Research on Rand's Economic Theories

[Matthew]

Greetings;

Does anyone know of research that investigates Ayn Rand's economic theories? Specifically, I have been looking for supporting research on inflation as described in chapter 12, "Egalitarianism and Inflation" from "Philosophy: Who Needs It".

Many thanks,

Matthew W. Yucha

Edited March 9, 2008 by Matthew

[Gary Brenner]

Greetings;

Does anyone know of research that investigates Ayn Rand's economic theories? Specifically, I have been looking for supporting research on inflation as described in chapter 12, "Egalitarianism and Inflation" from"Philosophy: Who Needs It".

Many thanks,

Matthew W. Yucha

I would start with a writer whose work Rand admired, Henry Hazlitt. His book What You Should Know About Inflation is sound in theory and analysis:

I present in this chapter a chart comparing the increase

in the cost of living, in wholesale commodity prices, and

in the amount of bank deposits and currency, for the twenty year

period from the end of 1939 to the end of 1959.

Taking the end of 1939 as the base, and giving it a value

of 100, the chart shows that in 1959 the cost of living (consumer

prices) had increased 113 per cent over 1939, wholesale

prices had increased 136 per cent, and the total supply

of bank deposits and currency had increased 270 per cent.

The basic cause of the increase in wholesale and consumer

prices was the increase in the supply of money and

credit. There was no "shortage of goods." As we noticed

in the preceding chapter, our rate of industrial production

in the twenty-year period increased 177 per cent. But though

the rate of industrial production almost tripled, the supply

of money and credit almost quadrupled. If it had not been

for the increase in production, the rise in prices would have

been much greater than it actually was.

Entire book online here:

http://www.mises.org/books/inflation.pdf

[Matthew]

I would start with a writer whose work Rand admired, Henry Hazlitt. His book What You Should Know About Inflation is sound in theory and analysis:

I present in this chapter a chart comparing the increase

in the cost of living, in wholesale commodity prices, and

in the amount of bank deposits and currency, for the twenty year

period from the end of 1939 to the end of 1959.

Taking the end of 1939 as the base, and giving it a value

of 100, the chart shows that in 1959 the cost of living (consumer

prices) had increased 113 per cent over 1939, wholesale

prices had increased 136 per cent, and the total supply

of bank deposits and currency had increased 270 per cent.

The basic cause of the increase in wholesale and consumer

prices was the increase in the supply of money and

credit. There was no "shortage of goods." As we noticed

in the preceding chapter, our rate of industrial production

in the twenty-year period increased 177 per cent. But though

the rate of industrial production almost tripled, the supply

of money and credit almost quadrupled. If it had not been

for the increase in production, the rise in prices would have

been much greater than it actually was.

Entire book online here:

http://www.mises.org/books/inflation.pdf

Thanks Gary, I will read this.

Sincerely,

Matthew W. Yucha

[agrippa1]

I'm having a hard time zeroing in on the concept referred to by the term "inflation."

I've been under impression that inflation is the rise in price of a representative set of goods.

On this forum and from von Mises, I'm told that inflation is the increase in the money supply, by definition.

Hazlitt seems to accept the definition: "undue expansion or increase in the currency of a country," but modifies it by including credit with currency.

So, I'm stuck on the word "undue." If the amount of currency/credit increases with the real expansion of the economy (assuming velocity of money is stable), it would seem that the ratio of money to product would be stable, and thus prices would be stable. If so, would this be considered "inflation" by anyone, and would it be a bad thing, and if so, why?

on edit: BTW, thanks for the link

Edited March 9, 2008 by agrippa1

[Gary Brenner]

I'm having a hard time zeroing in on the concept referred to by the term "inflation."

I've been under impression that inflation is the rise in price of a representative set of goods.

On this forum and from von Mises, I'm told that inflation is the increase in the money supply, by definition.

Hazlitt seems to accept the definition: "undue expansion or increase in the currency of a country," but modifies it by including credit with currency.

So, I'm stuck on the word "undue." If the amount of currency/credit increases with the real expansion of the economy (assuming velocity of money is stable), it would seem that the ratio of money to product would be stable, and thus prices would be stable. If so, would this be considered "inflation" by anyone, and would it be a bad thing, and if so, why?

on edit: BTW, thanks for the link

Bear in mind an increase in the money supply can happen without a central bank. If, for example, gold is the primary medium of exchange, a sudden glut of that metal on the market could cause a surge in prices. However, since the world's gold reserves are well known and widely held, that is an unlikely occurence.

Hazlitt, I believe, is using the word term "undue expansion" in the sense of not normal, i.e. artificially induced.

