Thursday, November 15, 2007 45 Comments

Who the heck is Benn Steil?

Readers ask: who the heck is Benn Steil? And why should I care?

Actually, everyone should care who Benn Steil is. At least, everyone who has more than a couple hundred bucks in the bank.

Benn Steil is this person. He is also the author of this article. And if you prefer the dulcet tones of his gentle yet masculine voice, you can listen to him here. I don't mean to sound like a conspiracy theorist, but when the CFR and Ron Paul are singing the same tune, you can be pretty sure the fat lady is at least in the building.

Most importantly, Benn Steil is singing. Which means he's not quacking.

The 20th century was the century of quack everything. Perhaps most infamous was the great Soviet quack-geneticist, Trofim Lysenko. But quackery in its Eastern edition was crude and unsubtle. Its associations with brute force were impossible to conceal, and it seldom lasted long when that force was removed.

No, the postwar Western university is our true Valhalla of quack. Quackologists will be studying this system for decades, and they will certainly not get bored. The sad fact is that almost everything studied and taught in Western universities today is quackery. The only exceptions are some areas of science and engineering. For example, I'm pretty sure that chemistry and biochemistry are generally quack-free. However, if Lee Smolin and Peter Woit are right (and Luboš Motl is wrong), we are beset even by quack physics.

We certainly have quack poetry, quack computer science, and quack history. "Journalism," for example, is quack history at its finest. And figures such as Freud, Rothko, Mann (read the whole thread, or at least to the "Piltdown Mann" bit), Mead, and Ashbery will have to appear on any list of history's great quacks. Their achievements may be surpassed, but how can they ever be forgotten?

And then there's economics.

Pretty much everyone thinks of 20th-century economics as a seething nest of quackery. Including most 20th-century economists. All they disagree on is who the quacks are.

It is incontrovertible that quack economics is alive and well in the world today. It is possible that the Austrian, Chicago, George Mason, New Keynesian, and "post-autistic" schools of economics are all quack. It is certainly not possible that they are all nonquack.

So how can you tell the difference between a real economist and a quack economist? I'm afraid a bit more than $64,000 is riding on this question.

Here is my answer. Please feel free to refute it in the comments section. I have an open mind, but it tends to close after a while when it doesn't hear any good arguments.

My test is that a real economist is an economist who believes that any quantity of money is adequate. A quack economist is an economist who believes that increasing prosperity - or even continuing prosperity - demands a continuously increasing quantity of money.

There is a word which means "an increasing quantity of money." The word starts with an I. However, in the 20th century this word started to be used in a new way, meaning "an aggregate increase in prices." While the two phenomena are certainly related, using the same label for both doesn't strike me as the ideal way to elucidate the relationship. And when you realize that the new meaning largely dominates in modern English usage, leaving no word at all for the old meaning, the needle on your quack detector may start to 'pop' a little.

For this reason, I prefer to borrow a term from a slightly different department of finance, and describe an increasing quantity of money as dilution. If there is any ambiguity, one can eliminate it by speaking of monetary dilution.

(As for an aggregate increase in prices, the obvious word is appreciation, which can be further categorized as asset price appreciation and consumer price appreciation. The general use of the I-word in newspapers today is the latter. No precise or objective distinction between "assets" and "consumer goods" can be constructed, of course, but the same can be said for the index baskets generally used to "measure" consumer price appreciation. Any number produced by a subjective index is fudge - it may still be useful, but it is useful only to the eye. Anyone who plugs any subjective number into any mathematical formula or model is a quack, period. But I digress.)

So we can reframe our quack detector by declaring that there are two kinds of economists: those who believe that monetary dilution is essential, and those who believe it is inessential. Not only is this a boolean distinction, it is a very sharply polarized one - as we'll see. In short, the conditions for a great quack hunt can only be described as ideal.

Our razor is as simple as could be. Dilutionists are quacks. Nondilutionists are nonquacks - unless of course they are peddling some other brand of quackery.

There is no ambiguity at all. This test applies to any economist, or supposed economist, past or present, professional or amateur. If the voters of a democratic nation are infected with quack economics, their government will hire quack economists who peddle quack prescriptions. As Miguel Ferrer put it in RoboCop, that's life in the big city.

For example, one common belief among amateur dilutionists is that if the economy of some country "grows" (another fudge factor) by 3% a year, its currency should also be diluted at 3% a year. Any professional economist, quack or nonquack, knows that this makes no sense at all. No serious economist believes it in the exact numerical form stated above. However, it's a common belief among the general public, and dilutionists seldom seem to disabuse them of it.

Why is dilutionism quackery? This is actually quite easy to see.

Modern currencies, such as the dollar, are fiat currencies. In principle, there is nothing at all wrong with a fiat currency. There is no valid economic objection to paper money, and there is no economic connection between dilutionism and fiat currency. In principle, it is perfectly easy to imagine a fiat currency system with a fixed quantity of currency.

Whatever your monetary system, money is a good like any other. It is not a "measure of value" or a "claim on wealth." It is a commodity, whether virtual, paper, or metallic. (The reasons that people are willing to exchange so many nice things for money, and the reasons they choose one form of money over another, are complex - we'll save them for another day.)

What makes money money, however, is that most or all people who hold money hold it not in order to use it directly, but in order to exchange it for other goods. True, you can write a phone number on a twenty-dollar bill, and you can melt down a Krugerrand and make it into a gold cokespoon. But neither of these uses are relevant to 99.999% of the people who hold twenties or Krugerrands.

In other words, when most people make decisions about money, they are concerned with the exchange rates between money and other goods - ie, the prices of nonmonetary goods in money. Any change in their money that does not affect the quantity of goods they can obtain in exchange for the quantity of money they own will not affect their behavior.

Therefore, monetary systems can be redenominated neutrally, by rescaling a currency so as to affect all moneyholders in exactly the same way.

For example, Turkey recently stripped six zeroes from its currency. Each million old Turkish lira was converted to one new Turkish lira. All contracts denominated in old Turkish lira were rewritten in new lira. And so on. This did not amount to a 99.9999% wealth tax. It did not change the behavior of Turks, or anyone else, in any nontrivial way. Similarly, if Turkey had doubled its currency, so that every million old lira was now 2 million new lira, there would have been no nontrivial effect.

On the other hand, if Turkey had converted every million old lira into one new lira, except for lira held by Armenians, who received half a new lira, the effect would have been a tax on Armenians. If it had doubled its currency, but not doubled debts to Armenians, so that your million old lira became 2 million new lira, but if you owed 1 million old lira to an Armenian, you still owed 1 million new lira, the effect would have been a partial repudiation of debts owed to Armenians. And so on.

