The Gold and Silver Thread

[Paulie]

This makes no sense at all. "If you define inflation as the creation of money, then gold has been more effective". The creation of money is irrelevant if it isn't raising nominal spending (and hence prices in the long run).

Stop!

The rest of your paragraph reinforces this point, so I've excluded it.

Clearly, you are an intelligent and well-educated individual, schooled in modern economic theory and, I think you are demonstrating an absolutely critical flaw in modern economic thought. I think it's part of the reason why so many conventional economists were unable to identify the stock market bubble of the late 90s and the housing bubble of the mid 00s, and the dangers they wrought.

A rising supply of money does NOT necessarily translate into higher consumer/producer price inflation. It might, or it might not. It depends on the circumstances. It probably (well, almost certainly) does over the long run but it may not over the short and intermediate term. Instead, excess liquidity can flow into asset markets, pushing up asset prices rather than into, say, labour markets. Austrians say that inflation is defined as the excess creation of money, and consumer price inflation is merely an effect of that. But it is not the only effect, and can manifest itself in other ways. Thus, the rising price of gold is, in part, indicative of the excess creation of money over the past decade. Thus, the argument goes, gold has been a good indicator of inflation, just not consumer price inflation. (At least not yet, anyways.) Maybe I'm wrong, I don't know, but I think this explains a lot of what has happened in the economy over the past 15-20 years.

Also, I seriously don't get why those of the Austrian persuasion don't understand this. Even under no central bank, under strictly free banking, the supply of money increases endogenously to offset increases in the demand to hold money. It's absurd that people think it's somehow optimal or natural for the supply of money to be fixed.

I agree. This is why I've argued with the gold bugs against the gold standard. The retort from the more thoughtful gold bugs paraphrases Churchill in that gold is the worst form of money, except for all the others. We've essentially had a completely free fiat money system for 40 years now. Some would say its worked pretty well. Others would say, "Yes, but communism 'worked' for nearly 70 years in the USSR before it collapsed under its inevitable logical contradictions." I have much more sympathy for this argument.

Or, perhaps a better analogy is Nassim Taleb's "Turkey Problem."

The Turkey Problem | Stephen Kinsella

This is a great point and one I neglected to consider...the asset markets. You can have stable CPI and other price inflation indicators, and still have inflated asset prices as a result of excess money creation. The excess liquidity sitting in bank reserves, while perhaps not being multiplied via lending, can be put to work in the asset markets which can and does lead to bubbles.

This is why I think the best way to describe inflation is an increase in the money supply.

 

[Paulie]

Except it's not fiat money that hasn't been working well, it's central bank discretion.

Why do you think that is? Why is it that the supposed most genius economic minds of our time seem to keep getting it wrong, while the supposed economic kooks of the world seem to be getting it right? ... i.e., the Austrians who foresaw the stock market and housing bubbles.

Is it really just a complete and total ineptitude on their part, or could they be directing monetary policy for the benefit of someone else besides the ones who are being negatively affected by it the most?

 

[DSGE]

This makes no sense at all. "If you define inflation as the creation of money, then gold has been more effective". The creation of money is irrelevant if it isn't raising nominal spending (and hence prices in the long run).

Stop!

The rest of your paragraph reinforces this point, so I've excluded it.

Clearly, you are an intelligent and well-educated individual, schooled in modern economic theory and, I think you are demonstrating an absolutely critical flaw in modern economic thought. I think it's part of the reason why so many conventional economists were unable to identify the stock market bubble of the late 90s and the housing bubble of the mid 00s, and the dangers they wrought.

A rising supply of money does NOT necessarily translate into higher consumer/producer price inflation. It might, or it might not. It depends on the circumstances. It probably (well, almost certainly) does over the long run but it may not over the short and intermediate term. Instead, excess liquidity can flow into asset markets, pushing up asset prices rather than into, say, labour markets. Austrians say that inflation is defined as the excess creation of money, and consumer price inflation is merely an effect of that. But it is not the only effect, and can manifest itself in other ways. Thus, the rising price of gold is, in part, indicative of the excess creation of money over the past decade. Thus, the argument goes, gold has been a good indicator of inflation, just not consumer price inflation. (At least not yet, anyways.) Maybe I'm wrong, I don't know, but I think this explains a lot of what has happened in the economy over the past 15-20 years.