In a free market economy, prices would tend to fall as productivity, driven by innovation, would likely increase faster than the metal backing for the currency.

[Mammon]

Bear in mind an increase in the money supply can happen without a central bank. If, for example, gold is the primary medium of exchange, a sudden glut of that metal on the market could cause a surge in prices. However, since the world's gold reserves are well known and widely held, that is an unlikely occurence.

Hazlitt, I believe, is using the word term "undue expansion" in the sense of not normal, i.e. artificially induced.

In a free market economy, prices would tend to fall as productivity, driven by innovation, would likely increase faster than the metal backing for the currency.

I second this post.

One of the reasons Gold is a good backer for currency is exactly the fact that there aren't any suddent bursts of it. The amount can be controlled (naturally, not by any government entity) and virtually put a hault to inflation (increase in the money supply without increase of actual things made).

[Publius]

I would start with a writer whose work Rand admired, Henry Hazlitt. His book What You Should Know About Inflation is sound in theory and analysis:

I present in this chapter a chart comparing the increase

in the cost of living, in wholesale commodity prices, and

in the amount of bank deposits and currency, for the twenty year

period from the end of 1939 to the end of 1959.

Taking the end of 1939 as the base, and giving it a value

of 100, the chart shows that in 1959 the cost of living (consumer

prices) had increased 113 per cent over 1939, wholesale

prices had increased 136 per cent, and the total supply

of bank deposits and currency had increased 270 per cent.

The basic cause of the increase in wholesale and consumer

prices was the increase in the supply of money and

credit. There was no "shortage of goods." As we noticed

in the preceding chapter, our rate of industrial production

in the twenty-year period increased 177 per cent. But though

the rate of industrial production almost tripled, the supply

of money and credit almost quadrupled. If it had not been

for the increase in production, the rise in prices would have

been much greater than it actually was.

Entire book online here:

http://www.mises.org/books/inflation.pdf

No offense but this paper is not "research". None of the information is cited back to an original source. The closest he comes is by just citing the names of other people.

[Thales]

Greetings;

Does anyone know of research that investigates Ayn Rand's economic theories? Specifically, I have been looking for supporting research on inflation as described in chapter 12, "Egalitarianism and Inflation" from "Philosophy: Who Needs It".

Many thanks,

Matthew W. Yucha

I don't think Ayn Rand had any economic theories, per se. She subscribed to free market economics. I believe she agreed with much of what the Austrians did. But, if you want a source, you might check out the work of George Reisman. He has a website http://www.capitalism.net.

Edited March 11, 2008 by Thales

[Capitalism Forever]

I'm having a hard time zeroing in on the concept referred to by the term "inflation."

I define inflation as a fall in the purchasing power of a currency.

If the currency in question is defined as a fixed amount of gold, as it ought to be, then inflation is a fall in the purchasing power of gold, or in other words a decline in the extent to which people value gold compared to how much they value other goods. This can happen when gold suddenly becomes much more readily available than it used to be (e.g. if a great bonanza is discovered or there is a dramatic improvement in mining technology) or if other goods become much less readily available than they used to be (e.g. due to a natural disaster or a grand-scale initiation of force against producers).

Under normal circumstances in a free economy, the supply of gold will tend to be quite stable (increasing at a steady annual rate), and other forms of wealth will tend to be produced in ever-increasing amounts (with wealth growing in quantity, quality, as well as diversity)--so the supply of both gold and other wealth will continuously increase, but the latter probably faster than the former. You will have a growing basket of goods to exchange for each gold coin: the purchasing power of your currency will increase, and prices will decline.

This relationship is expressed by the Equation of Exchange:

MV = PQ

where M is the money supply (number of dollars), V is the velocity of money (number of times each dollar is spent), P is the price level, and Q is the amount of goods produced and sold.

It is easy to see from the equation that if M increases (as in a gold rush), there will be a pressure on P to also increase, and similarly that if Q declines, P will--all other things remaining equal--have to increase. This is the case of inflation. On the other hand, if M keep growing slowly, and Q is hopefully growing fast, then P will be subject to a pressure to decrease--this is the deflation scenario.

If you have a currency that is not under the gold standard, but a is fiat currency whose supply depends on the whim of the government, you will typically have M growing faster than Q, causing P to continuously increase (inflation). The government does this in order to reduce the value of its debt--it is in effect a way of borrowing money and then when you see you can't repay it, saying you actually owe less.

[mrocktor]

I've been under impression that inflation is the rise in price of a representative set of goods.

On this forum and from von Mises, I'm told that inflation is the increase in the money supply, by definition.

