Friedman centenary

Today (Tuesday 31st) is Milton Friedman's centenary.  It seems appropriate to link to some Milton Friedman quotes here and here.  Various bloggers have offered their comments, including Bryan Caplan's ode, Tyler Cowen notes how much he is still needed, Lars Christensen writes him a letter, and David Glasner continues his campaign against the Wall St Journal editorial pages. [UPDATE A black Marxist student remembers being impressed that, in 1960, Friedman had a black secretary.]

David Glasner's tribute is an excellent summary:

Milton Friedman, by almost anyone’s reckoning, was one of the great figures of twentieth century economics. And I say this as someone who is very far from being an uncritical admirer of Friedman. But he was brilliant, industrious, had a superb understanding of microeconomic theory, and could apply microeconomic theory very creatively to derive interesting and testable implications of the theory to inform his historical and empirical studies in a broad range of topics. He put his exceptional skills as an economist, polemicist, and debater to effective use as an advocate for his conception of the classical liberal ideals of limited government, free trade, and personal liberty, achieving astonishing success as a popularizer of libertarian doctrines, becoming a familiar and sought-after television figure, a best-selling author, and an adviser first to Barry Goldwater, then to Richard Nixon (until Nixon treacherously imposed wage-and-price controls in 1971), and, most famously, to Ronald Reagan. The arc of his influence was closely correlated with the success of those three politicians.

Milton Friedman would cheerfully advise anyone about how to improve the economic condition of their people including (infamously) Gen. Pinochet and (often ignored) Communist China. (Pinochet, of course, relinquished power after losing a referendum; don't see the Beijing regime doing that any time soon.)

Milton Friedman was an opponent of conscription [the highlight of his famous exchange with Gen. Westmoreland is here], in favour of drug legalisation, an innovative thinker on welfare (proposing the negative income tax and education vouchers) and a critic of the IMF and the World Bank. (In particular, he did not approve of the way the IMF protected banks and other institutions who lent to developing countries at the expense of their taxpayers.) As this paper (pdf) points out, Milton Friedman's comments on Japanese monetary policy make it pretty clear he would not have been impressed by our current "hard money" monetary-contraction inflation hawks.

There is also a "fantasy Friedman" on whom various falsities are projected--such as that he supported IMF policy, that the Euro followed his proscriptions (he was deeply sceptical about its prospects) or that he only worried about inflation. The last is hilariously untrue, since he co-wrote the classic analysis of the dire effects of monetary contraction deflation, A Monetary History of the United States.

One of his great virtues was his ability to be clear, with a gift for vivid explanatory metaphors. An OpEd on "the Fed's thermostat" (pdf) is a good example.  He once proposed "the mother-in-law test". Any economic idea he could not explain to his mother-in-law over a cup of tea was probably wrong.  If you couldn't be clear to interested lay folk, what was the point?

He thought Keynes was a great economist and was a friend of Friederich Hayek (though apparently they ended up agreeing not to discuss matters monetary, as their disagreements were too strong).

His son is also very independent minded, which speaks well of his parenting skills. David Friedman (who has no degree in economics and is one of the prominent early figures in the SCA) wrote one of the first pieces I ever read which applied economic reasoning to a non-"economic" subject--why C18th armies had bright complicated uniforms. (To make it clear if a soldier broke ranks, since the inaccurate muskets of the period worked best if fired at once in clumped groups, which also made the soldiers better targets.)

Paul Krugman [who respects Friedman] once wrote of something Milton Friedman had written that it was "typical Milton; too simple but mostly correct".  To be "mostly correct" seemed to me then, and does now, as high praise.

Milton Friedman, July 31, 1912 – November 16, 2006. Requiescat in pace.

Broken by the fix

What do the goldzone Great Depression (1929-3?) and the Eurozone Great Recession (2008-?) have in common? They were both created by European central banks with the US Federal Reserve (the Fed) as accessory during and after the fact. (Yes, the monetary shock which set off the Great Recession started in Europe though the responsibility of the European Central Bank [ECB] in that initial shock was a bit more indirect than that of the Bank of France in the Depression; the ECB was much more directly culpable in the subsequent monetary contraction.)

When Nobel laureate Thomas Sargent described the euro as an artificial gold standard he was zeroing in on common features--the goldzone and the Eurozone both being fixed exchange rate systems operating over institutionally divergent countries with limited labour flows, no fiscal union (so no significant fiscal transfers) nor common risk pool otherwise (in the case of the eurozone, no lender of last resort). Having the Eurozone include Mediterranean economies was not (pdf) a monetary union that conventional Optimum Currency Area (OCA) theory supported. While economist Charles Goodhart is quite correct when he points out that OCA theory cannot explain the boundaries of existing currency realms--that being a result of the operation of state power--if OCA theory is seen as providing an analysis of whether currency realms should amalgamate, it turns out to be very powerful, as the travails of the Eurozone are proceeding to demonstrate.