Also, I seriously don't get why those of the Austrian persuasion don't understand this. Even under no central bank, under strictly free banking, the supply of money increases endogenously to offset increases in the demand to hold money. It's absurd that people think it's somehow optimal or natural for the supply of money to be fixed.

I agree. This is why I've argued with the gold bugs against the gold standard. The retort from the more thoughtful gold bugs paraphrases Churchill in that gold is the worst form of money, except for all the others. We've essentially had a completely free fiat money system for 40 years now. Some would say its worked pretty well. Others would say, "Yes, but communism 'worked' for nearly 70 years in the USSR before it collapsed under its inevitable logical contradictions." I have much more sympathy for this argument.

Or, perhaps a better analogy is Nassim Taleb's "Turkey Problem."

The Turkey Problem | Stephen Kinsella

This is a great point and one I neglected to consider...the asset markets. You can have stable CPI and other price inflation indicators, and still have inflated asset prices as a result of excess money creation. The excess liquidity sitting in bank reserves, while perhaps not being multiplied via lending, can be put to work in the asset markets which can and does lead to bubbles.

This is why I think the best way to describe inflation is an increase in the money supply.

How is it that asset prices are increasing but not the prices of consumption/investment goods? The only way that happens is if one agent who is holding money rather than spending it buys an asset from another person whose intention is just to whole the money as liquidity and not to spend it. If asset prices are increasing in this way, so the fuck what? That's having no real effect on economic activity. What matters is if somebody buys an asset, the proceeds of which then get used to purchase consumption/investment goods (raising their prices). I mean that's the whole thing with the Austrian school isn't it? The relative price of consumption and investment goods gets distorted leading to resources being mal-distributed. If it's just increasing asset prices without leading to increase goods prices, it doesn't have any real effect.


Looking at the money supply to assess the stance of monetary policy is a mistake because it doesn't account for changes in the desire to hold money. Back in the old days, everybody thought monetary velocity was constant. So Austrians could say that inflation is an increase in the money supply, and monetarists could recommend a constant money growth rule. We know that velocity isn't actually constant, so we have to account for changes in the demand for money. So instead of talking about a rising money supply as easy money, we should be talking about rising nominal spending.

 

[Paulie]

Stop!

The rest of your paragraph reinforces this point, so I've excluded it.

Clearly, you are an intelligent and well-educated individual, schooled in modern economic theory and, I think you are demonstrating an absolutely critical flaw in modern economic thought. I think it's part of the reason why so many conventional economists were unable to identify the stock market bubble of the late 90s and the housing bubble of the mid 00s, and the dangers they wrought.

A rising supply of money does NOT necessarily translate into higher consumer/producer price inflation. It might, or it might not. It depends on the circumstances. It probably (well, almost certainly) does over the long run but it may not over the short and intermediate term. Instead, excess liquidity can flow into asset markets, pushing up asset prices rather than into, say, labour markets. Austrians say that inflation is defined as the excess creation of money, and consumer price inflation is merely an effect of that. But it is not the only effect, and can manifest itself in other ways. Thus, the rising price of gold is, in part, indicative of the excess creation of money over the past decade. Thus, the argument goes, gold has been a good indicator of inflation, just not consumer price inflation. (At least not yet, anyways.) Maybe I'm wrong, I don't know, but I think this explains a lot of what has happened in the economy over the past 15-20 years.



I agree. This is why I've argued with the gold bugs against the gold standard. The retort from the more thoughtful gold bugs paraphrases Churchill in that gold is the worst form of money, except for all the others. We've essentially had a completely free fiat money system for 40 years now. Some would say its worked pretty well. Others would say, "Yes, but communism 'worked' for nearly 70 years in the USSR before it collapsed under its inevitable logical contradictions." I have much more sympathy for this argument.

Or, perhaps a better analogy is Nassim Taleb's "Turkey Problem."

The Turkey Problem | Stephen Kinsella

This is a great point and one I neglected to consider...the asset markets. You can have stable CPI and other price inflation indicators, and still have inflated asset prices as a result of excess money creation. The excess liquidity sitting in bank reserves, while perhaps not being multiplied via lending, can be put to work in the asset markets which can and does lead to bubbles.

This is why I think the best way to describe inflation is an increase in the money supply.