To solve this apparent contradiction, you need only to look at your definition carefully. What does "representative" mean in that phrase? Representative of what?

The only truly "representative" set of goods, when speaking of an economy as a whole, is the lot of them. Taking all the goods as your "representative" set, your definition of inflation coincides with the Austrian one (i.e. the prices of ALL goods can only rise by an increase in the supply of money).

If you are not speaking of the whole economy, then the use of the term "inflation" is innapropriate. If specific prices are rising, such as the "cost of living" (however you arbitrarily define that set of goods), then it is just that: rising prices. Only by looking at the money supply can you break down how much of the rise is inflation and how much is actualy just higher prices.

[Capitalism Forever]

the Austrian one (i.e. the prices of ALL goods can only rise by an increase in the supply of money).

How about a decline in output? How about an increase in the velocity of money?

[mrocktor]

How about a decline in output? How about an increase in the velocity of money?

Good points. It is the relative supply of money to transactions involving money that matters. If the stock of goods remains constant but they are traded more, that would be a relative decrease in the supply of money. If the stock of goods were reduced, that would be a relative increase in the suply of money.

In a free capitalistic economy, one can make the assumption that the stock of goods will be continuously expanded, and that the amount of transactions will remain fairly proportional to the stock of goods (I hate the name "velocity of money"). Under these conditions, only increasing the stock of money can cause inflation.

[Capitalism Forever]

In a free capitalistic economy, one can make the assumption that the stock of goods will be continuously expanded

That will definitely be the case under normal circumstances, as the free economy's wealth won't be subject to periodic destruction by its own government, but in the case of a natural disaster or foreign invasion, a substantial portion of the country's wealth could still be (temporarily) destroyed.

and that the amount of transactions will remain fairly proportional to the stock of goods (I hate the name "velocity of money").

I don't necessarily agree with this either, but I don't want to get into debating it right now.

[John McVey]

I define inflation as a fall in the purchasing power of a currency.

The definition of inflation as a fall in purchasing power of the currency is off. That fall is a consequence of inflation but its not itself the inflation.

As has been noted there are other reasons for a fall in the purchasing power of a unit of currency besides an increase in the number of those units. Remember Objectivist epistemology: the key feature of a concept that serves as its definition must be that which distinguishes the constituents not just from all others equally but from the genus group of which the constituents are a subset. The genus group is causes relating to falls in purchasing power, of which inflation is just one concept among them. If the word inflation is to have any meaning, if real causes are to be identified and named, then inflation must be kept separate from those other causes (eg an increase in velocity or a decrease in output, as Roland rightly noted). Inflation is a monetary act - that cause can only be something to do with an increase in the money supply, so as to differentiate inflation from other causes of a decline in purchasing power.

Further, just look at the word: inflation, as in the act or consequence of inflating something. Don't just look in an ordinary dictionary for the present meaning, look at its etymology too:

1340, from L. inflationem (nom. inflatio), noun of action from inflare "blow into, puff up," from in- "into" + flare "to blow" (see blow (v.1)). Monetary sense of "enlargement of prices" (originally by an increase in the amount of money in circulation) first recorded 1838 in Amer.Eng. Inflate (v.) is 1533, from L. inflatus, pp. of inflare.

Objective epistemology, the very word itself, and its original usage, all point to the same one sort of thing: inflation is an increase of some kind, not a fall.

So far the Austrians could agree with that, as do a number here, but I go further. I don't think inflation is every increase in the money supply, but instead that it is an increase in the money supply that is not accompanied by a corresponding increase in actual commodity backing. That means an increase in the amount of gold circulating around in coins sufficient enough to lower the per unit value of that gold is not inflation. In contrast, an increase in the amount of fiat notes and coins circulating is inflation even if the increase is not large enough to make prices rise! There is a third possibility involving a gold standard, which I will get to later.

As to why I don't hold that all increases are inflation, I have two reasons for this. The minor one is simple, that the very word lends itself to the idea that what it is being increase with is mere air and not something of real value. Defining inflation as all increases misses a key point about why people got upset about inflation in the first place. Inflation (and deflation) is a pejorative term, suggesting that someone is cheating or stealing, which is exactly what rulers of old did when they debased the money supply. The consequences of that are why inflation were and still are hated, and it is right that they should be hated. However, if the increase is of real commodities with real value, nobody is cheating or stealing anything, so calling that inflation unduly casts aspersions upon the causes. I see no reason why inflation (and deflation) should stop being pejoratives, and I would say that taking the moral evaluation element of the word away from it is a dangerous thing to do because it plays right into the hands of demagogues. Since there is nothing wrong with an increase in gold in circulation, and that it is not a mere pumping up with air, inflation is simply not the word to use either for it or for its market-price consequences.