There is no distinction between monetary dilution and redenomination. If you dilute a monetary supply by 10%, you are exchanging 1 million old lira for 1.1 million new lira, whether or not you choose to think of it this way.

However, the type of monetary dilution that we think of when we use the "I" word is never, ever a neutral redenomination. There are many ways of creating new money - counterfeiting in a fiat currency system, gold mining under a gold standard, etc. None of them distribute an equal share of the new money across every unit of the old money. None of them rewrite contracts or debts. If they did, they would be neutral, and no one would bother.

One easy way to see this clearly is to imagine a monetary system in which money is measured in fractions of the outstanding money supply. Instead of a number like $1000, your bank statement would have a number like "one billionth," meaning that you owned a billionth of all the dollars in the world.

Redenomination in this kind of fractional monetary system is so trivial that the operation does not even exist. Moreover, we can redefine any monetary system in these fractional terms - as long as we can define the quantity of currency in the system. It is just a matter of changing our accounting convention.

So what would nonneutral dilution look like under fractional accounting? The answer is simple - it looks like redistribution. When you dilute lira owned by Armenians but not lira owned by Turks, the result is precisely the same as taking lira from Armenians and giving it to Turks.

Every nonneutral dilution can be defined as the combination of a neutral redenomination and a nonneutral redistribution.

And this is why dilutionists are quacks. Dilutionists are quacks because it is impossible to imagine a way in which the systematic pilfering of wallets could somehow be essential to commerce and industry.

We can categorize monetary systems as closed-loop (no new money is created) or open-loop (new money is created). Even the gold standard is an open-loop financial system, because new gold can be discovered and mined. 19th-century gold discoveries in Australia, California and Canada had substantial global monetary effects. But at least Mother Earth is in control of this particular loop.

Obviously, fiat currencies are all at least potentially open-loop. Typically the State, by persecuting all counterfeiters other than itself, controls the loop. For example, the most naive form of dilution is simply for the government to print money and spend it.

This is not how dilution works in most Western countries today. Rather, modern governments use their fiat currencies to issue perfect loan guarantees. For just one example, a conventional bank "deposit" in the US is actually a zero-maturity loan from you to your bank. This loan is nominally "insured" by a "corporation" called the FDIC, but this risk is not an insurable risk, nor does the FDIC store the slightest fraction of the funds it would need to make its guarantee 100% reliable. However, the guarantee is indeed 100% reliable, because the FDIC is ultimately backed by the US's power to create as many dollars as it wants, and the US has every political incentive to exercise this power.

(Another way to understand dilution via loan guarantee is to realize that the US's power to define a piece of paper as a "dollar" is no different from its ability to define a slice of your checking account as a "dollar." The US can fix the price of any good relative to its own fiat. If Congress wants to declare that every Honus Wagner baseball card has a face value of one billion dollars, it has all the power it needs to do so. But again, I digress.)

Why would anyone ever believe in dilution? Well, there is a very straightforward way to use dilution to create apparent prosperity: use it to redistribute money from people who are saving money, to people who are spending it. While typically the savers and the spenders are not the same people, if you can imagine a government program that would force anyone with a large nest egg to spend it all this year, you can certainly imagine the resulting boom.

Again, however, we see that dilution can accomplish no objective which cannot also be accomplished by redistribution. And what is the advantage of dilution over redistribution? Simply that dilution is easier to hide, and harder to resist. In other words, we will expect to see a state choose dilution over redistribution when that state is either deceptive or weak. Or, of course, both.

And there is an even more troubling fact.

The fact is that all famous 20th-century economists - Fisher, Keynes, Friedman, Samuelson, Galbraith, etc, etc - and 99.9% of working economists today are dilutionists. In other words, they believe that a closed-loop monetary system, or even a nearly-closed system such as the gold standard, is impractical or at least suboptimal.

We can even link to bloggers. Cowen and Tabarrok: dilutionists. Kling and Caplan: dilutionists. McArdle: dilutionist. Mankiw: dilutionist. Levitt: dilutionist. DeLong: major dilutionist. Und so weiter. Pretty much your only nondilutionists are to be found in the Austrian School, and even there you need to be careful.

Therefore, we are left with the conclusion that either (a) the above analysis is in some way wrong, or (b) 20th-century economics was dominated by quacks, and mostly remains so.

It's not at all clear why (b) should even start to be surprising. Didn't we already know that the 20th century was the era of quack economics? What was the Soviet Union but a giant outdoor experiment in economic quackery?

I say "20th century" because we observe an interesting fact: when we scroll back in time, we see that dilutionism makes itself quite scarce.

Madison wrote in Federalist 10 of "a rage for paper money, for an abolition of debts, for an equal division of property, or for any other improper or wicked project." Burke is even more colorful:
When all the frauds, impostures, violences, rapines, burnings, murders, confiscations, compulsory paper currencies, and every description of tyranny and cruelty employed to bring about and to uphold this Revolution have their natural effect, that is, to shock the moral sentiments of all virtuous and sober minds...
Ben Franklin was the leading colonial enthusiast of open-loop finance, a perspective not at all inconsistent with his general harebrainedness. The fate of the Continental dollar, not to mention the French assignat, did a reasonably good job of discrediting dilutionism. Even Lincoln's greenbacks were formally limited in supply, and after the war this limit held.

In general, anyone who openly proposed outright dilutionism in the 19th century was treated as a monetary crank - much as Ron Paul is now for his espousal of the gold standard. (Frum's arguments, if you can call them that, are quite typical of the canon. At least he's in good company - not just with the 20th century's top economists, but also one of its great poets.)

But even the classical gold standard of the 19th century was quite diluted. The 19th-century banking system never had anything like enough gold to redeem all current claims in metal. Frequent panics and cycles were the result, culminating in the events of the early 1930s, in which a worldwide rush for redemption eliminated the last vestiges of closed-loop finance.