This surprised-by-American-scepticism paper [pdf] by European economists--scepticism largely driven by OCA theory--reads rather differently now. Though labour mobility is supposed to be one of the key differences between the US and the Eurozone, yet land-rationing in the richer US cities is seriously reducing labour mobility, making the US more like the Eurozone and undermining its macroeconomic resilience.

Inflation phobia
Milton Friedman was famously an advocate of (pdf) floating exchange rates, Frederich Hayek an advocate of (pdf) fixed exchange rates. The latter seems an odd position for a free market thinker to take. Especially when Hayek was also an advocate for the gold standard, if one was going to keep the state money monopoly. A series of fixed prices (fixed exchange rates, fixed gold price) erected on monopoly provision seems a very odd position for a free market thinker to take.

The explanation is simple: fear of inflation. A fixed price of money in gold means--given gold's scarcity--that the possibilities of inflation are greatly reduced. A fixed exchange rate means giving up the ability to domestically inflate (as Greece, Italy, Portugal and Spain are currently discovering). A monetary authority can control price stability or it can control the exchange rate, it cannot do both. Being in the goldzone means inflation will only occur if the price of gold is falling, which it is unlikely to do by much, given that stocks greatly outweigh new production.[i]

The experience of inflation is another feature in common between the goldzone Great Depression and the eurozone Great Recession. Both the great deflation of the former and the disinflation of the latter occurred after dramatic periods of inflation. In the case of the interwar goldzone; the wartime inflations, the German and Austrian hyperinflations, the French early 1920s inflation. Fear of inflation dominated the thinking of monetary authorities--indeed, paralysed their thinking. To the extent that the Fed is paying people not to spend money.
In our own time, the Great Inflation from the late 1960s to the early 1980s has profoundly affected the thinking of monetary authorities; indeed, paralysed it. The success of inflation targeting in squeezing inflation out of Western economies has made it a policy fetish that central bankers cannot see beyond, just as the gold standard was a policy fetish monetary authorities in the early 1930s could not see beyond. Not even to make adjustments necessary to save it. It has been a continuing pattern for central bank policy to respond more to the traumas of the past than the dilemmas of the present.

Been there, done that
It is a sad reflection on the ability of policy makers to find new ways of making old mistakes that if one reads either version of the paper (pdf) by Barry Eichengreen and Peter Temin, The Gold Standard and the Great Depression, and replaces 'gold standard' with 'inflation targeting', one gets an almost perfect description of the current failures of central banks and the mentality behind such. Particularly when the Eichengreen and Temin say (p.19 of the NBER paper):

policies were perverse because they were designed to preserve the gold standard, not employment.

Replace 'gold standard' with 'inflation target' and that is exactly what has been happening in our own time.[ii] Indeed, it was worse than that, as the the Fed and the Bank of France were not even "doing" the gold standard properly (pdf). Just as the European Central Bank and the Fed are now not even doing inflation targeting properly. (To the extent that the IMF is now reporting a significant risk of deflation [pdf] in Mediterranean Eurozone countries.) Just to increase the similarities between the Great Depression and Great Recession, inflation targeting that implicitly or explicitly incorporates "headline" inflation which includes oil and commodity price shocks turns into a de facto commodity standard (since a rise in commodity prices leads to monetary tightening; so the value of money is tied to commodity prices).

As for the authors' comment:

Central bankers continued to kick the world economy while it was down until it lost consciousness (p.2)

that is a fair description of the role of the ECB in the Eurozone crisis. With the added proviso that many think some beating is warranted: alas for such righteous monetary Calvinists, the policy of the beatings continuing until performance improves has long since degenerated into pointless and destructive monetary sadism.

Which makes Greece an enormously useful scapegoat for the ECB.  While people are pointing at its obvious policy dysfunctions (a country rated by the World Bank as 100 out of 183 in difficulty of doing business has considerable capacity to improve its economic performance through its state simply stopping spending money and effort getting in the way of people transacting[iii]), and the undoubted economic rigidities in other Mediterranean Eurozone countries (Italy is rated 87, Spain 44 and Portugal 30 in difficulty of doing business compared to Germany at 19), the ECB is avoiding any accountability for its actions. (Which would make it the ultimate EU creation; the EU being a construction where power without accountability is not a bug, it's a feature.)