How is it that asset prices are increasing but not the prices of consumption/investment goods? The only way that happens is if one agent who is holding money rather than spending it buys an asset from another person whose intention is just to whole the money as liquidity and not to spend it. If asset prices are increasing in this way, so the fuck what? That's having no real effect on economic activity. What matters is if somebody buys an asset, the proceeds of which then get used to purchase consumption/investment goods (raising their prices). I mean that's the whole thing with the Austrian school isn't it? The relative price of consumption and investment goods gets distorted leading to resources being mal-distributed. If it's just increasing asset prices without leading to increase goods prices, it doesn't have any real effect.


Looking at the money supply to assess the stance of monetary policy is a mistake because it doesn't account for changes in the desire to hold money. Back in the old days, everybody thought monetary velocity was constant. So Austrians could say that inflation is an increase in the money supply, and monetarists could recommend a constant money growth rule. We know that velocity isn't actually constant, so we have to account for changes in the demand for money. So instead of talking about a rising money supply as easy money, we should be talking about rising nominal spending.

Asset price increases in this case precede consumer goods price increases. But how do we get to the consumer price inflation if the asset bubble bursts before that happens? You're ignoring the housing bubble situation. Housing and related investment products almost led to the systemic failure of the entire global economy. The deflationary collapse that ensued would nullify any trailing consumer price increases, and then it's wash, rinse, repeat, with Fed monetary policy. The Fed seems to think reflating the economy is good, and that an asset bubble or bubbles is just a consequence worth enduring. The problem with that is bubbles don't inflate forever.

That cash runs to gold in this monetary environment is really not hard to understand. But USD will also run to stronger currencies as well. Any of these moves is a hedge against inflation, or the devaluation of the currency if that's how you'd prefer to look at it.

 

[DSGE]

Except it's not fiat money that hasn't been working well, it's central bank discretion.

Why do you think that is? Why is it that the supposed most genius economic minds of our time seem to keep getting it wrong,

Maybe the Fed isn't as insulated as we like to think and they actually do face political pressures? Maybe there are perverse incentives we're unaware of? Maybe the power goes to their head? I don't know, and I don't care. Forget about analysing why discretion doesn't work, just take away their damn discretion! Then it becomes a moot point.

We may disagree on what rules to constrain them with [though I think I could get you to come around to my side (hint: my side is that as long as it's a given that there is a central bank, they should aim to achieve what would otherwise happen in a free market: the stabilisation of nominal spending)], but I think we both agree that they need to have strict operating rules and accountability if they're going to exist at all.

while the supposed economic kooks of the world seem to be getting it right? ... i.e., the Austrians who foresaw the stock market and housing bubbles.

I'm gonna let that one slide.

 

[Paulie]

Except it's not fiat money that hasn't been working well, it's central bank discretion.

Why do you think that is? Why is it that the supposed most genius economic minds of our time seem to keep getting it wrong,

Maybe the Fed isn't as insulated as we like to think and they actually do face political pressures? Maybe there are perverse incentives we're unaware of? Maybe the power goes to their head? I don't know, and I don't care. Forget about analysing why discretion doesn't work, just take away their damn discretion! Then it becomes a moot point.

We may disagree on what rules to constrain them with [though I think I could get you to come around to my side (hint: my side is that as long as it's a given that there is a central bank, they should aim to achieve what would otherwise happen in a free market: the stabilisation of nominal spending)], but I think we both agree that they need to have strict operating rules and accountability if they're going to exist at all.

while the supposed economic kooks of the world seem to be getting it right? ... i.e., the Austrians who foresaw the stock market and housing bubbles.

I'm gonna let that one slide.

Fair enough on your first part, but why "let it slide"? Are you suggesting the Austrians didn't warn of the housing bubble while even Greenspan (a supposed somewhat advocate of the Austrian school) was off in lala land?

 

[DSGE]

This is a great point and one I neglected to consider...the asset markets. You can have stable CPI and other price inflation indicators, and still have inflated asset prices as a result of excess money creation. The excess liquidity sitting in bank reserves, while perhaps not being multiplied via lending, can be put to work in the asset markets which can and does lead to bubbles.

This is why I think the best way to describe inflation is an increase in the money supply.