To find what Austrian economists call a "100%-reserve" monetary system, you have to look in more obscure corners of history - such as the Amsterdamsche Wisselbank. Or, as Condy Raguet claimed in 1840, Gibraltar:
Such being the theory of this branch of my subject, I have the satisfaction to state in regard to the practice under it, upon the testimony of a respectable American merchant, who resided and carried on extensive operations for near twenty years at Gibraltar, where there has never been any but a metallic currency, that he never knew during that whole period, such a thing as a general pressure for money. He has known individuals fail from incautious speculation, or indiscreet advances, or expensive living; but he never saw a time that money was not readily obtainable, at the ordinary rate of interest, by any merchant in good credit. He assured me, that no such thing as a general rise or fall in the prices of commodities, or property was known there; and that so satisfied were the inhabitants of the advantages they enjoyed from a metallic currency, although attended by the inconvenience of keeping in iron chests, and of counting large sums in Spanish dollars and doubloons, that several attempts to establish a bank there were put down almost by common consent.
I'm not sure on the details, but I'm afraid there are banks in Gibraltar now. However, if you prefer to store your portfolio in doubloons, there is always Jersey. Yes - in fact, this is exactly what Benn Steil is talking about.

See also Sebastian Mallaby, in Monday's Washington Post. Again, the CFR rears its ugly head.

Basically, what we're looking at here is the harsh but necessary process of waking up from the last century. There is a reason that quackery, in economics and poetry and nutrition and painting and history and psychology and paleoclimatology and computer science and just about any other department you can name, did so well in the 20th-century university system. Reality knows no master, but quackery is useful. Sometimes it's even profitable.

And will we end up back on the gold standard? Possibly. I really have no idea.

As Lech Walesa used to say, it's easy to turn an aquarium into fish soup. It's a lot harder to turn fish soup into an aquarium. Likewise, it's easy to go from a closed-loop currency to an open-loop currency. Going back, on the other hand...

In the '80s and '90s, governments found it not all that hard to reverse quack central planning. Often the corporations nationalized in the '30s through the '60s were even structurally intact, and could just be resold. Reprivatizing the monetary system is a completely different level of difficulty. It involves revising not just decades, but centuries, of Western financial practice.

Worse, any transition to a fully backed gold standard implies a preposterous discontinuity in the gold price. If such a transition is officially planned, it would demand a level of secrecy and coordinated execution that would make the CFR look like MySpace. If it happens spontaneously in the market, as Steil suggests - the mind boggles. I can imagine how this could happen on a purely economic level. I can't imagine how it would interact with politics.

But history is out there. It has not been repealed. The present is not permanent. In fact, to the future, it may look pretty strange.

[BTW: I know I promised to wrap up the Dawkins series this week. However, on further reflection, I feel it may actually need to be not ended, but extended. Hopefully this week's posts have provided UR readers with a wider window on the alternate reality around us.]


Blogger Alan said...

First, I'm not exactly sure how you posted that at 9 am, considering it is now 5:48 am on the eastern seaboard.


November 15, 2007 at 2:48 AM  
Anonymous Prakash said...


Have you read about mutual credit systems? Those systems have a distinction between the possibility of money creation and the actual money created. Everyone in the monetary system has a creditbook which begins at zero and can go down upto the average monthly income, say Rs. A. Everytime you sell a product or a service, the balance in your book goes up and the balance in the buyer's book comes down. The theoritical limit of money creation in this system is (n-1)*A. n is the number of people in the system. The theoritical limit is approached when everyone has exhausted their credit buying from one person. But in reality that limit is never reached because even that fellow (the great seller)has needs. He/She will also buy goods and services from someone else for himself.

The real money creation in such a system will be the sum of all positive balances, which is also the sum of all negative balances. But most people will consume as much as they provide and their balances will tend to be near zero.

Such a system can be made either closed or open. In a closed system, the initial setup will be the only time that creditbooks will be issued and credit books will have to be transferable. In an open system, every person who will be allowed into the mutual credit union will be given a creditbook.

So, money need not be in the strict confines you mention. If there is a flaw in the above, please point it out.

November 15, 2007 at 4:24 AM  
Blogger Jewish Atheist said...

The fact is that all famous 20th-century economists - Fisher, Keynes, Friedman, Samuelson, Galbraith, etc, etc - and 99.9% of working economists today are dilutionists.

If that's the case, can you explain to those of us who don't know much about economics the following:

* How do you know dilutionism is quackery?

* Why don't all those supposed experts know it?

* If dilutionism is quackery, how, precisely, would we be better off today if we had never switched to fiat currency? Is the negative effects something that haven't happened yet, but you believe is imminent or inevitable? Is there a way to test this hypothesis?

In general, what is your methodology for deciding that you are correct when the overwhelming majority of "experts" disagrees with you? I don't mean this derisively; I'm genuinely curious. Are you convinced that you are less biased? More knowledgeable? Just plain smarter? Do you have advice for those of us who are neither as smart nor as knowledgeable as you or the experts? What criteria should we use in deciding who to believe?

November 15, 2007 at 7:33 AM  
Anonymous Randy said...

It seems to me that the problem is matching the supply of money to the supply of wealth.

Let's take for example an acre of farmland in Iowa. Modern farmers bring in a considerably higher yield than did the farmers of just a few decades ago. Should this acre of land be valued precisely as it was valued when it was first cleared? I'd say not. Our increase in farming knowledge has increased our supply of wealth, and the increase in the supply of wealth should be matched by an increase in the supply of money. I would, however, agree that an increase in the supply of money beyond the increase in the supply of wealth would be dilution.

November 15, 2007 at 8:45 AM  
Blogger Dan Weber said...

For example, one common belief among amateur dilutionists is that if the economy of some country "grows" (another fudge factor) by 3% a year, its currency should also be diluted at 3% a year.

Okay, as useful as I find your re-defintion of words, it can get confusing at times like this. Maybe I'm just an amateur.

If the United States grows its economy by 3%, and we want dollars to maintain a constant value, why would we not want 3% more dollars to exist next year?

I can see the value in there being only, say, a trillion dollars, ever, and we have to fight for them. But that doesn't say why a constant-value dollar is bad, in and of itself. (I won't deny that government can abuse a fiat system, but that's wasn't the point in the quote.)

November 15, 2007 at 9:14 AM  
Blogger George Weinberg said...

I guess it's time to post this.

November 15, 2007 at 9:39 AM  
Anonymous z-anon said...

I'm curious in what sense you believe Milton Friedman, and others of the Chicago School, think that dilution is necessary or useful? Chicago School economics very clearly sees dilution as being a transfer of wealth from savings to consumption -- which is precisely what you point out in your post -- and it thinks it's a bad thing.

The standard reason why they allow a small amount of inflation to be acceptable is because nominal wages are sticky downward -- it's very difficult to make someone take a paycut -- so you keep their nominal wage growth below inflation and cut their wages that way.

There are good reasons why you would want (or need) to give someone a wage cut. There are good reasons why this will be resisted. Nonetheless, given that price stickiness is assymmetric up and down, you can see why dilution would be a good mechanism to speed up price discovery in a market.


