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Thanks for that explanation, John; I've got a much clearer picture about what is meant by this "reassertion" thing now.

Let me ask you a question I also asked adrock before: Assuming a gold-based, laissez-faire economy, if a miner found a large bonanza of gold (and invested most of it into loans and bonds, causing a perceivable drop in interest rates) would a boom-bust sequence ensue? I mean, the new-found gold would eventually make its way into the incomes of individuals, who would have to decide what to do with it, just like the money lent by the banks you talked about. Since the actual return rates have fallen, they will be less inclined to invest than before, which means that the low rates will become difficult to maintain, unless the miners continue to find unusually big bonanzas. But gold production will inevitably return to its normal level sooner or later, ending the boom and causing a bust.

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The fact is, we already know what would happen with a sudden surge of gold into the economy. When Spain conquered what is now Peru, they shipped back literally hundreds of tons of gold, and the result was price inflation (the symptom of inflating the money supply) in Spain, which later spread to the rest of Europe as the gold was traded by Spain.

Gold does not guarantee price stability. It does mean governments will find it much harder to monkey with the money supply.

(Time to pick on the Spaniards again. When platinum was discovered in what is now Colombia in the early 1700s, it was a nuisance; it was a bunch of heavy white nuggets mixed in with the yellow nuggets after panning (it is even denser than gold and won't leave the pan during panning). It had to be painstakingly separated from the gold, nugget by nugget and typically grain by grain, and at the time was worthless, actually it had negative value since it cost money to get rid of it. Eventually, however, mint workers discovered that even though platinum could not be melted with the technology of the day, it would dissolve in molten gold, was even more dense, and just as acid resistant--it literally withstood the acid test. It was easy enough to get, say, a pound of that white junk, melt it into the gold, and pocket a pound of gold, with no one the wiser. Spain had to resort to *banning* platinum, and would buy it up at the site it was mined at. Later on when the Spanish government wanted to debase their currency they would put some platinum into their gold coinage. Much later (late 1800s) the value of platinum, due to discovered industrial applications, finally exceeded that of gold.)

I understand that all the gold ever mined would form a cube 65 feet on a side (about 20 meters). I've also seen that given as a weight (19.3 metric tons per cubic meter gives approximately 154,400 metric tons or almost 5 billion troy ounces, less than one ounce average for every person on the planet. (Hmm, I seem to have more than my "share" of the stuff. :P )

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Let me ask you a question I also asked adrock before: Assuming a gold-based, laissez-faire economy, if a miner found a large bonanza of gold (and invested most of it into loans and bonds, causing a perceivable drop in interest rates) would a boom-bust sequence ensue? I mean, the new-found gold would eventually make its way into the incomes of individuals, who would have to decide what to do with it, just like the money lent by the banks you talked about. Since the actual return rates have fallen, they will be less inclined to invest than before, which means that the low rates will become difficult to maintain, unless the miners continue to find unusually big bonanzas. But gold production will inevitably return to its normal level sooner or later, ending the boom and causing a bust.

Sorry Cap, I have been super busy the last few weeks. I wish I had more time, this conversation is enjoyable to me.

In short on this point: Gold need not be the only medium of exchange in a free economy. Your scenario implicitly denies the possibility that if gold production increases to a level where the supply of gold becomes overabundant, people will simply stop using gold as a medium of exchange. I hold that this is what will happen. If this is the case, then there need not be any boom-bust cycle.

But, even assuming that is not the case, there will be no boom-bust cycle, because the increased production of gold is an increase in production; that is, an increase in real wealth. You see that the Spain example provided by Steve is actually not an increase in the production of a free economy; it is an increase in looted/plundered "wealth" in a non-market economy, so the scenario is not particularly relevant.

Edited by adrock3215
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But a similar (but smaller) inflationary effect was seen when gold began pouring out of California. You *do* get a price hike and it has *nothing* to do with any production (other than gold) increasing or decreasing. And it has nothing to do with looting in this case.

Certainly people can switch to something else, like silver. OBTW it has actually gotten cheaper, relative to gold, in the last 150 or so years. In the 1700s and early 1800s the ratio of value varied from 14:1 to 16:1, it's now at something like 80:1. ($820.9:$10.53 as of this moment, I did a quick estimate.) Obviously an Objective system would not try to arbitrarily fix this ratio, such attempts always cause problems when the market ratio changes (one or the other type of coin is worth more than its face value, and disappears into the melting pot).