Conversely, the worst thing for the Eurozone would be for Greece, or any other country, to leave--and promptly start to do better. Moreover, economic rigidity hardly explains the level of economic pain in the Great Recession—the UK is ranked 7, Ireland 10, USA 4 in difficulty of doing business. Nor does public debt on its own--even within the Eurozone, Spain has a lower level of public debt than Germany (pdf).

Compared to the ECB's destructive monetary austerity, the Fed is more in the situation of having belted the US economy into a TKO,[iv] then helped it sit back up a bit, and offered some water, but resolutely refuses to help the punch-drunk economy stand, proclaiming that if it cannot stand up on its own, it is not fit to, while promising that it won't let it fall to the matt again. Monetary policy matters.

Contractionary blindness
The great blindness involved in this inflationphobia is to think that inflation is the only significant monetary danger. Firstly, serious monetary-contraction deflation is worse than monetary-expansion inflation, even hyperinflation. Both undermine economic calculation, but inflation tends to promote transactions (as people spend before their money loses value), deflation to restrict them (as people defer using money that will buy more later, leading to falling spending and thus falling income). Generally, falling transactions, falling economic activity, is worse than rising.

[Read the rest at Skepticlawyer or at Critical Thinking Applied.]

Chocolate!

Time for some more food p0rn.

Are your bites bloc-sized?

It's always time for chocolate.

Have caterpillar tracks, will climb

Venezia is not a wheelchair friendly city.  Almost all the bridges are stepped.

But we were taken with this solution to the problem of wheelchairs and stairs.

Dr Who fans will no doubt go to a famous joke about the Daleks.

Debt and Boom

The slogan for this post is: don't think debt, think safe assets.

(This post is partly provoked by this post by Paul Krugman responded to by Scott Sumner and by Marcus Nunes.)

In my Debt, Doom and Despair post I noted that a hugely debt-burdened post-Napoleonic Wars UK (where the national public debt was probably about 250% of GDP or about 25 times the revenue of the British government) went on to an amazing surge in population and mass prosperity.  (In fact, by far the most remarkable in all of human history up to that time.)

What if it was not a coincidence? What if the debt burden actually encouraged said surge?  After all, WWII left the British, Australian and US governments all highly indebted (at about 240%, 150% and 120% of GDP respectively) yet all experienced amazing postwar surges in population and prosperity. All surges marked by high rates of productivity increases from expanding technology and global trade.

One's persons debt is another person's asset.What were the British, US and Australian governments doing in running up such huge debts? They were creating a huge level of safe assets, given that none of these three governments have defaulted on their bonds, ever.  One reason why Britain went back on gold in 1925 at the pre-war (over-valued) parity was to "keep faith" with its bondholders.

So, those high levels of public debt were also creating high levels of income from safe assets. If you are, for example, 1815 Britain, and debt is 250% of GDP, then a significant amount of income, compared to total production, is flowing from said safe assets.

Expropriating risk managers
There are two basic things states do: they expropriate and they manage risk. The latter is necessary for the former and goes back to the origins of rulership--dead farmers cannot pay taxes.  In ibn Kaldun's definition, cited and admired by Ernest Gellner, government is:

an institution which prevents injustice other than such as it commits itself.

This the paradox of politics or the paradox of rulership--we need the state to protect us from social predators but the state itself is the most potentially dangerous of social predators. It is a paradox that can never be fixed, only managed more or less well.

One of the tricks of rulership, refined by medieval rulers such as Alfonso IX of Leon, and Edward I of England, is that, if you get consent for your taxation, you can do a higher level of taxation because it lowers the "resistance cost". Democratic welfare states have taken the consent-benefit trade-off up to record levels (for any non-patrimonial or totalitarian polities; i.e. for societies with any free element). Welfarism is the domestic aggrandisement of the expropriating state as imperialism is its external aggrandisement. (One of the ways we can tell that welfarism is, at least in part, an excuse for state aggrandisement is how weakly expenditure is tested against effectiveness in improving social outcomes; conversely if there is less inherent nobility in welfarism than appears, there were also positives in imperialism, albeit at wildly varying levels.)

But the public goods, and latterly welfare, provided by the state in return for implicit or explicit consent for its expropriations are overwhelmingly about risk-management. And risk management is a genuine service. Consider protection of life, person and property; or mitigating the risks of unemployment, sickness, disability, old age.

Balancing risks
For any given level of risk aversion by potential investors, creating a safe income stream raises the risk threshold for further investment. People will be more willing to tolerate higher levels of risk in their other investments.

Such as in highly uncertain investment in new technology. True, that leaves one open to asset booms and busts (pdf). Nevertheless, net economic outcome is likely to be a long term acceleration in productivity (pdf). And the surge in population and prosperity such involves.