How is it that asset prices are increasing but not the prices of consumption/investment goods? The only way that happens is if one agent who is holding money rather than spending it buys an asset from another person whose intention is just to whole the money as liquidity and not to spend it. If asset prices are increasing in this way, so the fuck what? That's having no real effect on economic activity. What matters is if somebody buys an asset, the proceeds of which then get used to purchase consumption/investment goods (raising their prices). I mean that's the whole thing with the Austrian school isn't it? The relative price of consumption and investment goods gets distorted leading to resources being mal-distributed. If it's just increasing asset prices without leading to increase goods prices, it doesn't have any real effect.


Looking at the money supply to assess the stance of monetary policy is a mistake because it doesn't account for changes in the desire to hold money. Back in the old days, everybody thought monetary velocity was constant. So Austrians could say that inflation is an increase in the money supply, and monetarists could recommend a constant money growth rule. We know that velocity isn't actually constant, so we have to account for changes in the demand for money. So instead of talking about a rising money supply as easy money, we should be talking about rising nominal spending.

Asset price increases in this case precede consumer goods price increases. But how do we get to the consumer price inflation if the asset bubble bursts before that happens?

I don't understand what this is saying.

You're ignoring the housing bubble situation. Housing and related investment products almost led to the systemic failure of the entire global economy. The deflationary collapse that ensued would nullify any trailing consumer price increases, and then it's wash, rinse, repeat, with Fed monetary policy.

With the housing bubble situation, taking as given that I buy this story (which I don't), the Fed's easy money is channelled into raising the price of houses. There we go. The price of houses go up, the price of building material goes up, the price of construction labour goes up. It's not just "inflated asset prices". The prices of real goods and services are being affected by the loose money. So the housing bubble is not an example of asset prices being inflated without any effect on the price of goods.

The Fed seems to think reflating the economy is good, and that an asset bubble or bubbles is just a consequence worth enduring. The problem with that is bubbles don't inflate forever.

Serious misunderstanding of monetary policy there. Have you really taken the time to learn what the Fed thinks? Or are you just guessing what they think based on your biases?

 

[DSGE]

Why do you think that is? Why is it that the supposed most genius economic minds of our time seem to keep getting it wrong,

Maybe the Fed isn't as insulated as we like to think and they actually do face political pressures? Maybe there are perverse incentives we're unaware of? Maybe the power goes to their head? I don't know, and I don't care. Forget about analysing why discretion doesn't work, just take away their damn discretion! Then it becomes a moot point.

We may disagree on what rules to constrain them with [though I think I could get you to come around to my side (hint: my side is that as long as it's a given that there is a central bank, they should aim to achieve what would otherwise happen in a free market: the stabilisation of nominal spending)], but I think we both agree that they need to have strict operating rules and accountability if they're going to exist at all.

while the supposed economic kooks of the world seem to be getting it right? ... i.e., the Austrians who foresaw the stock market and housing bubbles.

I'm gonna let that one slide.

Fair enough on your first part, but why "let it slide"? Are you suggesting the Austrians didn't warn of the housing bubble while even Greenspan (a supposed somewhat advocate of the Austrian school) was off in lala land?

I think when it comes to bubbles the Austrians are a stopped clock. I also think there's a pretty big case of confirmation bias (they're not held accountable for their incorrect predictions of doom and gloom). The fact of the matter is, bubbles are only noticed after the fact. Great, they looked at a case-shiller home price index chart and noticed it got crazy. The same happened in Australia, no collapse of home prices here though (which you kind of think would have happened the same time it was happening to everyone else). Funny how they can't take the same method and apply it to gold prices though. And how many of the "predictions" were at least somewhat specific? "Hey guys, these MBSs and CDOs are kind of fucked up. Might want to watch out for those". I didn't hear any of that. Only "the Fed is kept interest rates too low for too long, the price of housing is quite a bit higher than its historical trend, housing bubble!". Honestly, I'd rather ask John Edwards for investment advice (the psychic, not the senator).

 

[TakeAStepBack]

Yeah, no. That is not how the predictions happened. Austrian scholars had the housing bubble pegged in 2002. The only thing they did not predict to the T, and never do, is the timing of the burst.

 

[DSGE]

Yeah, no. That is not how the predictions happened. Austrian scholars had the housing bubble pegged in 2002. The only thing they did not predict to the T, and never do, is the timing of the burst.

