Cowen on Monetary Misperception

Steven Horwitz

Tyler Cowen raises this question over at Marginal Revolution:

I have never heard a market-oriented economist argue that a rise in the minimum wage boosts the demand for labor.  You might try this argument: "The government is certifying that these workers are worth this much.  The government is defining the market price.  Entrepreneurs will believe that price and hire workers in the expectation of finding an equivalent or even superior marginal product.  The government said that was the right price." 

No go.  Market-oriented economists instead claim that entrepreneurs "see through" to the real marginal products of these laborers.  The demand for labor, rather than rising, would fall and unemployment would result.

So what happens when the Fed "sets" short-term interest rates or influences other prices?  What is postulated by monetary misperceptions theories, including Austrian business cycle theory?  Entrepreneurs no longer see through to the fundamentals.  Instead, entrepreneurs are taken to believe this Fed-influenced rate is the correct price and they make their plans accordingly.

What is the difference between these two cases?

Several commenters at MR are on the right track I think, but let me take a shot at it with some different language.

The difference is that when central banks create excess supplies of money and push interest rates below their natural level, there really are resources available to borrowers. Yes, the interest rate is sending a false signal about underlying time preferences, but the loans banks are making at the lower rate really do represent resources to the borrower.  Of course those resources are not the result of real savings elsewhere and represent losses to the rest of society, but they are still a gain to the borrower.  Hence there's nothing to "see through" in the sense that there's no binding constraint on the borrower in the same way that the underlying productivity of the worker binds the employer who is considering hiring at the minimum wage.

In supply and demand terms, a minimum wage law drives a wedge between quantity supplied and demanded with a price floor.  Inflation pushes down the interest rate not by directly imposing a price but by shifting the supply of loanable funds curve outward through forced savings in a way that creates a credit market equilibrium interest rate (the market rate) that no longer reflects underlying time preferences (the natural rate).  The fact that we trade time in the form of money, rather than somehow directly, is what makes this divergence possible and what distinguishes it from the labor market.  Such a separation is not possible there and price controls will create shortage and surpluses.

As several commenters note:  the minimum wage is a price control, but an inflation-driven fall in the market rate is a quantity adjustment masquerading as a false price.  The low interest rate is the result of the underlying problem:  too much credit.  The credit, though, is "real" to the borrowers, even if it is an illusion with respect to voluntary savings.

During the boom, borrowers really do acquire resources and some will profit handsomely if they get out in time.  The fact that the errors embedded in the boom take time to manifest, along with the idea that inflation is ultimately a distortion on the quantity axis not the price axis, enables borrowers to not face the immediate constraint that they do in the minimum wage case.

Tyler seems to be forgetting that money is different.  Its "loose joint" properties mean things don't work quite the same way there.

Comments

[Doc Merlin]

I like your response. This is the way I think about it.

Naturally, during excess money printing, people short money and go long non-nominal assets. The problem is that it is really hard to unwind debt, so when conditions change again its very painful.

'Hence there's nothing to "see through" in the sense that there's no binding constraint on the borrower in the same way that the underlying productivity of the worker binds the employer who is considering hiring at the minimum wage'

Completely agreed here.

[Allan Walstad]

Exactly. Raising the minimum wage doesn't increase the productivity of the employee. That's obvious to everybody. But if the Fed dumps a bunch of money on the market, and if you take advantage quickly enough, you really can command more resources at this moment. It's far from obvious, without thinking about the issue carefully, that because actual saved resources are limited the overall result will be to stimulate unsustainable capital projects whose failure will cause a recession. Nor must it be clear to the individual entrepreneur that his or her project need be one of those that fail.

[J Johnson]

This only applies when the entrepreneur doesn't think the whole system is poised to fall into shards around their ears.

[Taylor]

Not so fast.

How are the resources "really available to the borrower" when he or she is a property developer who overextends, takes on too many projects and goes bankrupt? Your argument depends on a borrower making a quick buck and getting out in time. That may not be the typical case.

Even if it is, what about the analogous case in the minimum wage example of a labor hire firm that seconds "more productive" workers to other firms at a mark-up. Making a quick buck and getting out in time?

If you reject the analogy then you are really saying that real labour productivity is obvious and real rates of return aren't. In that case I refer you to some interesting comments of Douglass North on assessing academic productivity in Ostrom's book Competition and Cooperation.

[Richard Ebeling]

Steve has the heart of the matter when he points out that with interest rate distortions that push interest rates below the "natural" rate of interest (real savings = investment), this mismatch is given the illusionary appearance of being compatible due to the ability of the monetary authority to provide additional units of media of exchange to those who wish to borrow at these artificial rates of interest.

This facilitates and generates the false belief that real resources may be available to begin, bring to completion, and profitability sustain some investment project.

Someone is interested in borrowing money for an investment, a home mortgage, etc. He does not ask, "Does the money potentially available from the lender "real" savings?" He merely compares the market price signals -- the cost of borrowing relative to the anticipated profitability of the project.

