Market Monetarism, NGDP Targeting, Same Ole Same Ole.

Lio67 sent me a comment. “I wonder what Smiling Dave has to tell about market monetarism and NGDP targeting. I have not yet seen anything about it in this blog. I think this is a hot topic!”

OK, off to Wikipedia:

Market monetarism is a school of macroeconomic thought that advocates that central banks target the level of nominal income instead of inflation, unemployment, or other measures of economic activity, including in times of shocks such as the bursting of the real estate bubble in 2006.

In other words, up until now the central banks of the world had two jobs. The first was to keep inflation at a satisfactory rate. In the old days, when the average person hated inflation, they said satisfactory meant to keep it low, thus keeping the citizenry satisfied. But years and years of continual brainwashing have finally convinced people that inflation is not so bad, after all. So now “satisfactory” means “satisfactory to the powers that be”, meaning high enough to give them free money, but low enough to keep the citizenry from rioting.

The result? Exactly what Austrian Economics predicts, mainly a boom followed by a bust, or recession. The higher the inflation, and thus the higher the initial boom, the worse the bust. Since the mainstream economists in charge believe inflation is a cure for the bust, they have been inflating like good little boys. And Austrian Economics agree that it will, in theory, give temporary relief, but with a painful payback to follow.

Now, to the surprise of the mainstream, this time around the relief is not here, despite the inflating. What gives? Austrians who thumb through their copy of Human Action know the answer:

The boom can last only as long as the credit expansion progresses at an
ever-accelerated pace.

In other words, once you start inflating, you have to keep inflating faster and faster, more and more, or else the recession will come. [Because every inflation creates more parasitic jobs, what Mises called malinvestments, which need more paychecks]. And so it has come. We have been inflating for so many years now, it would require vast amounts of inflation to bring the zombie economy back to a semblance of life.

Another job central banks have is to keep employment high. Austrians understand that a requisite for that is that the central bank get out of the way and stop printing money. But then, where would the govt get its free money from? So the mainstream has a different answer. Inflate, and that will increase employment, too. Again, Austrians agree that this might work in the short run. And again, they add that to keep it going, you need ever accelerating inflation. And again, we have reached the point where the kind of inflation that central banks have dared until now is just not working.

So what can they do? The answer, of course, is going to be print at an ever accelerating rate. Austrians know it [as above], and the mainstream knows it [though they have other explanations why, and do not see any bad side effects]. But what is the justification? To handle inflation? High inflation is not exactly handling inflation. To keep everyone employed? Even with full employment, people will be very unhappy if their money buys a lot less than it use to last week, every single week. So they need a new to justify the vast money printing that awaits us.

And that’s where Money Monetarism, by incredible coincidence, comes in. It’s as if the Heavens had opened and revealed a new and convenient truth. Under this new plan, the money printing is supposedly going to save the whole economy. Everyone will benefit. And don’t worry, if prices are going up now, our new handy dandy system will make them go down someday. Chin up, guys. Prices are only going up because the economy needs it. When it’s no longer absolutely necessary, prices will normalize. [Or at least, that's what they say. An Austrian will counter that it will always be necessary, as explained above].

So what does Money Monetarism mean? “Monetarism” is code for “printing money”. ”Money Monetarism” means “printing enough money so that it looks like everyone is getting richer”, as opposed to printing to take care of inflation or unemployment or to manipulate an interest rate.

What’s the plan? Very simple. Look at the GDP today. Say it’s 14 trillion dollars. We want GDP to grow by five percent a year, which they think is an indication of a thriving economy. But there is a recession, and GDP is actually sinking, not growing. So what do we do? Simple. 5% of 14 trillion is 700 billion, right? So we’ll just print a new seven hundred billion, give it to the govt or the banks to spend, and voila. GDP has grown by 5%.

Now a wise guy may ask, “Uh, fellows? You have created more paper, but even you know that an economy gets richer by increasing production, not by increasing paper money.”

And they have an answer. “We are all Keynesian now. More paper means more spending. More spending creates more jobs. More jobs creates more demand, which magically creates more supply [despite Austrians mocking this assertion, we think it's true anyway], which is, by definition, increased production.”

Here’s the line from Wikipedia that shows their thinking, emphasis mine:

Monetary policy which would ensure a NGDP expectation is met (e.g. a level that reflects 5% NGDP growth from a normal trendline) by definition avoids recessions in nominal terms, and by maintaining aggregate demand also avoids deep recessions in real terms.

In other words, Money Monetarism is the same old tired Keynesian-ism, disproven many times over by the great Austrians. [Do a search here for Keynes].

The key tenet of modern Keynesian-ism is “Print money, and everything will be fine.” The only question is “How much money?” Until now, the various answers were until inflation is 2 percent, or until interest rates are zero percent, with minor variations. But those don’t work anymore, because they give answers way too small for the advanced state of decline we are in. The zombie economy will no longer walk with so little printed money pumped into it.

Along comes Money Monetarism with a new answer to “How much money do we print?”, one that is way way higher than anything done until now.

Here’s a frightening quote from Wikipedia, emphasis mine:

The Economist describes the market monetarist approach as potentially including “‘heroic’ purchases of assets, on a bigger scale than anything yet tried by the Fed or the Bank of England.”

Some heroes. As if you have to be a hero to spend other people’s money.

One final thought. The Fed does not have to report to anyone how much money it prints, nor what it does with the money. I suspect that it has already gone way beyond printing the 5% a year that the Money Monetarist crowd thinks is the magic number that will make everyone happy. But that’s just me.

OK, Lio67, that’s all I’ve got.

Why Bitcoins Are Doomed.

The Freeman has an article about how wonderful bitcoin is, listing the many advantages it has over every other type of currency.

We disagree. Imagine if instead of money, the bitcoin people had decided that their digital thingies should be clothing, BitClothes.