The second reason shows why this is wrong:

If the currency in question is defined as a fixed amount of gold, as it ought to be, then inflation is a fall in the purchasing power of gold, or in other words a decline in the extent to which people value gold compared to how much they value other goods. This can happen when gold suddenly becomes much more readily available than it used to be (e.g. if a great bonanza is discovered or there is a dramatic improvement in mining technology) or if other goods become much less readily available than they used to be (e.g. due to a natural disaster or a grand-scale initiation of force against producers).

That definition and explanation of consequences is missing the point about inflation entirely. The major reason why I reject inflation being defined as all increases in the money supply revolves around the fact that real money is commodity money, and recognising the nature of inflation's sister-concept of deflation. When the amount of gold in circulation increases, what happens is not inflation but merely a total re-balancing of everyone's hierarchy of values for all commodities. That is, if as a result of an increase in gold coins the value of each falls, some of those coins will then be withdrawn and turned to plate or jewelery and so on, and in turn people will rearrange their valuations of everything else because of how they value gold products, and so on through out the entire set of possible commodities people can by. Calling that inflation is bizarre, which can be seen when one considers it in parallel with the meaning of deflation...

Under normal circumstances in a free economy, the supply of gold will tend to be quite stable (increasing at a steady annual rate), and other forms of wealth will tend to be produced in ever-increasing amounts (with wealth growing in quantity, quality, as well as diversity)--so the supply of both gold and other wealth will continuously increase, but the latter probably faster than the former. You will have a growing basket of goods to exchange for each gold coin: the purchasing power of your currency will increase, and prices will decline.

Entirely true, but also misses the point in exactly the same way. Technology makes the quantity of everything go up, and indeed the increase in the first commodity from efficiency improvements runs ahead of the same in the money supply (unless the commodity is the money supply commodity), so the consequence is a fall in prices. Calling that deflation is bizarre, because the very word says something physical is being reduced, that air or whatnot is being withdrawn - but nothing is being withdrawn! The word deflation just does not describe the situation at all - the general meaning of the word is simply not at all consistent with its attempted application as describing the causes of what's going on here. Likewise, inflation cannot properly be used to describe an increase in commodity money for the same reason set in reverse.

Okay, the third way of having inflation:

This relationship is expressed by the Equation of Exchange:

MV = PQ

where M is the money supply (number of dollars), V is the velocity of money (number of times each dollar is spent), P is the price level, and Q is the amount of goods produced and sold.

It is more accurate to express the equation as BXV = PQ. B is the amount of base currency (real gold coins or fiat paper) and X is the credit multiplier (there are proper standard algebraic symbols in the textbooks, but I forget what they are). The total money supply is then not just the amount of currency but that amount times the multiplier: M = BX. This multiplier arises whenever fractional reserve banking is in practice. Mathematically, the credit multiplier is the inverse of the reserve fraction: if the reserve fraction is 50%, then the multiplier is 1 / 0.50 = 2, while a fraction of 25% means 4, 5% means 20, and so on. (I'm not going to discuss the propriety or otherwise of the practice here). When the banking system has a multiplier greater than the base of 1 (ie 100% reserve) then the extra money so created is what von Mises called "fiduciary" media, because they rely not on being backed by cash (real or fiat) in the banks' vaults but upon customers' faith in the continued solvency of the banks.

The reason this is important is that there can be inflation for reasons other than an increase in the base currency. An increase in the amount of fiat currency is definitely always inflation. We can note that even under a gold standard there can be inflation. However, unlike with fiat currency that inflation wont be because the amount of gold in circulation has increased. Rather, the cause under a gold standard is that the average multiplier can increase when banks lower the amount of gold coins they keep in reserve to fund occasional withdrawals by their customers as a proportion of those customers' total deposit and cheque account holdings. Conversely, deflation can occur even under a gold standard simply through the banks increasing their reserves as a total proportion of those accounts. Under free banking the multiplier is low (or non-existent) because a bank that goes too far will face what is called "adverse clearing" - that is, people who accept in payment notes from that bank, or cheques drawn upon accounts with that bank, will go to the banks and redeem the notes or cheques for real coins the moment they think the bank can't pay up rather than crediting their own accounts with that bank. That is what a run was originally about, and the fear of that kept the banks in check from extending credit too far. That in turn kept inflation to a minimum, often not even being enough to counter the effect of efficiency leading to price drops.