(And by the way, all this was very clearly stated in the way that Steve did, and that I am trying to re-express, by Knut Wicksell in "Interest and Prices" and in his "Lectures on Political Economy" when he constrasted lending and borrowing in "natura" with the case when this occurs through the intermediation of money.)

In comparison, no similar illusion necessarily occurs with a minimum wage law. The employer compares the anticipated value of the marginal product of the employee that is currently or could be hired, with the market wage that he is or would have to pay him.

A higher wage for a certain type of labor does not tell the employer that that worker is now more valuable in his particular line of enterprise and therefore is "worth it."

The higher wage tells him (if he reflects as an economist might) that the opportunity cost of this employee has risen in alternative employments, or the government has mandated a higher wage than the market had been nor would set.

So the minimum wage case is not related in any way, in my view, to the interest rate manipulation case.

Richard Ebeling

[Steve Horwitz]

Let me just second Richard's nod to Wicksell. It's all right there in ol' Knut.

In fact, I would argue that my Routledge book is best characterized not so much as "Austrian macroeconomics" but as "Post-Wicksellian macro". What ultimately renders the Yeagerian approach and the Austrian approach consistent is their common heritage in Wicksell.

[The Cuttlefish of Cthulu]

Isn't the idea of a "natural" rate of interest (the rate at which supply and demand are equilibrated across the structure of production, without reference to capital markets) at odds with the socialist calculation argument (which says the allocation of such goods is impossible without a market in those goods)?

[Rob]

I think with the minimum wage there is symmetry across firms. All entrepreneurs recognize the law and proceed accordingly. On the other hand, even if entrepreneurs know the Fed is expanding the money supply, the firm might misperceive a rise in the price of its product as a real change rather than a nominal one. Moreover, this is possible even if everyone knows the money supply is doubling, because of price stickiness. Knowing the behavior of prices after prior Fed actions, the entrepreneur will make his best guess, but will be occasionally wrong. During any given time, there will inevitably be malinvestment.

[Richard Ebeling]

In answer to "Cuttlefish of Chhulu,"

Yes, the complex market order, including the savings and investment nexus, could not function (indeed, really not exist in the "modern" sense) without a capital market with price system.

But to get behind the "veil of money," and understand a variety of "real relationships" at work, a "mental experiment" is undertaken in which you imagine the "real" savings of the economy juxtaposed to the demand for "real" investment and the intertemporal price at which the real resouces set set out of real income and not consumed would be available to facilitate investment activities of various types and time durations with those set-aside real saved resources.

This can serve as a conceptual point of orientation for certain types of theorizing about what is happening in a dynamic, money-using economy.

Richard Ebeling

[Lode Cossaer]

The problem is that a minimumwage is a minimum price, whilst the average interestratesetting is a 'maximumprice'. Just like consumers don't stop buying certain goods, even though the price isn't real (due to collective action problems and 'first come, first served'-principles), so it would be foolish for investments to not make us of the lower interest rates. The real relevant comparison is to a maximum price on goods and not to a minimum price. And I would say the mechanism is similar: as soon as it's possible, the market will start adjusting/adjust to the new maximum price, resulting in discoordination effects. But because it's the interest rate, that means the whole of the 'time market' is being distorted, which has a far more intense impact on the whole economy, than, for example, a maximum price on bread.

I always try to explain the problem with interest rate setting as it were a price control, i.e. a maximum price on credit. But you can't 'hide' a maximum price on bread (magically create bread?), but for a while you càn hide the effect of a maximum price on credit, because creating new money (even if you were to print it) doesn't take to much resources. But the effects will happen.

[Steve Horwitz]

Right Lode, but that's why I think it's wrong to view "too low" interest rates as a manipulation on the price axis. It's the result of an increase in supply, just one that doesn't reflect the reality of what consumers want - this is the way that trading time in the form of money allows us to separate the quantity of loanable funds available from the underlying voluntary savings.

It's also Richard's point about the mental experiment necessary to understand the natural rate of interest. Again, the key to this is that we trade time in the form of money, not directly itself.

[Allan Walstad]

"If you reject the analogy then you are really saying that real labour productivity is obvious and real rates of return aren't."

Real rates of return on specific capital investments are of course not obvious ex ante; otherwise, no startup firms would ever fail.

If you accept the analogy, then you are really saying either that employers should think that workers suddenly become more productive just because government raised the minimum wage, or, that they should think a freshly minted $20 fiat bill can't buy $20 worth of goods. The fact is that if banks have more money to lend, then unless they've been badly spooked they will lower rates instead of sitting on the cash; prospective borrowers will find that their cost (including finance costs) to purchase land and equipment has decreased. It's a substantially higher analytical step to take into account the longer-term systemic effects that will arise from a distortion of interest rates.

[The Cuttlefish of Cthulu]

Prof Ebeling, thank you for your response. However, when you speak of things like "veil of money" or "real relationships" that you yourself put in quotations, I assume you would agree that you are speaking metaphorically here, yes? Money is more than a "veil," I would say.