[Read the rest at Skepticlawyer or at Critical Thinking Applied.]

The mystery of the human and the trade-offs of control

What is the biggest difference in decision-making between buying equipment and hiring a person?  The characteristics of the equipment are much easier to discern.

Sure, there can be hidden flaws in machinery and buildings. You may have to take the equipment for a test run, you may need some expert to have a look at it, but, in a very important sense, what you see is what you get. And, once you are used to one example of a piece of equipment, the next item of the same thing is likely to have the same characteristics. Indeed, the higher quality the provider, the more reliable this sameness is.

People are so not like that. They vary greatly in ways which matter to an employer (or, indeed, anyone else seeking to interact with them) but which are not easy to discern. The only reliable way to find out about a particular person is to interact with them. (Nobel Laureate James Heckman has co-written a study on how "soft skills" matter [pdf] [via], on how personality traits affect life outcomes yet can be hard to assess.)

Who is telling me
Much of how labour markets work is dominated by the opacity of relevant personal characteristics. For example, the biggest labour market intermediary (way people get jobs) is generally "friends, relatives, acquaintances, etc"--someone they know told them about the job and/or the employer about them.

You can spread information about a job much more easily by posting a job vacancy.  But that will tell you almost nothing about the applicants. Personal networks provide much richer information; even if it is just "I don't know Bob, but Kate recommended him and Kate wouldn't steer me wrong" and/or "I have a high regard for Kate's judgement". You can judge the recommendation on the reliability of the recommender and to what extent the recommender is, in effect, acting as a guarantor (so as to avoid harming your existing connection).

Recommendation through existing networks thus becomes a proxy for judging the personal characteristics you cannot directly discern.

It tells me what
Such proxies abound. Has someone else taken the risk of hiring you? If yes, have they persisted in that choice for any length of time?  Hence the best place from which to get a job is being already in one. Does your education suggest that you have application and persistence? Hence the value of education qualifications is surprisingly weakly connected to the alleged content of that education. And so forth.

This is where making it hard to sack someone (in Australia "unfair dismissals" legislation) tends to so retard the operation of labour markets, for it greatly increases the risk in hiring someone precisely because of the opacity of personal characteristics. If the minimum cost of getting rid of a complete dud is, say, $3,000 in legal fees, employer time and "go away" money, then that adds a $3,000 risk premium to every hire. This is then offset by not hiring if it pushes the risk too high for expected benefits or relying even more heavily on other filtering mechanisms. Both responses hit the most marginal would-be labour market entrants hardest. But, like much labour market regulation (indeed, much regulation generally), job-protection legislation is about protecting incumbents.

It also weakens the signal of simply being in a job, as the employer's persistence in keeping you becomes a weakened recommendation.

What can I tell?
Given the difficulty in discerning the relevant characteristics, the harder it seems to "read" someone, the less attractive they are as employees. Language and cultural differences--to the extent they seem to make it harder to discern characteristics, communicate information and predict behaviour--become an employment negative. Effects which can be hard to distinguish from actual ethnic antipathy.

So, if you are a young Muslim male in a Western European country with strong "job protection" legislation, your chances of employment are not good. Or even just being young; there are reasons why France exports young people to Britain (while Britain exports retirees to France), as these job emigres in London (helping to make London France's sixth biggest city) can attest:

[Read the rest at Skepticlawyer.]

Going for gold: perils of entering the goldzone

Who would want the global monetary system to be at the mercy of the Bank of China?  Not conservative, free market types in the United States and elsewhere, one guesses.

Actually, it turns out lots of them do; all the people who support some sort of return to the gold standard, who think that the US (and other countries) should recreate the goldzone. Let me explain.

Gold shines
Some folk are quite impressed by the way the price of gold has shot up in recent years (all gold statistics are from the World Gold Council website).

Gold price in US$: on the up and up

As the price has shot up, so has gold's attraction as an investment. It is a striking illustration of the mystique of gold that folk who, if any other asset quadrupled in price in 6 years, would call "bubble", see the surge in the gold price as saying something profound about the global economic situation and monetary system.

Mined and recycled gold increasingly flows into (private) vaults

While industrial and dental use of gold has remained fairly constant, there has been a strong shift from demand for gold being dominated by jewellery to increasing interest in coins and bullion. With investment hitting 40% of mined and recycled gold, it is likely at about the levels that flowed into monetary gold at the height of the gold standard; movement between monetary and non-monetary uses of gold being an important feature (pdf) of the 1873-1914 gold standard.