They would sing the praises of BitClothing. Never needs washing, one size fits all, no more clunky suitcases or lack of closet space, never wears out, etc.

Yes, BitClothes have all those advantages, but they aren’t clothes at all.

Bitcoins lack the first essential of being money. Here’s Ludwig von Mises:

As soon as an economic good is demanded not only by those who want to use it for consumption or production, but also by people who want to keep it as a medium of exchange and to give it away at need in a later act of exchange, the demand for it increases. A new employment for this good has emerged and creates an additional demand for it. Such an additional demand brings about a rise in its value in exchange, i.e., in the quantity of other goods which are offered for its acquisition. The amount of other goods which can be obtained in giving away a medium of exchange, its “price” as expressed in terms of various goods and services, is in part determined by the demand of those who want to acquire it as a medium of exchange.

We’ll use gold as an example. The caveman liked gold because it made pretty trinkets. This didn’t mean much, really, and he certainly would not pay $1,600 an ounce for it. But as time went on, and people started using gold as money, that made it more valuable. It’s the law of supply and demand at work. Increase the demand for gold, since more people want it now that it is used as money, and you increase its price.

Thus the demand for a medium of exchange is the composite of two partial demands: the demand displayed by the intention to use it in consumption and production and that displayed by the intention to use it as a medium of exchange. The value in exchange (purchasing power) of a medium of exchange is the resultant of the cumulative effect of both partial demands.

In other words, the reason people want a gold coin, when it is used as money, and what determines what they are willing to give in exchange for a gold coin, is the two uses it has, as jewelry and as money.

Now the extent of that part of the demand for a medium of exchange which is displayed on account of its service as a medium of exchange depends on its value in exchange. This fact raises difficulties which many economists considered insoluble. It is illogical, they said, to explain the purchasing power of money by reference to the demand for money, and the demand for money by reference to its purchasing power.

Let’s put aside the jewelry aspect of gold, and concentrate only on its value as money. People want gold because it has purchasing power, and it has purchasing power because people want it. That’s called circular reasoning.

How on Earth did a gold coin ever get to have the ability to buy $1,600 worth of groceries? Because people want it so badly? Well, why do they want it so badly? Because it can buy $1,600 worth of groceries?

Mises did not originate the question, but he did come up with the answer:

The difficulty is, however, merely apparent. The purchasing power which we explain by referring to the extent of specific demand is not the same purchasing power the height of which determines this specific demand. The problem is to conceive the determination of the purchasing power of the immediate future, of the impending moment. For the solution of this problem we refer to the purchasing power of the immediate past, of the moment just passed. These are two distinct magnitudes. It is erroneous to object to our theorem, which may be called the regression theorem, that it moves in a vicious circle.

People want gold today because yesterday they saw they can buy a lot with it.

But, say the critics, this is tantamount to merely pushing back the problem. One must still explain the determination of yesterday’s purchasing power. If one explains this by referring to the purchasing power of the day before yesterday and so on, one slips into a regressus in infinitum. This reasoning, they assert, is certainly not a complete and logically satisfactory solution of the problem involved. 

In other words, it’s worth $1,600 today because that’s what you could get with it yesterday. But what about yesterday? You can’t go back and back to the beginning of time, right?

The regression does not go back endlessly. If we trace the purchasing power of money back step by step, we finally arrive at the point at which the service of the good concerned as a medium of exchange begins. At this point yesterday’s exchange value is exclusively determined by the nonmonetary demand by those who want to use this good for other employments than that of a medium of exchange.

In other words, if you go back far enough, you get to the day when gold was useful as jewellery only, worth say a dime. Someone realized people are happy to take gold coins valued at a dime apiece. What have they got to lose? That’s what the gold is worth for jewellery, anyway. And from there, as gold coins became more popular as money, they started becoming worth more than a dime.

And this is where bitcoins fail. No matter how far back you go, bitcoins were never worth anything intrinsically. There was never a reason for bitcoins to suddenly become worth a dime, or any other price. They are totally useless as jewellery, or anything else. So that there is no reason people should accept them as being worth a dime, much less $266.

More on bitcoin here.

Vickrey’s Fallacy 4, Inflation is Good, Fighting Inflation is Bad.

Source: http://www.columbia.edu/dlc/wp/econ/vickrey.html

You have the floor, Mr. Vickrey, Nobel Prize laureate, in italicized font. Dave will comment in regular font.

Fallacy 4

Inflation is called the “cruelest tax.” The perception seems to be that if only prices would stop rising, one’s income would go further, disregarding the consequences for income.

What he means is that sure, your income looks like it will go further if there is no inflation, but without wonderful wonderful inflation, you may not have an income in the first place.

First he lays out his case that your income won’t really go further:

Current reality: The tax element in anticipated inflation in terms of gain to the government and loss to the holders of currency and government securities, is limited to the reduction in the value in real terms of non-interest-bearing currency, (equivalent to the increase in the interest rate saving on the no-interest loan, as compared to what it would have been with no inflation), plus the gain from the increment of inflation over what was anticipated at the time the interest rate on the outstanding debt was established.

An 85 word sentence. What does it say? That yes, the govt does gain from inflation, and yes it is a tax. And who pays this tax? Anyone the govt owes money to [since he will be repaid in money with less purchasing power] and anyone who has US dollars in his possession [because his dollars now have less purchasing power].

But how much will these people really lose? Only whatever purchasing power was lost [for those who have dollars], plus a loss of interest [for those who lent their money to the govt].

In other words, yes, you will lose money, but Vickrey will soon claim that when the chips are down, you won’t lose anything. The banks will reimburse you, unless you are some silly old fogey.

What’s really bad is deflation:

On the other hand, a reduction in the rate of inflation below that previously anticipated would result in a windfall subsidy to holders of long-term government debt and a corresponding increase in the real impact of the debt on the fisc.