[Andrew Larson]

Another difference in this comparison is information. In the case of the minimum wage, the employer makes a subjective determination of MRP on the spot. In contrast, in the case of increased money supply, the distortion extends far into the future and is summarized by a defficient NPV. The realization of a true lack of resources does not set in until early commitments of real resources have already been made. If a capitalist is lucky, his project will finish sooner rather than later. Capitalists continue to gather new information on resources into the future, eventually realizing a lack of real resources to bring all projects to completion.

[Lode Cossaer]

To be sure I get the point: you would argue that the manipulation of the interestcurve creates a _shift_ in the supplycurve, just one that doesn't effect the reality?

I'm not quite sure what difference it makes to view it either way; don't the same mechanisms logically follow from both visions? Or am I missing something?

Anyway; what we can agree on, I think, is that the problem with the setting of the interest rate is that it's a long term effect, perversive through out the entire economy, creating profit opportunities in the mean while (and that's why investors invest based upon it), but unsustainable in the long run.

[fundamentalist]

The obvious difference between money and labor is that the Fed makes all of the money and no one controls the supply of labor. If people had a choice in money, they would be able to see through the Fed’s false advertising for its money, but they don’t. People do have choices in labor; they can compare one worker against others. They can’t compare money because the Feds have a monopoly on it.

And the Fed is offering something for nothing. That’s not the case with the minimum wage, which offers less value. Even those who see through the Fed’s lies, they would be foolish not to take advantage of low interest rates if for nothing else but the carry trade.

[Current]

A monetary injection isn't like a price control on labour. Like Steve says it's a shift of the supply curve for credit not a movement along it. The fed can't print more labourers, so there is no comparison.

With a little imagination though it is possible to envisage an analogous situation. Let's suppose we have imperialist power X. The government of X are planning to take over the small country Y by war. Y is poor, feudal and backward it has a lot of poor natives. So, entrepreneurs in X expect these people to join the labour force soon and push downward the cost of labour. So, they stop investing in more capital intensive means of production and instead invest in more labour intensive production ahead of the change. However, the war fails and Y remains independent. So, the investments based on it succeeding fail along with it.

[Tyler Cowen]

Lots of talk and terms, but you're still saying that in one case entrepreneurs make the mistake and in the other they don't. The "resources available to borrowers" are still a mistake, I would sooner say "traps available to borrowers," even if some of them can get out in time they all can't and they certainly can't on average.

[Current]

Here's an analogy with labour of what happens with debt during ABCT...

Fred ferments high-quality cider, he buys the apple juice he uses from Jim. Jim presses the apple juice and sells it to Fred. Sheila grows the Apples.

Unknown to Fred, Sheila has recieved a one-off grant to employ unemployed people to pick her apples. The other apples growers in the area have the same subsidy. Because of this the price of apples is below cost.

Eventually Fred and Jim's businesses will fail because the subsidy will run out and the price of apples will rise. When it does they will be forced to raise the price of their cider to a level where there is no longer enough demand for their businesses to be profitable.

[Nikolaj]

Dear Mr Cowen, here is my solution:

the entrepreneurs make mistakes in the case of the credit expansion because in the fractional reserve system with the maturity transformation there are inconsistent property titles in money, i.e. economic calculation is made impossible. Different people have claims on the same amount of money in the same time, so nobody can calculate the correct interest rate anymore. In a fiat money regime money is not a private good with the opportunity costs, as it is in the gold reserve 100% reserve system. If you accept the argument that economic calculation depends upon the private property rights (Mises' theorem of the impossibility of socialism), and also if you accept the regression theorem (money as a scarce physical commodity, with every piece of it privately owned and the opportunity costs), then the entrepreneurial failure in the fractional reserve system is unavoidable. In the fractional reserve system, nobody can really now what is the real supply of capital, what is the "real" saving, natural interest rate etc. All these analytical cathetogries of the ABCT have precise meaning ONLY in the 100% reseerve system, because only in that system there is a consistent structure of private property rights in money. All of this follows directly from the Mises' regression theorem and his calculation argument.

On the other hand, when government increases the minimum wage, economic calculation is unhampered by this measure. Supply and demand for labour and the actual price of labour can be calculated because every resources is privately owned and there are no inconsistent property titles in human bodies and labor hours (as there is in the case of money). The entrepreneur who is prevented from ever knowing what is the real supply of capital by fractional reserve manipulations, does not have similar problems with the understanding what is the real supply of labor, and can calculate price of labor.

So, your argument against the Austrian credit cycle theory is correct, but only insofar as it is directed against the Austrians who accept the fractional reserve system as legitimate. They really are not able to explain what is the difference in terms of economic calculation between the loan market and the labor market. However, your objection is easily answered in the framework of 100% gold reserve system and Misesian/Rothbardian monetary theory.

[Bill]

Current:

Fred and Jim's businesses don't necessarily fail.

They will contract and make less money.

There is actually one more step to the story.

The cider maker buys extra barrels or the juice maker a new press. They do so based upon extra sales they make at the lower prices they charge because of the extra low cost of the apples. (I suppose there is some sense that the apples are "below cost" but I wouldn't say that.)