Nowadays the multiplier is much higher than it was under free banking, and our financial system is all the shakier for it - not despite capital adequacy regulations and the like but because of them, through engendering ignorance and complacency on the part of customers and the promise of bail-outs inviting banks to undertake riskier behaviour than they would otherwise engage in. These two, inflation and deflation through changes in reserves, were part of what happened during the late 20's and early 30's. The Austrians overrate their importance, IMHO, but they most certainly did play a notable part in the Depression. This was especially the case during the Depression itself, when the government's actions caused bank failures and wiped out those accounts in the process, taking their contribution to the money supply with them - the money supply had been deflated by 30% or so by the end of it, and the Fed not long ago admitted its culpability in the matter (long after such an admission would endanger the Fed's political existence, of course).

JJM

Edited March 13, 2008 by John McVey

[John McVey]

and that the amount of transactions will remain fairly proportional to the stock of goods (I hate the name "velocity of money").

There's nothing wrong with the term or what it describes, when properly understood. All it means is the number of times on average that a unit of currency changes hands.

There's more to the velocity than just the number of transactions per year. Velocity, properly understood, is a reflection of people's demand for money, as influenced by the total quantity of money and the average number of transactions per year. The demand for money is people's want of money, not to spend on known transactions, but to act as a buffer against unknown transactions until next time they get paid. Generally, it is the "float" that businesses and people want to have over and above their planned spending for the coming financial time-frame. It consists of the amounts held in checkout tills, petty cash drawers, ATM's and all the rest of business holdings of cash, plus the float that people tend to keep on person or in the house, and also what people store in other safe locations (eg deposit boxes).

One of the good things Murrary Rothbard did was to show that the understanding of what drives the purchasing power of money can be had using standard microeconomic principles rather than going off into the Lala-Land of Keynesian macroeconomics. Here's roughly how it works. Normally, people will replenish the float to a predetermined amount, and this tends to stay the same proportion of total purchasing power they will earn. People will spend out of their actual holdings until the purchasing-power of their holdings (note NOT the nominal cash amount) falls to that minimum, and likewise will curtail spending and save more as holdings until the purchasing-power goes up to the minimum. This relates to velocity because their total purchases - both business and consumer spending alike in total (*) - is the PQ of equation that Roland introduced. Working backwards, then, velocity is PQ / M. When people are confident in the money, they will have a high demand for it, encouraging them to hang on to cash for a bit longer because it keeps its value, leading to it having a high purchasing power because less is being spent on the total goods: same Q, same M, but low P through low spending leads to low V. Conversely, when people have a low opinion of it, they will have a low demand for it, will want to get rid of it, will spend more and so have more spending chasing the same goods, thus lowering P for the same Q and M, leading to a higher V.

When things for the currency get really bad, the velocity of money hits the roof because the demand for money falls through the floor. People no longer trust the currency so will try to spend ALL of their income ASAP - this is called "flight to values", ie goods, any goods, rather than holding cash. Their floats are pushed to near zero, the attempt to purchase drives prices high (P up) because there's still only so much output to buy. That output is even likely to be falling, for the same reason as why there's distrust of the M to begin with: government action making life, hence production, difficult. The most common cause is inflation by governments (though it is not the only cause), and when inflation gets bad so much that governments have to print more to pay their debts, people no longer have any demand for the currency and the result is a runaway inflation that von Mises called the "crack-up boom".

(* many economists get weird notions of strange multipliers coming from and going to nowhere because they steadfastly refuse to consider business spending, dismissing it as part of the "double counting" alleged-fallacy blah blah blah. They talk about consumer velocity as distinct from full transactional velocity. "Consumer velocity" is drivel. The only real velocity is the full transactional kind, that relating to the frequency and amount spent by everyone, business and consumer alike.)

Anyway... bonus points if you can figure out how credit cards are NOT money but whose introduction nevertheless caused general price increases without necessarily being inflationary

JJM

[Capitalism Forever]

inflation is an increase of some kind, not a fall

An increase in the price level, which is the same thing as a fall in purchasing power. It isn't clear from your post what you think inflation is if not this.

[mrocktor]

There's nothing wrong with the term or what it describes, when properly understood.

Thanks. I still dislike the name, but I can accept the concept.

[agrippa1]

I don't think inflation is every increase in the money supply, but instead that it is an increase in the money supply that is not accompanied by a corresponding increase in actual commodity backing.

I believe this definition has a measure of arbitrariness based on a bias towards an intrinsic value of a commodity.