Because if there is deflation, the people who lent money to the govt will get a “windfall subsidy”. Not only that, the govt will lose money. The national debt will increase in real terms.

This is nonsense. In an economy where there is anticipated deflation, loans will be made with due consideration of that fact. The terms of the loans will stipulate that in case of deflation, the real, not nominal, amounts of money are what count.

Such stipulations happen all over the world for inflation, things like cost of living increases and the like. We are so unused to actual deflation that we don’t realize that it can be handled in contracts and loans just like inflation is today.

Bottom line, Vickrey admits you lose money because of inflation, that it is a tax, that the govt makes money from inflation. But that was only in the bad old days:

In previous regimes where regulations forbade the crediting of interest on demand deposits, the seigniorage profit on these balances, reflecting the loss to depositors in purchasing power, that would be enhanced by inflation would accrue to banks, with competition inducing some pass-through to customers in terms of uncharged-for services.

Those stupid previous regimes didn’t know how to protect you. And who made money from inflation back then? Banks, that’s who. They should have been giving you interest to compensate you for your losses due to inflation, and they didn’t.

In an economy where most transactions are in terms of credit card and bank accounts with respect to which interest may be charged or credited, the burden will be trivial for most individuals, limited to loss of interest on currency outstanding.

After all, 90 percent of the money in the US is not cash, but exists in computers in banks. So you won’t lose any purchasing power from that 90%, nor from any cash you were smart enough to put in a bank. You’ll just lose a trivial amount of money, what you had in cash. What do you care about a few pennies, right?

Right there we saw an example of the imaginative thinking that got Vickrey his Nobel prize. Because the banks can give you some free interest because you lost money due to inflation, Vickrey took it for granted that they will. But guess what? It’s not happening, and never has. It’s hard for me to express the contempt I have for someone who wrote that last italicized paragraph. Not because he’s stupid, which he isn’t, but because of the intellectual dishonesty involved.

Continuing his Bizzaro world fantasy that all cash in a bank is safe from inflation, Vickrey then resolves a little brain teaser. If nobody loses from inflation, then how how does the govt gain [something he freely admitted at the very start]? How is it a tax if nobody loses anything?

Most of the gain to the government will be derived from those using large quantities of currency for tax evasion or the carrying on of illicit activity. plus burdens on those few who keep cash under the mattress of in cookie jars.

The govt will gain from criminals who use cash, and from fools who don’t trust banks. And those fools are few in number, so don’t worry about them.

So waddaya know? Who is doing all the hoarding in our economy? Nobody. And what about the Keynesian thing, which Vickrey believed in, that hoarding is what is ruining our economy, and we need the govt to save us from hoarding? Well, that hoarding is coming from tax evaders and people carrying on illicit activity.

How far we have come from the simple days of John Maynard Keynes. He wrote that everyone will hoard. Now it turns out that the only reason to hoard is because the govt is taxing us and making things illegal. In other words, Vickrey is saying that if the govt lowered taxes in the first place, and legalized marijuana and the like, there would be no hoarding. Govt taxes and laws are ruining the economy, he is saying here.

Did he ever come out in favor of lowering taxes drastically to save the economy? Of legalizing things that people want to be legal? Not him. His thinking went like this. The govt’s high taxes are causing people to hide their money. This is bad for the economy. The solution is to tax everyone even more, not just those who hide their money. Duh, lower the taxes in the first place, Mr Vickrey.

You know, Columbia University is actually providing free copies of Vickrey’s paper on the internet. Have they no regard for his reputation? Does it not behoove them to hide this little work of his, to save the Vickreys from embarrassment?

[Just as an aside, Austrians say that hoarding is good for the economy, not bad, See this gem.]

The main difficulty with inflation, indeed, is not with the effects of inflation itself, but the unemployment produced by inappropriate attempts to control the inflation.

In other words, with no inflation, there will be unemployment. Which is true. In an economy ruined by previous inflations, those people with unprofitable jobs will have to move on to profitable ones. And if the govt makes laws impeding employment, the unemployment will be chronic and high, as in some countries in Europe.

But inflation is at best a very temporary solution. The way it works is, the govt prints a lot of money to pay workers who should have moved on to other jobs long ago. These workers who make no money for their company, or for anyone else, are bottomless pits, requiring new paychecks constantly. So more money will have to be printed. [A typical case is Solyndra, which gobbled up $500 million dollars of govt money and then went bankrupt].

The problem is, every time money is printed, more unprofitable jobs are created. Each round of money printing has to be bigger than the one before. Mises said the rate of increase is exponential. Very very scary thought, because at the end of this rainbow of horror is total collapse of the value of the dollar.

Actually, unanticipated acceleration of inflation can reduce the real deficit relative to the nominal deficit by reducing the real value of the outstanding long-term debt.

Here Vickrey is explaining how wonderful inflation is. The govt, which can cause inflation by printing money, can use it to cheat those who lent it money, repaying them in money that has lost real value.

Vickrey family, where are you? Tell Columbia University to take Mr Vickrey’s paper off the internet. You don’t want him on record as saying stuff like that.

If a policy of limiting the nominal budget deficit is persisted in, this is likely to result in continued excessive unemployment due to reduction in effective demand.

We spoke about this before. By reduction in effective demand he means the govt won’t print money to pay workers who should have gotten real jobs, instead of jobs that rely on govt handouts.

The answer is not to decrease the nominal deficit to check inflation by increased unemployment,

Nobody said it was. The way to check inflation is to stop inflating the money supply. This will result in unemployment of people who have unprofitable or parasitic jobs, but that’s a good thing for the economy as a whole, and ultimately, for the workers themselves.