When the subsidy runs out, and apple prices rise, they will continue to produce more juice and cider than before. But they will lose money--they won't cover the cost of the specific capital they purchased.

Tyler's point has always been that this is an entrepreneurial error.

Suppose rather than a subsidy, there was some other change in the labor market that resulted in extra low wages. A peach blight resulted in lots of apple pickers.

By the way, Tyler's new example of the minimum wage hardly fits.

Your example of a temporary subsidy is on the mark.

[Lode Cossaer]

"Different people have claims on the same amount of money in the same time, so nobody can calculate the correct interest rate anymore."

Of course, that is not the case in a working free banking system.

[Nikolaj]

"Of course, that is not the case in a working free banking system."

Of course, if by "a working free banking system" you mean a system of free banks with the 100% reserves, you are right. However, if you by that phrase mean the system of fractional reserve banks, then you are wrong, because in that system obviously some amount of fiduciary media will always exist, i.e. some level of inconsistent property claims, leading to the problems I described.

[Lode Cossaer]

Nope, they won't. And the reason is fairly obvious; everyone has full control over it's property; even if there is such a thing as moneyclaims that can't alle be fully redeemed at the same time. As long as it isn't - and that's what the 'working' refers too - there is no problem, because there is plan consistency. Imagine you and your wife both 'owning' a car, as long as you and your wife don't want to use the car at the same time, there is plan consistency and there is no problem. The problem starts when you both one to use the car at the same time for different purposes. It's up to the banks to avoid these kind of mistakes - and they will get penalized if they don't.

[Greg Ransom]

Tyler's question tells us more about him than it does about economics, doesn't it?

[Pietro M.]

Cowen's argument shows a part of ABCT that is not sufficiently explicit and as long as it is be explicitly microfounded it won't convince many economists.

If I remember well, a similar argument was proposed by Lachmann against Mises in 1943. Mises answered that error clusters were an empirical generalization, i.e., he considered the criticism to be irrelevant (cfr Garrison in "Time and money") because the alternative was too unlikely.

However, this implies that the passage from monetary expansion (in terms or M or MV or whatever, it's immaterial) to error clusters is not theoretically well founded, but a likely empirical assumption.

Now, I find it more convincing to neglect ratex because they are unlikely instead of neglecting an obvious fact because it has not been shown to be apriori necessary, but the problem exists anyway.

[Pietro M.]

"as long as it is be" should be "as long as it is not"

[Pietro M.]

Let's try an answer based on four elements:

1. Mises's conception of money as a coordination device ("The nonneutrality of money")
2. Carilli and Dempster's prisoner's dilemma model.
3. O'Driscoll's focus on coordination problems
4. Garrison's analysis of the role of moral hazard in booms.

The argument should be as follows:

1. Monetary policy has redistributive effects
2. The competitive market process under these externalities do not lead to efficient outcomes
3. Malinvesting causes profits, because it is the individually rational strategy to participate on the victor's side in the redistributive game
4. Not malinvesting is a superior strategy, but it is a prisoner's dilemma and it is unlikely that it can be put in practise because competitive pressures will remove conservative entrepreneurs from the market during the boom
5. No one in the market knows the right solution, but prices signal and incentivise malinvestments
6. Herding behavior is a tragedy of the commons because no single entrepreneurs contributes to systemic fragility, but every entrepreneur can profit out of it by malinvesting, and suffers losses to avoid malinvesting (under socialized costs, everybody pays other people's costs, but only adding to malinvestment it can obtain profits).
7. As long as herding doesn't occur on a mass scale, malinvesting is safe, especially if central banks are active in avoiding recessions.
8. The only strategy to avoid losses is to escape the capital intensive sectors because they will fail during the recession (if central banks are not effective in socializing costs through countercylical means), and escape labor-intensive sectors because resources will be bid toward the other sectors during the boom.
9. Autarky is the only real solution, but it is so inefficient that inefficient boom/Bust cycles are a superior alternative also when great depressions are likely. It is better to play a vicious game than not to play at all. Avoiding the externality and cost socialization effects of activist monetary policy would largely remove the viciousness of the game, resulting in a first best solution.

[Nikolaj]

Lode,

What is relevant for the economic calculation is not a "plan consistency", but consistency of the property rights. It is not a problem whether plans are coordinated in terms of whether people will go in clusters to redeem their claims to money and push the banks into bankruptcy that way or not. That's just a tip of an iceberg, and completely irrelevant for understanding the nexus between the economic calculation and credit cycle. The real problem is; let's suppose the banks suceeded in avoiding the panic. There were no bank runs. Banks increased the money supply for 50% and people went along. How the individual plans are "coordinated" or "made consistent" in this situation? The corporate borrowers who got the larger loans will invest in a more roundabout structure of production, and the entire sequence of Mises-Hayek credit cycle will be set in motion. The investment based on this "plan cooridnation" will have to be liquidated at the end. The social rate of time preference was higher than calculation mechanism of the fractional reserve system indicated at the beginning, and this inconsistency has to be revealed and removed the harder way afterwards, by a recession. If anything, the fractional reserve's principal effect is to mis-communicate the knowledge about the real "plans" of the individuals across the entire economic system and induce the people to act in accordance with this wrong, or distorted information.

