Commenting on my Krugman article, Pedro Al Sombrero Negro raised many interesting points. I’m going to copy his full comment here, and add my response. As always, all quotes from anyone in italics, my comments in regular font.
But first, an apology in advance for using a writing style to reply that Pedro may not deserve. I am thankful that you read my article, Pedro, and still more thankful that you bother to comment on them. So there is nothing personal in the sarcastic style that follows. It’s just the way my mind thinks, for some reason.
Pedro starts right in:
It seems your whole point is built on the assumption that bank can choose to lend as much as they legally can: this is just not true, nor observed in real life. Banks only lend to creditworthy borrowers, and that is if they show up !
Have you been living in a cave with that sombrero, Pedro? Have you not heard of toxic assets [=loans to uncreditworthy borrowers], bank bailouts, the current recession we are in? That happened in real life. On such a vast scale that all the banks went bankrupt [=lost all their money] because of loans to the uncreditworthy.
And you assume they won’t show up? That is what lowering interest rates is for.
The whole reason keynesianism exist in the first place is because there is such a thing as a situation in which the effective private sector demand for loans is lower than the total debt repayment mometum, hence triggering a debt deflation movement.
Not exactly. In fact the reverse is true. The whole reason it exists , meaning the false assumption Keynes made, it that people will have money lying around that they don’t want to lend, despite businesses dying for the money.
But hey, don’t take my word for it. Let’s go the source. Here’s Keynes in Chapter 3:
Moreover the richer the community, the wider will tend to be the gap between its actual and its potential production; and therefore the more obvious and outrageous the defects of the economic system. For a poor community will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment; whereas a wealthy community will have to discover much ampler opportunities for investment if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members.
If in a potentially wealthy community the inducement to invest is weak, then, in spite of its potential wealth, the working of the principle of effective demand will compel it to reduce its actual output, until, in spite of its potential wealth, it has become so poor that its surplus over its consumption is sufficiently diminished to correspond to the weakness of the inducement to invest.
But worse still. Not only is the marginal propensity to consume weaker in a wealthy community, but, owing to its accumulation of capital being already larger, the opportunities for further investment are less attractive unless the rate of interest falls at a sufficiently rapid rate; which ‘brings us to the theory of the rate of interest and to the reasons why it does not automatically fall to the appropriate level, which will occupy Book IV.
For those who don’t want to bother deciphering that stuff, here’s Mises paraphrase:
John Maynard Keynes [1883–1946] succeeded with his anti-saving program. According to him, there is danger in over-saving. He believed, and many people accepted his view, that opportunities for investment were limited. There may not be sufficient investment opportunities to absorb all the income that is set aside as savings. Business will become bad because there is too much savings. Therefore, it was possible to save too much.
The same doctrine from another point of view had been prevalent for a very long time. People believed that a new invention—a labor-saving device—would produce what was called “technological unemployment.” This was the idea that led the early unions to destroy machines. Present-day unions still have the same idea, but they are not so unsophisticated as to destroy the machines—they have more refined methods.
And by the way, why does Mises think the Keynesian thing is ridiculous?
As far as we can see, human wants are practically unlimited. What we need to fulfill satisfactions is more accumulation of capital goods. The only reason we don’t have a higher standard of living in this country is that we don’t have enough capital goods to produce all the things that people would like to have. I don’t want to say that people always make the best use of economic improvements. But whatever it is that you want, it requires more investment and more manpower to satisfy it. We could improve conditions, we could think of more ways to employ capital, even in the wealthiest parts of the United States, even in California.
There will always be plenty of room for investment as long as there is scarcity of the material factors of production. We cannot imagine a state of affairs without this scarcity. We cannot imagine life in a “Land of Cockaigne,” where people have only to open their mouths and let food enter and where everything else people wanted was available.
Bottom line, Keynes wasn’t talking about “no effective demand” for loans. Businesses are dying for those loans, so they can, you know, stay in business. But they won’t get them.