I understand why you say this - because the amount of that commodity is not subject to the whims of a fiat currency provider, but that is a judgment of motives and human tendencies, not of the results of such tendencies. The choice of gold as a holder of value is based mainly on two things: First, it is not perishable. Second, it had a very high general value for its excellent jewelry making properties (soft, weighty, shiny, cool color, non-tarnishing), relative to weight and volume, when man was looking for a way to artificially hold value in money for market transactions.

If the supply of gold increases quickly, the economic results are identical to an arbitrary increase in fiat currency, so why the distinction?

BTW, I've been reading up on inflation recently, and it seems to me that currency can be thought of as gov't debt (under the gold standard, it was an IOU for gold). In that case, why do we separate currency as the cause of inflation, when other government debt makes up the lion's share? I believe what you will find if you look at the total amount of value lost to inflation over the years, is that it roughly equals the total federal debt, including currency.

As Greenspan stated:

The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy's books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.

-Alan Greenspan, "Gold and Economic Freedom," Capitalism: The Unknown Ideal, 101.

Is the answer: Credit cards allow banks to make automatic bookkeeping adjustments to their customers' deposit records without entailing the transfer of currency?

BTW, this is a method banks use to allow them to decrease the fractional reserve of cash in their vaults.

[Capitalism Forever]

it seems to me that currency can be thought of as gov't debt (under the gold standard, it was an IOU for gold)

Yes, Treasury bonds play a similar role today as gold plays in a free economy, but there are two major differences:

1. The amount of gold that is minted into coins is determined by the market, whereas the number of bonds that are "bought" by the Fed is up to the whim of the Fed.
   
2. Gold coins can be melted and turned into a fixed amount of a valuable metal, whereas fiat dollars are not guaranteed to be convertible into any fixed amount of value; the most you can count on is that the government will be quite willing to take them off you, in exchange for one of two things:
   


1. Freshly issued bonds
   
2. Not sending you to jail
   

Freshly issued bonds are themselves denominated in dollars, so if you have $100 in bills, it means you can rest assured you can exchange it for $100 in bonds. But how much is a freshly issued $100 bond worth? Well, exactly $100--so you get a circularity in the place of a fixed amount of precious metal. If the purchasing power of a dollar is determined in any way, this is clearly not how it is determined.

Not sending you to jail is also denominated in dollars--or more precisely, and what's worse, as a percentage of your income measured in dollars. If there were a fixed, unchangeable law saying that no individual or corporation shall have to pay more than, say, $10,000 a year in taxes, then at least the dollar would have some sort of objective value: 1/10,000 of keeping your freedom for a year. Instead, the law simply says that the government can make you pay however much it pleases, which again means that this gives no fixed purchasing power to the dollar. By expressing your taxes as a percentage < 100% of your income, the government grants you one assurance: that if you trade in its fiat dollars and not any other currency, your taxes will turn out to be less than your income. Of course, this is an assurance that is very much in the interest of the government to grant, since it is what makes people trade in its fiat currency in preference of a sound one.

[John McVey]

An increase in the price level, which is the same thing as a fall in purchasing power. It isn't clear from your post what you think inflation is if not this.

I'm defining inflation as an increase in the money supply that is not exclusively an increase in the amount of commodity money physically in circulation. Alternatively, inflation is an increase in the amount of media of exchange other than arising from an increase in the quantity of the real commodity being used as the basis of that media of exchange. Whether or not a general price increase is associated with that is beside the point, as there can be inflation even when general prices fall / purchasing power increases.

I'm distinguishing an increase in gold coins (or silver etc) from an increase in both fiat money and fiduciary media. The latter two are inflation because they contribute nothing to the economy, while increase in the amount of the commodity serving as money is not inflation as this is a contribution of value to the economy. The fact that one of the consequences of that contribution is affects on money prices is not sufficient to call it inflation. What's happening is a shift in people's relative valuations. The value of the commodity serving as money is not the only one that may fall even if the cause is only an increase in that commodity. Insert a song-and-dance about the connection between changes in people's real income levels and changes in their relative priorities of what to do with it - I can explain that more if you like.

JJM

[John McVey]

I believe this definition has a measure of arbitrariness based on a bias towards an intrinsic value of a commodity.

No, what I have in mind has nothing to do with intrinsic value. There is no such thing as intrinsic value, or subjective value for that matter, as I have argued at length by working from "The Objectivist Ethics" and works by other Objectivists. What I am basing the definition on is the fact that from the very start the term was used to denote an injection of air or something else with no value at all, in contrast to something which is an objective value even if that value changes when the quantity of it increases.

If the supply of gold increases quickly, the economic results are identical to an arbitrary increase in fiat currency, so why the distinction?