Here’s a little example from recent news about what happened when Greece did what Vickrey wanted, and worried about jobs instead of productivity:

The right to a permanent position once hired by the public sector had been protected by the Greek constitution before Sunday, and about one in four Greeks is on the public payroll.

The bill, which passed in a 168-123 vote, will allow for the first civil service layoffs in more than a century…A provision also aims to bypass, if needed, the notoriously slow and lenient disciplinary councils, which have refused to lay off even people convicted of felonies [= serious crimes]. More than 2,000 such cases are pending, nearly 600 on appeal.

Everyone had a job, nobody got fired ever, one fourth of the country was actively doing nothing, and the rest is history. The Greek situation is terrifying all Europe.

Vickrey continues with his ideas about how to fight inflation. Hint: By giving the govt more money.

but rather to increase the nominal deficit to maintain the real deficit,

At least he is being consistent here. You’ll remember how his first fallacy claimed that govt deficits are great for all of us. I hope you remember our rebuttal, too.

controlling inflation, if necessary, by direct means that do not involve increased unemployment.

Direct means such as what? He probably means wage and price controls, which are notorious for ruining an economy.

Bottom line, the reality is that inflation is terrible for everyone but the govt and its pals. Mr Vickrey loves the govt, as is clear from his article, so he thinks inflation is good. He tries to convince us that we won’t suffer from inflation, that only people the govt actively dislikes will lose. But he has to resort to such lies, and such open encouragement of the govt cheating those who lend it money, that I’m sure the Nobel Prize Committee is stripping him of his prize as we speak.

Nobel Commitee Knuckles Under as Dave Prepares his Article about Fallacy 4, Inflation.

To ensure deniability on their side and poetic license on Dave’s, the Nobel Prize committee visited Smiling Dave in the dead of night.

SD: Come in, guys. Where’s the check?

Committee Member: There are conditions.

SD: Such as?

CM: Vickrey keeps his prize. Yours will be for Literature, not Economics. No more exposing our laureates as buffoons.

SD: In other words, you want me to sell out?

After some haggling, a deal was struck. Dave would get his award money in gold Krona. The Nobel Committee would advertise heavily on his site, for all time. Speaking engagements would be arranged, with suitable honorariums.

In return, Dave makes no future mention of Vickrey’s prize. Dave will get his in Economics, for researches into bitcoin. Nothing in the acceptance speech about Austrian Economics.

CM: And enough with the stupid jokes on your blog, already. I mean, seriously.

Dave went to bed that night a happy man. He turned on his favorite song, There Ain’t No Cure For Love, by Leonard Cohen.

All the rocket ships are climbing through the sky

The holy books are open wide,

the doctors working day and night

But they’ll never ever find that cure for love

There ain’t no drink, no drug, ah tell them, angels

There’s nothing pure enough to be a cure for love

Somehow, hearing this was unsettling to Dave.

It’s written in the scriptures,

it’s written there in blood

I even heard the angels declare it from above

There ain’t no cure, there ain’t no cure,

there ain’t no cure for love

“What about gold Krona and honorariums?” Dave asked the now silent room.

“There ain’t no cure for love,” was the haunting reply.

Word of Smiling Dave Spreads to New Jersey.

The New Jersey Libertarian Party website has copied Smiling Dave’s most popular article, How Mises’ Dismissed that Whole Keynesian Thing with a Decisive One Liner. No money changed hands.

This will further Dave’s campaign to get Vickrey’s Nobel Prize transferred to him.

Stockholm officially denied even knowing about the campaign’s existence.

“Smiling Dave can just quit wasting his time right now. Our decisions about Nobel recipients are final. William Vickrey won his prize, deservedly, and he’s keeping it.”

Yeah, right.

You can put my humble articles on your website, too, free. Just go to the bottom of this page, where it’s black, and read the simple requirements.

P.S. All Dave’s posts are also featured on a site run by his good friend, who has figured out how to actually make money from the internet. Link:  http://2013.dragontau.com/

P.P.S. And someone has published Dave’s article about Wage Slavery on their fresh new website. [Also available right here]. Tremble, William Vickrey.

Smiling Dave Takes on Nobel Prize Winner Vickrey. Third Topic. Do Deficits Crowd Out Anyone?

The late Nobel Prize Winner William Vickrey is not taking Dave’s campaign to steal his Nobel Prize lying down [excuse the pun]. Using his Ouija Board, Dave has talked with Vickrey.

WV: Go pester somebody else, you ghoul. Have you no respect for the dead?

SD: Bill, that article of yours, Fifteen Fatal Fallacies of Financial Fundamentalism, is doing a lot of damage here amongst the living. People actually believe that stuff.

WV: In that case, Dave, please show everyone its mistakes. I led a saintly life in my day, and encouraging economic disaster was my only sin. Had I known that the Good Lord Himself is an Austrian Economist, I would never have written that thing.

Respecting Vickrey’s plea from the Afterlife, Dave continues his discussion of Vickrey’s article. [Index: Part One, Part Two, Part Three, and thou starest at Part Four right here]. As always, he gets the italicized font, I get the normal one.

Here’s Vickrey:

Fallacy 3

Government borrowing is supposed to “crowd out” private investment.

The current reality is that on the contrary, the expenditure of the borrowed funds (unlike the expenditure of tax revenues) will generate added disposable income,…

If you tax someone, you take away his disposable income. But if you borrow, and I presume he means from abroad or else it’s just like taxing, you generate disposable income, says Vickrey. Think of it this way. If the govt is like a Vegas gambler gone broke, it won’t be able to tip the waiters and butlers and all the good citizens of Las Vegas. But if he borrows a few million bucks, there’s plenty of money to tip people with. And the wild lavish parties he organizes will bring money to the coffers of all the liquor stores, the restaurants, the casinos, everybody wins. What could possibly go wrong, asks Vickrey rhetorically?