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Let me ask you a question I also asked adrock before: Assuming a gold-based, laissez-faire economy, if a miner found a large bonanza of gold (and invested most of it into loans and bonds, causing a perceivable drop in interest rates) would a boom-bust sequence ensue?

Generally, across a major economy that is free, no, for two chief reasons.

The first is simply the fact that the effect would be spread out far and wide in short order. That would hold - and did hold - in the time of the Conquistadors. The effects of the influx of money would flow into the whole economy fairly quickly. Steve is right that there would be at least some monetary effect, but it would not be a major boom-bust-cycle-causing event. The reason is that as the value of gold as money drops it would be tempered by a withdrawal of gold from the money supply for jewellery or other industrial use - it is the prospect of doing just that at any time that gives objectivity to the use of gold coins. Even today, for instance, in Asia there is a lot of high-carat low-sentimental-value gold jewellery whose owners are perfectly willing to part with or add to depending on their opinion of how gold is going. That writ large would be present in a laissez-faire economy, and would buffer the monetary effects. That backs up what Adrock said about the mining being production of real wealth.

As to Spain, Adrock is right, there, too - Spain's problem was its lack of freedom. By contrast to Spain's living-by-plunder, the other countries upon whom they spent the money to buy goods from prospered in a more consistent manner. Yes, there was mild inflation because of gold and silver finds in the New World making their way to Europe, but the rate was so low that most didn't even notice it. If memory serves me, Adam Smith noted that fact as one of the reasons why many a land-owning family found the real value of its contractually-negotiated income go down over time and not inclined to renegotiating the contracts.

Additionally, again IMSM, von Mises notes in the Theory of Money and Credit that even the big gold booms of the 19th century (California, Australia, South Africa) didn't expand total gold stocks as much as a wild imagination would be inclined to believe - about 1 or 2%pa peak, I think? Today that would be even harder to maintain, because as Steve notes there is such an enormous amount of gold already mined and ready for use. A bonanza as you describe would have to be of astronomical proportions, both figuratively and literally (cf the nickel mine in Sudbury, Ontario).

The second reason is that gold, once mined, almost entirely stays in human hands forever thereafter, which is in stark contrast to the deflationary effect that banks' needs to rebuild reserves would have (bank failures even more so). The reserve-building (or failures) in a central-bank-having economy reduces the money supply, necessitating general price decreases for markets to clear again, which messes with profitability because of longer-term contractually-negotiated prices. With gold there would be almost no such price decreases in net because the money supply would not be reduced anywhere near as substantially, with effects being a lot more isolated among particular businesses. After the extra-growth phase was over the come-down-phase would therefore be considerably more muted than were the economy not free, so much so that often it would just mean the economy was merely not growing as fast as it does on average but still growing! I believe that describes a large part of the 19th century US, where people were upset because economic growth fell to 3% from 8%, but I can't remember where I got that statistic from.

JJM

Edited by John McVey
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The fact is, we already know what would happen with a sudden surge of gold into the economy. When Spain conquered

The fact that prices rose is not surprising to anyone who knows a little about supply and demand. But that was not the question. The question was whether there would be a boom and bust, a la Austrian cycle theory--i.e., whether producers would invest into projects based on the assumption that interest rates would continue to remain low, but then go bankrupt when time preferences "reasserted" themselves. A major assumption of the scenario is that the miners invest most of the gold into loans and bonds, thereby causing interest rates to drop--something I'm not sure the Spanish did.

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Gold need not be the only medium of exchange in a free economy. Your scenario implicitly denies the possibility that if gold production increases to a level where the supply of gold becomes overabundant, people will simply stop using gold as a medium of exchange. I hold that this is what will happen.

But what do you mean by "overabundant" ? It is clear that if gold became as abundant as water, people would switch to something else. But it is also clear (to me, at least) that if the supply of gold rose by something like 2-3% per annum, there would be no switch. My scenario is about an addition to loanable gold that is sufficient to produce a perceivable drop in interest rates; I don't think this needs to be much more than a couple per cent of the existing gold supply.