Therefore, the fractional reserve system, rather than "coordinating" anything, brings about exactly the plan discoordination. The genuine time preference is falsified when private banks emit any amount of fiduciary media: the banks assume that any amount of cash balances increased mean the justification for an increase in the credit supply for an equal amount. Demand for money and saving are the same thing! But, that just assumes that money in cash balances is all for saving, and none for spending, which is ridiculous. As de Soto puts it, this is as if the banks were granted an "aposteriori loan" by the public for their credit inflation.

As for your example, that's exactly the problem I emphasize - my wife and I cannot be the owners of the same car in the same time. No court in the world would accept both of as as 100% owners of the same car in the same time. It would be fine if my wife and I could have one car and claimed the property rights over the two cars (a fractional reserve automobile industry). And when our afternoon plans about where to go are "discoordinated", then to get an additional car from the government as a bailout, because her plan is "too big to fail". I would like that, believe me. Can you help me with the promotion of this doctrine to the relevant authorities? :)

The same is, of course, true for money, except that banksters have much better advocates and lobbyists than my wife and I do (many of them being the economists, unfortunately...).

[Lode Cossaer]

"No court in the world would accept both of as as 100% owners of the same car in the same time."

That is _not_ the relevant comparison. The relevant comparison is: (1) can I use the car when you aren't using it and (2) may I use it? The second one refers to the legal doctrine concerning free banking, and, it's perfectly possible to construct a contract in a way that allows for free banking. The first question refers to the way that people are using their check balance accounts; and a lot of people use a part of their checking account as a savingsaccount and thus it can be used for investment - and the bank takes upon itself the risk for matching checking accounts and the way people use their checking accounts as savings. In return; the consumer get the 'reward' by having interest on their checking account (because it's partly used as a savingsaccount).

Let's illustrate it. Let's assume we have solved, by some sort of a very explicit and clear contract, the legal problems that De Soto raises. Imagine someone having a checking account and the bank has perfect information that he won't draw money from that account for a week. What's wrong with lending out the money on a short term notice, getting the money back after the week (with interest) and pay a part of this interest to the guy who owned the checking account?

There was no mismatch between propertyclaims; the guy didn't claimed the property. There is no problem of interest; because for all relevant purposes, the guy was saving the money for a week. The only problem in real life is the fact that banks don't have perfect information; that's why they keep some reserve in their banks and, depending on how volatile the consumers are, this will be more or less.

So no; there is no problem of a businesscycle in a working free banking system.

[Rafael Guthmann]

A take on the problem from a different perspective:

To say that a rise in minimum wage will increase unemployment also assumes that workers are fooled by the minimum wage in offering their labor at prices that it cannot be sold. If workers had perfect knowledge of the labor market there wouldn't be unemployment even with price controls, since nobody would make offer plans that wouldn't succeed.

So, we have entrepreneurial errors on the part of the workers in the minimum wage creates unemployment case.

[Rafael Guthmann]

Dr. Cowen wrote:
"Lots of talk and terms, but you're still saying that in one case entrepreneurs make the mistake and in the other they don't. The "resources available to borrowers" are still a mistake, I would sooner say "traps available to borrowers," even if some of them can get out in time they all can't and they certainly can't on average.

In both cases we have "aggregate" errors on the part of the agents, in the sense that in both cases the structure of plans of all agents aren't compatible with the underlying reality.

The difference is that in the minimum wage case we have the near instantaneous manifestation of this discoordination while the discoordination caused by the credit expansion takes a longer time frame to be perceived.

The greater the degree of complexity and roundaboutness of the capital structure, the more difficult is for the entrepreneurs to discover the errors. But you can have business cycles without capital, in this case the emission of money will make the individuals in the economy believe that the set of feasible consumption is larger than it really is (boom), they will eventually discovery it, and their expectations will be revised downwards (bust).

[Rafael Guthmann]

The individuals will take time to discover the real size of the set of feasible consumption because discovery takes time. The business cycle happens because discovery takes time. And discovery takes longer when the capital structure is complex.

To make the economy invulnerable to artificial bubbles created by monetary expansion, you need to assume that decision makers always have perfect knowledge. Austrian never assume that.

[Nikolaj]

Lode,

yes there is a problem of business cycle in free banking, only it could have been less pronounced than in the central banking regime. Money is an instrument of economic calculation which allows the rational distribution of the real resources according to the real time preference of the public. It is completely besides the point to analyze whether free banks can manage to get away with the transformation of the demand deposits into the loans without the panic. The problem is - can they make by a miracle the same contract in the same time a deposit, and a loan?