Everything, replies Dave. And for two excellent reasons. First of all, somebody is going to have to repay that borrowed money back, and with interest. Meaning the very citizens who will supposedly get more more disposable income today are going to have less disposable income tomorrow, thank you very much for spending their money, govt.

Second, money isn’t everything. Even today, when they supposedly have more disposable income thanks to all the govt spending, they really have less. And why? Because the govt is using the borrowed money to buy everything up. Going back to the Vegas parable, all the liquor stores and supermarkets will be emptied for that big govt party, leaving the everyone else with no food and liquor.

…enhance the demand for the products of private industry,

Here he’s going along with the Keynesian assumption that artificially increasing demand is a good thing in and of itself. But it’s not. When a certain industry or business, call it Ajax Industries, suffers from lack of demand for its products, that means they have not lowered their prices enough to be able to sell their product. And why haven’t they? Because their costs of production are too high to allow for selling their product cheaply. Which means someone other business or industry, call it B Industries, is able to pay the high price for the resources needed, and still make a profit. In other words, people are so coveting what B makes that they are willing to pay a high price for it, but are not willing to pay that high price for what Ajax is making. Meaning the people want B, not Ajax. Obviously, Ajax has to cut down production and let the resources go to B. The consumer has stated his desire. Thus, artificially letting Ajax keep producing is denying the citizens of what they want, B.

And if it’s the whole economy that suffers from lack of demand, meaning there is generalized hoarding, we have shown that in that case, as well, what is really going on is that the public wants different products made.

…and make private investment more profitable.

His reasoning is that if the govt is buying from Ajax with all that borrowed money, that’s more profit for Ajax. But of course, the govt doesn’t buy from everyone, does it, certainly not equally. Sure, there will be more profits for Ajax, but less for B.

Really, Bill, this line is so dishonest.

As long as there are plenty of idle resources lying around,…

meaning stuff nobody wanted to be made in the first place,

…and monetary authorities behave sensibly, (instead of trying to counter the supposedly inflationary effect of the deficit)…

Why does he say supposedly? Give the govt new money to spend that it borrowed from somewhere, then of course prices will rise [or will not fall if they were due for a fall, which comes to the same thing], since demand has increased with that influx of money.

those with a prospect for profitable investment can be enabled to obtain financing.

The idea being that with the govt borrowing new money, some of it will find its way into the banks, who will lend it to those with a prospect for profitable investment.

But why didn’t the banks lend money to these prospects for profitable investment before the govt borrowing? Must be because in their professional estimation, those prospects were actually rather risky. So this whole scenario Vickrey describes is fiction.

Under these circumstances, each additional dollar of deficit will in the medium long run induce two or more additional dollars of private investment. The capital created is an increment to someone’s wealth and ipso facto someone’s saving. “

The idea being that these prospects for profitable investment will succeed and make money hand over fist and will inevitably use the money for even more investment.

Supply creates its own demand” fails as soon as some of the income generated by the supply is saved,

William, have you forgotten so soon? We just refuted that last article.

WV: Heh heh, thought I could sneak that one by you.

but investment does create its own saving, and more.

Assuming the investment is not a foolish one. See above about the banks thinking it was a foolish one.

Any crowding out that may occur is the result, not of underlying economic reality, but of inappropriate restrictive reactions on the part of a monetary authority in response to the deficit.

In other words, having more borrowed cash in the economy can only do good, if only the guys in charge don’t mess up and reduce the amount of money by their ineptness.

Well, we have shown that crowding out will happen, and it will be the result of underlying economic reality. There are only so many resources to divvy up. When the govt borrows money and uses it to take those resources either for itself or for its buddies with unprofitable companies, that crowds out everyone else from getting hold of those resources.

Suddenly, Dave noticed eery lightning flashes and all the doors in his house started creaking. The Ouija board Planchette started moving rapidly on its own, untouched by human hands. Then a distinguished Nobel Prize winning voice filled the room.

WV: Smiling Dave! You have angered the spirit world.

SD: Eh?

WV: You forgot about one key argument.

SD: Go on.

WV: We are talking about an economy with idle resources. Nobody else is using them. When the govt borrows money and starts spending, it will use the money to get those idle resources going. No one will be crowded out of using them, because nobody wanted them in the first place. You have two seconds to reply, or else be blasted into smithereens by lightning bolts and creaky doors.

Smiling Dave was unperturbed. He laughed down from lazy eyelids and flicked a speak of dust from the wrist of his shirt sleeve.

SD: Those resources aren’t idle. They are in transit.

WV: What?

SD: Those resources have just left the companies the govt wants to hand them to, and are out there looking for a better place. After all, how do resources become idle in the first place? Because they were being used in unprofitable businesses, and got the boot. They were working for Ajax, and are now on their way to B, as above.

A deathly stillness fills the house.

WV: You know, I never thought of it that way.

Fatal Flaw in AS-AD curves.

Imagine trying to model marriage with a simplified universe of Robinson Crusoe alone on island. It doesn’t work like that. Marriage requires two people minimum. You can’t model marriage with just one person. And if you do, good luck with all the stupid conclusions you will reach.

An AS-AD model is making the same mistake. It, too, is pretending there is only one producer creating only one product and selling to only one consumer. Such a model is as flawed as modeling a marriage with only one person.

If we assume only one of everything, the Keynesian story is inevitable. Less consumption means the one company in existence has to cut down on production and fire people, who have nowhere to go, forever. After all, there is only one job available in this economy, and they just got kicked out of that job. Conclusion: Consumption must be kept up at all costs if we wish to avoid chronic unemployment.

But once we make the simple modification in our model, of having various products and various producers, the whole picture changes. If people consume less, and as a result folks get laid off, they will now get to work making what they need for themselves, if there are no other consumers  to produce for. These people lost their jobs. They are broke. They need things. Some clever entrepreneur will notice this, and get them to work making what they themselves need.