After surging in price in 1979-80, gold was actually losing value as an investment in real terms until 2005, when it began a price surge which has seen it storm past its 1980 highpoint: but low real interest rates make gold a better investment (pdf). While Asian demand had tended to dominate the market, the striking change in demand for gold as an investment has been the dramatic European (particularly German) embrace of gold from 2008 onwards.

Investment gold, in tonnes

A certain Euro-nervousness perhaps.  Looking at jewellery and investment demand together, the way Asian demand dominates the gold market is clear.

Big in Asia: demand for gold for jewellery and investment in 2011, in tonnes.

India has long been a strong market for gold and, as they and the Chinese are getting richer; this (along with the aforementioned Euro-nervousness) is reflected in the demand for gold. For all the (largely American) goldbug chatter, Americans are not nearly as in love with gold as others are.

Still, there are voices calling for us all to enter the goldzone, to "go back to gold" as the basis for the international monetary system. But doing so would have implications they may not have considered fully.

Entering the goldzone
Money is a transaction good: the value of money is what it can be swapped for. In a monetary exchange economy, the price level (P) is the average swap value of money in circulation for goods and services. Using the Fisher-Friedman equation of exchange (money stock x rate of turnover of money for goods and services = prices x output: i.e. MV = Py), then P = MV/y.

The cost of production of money is merely a minimum constraint on its supply. For notes, this clearly not much of a constraint. (For coins, some premium over metal value for transaction utility can also be a factor.) In the case of a monopoly provider of non-convertible notes, there is no other constraint on its supply except that adopted by the monopoly provider. In economist George Selgin's words:

The disadvantage of fiat money [.i.e. non-convertible money], relative to commodity money, rests precisely in the fact that its scarcity, being thus contrived, is also contingent. A matter of deliberate policy only, it is subject to adjustment at the will of the monetary authorities or, if those authorities are bound by a monetary rule, at that of the legislature. Consequently, although a fiat money can be managed so as to not only preserve its purchasing power over time, but also so as to achieve the greatest possible degree of overall macroeconomic stability, there is no guarantee that it will be so managed, and market forces themselves offer no effective check against its arbitrary mismanagement.

[Read the rest at Skepticlawyer or at Critical Thinking Applied.]

Debt, doom and despair

It is a matter of some comment that the public debt burden of the United States has recently increased somewhat.

Upward, ever upward

And that this surge in debt has come from increased spending

A more elevated state

More than from falling revenues.

Buy now, pay later

(The "negative deficits" in Truman's and Clinton's second terms meant the US federal government was running a budgetary surplus.)

Fiscal surge
This surge in the federal budget deficit and federal public debt was in the service of fiscal stimulus (and keeping State and Local government spending up in the face of falling revenues). Various Keynesians have argued that the fiscal stimulus was not nearly large enough or, at least, could have been usefully larger.

My take on this is that (1) if the US Congress could spend so much for so little stimulus effect, then fiscal stimulus is--as a matter of practical politics--an amazingly wasteful way of getting economic stimulus. And (2) since the fundamental problem was contractionary monetary policies, and the monetary authorities "move last", then fiscal stimulus becomes even more problematic. (As Scott Sumner points out, the fiscal multiplier is a measure of central bank incompetence.)

Your debt, my asset
But what I want to focus on here is the level of US debt. The first thing to remember, is one person's debt is another person's asset. So, a measure of US public debt is also a measure of financial assets held by whomever. It is a perfectly reasonable question whether the US state can manage its level of debt, and whether its public finances might have become somewhat debt-addicted, but let us not get the idea that debt is all just negative. Lots of folk, including lots of American citizens (indeed, mostly American citizens), are getting nice incomes out of that debt. As long as US debt/bonds are regarded as "safe assets", they will be saleable. (The less safe they are rated, the more expensive they will be to sell, but there are no signs of that.)


[Read the rest at Skepticlawyer or at Critical Thinking Applied.]

Masks!

Venezia is very much a city for masks.  They are on sale throughout the city.

Carnevale may be only once a year, but the accoutrements are sold all year round.

The RBA is not the Fed, thank goodness

This is based on a comment I made here.

At the Bubbles and Busts blog, there is a post criticising Marcus Nunes' post positively contrasting Australia's economic performance over New Zealand for failing to deal with Australian economist Steve Keen's warnings over the Australian housing bubbles and their debt-deflation implications.