But, even assuming that is not the case, there will be no boom-bust cycle, because the increased production of gold is an increase in production; that is, an increase in real wealth. You see that the Spain example provided by Steve is actually not an increase in the production of a free economy; it is an increase in looted/plundered "wealth" in a non-market economy, so the scenario is not particularly relevant.

But how would you classify the action of banks in a free market economy? Are they looters or plunderers or something similar?

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Generally, across a major economy that is free, no, for two chief reasons.

The first is simply the fact that the effect would be spread out far and wide in short order.

Why does it take longer with the gold lent by banks?

The second reason is that gold, once mined, almost entirely stays in human hands forever thereafter, which is in stark contrast to the deflationary effect that banks' needs to rebuild reserves would have

Why do the banks need to rebuild their reserves?

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First up, let me correct an error. The general price rises in Europe caused by Spanish plunder being spent there were not inflation. They were just a long process of price readjustments.

Why does it take longer with the gold lent by banks?

I'm sorry, but I don't quite understand the question? It wouldn't make any difference whether gold or fiat notes were money to the question of how quickly the effects of monetary expansion (from whatever cause) spread. The information and decisions flow from any one part of the world to another as fast as communication channels let them, and the physical money travels as fast as armoured vans on the roads go, both irrespective of what the money is made of.

Why do the banks need to rebuild their reserves?

Because in the downturn some people will have lost their jobs, some businesses will have net drains on their cash reserves because revenues fall faster than costs, and so forth. Everyone still needs to pay the bills, so money must still be spent despite a loss of money coming in. Before the bottom of the downturn, that means a net outflow of cash from savings until expenses are reduced sufficiently, and that's without further consideration of people beginning to fear for the continued existence of their savings in the banks.

If the money supply is fractional then that drawdown is a drain on reserves because the percentage of cash outflow compared to total cash stocks is higher than the percentage of liability reductions to total outstanding liabilities. Say that a bank has a policy of 75% reserves. On deposit/note liabilities of 100m, the bank has 75m in specie sitting in a vault as reserve. Customers withdraw say 5m in specie, reducing both the stock of specie and the liabilities by that amount - but 5m is a higher proportion of 75m than it is of 100m. So, now there are reserves of 70m and liabilities of 95m, making the reserve fraction fall to 70/95 = 73.6%. If the bank is to keep its remaining customers it has to raise reserves back to 75%, which on 95m liabilities means adding 1,250,000 in specie to the reserves so that 71,250,000 / 95,000,000 = 75%.

JJM

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I'm sorry, but I don't quite understand the question? It wouldn't make any difference whether gold or fiat notes were money to the question of how quickly the effects of monetary expansion (from whatever cause) spread. The information and decisions flow from any one part of the world to another as fast as communication channels let them, and the physical money travels as fast as armoured vans on the roads go, both irrespective of what the money is made of.

Well, I supposed that you implied the effect would not "be spread out far and wide in short order" in the case of the banks doing what you call "credit expansion"--that this was one of the differences between the latter and an increase in gold mining explaining why gold mining would not lead to a boom and bust and "credit expansion" would.

Because in the downturn some people will have lost their jobs, some businesses will have net drains on their cash reserves because revenues fall faster than costs, and so forth. Everyone still needs to pay the bills, so money must still be spent despite a loss of money coming in. [...] Say that a bank has a policy of 75% reserves. On deposit/note liabilities of 100m, the bank has 75m in specie sitting in a vault as reserve. Customers withdraw say 5m in specie, reducing both the stock of specie and the liabilities by that amount - but 5m is a higher proportion of 75m than it is of 100m.

OK, so suppose I withdraw some gold to pay my bills. Where does that gold go? Isn't the recipient likely to deposit it in his own bank, increasing that bank's reserves--so that between the two banks, the reserves remain the same? What you seem to describe is a shift in preferences, from holding money on checking accounts towards holding money in gold--but I am not convinced that an economic downturn would cause such a change in preferences. There would be a change in the spread between production and consumption, yes, and that would reduce saveable income (or even turn it negative) but that is something different from what form people hold the funds for their transactional needs in.

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First up, let me correct an error. The general price rises in Europe caused by Spanish plunder being spent there were not inflation. They were just a long process of price readjustments.

