the place of money (the last figures I saw put the negotiation of bills as being roughly a quarter of the total amount spent to acquire bills), but bills tend to be high-value instruments rather than the notes and coins you're thinking of. They also presently attract stamp duty, which in a laissez-faire world would become the voluntary kind Miss Rand wrote about as being required for a court to hear a dispute relating to them. That part would be unlikely in relation to notes and coins.

The other and more diffuse source of revenue is the advertising effect of the note. A bank having its notes in circulation is effectively a bank having great numbers of its advertising flyers in people's pockets and regularly being made visible when spent. The very fact that people would trust the bank enough to keep and use the note will itself help further that bank's reputation and gain more customers for the banks' other services - that is no trivial value. The advertising effect will also reduce the amount of seignorage the bank will charge for the issue of those notes (and minting of coins).

As a historical note, there was a drawn out process of the US government deliberately destroying the advertising effect over the course of the decades leading up to the founding of the Federal Reserve System. Initially, notes were distinctive to each bank, but over the years (starting with the Civil War and the greenbacks, I think?) regulations on note design became ever more restrictive and aimed at uniformity, so that by the founding of the Fed the notes were more or less indistinguishable from each other. With that (and other things) in place it was a cinch for the Fed to monopolise note issue without requiring any change in people's attitudes towards what notes they used. The founding of the Fed and its machinery was not all some sudden thing, but a coup that had been planned for a very long time and had been implemented bit by bit.

If the bank could not earn interest, a bill issued for depositing a $1 coin today would be worth $.95 next year, $.90 in two years, $.85 in three years--and $.72291666666... in 5 years, 6 months, and 15 days.

During which time the bank should have made additional earnings by wisely using the initial seignorage revenue it earned by parlaying it into other business activities whose customers had been drummed up by advertising. If a bank did well, then of course it will have no problems in redeeming face value of its issued notes just as the law of contract requires it. If a bank did not then that's on the shareholders' heads, and if in the face of this the bank does not fulfill its contractual obligations by redeeming the note at face value then it is acting illegally.

If you had ten dollar bills in your wallet, you would have to look at the date on each of them, compute the number of days since then, then look at the bill to see what the bank charges for keeping, multiply the number of days with the charge, and substract it from the nominal value of the bill--all this just to find out how much money you have on you.

The charges had already been paid by whoever first bought the note from the bank with gold, and so play no further part in valuation. After that the note can trade freely on its face value without anyone else having to make calculations - unless it is known or suspected that the bank practices FRB in relation to notes issue, in which case a risk premium is used as a discount factor. That is actually how it used to be done, and financial ratings agencies regularly published their opinions about the solvency of banks for the purpose of helping people form opinions about how to discount notes. Time-preference only enters into people's valuation of notes insofar as it affects the entire phenomenon of the demand for money as such, irrespective of whether that money consists of gold or notes.

But in exchange, you can be 100% sure that the bank will be able to give you nice and shiny gold coins if for some strange reason you suddenly develop an urge to have them--instead of the 99.9999% assurance you would have with fractional-reserve banking. That a good deal?

Not if the bank's reserve policies or its key officers are irrational or unpredictable, no. Any practice of FRB that would rationally give rise to 99.9999% confidence on the part of bank customers would involve an X so close to 1.00 as not to be worth the bank's administrative trouble to practice it at all. Making FRB worthwhile would mean doing it far enough to earn an interest on the fiduciary money lent out to cover the administrative overhead it generates, and so would mean a confidence level significantly less than 99%. That's not likely in a world populated by rational people because they know that the bank adds nothing to the economy in doing so and makes that bank less solvent, and so they would shun that bank. That's why I think there would be little departure from 1.00.

Gold coins are weighty for big sums and fiddly for small (a gap that silver can fill, to a point), but have the upside of being the real thing and possesses all those attributes that made gold the objective choice for money in the first place. Money substitutes are easier to use physically, but have the downside of users having to pay heed to issuers' rationality, which is not always easy to judge. There is a trade-off there that anyone who has the option between them has to make. Nothing can absolve a man of the responsibility to judge that trade-off for himself. IMHO, one of the reasons for public support for central banking is that it allows men the illusion of escape from that responsibility. The publications of those ratings agencies, for example, were often hefty tomes and had price tags to match, so naturally the sirens' singing of eliminating the need for them drew many to the rocks. The supposed-benefits of FRB are a major theme in that song, but not the only one.

JJM

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There is nothing wrong with defining a concept for both an action and its consequence.
There is if the aim is to keep in mind the natures of different causes with similar consequences for the immediate future but which causes lead to different paths of consequences as time passes. Calling different causes by the same one used-daily term obscures this crucial difference.

I meant one concept for an action and another for its consequence. Such as "issuing fiat money" for the action and "inflation" for the consequence (= rise in P).

It's the same principle as gays having every right to expect the government to recognise the existence of and protect the content of their contract of personal partnership but being disallowed from calling it marriage because (amongst other reasons) there are third-party legal ramifications relating to that term and related ones like husband and wife.

They can call it whatever they please between themselves if there are no third parties involved. I agree that they have no right to represent it as a marriage to third parties--but I don't think we should put a policeman into their bedroom to monitor what they whisper into each other's ears. (What cop would want that job anyway? :))

notice how indignant they get when they find out that they are unsecured creditors

What do you mean by "unsecured" ?