That impending crunch is a long time coming. I agree completely that Australian housing prices are a series of bubbles and that many Australian households are highly leveraged on bureaucratic approval. But the air was out of the various American housing bubbles before the Global Financial Crisis or Great Recession hit. The former was a result of (1) some bizarre evolution in financial instruments, (2) poor prudential regulation, (3) a pattern of the destruction of prudence by intervention and the (4) US Fed deciding to go with specific credit management (pdf) rather than general liquidity support. It then proceeded to (5) disinflate by "passively" tightening monetary policy in what Matt Yglesias rightfully calls a massive failure in monetary policy while (6) entirely fail to anchor income expectations (giving it what I have called unbalanced credibility).

In the case of Australia, (1) does not apply anywhere to the same degree (2) is likely rather better (but as yet not seriously tested by a domestic crisis rather than an imported one) (3) does not really apply (4) is not something the Reserve Bank of Australia (RBA) is likely to do, (5) it won't do and (6) it does the reverse.



Like Keen, I admire Fisher's Debt-Deflation analysis (pdf) of the Great Depression. But that analysis was in the situation of massive deflation imposed on the goldzone by the Bank of France abetted by (pdf) the US Federal Reserve. You need seriously destructive monetary policy to get the effect.



Yes, it will be ugly when the bubbles burst but better monetary policy than the Fed managed will make things a lot less ugly in Australia when and if the housing bubbles burst (rather than subsiding).

There is no such thing as just money

I have been doing a fair bit of reading in the history of money and monetary theory to try and understand money, particularly its origin and use. A thing reveals its nature through history, to understand the history of something is to much better understand it.

I was aware that modern macroeconomics is bedevilled by a lack of a common analytical language in talking about money. But the problem goes deeper than that; money is a multi-dimensional phenomenon.

I am not talking here about debates over monetary base (coins, notes and bank reserves with the central bank) and the various monetary aggregates (M1, M2, M3 etc). These debates are even less interesting than they appear, not least because expectations matter so much.

Nor even that when economists talk of the "demand for money" they mean the demand to hold money, not the willingness to spend money (which, in a monetary exchange economy, is the demand for goods and services; and money actually spent on goods and services is aggregate demand). Though one way of thinking of money held is as a proportion of money passing through, and shifts in the proportion of money held rather than spent can be very important in its macroeconomic effects. Especially if the money supply does not adjust accordingly, because then an increase in the demand to hold money can lead to a fall in transactions and hence (since one person's spending is another person's income) a fall in incomes, spiralling down into those transaction crashes/goods-and-services gluts we call recessions or depressions.

The problem in talking about money qua money, is that there are so many institutional possibilities with money. Let us just consider the situation were notes exist, so cost of production is not an effective constraint (and ignoring coins and the history of money before notes).

A "theory of money" has to consider to following dimensions:
(1) Is there a monopoly supplier of local notes or are there competitive suppliers?
(2) Are the notes convertible into gold, silver or some other commodities?
(3) If not convertible, are the notes backed in some other way?
(4) If not, is the supply of notes limited in some other way beyond cost of production?

If (2) is true, then the price level (P) is determined by the ratio of monetised backing (for example, gold if a gold standard is operating) to output (y), since notes can always be "swapped out" for gold, so the level of monetised gold (mG) sets the swap value of notes for output. (So P = mG/y.) So, if monetised gold rises faster than output, prices rise. If monetised gold rises slower than output, prices fall.

Note that if (2) applies, then the swap value of the notes (in terms of gold) is set, but their supply is not.[i] This setting of the swap value by a fixed price in gold leads to considerable price stability, as the gold/output ratio generally changes fairly slowly.[ii]  Changes in the rate of turnover of notes (i.e. in the demand to hold money) can easily be accommodated by changes in the supply of notes.

This price stability tends to lead to low levels of fluctuations in the rate of turnover/proportion of notes held--in Sweden, for example, in its gold standard era from 1873 to 1914, there was a steady decline (pdf) in the rate of turnover of notes/proportion of notes held.

If (2) does not apply, then the above is not how things work. So convertible or not convertible becomes a vital issue for effective analysis.

If you have a monopoly supplier of notes that are not convertible nor backed nor otherwise supply limited--so (2), (3) and (4) do not apply--then you have hyperinflation, for the reasons explained nicely here (pdf) using the example of the German 1922-3 hyperinflation:

throughout the hyperinflation episode the Reichsbank’s president, Rudolf Havenstein, considered it his duty to supply the growing sums of money required to conduct real transactions at skyrocketing prices. Citing the real bills doctrine, he refused to believe that issuing money in favor of businessmen against genuine commercial bills could have an inflationary effect. He simply failed to understand that linking the money supply to a nominal variable that moves in step with prices is tantamount to creating an engine of inflation. That is, he succumbed to the fallacy of using one uncontrolled nominal variable (the money value of economic activity) to regulate another nominal variable (the money stock).