After Explaining Vickrey’s Second Fallacy at Length, Smiling Dave is Ready to Respond

This is the third article in an ongoing series.

Part 1 explores Vickrey’s Claim that Deficits are Great.

Part 2 lays out his case that savings is just terrible for an economy not running at full capacity.

And here we are at part three, right here, where Smiling Dave continues his campaign to get Vikrey defrocked of his Nobel Prize, and have it handed over to Dave. The strategy is continue in a straight line, and refute all Vickrey wrote in Part 2.

Devil’s Advocate: Sure Dave, as if you stand a chance.

SD: Maybe I don’t, but Vickrey has already refuted himself, doing my job for me.

DA: What are you talking about.

SD: It’s in his very last line, and I quote, “…the income generated by capital formation provides a source of additional savings.”

DA: And your point is?

SD: The same one Mises made, and Vickrey just admitted to. Nobody has money to save unless he works and earns money in the first place. In other words, the very fact our man Mr A, as we shall call him, has money to save today is because he has increased capital formation yesterday. Normally, he then reduces the capital formation somewhat, by spending that money and consuming, meaning eating up, part of the capital stock. But now that he saves, which is an act of not consuming, the bottom line is that he has increased the capital stock.

DA: Dave, you could have said it much simpler. Spending is consumption, eating up what is there. Saving, even if not invested in anything, is a benefit to the economy because it does not reduce the capital stock.

SD: Exactly. So that even if the saved money goes nowhere, investment, in the sense of an increase in the capital stock [= the whole point and goal of investment] has already happened,

DA: But what about the domino effect Vickrey talked about? Mr A saves means Mr B and a long line of people behind him all go hungry.

SD: They won’t go hungry. They will all just get new jobs. Here’s how it works. When Mr A saves, he is telling his vendor he no longer wants what the vendor was selling. The vendor then tells his supplier that he, too, no longer wants what the supplier is supplying. This message is transmitted all the way down the line. Of course, Mr A is not doing anything evil by not buying stuff he doesn’t want. It’s his money, right? He worked for it, and he thus is the boss over it, to do as he wishes.

As a result, people who used to work at making widget X that Mr A no longer wants will stop making it. Exactly the right thing to do. What will they do, now they are no longer making what Mr A wants? Get new jobs, making what he does want.

DA: But suppose he doesn’t want anything?

SD: Then they will work making what somebody else wants.

DA: But suppose nobody wants anything? Suppose everyone already has all they want, and there are no jobs at all left?

SD: What about the unemployed themselves? Don’t they want something? I thought they were hungry and needed food and stuff.

DA: But they don’t have any money.

SD: So they get jobs making stuff they need, and then with the salary they earn, they buy it.

DA: It seems so obvious now. Why didn’t Vickrey think of that?

SD: If I’m going to claim his Nobel Prize, I may as well read his mind while I’m at it.

I found the answer to this one in Kel Kelly’s beautiful [free] book, The Case For Legalizing Capitalism. Talking about Keynesians, he says:

They believe there is only a finite amount of work to be done. This argument is the same as saying that there are no more goods and services people want in their lives (i.e. as consumers we would have no more demand for the additional things we would make as workers). Keynesians believe that, given a static quantity of money, we only have so much we want to buy in physical terms and no more. No matter how cheap things are, we will not purchase any additional amounts of the things we buy because we always have enough of them. Keynesians therefore believe that we are capable of producing more than we can consume (the overproduction doctrine). But if one imagines a world in which everything is free it becomes clear that in fact we would all consume more of the things we want, given the ability to.

But for most of us living in the real world, if the price of most food, jewelry, or clothes, or anything that we need or want, was simply less expensive, most of us would consume more of these things. The same applies to employers “consuming” workers: if employers have a set amount of money they can spend on labor — which they do — with lower wages, more workers would be employed with that same amount of money (each earning less money). This is elementary to even most non-economists. All goods eventually get sold at some price. A purse that originally cost $300 at Macy’s might end up being sold at outlet malls for $30, but it gets sold at the price people are willing to pay for it.

DA: Now I’m all confused. What really goes on when somebody saves and doesn’t do anything with the money?

SD: Three things happen at once.

First, he officially is working for free. He earned the money that he is now saving in the first place by being productive, meaning increasing the capital stock, meaning making it possible for everyone to get wealthier. But he is not asking for any concrete thing in return, only mere money. Meaning he is leaving the goodies out there for other people to buy.

Second, he indicates to producers that the time has come to change things around, to use their capital to produce for the needs of a population with different wants. There may be temporary unemployment until everyone finds their new niche, but that’s always happening anyway. Fads come and go. One day clunky PCs are in, the next everyone wants iPads instead.

Third, he reduces the supply of money. This reduces prices and increases the purchasing power of everyone else. Not a bad thing at all.

Note that all this assumes the fellow does not even bother to invest his money. So that Vickrey’s whole speil about how he won’t invest it becomes irrelevant.

DA: I just emailed Stockholm. They are sending over a representative.

SD; Where’s my white tie and tails?

Smiling Dave Takes on Nobel Prize Winner William Vickrey. Second Topic, Savings Do Not Stimulate Investment.

In Which Smiling Dave Continues his Campaign to get Vickrey’s Nobel Prize Transferred to Himself.

Part 1 here.

Vickrey goes for the jugular now, attacking one of the most fundamental tenets of Austrian Economics and common sense. He calls it a fallacy. You have the floor, Mr Vickrey:

Fallacy 2

Urging or providing incentives for individuals to try to save more is said to stimulate investment and economic growth.

Since this makes no sense at all to him, Vickrey does Austrians a kindness and inserts an assumption, which, though totally artificial and incorrect, will make some kind of sense of how Austrians came to such a fallacy:

This seems to derive from an assumption of an unchanged aggregate output so that what is not used for consumption will necessarily and automatically be devoted to capital formation.