Oh, my mistake. So you can link me up to "Austrian scholars" talking about the crucial importance of securitization, weird asset backed securities, agency problems and leverage in the development of the soon-to-be housing bubble? Because seriously, all I've heard is "low interest rates + high house prices => housing bubble"

 

[Paulie]

Yeah, no. That is not how the predictions happened. Austrian scholars had the housing bubble pegged in 2002. The only thing they did not predict to the T, and never do, is the timing of the burst.

Oh, my mistake. So you can link me up to "Austrian scholars" talking about the crucial importance of securitization, weird asset backed securities, agency problems and leverage in the development of the soon-to-be housing bubble? Because seriously, all I've heard is "low interest rates + high house prices => housing bubble"

Why does it really matter at the end of the day what specifics they warned about? It's a chicken/egg scenario. Absent artificially low interest rates...basically a dangling carrot in front of the faces of the masses...would there have been such extreme malinvestment in housing?

Something has to kick a bubble off...it doesn't just start because people all think it would be real awesome and neato to chase housing now that the stock chase was over. The smart money saw a huge opportunity to grab home loans for cheap, and then eventually the stupid money followed suit...this is expected human behavior, herd mentality, whatever you want to call it. Housing has been around for centuries. The bubble doesn't just happen in a vacuum. The initial motivation has to be there, and then as the craze progresses, the smart money progresses into more comprehensive ways to continue profiting from it, i.e. the securities markets.

If you have a better way of explaining the bubble from inception to collapse, I'd love to hear it.

 

[TakeAStepBack]

I'd have to go dig up what i read that far back. The talk of the time was that the federal reserve was creating a climate of moral hazard and malinvestment. Along with the signs of booming credit heading into both residential and commercial real estate. These guys have been getting it right for the last hundred years, right down to Mises qaccurately predicting both the great depression and the federal reserves reactions.

Predictions among Austrian scholars was all over the place at that time (2001-2002) and slowly narrowed in as the burst became obvious to even the most in need of economic remediation.

 

[Paulie]

Isn't the whole point of the Fed targeting such a low interest rate, to spur borrowing and spending? If people aren't borrowing at 6%, and still not at 4%, then perhaps 2% might finally do the trick.

It did.

 

[TakeAStepBack]

Basically, yes. They got the seen out of the action, but as per usual, completely missed the unseen consequence of the actions. The Austrian scholars tend to search for, pin point and develop the understanding of the unseen. They've got it down pretty good.

Also, not all Austrian scholars agree on a gold standard. Some advocate for free banking, some for specie money, etc..the one thing they agree on is that gold is not an investment, gold is not a commodity. Gold is money par excellence as it has been for over 5,000 years.

 

[DSGE]

Yeah, no. That is not how the predictions happened. Austrian scholars had the housing bubble pegged in 2002. The only thing they did not predict to the T, and never do, is the timing of the burst.

Oh, my mistake. So you can link me up to "Austrian scholars" talking about the crucial importance of securitization, weird asset backed securities, agency problems and leverage in the development of the soon-to-be housing bubble? Because seriously, all I've heard is "low interest rates + high house prices => housing bubble"

Why does it really matter at the end of the day what specifics they warned about? It's a chicken/egg scenario. Absent artificially low interest rates...basically a dangling carrot in front of the faces of the masses...would there have been such extreme malinvestment in housing?

Something has to kick a bubble off...it doesn't just start because people all think it would be real awesome and neato to chase housing now that the stock chase was over. The smart money saw a huge opportunity to grab home loans for cheap, and then eventually the stupid money followed suit...this is expected human behavior, herd mentality, whatever you want to call it. Housing has been around for centuries. The bubble doesn't just happen in a vacuum. The initial motivation has to be there, and then as the craze progresses, the smart money progresses into more comprehensive ways to continue profiting from it, i.e. the securities markets.

First thing's first, "artifically low interest rates". How do you gauge whether interest rates are "artificially low" or whether they reflect the "natural rate of interest"? Do you assume that the "natural rate" is constant for no reason, or that it's somehow impossible that it could fall to 1% (or lower)? I'd really like to know how an Austrian assesses the tightness/loosness of monetary policy.