[Read the rest at Skepticlawyer or at Critical Thinking Applied.]

Imperialism, it is what rulerships do

I came across (via) this very silly statement:

The very idea of empire was created in ancient Rome ...

That would be news to the Persians, the Chaldeans, the Assyrians, the Babylonians, the Hittites, the Egyptians, the House of Ur, the Gutians, the Akkadians, the ... And that is just the Middle East.

When revenue was based on control of farmers and trade, then imperialism was what all rulerships did to the limits of territory they could control and which generated a positive return. It was about optimising expropriation, both intensively (pdf) and extensively.  What else would one have expected?  It is not possible to understand the history of farming-and-trade rulerships until one understands what a natural feature of rulership imperialism was.

Of course, creating a serious empire was not easy. You had to have the organisational and military power to seize and hold significant territory. So, what you could do, what those around you could do, what the geography was, all mattered. But, within those constraints, imperialism came naturally to farming-and-trade rulerships.

May the best predator win
As river-valley rulerships arose, there tended to be a fairly Darwinian "survival of the fittest" process of expansion and elimination until one rulership dominated a river valley. It was a bit like putting a whole lot of yabbies in a fish tank and leaving them; the stronger predators eat the weaker until you are left with one uber-yabbie or, in this case, uber-rulership. (The post-Roman British Isles displayed a not dissimilar pattern, until the English Crown ruled the lot.) The process could take a long time (from the start of the Kingdom of Wessex to the union of the British Isles under one monarch, about a thousand years, although English absorption of Wales and domination of Ireland predated the full unification by centuries).

As organisational capacities improved, this domination of a river valley could expand until you dominated several river valleys or, in the case of the Roman Empire, an entire sea, their Mare Nostrum("Our Sea"). Empires tended to be river-and-coasts-based because rivers and coasts were where the fertile land was and water transport was a lot cheaper and quicker than land transport--the rough estimate is that water transport was about 15 times cheaper than land transport, so travelling 100km by land was the equivalent of travelling about 1500km by water. Hence, rivers and coasts were where the farming and the trade that rulers expropriated to fund their rulerships were and where control could be maintained.

It is not surprising that the largest (and longest surviving) Empire of the above series was the one that was spectacularly good at road building. But it was still based on a sea.

The exceptions to this coast-and-rivers pattern were the horse-archer empires of Central Eurasia. But they were based on flat plains and lots of horses. Cavalry could easily go 40km in a day, so you could send a cavalry force 1000km in 25 days and couriers much quicker. They also had the Silk Road trade system to manage and exploit.

Problems of empire
All such empires ran into what modern economics calls principal-agent problems, the difficulty of maintaining stable internal control, and organisational advantage problems--those you interacted with learn from you. So, maintaining internal coherence and external effectiveness was a difficult balancing act.

Ibn Khaldun famously set out the pattern for the rise and fall of farming-and-trade rulerships. First, a group bound by common feeling seizes power. Then the ruler separates himself from the original group to entrench his own power. The regime slowly decays as group solidarity fades and corruption (the ruler's agents enriching themselves in ways that undermine the ruler's expropriation) erodes social resilience and regime power. Until the regime finally collapses.

Lest one think this a relic from the past, let's match the most recent Eurasian empire to rise and fall (the Soviet Empire) against the pattern: a group bound by common feeling seizes power (Lenin 1917-1924). The ruler separates himself from the original group to entrench his own power (Stalin 1924-1953). The regime slowly decays as group solidarity fades and corruption erodes social resilience and regime power (Khruschev to Chernenko 1953-1985). Until the regime finally collapses (Gorbachev1985-1991).



[Read the rest at Skepticlawyer or at Critical Thinking Applied.]

The slow adaptation of US wages to the fall in money income

This is based on a comment I made here.


George Selgin posted a challenge to market monetarist analysis which he has also attempted to answer and to which Scott Sumner has responded to particularly thoughtfully. Both the last two posts included this graph:

NGDP (US nominal GDP) fell in a heap, yet average hourly earnings kept growing, albeit at a slower rate. Both George Selgin and Scott Sumner have very sensible suggestions about possible reasons. Further factors which occur to me include that one consequences of persistent unemployment is that what might be called "competitive" supply narrows, as the insider-outsider gap grows, as Evan Soltas has pointed out nicely. That takes time to kick in, but it does mean the "natural rate" of unemployment increases just from having unemployment.

Secondly, the public sector is not so affected (i.e. it has a higher rate of earnings growth than the private sector).