November 15, 2007 at 10:20 AM  
Anonymous randy said...


Good article. It seems to me that the primary purpose of money is to reduce transaction costs. Wealth existed before money. Money was created to make transfers of wealth more efficient. So while I do see many potential problems with how money is created (theft by fiat), I don't have any problem with the fact that money is created.

November 15, 2007 at 10:57 AM  
Anonymous Anonymous said...

dan weber: "If the United States grows its economy by 3%, and we want dollars to maintain a constant value, why would we not want 3% more dollars to exist next year?"

That's perfectly clear thinking. It's just that the second part needs a closer look. If your dollar buys three times as much food or kilowatt-hours or vacation days, you should be happy if your pay is only cut in half. "Should"!We only want dollars to maintain a constant value out of tradition, and because of the one-way stickiness z-anon lucidly outlined. If it didn't happen consistently, it wouldn't be expected. (Oddly enough, I was first introduced to the whole "cut wages through inflation and the workforce won't mind so much" advice in ... The General Theory by JM Keynes.)

My point is, maybe we need to consider the economics separately from the psychology, and give "all due respect" to each mindset. Ask: "Is it good when the dollar loses value?", the public will say no. Ask: "Do you want to earn fewer dollars per hour?", they'll say no quite a bit louder. Dollars have a consistent enough value that noneconomists often start treating them as commodities; when they learn in Econ 101 that they aren't commodities, their reaction is often bitterness.

The point is that psychology trumps economics sometimes. This may be why people describe gold standard economics as "autistic" - the better your understanding of economics (specifically, monetary policy), the harder it is to understand the public's reaction to price changes.

Inflation and deflation both cause negative emotions for fundamentally non-economic reasons. The public says either (a) "I'm angry because deflation has caused a paycut, which is only offset by dearer currency" or (b) "I'm angry because inflation eroded my pay rise". The autistic/economist says "Your real wages remained the same despite the aggregate price change; your mood should not be affected by something as superficial as a consumer price, as measured in a fiat currency."

Statements like "Your mood should not be affected ..." are quite wise coming from Buddhist sages and quite the opposite coming from social scientists. We have yet to teach the public to focus on real wages instead of money wages. We are even further from the non-economic, normative goal of teaching people to stop expecting the world to give them a living, to stop expecting their real wages to increase if their productivity doesn't, etc. This is all complicated greatly by dim memories of a generation which got increasing real wages pretty consistently ... I suppose the era was roughly 1940-1965. For them the expectation came true even if it wasn't quite realistic.

November 15, 2007 at 11:09 AM  
Blogger Alan said...

Gold and silver would be an actual honest election issue if the educrats weren't profoundly dysfunctional.

November 15, 2007 at 11:26 AM  
Blogger Studd Beefpile said...

Hard currency is probably ideal from an economic perspective, but from a social perspective, inflation helps keep the wheels of society turning. Z-anon is right, people HATE it when their income declines in dollar terms. In the US, a great deal of the proto-progressive Populist's anger was at falling prices, despite the fact that their lives were improving in absolute material terms. The Friedman system is inflationary, but it is at least highly transparent, rational, and predictable. All good formalists ought to prefer it to the current nonsense, if only as the lesser evil.

Second, the gold standard is an absolutely foolish notion. Hard currency and the gold standard are, as MM points out, not the same thing. Hard currency is defensible, a gold standard is merely an outdated historical tool meant to aproximate hard currency, and like all outdated tools it should be discarded.

November 15, 2007 at 11:40 AM  
Blogger Mencius Moldbug said...


Sorry - the post date is meaningless. Blogger lets you set it. Haven't you ever gotten tomorrow's paper in the middle of the night?

November 15, 2007 at 1:57 PM  
Anonymous Michael S. said...

The benefit of the gold standard is that it is not utterly manipulable by politicians, because there is a finite amount of gold in the world (including what is still in the earth's crust). The detriment of the gold standard is that the supply of specie cannot increase in proportion to real increases in the total amount of wealth. And there has been a real increase in wealth, as measured by improvement in the general standard of living. The probably unreachable ideal is a currency that represents a constant unit of purchasing power.

The hazard of the fractional-reserve gold standard as historically administered was that when the gold reserves that backed a circulating currency fell (due perhaps to a transfer from one nation's central bank to another), the amount of currency in circulation also fell, and by a multiple of the amount by which the reserve contracted. This led to periodic liquidity crises like the panics of 1893 and 1907.

The pressure for bimetallism - William Jennings Bryan's pet cause of "free coinage of silver at a ratio of 16 to 1 with gold" - arose from these panics. It was basically a plea for inflation, put in the only terms that a society which expected currency to be backed by a precious metal was willing to accept. The silver content in old U.S. coins is worth the face amount when silver is priced at $1.29 per ounce. The 16:1 ratio between the prices of silver and gold had roughly obtained through most of the 18th and early 19th centuries, but in the late 19th century the Comstock lode was discovered, and silver fell to a market price of perhaps 35 cents per ounce. This makes clear the extent of the inflation that Bryan proposed as a remedy for the evils of the panic of 1893, which he correctly understood was the result of the operation of fractional-reserve central banking based on a gold standard.

It is interesting to note that in the late 19th century, as great a political difference existed between the gold Democrats (exemplified by Grover Cleveland) and the silver Democrats (whose spokesman was Bryan) as did between Denocrats generally and Republicans. Cleveland is a much underappreciated president. Mencken said that he was a good man in a bad job, which seems about right to me.

The torch of the silver Democrats was, in a little-noted way, passed to Franklin Roosevelt early in his presidency, when legislation was passed enabling him to cause silver to be coined freely at 16:1 with gold. He opted not to use this authority, choosing instead to devalue the dollar relative to gold by a lesser amount, and restricting the private ownership of gold. The time is within fairly recent memory when American citizens could not lawfully own gold bullion or coins that were not deemed numismatically collectible.

The key to the successful function of the gold standard appears to me to lie in the skillful administration of central banking. Not only that, but the premises of that central banking practice must be accepted by all of the developed economies in the world. In examining the last period of history in which this was true, roughly speaking a century between the conclusion of the Napoleonic wars and the inception of World War I, the purchasing power of the pound remained remarkably constant. It is noteworthy that during this period, the central banks were privately operated. The Bank of England remained private until the time of Attlee and the United States had J.P.Morgan as its unofficial central banker.