I am not a gold bug

Well not a 24 carat one because you don't want to throw me into jail for opening a checking account, but since you apparently don't think I have a right to call it a deposit if I do so, I'll give you at least 22 carat. :D

During which time the bank should have made additional earnings by wisely using the initial seignorage revenue it earned

Okay, let's say the bank wants 5% per annum for storing a gold coin, and suppose it can earn 10% on its investments. This means that it needs to charge 50% seignorage. Who's going to put his gold coins into a bank for such a price?

You may quibble with the magnitude of my figures, but the point is that you are way overestimating people's aversion to keeping their coins at home, and way underestimating their aversion to the small risk that is associated with fractional-reserve accounts, especially if the former is going to cost them money while the latter is going to yield them money. And if somebody does decide to store some of his capital in a very safe but completely unproductive form, he will typically want the costs of such storage to be proportional to the amount of time they are stored for. When a bank does safekeeping, it is in the interest of both the bank and the client to make the charges proportional to time.

Not if the bank's reserve policies or its key officers are irrational or unpredictable, no. Any practice of FRB that would rationally give rise to 99.9999% confidence on the part of bank customers would involve an X so close to 1.00 as not to be worth the bank's administrative trouble to practice it at all.

Make it 99.9% then. Say, a 99.9% confidence that the client will get back at least 90% of the value of his investment within 3 months of indicating his desire to withdraw. Does that sound like an unacceptable risk?

There is some risk even if you "invest" your money into a safebox: there may be a big gold rush somewhere in Africa next year, or heavy economic downturn caused by a war, and your very safely kept gold coins might lose 10% of their value. There is no way of storing wealth that is totally risk-free. You weigh the expected returns and the potential downsides of each investment, and choose the one you like best. There is nothing about the nature of a fractional-reserve checking account that should necessarily scare a majority of people away from investing a small portion of their wealth that way. Quite on the contrary, it offers them a convenience that I think would motivate them to hold such accounts in a free, gold-standard economy just like it motivates them to hold such accounts now.

the bank adds nothing to the economy in doing so

What do you mean by "add to the economy" ? The bank adds something to my wallet in doing so, while also making it possible for me to carry a wallet instead of a big bag of gold. That's good enough for me!

But suppose that's just me being a sucker, unable to judge risks rationally just like I am unable to appreciate the great taste of Pepsi in comparison with Coke. Do you really think people like that would form a tiny minority in our hypothetical gold-standard economy? If the proportion of "suckers" is even only 10%, fractional banking would be a major force in that economy, and X would be quite significantly above 1. If 10% of 300 million Americans had fractional-reserve checking accounts, that would be 30 million accounts--making the American fractional-bank industry larger than Australia's banking industry is today!

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Re. MV = PQ, this article pretty much sums up why I don't like the "velocity of money" idea as relevant to inflation. Basically: the velocity of money has to follow the velocity of goods - it's not an invalid concept but it can't be central to the issue of inflation.

Hazlitt's main point seems to be that V is not a "causal factor" with regard to the price level. With this, I agree, but only because I hold that none of the variables are causes: neither M nor V nor P nor Q. Only concretes exist, and only concretes can be causes--in this case, the individuals who produce and trade.The variables are simply measurements of their actions. But there are relationships among the variables, because there are relationships among the actions of the individuals--for example, if an individual successfully applies himself to developing a new technology that significantly increases Q, then his action will have an influence on the actions of other individuals and thereby on M, V, and P--and I posit that there may be certain laws and regularities in the patterns followed by these variables in their response to such an action, and that these potential patterns and regularities are worth investigating.

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Re. MV = PQ, this article pretty much sums up why I don't like the "velocity of money" idea as relevant to inflation. Basically: the velocity of money has to follow the velocity of goods - it's not an invalid concept but it can't be central to the issue of inflation.

He's mostly right, and from what I can remember about the quantity school he is perfectly correct to attack the mathematicism of that school's adherents. Velocity is not a figure that can be so easily calculated as the rearrangement of the formula suggests. It's fine as a basic pedagogical tool, but if the money supply or other issues change in the accounting period over which PQ is relevant then all bets are off.

What I disagree with is his treatment of velocity being exclusively a derivative. He says "V is never an independent factor on the side of money" This is wrong. There is an element to it that is an independent causal factor leading to influences on price levels. That element is the distribution of frequencies in which people and businesses pay and are paid. For instance, people can get their incomes daily, weekly, fortnightly, monthly, quarterly, etc. The proportions of who gets what and when can change, such as a guy at my workplace who shifted from wages to salary and hence from fortnightly pay to monthly. Hazlitt does refer to people being paid weekly, but he made no mention of the distribution of different pay-periods or the fact that it can change. It isn't much of a change, but the issue is still there as an independent factor.

He is correct in that the vast bulk of "velocity" is actually the psychology of demand for money, as influenced by expectations that are themselves related to M and Q factors. My dispute is rather trivial, but valid nevertheless.

JJM

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he is perfectly correct to attack the mathematicism

This is one of the worst parts of the Austrian school's philosophical foundation. Declaring that math does not apply to your theory is an admission that you do not feel bound by the law of identity.

Note how Hazlitt dismisses the sigificance of the Equation of Exchange with the words: "the two sides of this equation are equal only because they are identical" (italics his, bold mine). Should we dismiss the significance of "A is A", and all that is built on it, because "the two sides are identical" ?

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This is one of the worst parts of the Austrian school's philosophical foundation. Declaring that math does not apply to your theory is an admission that you do not feel bound by the law of identity.

He was attacking the idea that economics can be pursued using mathematics in a rationalistic fashion without bothering to take a look at the real-world mechanics of trade. He was effectively affirming the law of identity, not challenging it. The mathematicists are the guilty party there because they reduce reality to numbers, Pythagoras-style.

JJM

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