Also of interest is that Keynes does not say a word about the “problem” you mention, “debt repayment momentum” being larger than “effective demand” for loans. Not a word about that. All he talks about is not enough consumer spending, and not enough profitable investment opportunities. In fact, he explicitly stated that if effective demand for loans gets out of hand, then we are doomed. He called it “debauching the currency”. Here’s the quote:
Lenin is said to have declared that the best way to destroy the Capitalistic System was to debauch the currency… Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million can diagnose. [Source: The Economic Consequences of the Peace, 1920, page 235]
Now I know that Keynesianism nowadays is very different from Keynesianism in 1936. Facts just kept slapping Keynesianism in the face, so new versions of it had to be thought up every few years. In fact, Wikipedia quotes economists who write that Keynes’s actual book is actually useless nowadays. The only thing that has been retained through all the reincarnations of Keynesianism is the notion that the govt has to spend a lot of money, or we are all doomed.
So it may very well be that the latest teachings in the schools is what Pedro Al Sombrero Negro is saying, that the problem govt has to solve is that people are paying their debts faster than they are taking on new debt. This is terrible, apparently, and so we need the govt to step in and borrow lots of money. Ths schools may have even rewritten history, Joseph Stalin style, and claim that Keynes said the same thing.
OK, Let’s look into it. What is so terrible if people are not constantly getting into greater and greater debt? Pedro tells us:
…(A fast decrease in broad money as opposed to a healthy economy that sees a steady increase in the monetary mass)…
So that’s what they are telling the gullible nowadays. A healthy economy sees a steady increase in the monetary mass [=inflation of the money supply], they taught poor Pedro. Obviously, he hasn’t read any Austrian economics, or my blog, or even what Keynes had to say about inflation [see above], or he would know better. So go to mises.org and do a search for inflation, or go there and get a free copy of Hazlitt’s books on inflation, or search my blog [this article for example, in which a Nobel Prize winner lays out the case for inflation, and Smiling Dave leaves him as the dust beneath his chariot wheels].
Firstly, you cannot compare a debt repayment with a traditional transaction because the former reduces the monetary mass when the latter simply transfer money from one person to another;
To be crystal clear, my position is twofold. My basic one is that of the great Austrians, that a decrease in the “monetary mass” does no harm. As Mises said, all the achievements of Capitalism would have happened no matter what the monetary mass. [See this article for more about this point. It talks about the monetary mass dwindling because people hoard their money, but the principles are the same].
In the Krugman article I was doing something else, hoisting Krugman on his own petard. I was addressing Krugman’s fears of a shrinkage of spending when people pay their debts, and taking the position that even in his own twisted view of things, paying your debts does not mean less spending. The guy you repaid the money to will spend it, never fear. That’s why he wanted the money in the first place. To use it.
I mean, think about it. If the money you repay the bank “disappears”, why do they even want it back in the first place? Obviously, it doesn’t really disappear. As I explained in earlier replies.
…then most importantly, and correct me if I’m wrong, but you seem to miss a major feature of the banking system: the endogeneity of money. Banks don’t choose to lend money out, they can only lend if, and only if, there are profitable projects and creditworhty borrowers to ask for loans, in other words, it is the demand side for loans that determines the total size of the market. Banks cannot force entire populations to get in debt against their will (they can try to influence them, think revolving credit and the like, but that’s nowhere near deciding to lend out money at will).
I dunno. The whole reason banks are banks is to lend people money. That’s how they pay their salaries and make their profits.
Wikipedia says the first banks opened up in 2000 B.C. Since then, no bank has ever closed down because “we had nobody to lend to.” It just doesn’t happen. Is that what Krugman is afraid of? That J P Morgan Chase and Citibank and all the others will lock their doors because they have nothing to do?
Banks are never reserve constrained, and there is no such thing as a “money multiplier” that would suppose an increase in reserves or depostis would automatically trigger an increase in loans, even the Fed admitted it.
Again, why do they bother to collect the loans? Why do they go bankrupt when they are not repaid? Why is there a recession now? Why did the Fed buy up toxic assets [=loans that will not be repaid]? The money disappears even if they get paid back, you and Krugman say, so what difference does it make?
The whole problem lies in the fact that a sharp decrease in the money supply can have (and recently had) massive spillover effects that artificially reduce money velocity and demand in industry otherwise not particularly malinvested:
Prove this, don’t assert it. Mises laid out his case that a sharp decrease in the money supply does nothing. I elaborated on it in this article. What is your refutation?
some keynesians (among others) uses this as a argument to justify deficit spending to compensate this phenomenon: this is debattable, and very much so, but the underlying problem is there, and I see no point in avoiding to expose it. Cheers.
There is no underlying “problem”, and even if there was, it is not really a problem, all as explained above.