If you are asserting that I misused inflation to refer to the price increases, I concede your point (I generally try to use the phrase "price inflation" to specifically refer to the increase in prices that typically accompanies inflation); if you are trying somehow to assert that the increase in the gold supply was not inflationary, then I disagree. Inflation is *any* increase in the money supply, regardless of whether it's done by running the printing press (for paper money) or by debasing the coinage (as done numerous times in the past) or by producing and putting more gold into circulation.

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Well, I supposed that you implied the effect would not "be spread out far and wide in short order" in the case of the banks doing what you call "credit expansion"--that this was one of the differences between the latter and an increase in gold mining explaining why gold mining would not lead to a boom and bust and "credit expansion" would.

I had a look at my original words, and I wasn't clear enough. My fault. I meant that the effects of a single bank's expansion would spread far and wide in the time of the Conquistadors just as it would today. The difference between today and then is seconds versus a few weeks, where weeks is still quick enough in a free economy to prevent a major boom-bust cycle happening in the local area. Spain's problem was law that hindered that from happening (they put bans on gold export, which just made internal prices rise and created incentives to smuggle imports in and gold out).

OK, so suppose I withdraw some gold to pay my bills. Where does that gold go?

Right where you said it does, into your pockets.

Isn't the recipient likely to deposit it in his own bank, increasing that bank's reserves--so that between the two banks, the reserves remain the same? What you seem to describe is a shift in preferences, from holding money on checking accounts towards holding money in gold--but I am not convinced that an economic downturn would cause such a change in preferences.

In time it would lead to the same, but there is always that delay. It is not a shift in preferences (unless bank solvency comes into question), just recognition of the fact that things don't happen instantaneously. For so long as the downturn is still in progress the equilibrium of cash in meeting cash out wont be met. One of the markers of the bottom being reached is when that equilibrium is finally met.

In a non-fractional economy, the delay is very short because the money supply remains unchanged (gold stays in human hands after mining, as I noted). What having a fractional system does is make the end of the delay take longer to reach because the money supply itself is being diminished by the withdrawals, continuning to reduce revenues while the fall in expenses lags behind. The fact that the money supply is being diminished, and that actual reserves are consistently being below spec, can lead to people questioning the solvency of banks more strongly than were it not fractional, which then does change people's preferences for the concrete methods by which they express their demand for money.

JJM

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If you are asserting that I misused inflation to refer to the price increases

No, the error was mine in post #30 (para 3).

if you are trying somehow to assert that the increase in the gold supply was not inflationary, then I disagree. Inflation is *any* increase in the money supply, regardless of whether it's done by running the printing press (for paper money) or by debasing the coinage (as done numerous times in the past) or by producing and putting more gold into circulation.

I've answered that already elsewhere, such as on this thread and this one.

JJM

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But what do you mean by "overabundant" ? It is clear that if gold became as abundant as water, people would switch to something else. But it is also clear (to me, at least) that if the supply of gold rose by something like 2-3% per annum, there would be no switch. My scenario is about an addition to loanable gold that is sufficient to produce a perceivable drop in interest rates; I don't think this needs to be much more than a couple per cent of the existing gold supply.

Cap, you are continuing to equate the production of a gold mine with the running of the printing press that occurs in a fiat system, but these two scenarios are really quite incomparable because they are radically different in nature.

The two scenarios that you keep setting up are antipodes. A gold mine increasing production is an increase in production, and an increase in production is an increase in real wealth. By illustrative contrast, an increase in fiat notes is NOT an increase in productive activity, it is an increase in phony wealth.

Increased gold mining is an increase in real wealth precisely because the gold miner has to find somebody to trade his gold with; that is to say, he can't just walk out into the streets and declare by fiat that somebody accept his newly found gold. The gold miner has to find someone willing to exchange the products of his or her own productive effort for his newly mined gold. He is bound by the economic law that he has to exchange value for value. The fiat printer is not bound by this law, for he is able to exchange something of no value for something of value, and is therefore a cheat and a looter.

But how would you classify the action of banks in a free market economy? Are they looters or plunderers or something similar?

That's easy. In a free market economy, all economic transactions are voluntary, and therefore there can be no legally permissible looting. A bank would simply be a business that produces a service which is valuable to those who voluntarily conduct business with it.