Morgan's command of the knowledge necessary for successful central banking would undoubtedly have put Greenspan's to shame, were there a way to compare the two men. Morgan's mathematical genius is little known or credited today. He was said to figure out his foreign currency arbitrage transactions for the day at the breakfast table before going in to his office. Morgan was educated at Göttingen. It is said that when he let his tutors know he was returning to his father's banking business, they told him he was making a mistake, and should stay, because he had a shot at becoming a professor. To put this in perspective, the leading mathematician at Göttingen at the time was Karl-Friedrich Gauss.

The Great Depression, as Milton Friedman and others demonstrated, was not caused by "market failure" as claimed by Keynes, but by the ineptitude of the central banks after World War I. The Bank of England bears some of the blame for trying to restore the gold standard at the previous valuation of the pound after its wartime inflation. Nonetheless, the Federal Reserve system in the United States was worse, and its response to the crash of 1929 was clumsy and wrongheaded. It may usefully be contrasted with Morgan's handling of the panics of 1893 and 1907.

Central banking may not be able to prevent a panic or crash, but it can and should try to avoid causing one, while its response in the aftermath can make the difference between a brief contraction and a protracted depression like that of the 'thirties.

Of the New Deal we must observe that not only didn't it end or even very much mitigate the Depression, but worsened and lengthened it. Furthermore, the appeal of Keynesianism during this period lay almost entirely in serving to provide an intellectually respectable pretext to do what politicians wanted to do, and were in fact already doing when Keynes's "General Theory" was published in 1936. As analysis, it is hard to imagine anything more perversely wrong, this side of Marxism.

November 15, 2007 at 2:01 PM  
Blogger Alan said...

Regarding the post date, I perhaps should have included a " :) " For some reason I always want to point out these little inconsistencies. Perhaps I'm keeping in practice?

New game: spot the meaningless communication. It's your turn.

Also, it opens it up for people to make fun of me for posting before 6 am, which is good for a laugh as well.

Of note to everyone reading these kinds of things, the Fed has started moving against metals. It raided one of the two gold exchange-traded-funds, shutting it down for alleged fraud, and is similarly moving against domestic metal coin makers, such as the Liberty Dollar I linked to above.

(Google gold ETF)

Michael S.,
I was thinking about some homeostatic currency with a built in feedback mechanism to keep prices constant.
Just in the abstract.

Then I realized that commodity prices don't move in tandem. For instance the price of bread may drop though the floor, relative to milk.

As such, a truly hard non-levitating non-delevitating currency is pretty much a contradiction in terms. The currency will always be inflating or deflating in relation to something.

Since printing money is essentially pilfering, I think deflation is probably the way to go.
Still, the most parsimonious explanation is that inflation and deflation have costs and benefits, different winners and losers. Just pick the one you like better.

But certainly, prosperity itself doesn't depend on inflation, negative correlations to historical gold standards prove nothing.

Oh wait, I thought it was your turn in the spot-the-meaninglessness game.

November 15, 2007 at 2:59 PM  
Blogger Daniel A. Nagy said...

This comment has been removed by the author.

November 16, 2007 at 2:04 AM  
Blogger Daniel A. Nagy said...

I admit to having a bit of a head start, because MM has already told me this argument in private conversation.

Let me refute the argument in a toy economy of three: Alice, Bob and Carol, consuming, respectively, widgets, bidgets and cidgets and producing bidgets, cidgets and widgets. A kilo a day. Production is instantaneous, on demand. All three products are perishable (must be consumed within 24 hours of production and fresh ones taste better).

It is easy to see that in this economy, all demand is met by adequate supply and the price of equal quantities of w, b and c produced at the same time are equal.

Using direct barter, the economy would not work very well, because although only two barters are needed to make everybody happy (e.g. AB followed by AC), A will be reluctant to take a fresh c in exchange for a fresh b, because what she really needs is a fresh w and she will only be able to offer a half-rotten c for it, which C will be reluctant to take.

Exercise for the reader: prove that if any one of these products were non-perishable, it would work as money and fix the economy.

Now, if, for some reason B (Bob Banker) had a good reputation, instead of giving A a fresh cidget in exchange for a fresh bidget, he would write a negotiable promissory note, promising a fresh cidget to the bearer. Then B will eat his bidget, A will buy a widget from C for it and C will redeem it with B. The improved efficiency over barter is obvious.

However, the total value of fiat currency (as measured in kilograms of fresh xidgets) in this economy matters a lot. The optimal amount in circulation should be above what buys just enough to save from a death by starvation and below one kilo of xidgets. If the total value in circulation is outside these limits (in either direction), people will be forced to resort to inefficient barter or face starvation. Within these limits there are still differences, but those are less consequential and depend on the transaction cost as measured in the cost of having to eat a less fresh xidget.

While not trivial, it is also easy to see that if the two ladies know exactly how many promissory notes Bob has written, then Alice will enforce the optimal amount of B notes in circulation for purely selfish reasons.

It is even less trivial to see that if they have some (any fixed) amount of gold (arbitrarily distributed in the beginning), that has no utility beyond being a convenient means of exchange, the resulting economy would be LESS efficient, than the one with B's fiat currency.

November 16, 2007 at 2:13 AM  
Blogger Daniel A. Nagy said...

Additional remarks

By non-perisbale in the excercise I meant that it won't taste worse over time, but it will still become unedible after 24 hours. Otherwise, it won't fix the economy.

By consuming a kilo a day, I mean that eating (much) less than a kilo within 24 hours causes death by starvation.

By producing a kilo a day, I mean that it is not possible to produce more than a kilo within a 24-hour interval.

November 16, 2007 at 2:19 AM  
Anonymous Anonymous (Apple) Put said...

Greetings, M. –

Deposit insurance benefits are paid when a bank defaults on its obligation. This amounts to a government expenditure funded by a government tax. The cost/benefit distribution is asymmetric or non-neutral. The taxpayer pays for the ‘moral hazard’ due to the depositor’s indiscriminate choice of banks.

General tax revenues fund the monetary loss. This doesn’t require monetary dilution. Monetary dilution may occur adjoined to the circumstances of this example, but it doesn’t result directly from the payment of a deposit insurance benefit or the collection of a tax. The payment is a transfer of money from the taxpayer to the otherwise money-losing depositor. Indeed, if the money supply were otherwise fixed, it would contract in this case. The destruction of money that generates the requirement for a deposit insurance payment shrinks the money supply.