The distinction is important because more gold is still a total increase in real value. The consequence of that increase is also a fall in the value per unit, but the total still goes up. If you want to graph it, the total value on the vertical and the quantity on the horizontal, the line starts going up at 45 degrees but soon starts drooping though never falling to total flatness. There is always a real contribution, however small, when the quantity increases. Look up the (improperly named) Law of Diminishing Marginal Utility. The subjectivists formulated it, and "utility" is a bogus concept, but the Law itself does have a real objective basis.

In contrast, an increase in fiat currency or fiduciary media contributes nothing whatever. When the quantity of those goes up there is no change at all in the amount of objective value. Those doing the increasing are not providing value, and instead are effectively stealing value. When done by government, or by financial institutions on the sly, then this is objectively a crime, while in the case of fiduciary media it need not be if certain conditions are met (ie I dislike fractional reserve banking but I don't think it automatically should be made illegal so long as people are told what is going on and are free to reject or not as they choose the various fiduciary media from banks that practice FRB).

BTW, I've been reading up on inflation recently, and it seems to me that currency can be thought of as gov't debt (under the gold standard, it was an IOU for gold). In that case, why do we separate currency as the cause of inflation, when other government debt makes up the lion's share? I believe what you will find if you look at the total amount of value lost to inflation over the years, is that it roughly equals the total federal debt, including currency.

That's because bonds (types of tradable debt contracts) are assets to those who purchase them (ie lend money to the issuers). The capital adequacy standards for banks allows them to treat their holdings of government debt as backing for their own liabilities in turn. It is those liabilities - ie the deposit and cheque accounts of their customers - that through fractional reserve banking become the vast bulk of the modern money supply. Government debt is not the money itself but is a substitute for banks' holding gold as the asset-backing for their fiduciary media, and it is those media that are the major part of the money supply. An increase in debt issued by government becomes an increase in debt purchased by banks, which becomes more asset backing for their liabilities, which becomes more money. It's more complicated than that, but that's the gist of it.

ps: I am not saying there is some nasty machinations being done by the banks. Some can be held at fault, but not the industry overall. If you've seen it, that five-part "Money-as-debt" You Tube thing is nonsense based on half-truths. I can PM you my take on it that I already gave to others, if you like.

Is the answer: Credit cards allow banks to make automatic bookkeeping adjustments to their customers' deposit records without entailing the transfer of currency?

You're half-way there. What does customers' not having to hold as much currency result in? What was the context of the comment?

JJM

[Capitalism Forever]

I'm defining inflation as an increase in the money supply that is not exclusively an increase in the amount of commodity money physically in circulation.

So would that be an increase, using your symbology, in M - B? Or an increase in M/B (which is, more simply put, an increase in X)?

Moving on from identification to evaluation, do you think inflation so defined is necessarily a bad thing? From your comment on fractional reserves, it seems like you do, and indeed you would prefer X to just stay 1, which in plain English means "no fractional reserves"--is that right? (Would you even call any X > 1 an instance of inflation?)

[John McVey]

So would that be an increase, using your symbology, in M - B? Or an increase in M/B (which is, more simply put, an increase in X)?

If B is physically made of fiat currency then even an increase in B itself is inflation. If OTOH B is proper commodity money then inflation is the increase of M-B, yes. An increase in X is also inflation, but an even worse than just an increase in M with a constant X.

Moving on from identification to evaluation, do you think inflation so defined is necessarily a bad thing? From your comment on fractional reserves, it seems like you do, and indeed you would prefer X to just stay 1, which in plain English means "no fractional reserves"--is that right?

Yes, it is. In theory, restricting inflation to the increase of fiat paper or fiduciary media (or both) fits the meaning of the word while also remaining consistent with the opposite phenomenon of deflation. In practice, an increase in even just the fiduciary media on a gold base just serves to make the financial sector more shaky because total nominal revenues in the economy become ever more dependent upon the continued solvency of the banks who practice it, banks who have not offered a single thing of real value in return. That's why one of the conditions of the non-illegality of FRB must be that people have the right to refuse to accept the notes, bills of exchange, cheques, wire transfers, direct-deposits, etc, of that bank or that bank's customers as payments for the values these people offer.

If that condition held then I doubt very much that X would significantly depart from 1, certainly not for extended periods. On a related note, minor fluctuations in X would be a major proportion of the "noise signal" on a tracking of economic growth in even the fully laissez-faire economy. That is also what von Mises was on about in reference to the connection between the money supply and productive output. There'd be localisation involved in it too, though these days the ripples would spread around the globe so fast as to be almost undetectable without direct access to financial institutions' intimate records. In the past, however, that would take a notable amount of time, and so an economic historian could observe it.