If you have a better way of explaining the bubble from inception to collapse, I'd love to hear it.

We came up with some cool securities which helped spread risk awesomely when the price of the underlying asset was non-decreasing. These assets got rated default-risk free but paid a premium as if they were risky. There was a change in relative demand towards these assets because a) they paid a higher return for the same perceived amount of risk, b) their AAA rating meant you could become highly leveraged on them. Mortgage originators kept lowering their lending standards so that they could spit out more of these wicked assets. When housing prices eventually declined all these assets went to shit. But by that time they were systemic. The fall in housing prices couldn't be mitigated the usual way, by an increase in the demand and supply of mortgage credit, since the mechanism through which that happened was now fucked beyond belief. So home prices just totally tanked.

 

[DSGE]

Isn't the whole point of the Fed targeting such a low interest rate, to spur borrowing and spending? If people aren't borrowing at 6%, and still not at 4%, then perhaps 2% might finally do the trick.

It did.

No. The Fed tries to target 2% PCE inflation. That effectively has them trying to target the unobservable "natural rate of interest".

 

[DSGE]

I'd have to go dig up what i read that far back. The talk of the time was that the federal reserve was creating a climate of moral hazard and malinvestment. Along with the signs of booming credit heading into both residential and commercial real estate. These guys have been getting it right for the last hundred years, right down to Mises qaccurately predicting both the great depression and the federal reserves reactions.

Predictions among Austrian scholars was all over the place at that time (2001-2002) and slowly narrowed in as the burst became obvious to even the most in need of economic remediation.

Sources are always welcome.

 

[DSGE]

Also, not all Austrian scholars agree on a gold standard. Some advocate for free banking, some for specie money, etc

Free banking is the correct one.

..the one thing they agree on is that gold is not an investment, gold is not a commodity. Gold is money par excellence as it has been for over 5,000 years.

Well that's super dumb. Crazy super dumb. Gold is not remotely money. T-bills are closer to being money than gold. Gold used to be a medium of exchange. It's not any more. Austrians need to deal with it.

 

[Paulie]

Isn't the whole point of the Fed targeting such a low interest rate, to spur borrowing and spending? If people aren't borrowing at 6%, and still not at 4%, then perhaps 2% might finally do the trick.

It did.

No. The Fed tries to target 2% PCE inflation. That effectively has them trying to target the unobservable "natural rate of interest".

Yes, we all know the Fed is tasked with keeping prices stable and employment full, but lowering the fed funds rate to 2% and increasing bank reserves is to get money moving again. The inflation rate isn't going to rise to their target if people aren't borrowing and spending, right? Like you said, otherwise it would just sit there and may as well not even exist. So of COURSE the Fed intends to get to a rate of interest that will entice people to borrow.

When real estate loans become that cheap, is it really incredible that cash flocked to it?

Where would all the systemic meltdown of the mortgage securities market have come from, absent this rush to real estate?

 

[DSGE]

Isn't the whole point of the Fed targeting such a low interest rate, to spur borrowing and spending? If people aren't borrowing at 6%, and still not at 4%, then perhaps 2% might finally do the trick.

It did.

No. The Fed tries to target 2% PCE inflation. That effectively has them trying to target the unobservable "natural rate of interest".

Yes, we all know the Fed is tasked with keeping prices stable and employment full, but lowering the fed funds rate to 2% and increasing bank reserves is to get money moving again. The inflation rate isn't going to rise to their target if people aren't borrowing and spending, right? Like you said, otherwise it would just sit there and may as well not even exist. So of COURSE the Fed intends to get to a rate of interest that will entice people to borrow.

Right, but that happens anyway. The "natural rate of interest" moves to equilibrate the demand for loanable funds with the supply of loanable funds. I'm saying, don't automatically equate 1% interest rates with "artificially low". It's entirely possible that the "natural rate" has moved that low because of changes in investment demand/savings preference. So in your model, how do you tell if the interest rate is "artificially" low or "naturally" low?

When real estate loans become that cheap, is it really incredible that cash flocked to it?

Where would all the systemic meltdown of the mortgage securities market have come from, absent this rush to real estate?

There was a rush to real estate, obviously. I'm just saying it's from a different source. You're saying it's from artificially created credit. I'm saying it's from natural credit due to the perceived return on housing now being much higher.