On the other hand, a central bank would be a looter and a plunderer, because it forces people at the point of a gun to conduct business with it.

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OK, so suppose I withdraw some gold to pay my bills. Where does that gold go?

Right where you said it does, into your pockets.

But it only resides there temporarily, until I drive to the service providers' offices and hand them the gold. And what will the service providers do with the gold? They will deposit it with their bank so they can pay their own bills when they become due. Out of the reserves of one bank, into the reserves of another--I see no net withdrawal taking place here. Money continues to circulate as the means of exchange just like it circulated before the boom began. There may be a net capital consumption taking place in the economy, but that is not the same thing as a net withdrawal of gold from transactional accounts. Capital includes all kinds of wealth, not just money--and when capital is being consumed, it is not the money that gets consumed.

Besides, I'm already granting you too much with the assumption that I am paying my bills by driving around with gold in my pockets. If I need to eat into my savings just to pay my bills, why would I want to make it worse by spending a lot of money on gas when I can pay my bills using just a little ink (or better still, electricity, as in online bill payments)? Cash-free forms of payment are usually more efficient than handing over gold in person, so I think it is a fair assumption that most people will prefer to use them in a rational society, and that bill payments will therefore, as a rule, take place without the need to withdraw gold. If you make that assumption, it becomes even clearer that capital consumption does not necessitate a net outflow of gold from the banking system.

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Cap, you are continuing to equate the production of a gold mine with the running of the printing press that occurs in a fiat system

No, I am not arguing for a fiat system. That's the last thing I would want to argue for! What I am equating comparing is

  • an increase in the money supply resulting from increased gold production in a laissez-faire, gold-standard economy and
  • an increase in the money supply resulting from the voluntary transactions of banks and their customers in a laissez-faire, gold-standard economy.

They have two key characteristics in common: 1., both are an increase in the money supply (i.e. the supply of assets serving as means of exchange), and 2., both are scenarios under the gold standard, in a laissez-faire economy, where--as you have just said--all economic transactions are voluntary, and therefore banks are productive businesses providing valuable services to their customers, not looters or plunderers.

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If you make that assumption, it becomes even clearer that capital consumption does not necessitate a net outflow of gold from the banking system.

Yes, you're mostly right, the straight capital-consumption element for specie withdrawals is being considerably overstated. Once more this is my fault. The prime reason for specie withdrawals will be concern about bank insolvency rather than for paying bills. What I have stated about delays and equilibria is correct in reasoning, but over-emphasised in its volume and hence importance. There are now, and I imagine there always will be, merchants who operate on a cash-only basis (EFTPOS and credit-card systems do cost the merchants money, up to as much as 4% of gross revenues for some systems), but they will also be the merchants whose products one is least likely to buy when one is in the red.

So, my answer in post #34 to your prior question in post #33, "why do banks need to rebuild reserves," was wrong in its first paragraph. I forgot context, that of reserve rebuilding only applying to banks operating fractionally. Banks would need to rebuild reserves as part of the means to retaining its remaining custom, and in future to regain lost custom, by demonstrating that they are being prudent. The specie withdrawals (the said lost custom) would occur because there is a shift in preferences on how people express the demand for money - from risky fractional accounts or fractional notes holdings to low-risk specie, non-fractional accounts or non-fractional notes. The second paragraph of my answer then holds, but the 5m in withdrawals is solvency-concern-driven rather than bills-paying driven, and the need to rebuild reserves by 1.25m is subsequent to that.

JJM

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So, my answer in post #34 to your prior question in post #33, "why do banks need to rebuild reserves," was wrong in its first paragraph. I forgot context, that of reserve rebuilding only applying to banks operating fractionally. Banks would need to rebuild reserves as part of the means to retaining its remaining custom, and in future to regain lost custom, by demonstrating that they are being prudent. The specie withdrawals (the said lost custom) would occur because there is a shift in preferences on how people express the demand for money - from risky fractional accounts or fractional notes holdings to low-risk specie, non-fractional accounts or non-fractional notes.

I see, thanks for the correction. So let me get back to the other issue you named, the issue of time delays. In this post:

In time it would lead to the same, but there is always that delay. It is not a shift in preferences (unless bank solvency comes into question), just recognition of the fact that things don't happen instantaneously. For so long as the downturn is still in progress the equilibrium of cash in meeting cash out wont be met. One of the markers of the bottom being reached is when that equilibrium is finally met.