(Would you even call any X > 1 an instance of inflation?)

The mere fact of being >1, no, so long as the base currency itself also is unchanged in quantity. Inflation is when:

1) X increases, no matter what B is or is made of

2) B increases when B is commodity money, while X>1 even if X remains constant

3) B increases when B is fiat money, no matter what X is.

I had an interesting thought - what if, as highly unlikely as it may be, X goes down while a B made of fiat paper goes up so that BX remains constant? Is that inflation or not? My answer is that it is simultaneously inflation and deflation, each in different elements of the money supply, such that their effects cancel each other out as far as the money supply of the moment goes. However, such a move cannot be glossed over, because the increase in B is apt to be far more permanent than the decrease in X. That means it still bodes ill inflation-wise for the future and so forecasters of it should be acutely aware of the physical realities when making their projections. Don't be fooled by the tyranny of aggregates.

JJM

[Capitalism Forever]

If that condition held then I doubt very much that X would significantly depart from 1, certainly not for extended periods.

I see, so your objection is in essence not to my defintion of inflation, but to fractional-reserve banking. But the fact that you don't want to outlaw either makes you much better in my book than the Murray Rothbard-style gold bugs.

I don't see why free people would shun the fractional-reserve money of reputable banks. It allows them to hold immediately-available funds and still earn interest on them rather than incur the costs and inconveniences of carrying gold coins in their pockets or having to pay a fee for a checking account that yields no interest. It also makes possible the existence of paper bills and small-change coins not made of gold, which is another convenient means of payment for certain low-volume ad-hoc transactions.

[John McVey]

so your objection is in essence not to my definition of inflation,

Yes it is, I am objecting to your definition. 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.

If X is always 1 and the money supply is made strictly of commodity money (which includes claims to and substitutes for commodity money that is held untouched and non-circulating) then there is never inflation (or deflation), irrespective of what happens to purchasing power. A temporary departure of X from 1 would most likely be the result of a robbery or some disaster like a shipwreck: the claims / substitutes are still outstanding and circulate as money but the underlying commodity that was held in reserve was lost. That departure would then be inflationary, and its correction deflationary.

But the fact that you don't want to outlaw either makes you much better in my book than the Murray Rothbard-style gold bugs.

I look at fractional reserve banking the way I look at the use of intoxicating substances - shouldn't be illegal even though it is frequently immoral, but it is not inherently immoral.

I don't see why free people would shun the fractional-reserve money of reputable banks. It allows them to hold immediately-available funds and still earn interest on them rather than incur the costs and inconveniences of carrying gold coins in their pockets or having to pay a fee for a checking account that yields no interest.

Entirely true. That is the essence of why it shouldn't automatically be illegal. The key requirement is that customers are told that this is being done to the funds they have entrusted to their bank. If the customers are happy with that arrangement, fine. If the bank folds and their accounts wiped out then it is on their own heads. Likewise, other trading partners of that bank's customers take it on their own heads to accept payment via the banks in question, and from there on in similar fashion to the rest of the whole economy.

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. Customers can still have transaction accounts that are fractionally reserved, but financial institutions shouldn't label them or payments into them as "deposit". Accounts marked as deposit should be recognised by the courts as being held under contracts of bailment, not contracts of credit. The difference is the same as between someone putting material a safe deposit box and someone putting material into a commonly-accessible pool expressly made available for short-term use. If the provider of the former "borrows" from the safe deposit box then that is objectively a crime (also, think of the Ferrari scenes in "Ferris Bueller's Day Off"), while it is not to do so from the common pool. A cash deposit account should in practice be treated as the customer putting that cash into one large safety deposit box, made possible through application of the concept of fungibility. If the bank goes under then that bank's creditors have no recourse whatever to the cash held as reserve for deposit accounts because that money does not at all belong to the banks in exactly the same way as banks not owning the contents of individual deposit boxes.

It also makes possible the existence of paper bills and small-change coins not made of gold, which is another convenient means of payment for certain low-volume ad-hoc transactions.

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. Saying that FRB has to exist for the use of money substitutes is implicitly relying on the fallacy of the insufficiency of cash - which is a fallacy because it is indefinitely divisible.

BTW, the value (such as it is) of FRB in relation to non-depository customers is the acceptance of a bit more risk in return for a share of the banks' earnings from its use: such accounts would legally be credit contracts. FRB in relation to the issue of money substitutes has no such saving grace - but still shouldn't be illegal as the contract is also a valid credit one.

JJM