More generally, money in a fiat system is created by credit. Banks create credit and therefore the money supply. This includes central and non-central banks. So credit creation is the origin of ‘monetary dilution’. This is somewhat consistent with your view that dilution is used “to create apparent prosperity: use it to redistribute money from people who are saving money, to people who are spending it”. The real asset (held by the saver) depreciates; the real liability (issued by the spender) appreciates.

Conversely, a fixed money supply implies a fixed credit supply. This implies that banks are not permitted to create credit beyond the fixed supply.

(I’ve never understood the rigid hold on the money focus alone, in any kind of monetary analysis, when credit is the cause and money is the effect. Credit is the mother of all money.)

A series of unfolding questions:

If my logic holds so far, what would be the criterion that establishes the agreed upon fixed supply of credit?

What would be the banking process for maintaining this fixed credit supply?

Or is the required system one in which money is not the creation of credit, where there is no credit, and where there is no banking system?

What exactly is the relationship between the idea of a fixed money supply and the idea of a banking system and credit?

Do these questions run into any meaningful intersection in the neighborhood of Austrian economics?

Respectfully submitted via Setserland,

Anonymous (Apple) Put

P.S. I apologize if some of my analysis is implicitly accounting oriented, particularly since I’m using it in the environment of your own blog. I did not invent accounting. Please do not hold its existence against me.

November 16, 2007 at 5:07 AM  
Anonymous anonymous (apple) put said...


"The real asset (held by the saver) depreciates; the real liability (issued by the spender) appreciates."

I meant the real liability depreciates, but wealth appreciates as a result.

November 16, 2007 at 5:23 AM  
Blogger Michael said...

Actually Mencius, it's not hard at all to see all those schools of economics you mentioned, with the exception of the Austrian school as non-quackery simultaneously (though I would personally not bet on the Keynesians), while it's pretty close to impossible to see the Austrian school as non-quackery while seeing *any* body of reasoning as non-quackery given that it argues against reason itself (e.g. math and empiricism).

November 16, 2007 at 5:58 AM  
Blogger Tanstaafl said...

Bravo MM.

Now connect the quackery of Globalist economics to the quackery of Progressivist politics and you'll have decoded the quackery behind the West's immigration invasion.

As for the effects of inflationary redistribution, could you go beyond the plebian savers and spenders and examine how it effects the plutocrats? The current owners of gold I would imagine are not just passively wishing for a switch to a 100% reserve gold standard.

Here's a non-quack explanation of how we got here and why.

November 16, 2007 at 12:09 PM  
Anonymous TGGP said...

Tanstaafl, were you not paying attention? MM clearly called Benjamin Franklin a quack while your video praises him as a paragon of economic good sense. They have similarly contradictory views of Lincoln's greenbacks and the gold standard. Even if MM is a quack, he's far more sensible than your idiotic video. I can't believe I threw away more than two hours of my life on that.

I say the heterodox schools of economics are quackery, so that removes the Austrians and Post-Autistics. Also, Caplan is an anarchist and I don't think he can be considered a dilutionist. I'm not sure about Tabarrok but I suspect he is similarly radical. I think you might be too hard on the Chicago school as well. Friedman is the one who replaced the earlier Keynesian Phillips-curve paradigm with "inflation is anywhere and everywhere a monetary phenomenon". You're still more sensible than this guy though.

November 16, 2007 at 1:09 PM  
Blogger Tanstaafl said...

tggp, you spent 2 hours watching that video and didn't pay attention?

MM put his finger on the quackery of private fiat money dilution, such as the Fed perpetrates. He contrasts that with and expresses a preference for a 100% reserve gold standard to end the quackery.

I linked that video because it explores another alternative: the non-quackery of fiat money owned by We the People, which is what Franklin, Jackson, Lincoln, and many other distinguished Americans have supported in the past. The key distinction from the current quack system is ownership. Perhaps MM disparages Franklin because he thinks fiat is the problem rather than ownership. Perhaps he'll actually address my comments some day.

I'll connect the dots for you: when a nation's money is privately controlled those private interests will naturally drive monetary policy. In MM's terms, public ownership is more likely to keep the monetary system more closed, ie less prone to dilution. Under the Fed's private control the US public has instead had their economy "rowed" between credit bubbles and crashes by the narrow private interests.

Those who watch the video might also be surprised to learn that our current system came into being under somewhat illegitimate circumstances after a long struggle against it, and that those circumstances and the system itself have been questioned ever since by many respected people.

November 16, 2007 at 8:04 PM  
Anonymous Randy said...


Good point about credit being the mother of all money. I believe we could take it a step further and say that credit is money. Who pays for anything with cash these days? Yes, there is an element of risk in accepting credit, but there is an element of risk in accepting any form of money. Metals can be diluted or shaved. Paper can be over produced or counterfeited. Salt can get wet. Cattle can be diseased. The trick in accepting credit is that one has to know the other person, but we have agents to take care of that for us (VISA and Mastercard, financial institutions, etc.). Just a thought, but of all forms of money, credit is the one over which government has the least control. So how is that a bad thing?

November 17, 2007 at 4:40 AM  
Blogger Daniel A. Nagy said...


While I agree with you guys 100% that credit is the best form of money (also holds in my small toy economy), it does not solve one question:
What is the denomination of your credit?
I think that in this time and age, it should be some unit of a service that the issuer can provide at any time, which may or may not be commodity backing. For example, SMS (short text messaging over mobile networks) would be a very nice backing for a credit-currency. Mobile operators are already busily replacing banks in many sectors of the economy.

November 17, 2007 at 6:25 PM  
Anonymous Anonymous (Apple) Put said...

All deposit-taking banks are extensions of a central bank function. There is no real difference between the notes issued by a central bank and the ‘deposits’ created by a commercial bank insofar as money dilution is concerned. In some cases, governments provide insurance to compensate commercial bank depositors for losses due to solvency risk or liquidity risk. This is a contingent tax rather than money dilution per se. And governments can lose the confidence of note holders, regardless of the supply of money.

Even if money is not a measure of value or a claim on wealth, it represents a future claim on something that will have some measure of future value in the form of future non-money goods and services. Money represents future value even if the nature of the exchange and its value is currently uncertain. Moreover, the value of future goods and services would be currently uncertain even in the absence of money. In short, money is risky, measured in terms of its eventual usefulness in obtaining something of value in exchange. But so is the value of things apart from money.

The creation of fiat money requires that banks lend it; i.e. it requires the credit function. This holds for central banks and commercial banks. Central banks create fiat money by buying government debt. Banks create money when they extend credit but eliminate it when the loan is repaid. (Of course, credit renewal can extend loan repayment, especially in the case of a lending to a government.) Thus, new credit is a contract with a “closed-loop” characteristic. But total credit is “open-loop”, because it allows for the dilution of the money supply in its totality, as a result of the growth of all credit contracts outstanding.