In other words, the factories will keep on churning out products at the same rate as ever, even though people are no longer buying their stuff. Not only that, none of the saved money is hoarded, but either spent on consuming or is devoted to capital formation. Only with these two ridiculous assumptions can we think for a moment that saving stimulates investment, says Vickrey. But in the real world, things are different, he explains:

Again, actually the exact reverse is true. In a money economy, for most individuals a decision to try to save more means a decision to spend less…

So there will be hoarding in the real world, says Vickrey, and the disaster will follow:

…less spending by a saver means less income and less saving for the vendors and producers…

I mean, if the customers are hanging on to their money, it won’t ever get to the vendors and producers. It can’t be in two places at once, right?

and aggregate saving is not increased, but diminished …

You’d think that if people start saving more money, there will be more saved money. But no, says Vickrey, there will be less! And why is that?

…as vendors in turn reduce their purchases, national income is reduced…

All that saved money means less money to the vendors, which means less money to their suppliers, which means any money that is saved means someone, the fellow who used to get the saved money, will go hungry. It’s simple math, says Vickrey. One dollar not spent means one dollar less income to someone, in fact to a long chain of someones. That selfish fellow who spent one dollar less is causing everyone to go broke.

…and with it national saving.

Sure the one guy who started this horrific domino effect gets to save a dollar, but that will result in a whole slew of people who depended on his purchases going broke. One person saves; ten or twenty or more go broke or get fired. You don’t expect them to save anything, do you?

A given individual may indeed succeed in increasing his own saving, but only at the expense of reducing the income and saving of others by even more.

I bet you didn’t realize how selfish you are, ruining the economy because you wanted to save your money for when you retire or some silly reason like that.

In fact, it makes one wonder about Social Security, come to think of it. All that money, billions and billions of dollars, just sitting there waiting for people to spend in their old age as opposed to right now, thus wreaking havoc on an unsuspecting economy. No wonder we are in a depression. Surely Vickrey must have been a firebrand all his life, lashing out with all his Nobel Prize prestige against Social Security. What’s that? He didn’t say a word? Not in 84 years? Odd.

At any rate, Vickrey now paints a very clear, if depressing, picture for us. Some people will starve right away:

Where the saving consists of reduced spending on nonstorable services, such as a haircut, the effect on the vendor’s income and saving is immediate and obvious. 

Others may fool themselves into thinking they are getting richer, until they find out they are getting poorer:

Where a storable commodity is involved, there may be an immediate temporary investment in inventory, but this will soon disappear as the vendor cuts back on orders from his suppliers to return the inventory to a normal level, eventually leading to a cutback of production, employment, and income.

You had one job, says Vickrey, to get a haircut. And look how you messed up everything. Production, employment, income, all devastated because of your selfish saving.

The penitent reader may try to have the best of both worlds, by putting his money in a bank. That way, he gets to save it, and yet the money will lent out by the bank to businesses. It’s what banks do, right?

Wrong, say Vickrey.

Saving does not create “loanable funds” out of thin air.

That dollar you put in the bank is not a dollar at all, but thin air, at least in the grand scheme of things. Vickrey explains why.

There is no presumption that the additional bank balance of the saver will increase the ability of his bank to extend credit by more than the credit supplying ability of the vendor’s bank will be reduced.

Sure, your bank got an extra dollar, but twenty or more other banks lost a dollar. Remember all those widows and orphans and barbers who were relying on your money, your one measly dollar, for their daily bread? Remember how they had to dig into their bank account to keep on surviving? Not only have you killed them, but have killed the entire banking industry as well, you selfish old goat.

Besides, continues Vickrey, we know very well what you will do with your wicked saved money. You aren’t going to invest it. Businessmen, meaning that long twenty link chain of barbers and businessmen and vendors who will not get your dollar anymore, are the ones who would have invested it. Not you:

If anything, the vendor is more likely to be active in equities markets or to use credit enhanced by the sale to invest in his business, than a saver responding to inducements such as IRA’s, exemption or deferral of taxes on pension fund accruals, and the like, so that the net effect of the saving inducement is to reduce the overall extension of bank loans.

Not only that, Vickrey explains, but your saving means businesses suffer, remember? Do you think the banks will want to lend money to struggling businesses?

Attempted saving, with corresponding reduction in spending, does nothing to enhance the willingness of banks and other lenders to finance adequately promising investment projects.

Summing it all up, Vickrey explains that as long as there is one iota of unused resources on this planet, one unemployed person, one factory producing at less than full speed ahead, saving money will not lead to more investing. That’s laughable, he says. In fact, you’ve got it all backwards, he says. Capital formation leads to savings, not the other way around. Don’t put the cart before the horse:

With unemployed resources available, saving is neither a prerequisite nor a stimulus to, but a consequence of capital formation, as the income generated by capital formation provides a source of additional savings.

And just at the wrong moment, again, Devil’s Advocate shows up.

DA: He sure zinged you this time, Dave. Everything he says makes a ton of sense.

SD: He didn’t win a Nobel prize for nothing.

DA: So you finally admit you are wrong. Never thought I’d see the day.

SD: Oh, no, I’m not wrong. He won a Nobel Prize for sounding like he makes sense. But in reality he makes no sense at all.

DA: Ha! I suppose you have a refutation in your magic bag, Felix the Cat?

SD: It so happens that I do. But the blog is already long. Tune in next time.

Smiling Dave Takes on Nobel Prize Winner William Vickrey. First Topic, Deficits are Wonderful.

Nobel Prize winner William Vickrey wrote an article with an amusing title, Fifteen Fatal Fallacies of Financial Fundamentalism, in which uses the usual Keynesian thinking to disagree with sound economics.