In order to make the property rights claims consistent, every dollar lent out by the banks must be either bank's money or credit obtained from the clients for the same period. If a bank creates more credit than it takes up it creates the property titles for more money than it owns. This is not just a "legal" issue, but primarily the economic one. If I deposit 100$ in a bank and have a right to withdraw it on a short notice, how then the other guy (say, corporate borrower to whom my money was lent) can have the property title over the same 100$ in the same time? I don't know what does it mean to say, as you did, that if the bank has a "perfect information" that person A will not withdraw her cash in the next 7 days, than everything is fine? The bank could have known that with a "perfect certainty" only if the person in question made a time-deposit. But, notice that in this case we would be talking about the credit, rather than a deposit in the economic sense - a person gives a loan to the bank for the next 7 days. If it were not a time-deposit, than the bank could not know whether the person is going to withdraw the money or not.

So the inconsistency of property titles does not depend in the least upon whether the various people would actually claimed the same piece of money (this is slightly metaphorical way of speaking since money is a fungible good). In other words, as we have seen time and again, the credit cycle can arise even without the bank runs and massive bankruptcies. The only thing that defines the property rights consistency is a time structure of bank's assets and liabilities. If there is a mismatch between the two ("borrowing short, lending long"), the property rights are confused, and the mechanism of monetary calculation is distorted. And all the forces that drive the ABCT are set in motion. And the real effects in the structure of production are here, quite irrespective of whether the banks will survive or not.

So, the credit cycle by all means can occur in free banking.

[Lode Cossaer]

I don't feel that you have answered the arguments I raised, so I would refer to my previous post for the arguments.

[fundamentalist]

Cowen: "Lots of talk and terms, but you're still saying that in one case entrepreneurs make the mistake and in the other they don't."

I guess I don't understand what his problem is. Is he saying that entrepreneurs ought to always be right or always be wrong? They can't be right sometimes and wrong others? I thought his issue was why are entrepreneurs right about wages and not about interest rates. The simple answer is that they are very different commodities and markets. Entrepreneurs understand one better than they do the other. Most don't know any economics, but if they do they have learned mainstream econ which makes them much easier to fool.

The Fed depends heavily upon fooling borrowers. If the Fed couldn't fool them (as Mises and Hayek wrote decades ago) then their monetary policies would have no effect.

[Niko]

@Lode Cossaer:

Hello,
Your example with the car is useful. You can use my car when I’m not using it if I want to. If you take it without my permition, you are stealing it, and I doubt that the argument that you intended to return it in time so I did not find out would stand in court. Now, with money is very intresting because the financial instruments do allow for two people to claim ownership for the same sume of money and use it too, something that it is imposible with a car. But even if a bank could have perfect information and meet all its obligations, there would still be a business cycle because I didn’t agree with the loan. If a give you the car for you to use it, even for free (no interest), I trust you and, most importantly, I know I wont use it for the hole period you are using it. This also aplies for a loan. You see, interest rates reflect time preference, and if I increase my savings, but I don’t want to rent them, it means I do expect unexpected consumption, or I’m saving for a big buy, still consumption, but I am not willing to finance an investment.

[Niko]

"it means I do expect unexpected consumption"

Bad English. I meant I increase my savings against uncertainty.

[The Cuttlefish of Cthulu]

"The relevant comparison is: (1) can I use the car when you aren't using it "

Well, very obviously, you and I cannot both use the car in the same way. I cannot drive it while you are, say. Your analogy here can only hold if you assume money does not obey some law of scarcity as other goods do (if in fact you are even assuming money is not a good, eg some kind of asset).

[Lode Cossaer]

Hi Niko,

I'm not entirely sure why 'not giving authorization' would make it a businesscycle; not everything that is illegal, creates a businesscycle. You missed however this little piece: "Let's illustrate it. Let's assume we have solved, by some sort of a very explicit and clear contract, the legal problems that De Soto raises." There is no a priori reason why it would be impossible to design a contract that way that it allows for this kind of banking.

The businesscycle will occur as soon as there _is_ a mismatch between funds, but the possibility of that happening, is not a sufficient condition to have a businesscycle. Again; if the bank has full information on how you would use the checking account, there will be no businesscycle - even if it were illegal. Since there is no such thing as perfect information, they have to make the estimations how much of the funds in the checkingaccount will be used as if it were savingsaccounts. That's their problem; and they can take more or less risks and give interest accordingly to the people who provide the funding.

"You see, interest rates reflect time preference, and if I increase my savings, but I don’t want to rent them, it means I do expect unexpected consumption, or I’m saving for a big buy, still consumption, but I am not willing to finance an investment."

Yes, that's true, but the fact is: if you are saving to finance a big consumption thing, you are, in fact 'saving' - even if you it in your checkingaccount - and if the bank estimates this, she can lend it out, without creating a businesscycle. (And it will depend on the contract wether or not this is legal, but again; there are ways to draw up a contract that this is specified and thus legal.)

The fact that you do expect unexpected consumption is also taken in account; the bank doesn't have full information and has to make the estimation; but she can be reasonably sure not everything on the checkingsaccount will be used always - depending on the volatility of their costumers. So that get's taken in account too.

The fact that you use your checking account as it were a savingsaccount - i.e. let funds on it that you aren't using until a certain moment in time - means that it reflects time preference, and the bank can take that into account. With less security as a full savingsaccount and that's why she wouldn't lend out everything, but their is a reasonable presumption - depending on the volatility - that not everyone will redraw everything at the same time. (That's why you, in the past, you had the ittle '90 days notice' messages, that weren't used that often.)