If a given level of credit and money is warranted at a given level of economic activity, why shouldn’t a different level be warranted at a different level of economic activity? Is this a matter of dilution, or synchronization between the level of economic activity, the creation of credit, and the incidence of money exchange? If a fixed money supply is sufficient to accompany any given level of economic activity, what relationship determines the appropriate level of that supply? Why can’t the supply be 0? Conversely, if 0 won’t work, what level will? Fixedness implies uniqueness. If there is more than one answer, fixed becomes variable. What determines the non-0, unique, fixed supply of money? If not economics, what? And if economics, why is the function a singularity? There seems to be a contradiction here in terms of establishing a quack-free money zone. Arguments that prevail at the margin seem to be more difficult in integration.

November 18, 2007 at 5:46 AM  
Blogger Tanstaafl said...

The majority of money is indeed credit, eg. mortgages. But the open-loop in credit results mainly from fractional reserve requirements. This happens because banks can lend out several dollars for every dollar they actually hold in deposit they can effectively mint money. That money can be deposited and magnified again, and again, ad infinitum. Did you ever wonder how tens of billions in losses suffered in Europe and the Pacific Rim could be blamed on "subprime" mortgage defaults in the US? Fractional banking is the answer.

If banks were required to hold 100% reserves, whether the standard were gold or fiat, then this source of dilution would be closed.

However, the open-loop in credit would remain. It would still be possible, for example, to create assets through invention or industry. Such a source of money is actually be good for sociey, because it motivates and rewards those who are productive. In contrast the current fractional system motivates and rewards those who engage in predatory or parasitic techniques.

This whole Mises Institute video is interesting and relevant to MM's post, but specifically concerning my point here you can fast-forward to about 21:00 to hear how even a gold standard can be (and was) diluted by fractional reserve.

November 18, 2007 at 11:33 AM  
Blogger Tanstaafl said...

What is the denomination of your credit?
I think that in this time and age, it should be some unit of a service that the issuer can provide at any time, which may or may not be commodity backing.

I propose toilet cleaning as the unit of service. It's value is small but obvious, in ubiquitous demand, and it's form is self-regulating.

If you doubt the value of toilet cleaning you'll have to argue with the priests of the Holy Global Economy and their many followers. They consider toilet cleaning so valuable that they argue any practitioner of this skill is worthy of US citizenship. (Then again that may reflect more on the low value they attach to US citizenship.)

November 18, 2007 at 1:05 PM  
Anonymous Anonymous (Apple) Put said...

The issue of fractional reserve banking is an interesting one. The textbook explanation of the reserve multiplier is completely wrong, and has been for years. The consequence of this error, which should delight many readers of this blog, is that it actually strengthens the arguments of those who oppose the same money dilution effect that is erroneously attributed to fractional reserve banking.

The correct interpretation of the reserve requirement effect is that its operation is equivalent to a system in which required reserves are effectively zero. This effectively boosts the multiplier erroneously described in textbooks to infinity, regardless of the stated reserve ratio.

This is evident from the following explanation, overlooked and misunderstood by virtually all economists, as enunciated by the Federal Reserve itself:

“ Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves. Consequently, reserve requirements currently play a relatively limited role in money creation in the United States. “

This is from:

The significance of the above paragraph is that it confirms that the central bank supplies reserves in response to the path of deposit growth that generates the reserve requirement (as opposed to the vice versa causality described in the textbooks.) It also confirms that the mechanism of central bank reserve discipline is essentially one of interest rate targeting – not the alleged textbook control of reserve requirements over deposit expansion.

This explains in part why many countries have reduced reserve requirements over time, and some have even eliminated them. The required reserve ratio makes no difference to the money expansion effect.

It also raises the question that if traditional economics is so wrong on such a fundamental point, what else can it be wrong on? Unfortunately, Austrian economics has also been quite wrong on the technical premise of its criticism of fractional reserve banking, although the correction to that error is even more supportive to the Austrian line of criticism.

November 18, 2007 at 1:30 PM  
Blogger George Weinberg said...

I think when Mencius says the amount of money doesn't matter, he's talking about the physical quantity, not the value. That is, let's say that people are using gold coins as money, and that's pretty much all that gold is being used for. It doesn't matter much how much gold there is in the world. The more gold there is, the less stuff an ounce of gold will get you. Of course, it would not be good if a gold coin was too large to carry around with you or too small to see, but within those limits any quantity of gold is ok.

But even if everyone used gold coins for money and the total quantity of gold was fixed, the value of all the world's gold would not be fixed in any meaningful sense, since the value of all the world's goods is not constant over time, nor is the fraction of the world's goods which are money.

November 18, 2007 at 2:48 PM  
Blogger Tanstaafl said...

Yes apple, the Money Masters video, the one tggp didn't like, says:

The central bank scam is really a hidden tax. The nation sells bonds to the central bank to pay for things it does not have the political will to raise taxes to pay for. But the bonds are purchased with money the central bank creates out of nothing. More money in circulation makes your money worth less. The government gets as much money as it needs, and the people pay for it in inflation. The beauty of the plan is not one person in a thousand can figure it out because it's usually hidden behind complex-sounding economics gibberish.

This view is echoed near the end of the Mises Institute video - the main example being LBJ's funding of the Vietnam war.

Of course most of economics is bullshit. Just look at what worship of their Holy Global Economy has done to the West in the last century. Booms, busts, revolutions, wars - now they're inviting the Third World to colonize us.

I'm so glad we have intelligent and trustworthy people in charge. Imagine how screwed up things would be if they weren't doing their very best to keep our world safe and stable.

November 18, 2007 at 3:50 PM  
Anonymous Randy said...


If I'm reading you correctly, doesn't it follow that the creation of credit/money is limited only by the demand for credit/money and by the willingness of the verifying agents (financial institutions) to extend credit. Further, the destruction of credit/money is accomplished when there is a failure to generate a corresponding amount of wealth with the credit/money created. Is this not a closed system?

November 19, 2007 at 9:24 AM  
Anonymous Anonymous (Apple) Put said...


“ doesn't it follow that the creation of credit/money is limited only by the demand for credit/money and by the willingness of the verifying agents (financial institutions) to extend credit ”

I agree.

“ Further, the destruction of credit/money is accomplished when there is a failure to generate a corresponding amount of wealth with the credit/money created. Is this not a closed system?”