Never one to miss an opportunity for winning a Noble Prize, Dave decided he will show the errors in Vickrey’s thinking. When Dave’s article gets the attention it deserves, surely the Prize committee will take back the prize from Vickrey, who knows nothing about economics, and hand it over to Smiling Dave, who could use the money and prestige to live the high life.

As always, quotes in italics, me in normal font. Let’s dive right in to the first supposed fallacy Vickrey supposedly refutes:

Fallacy 1

Deficits are considered to represent sinful profligate spending at the expense of future generations who will be left with a smaller endowment of invested capital.

He refers to deficits in the govt’s budget. Very well put. That’s exactly what govt deficits are. So why does Vickrey think govt deficits are OK?

This fallacy seems to stem from a false analogy to borrowing by individuals.

What? No analogy here. The argument applies directly to govt spending, without resorting to analogies. Deficits means you are borrowing money. Which someone will have to repay with interest. Exactly what the “fallacy” says. Here’s why Vickrey think it’s a fallacy:

Current reality is almost the exact opposite. Deficits add to the net disposable income of individuals, to the extent that government disbursements that constitute income to recipients exceed that abstracted from disposable income in taxes, fees, and other charges.

In other words, the US govt borrows the money from the Chinese, and gives it away for free to all the happy citizens. Just like Greece and the other PIIGS did recently. What could possibly go wrong?

This added purchasing power, when spent, provides markets for private production, inducing producers to invest in additional plant capacity, which will form part of the real heritage left to the future.

The citizens take that free money and spend it. And now producers get all that money and will build new factories with it, which we will leave for our children and grandchildren to benefit from. So we are not ripping off the future generations when we borrow that Chinese money, says Vickrey. Just the opposite, we are making them richer, with increased productive capacity. They will look at all those factories we built and thank us.

Sounds lovely, no? Yes, it sounds lovely on paper. The reality is a bit harsher. Well, much harsher.

First of all, Vickrey’s cheery scenario assumes the citizens getting all that free money will buy local products with it. But for some odd reason, this never happens. The money always seems to go abroad. The PIIGS spent their free money on German and Chinese goods, not on PIIGy goods. The reason is, of course, that the PIIGS are so used to getting free money they don’t feel like actually working. Thus, nothing is produced in the PIIG countries, and so the money is spent abroad.

Same thing is happening in the US. We net import many billion dollars a day of Chinese goods, have been for many many years, basically since we started taking Vickrey’s Nobel Prize quality advice in the nineties. Now, maybe future generations of Americans will be very pleased at the lovely Chinese factories they helped build in China. But those Chinese factories will not belong to our children. They may form part of the heritage left to the future, but not our future.

This is in addition to whatever public investment takes place in infrastructure, education, research, and the like.

The money the govt borrows from the Chinese and keeps for itself, as opposed to handing out free to the voters, will be spent on bettering our situation, making us smarter as we tool around on our govt highways whose potholes have all been fixed. So says Vickrey.

Again, that’s not what happened, is it? Obama is whining about our infrastructure and education to this very day. All that borrowed money, trillions of dollars over the years, and our infrastructure is worse than ever, as is our education.

And why? Where is the hole in Vickrey’s reasoning? Simple. The govt does not borrow money to improve the lot of its citizens, to educate them and give them free education and free infrastructure. It borrows money to improve the personal lives of politicians. That’s just the way it is. Or maybe the last few decades were an exception, and from now on things will be different. But so far Vickrey is dead wrong.

Larger deficits, sufficient to recycle savings out of a growing gross domestic product (GDP) in excess of what can be recycled by profit-seeking private investment, are not an economic sin but an economic necessity.

In other words, people sometimes do something awful to the economy, say Vickrey. They save their money. They do this because they want to be able to retire, or pay for their children’s education, or other evil reasons. This is terrible, and we have to find a way to get that money out of their hands. Now some of it they will save in banks, who will lend the money to investors, and that’s fine. But what about the rest, the money these people stubbornly refuse to put in a bank, but stash under the mattress? We have to take that away from them.

Vickrey presumes that a nice fat govt deficit will take care of things. Just have the govt borrow enough money from the Chinese, and the money under the mattress will dissolve somehow. Of course, this makes no sense whatsoever. So Vickrey must be talking not about borrowing money from the Chinese, but about deficit spending that will be paid for by printing new money. That will cause inflation, and yes, it will indeed wipe out any savings people may have.

And this is a necessity, says Vickrey. We just have to make sure nobody can save anything. Vicker doesn’t explain why he thinks so, but Smiling Dave can read his mind. It’s because money saved supposedly reduces aggregate demand, which, like a good Keynesian, Vickrey thinks is a bad thing. We have written many articles explaining why he’s wrong [such as this one, which gives Mises's reason].

But let’s note for now that Vickrey is admitting that inflation wipes out everyone’s savings. This may be important when he talks later about how great inflation is.

Even the analogy itself is faulty. If General Motors, AT&T, and individual households had been required to balance their budgets in the manner being applied to the Federal government, there would be no corporate bonds, no mortgages, no bank loans, and many fewer automobiles, telephones, and houses.

Even his reasoning is faulty. He doesn’t understand that there are two kinds of borrowing. You can borrow to consume, like a drug addict borrowing money to buy more drug, or you can borrow to increase your production, like corporations do. if you borrow to consume, you will go broke, because you have to repay the loan with interest. Only if you borrow to increase production can you use the profits from the increased production to pay off your loan, and have some profit left over.

The govt certainly does not borrow to increase production, because it does not produce anything. The govt borrows to consume, to spend, to use up resources for its own desires. Our children will be left having to pay the loans back with interest, and with their capital stock depleted by the govts present gobbling up of resources.

Well, we have dealt with only the first fallacy of Vickrey’s, and it’s already a long article. So we’ll end now, and see about future articles later.