In a non-fractional economy, the delay is very short because the money supply remains unchanged (gold stays in human hands after mining, as I noted). What having a fractional system does is make the end of the delay take longer to reach because the money supply itself is being diminished by the withdrawals, continuning to reduce revenues while the fall in expenses lags behind.

--you seem to be talking about the phase when the downturn is already under way, but it still isn't clear to me why the downturn happens in the first place under fractional reserves but not in a 100%-gold economy. I understand you hold there is a difference in quality between a purely gold-induced boom and a fractional-reserve boom, which explains why the former is not followed by a bust but the latter is, and that the difference has to do with time delays. Would that be correct?

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it still isn't clear to me why the downturn happens in the first place under fractional reserves but not in a 100%-gold economy.

A downturn can happen in both. The cause (outside of government) will be the result of either someone making a mistake in capital allocation that is large enough to be felt by an unusually large number of others or the coincidental and unusual aggregation of a number of smaller mistakes happening at the same time.

What a fractional-reserves system does is magnify the volume and time taken by each phase, introduce a source of reasons why the mistakes would occur together, and also to introduce a new source of reasons for making mistakes, all of which increase volatility in a manner that is difficult to accommodate in forecasts (if the attempt to do so is even made). Total malinvestments are thus greater under fractional money than non-fractional money, build up over a longer period of time, and take a longer amount of time to liquidate.

I understand you hold there is a difference in quality between a purely gold-induced boom and a fractional-reserve boom, which explains why the former is not followed by a bust but the latter is, and that the difference has to do with time delays. Would that be correct?

Delays are only part of it, and the original emphasis I had on it was based on my error .

The difference between an upswing caused by a gold find and an upswing caused by an increase in fiduciary media is that the former is more easily identified by all participants in the economy, and ahead of time, than the latter is. A gold find will be a news item before the gold comes on stream, making it easier to prepare for in a reasonable manner, whereas a significant shift in reserve policies would often have to be inferred after it is already underway and by which time individual businesses may have already have mistaken the increase in revenues for an increase in their customer's real production and hence maintainable purchasing power.

On top of that, the reason why a fractional-bust is worse than a non-fractional one is that the latter does not involve a diminution of the money supply. A diminution of the money supply lowers total revenues in the whole economy, over and above the individual woes of each business or person. Just as the boom causes more people than normal to make mistakes, the diminution negatively affects more people than just those who made the original mistakes. Total expenses also fall, but they lag behind the fall in revenues because people are still contractually bound to pay prior negotiated prices for things. The economy wont return to normal until the money supply stops falling and the entire structure of all prices has changed to reflect that total smaller money supply - that is, when contracts are replaced, renegotiated, or terminated due to bankruptcy. That is the part that takes some time, partly because people can't finalise proper forecasts and pricing until the money supply stops falling, and partly because it physically takes time for the entire set of contracts to be changed (eg there will be those who wont allow renegotiation and will demand that contracts run their time, which is of course their right to demand).

If, by contrast, the money supply isn't fractional then no such painful set of events is required because the money supply and total revenues merely hit plateaus at higher levels reflecting the consequence of the gold-find. This plateau is reached at the point in time where, in a fractional economy, the money supply would be just starting to fall and still has a ways to go yet before it reaches its own lower plateau. Thus people are able to reassess the value of money and make reliable forecasts much sooner after the end of the upswing than in a fractional economy, and the total amount of malinvestments to be liquidated is limited only to those who made the initial mistakes.

JJM

Edited by John McVey
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No, I am not arguing for a fiat system. That's the last thing I would want to argue for! What I am equating comparing is
  • an increase in the money supply resulting from increased gold production in a laissez-faire, gold-standard economy and
  • an increase in the money supply resulting from the voluntary transactions of banks and their customers in a laissez-faire, gold-standard economy.

Ok, but how does this relate to your rejection of the Austrian Business Cycle? I'm trying to get a feel for where we're going...Is this the main thing that you don't understand, or is there a larger point that you disagree with?