This is not quite the way I meant it. If credit creates money, then the repayment of credit extinguishes (i.e. destroys) money. That’s closed at the level of the individual borrower. But if banks are constantly growing the amount of credit extended, and therefore the amount of credit outstanding, then money is growing. That’s open at the level of the system.

Closer to your statement, credit losses are a case of credit destruction without money destruction. From an accounting perspective, they destroy equity while leaving the amount of money unchanged.

November 19, 2007 at 10:01 AM  
Anonymous Randy said...


Well out of my league here, but I find the concept fascinating.

If I borrow to build a home, the bank creates credit which is money, which I convert into new wealth - a new home. When the credit is repaid the books are balanced, but there is also my new wealth in the home which can be turned fairly easily back into money. I don't see that the credit/money/wealth is destroyed - it merely changes form. What can destroy it is a failure of character, trust, or both. If I lose my job or let the property go to hell, if the nation takes a turn to the left, etc., then wealth can and will be destroyed. If you're still with me, I'm thinking that real money consists of character and trust, and that, in this information age, it can be fairly easily accounted for with electronic credits. I'm thinking that the government can play a significant part in creating or destroying credit/money/wealth, and that it does so by creating or destroying character and trust.

November 19, 2007 at 11:45 AM  
Anonymous Anonymous (Apple) Put said...


I agree that government can play a role in the destruction of true wealth …as well as trust and character.

My point is really one of mechanics.

When you borrow to buy a house, the bank creates mortgage credit by lending to you. It creates the money that is extended to you via the credit, which you use to buy the house.

The result at the beginning is:

a) You have positive wealth in the form of the house
b) You have negative wealth in the form of the money you owe (mortgage credit owing)
c) The house seller has positive wealth in the form of the money you give him

So your starting net position is 0 since your positive house wealth is offset by your negative wealth due to credit owing.

Over time, you earn money. You repay the mortgage credit. Your net wealth turns positive.

The bank uses the money that you repay to reduce the credit that created it in the first place. That amount of money essentially disappears from the economy.

So, when the credit is finally repaid, the process is ‘closed’ from a money dilution perspective. But up until then, it is ‘open’, since part of the amount of money that was originally created by the credit is still circulating in the economy. At the end, the house seller has taken the actual money originally created and done other things with it, but you’ve gathered back an equivalent amount from the economy to repay your mortgage. The individual credit loop thus is ‘closed’.

Meanwhile, a growing number of people with larger and larger mortgages are doing this over the years, so the amount of outstanding mortgage credit is normally growing (except right now in the US), even though individual mortgages are normally being repaid (except right now in the US), and the overall money dilution effect is continuously ‘open’, due to the effect of composition in total.

I always think of these various steps as exchanges between two parties of distinct forms of wealth - rather than conversions or changes in the form of wealth held by one party.

November 19, 2007 at 1:41 PM  
Blogger Tanstaafl said...

The conversation is so far over my head I can't imagine how the small detail of interest is missing from the discussion. The word abracadabra comes to mind.

Under fractional reserve requirements the bank collects interest on money it creates out of thin air. It operates with virtually nothing at risk. Will we see even a handful of scapegoats go to jail for their scandalous role in our current credit bubble? Most of the bankers won't even lose their jobs.

As for the government playing a role in the destruction of true wealth, I can attest to that first hand. I was foolish enough to trust that my government would enforce its borders and defend its sovereignty. Thus I moved to and built a home in southern California. The true wealth represented by that home is now threatened by the fact that, as any prospective buyer can now plainly see, the US government has defaulted on its responsibility to enforce our border.

If you were to move a house from the US to Mexico, what would you expect to happen to its value? Who would ever do anything so foolish? Unfortunately for me Mexico is moving to my house.

I've lost all confidence in the US government, and I'm not alone. I strongly doubt that loss is or even can be accounted for any economist's bullshit theories.

November 19, 2007 at 3:11 PM  
Anonymous Randy said...

Thanks for the comments Apple. You got me to thinking (just as MM always does). I think I'm on to something here but I can't quite nail it down. Laying it out like you do makes sense, but I think there are more pluses and minuses to consider. But for now, I think I should do more thinking and less writing.

November 19, 2007 at 3:24 PM  
Blogger Independent Accountant said...

On 18 November I made a post titled "Amnesiac Economists" at and mentioned Ben Steil. He is the latest in a long series of what I call "monetary cranks". has some of the stupiest economists post there.

December 2, 2007 at 10:16 PM  
Blogger Born Again Democrat said...

A historical note, if anybody's interested. It was Keynes, in his so-called General Theory of Unemployment, made the case for dilution. I say "so-called" because it was really a "special" theory for the situation in which you have "sticky" wages. That's econo speak for the reality that wage workers, especially if they are organized, will not quietly accept real reductions in their nominal wage rates ("you were making $5 an hour, but business is bad and I can only afford to pay you $4"). There is historical evidence that this is actually true.

So to get around that pesky inconvenience, Keynes advocated a gentle inflation, arguing that the effect is the same, and that "not one man in ten thousand understands inflation."

In other words, inflation would reduced real wages surreptiously, which would increase the demand for labor and restore full employment in an economy where workers refuse to take nominal wage cuts. That's the real secret message of K's classic tome -- if you read carefully you can spot it between the lines in the first 50 pages or so.

Trouble was, the labor unions eventually caught on (we're talking the 1960's and 70's now) and started negotiating so-called COLA's ("cost of living adjustments")in their collective bargaining contracts, which automatically increased nominal wages to keep real wages from falling.

And when that happened we started getting the phenomenon of "stagflation" which orthodox Keysians thought a theoretic impossibility: inflation and unemployment went up together, and the market was no longer able to adjust the real price of labor to clear the market (employ everybody who wanted a job).

Then we got Nafta and Gatt, which busted the unions with foreign competition, and both COLA's and stagflation disappeared.

But wages are still sticky when they are understood as an hourly rate of pay which has been agreed to, which is why guys like Friedman went along with the idea that a low rate of inflation was probably a good thing.

Bottom line: gotta live in the real world, not the ideal one. Otherwise you really are a quack! Just joking.

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February 25, 2009 at 6:41 PM  
Anonymous Anonymous said...

^^ nice blog!! thanks a lot! ^^

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March 2, 2009 at 9:50 PM  
Anonymous Anonymous said...


March 6, 2009 at 4:48 AM  
Anonymous Anonymous said...








March 10, 2009 at 11:14 PM  

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