[Niko]

Lode Cossaer:

The contract is the last line of defense for free banking. But if the client agrees to have his money lend, then he also agrees to have no claim to them for the duration of the loan, only for interest. It is not about how we call the accounts, it is about how he sees the money he deposit. If the client agrees to have his money lend, but also retains the right to claim them in full at any time, then they are both partners in crime because you also have another contract to consider: between the lender and the borrower.

Also the contracts with the other clients grand the right for lending money, if they do, not to cover whims of another client who didn't want to loose anything, which the act of lending assumes, but only to gain. And willing partners in a Ponzi scheme doesn't make the scheme legal, and if it is legal (well, it is actually), it doesn't make it economically feasible.

But we do have a problem with time preferences in a perfect information environment: if I save for a larger buy, I have my eyes on an already existing item, the current production structure and consumer goods satisfy me, but it requires more of my paychecks.

[Lode Cossaer]

I wouldn't consider the contract the 'last line of defense', but 'the last line of attack'. 'We would like it to cause an ABCT, but because that's not true; we'll just argue the unjustifiable nature of it.'

In any case; no, there is still a difference between a savingsaccount and a checkingaccount of which the bank will lend out a part of the money. That's the difference between a bank and a warehouse.

"f the client agrees to have his money lend, but also retains the right to claim them in full at any time, then they are both partners in crime because you also have another contract to consider: between the lender and the borrower." <= I don't really see the problem there; because there is no lender/borrower problem, but even if you see one; that could _also_ be solved by contractual agreements. The thing you just have to lose is the insane idea that there are '2 propertyclaims concerning the same property'; a bankliability is not the same as a propertytitle to a specific object.

"if I save for a larger buy, I have my eyes on an already existing item, the current production structure and consumer goods satisfy me, but it requires more of my paychecks."; of course, that is completely irrelevant for the question wether or not it would cause an abct. Again; if you act as if your checking account is a savingsaccount, it makes no different if the banks uses it as a savingsaccount. The only problem is the degree to which the bank can estimate it.

[Niko]

So I own 1000 dollars and some other guy, after some banking tricks, owns my 1000, while I still own my 1000 dollars. And I am the one with an insane idea. It is all a matter of property, and no contract can change an economic laws.

And how can we take the borrower out of the conversation, when he is the one that now owns my money?

And the bank cannot estimate my time preference, it cannot estimate anything, only act as a middle man. In the end the loan will go to finance something there is no demand for, yet. This is ABCT.

But, as you admit, free banking in the end rests on the perfect knowledge of the bankers, although even if they would have it, there would still be ABCT. In light of today's events, one can hardly count on that.

[Niko]

The problem is not if one can design a contract to answer de Soto's legal problems, but if the contract can be met by all parties. It doesn't matter if it is lawful or not, but if it is economically feasible.

[Current]

Going back to Pietro M.'s comments about ratex and the start of ABCT....

I think Pietro M is pretty much right. There are several explanations that are interlinked.

In "The Theory of Money and Credit" Mises suggests an theory of expectations that I think is very reasonable. He suggests that in the large capital markets such as the bond, stock and money markets something close to ratex can be expected because the agents in those markets compete exactly on that. They depend upon coming to correct conclusions about future prices. But, in general business the entrepreneurs task is to combine factors in the correct way as well as to forsee the future. In that situation entrepreneurs can only look forward at most a few prices down or up the line. They can develop expectations of the price changes of their suppliers and customers perhaps, but not expectations of the impact of those further away than that.

So, in high-finance the problem is mainly the prisoners-dilema one. Then further away from high finance the problem becomes more one of account-falsification or if you prefer, false price-signals.

[Lode Cossaer]

"So I own 1000 dollars and some other guy, after some banking tricks, owns my 1000, while I still own my 1000 dollars. And I am the one with an insane idea. It is all a matter of property, and no contract can change an economic laws."

Bankliability... Not the same as property title to a specific item...

"And the bank cannot estimate my time preference, it cannot estimate anything, only act as a middle man." <= How do you say 'it cannot'? Based on what? If I can guess that you won't use your money for a week - and got it correctly - than I've estimated it correctly. So... what's the 'cannot' all about? Obviously; it's not impossible.

" In the end the loan will go to finance something there is no demand for, yet. " <= Well, not exactly... Because it was based on sustainable funds, there is no problem.

"free banking in the end rests on the perfect knowledge of the bankers, although even if they would have it, there would still be ABCT." <= Well, no... I made the assumption to clarify a mechanism, and than I loose that assumption, and introduce entrepreneurial error.

But again; it wouldn't be an ABCT; it's based on sustainable funds, because, as long as you don't use your money, your are in fact delaying consumption and thus the resources are available. :/

Btw. Pick your battle: the legal or economic issues.

[Niko]

"Bankliability... Not the same as property title to a specific item... "
I don't really see the point. Two persons can use the same 1000 dollars. We have another name for it, but it is still a problem.