The two actions you are comparing are vastly different, but they are being blurred by remnants of our earlier discussion on money. The first action you named involves a permanent increase in the monetary base of the economy, while the second involves a temporary increase in M1. The important thing to note is that fractional reserve notes can be destroyed as easily as they can be created. Gold, once discovered and used in exchange, exists in the economy forever (as far as I know).

Edited by adrock3215
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The difference between an upswing caused by a gold find and an upswing caused by an increase in fiduciary media is that the former is more easily identified by all participants in the economy, and ahead of time, than the latter is. A gold find will be a news item before the gold comes on stream, making it easier to prepare for in a reasonable manner, whereas a significant shift in reserve policies would often have to be inferred after it is already underway and by which time individual businesses may have already have mistaken the increase in revenues for an increase in their customer's real production and hence maintainable purchasing power.

On top of that, the reason why a fractional-bust is worse than a non-fractional one is that the latter does not involve a diminution of the money supply. A diminution of the money supply lowers total revenues in the whole economy, over and above the individual woes of each business or person. Just as the boom causes more people than normal to make mistakes, the diminution negatively affects more people than just those who made the original mistakes. Total expenses also fall, but they lag behind the fall in revenues because people are still contractually bound to pay prior negotiated prices for things. The economy wont return to normal until the money supply stops falling and the entire structure of all prices has changed to reflect that total smaller money supply - that is, when contracts are replaced, renegotiated, or terminated due to bankruptcy. That is the part that takes some time, partly because people can't finalise proper forecasts and pricing until the money supply stops falling, and partly because it physically takes time for the entire set of contracts to be changed (eg there will be those who wont allow renegotiation and will demand that contracts run their time, which is of course their right to demand).

I see, it's starting to make more sense now. Let me try and sum up the essential points to see if I understand them right:

  • An unexpected increase in the money supply can cause people to make mistakes in their calculations (by perceiving an increased demand for their goods in nominal terms, but failing to predict a corresponding rise in their costs), leading to malinvestments
  • An increase in the money supply caused by a lowering of reserve rates is likely to mislead a much greater number of people than a simple gold find, due to its subtle and less well-publicized nature
  • The essential characteristic of the malinvestments is that they are more long-term oriented than the time preferences of the investing public would warrant
  • Banks will try to remedy the situation by making additional capital available by means of further lowering their reserve rates
  • This leads to reserve rates becoming so low that banks will often fail to meet their customers' gold-withdrawal demands
  • The resulting loss of confidence in the banks induces a net withdrawal of gold from the banking system, causing a sudden drop in the money supply
  • The drop in the money supply causes further adjustment-related economic difficulties

Is this a more or less correct summary of the theory?

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Ok, but how does this relate to your rejection of the Austrian Business Cycle?

Remember that I didn't say I "rejected" it, only that I was "not convinced." I had read several presentations of the theory, but found most of them to be unclear and therefore unconvincing. I am trying to understand what exactly the theory says, to connect it to the facts of reality, which is why I am asking all sorts of questions.

I am particularly interested in the theory as it applies to fractional-reserve banking in a gold-based free market. I hold that to be the ideal system, while the Austrian theory seems to be saying it's essentially the same as fiat money under a central bank system.

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Cap: The theory pertains to a fiat system and the actions of its central bank. It is a mistake to try to base ABCT on a laissez-faire economy, as your last post described. The central thesis of ABCT is that there are no business cycles (at least in the "boom and bust" sense that we know them as) in a laissez-faire economy. Business cycles in the modern pseudo-capitalist nations as such are caused entirely by the manipulation of money and credit by a central authority. 'Reserve rates' have less to do with the theory than the printing press, i.e. creating money out of thin air to manipulate the prevailing rates in the various and sundry credit markets.

Your third bullet point ("The essential characteristic of the malinvestments is that they are more long-term oriented than the time preferences of the investing public would warrant") is the central unifier of Austrian cycle theory. Under a fiat system with expansionary monetary policy, the time preferences of consumers are not aligned with those of businessmen, and therefore businessmen make long-term investments without borrowing from savers. As a consequence, there is no transfer of wealth from savers to borrowers, only an increase in paper notes floating around, and therefore investments are not made with real wealth saved from earlier productive activity.