Also, it is mainly hirings which change over the business cycle. While private sector earnings growth does seem to be tracking roughly CPI.  So, it seems employers are paying to keep the employees they have and they're not leaving so much.  Nominal wage stickiness is surely to a significant degree about preserving relationships with existing workers, so if those relationships are being "stretched out" that would slow down adjustment.

Finally, one way to adjust is to cut back hours worked, which would not show up in the average hourly earnings.

Why did the Canadian colonies not revolt in 1776?

This is based on a comment I made here.

One of the striking questions about the American Revolution is why the Canadian colonies did not join in the revolt against the British Crown, as they suffered as much "no taxation without representation" as did the colonies further South.

A plausible explanation is that they did not care about the implications of Somersett's Case, as slavery was not significant, their population was too low for serious land-hunger, so they did not care about the Royal Proclamation of 1763 protecting Amerindian land, and the division between British and French colonists gave the British Crown a useful role as mediator and protector.

By contrast, the colonies further South did have slaves in significant numbers, did want to grab Amerindian land and did not feel territorially threatened after the smashing British victory in North America in the Seven Years War. So their lack of say in British decisions mattered much more for them and they did not feel they needed British Imperial forces anymore. A judgement summed up brilliantly in the slogan "no taxation without representation"; code for, "we do not get a say in decisions which matter for us, so the Imperial deal does not work for us anymore".

The (slave) colonies, further South in the Caribbean, still felt territorially threatened, so the Imperial deal was still working for them, so they did not revolt.

This analysis also makes the American Civil War very much a continuation of the above. North and South were in dispute over expanding into Amerindian land and the South wanted to protect slavery. So, the American Union deal was no longer working for the South, so they seceded from the Union just as the original 13 colonies had seceded from the British Crown. When the South claimed it was just re-doing the American Revolution, they had a point.

But not as much of one as they liked to claim. After all, they had plenty of representation in the United States. The Southern Revolt was a re-run of the American Revolution, just without the bits that gave the American War of Independence far more resonance than a squabble over keeping slaves and stealing land. On the contrary, where the American Revolt had had the US Declaration of Independence, the writings of Thomas Paine, Patrick Henry's Give me liberty or give me death speech, it was the Northern cause which produced the Gettysburg Address and Lincoln's Second Inaugural Address, major contributions to the formulation of modern political democracy. 

There are some unlovely themes in American history, but that is far from all there is.

Uncertainty, bubbles and business cycles

This is based on a comments I made here and here.

I don't believe the "Greenspan caused the housing bubble" argument, as it depended where you were in the US whether there was a housing (land) bubble and the US economy was not seriously hitting capacity limits prior to the Fed-caused NGDP crash.  But that asset prices will tend to be strong if people have strong income expectations, that I believe.  (Why this is regarded as a bad thing is a bit of a mystery.)  That technological innovation causes asset-price volatility (pdf) makes perfect sense too.

If folk are so worried about housing (land) bubbles, perhaps they should look at the supply constraints that are clearly a necessary element. But too many folk want the supply constraints, because it keeps the price of their housing land up.

But we cannot abolish uncertainty (see above about technological innovation to start with), or that how people frame uncertainty (what Keynes called "animal spirits") will be unstable because it will be vulnerable to new information. What we can do is work on reducing supply-side constraints (Eurozone, I am looking at you also) and anchor people's income expectations so that uncertainty becoming negatively framed is less likely to occur across all markets--expectations being how we deal with lack of information (and there is no information from the future).

Of course, if one takes uncertainty seriously, the Austrian theory of the business cycle becomes much less plausible (but so does not thinking markets are stupid on the "fool me once, shame on you; fool me twice, shame on me; fool me again and again in the same way, I must be a real idiot" principle).

Also, surely the reason folk cannot find a definitive relationship between uncertainty and economic activity (beyond the effects of poor income expectations), is that uncertainty can be framed positively or negatively.  (Implicitly) assuming that uncertainty is always framed negatively seems an unwarranted assumption to me. For, if you do so, technological innovation is always bad, since it must raise uncertainty.  I prefer the view that technological innovation generates asset-price volatility, since it raises uncertainty.

If you frame uncertainty positively, you rate the risk of loss as being much less than the risk of gain.  The loss asymmetry (firms care more about avoiding losses than getting profits) lacks "bite".   If you frame uncertainty negatively, things are in reverse, and loss asymmetry has lots of "bite".

In a world without uncertainty, growth is at potential.  But there are also no profits.  We never live in a world without uncertainty. We do live in a world where uncertainty generates volatility because how it is framed shifts due to being vulnerable to new information (uncertainty being the area where information is insufficient to calculate risks). So, bubbles will happen, at least to some degree.