"But again; it wouldn't be an ABCT; it's based on sustainable funds, because, as long as you don't use your money, your are in fact delaying consumption and thus the resources are available."

As far as I know in Austrian economics money are mostly idle. By your logic if I put 1000 dollars in my pocket in order to buy something in the evening and someone steals them from me, it is ok if he returns them by the time I make my transaction. Probably not a good example, but it shows what I mean when talking about time preferences. If someone loans my money to finance an investment, while I'm still intent on buying present consumption goods, he will generate an ABC.

"Btw. Pick your battle: the legal or economic issues"
Bastiat said we have laws because we have private property, not the other way around. You cannot separate the rules of conduct from economic laws. Even if the legal system allows for some form of theft, the economic laws will still apply and render the legal system bankrupt.

[Lode Cossaer]

"I don't really see the point. Two persons can use the same 1000 dollars. We have another name for it, but it is still a problem." <=

Even if you want to look at it that way; they _aren't_ using it at the same time. Just look you can have 2 people have a claim against a car: the economic problems only exist when they want to use them at the same time for different things - and the correlation is the bank having financial problems then. Even if you want to use the lingo of 'a claim against the same 1000 dollars', it doesn't follow there is a problem. The problem exists when they want to use it at the same point. But again; banks have a reasonable reason to believe that some parts of the checkingaccounts are used as savingaccounts, i.e. money they aren't using, (but want to use at an instance notice; and that's oke, as long as they can pay for these things). Let's not forget that the bank doesn't actually increase the moneysupply as such; because the lending out also creates assets, i.e. the loans that have to be repaid.

"By your logic if I put 1000 dollars in my pocket in order to buy something in the evening and someone steals them from me, it is ok if he returns them by the time I make my transaction."

No, actually this is a good example. To be sure: this is obviously theft. Again; I'm saying that there are ways to go around the legal objections of theft, by constructing the contract in such a way that nobody get's fraud by it. But if you disregard the theft and you disregard the uncertainty caused by the theft: yes, there is no economic problem there. I'm not saying it's 'oke' in a legal sense, I'm saying that from an economic point, it's oke; it's just a very short term loan. (That short that it wouldn't make sense, and he isn't giving interest, which is weird, but disregarding all that.) There is no abct caused by this little act of theft. It's theft, because you didn't allow for it. And yes, that's bad. But this doesn't cause an abct.

You keep speaking of theft, but it's obvious that you can have a contract designed that way that it isn't theft. I'm not saying it can't be theft: if the bank is a warehouse, it's theft. If I give a warehouse my couch and they lend it out to make extra money out of it, it's theft. But that doesn't mean it causes something like an abct.

[Niko]

OK, I give up.

[Lode Cossaer]

Ok.

[Younhee Kuak]

According to what I have learned in my economics class this summer, the Fed has problems in controlling the money supply. The Fed does not control the amount of money that households choose to hold as deposits in banks and. It also does not control the amount that bankers choose to lend. The amount of moeny in the economy mostly depends on behavior of depositors and bankers. For that reason, the Fed cannot perfectly control the money supply.

In recent years, the Fed has set a target for the federal funds rate, a short-term interest rate at which banks make lonads to one another. Even though the actual federal funds rate is determined by supply and demand in the market for loans among banks, the Fed can influence the market by using oepn-market operations.
When the Fed realizes its target, it eventually adjusts the money supply.

In this blog, entrepreneurs are mentioned to be taken to believe that Fed-influenced rate is correct price, however, I do not truly agree with that mention. Since depositors and bankers have more pivotal roles in deciding the amount of money in the ecenomy than the Fed, the Fed-influenced rate may be differnt from the actual demand of depositors and bankers.

Although the Fed sometimes cannot predict correct price, I believe that it takes very significant roles in overseeing the banking system and regulating the quantity of money in the economy. Hence, the Fed is fundamental in our society.

[Younhee Kuak]

According to what I have learned in my economics class this summer, the Fed has problems in controlling the money supply. The Fed does not control the amount of money that households choose to hold as deposits in banks. It also does not control the amount that bankers choose to lend. The amount of moeny in the economy mostly depends on behavior of depositors and bankers. For that reason, the Fed cannot perfectly control the money supply.

In recent years, the Fed has set a target for the federal funds rate, a short-term interest rate at which banks make loans to one another. Even though the actual federal funds rate is determined by supply and demand in the market for loans among banks, the Fed can influence the market by using oepn-market operations.
When the Fed realizes its target, it eventually adjusts the money supply.

In this blog, entrepreneurs are mentioned to be taken to believe that Fed-influenced rate is correct price; however, I do not truly agree with that mention. Since depositors and bankers have more pivotal roles in deciding the amount of money in the ecenomy than the Fed, the Fed-influenced rate may be differnt from the actual demand of depositors and bankers.

Although the Fed sometimes cannot predict correct price, I believe that it takes very significant roles in overseeing the banking system and regulating the quantity of money in the economy. Hence, the Fed is fundamental in our society.