Edited by adrock3215
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An unexpected increase in the money supply can cause people to make mistakes in their calculations (by perceiving an increased demand for their goods in nominal terms, but failing to predict a corresponding rise in their costs), leading to malinvestments

More or less. All increases can occasion the making of extra mistakes, but unexpected ones moreso.

An increase in the money supply caused by a lowering of reserve rates is likely to mislead a much greater number of people than a simple gold find, due to its subtle and less well-publicized nature

In the main, yes. Again, both can mislead, but lowering reserve ratios has a notably higher propensity to do so.

The essential characteristic of the malinvestments is that they are more long-term oriented than the time preferences of the investing public would warrant

Yup. As Adrock said, this is central to the whole thing, both of the full ABCT and this simple discussion of gold-finds versus fiduciary expansion.

Banks will try to remedy the situation by making additional capital available by means of further lowering their reserve rates

No. What banks do next is the product of the thoughts of individual bankers. Different banks will have different responses, which in a laissez-faire economy acts as another diversification mechanism. If OTOH the bank in question is the central bank, then its response is of enormous importance and effect because it affects everyone in the whole economy (in addition to it being of a much greater magnitude in general and involving substantially higher credit multipliers), and so one really gets the traditional boom-and-bust scenario. What happens in a laissez-faire economy, even one that includes the use of fractional reserves, wont have a patch on that.

This leads to reserve rates becoming so low that banks will often fail to meet their customers' gold-withdrawal demands

The resulting loss of confidence in the banks induces a net withdrawal of gold from the banking system, causing a sudden drop in the money supply

Possibly, but in a laissez-faire economy (including one practicing fractional banking) this would be unusual. At the mild level of fractionality as would be present in LFC, most banks would cover withdrawals by building up reserves again out of funds from maturing loans or sales of those loans to others before those banks got anywhere near defaulting on their note/deposit liabilities. Nevertheless, the risk is there, and for that reason there will always be at least some customers who do withdraw in specie. The riskier a bank operates, the greater the number of its customers who will be inclined to flee to specie when trouble brews.

I should add at this point (and which was remiss of me not to mention before) that different banks will have different reserve policies. What is more likely to happen is that customers will in aggregate shift banks in favour of those that operate at higher fractions, based on their assessment of risk versus reward - they (especially corporate treasury units with coolly-calculating professional staffs doing it constantly and with big sums) will compare differing rates interest on accounts in different banks with different degrees of risk attached, and move funds as they judge fit. The aggregate fraction for the banking system then goes higher, which makes for a lower credit multiplier, which makes for a reduction in the money supply.

The drop in the money supply causes further adjustment-related economic difficulties

In comparison to were the new money resulting from a gold find, yes.

JJM

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The theory pertains to a fiat system and the actions of its central bank.

My problem is that, from the way the theory is usually stated, this is not at all apparent. The cycles are usually blamed on "credit expansion, "which is another concept whose intended meaning I am not sure about--but from the way von Mises uses it in Human Action, I had the distinct impression that it includes the actions of fractional-reserve banks under the gold standard. Generally, I do not see advocates of the theory making a clear distinction between free fractional-reserve banking and fiat-money central banking, and the same people who advocate the theory are often also opposed to fractional reserves (either totally, saying it's "fraud," or in a softer way, saying it's legally fine but not a good idea, as does John McVey).

Here is an example of what I mean by von Mises's use of "credit expansion" :

What differentiates credit expansion from an increase in the supply of money as it can appear in an economy employing only commodity money and no fiduciary media at all is conditioned by divergences in the quantity of the increase and in the temporal sequence of its effects on the various parts of the market. Even a rapid increase in the production of the precious metals can never have the range which credit expansion can attain. The gold standard was an efficacious check upon credit expansion, as it forced the banks not to exceed certain limits in their expansionist ventures.

So yes, on the one hand, he is saying that the gold standard is an "efficacious check," but on the other hand, he is implying that the banks, in the plural, are the ones with the "expansionist" tendencies, even under the gold standard. Credit expansion is differentiated from "an increase in the supply of money as it can appear in an economy employing [emphasis added] only commodity money and no fiduciary media at all," meaning that there are two alternatives: 1., only commodity money, 2., credit expansion is a possibility. This would imply that credit expansion is a possibility under the gold standard when there are "fiduciary media," i.e. fractional reserves.

So my next question is: What is the definition of "credit expansion" ?

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